Evanston Ins. Co. v. Desert State Life Mgmt.

56 F.4th 899

EVANSTON INSURANCE COMPANY, Plaintiff - Appellant,

v.DESERT STATE LIFE MANAGEMENT; Christopher Moya, in his capacity as Receiver for the receivership estate of Desert State Life Management; Paul A. Donisthorpe; L. Helen Bennett; Liane Kerr; Ayudando Guardians, Inc., a New Mexico nonprofit corporation, on behalf of seven protected persons; Joseph Perez; Christine Gallegos, individually and as Guardian of Victor Baldizan, an incapacitated adult; Scott K. Atkinson, as Guardian ad Litem for Vincent Esquibel, Jr., an incapacitated person; Charles Reynolds, as Conservator for J.W., an incapacitated person; Cameron Graham, as Trustee for Andrew Graham; Ascending Hope, LLC ; CNRAG, Inc.; Decades, LLC, Defendants - Appellees.

No. 21-2145

United States Court of Appeals, Tenth Circuit.

FILED December 30, 2022

Thomas C. Bird of Jennings Haug Keleher McLeod, Albuquerque, New Mexico (Ann Maloney Conway and Julianna T. Hopper of Jennings Haug Keleher McLeod, Albuquerque, New Mexico; Joseph J. Borders of McJessy, Ching & Thompson, Chicago, Illinois, with him on the brief) for Plaintiff-Appellant.

Maureen A. Sanders of Sanders & Westbrook, Albuquerque, New Mexico, for Defendant-Appellee L. Helen Bennett ; Frank T. Davis of Harrison Hart & Davis, Albuquerque, New Mexico, for Defendants-Appellees Joseph Perez, Christine Gallegos, Scott K. Atkinson, Charles Reynolds, and Cameron Graham.

Before TYMKOVICH, BRISCOE, and PHILLIPS, Circuit Judges.

PHILLIPS, Circuit Judge.

Evanston Insurance Company appeals from a bench trial on an insurance-coverage dispute. After determining that Evanston failed to timely rescind the policy and that a policy exclusion did not apply, the district court required Evanston to continue defending Desert State Life Management against a class action arising from its former CEO's embezzlement scheme. Though we agree with the district court that rescission was untimely, we disagree about the likely application of New Mexico law on applying policy exclusions. For the following reasons, we affirm in part, reverse in part, and remand for the court to enter judgment for Evanston.

BACKGROUND

I. Factual Background¹

Four things underlie this appeal: Paul Donisthorpe's application for the Evanston insurance policy, his embezzlement scheme, the former clients’ class action, and Evanston's response to Donisthorpe's misconduct.

Desert State Life Management was a New Mexico trust corporation that acted as a trustee for disabled individuals. From 2008 to March 2017, Donisthorpe served as its CEO. In October 2016, Donisthorpe applied for an Evanston professional-liability insurance policy on Desert State's behalf. Donisthorpe answered "no" to the following application question:

Is the applicant [Desert State] or any principal, partner, owner, officer, director, employee, manager or managing member of the Applicant or any person(s) or organization(s) proposed for this insurance aware of any fact, circumstance, situation, incident or allegation of negligence or wrongdoing, which might afford grounds for any claim such as would fall under th[e] proposed insurance?

Evanston , 484 F. Supp. 3d at 1001. The application also contained the following notice:

NOTICE TO THE APPLICANT – PLEASE READ CAREFULLY No fact, circumstance or situation indicating the probability of a claim or action for which coverage may be afforded by the proposed insurance is now known by any person(s) or entity(ies) proposed for this insurance other than that which is disclosed in this application. It is agreed by all concerned that if there be knowledge of any such fact, circumstance or situation, any claim subsequently emanating therefrom shall be excluded from coverage under the proposed [insurance].

* * *

This application, information submitted with this application and all previous applications and material changes thereto of which the underwriting manager, Company [Evanston] and/or affiliates thereof receives notice is on file with the underwriting manager, Company and/or affiliates thereof and is considered physically attached to and part of the policy if [issued]. The underwriting manager, Company and/or affiliates thereof will have relied upon this application and all such attachments in issuing the policy.

* * *

WARRANTY

I/We warrant to the Company, that I/We understand and accept the notice stated above and that the information contained herein is true and that it shall be the basis of the policy [ ]and deemed incorporated therein, should the Company evidence its acceptance of this application by issuance of a policy. I/We authorize the release of claim information from any prior insurer to the underwriting manager, Company and/or affiliates thereof.

Id. at 1001–02.

Based on Donisthorpe's application responses, Evanston issued Desert State a professional-liability insurance policy. Under the policy, "Insureds" included (1) Desert State (as the Named Insured); (2) past and present Desert State officers and directors, plus their spouses; and (3) past and present Desert State employees.

The policy's insuring agreement, "Coverage A," outlined Desert State's coverage:

The Company shall pay on behalf of the Insured all sums in excess of the Deductible amount stated in Item 5.A. of the Declarations, which the Insured shall become legally obligated to pay as Damages as a result of a Claim^[2] first made against the Insured during the Policy Period or during the Extended Reporting Period, if exercised, and reported to the Company pursuant to the Section Claims A., Claims Reporting Provision,

By reason of:

1. A Wrongful Act;^[3] or

2. A Personal Injury;

In the Performance of Specified Professional Services rendered or that should have been rendered by the Insured or by any person for whose Wrongful Act or Personal Injury the Insured is legally responsible,

Provided:

a. The entirety of such Wrongful Act(s) or Personal Injury(ies) happens during the Policy Period or on or after the applicable Retroactive Date stated in Item 5.A. of the Declarations and before the end of the Policy Period; and

b. Prior to the effective date of this Coverage Part the Insured had no knowledge of such Wrongful Act(s) or Personal Injury(ies) or any fact, circumstance, situation or incident, which may have led a reasonable person in the Insured's position to conclude that a Claim was likely.

Id. at 1004–05.

The policy also contained several coverage exclusions. Among them was Exclusion P, which excluded coverage for claims "[b]ased upon or arising out of any conversion, misappropriation, commingling [of] or defalcation of funds or property." Evanston , 434 F. Supp. 3d at 1066 (first alteration in original).

Despite the notices, coverages, and exclusions, Donisthorpe completed Evanston's application while running an embezzlement scheme that exposed Desert State to liability. Donisthorpe intentionally misappropriated and commingled over $4.9 million of Desert State's client funds for his own use. Donisthorpe hid his scheme by presenting fraudulent reports to Desert State's board of directors and to New Mexico regulators.

After a March 2017 investigation, regulators declared Desert State financially unsound. Also in March, L. Helen Bennett, a Desert State director, told Evanston about Donisthorpe's misconduct. Evanston also began receiving claims from Desert State clients that confirmed Bennett's report. Evanston ultimately opted not to rescind the policy; instead, it notified Desert State that it wouldn't be renewing the policy. In August, Christopher Moya was appointed Desert State's receiver.

In November 2017, Donisthorpe pleaded guilty to a two-count federal felony information charging him with wire fraud and money laundering. He was sentenced to 144 months in prison and was ordered to pay $6.8 million in restitution and a $4.8 million money judgment.

Donisthorpe's criminal case triggered demands for restitution among former Desert State clients. These former clients sued Desert State, Donisthorpe, Liane Kerr (Donisthorpe's ex-wife), Bennett, and others; the clients’ cases were consolidated into a class action. Their class-action complaint incorporated admissions from Donisthorpe's guilty plea and contained ten claims, including

• Claim 1: Negligence and Gross Negligence (against Desert State, Donisthorpe, and Bennett);

• Claim 2: Breach of Fiduciary Duty (against Desert State, Donisthorpe, and Bennett);

• Claim 3: Conversion (against Desert State and Donisthorpe);

• Claim 4: Violations of New Mexico Uniform Trust Code (against Desert State, Donisthorpe, and Bennett);

• Claim 5: Violations of New Mexico Unfair Practices Act (against Desert State, Donisthorpe, and others); and

• Claim 6: Violations of New Mexico Uniform Voidable Transactions Act (against Desert State, Donisthorpe, Kerr, and others).⁴

Moya asked Evanston to defend and indemnify Desert State, including against the class-action claims. As discussed below, Evanston did not respond until January 2018.

By mid-December 2017, Evanston learned that Donisthorpe had pleaded guilty. And based on statements during his plea hearing, Evanston determined that Donisthorpe had made material misrepresentations when applying for insurance on Desert State's behalf. Evanston had no evidence that any Insured besides Donisthorpe had participated in the scheme, so Evanston assumed (correctly) that no Insured other than Donisthorpe had made material misrepresentations on the insurance application.

In January 2018, Evanston sent a reservation-of-rights letter to Moya. Evanston agreed to defend Desert State against the class action but reserved all its rights, including its right to rescind the policy. The company also warned that it could deny coverage based on the Insured's knowledge of "Wrongful Acts, facts, circumstances, or incidents that would lead a reasonable person to conclude that a Claim was likely." Evanston , 484 F. Supp. 3d at 1013. And Evanston reserved its right to deny coverage based on policy exclusions.

In June—six months after learning of...