Crown Capital Securities, L.P. v. Endurance American Specialty Insurance Company

In Crown Capital Securities, L.P. v. Endurance American Specialty Ins. Co., 235 Cal.App.4th 1122 (April 10, 2015), the California Second District Court of Appeal affirmed the trial court’s entry of summary judgment in favor of Endurance American Specialty Insurance Company (“Endurance”) in connection with its denial of the defense of multiple claims based on erroneous investment advice provided by the insured, Crown Capital Securities, L.P. (“Crown Capital”). Endurance denied Crown Capital’s tender of three claims based on negligent investment advice which were tendered by Crown Capital under a professional liability policy purchased from Endurance for the period of April 1, 2010 to April 1, 2011. As a result of Endurance’s denial of Crown Capital’s tender of the subject claims, Crown Capital filed an action against Endurance alleging causes of action for reformation, breach of contract and bad faith.

The parties’ dispute arose out of Crown Capital’s recommendation that investors invest money in real estate investments operated by an entity known as DBSI, Inc. (“DBSI”). Such entity filed for bankruptcy on November 10, 2008. Subsequently, a court appointed examiner filed a “final report of examiner” with respect to the operation of DBSI which concluded that it engaged in a fraudulent Ponzi scheme.

As a result, on October 26, 2009, investor George Bou-Sliman sent a letter to Crown Capital which attached a summary of the final report. The letter advised that Crown Capital was obligated to pay for the loss sustained by Mr. Bou-Sliman.

On April 20, 2010, Crown Capital executed an application for professional liability insurance from Endurance for a professional liability insurance policy for work performed by its security broker – dealers and investment advisors (“Application”). In that regard, the Court of Appeal noted Crown Capital’s responses to the questions on the Application as follows:

Concerning Crown Capital's claims experience, question 9 of the application asked, “Have any claims, suits or proceedings (including without limitation: any shareholder action or derivative suit; or any civil, criminal, or regulatory action, or any complaint, investigation or proceeding related thereto) been made during the past five years against: (a) the Applicant; (b) its predecessors in business; (c) any subsidiary or affiliate of the Applicant; (d) any other entity proposed for coverage; or (e) any past or present principal, partner, managing member, director, officer, employee, leased employee or independent contractor of the Applicant, its predecessors in business, any subsidiary or affiliate of the Applicant or any other entity proposed for coverage?” Paulsen answered that question, “Yes.”

Further concerning Crown Capital's claims experience, Question 10 of the application asked, “Is the Applicant (after diligent inquiry of each principal, partner, managing member, director or officer) aware of any fact, circumstance, incident, situation, or accident (including without limitation: any shareholder action or derivative suit; or any civil, criminal, or regulatory action, or any complaint, investigation or proceeding related thereto) that may result in a claim being made against: (a) the Applicant; (b) its predecessors in business; (c) any subsidiary or affiliate of the Applicant; (d) any other entity proposed for coverage; or (e) any past or present principal, partner, managing member, director, officer, employee, leased employee or independent contractor of the Applicant, its predecessors in business, any subsidiary or affiliate of the Applicant or any other entity proposed for coverage?” Paulsen answered that question, “No.”

The Court of Appeal also noted that the Application contained the following exclusion:

“NOTE: It is agreed that any claim or lawsuit against the Applicant, or any principal, partner, managing member, director, officer or employee of the Applicant, or any other proposed insured, arising from any fact, circumstance, act, error or omission disclosed or required to be disclosed in response to Questions 9, 10 and/or 11, is hereby expressly excluded from coverage under the proposed insurance policy.” The application stated in part that “this Application shall be the basis of the insurance and shall be considered physically attached to and become part of the Policy” if a policy is issued.

When Crown Capital applied for the Endurance policy, it submitted a loss run report from its previous insurer, Arch Specialty Insurance Company. The loss run report disclosed the Bou-Sliman claim. Thereafter, on August 3, 2010, Endurance issued to Crown Capital a professional liability policy for the term of April 1, 2010 to April 1, 2011.

Subsequently, three different claims were asserted against Crown Capital arising out of investments with DBSI which were recommended by Crown Capital to its customers. The claims involved different investments and recommendations made by different brokers employed by Crown Capital.

In response, Endurance denied coverage of each of the claims based on the Application exclusion in its policy. Endurance reasoned that each of the claims arose out of related facts and circumstances, and should have been disclosed by Crown Capital on its Application.

After Crown Capital filed its action against Endurance, a motion for summary judgment was filed by Endurance based on the Application exclusion. Subsequently, the trial court granted such motion and entered judgment in favor of Endurance.

In affirming the trial court’s entry of summary judgment, the Court of Appeal held as follows:

It is undisputed that Crown Capital was aware of the Bou-Sliman Claim when Crown Capital applied for the Policy, for that claim was reported in the application. In connection with its affirmative response to Question 9 of the application for the Policy, which question asked about claims made against Crown Capital within the previous five years, Crown Capital submitted to Endurance the Arch Specialty Insurance Company loss run report, which listed the Bou-Sliman Claim. The Bou-Sliman Claim notified Crown Capital of DBSI's bankruptcy. Like the Bou-Sliman Claim, the Bochner, Biles, and Grana Claims arose out of the DBSI Ponzi scheme—i.e., DBSI used new investor money to pay existing debt and payment obligations—and those claimants alleged that Crown Capital failed to exercise due diligence in assessing the viability of DBSI investments.

Crown Capital was aware that DBSI had declared bankruptcy and allegedly had been operating a Ponzi scheme, that Bou-Sliman had claimed that Crown Capital had failed to exercise due diligence in connection with a DBSI investment, and that its broker-dealers had sold other DBSI investments to their customers—i.e., investments that were part of a Ponzi scheme that was the subject of a bankruptcy proceeding. Thus, Crown Capital was aware of facts and circumstances that might result in a claim or claims being made against it, which awareness it was required to disclose under Question 10 of the application for the Policy. This requirement existed even though the Bochner, Biles, and Grana Claims did not involve the same investor or the same investment that was at issue in the Bou-Sliman Claim, and none of the investments at issue in the Bochner, Biles, or Grana Claims was recommended by the same Crown Capital dealer-broker who recommended the Northpointe Towers investment to Bou-Sliman. The Application Exclusion applied to claims that were the subject of required disclosure under Question 10.

The Court of Appeal also rejected Crown Capital’s argument that the claims alleged causes of action based on conduct other than the failure to exercise due diligence in connection with the DBSI Investments. The Court of Appeal reasoned as follows:

Although advancing various theories, all of the causes of action that Bochner, Biles, and Grana asserted in their claims against Crown Capital and its broker-dealers concerned the purchase of DBSI investments. At the time that Crown Capital applied for the Policy, it was aware of facts and circumstances that might result in a claim being made against Crown Capital—i.e., DBSI's bankruptcy, the alleged operation of a Ponzi scheme, and the investment by Crown Capital's customers in DBSI investments. The awareness of those potential claims brought such claims within the Application Exclusion regardless of the theory upon which such claims might be based. Accordingly, the trial court properly ruled that the entire Bochner, Biles, and Grana Claims, regardless of the theory of liability, were excluded from coverage under the Application Exclusion.