International Society of Primerus Law Firms

Excess Insurer Has No Duty to Indemnify Where Excess Insurer Policy Incorporates Prior Knowledge Exclusion of Primary Insurance Policy, and Insured Had Prior Knowledge of Potential Claim

By: Thomas Paschos

Thomas Paschos & Associates, P.C.

Hassonfield, NJ

In Executive Risk Indemnity Inc. v. Pepper Hamilton, LLP, — N.E.2d —, 2009 WL 3347222 (N.Y. Oct. 20, 2009), the New York Supreme Court was asked to determine, under Pennsylvania law, whether excess insurers Executive Risk Indemnity Inc. and Twin City Fire Insurance Company, based upon their prior knowledge exclusions, were entitled to summary judgment declaring that they have no obligation to indemnify defendants Pepper Hamilton LLP and one of its members in actions asserted against them for professional malpractice.

The dispute centered on Pepper Hamiltons representation of Student Finance Corporation (SFC) and its principal. SFC financed loans to students attending vocational schools and acquired student loans from other lenders. In March 2002, Pepper Hamilton learned that SFC had been involved in securities fraud in failing to disclose the forbearance payments. The firm terminated its representation of SFC one month later.

In July of 2002, Pepper Hamilton’s general counsel sent a memorandum to the attorneys regarding the firm’s insurance application and inquired whether any person was aware of any fact or circumstance, act, error, omission or personal injury which might be expected to be the basis of the claim or suit for lawyers professional liability. In August of 2002, the partner who was aware of the SFC fraud advised the firm, but the application submitted by the firm in September did not disclose any information concerning SFC, and in a letter to Twin City, dated October 25, 2002, Pepper Hamilton warranted that it had no material changes to its application.

Eventually, SFC was forced into bankruptcy. In April 2004, Pepper Hamilton was advised that valid claims and causes of action could be brought against Pepper Hamilton on behalf of the estate and/or creditors of SFC. Pepper Hamilton immediately contacted its primary insurer Westport and excess insurers Executive Risk, Twin City and Continental Casualty and informed them of the potential claims. Lawsuits were filed against the firm in early 2005 and the firms primary insurer, Westport, defended the claims. However, the excess insurers denied coverage.

Executive Risk commenced this action against the Pepper Hamilton and Westport, seeking a declaration that it had no obligation to indemnify defendants in the underlying actions. The law firm defendants counterclaimed for a declaration in their favor and brought third-party claims against Twin City and Continental Casualty. Executive Risk and Twin City relied upon Westport’s prior knowledge exclusion, expressly incorporated into their policies.

Under Pennsylvania law, a court must consider a two-pronged test when determining whether a prior knowledge exclusion applies. Specifically, it must be shown that the insured knew prior to effective date of the policy of certain facts that occurred prior to that effective date. Then, a court must determine that a reasonable attorney in possession of such facts would have a basis to believe that the insured might expect such facts to be the basis of a claim against the insured.

The New York Supreme Court evaluated the facts and found that the law firm defendants knew of SFC’s securities fraud months prior to the effective dates of the Executive Risk and Twin City policies and that they had sufficient knowledge that a claim could be brought against the law firm. As such, the court granted summary judgment in favor of the excess insurers and declared that based on the policies’ prior knowledge exclusions, Executive Risk and Twin City had no obligation to indemnify the law firm defendants in the underlying actions.

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