Running Bare
No, that’s not covered, and apparently it’s never been covered.
Imagine running a business where you’re responsible for transferring your client’s funds. Maybe you’re a lawyer, an accountant, a title company or some other profession where you have to coordinate the transfer of funds to finish the transactions. You would want a professional liability policy that covers this exposure. You purchase a policy designed for your industry. You should be covered now, right?
You would be wrong.
I’ve been writing lately about coverage gaps I’ve been finding in professional liability policies. Let me be clear; I think it’s perfectly fine and reasonable for carriers to clearly and unambiguously carve out and exclude certain exposures they don’t want to accept. My problem is when policyholders purchase policies from carriers who write coverage for their particular industry not realizing that the carrier has carved out major exposures the insured assumes are covered.
I’ve written here, here, and most recently here, about how carriers can have overly broad exclusions that unsavvy business owners (and sometimes their insurance agents!) fail to appreciate. To summarise, when an exclusion says if any claim should arise “...based upon or arising out of, directly or indirectly…” followed by the exposure, then if a claim touches that exposure you’ll most likely be left to handle the claim all by yourself.
Let’s talk about an industry that both:
Purchases Professional Liability policies
That policy will have an overly broad exclusion that carves out one of the main exposures
This exclusion has apparently been in the industry for a LONG TIME
Title Agents/Escrow Agents
If you’ve ever purchased or sold a home, then you’ve dealt with a title agent. It’s their job to coordinate as a neutral third party to facilitate real estate transactions. As you can imagine, title agents have a large exposure around the proper transfer of funds.
So a Professional Liability policy that had, say, a commingling of funds exclusion, or transfer of funds exclusion… that would carve out a lot of the coverage for which the title agent is depending upon. More than likely the title agents are expecting their professional liability policies to consider claims arising from ALL of their professional services, including the proper transfer of funds.
What percentage of title agents who have a Professional Liability policy do you think is aware that their policy more than likely has this exclusion baked in?
Carriers Haven’t Been Covering Funds Transfers Mistakes For a While, Apparently
I recently had a title agent E&O submission which prompted me to scour the marketplace looking for good coverage. I couldn’t believe that everyone seems to carve out any exposure related to the insured’s potential for error in transferring their client’s funds.
When I bring this up to my underwriters, I’m usually told, “Lucas, that’s a crime exposure. We’re not trying to have our policy double up as an E&O policy and a crime policy.”
On the surface this makes sense. Title companies, anyone with large cash exposures or access to clients funds needs to have robust crime coverage.
But crime coverages are for when the insured falls victim to a crime. What if the funds transfer was a mistake, and not a crime?
Nope, still no coverage under the E&O policy.
And not only is this carved out in most title agent E&O policies today, it’s BEEN carved out for a while, and courts have been affirming those claim denials.
Consider Northland Insurance Company vs. Cailu Title Corporation (2003). Cailu was a Michigan title company who carried an E&O policy with Northland with coverage for “professional services as a title agent, abstracter, escrow agent and notary public.”
Like any E&O policy, this one contained a cadre of exclusions, and notably for our interests it contained this exclusion:
Handling of Funds
Any damages arising out of the commingling, conversion, misappropriation or defalcation of funds or other property.
Trouble began when a title insurance underwriter saw Cailu’s checks start to bounce. While the issues were eventually fixed, the underwriter decided to investigate and discovered that Cailu’s escrow account was short $300,000. The underwriter filed suit against Cailu, alleging breach of contract, embezzlement and defalcation, conversion, and commingling of funds.
The court does a good job of laying the groundwork for reviewing the claim denial. If a policy clearly and unambiguously excludes a particular coverage, then coverage is rightfully denied.
“Yet if a contract, however inartfully worded or clumsily arranged, fairly admits of but one interpretation it may not be said to be ambiguous or, indeed, fatally unclear.”
What’s interesting here is how the title underwriter amended their complaint to include allegations of negligence in an attempt to trigger coverage under the professional liability policy. They retracted their original statement that fraud occurred since the policy excludes fraud and other criminal acts. By narrowing the complaint to negligence, they were hoping to trigger the policy for coverage.
Did their clever lawyering help to trigger the policy?
“The district court below held that any damages sustained as a result of the breach of contract, conversion, commingling, defalcation, embezzlement, or breach of fiduciary duty fell within the exclusions of the policy regardless of whether the conduct was negligent or intentional. We agree with this finding.”
The court further clarified that even if the claims of commingling, embezzlement, or any type of malintent Cailu used on the handling of their client’s funds was true, it didn’t matter.
“Even if true, claims for defalcation, conversion, and commingling are excluded by the “Handling of Funds” exclusion. Consequently, regardless of whether a jury concluded that commingling, conversion or defalcation occurred, they are expressly excluded by the policy.”
“However, even if the insured acted without knowledge of the dishonest, fraudulent, criminal or malicious nature of the act or omission, the damages, regardless of mens rea, would still be excluded from coverage if those damages resulted from one of the other listed exclusions. Here, even if the insured acted with no criminal intent, but the conduct at issue constituted commingling, conversion, misappropriation or defalcation of funds, coverage would be barred by the “Handling of Funds” exclusion.”
Northland won this case and was completely off the hook for Cailu’s negligence.
One thing the court did NOT address, and I wish it had; what did this policy actually cover? “Handling of funds”...that’s the core service that a title company provides. It’s certainly their biggest exposure. How can you write the professional liability for a company and carve out the main area from which the claims will arise?
But hey, I guess that sucks for title companies!
Not so fast. This exclusion hits other classes of business as well, in ways that not even I could have predicted.
But We Don’t Transfer Funds!
Next we have a Pre-Employment Background Screening company. They run background checks on prospective employees their clients are looking to hire.
This particular company, Human Resource Advantage (HRA), conducted a background check on an employee for their client. Long story short; this employee used a fraudulent social security number, which was how HRA missed the prior acts of embezzlement, grand theft and forgery committed by said employee. This criminal employee ended up embezzling more than $1,000,000 while employed by the client. The client sued HRA for damages ($3.77M in total damages was awarded btw) for failing to properly vet this employee. HRA tendered the claim to their E&O carrier expecting coverage.
You can imagine how surprised they were when their carrier denied the claim for, you guessed it, the “Handling of Funds” exclusion.
Now this case is really interesting because the court fleshes out several reasons for why this exclusion should prevail. HRA offered to the court some reasons for why the exclusion should not be applied, 3 of which we’ll analyze here:
[The exclusion] is subject to at least two reasonable interpretations and is therefore ambiguous.
HRA asserts the carrier failed to alert HRA to the broad reading of [the exclusion]
HRA maintains the underlying claim does not arise from a misappropriation of funds, but instead an alleged “fail[ure] to conduct a proper pre-employment background screening;” a claim it argues falls outside the scope of [the exclusion].
For #1, the court did not find that the insured made a reasonable argument that the exclusion was ambiguous. See the exclusion here for yourself:
“Arising out of or resulting, directly or indirectly, from any actual or alleged commingling, misappropriation or improper use of funds or monies.”
Not very ambiguous, is it?
On to #2, did the carrier have an obligation to inform the insured as to how broad the exclusion was? Here’s what the court said:
“Because the court finds [the exclusion] to be unambiguous, the court need not consider the expectations of the insured.
Relatedly, because the court finds [the exclusion] is conspicuous, plain and clear as explained above, [the carrier] was under no legal obligation to alert HRA to the broad applicability of [the exclusion]”
Take it straight from the District Court of Eastern California. If the policy wording is clear and unambiguous, then the carrier is under NO obligation to explain the broadness of the exclusions to the policyholder.
And this isn’t unique to California, a state who tends to be more prone to consumer protection. This is a pretty universal reading of absolute exclusion wording across the country with very few exceptions.
Now to #3, did HRA’s argument that the claim was itself an E&O claim and not a funds transfer claim have any sway? Again we’ll cite the court:
“As with the broad reading of “any claim” explained above, “California courts have consistently given a broad interpretation to the terms ‘arising out of’ or ‘arising from’ in various kinds of insurance provisions.”
Moreover, the phrase “arising out of” does not imply any specific causality requirement.
Thus, the misappropriation of funds is at least incidentally connected to the underlying claim, and coverage for that claim is therefore within the scope of [the exclusion].
“Arising out of” does not imply any specific causality. It doesn’t have too. It simply needs to be a part of the claim. That’s crazy, but again not unique to California.
What’s Our Takeaways?
How should we react to the broadness of the absolute exclusions? There’s a couple of worthwhile items that come to mind:
First, if you have a professional liability policy, read the exclusions section. If you come across absolute exclusion wording, “Based upon or arising out of, directly or indirectly from…” then know that whatever follows that wording, if you have a claim that touches that exposure, there’s no coverage.
Push back. If you find these exclusions, ask your agent or your carrier to carve that coverage back. If they refuse, push to find someone who will. If you care about these exposures, and you’re willing to pay for good, quality coverage, then go find someone who can properly transfer your risk to themselves.
Are you or someone you know a professional that has a large funds transfer exposure, like a trustee, title agent, escrow agent, lawyer, accountant, or any of the above? Share this article with them and let them know the dangers potentially lurking in their policy.
Even if they don’t have a large funds transfer exposure, this exclusion can still bite back in the worst way as we saw with the HRA case. Use your imagination when you read absolute exclusions and seriously consider the worst case scenarios.
If you have questions about your E&O policy, feel free to reach out! I’m happy to offer my 2 cents.
Absolute exclusions carve out the exposures absolutely. Let the buyer beware, and let the carriers reconsider excluding these important coverages.
Disclaimer: This analysis is provided for educational purposes only. The policy language examples and case law referenced are drawn from publicly available court filings, legal precedent, and published decisions. This article does not constitute legal advice. Readers should not rely on this analysis as a definitive statement of applicable law in their jurisdiction or as coverage guidance specific to their policies. For coverage questions specific to your policy, consult qualified coverage counsel. All court documents cited (Northland Insurance Company v. Cailu Title Corporation, Human Resource Advantage LLC v. The Hanover Insurance Company) are matters of public record and are cited for educational and analytical purposes only.