Application of the Innocent Insured Clause

Professional Liability Matters has repeatedly stressed the importance of accurate, timely and careful reporting of potential claims.  Whether it be during the application or renewal process or somewhere down the road, most insureds are contractually obligated to report threatened claims. This requires that the organization solicit responses from all professionals (which can be a logistics problem for larger organizations). Many firms submit a short questionnaire that must be answered by everyone.  But how is coverage implicated for the organization when one bad apple knowingly conceals a claim?

A recent decision out of Illinois highlights issues arising when one member of a partnership conceals a potential claim to the detriment of the organization. That was the issue in Illinois State Bar Association Mutual Ins. Co. v. Law Office of Tuzzolino and Terpinas, et. al. In that dispute, an insurer sought to rescind a professional malpractice policy issued to a small law firm. Allegedly, one of the partners (Sam) failed to disclose to his partner (Will) and to their insurer during the renewal process the existence of a legal malpractice claim. Both partners checked the “no” option when prompted in the application whether they were aware of any claims. Sam unquestionably knew of the underlying malpractice while Will did not.

Will responded to the rescission complaint that coverage should still apply to him as a result of the rarely cited “innocent insured clause.” Pursuant to that clause, coverage applied to the firm as a whole because Will was not aware of any underlying claim and engaged in the insurance application process in good faith. The court agreed. The court concluded that under the doctrine even though Sam lied on the renewal form, the unknowing partner was protected as an innocent co-insured.

The story could have ended differently in another jurisdiction. Thus, when completing a renewal process, professionals must establish a rigid and thorough practice to vet members about potential liability. The failure to do so could mean significant exposure and contested litigation.