Changed Theory of Damages Not a New “Claim”

Claims Made Policy only Responds to Claims Made During Policy Period

During the damages phase of an ten year old lawsuit plaintiffs in the case argued that the bank owed certain damages not alleged in the original suit. The defendant called upon its claims made policy insurer, Federal Insurance, to defend against the argument and to cover the bank’s corresponding losses. Federal Insurance refused, explaining in part that the damages argument was not a “claim” under the policy.

In Market Street Bancshares, Inc., parent organization of Peoples National Bank, N.A., a/k/a Peoples National Bank of McLeansboro v. Federal Insurance Co., d/b/a Chubb Group of Insurance Companies, No. 18-3395, United States Court of Appeals For the Seventh Circuit (June 19, 2020) was asked to reverse a trial court decision in favor of the insurer.

BACKGROUND

In 2014, in exchange for an insurance premium, the insurer, Federal Insurance Company, agreed to defend and indemnify the bank, Peoples National Bank, against “claims” made by third parties during the policy period, which ran from April 15, 2014, to April 15, 2017. When they entered this agreement, the bank had been embroiled in an ongoing lawsuit for about a decade.

Peoples National Bank became entrenched in litigation after a business deal collapsed, triggering obligations that the bank failed to fulfill. The business deal had to do with a corporation that Terry and Robert Newman formed in 1996 to operate various Taco John’s restaurant franchises.

In 2001, the Newmans agreed to sell their corporation to Amigos Food Service, LLC. The sale involved various agreements by the Newmans, Amigos, and Peoples. One agreement provided that Amigos would secure a $150,000 letter of credit naming the Newmans and Peoples as beneficiaries. Another agreement—between the Newmans and Peoples—provided that $81,000 of the letter-of-credit proceeds would be retained to assure rent payments on the property in Anna, Illinois.

Ultimately, Amigos defaulted on its obligations. Rent on the Anna property went unpaid. And the landlords demanded the unpaid rent from the Newmans, who turned to Peoples for the $81,000 letter-of-credit proceeds set aside for this purpose. But the money wasn’t available. Peoples had allocated it to satisfy other debts Amigos had accumulated. As a result, the Newmans failed to pay the overdue rent, the landlords sued the Newmans for it in Illinois state court, and the Newmans filed a third-party complaint against Peoples in 2003.

About nine years passed before the Illinois trial court entered judgment on the Newmans’ contract claim; the court determined that Peoples was liable for breaching its agreement concerning the letter-of-credit proceeds. About two years after that, in 2015, the court granted summary judgment to the Newmans on their other two counts.

Between those judgments, in 2014, Peoples entered an agreement with Federal Insurance for professional liability insurance. The agreement was for a claims-made policy under which Federal Insurance would defend and indemnify Peoples against “Loss on account of any Claim first made against [Peoples] during the Policy Period.” The policy period spanned three years, April 15, 2014, to April 15, 2017.

In 2016, the Newmans’ case went to a bench trial on damages for the conversion and breach-of-fiduciary-duty counts. The Newmans argued for and presented evidence of damages based on the so-called “Pledge Agreement”—one of the agreements entered in connection with the Newmans’ sale of the corporation. Basically, the Newmans argued that the bank was required, under the Pledge Agreement, to timely notify the Newmans of Amigos’s default and that the bank’s failure to do so caused certain damages. The Newmans later submitted a written closing argument for the Pledge Agreement damages, and the trial court awarded those damages alongside others.

While that damages issue was pending, Peoples gave Federal Insurance information about the Newmans’ lawsuit and contended that the Newmans’ damages argument based on the Pledge Agreement was a “claim” made during the policy period, triggering Federal Insurance’s duty to defend and indemnify Peoples against it. Federal Insurance explained that the damages argument was not a “claim” under the policy; and even if it were, it fell outside the covered period, because it would have been considered “first made” when the Newmans commenced the lawsuit in 2003, well outside the policy period.

The bank maintained that the Newmans’ damages assertion based on the Pledge Agreement is a “claim,” under the insurance policy, that gave rise to Federal Insurance’s duty to defend and indemnify.

ANALYSIS

The insurance policy provided that Federal Insurance had a “duty to defend any Claim covered by” the policy and must pay Peoples for “loss,” including “defense costs,” on account of a covered “claim.” Illinois law recognizes that the insurer’s duty to defend arises when the facts alleged in the underlying complaint fall within, or potentially within, the policy’s coverage provisions.

The issue to be resolved by the Seventh Circuit was whether the Newmans’ damages assertion—advanced about thirteen years into the lawsuit—potentially bring it within the policy’s coverage. If a provision is susceptible to only one reasonable reading, no ambiguity exists, and the policy must be applied as written.

The type of insurance purchased here is a claims-made, professional-liability policy. In a claims-made policy like this one, the pertinent risk is that an injured third party will assert a claim against the insured during the policy period. This contrasts with the risk involved in an occurrence policy—the risk that an injurious act or omission will occur during the policy period.

The difference between these risks highlights the purpose of a claims-made policy which is to allow the insurance company to easily identify its risk, which in turn may offer insureds more-available and less-expensive policies. Because the claims made policy protects against the risk of an injured party bringing a claim against the insured during the covered period, the insurer’s risk exposure is clearer; claims brought outside the policy period are not covered.

Peoples does not contest that the Newmans’ 2003 complaint, which commenced the underlying lawsuit, initiated a “claim” under the policy’s definition nor can Peoples contest that the Newmans’ closing argument in the damages phase of that lawsuit was part of the civil action begun in 2003. Under the policy, a “claim” taking the form of “a civil proceeding commenced by the service of a complaint” spans the entire civil action, not just the legal theories and factual allegations in the complaint that commenced the action. Because the Newmans’ damages argument was part of the civil action begun by the 2003 complaint, the damages argument is not itself a “claim.” Based on the plain meaning of the policy’s terms, read in context and in light of the policy’s purpose and the ordinary meaning of “a civil proceeding” the whole civil action brought by the third party against the insured.

The question is not where the causes of action in a lawsuit begin and end; it is whether the damages argument is a “claim” under the insurance policy. Put differently, the policy’s terms—rather than the plaintiffs’ causes of action—dictate the scope of a “claim.”

The purpose underlying the claims-made policy likewise indicates that each type of “claim” excludes the others. Just as giving “proceeding” a narrow meaning would muddy the insurer’s risk exposure, so too would the scenario of overlapping claims. If an argument in the damages phase of a lawsuit could be both part of a “claim” begun by a complaint and itself a “claim,” the insurer’s risk exposure would be significantly more difficult to calculate.

ZALMA OPINION

The plaintiff bank, that saved money by purchasing a claims made policy rather than an “occurrence” policy (which would have excluded the Newman’s suit if disclosed) to cover an old suit because the plaintiffs alleged a different kind of damages on the old law suit. It was a creative claim but the Seventh Circuit realized that accepting the argument would totally change the purpose and meaning of a claims made policy. Creative but not convincing, Federal did not owe defense or indemnity.


© 2020 – Barry Zalma

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 52 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

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