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E&O Policy Exclusion Bars Coverage for Negligence Claim Against Law Firm Arising from Third Party’s Misappropriation of Client’s Funds
Posted in E&O Policies

On May 10, 2023, Judge Komitee of the EDNY issued a decision in Huang & Assocs., P.C. v. Hanover Ins. Co., Case No. 21-CV-4909(EK)(RER), holding that a law firm (Huang & Associates) was not entitled to coverage under its professional malpractice policy, for a negligence claim brought by a client whose funds were misappropriated by a third-party in a “real-estate transaction that went badly.”

The firm’s policy had an exclusion for any claim “[b]ased upon or arising out of, or relating directly or indirectly to . . . [a]ny actual or alleged conversion, commingling, defalcation, misappropriation, intentional or illegal use of funds, monies or property.”  In Mount Vernon Fire Ins. Co. v. Creative Housing Ltd., 88 N.Y.2d 347, 350 (1996), the Court of Appeals held that the term “arising out of” or “based on,” as used in the policy exclusion, require only but-for causation.  In that case, “a landlord covered by a general liability policy was sued by a victim of a criminal assault that occurred in the landlord’s building.  The victim alleged ‘negligent supervision, management and control of the premises.’”  The Court concluded that an exclusion for claims “based on Assault and Battery” applied to the negligence claim against the landlord because “no cause of action would exist ‘but for’ the assault.”

Judge Komitee held that the same result was required in this case.  The Court declined to follow one intermediate appellate court decision, which held that Mount Vernon was limited to CGL policies and did not apply to E&O policies that are “expressly intended to provide coverage for negligent acts, including negligence in the hiring or supervision of employees.”  Watkins Glen Cent. Sch. Dist. v. National Union Fire Ins. Co. of Pittsburgh, Pa., 286 A.D.2d 48 (2d Dep’t 2001).  Judge Komitee found this reasoning unpersuasive and concluded that the Court of Appeals would reject it, observing that the Second Department “did not even quote the language of the policy exclusion, much less wrestle with it in detail.”  Further, “Watkins Glen did not explain its conclusion that to apply the exclusion would ‘completely undermine the purpose’ of E&O coverage,” and, in fact, “[t]here are many scenarios in which E&O and malpractice insurance policies would provide coverage notwithstanding the application of the Mount Vernon rule.”     

In a decision discussed on this blog, the Appellate Division, First Department recently applied Mount Vernon to a policy exclusion for claims “arising out of” sexual misconduct, holding that coverage was excluded for a non-profit organization that was sued for negligent supervision by alleged victims of sexual abuse (“The underlying complaint’s negligent supervision claim necessarily arises out of sexual misconduct.”).

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