April 05, 2017 Top Story

Broad Exclusion Won’t Save Insurer Offering Illusory Coverage

Decision refuses to apply prior-knowledge exclusion for claims based on past wrongful acts

Stephen Carr

A federal circuit court of appeals decision recognized important limits on the ability of malpractice insurers to use prior-knowledge exclusions to shield themselves from covering many claims. The U.S Court of Appeals for the Fifth Circuit declined to enforce the plain language of an exclusion that would have barred coverage of almost any malpractice claim.

As written, the broad exclusion made the policyholder's retroactive coverage "illusory and facially absurd," the court's opinion found. The decision limited the ability of insurers to alter the terms of policy through contractual provisions. Yet the case also underscored the need for a law firm to contact insurance providers when indications of a potential claim arises.

According to John Mumford, Richmond, VA, cochair of the ABA Section of Litigation's Insurance Coverage Litigation Committee, "prior-knowledge coverage disputes are very fact intensive. The issue courts grapple with is whether there was some objective indication to the attorney or firm of a potential claim. This court essentially took the position that not every bad outcome in litigation rises to the level of notice of a potential claim, but that something more is required."

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