The United States District Court for the Eastern District of Arkansas has held that no coverage exists under an errors and omissions policy for claims arising out of the misappropriation and conversion of funds by an insured’s chief executive officer. Kerr v. Gotham Ins. Co., 2019 WL 5268625 (E.D. Ark. Oct. 17, 2019). The court held that the CEO’s conduct did not constitute the rendering of professional services and that the damages, despite arising from a negligence claim, represented the return of money to which the insured was not entitled, therefore falling outside the policy’s coverage.
The insured administered services to small businesses with self-funded health plans. Another entity provided excess coverage for claims above the retention limits. The insured’s CEO became a minority shareholder of the entity providing excess coverage and used the entity’s funds to pay claims of the insured rather than excess claims. The CEO also used the entity’s funds to pay personal expenses. The entity eventually went bankrupt. A receiver brought a claim against the insured and the CEO alleging breach of fiduciary duty, conversion, and “[a]lternatively, [n]egligence.” After the CEO pleaded guilty to criminal charges, the receiver and insured entered into a consent judgment for $2 million limited solely to recovery for the negligence claim, and the insured assigned its rights under the E&O policy to the receiver.
In coverage litigation, the court found multiple bars to coverage. First, the court determined that the CEO was not a covered person under the E&O policy, which provided coverage for errors arising out of the provision of professional services. The court held that, “[r]ather than render ‘Professional Services’ on behalf of [the insured], [the CEO] acted in his self-interest when he ignored the Business Plan and deliberately abused his position as a corporate officer” of the insured and the other entity.
The court also held that the amounts the receiver sought to recover did not constitute “Damages” under the policy. According to the court, each cause of action alleged against the insured sought to recover the exact amount that the CEO took from the other entity. Thus, even though the consent judgment admitted liability only for negligence, the court held that the judgment represented or was “substantially equivalent to” the “return of . . . monies to which [the] insured was not entitled” and so did not constitute “Damages.” The court also held that an exclusion barring coverage for the restitution of monies to which an insured was not entitled and a separate exclusion for conversion and misappropriation of funds barred coverage.
The court also considered whether several other exclusions barred coverage for the claim. The court held that an intentional acts exclusion applied to the negligence claim, given that the claim sought recovery for the CEO’s misuse of a credit card to which he pleaded guilty and that the “undisputed record” showed that the CEO intentionally disregarded the companies’ business plan. The court declined to apply an exclusion based on management of an non-covered business entity, finding that given the insured’s duty to distribute funds to the other entity, it was “far from clear” that the consent judgment arose from management of the other entity. Finally, the court held that an exclusion barring coverage for claims arising out of the insolvency of an insurance company or self-funded benefit plan precluded coverage.