Colliers Lanard & Axilbund v. Lloyds of London Hallmark Insurance Co., Inc. Certain Underwriters of Lloyds of London, (Pursuant to Rule 12(a), f.r.a.p.)
Docket: 05-3497
Court: Court of Appeals for the Third Circuit; August 11, 2006; Federal Appellate Court
Lloyds of London issued a "claims made" professional liability insurance policy to Colliers, Lanard, Axilbund (CL A), a real estate brokerage, which included retroactive coverage contingent upon the insured not having knowledge of any potential claims at the time of application. CL A filed a breach of contract suit after Lloyds denied coverage for a claim stemming from a mistake made prior to the policy's acquisition. Following a bench trial, the District Court ruled in favor of CL A, determining that the policy did not exclude the claim in question.
On appeal, the Third Circuit addressed the interpretation of the policy exclusion under New Jersey law. The court established that the policy's exclusion required a subjective assessment for whether the insured had knowledge of an act, error, or omission, and an objective assessment for whether such actions could reasonably lead to a claim. The court criticized the District Court for improperly applying an objective test to the first inquiry and a subjective test to the second, leading to an erroneous conclusion regarding policy exclusion. Consequently, the appellate court vacated the District Court's judgment and remanded the case for further proceedings.
The facts revealed that CL A, acting as a leasing broker for West Jersey Medical and Professional Plaza, made significant errors in lease agreements prepared by a salesman, Jason Wolf. These errors, which went unnoticed by both CL A’s General Counsel and West Jersey’s managing member, involved incorrect operating expense terms, which could potentially lead to claims against CL A.
Shapiro became aware of errors in tenant leases before July 2000 and discussed them with Wolf, who acknowledged the mistakes. On July 14, 2000, Wolf sent letters to the tenants, indicating a 'mutual mistake' and suggesting remedies. However, on July 24 and August 25, 2000, tenants Dr. Schaffer and Dr. Franciscan rejected this notion and Wolf's proposals, with Schaffer advising that further discussions should involve their attorney. It was stipulated at trial that CL A's in-house counsel, Mr. Gordon, was fully aware of the letters and responses.
On August 29, 2000, Gordon signed a liability insurance application with Lloyds, effective November 4, 2000, with a retroactive date of November 4, 1992. The policy covered claims arising after the retroactive date, provided the insured had no prior knowledge of potential claims.
On January 10, 2001, West Jersey's counsel notified CL A of intent to seek legal relief related to the leases, and CL A was served with a complaint on January 24, 2001. Gordon informed CL A's insurance broker about the lawsuit. On February 14, 2001, Lloyds denied coverage, stating CL A was aware of circumstances likely to result in a claim when signing the application.
CL A responded to the complaint and filed a counterclaim for lost commissions, ultimately settling with West Jersey, which suffered an estimated loss of $214,528. CL A took on $135,290.80 of that liability and incurred $112,062.09 in attorney fees.
On December 30, 2002, CL A sued Lloyds in the District Court to recover its costs from the West Jersey litigation. During a bench trial on April 18, 2005, Gordon testified that disputes typically settle and considered the tenants' letters as invitations to negotiate. He claimed he did not foresee CL A being drawn into litigation.
The District Court, referencing Liebling v. Garden State Indemnity, analyzed whether Gordon had knowledge of any act that could lead to a lawsuit—an objective question—and whether he reasonably expected such a claim, a subjective inquiry into his belief. The court concluded that the policy exclusion did not apply, as evidence suggested Gordon honestly believed a legal claim was unlikely.
The District Court determined that Lloyds' denial of coverage constituted a breach of contract. It found CL A's settlement with West Jersey to be reasonable and made in good faith, and acknowledged Lloyds' acceptance of CL A's attorneys' fees. On June 8, 2005, the court ordered Lloyds to pay CL A $247,352.89, which included the liability assumed for West Jersey's loss and attorneys' fees, minus deductibles. Lloyds subsequently appealed.
In appeals following a bench trial, legal conclusions are reviewed de novo, while factual findings are upheld unless clearly erroneous. The construction of an unambiguous contract is also subject to de novo review. In diversity cases without a state supreme court ruling on a pertinent issue, federal courts predict the likely state court outcome by considering relevant state court decisions, federal interpretations of state law, and rulings from other jurisdictions.
New Jersey insurance law principles apply to this case. Courts interpret insurance policy language according to its plain meaning; clear policies are enforced as written, while ambiguous ones favor the insured. Policy exclusions are narrowly interpreted, with the insurer bearing the burden to prove the applicability of exclusions, which must be specific, clear, and not against public policy to be valid. Furthermore, New Jersey courts aim to align interpretations of insurance contracts with the reasonable expectations of the insured, particularly in cases of ambiguity.
The New Jersey doctrine permits the reasonable expectations of the insured to take precedence over the literal meaning of an insurance policy in exceptional circumstances. However, this has been infrequently utilized by the New Jersey Supreme Court. In Sparks v. St. Paul Insurance Co., the court ruled that a policy exclusion conflicting with objectively reasonable expectations and public policy could be interpreted differently than its explicit terms. It is predicted that the New Jersey Supreme Court would uphold a clear policy exclusion according to its plain language unless it contravenes both public policy and the reasonable expectations of the insured. The court clarified that exceptional circumstances for such reinterpretation arise only when strict adherence to the exclusion would violate public policy.
In this case, the policy exclusion is deemed clear and unambiguous, requiring a subjective test for the insured's actual knowledge of relevant issues and an objective test regarding whether a reasonable professional would foresee a claim. The first part of the exclusion is satisfied by the insured's knowledge, while the second part relies on a reasonable expectation standard. This conclusion aligns with the ruling in Selko v. Home Insurance Company, which established a two-step inquiry based on policy language. Unlike Selko, the current exclusion’s structure inherently encompasses this two-part analysis without needing inferential reasoning.
The New Jersey Superior Court's decision in Liebling, which the District Court referenced, did not dispute the interpretation of policy exclusions established in Selko. The Liebling court confirmed that the exclusion language in question, which denies coverage for claims known or foreseeable at the contract's inception, aligns with Selko's objective standard for coverage denial. However, the Liebling court rejected Selko's mixed test for determining coverage, arguing it did not align with the reasonable expectations of attorneys seeking malpractice insurance. Instead, it embraced the New Jersey doctrine permitting the modification of unambiguous contract language to meet the reasonable expectations of the insured, as highlighted in the Estate of Logan case.
The Liebling court clarified that even unambiguous insurance contracts may be interpreted contrary to their plain meaning to fulfill insured parties' reasonable expectations. It concluded that the exclusion should be interpreted to deny coverage only if the insured knew of a deviation from professional standards and could foresee a likely malpractice claim based on known circumstances. Ultimately, the Liebling court's reasoning hinged on altering the exclusion's plain meaning to align with insured expectations, prompting a review of whether applying the exclusion as written would contravene public policy and the objectively reasonable expectations of the insured in the current case.
Sparks and Zuckerman v. National Union Fire Insurance Co. address public policy implications of exclusions in 'claims made' insurance policies. In Zuckerman, the New Jersey Supreme Court upheld an attorney malpractice policy providing 'unlimited retroactive coverage,' excluding only claims the insured knew or could reasonably foresee. The court justified this exclusion as reasonable to protect insurers from professionals who might purchase coverage after recognizing past errors, labeling this concern as 'moral hazard.' It concluded that the coverage offered was consistent with typical 'claims made' policies and did not violate public policy.
Conversely, in Sparks, a different exclusion in a 'claims made' medical malpractice policy was found to violate public policy. The court noted that this policy provided no retroactive coverage for incidents occurring prior to its effective date during the first year, offering minimal protection. The court highlighted the reality that malpractice errors are often discovered long after they occur, making timely reporting to the insurer within a year unlikely. It emphasized courts' responsibility to prevent the sale of policies that offer inadequate coverage due to their nature as contracts of adhesion. Ultimately, the Sparks court ruled that enforcing such narrow coverage would harm the public and violate public policy.
The combined findings of Zuckerman and Sparks indicate that while exclusions aimed at mitigating moral hazard can be reasonable, they must ensure adequate retroactive coverage and not serve as a complete barrier to it.
Applying a mixed subjective-objective standard to an exclusion in a 'claims made' professional liability policy does not violate New Jersey public policy. The reasoning from Selko, although based on Pennsylvania law, is applicable here: using an objective standard in the second part of the inquiry is justified, as it prevents coverage denials based on undisclosed misconduct by an insured attorney. An objective standard avoids rewarding ignorance and discourages dishonest post hoc rationalizations, which could lead to unpredictable outcomes. Concerns about 'moral hazards' are also relevant; a professional aware of an error might seek insurance but could disingenuously claim ignorance of potential claims. An objective test mitigates this risk. Thus, it is anticipated that the New Jersey Supreme Court would affirm that such a mixed standard aligns with public policy. Furthermore, it is predicted that extraordinary circumstances allowing for the insured's reasonable expectations to override the exclusion's plain language do not apply in this case, and that the mixed standard does not contravene the insured's reasonable expectations.
The New Jersey Supreme Court in Sparks determined that excluding certain claims violated public policy and the reasonable expectations of medical professionals by effectively barring retroactive claims. The ruling emphasized that medical professionals should have the option of either prospective coverage from 'occurrence' policies or retroactive coverage from 'claims made' policies, but not a policy offering neither. However, the current case involves a Lloyd's policy that generally provides retroactive coverage, rendering the Sparks reasoning inapplicable.
The New Jersey Superior Court in Liebling asserted that the mixed subjective-objective test established in Selko did not align with the reasonable expectations of the insured, although its decisions are not binding. The Liebling court based its analysis on the Wisconsin case Logan, rather than New Jersey precedents. In Logan, the attorney malpractice policy allowed retroactive coverage if the insured had no reason to believe they had breached a duty before the policy took effect. The insurer's argument for an objective standard was rejected by the Logan court, which found it inconsistent with the policy’s purpose and the insured's reasonable understanding.
The Logan court illustrated that applying an objective standard could deny retroactive coverage even if the insured was unaware of their breach, leading to illusory protection. It highlighted the inadequacy of solely focusing on whether the professional was subjectively aware of the error without considering the likelihood of a resulting claim. Thus, the Logan case contributes to understanding coverage expectations in professional liability insurance, particularly regarding the interplay between subjective awareness and the potential for claims.
Concerns raised by the Logan court regarding hypothetical scenarios do not apply when a professional is aware of their own error, with the only question being the potential for a claim. The Liebling court misapplied this distinction, ruling that coverage could only be denied if the insured recognized a deviation from professional standards and anticipated a claim based on known circumstances. However, once a professional acknowledges their error, the issues highlighted in Logan are irrelevant, as the moral hazard identified in Zuckerman becomes relevant—indicating a professional may seek additional insurance upon awareness of an error, regardless of the likelihood of a claim. The Liebling court's extension of Logan's reasoning overlooked the valid purposes served by exclusions in “claims made” policies, as clarified by Zuckerman. Therefore, it is predicted that the New Jersey Supreme Court would conclude that the mixed subjective-objective test in this case does not contravene New Jersey public policy or reasonable expectations of the insured. The court would likely affirm the application of the policy exclusion according to its clear language, which means the District Court mistakenly applied an objective test to the first inquiry and a subjective test to the second. Consequently, the judgment of the District Court will be vacated and the case remanded for further proceedings.
A "claims made" policy allows for retroactive coverage for liabilities from events before the policy's start date, provided the claim is made during the policy period. The District Court had diversity jurisdiction under 28 U.S.C. § 1332, and the appellate court has jurisdiction over the District Court's final judgment under 28 U.S.C. § 1291. CL A's counterclaim against West Jersey was based on West Jersey's responsibility for a mistake in the lease, which led to lost commissions. West Jersey acknowledged a debt of $247,398.00 in lost commissions, paying $112,107.20 to CL A in settlement.
The District Court referenced First American Title Ins. Co. v. Lawson for interpreting a policy exclusion, but this case dealt with an insurer's claim of equitable fraud related to misrepresentations in an insurance application, which is not directly applicable to the current appeal. Lloyds raised issues on appeal regarding whether a claim was made to CL A before the policy's effective date and whether CL A met its burden of proof on damages. The appellate court found that the District Court erred in its interpretation of the policy exclusion but rejected Lloyds' additional arguments.
Although the Selko case, decided under Pennsylvania law, was considered relevant, the Liebling court did not engage with Sparks or Zuckerman. The inquiry about the insured's reasonable expectations of coverage was not part of the current case. The District Court's assessment of Gordon's subjective belief about a potential claim against CL A was significantly influenced by Gordon's self-serving testimony, which the appellate court found questionable. Additionally, Wolf appeared to seek a legal theory, "mutual mistake," to partially shift responsibility for CL A's errors to the tenants. The New Jersey Supreme Court's denial of certification in Liebling is noted but deemed irrelevant to the current legal conclusions, as Liebling already established that insurers must demonstrate the insured's subjective belief about the likelihood of a claim, which was affirmed by the court.
The Liebling court determined that the insured was entitled to rescind the entire insurance policy due to equitable fraud, stemming from a knowingly false response to an application question regarding awareness of potential claims. The court concluded that a reversal on this legal point would not have changed the outcome of the Liebling case, rendering the New Jersey Supreme Court's decision not to review the Superior Court's ruling insignificant.
In the Zuckerman case, the policy excluded claims based on past conduct that the insured was aware of or could have reasonably foreseen might result in a claim. Although the Zuckerman court did not expressly address the exclusion's reasonableness, it indicated an objective test by stating that exclusions applied to claims the insured could have reasonably foreseen. This rationale suggests that the Zuckerman court implicitly endorsed an objective standard.
The current court expressed skepticism about whether a triable issue exists, particularly considering a reasonable professional in Gordon's situation would likely have anticipated a claim against CL. A due to knowledge of a drafting error and the tenants’ dismissal of CL. A's "mutual mistake" argument. The court decided to defer to the District Court regarding whether to grant judgment as a matter of law for Lloyds or to conduct a new trial under the appropriate standard.
