Florida Court Holds Prior Knowledge Exclusion Precludes Coverage for Malpractice Suit

In its recent decision in Farbstein v. Westport Ins. Corp., 2017 U.S. Dist. LEXIS 125990 (S.D. Fla. Aug. 9, 2017), the United States District Court for the District of Florida had occasion to consider the application of a prior knowledge exclusion in a lawyers professional liability policy.

At issue in Farbstein was Westport’s coverage obligations arising from its insured’s work associated with a real estate transaction.  The malpractice suit alleged that the insured learned just weeks prior to the deal’s closing that he had failed to negotiate a key term that had been requested by his client concerning responsibility for a pre-payment penalty clause in the mortgage existing on the property.  The insured acknowledged the mistake to his client, and admitted that there would be financial implications to the mistake, but nevertheless counseled his client to move forward with the transaction because the consequences of voiding the deal altogether could prove costlier than merely paying the penalty.  While discussing the consequences of the error with his client, the insured allegedly made reference to his professional liability policy.  On the insured’s advice, the deal closed and the client ultimately paid nearly a half million dollars extra in penalties as a result of the insured’s mistake.

Nearly one month after the closing of the deal, the insured’s professional liability policy expired, and the insured subsequently purchased a renewal claims made and reported policy from Westport. The i policy contained an exclusion applicable to any wrongful act committed prior to the policy’s inception date if the named insured “knew or could have reasonably foreseen that such WRONGFUL ACT might be expected to be the basis of a CLAIM.”  At issue in the ensuing coverage litigation was whether the insured reasonably could have expected a claim as of the inception date of the renewal policy.

In considering this question, the court acknowledged that while the duty to defend analysis is typically limited to the four corners of a complaint, extrinsic evidence sometimes can be considered for the purpose of resolving prior knowledge defenses, particularly when “the underlying complaint does not contain the facts relevant to whether the insured knew of the alleged wrongful acts prior to the inception of the policy.”  The court nevertheless observed that the malpractice suit contained specific allegations concerning the insured’s alleged conduct sufficiently demonstrating an act, error or omission committed prior to the policy’s inception, and that as such, it was not necessary to consider extrinsic facts to determine whether the insured had, in fact, committed a wrongful act.

Turning to the issue of the insured’s state of knowledge as of the inception date of the policy, the court observed that the prior knowledge exclusion in the Westport policy could apply based on one of two alternatives: either a subjective determination that the insured believed that a claim would be made or an objective determination that the insured reasonably should have expected a claim to be made.  The court noted that the complaint alleged that the insured had conversation he had with his client – well in advance of the policy’s inception – in which he admitted his mistake to his client and discussed the consequences of this error, which discussion included references to the attorney’s professional liability insurance.  These alleged facts, explained the court, sufficed to demonstrate a subjective knowledge on the insured’s part that a claim might be made during the policy period.  The court therefore concluded that the exclusion applied to preclude a defense and indemnity obligation.