Dishonesty Exclusion Bars Coverage for Claim Alleging Fraudulent Inducement to Extend Loan

Applying New York law, the United States District Court for the Northern District of New York has held that a dishonesty exclusion bars coverage for a claim alleging that a law firm representing the sellers of an inn fraudulently induced the underlying claimants to extend a loan to the inn’s purchaser. Lewis & Stanzione v. St. Paul Fire & Marine Ins. Co., 2015 WL 3795780 (N.D.N.Y. Jun. 17, 2015).

The underlying claim included a single count against the law firm’s named partner for fraud. Specifically, the underlying claimants alleged that the attorney was aware of representations made to the sellers of an inn regarding the inn purchaser’s ability to make loan repayments. The claimants contended that the attorney was simultaneously aware that the purchaser was indigent, but nonetheless aided and abetted the sellers’ fraud that induced the claimants’ extension of a loan to the purchaser so as to profit from mortgage proceeds, resulting in the claimants’ multimillion loss in foreclosing on the purchaser’s defaulted loan. The law firm’s E&O insurance policy barred coverage for claims “[a]rising out of any dishonest, fraudulent, criminal or malicious act, error, omission or ‘personal injury’ committed by, at the direction of, or with the knowledge of an insured[.]” After the insureds tendered the underlying claim for coverage, their insurer disclaimed coverage and cited its dishonesty exclusion.

In the coverage litigation that followed, the court held that because the underlying claim “allege[d] exclusively dishonest and fraudulent conduct on the part of [the insureds] and . . . assert[ed] only a single claim of fraud against [the insureds],” the dishonesty exclusion barred coverage for the underlying claim. The court rejected the insureds’ argument that the underlying claim arose out of covered events—namely, the allegation that the firm was providing legal services—because “[i]f the court were to read the [p]olicy to impose coverage obligations . . . solely because the [u]nderlying [c]omplaint allege[d] that [the insureds] rendered services, it would vitiate the . . . exclusion.” The court also rejected the insureds’ argument that a ruling for the insurer would conflict with an intermediate appellate court case that held that an insurer had a duty to defend an underlying wrongful death action where the insured was sued for negligence but extrinsic evidence indicated that the insured had acted intentionally. According to the court, the appellate court case was distinguishable because the allegations of the underlying fraud claim were “wholly within” the fraud exclusion. Finally, the court rejected the insured’s suggestion that an internal email by the insurer’s claims counsel expressing doubts about the merits of denying coverage rendered the dishonesty exclusion ambiguous. In the court’s view, “[w]hat claims counsel may or may not have initially questioned [wa]s irrelevant” given that all of the underlying allegations were within the ambit of the dishonesty exclusion.