Few things are certain in life. Death. Taxes. The ineptitude of New York Mets management. And also, the fact that if you sue an insurance company in state court, and the carrier has a basis upon which to remove the case to federal court, they’re going to do it. Insurance companies think that federal judges tend to be more defense-oriented and carrier-friendly. Also, they think they’re more likely to get summary judgment on the coverage issues in federal court, since summary judgment has become the preferred method of adjudicating disputes by the federal bench (often without oral argument).

Of course, rules are meant to be broken, and being in federal court is no guarantee for an insurance company.

Example; A lawyer here in New Jersey with some past disciplinary issues, Karim Arzadi, recently got sued by Allstate. Allstate also sued Arzadi’s law firm.  According to Allstate, Arzadi had “engaged in a continuing fraudulent scheme” that was designed to defraud Allstate “by inducing the payment of PIP [personal injury protection] healthcare benefits . . . pursuant to an unlawful practice. . . .”

Arzadi filed a claim for defense and indemnification with his professional liability insurance carrier, Evanston Insurance Company.  Evanston said, no, we’ll pass on that, arguing that policyholders who commit fraud forfeit their coverage.  According to Allstate, fraudulent conduct did “not fall under the [p]olicy’s definition of Professional Legal Services.”

So, Arzadi sued Allstate to enforce coverage, and the case wound up in federal court.

A word or two of background here:  Liability policies generally contain “conduct” exclusions that remove coverage for harm caused by acts that are fraudulent, criminal, or are intended to cause damage.  But those exclusions don’t preclude a defense for allegations of fraud, if there’s any possibility of ultimate coverage.  So, fraud exclusions typically won’t apply until there’s been a final adjudication, on the merits, that the policyholder actually committed fraud. (There also may be “severability” provisions that protect innocent policyholders from losing their coverage rights due to the actions of their guilty co-defendants.)

In the Arzadi decision (which you can read here), Judge Susan Wigenton rejected Evanston’s arguments. As to the “professional services” argument, the Court wrote: “The Allstate suit contains allegations that Arzadi advised clients how to proceed with their personal injury claims, which falls squarely within the policy’s definition of Professional Legal Services…The acts complained of – advising his clients that they ‘had valid bodily injury claims,’ ‘encouraging them to continue to undergo [unnecessary] treatment’ or making referrals for treatment – are acts that allegedly occurred in the context of Arzadi’s representation of his clients.”

With respect to the fraud contention, the Court wrote: “Defendant argues that under Exclusion F (the Fraudulent Acts Exclusion), Plaintiffs are barred from coverage because the Allstate suit alleges that Plaintiffs ‘committed intentional, willful, dishonest and fraudulent acts.’ While it is true that the Allstate suit contains fraud allegations, Exclusion F only bars coverage for fraudulent acts if a final judgment or adjudication is entered against Plaintiffs. The Allstate suit is in the preliminary stages of litigation and the underlying allegations have not been substantiated by any court. Therefore, this court finds that Exclusion F does not bar Plaintiffs from coverage.”  (Emphasis mine.)

The fraud coverage issue also recently came up in a federal case in California, Hanover v. Zagaris, involving an alleged kickback scheme, in which a brokerage firm recommended that its customers use a specific vendor to draft their natural hazard disclosure reports, without disclosing that the brokerage took a cut of the fee for preparing the documents. The policy in that case contained two potentially relevant exclusions. The first barred coverage for litigation over an act of fraudulent conduct, but that provision could only be invoked if the policyholder lost the underlying case. The other exclusion, dealing with a fraudulent “pattern of conduct,” was broader. The trial court agreed with the broker, though, finding that fiduciary duty and constructive fraud claims in the underlying case did not require an element of deception, only negligence or omission, and therefore, a possibility of coverage existed, requiring Hanover to defend. The judge also noted his frustration with the policy’s “undue complexity and convolution.”  You can read the trial court’s decision in Hanover here.

Hanover appealed to the Ninth Circuit, and as I write this, oral argument has just been held. One of the judges on the panel asked: “How do you jive the two different exclusions? Why doesn’t that not just, looking at this contract in general, create a level of confusion about what it really means, which warrants a suggestion that the contract has to be viewed in a light most favorable to the insured?”

An excellent question.