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Application Exclusion Broadly Eliminated Coverage for All Claims "Arising From" the Same Ponzi Scheme
Application Exclusion Broadly Eliminated Coverage for All Claims "Arising From" the Same Ponzi Scheme
By Elizabeth L. Musser, Esq. of Tressler LLP
In its professional liability insurance application, a securities broker-dealer disclosed one claim by an investor who lost money in a real estate investment Ponzi scheme, but failed to disclose other potential claims. The California Appellate Court concluded that claims "arising from" the same Ponzi scheme were all excluded from coverage, despite the fact that the claims involved different investment properties and different investment advisors.
Crown Capital Sec., L.P. v. Endurance Am. Specialty Ins. Co., 235 Cal. App. 4th 1122 (Apr. 10, 2015).
On April 20, 2010, securities firm Crown Capital Securities, L.P. (Crown Capital) executed an application for professional liability insurance for its broker-dealers and investment advisors from Endurance American Specialty Insurance Company (Endurance). In response to standard inquiries about known claims – including facts, circumstances, acts, errors and omissions that might lead to a claim – Crown Capital disclosed a loss run report from a prior carrier that identified an October 26, 2009, claim submitted by investor George Bou-Sliman. Bou-Sliman asserted that Crown Capital owed him for the loss of investment capital in real estate investments operated by DBSI, Inc.
DBSI filed for bankruptcy on November 10, 2008. On October 19, 2009, DBSI’s bankruptcy examiner filed his final report, concluding that DBSI engaged in various wrongdoing with respect to its investment products, including excessive insider distributions, pooling and commingling investor funds, and using new investor money to pay existing debt obligations. Investor Bou-Sliman sent the examiner’s report to Crown Capital on October 26, 2009, stating that in his view, the examiner confirmed that DBSI engaged in "an eight year long [P]onzi scheme to defraud and misappropriate funds from investors," and that as a result, Crown Capital is liable for Bou-Sliman’s investment losses.
Although Crown Capital disclosed Bou-Sliman’s claim in its Endurance insurance application, it did not disclose that there might be other claims, or facts or circumstances leading to other claims. Endurance issued a professional liability insurance policy to Bou-Sliman for the period April 1, 2010, to April 1, 2011. The Endurance policy contained an "Application Exclusion" specifically excluding from coverage any claim or lawsuit "arising from any fact, circumstance, act, error or omission disclosed or required to be disclosed" in the insurance application.
Crown Capital customers Kurt Bochner, Susan Biles and Linda Grana filed claims against Crown Capital with the Financial Industry Regulatory Authority (FINRA) during the Endurance policy period. The specific projects and investment advisors differed, but all three claims related to Crown Capital’s recommendation of real estate investments operated by DBSI.
Endurance denied coverage for the Bochner, Biles and Grana claims, on the theory that these claims were excluded under the policy’s Application Exclusion. Crown Capital filed the instant coverage action against Endurance for reformation of contract, breach of contract and bad faith, and Endurance filed a counterclaim seeking a declaration that each tendered claim was excluded from coverage. Endurance moved for summary adjudication. The trial court granted Endurance’s motion. Crown Capital appealed.
The California appellate court agreed with the trial court that the Application Exclusion eliminated any potential for coverage. The appellate court noted that the three undisclosed claims arose out of same events as Bou-Sliman’s claim, so the facts underlying the undisclosed claims should also have been disclosed. Although the three undisclosed claims involved different investment properties and different investment advisors than Bou-Sliman’s claim, all four claims were based on the common allegation that Crown Capital failed to use due diligence in assessing the viability of DBSI investments. Accordingly, all claims arose from the same facts and circumstances.
The appellate court rejected Crown Capital’s argument that "arising from" in the Application Exclusion should be interpreted narrowly, to apply only to Bou-Sliman’s particular investment, noting that California courts have interpreted "arising from" very broadly, even in exclusions.
Tressler Comments
California has a well-developed body of case law interpreting "arising out of" and "arising from" in insurance policies very broadly, even in exclusionary language. This case provides another example of such a decision. Of course, the appellate court was aided here by particularly bad facts for the policyholder, with the insured failing to reveal that its customers’ investments in DBSI were alleged to be part of a Ponzi scheme.
For additional information, please contact Elizabeth at
emusser@tresslerllp.com or (310) 203 -4855.
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