The Duty to Defend and Indemnify the Ghosts of Mississippi

National Casualty reminds us that some ghosts will not remain forever sleeping, that justice one day will out, and that insurers' obligations to defend and indemnify their insureds, and thus to ensure the existence of adequate assets for the wronged party, survive the passage of great time and the commission of great wrongs. But even notorious acts committed by those in the insured's employ ' by themselves ' will not confer knowledge upon the insured sufficient to defeat coverage.

Bradford Biegon is of counsel with the law firm Hollingsworth LLP in Washington, DC. He is part of the firm's Insurance practice and consults on matters regarding electronic discovery.

The U.S. District Court for the Southern District of Mississippi recently addressed whether an insurer's duty to defend and indemnify its insured under a claims-made policy for law enforcement wrongful actions covers allegations arising from the murder of two teenagers during civil rights unrest in 1964; the primary issues involved coverage in the presence of both covered and uncovered claims and the application of the known-loss exclusion. See National Casualty Company v. Franklin County, Mississippi, 2010 WL 1780197 (S.D. Miss., Apr. 29, 2010).

The County sought coverage for an action brought against it more than 40 years after two Franklin County, MS teenagers, Charles Moore and Henry Dee, were “kidnapped, beaten and murdered by members of the White Knights of the Ku Klux Klan.” 2010 WL 1780197 (S.D. Miss., Apr. 29, 2010). In 1964, two men were arrested and charged in connection with the crimes, but the charges were dismissed because of a “lack of evidence.” Id. For more than 40 years no one was prosecuted and convicted. In 2007, a federal grand jury indicted one of the two men originally accused of the abduction and murders. The other man charged in 1964 cooperated with the federal prosecutors, leading to a conviction and sentencing of the indicted man on all counts. Id. at *2.

In 2008, shortly after the prosecution and conviction, representatives filed suit against Franklin County on behalf of Moore's and Dee's beneficiaries. The suit alleged that two Franklin County sheriffs, constituting the entire department, had “conspired with the Klan and acted jointly and in concert with members of the Klan to deprive Moore and Dee of their constitutionally protected rights” in connection with their murder. Id. at *2. The complaint alleged the officers knew of the risk to the two teenagers but failed to take preventative action to protect them; refused to investigate or prosecute crimes committed by the Klan and covered up such crimes; knew of the kidnappings, but lied to the teenagers' families about the teenagers' whereabouts; and failed to cooperate with the FBI's investigation. See Id. at 4.

Franklin County notified National Casualty of the suit and sought coverage under a policy covering losses resulting from “'law enforcement wrongful act(s)' which arise out of and are committed during the course and scope of 'law enforcement activities' ' but only with respect to 'claims' first made against the insured during the 'policy period' or 'Extended Reporting Period.'” Id. at *3. The policy defined a law enforcement wrongful act as:

Any actual or alleged act, error or omission, neglect or breach of duty by the insured while conducting 'law enforcement activities which results in (a) “personal injury”; (b) “bodily injury” (including mental anguish and emotional distress); or (c) “property damage” ' caused by an “occurrence.” 'Personal injury' is defined to include, among other things, '[a]ssault and battery;
[d]iscrimination ' [h]umiliation or mental distress; ' and
[v]iolation of civil rights protected under 42 USC 1981 et sequential or State law.' Id. at * 3.

Covered Losses That Are Inseparable from Losses Not Covered

Although agreeing to defend the insured subject to a “reservation of rights,” National Casualty concurrently sought a declaratory judgment that exclusions within the policy relieved it of any obligation to either defend or indemnify the County.

National Casualty argued it owed no duty to defend or indemnify the County because the County had not suffered a covered “loss.” According to National Casualty, the policy required it to perform only in the event of a covered loss and the policy excluded from the definition of “loss” “'matters which may be deemed uninsurable under the law pursuant to which ' Coverage is to be construed.'” See Id. at *5. National Casualty argued that Mississippi law barred insurance for criminal acts and that the complaint in the underlying action plainly alleged the County's two officers had engaged in criminal acts.

The court rejected National Casualty's argument. Even though the complaint in the underlying action arguably alleged acts not covered by the policy, the complaint also alleged acts that were not excluded such that National Casualty was still obligated to defend. See Id. at *5 (“[T]he complaint also contains allegations that do not fit within the scope of any public policy against coverage for illegal acts.”). The court took the view that, if any act is covered, the entire action must be defended absent a reasonable means for pro-rating costs between covered and non-covered claims.

An insurer may not avoid its obligation to defend its insured simply because the defense of covered claims will benefit excluded claims. An insured is entitled to the full benefit of the defense the insurer owes, and that adequately defending the covered claims would also benefit the defense of intertwined uncovered claims does not relieve the carrier of its obligations. Because the court was not faced with covered and uncovered claims that were discrete and for which defense costs could be segregated, the court did not enter the debate sparked several years ago when the California Supreme Court identified a quasi-contractual right of recoupment for insurers in situations in which they can establish, after defending the entirety of a suit, that certain of the expenses were wholly unrelated to the covered claims. See Buss v. Superior Court, 939 P.2d 766 (Ca. 1997) (finding insurer could create quasi-contractual claim for reimbursement of defense costs that insurer can prove are unrelated to covered claims); see also Donald R. McMinn, The Duty to Defend Following Buss and Dotmar: Restrictions on Insurance Carriers' Ability to Avoid Defense Cost Through Allocation , 11 Mealey's Litig. Rep. Ins. 7 (1997) (discussing Buss and extent of defense coverage). However, other courts considering this problem conclude that if one of the underlying action's claims is covered, the insurer's obligation is written in terms of the defense of “suits,” and this extends to the entire suit. See, e.g., Blackhawk-Central City Sanitation District v. American Guarantee & Liability Ins. Co., 214 F.3d 1183, 1189 (10th Cir. 2000); Schultze v. Continental Ins. Co., 619 N.W.2d 510, 515 (N.D. 2001) (insurer has a duty to defend the entire lawsuit if there is potential liability or a possibility of coverage for one of the claims); General Agents Ins. Co. v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Ill. 2005) (rejecting Buss and holding that insurer must defend entirety of claim without recovery through recoupment).

Allegations of Excluded Conduct

National Casualty argued the policy's deliberate acts exclusion absolved it of any duty either to defend or indemnify the County for any liability arising from the claims alleged in the underlying complaint because the underlying complaint alleged the sheriffs had deliberately violated federal laws. See National Casualty, 2010 WL 1780197 at *6. The exclusion provided that National Casualty:

Will not be obligated to make any payment nor to defend any 'suit' in connection with any 'claim' made against the insured ' [a]rising out of the deliberate violation of any federal, state, or local statute, ordinance, rule or regulation committed by or with the knowledge and consent of the insured. This exclusion applies to both civil and criminal charges filed against the insured in his or her official or individual capacity if the charges result in an obligation to pay damages, a plea of guilty, a verdict of guilty, a sentence or plea of no contest. Id.

The court rejected National Casualty's argument, holding the exclusion applies to the duty to defend only when charges resulting from a criminal conviction, a plea agreement, or an obligation to pay civil damages had been brought against the insured's employees. See Id. The exclusion did not apply to the duty to defend if the mere allegations of the complaint alone could result in a conviction or civil damages, if proven. See Id. Thus, the exclusion would apply to the duty to defend only if the legality of the insured's conduct already had been adjudicated, and the claims being made, and for which the duty to defend was being invoked, rested upon that existing determination. (Because the duty to indemnify would not be ripe prior to an adjudication, the court could not determine the applicability of the exclusion to that duty.)

When, as here, state law precludes insureds from purchasing insurance coverage for illegal activities, the exclusion plays an important role, but should not be read broadly to defeat a duty to defend against mere allegations of illegal conduct given the possibility the allegations could be unfounded (and, hence, something for which an entity would want insurance coverage). Until such time as a conviction, plea, or liability determination has been made, the exclusion does not apply and should not be invoked to defeat a duty to defend.

Subjective and Objective Knowledge

National Casualty also argued the policy's “Prior Knowledge Exclusion” barred coverage for any claim arising out of any law enforcement wrongful act that took place prior to the policy period, if the insured knew of circumstances that could reasonably be expected to give rise to a claim. See Id. at *6. National Casualty argued that because the sheriffs had been aware of their own actions (those giving rise to the underlying claim against the County) and that knowledge should be imputed to the County, “[i]t follows that, prior to the policy period, Franklin county had knowledge of circumstances which could reasonably be expected to give rise to a claim.” Id.

The court applied both a subjective and objective inquiry to what the County knew. See Id. at *7. The court held the prior knowledge exclusion did not apply because there was no evidence that at the time the County procured the insurance, the County or any of its current employees had the requisite subjective knowledge of the acts and because, even if knowledge of such acts could be imputed to the County, a reasonable person would not have expected that knowledge of the circumstances happening decades ago would give rise to a potential claim during the policy period. See Id. at *8. Even if events at or near the time of policy renewal bring long-past events back into the spotlight, the thrust of the court's decision is that such events are not automatically excluded from coverage under a claims-made policy. Although the sheriffs' actions might be properly imputed to the County under the doctrine of respondeat superior, which seeks to hold the principal liable for the conduct of the agent, it is quite another matter currently to impute personal knowledge of agents employed 40 years previously to the employer, especially when the knowledge involves the agents' own unlawful conduct. An agent who has violated “a federal, state, or local statute, ordinance, rule, or regulation” is not likely to reveal that information to others, including his employers. Holloway v. Sacks & Sacks, Esqs., 713 N.Y.S.2d 162, 164 (N.Y. App. Div. 2000) (knowledge of associate's concealed acts of malpractice would not be imputed to partner completing malpractice insurance application without evidence the partner had subjective knowledge or should have had constructive knowledge of associate's actions).

The court's decision is in keeping with the view that an insured's duty to disclose circumstances that are potential sources of claims during underwriting or renewal is not unlimited and must be construed reasonably. The U.S. District Court for the Middle District of Pennsylvania underscored this point recently when it held that an insured did not breach a duty to disclose potential claims during underwriting because the insurer's underwriters failed to ask if any claims were pending against it, even though it asked the insured (ironically an insurance company) questions about the insured's claims handling practices. See Westchester Surplus Lines Ins. Co. v. Safe Auto Ins. Group Inc., 2010 WL 2640196 (M.D. Pa., Jun. 30, 2010).

National Casualty reminds us that some ghosts will not remain forever sleeping, that justice one day will out, and that insurers' obligations to defend and indemnify their insureds, and thus to ensure the existence of adequate assets for the wronged party, survive the passage of great time and the commission of great wrongs. But even notorious acts committed by those in the insured's employ ' by themselves ' will not confer knowledge upon the insured sufficient to defeat coverage.

Bradford Biegon is of counsel with the law firm Hollingsworth LLP in Washington, DC. He is part of the firm's Insurance practice and consults on matters regarding electronic discovery.