Evanston Insurance Company v. Desert State Life Management ( 2022 )

Appellate Case: 21-2145 Document: 010110791268 Date Filed: 12/30/2022 Page: 1
FILED
United States Court of Appeals
PUBLISH Tenth Circuit
UNITED STATES COURT OF APPEALS December 30, 2022
Christopher M. Wolpert
FOR THE TENTH CIRCUIT Clerk of Court
_________________________________
EVANSTON INSURANCE
COMPANY,
Plaintiff - Appellant,
v. No. 21-2145
DESERT STATE LIFE MANAGE-
MENT; CHRISTOPHER MOYA, in his
capacity as Receiver for the receiver-
ship estate of Desert State Life Man-
agement; PAUL A. DONISTHORPE;
L. HELEN BENNETT; LIANE KERR;
AYUDANDO GUARDIANS, INC., a
New Mexico nonprofit corporation, on
behalf of seven protected persons; JO-
SEPH PEREZ; CHRISTINE
GALLEGOS, individually and as
Guardian of Victor Baldizan, an inca-
pacitated adult; SCOTT K. ATKIN-
SON, as Guardian ad Litem for Vin-
cent Esquibel, Jr., an incapacitated
person; CHARLES REYNOLDS, as
Conservator for J.W., an incapacitated
person; CAMERON GRAHAM, as
Trustee for Andrew Graham; AS-
CENDING HOPE, LLC; CNRAG,
INC.; DECADES, LLC,
Defendants - Appellees.
_________________________________
Appeal from the United States District Court
for the District of New Mexico
(D.C. No. 1:18-CV-00654-JB-KK)
_________________________________
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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.
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BACKGROUND
I. Factual Background 1
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, of-
ficer, director, employee, manager or managing member of the Ap-
plicant or any person(s) or organization(s) proposed for this insur-
ance aware of any fact, circumstance, situation, incident or allega-
tion 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
1
These facts come mostly from the district court’s order denying
Evanston’s motion for summary judgment and its findings of fact and
conclusions of law after the bench trial. Evanston Ins. Co. v. Desert State Life
Mgmt., 434 F. Supp. 3d 1051 (D.N.M. 2020) (summary judgment); Evanston
Ins. Co. v. Desert State Life Mgmt., 484 F. Supp. 3d 987 (D.N.M. 2020) (bench
trial).
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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 [in-
surance].
⁎⁎⁎
This application, information submitted with this application and all
previous applications and material changes thereto of which the un-
derwriting 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 appli-
cation 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:
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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 respon-
sible,
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 In-
jury(ies) or any fact, circumstance, situation or incident,
which may have led a reasonable person in the Insured’s posi-
tion 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
2
The policy defined “Claim” to include “[a] written demand for money
damages” and “service of suit.” Id. at 1004.
3
The policy defined “Wrongful Act” as “a negligent act, error or
omission in Specified Professional Services.” Id. “Specified Professional
Services” included “Financial Case Management Services to Trust Accounts
and Conservatorships.” Id.
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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
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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 Transac-
tions 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
4
Claims 7, 8, and 9 alleged professional negligence and aiding and
abetting breach of fiduciary duty against Desert State’s certified public
accountant and the broker–dealer that held the former clients’ managed
investment accounts. Claim 10 alleged unjust enrichment against Kerr. These
claims aren’t at issue in this appeal.
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(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 Donisthorpe’s guilty plea—
Evanston sent Moya a letter offering to rescind the policy. The company cited
Donisthorpe’s misrepresentations on Desert State’s application. Evanston also
refunded Desert State for the premiums paid under the policy. But Desert State
did not accept the offer to rescind.
II. Procedural Background
In July 2018, Evanston sued Desert State, Donisthorpe, Kerr, and Bennett
in the U.S. District Court for the District of New Mexico. Evanston also sued
victims of Donisthorpe’s scheme and former Desert State clients, given their
interest in the dispute. In Count One, Evanston sought to rescind the policy. In
Count Two, as an alternative to rescission, Evanston sought a declaration that
Desert State, Donisthorpe, Kerr, and Bennett weren’t entitled to coverage under
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the policy and that Evanston had no duty to defend against claims arising from
Donisthorpe’s criminal conduct.
Evanston moved for summary judgment, but the case proceeded to a
bench trial without a ruling on the motion. After the October 2019 trial, the
district court denied summary judgment. It concluded that (1) the defendants
had satisfied all conditions precedent for coverage under the policy,
(2) Exclusion P did not exclude coverage for claims alleged in the class-action
complaint, and (3) Evanston wasn’t entitled to rescission because it failed to
promptly rescind. Evanston, 434 F. Supp. 3d at 1120, 1124–25. 5 After the trial,
the district court issued its findings of fact and conclusions of law. It concluded
that (1) the policy did not insure Donisthorpe and Kerr against claims arising
from the embezzlement scheme; but (2) the policy did insure Moya and Bennett
for such claims, including those in the class-action complaint. Evanston,
484 F. Supp. 3d at 1040–45.
The district court entered final judgment by separate order, and Evanston
timely appealed.
5
Moya and Desert State’s former clients also moved for summary
judgment. Their motions were granted in part and denied in part. See Evanston
Ins. Co. v. Desert State Life Mgmt., No. 1:18-CV-00654-JB-KK, 2020 WL
3448253 (D.N.M. Mar. 23, 2020). In an order that overlapped with its order
denying Evanston’s motion, the court concluded that (1) Evanston had waited
too long to rescind the policy and (2) the policy provided coverage to “innocent
insureds.” Id. at *3–4.
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STANDARD OF REVIEW
In an appeal from a bench trial, we review de novo the district court’s
legal conclusions. Sw. Stainless, LP v. Sappington, 582 F.3d 1176, 1183
(10th Cir. 2009) (citing Weyerhaeuser Co. v. Brantley, 510 F.3d 1256, 1260
(10th Cir. 2007)). We also review de novo the district court’s denial of
summary judgment on a legal issue. Kelley v. City of Albuquerque, 542 F.3d
802, 820 (10th Cir. 2008) (citations omitted). And we review de novo the
district court’s interpretation of state law. Genzer v. James River Ins. Co.,
934 F.3d 1156, 1164 (10th Cir. 2019) (citing Wade v. EMCASCO Ins. Co.,
483 F.3d 657, 666 (10th Cir. 2007)). If the state’s highest court has not decided
an issue, we predict how the court would rule by “consulting persuasive state
authority, such as dictum by the state’s highest court and precedential decisions
by a state’s intermediate appellate courts.” Jordan v. Maxim Healthcare Servs.,
Inc., 950 F.3d 724, 730–31 (10th Cir. 2020) (cleaned up).
DISCUSSION
On appeal, Evanston argues that the district court erred by denying
rescission and by concluding that the policy requires Evanston to defend Moya
and Bennett against the class-action claims. It raises four issues:
1. Did the district court err by concluding that Evanston’s attempted
rescission was untimely?
2. Did the district court err by refusing to impute Donisthorpe’s
knowledge to Desert State, based on agency law’s adverse-inter-
est exception?
3. Did the district court err by concluding that Bennett satisfied the
no-prior-knowledge condition in Coverage A?
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4. Did the district court err in making its Erie prediction that the
New Mexico Supreme Court would not enforce the unambiguous
Exclusion P?
Because the first and fourth issues resolve the appeal, we consider only whether
rescission and Exclusion P apply. And exercising jurisdiction under 28 U.S.C.
§ 1291, we affirm in part and reverse in part.
I. Rescission
We begin by reviewing whether Evanston’s attempted rescission was
untimely. We hold that it was and affirm the district court on this issue.
Rescission is an equitable remedy that results in the cancellation of a
contract. Branch v. Chamisa Dev. Corp., 223 P.3d 942, 946 (N.M. Ct. App.
2009). It’s available “where there has been a misrepresentation of a material
fact, the misrepresentation was made to be relied on, and has in fact been relied
on.” Prudential Ins. Co. of Am. v. Anaya, 428 P.2d 640, 643 (N.M. 1967). But a
party seeking to rescind “must promptly exercise it or [the] same will be
waived.” Yucca Mining & Petrol. Co. v. Howard C. Phillips Oil Co., 365 P.2d
925, 928 (N.M. 1961); see also Putney v. Schmidt, 120 P. 720, 723 (N.M. 1911)
(“[I]f [a party] seeks to rescind the [contract] upon the ground of fraud, he must
immediately, upon discovering the fraud, restore, or offer to restore, all that he
has received under the contract, as a condition precedent to his right to rescind
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the same.”). 6 To be prompt is to act “immediate[ly].” Prompt, Black’s Law
Dictionary (11th ed. 2019).
The district court concluded that “because Evanston Insurance did not act
‘immediately’ to rescind the Insurance Policy, it was not entitled to this
remedy.” Evanston, 484 F. Supp. 3d at 1016. The court noted that in other
states, “insurance companies are entitled to a reasonable time to investigate
before rescinding an insurance policy.” Evanston, 2020 WL 3448253, at *3
(citing California cases). These states “represent the majority rule that, ‘[i]f an
insurer decides to rescind a contract, it is required to act with reasonable
promptness after discovery of grounds for rescission.’” Id. (quoting 2 Steven
Plitt et al., Couch on Insurance § 31:98 (2019)). “By contrast,” the district
court reasoned, “rather than affording insurers a reasonable amount of time,
New Mexico requires that those seeking rescission ‘immediately, upon
discovering the fraud, restore, or offer to restore’ all that was received under
the contract.” Id. (quoting Putney, 120 P. at 723). The district court thus
concluded that “the Supreme Court of New Mexico would hold that an
insurance company in Evanston Insurance’s position delayed too long before
seeking rescission.” Id.
6
Evanston argues that we shouldn’t rely on this principle from Putney
given the case’s age. But the principle that rescission must be prompt has been
recognized in more recent New Mexico cases. In 2009, for example, the New
Mexico Court of Appeals acknowledged this principle from Putney. See
Branch, 223 P.3d at 947 (quoting Putney, 120 P. at 723).
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Based on Putney’s touchstone language—which has never been
overruled—we agree. The district court’s factual findings belie any suggestion
that Evanston acted promptly in seeking to rescind the policy. In March 2017,
New Mexico regulators began investigating Desert State’s finances, and by the
end of the month, they declared the corporation to be financially unsound. That
same month, Bennett notified Evanston about Donisthorpe’s alleged
misconduct. Though Evanston considered whether to rescind the policy in
March, it ultimately chose only to issue a letter of nonrenewal in July, with
Donisthorpe’s embezzlement contributing to that decision. In August, Desert
State was in receivership. Still, Evanston didn’t try to rescind. In November,
Donisthorpe pleaded guilty to wire fraud and money laundering. Evanston knew
about this guilty plea by mid-December. Still, no rescission. In January 2018,
months after Moya timely requested that Evanston defend and indemnify Desert
State against the class-action claims, Evanston sent the reservation-of-rights
letter. There, Evanston reserved its right to rescind the policy. Yet not until
June did Evanston try to rescind. And it cited Donisthorpe’s misrepresentations
on the insurance application—which it knew or should’ve known about months
earlier—as its reason for rescinding.
The concurrence describes the timing of Evanston’s discovering the fraud
as something about which “reasonable minds might differ” and ultimately fixes
the Putney point of no return in December 2017, when Evanston learned of
Donisthorpe’s guilty plea. Concurrence at 5. In the concurrence’s view,
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Evanston’s January reservation-of-rights letter bought the insurer time to
investigate “whether Donisthorpe’s plea gave sufficient grounds for rescission.”
Id. And citing Agnew v. Landers, 278 P.2d 970 (N.M. 1954), in which the New
Mexico Supreme Court excused a six-month rescission delay, the concurrence
finds Evanston’s June 2018 rescission to be timely.
As we see it, this logical chain snaps at each link. Evanston was on
notice of its right to rescind as early as March 2017, when Bennett first relayed
Donisthorpe’s misconduct to the insurer. Indeed, Evanston contemplated
rescinding the policy then, though it stopped short and only issued a
nonrenewal letter. But as the district court found, Donisthorpe’s embezzlement
undergirded Evanston’s nonrenewal decision. Evanston, 484 F. Supp. 3d
at 1012. It’s unclear why this actual knowledge of its insured’s fraud wouldn’t
trigger Putney’s immediacy requirement—or at least Evanston’s need to reserve
its rescission right (as the concurrence would allow).
The concurrence would hold that a “promptly issued” reservation-of-
rights letter followed by a “reasonable investigation (if necessary)” is
immediate enough under Putney. Concurrence at 2. Yet even giving effect to
Evanston’s reservation of rights and accepting that the letter was “promptly
issued,” the concurrence offers no limiting principle when the insurer
completes its investigation before reserving its rights. Evanston began
investigating Donisthorpe’s misconduct back in March 2017, not when it
reserved its rights in January 2018. In other words, it did not need the ensuing
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five months to continue exploring its options. The record is silent about what
Evanston did between January and June, but to us, that five-month delay looks
like “meander[ing],” “dragg[ing] its feet,” and “sleep[ing] on its rights.”
Concurrence at 3–4, 6. So the attempted rescission was still inexplicably late.
Nor does Agnew draw a bright line about how much delay is permissible.
The Agnew plaintiffs faced significant obstacles in their quest to rescind a
warranty deed. By the time the plaintiffs learned about the defendants’
misrepresentations, the plaintiffs had left New Mexico and were “concerned
with [other] affairs.” Agnew, 278 P.2d at 67. And the plaintiffs had to wait for a
third party to default on a promissory note before they could even take over the
property. Id. The court thus concluded that these obstacles, along with the
nature of the defendants’ misrepresentations, excused the six-month delay:
[T]he [defendants’] misrepresentations of fact . . . by their very na-
ture placed plaintiffs in a position so complex and so difficult to
evaluate that the time required by them to return to New Mexico,
employ counsel and explore the possibilities of salvaging this trans-
action cannot be deemed an inordinate delay in the exercise of their
right to rescission.
Id. We read Agnew to hold that circumstances outside a party’s control can
excuse a delayed rescission.
Here, by contrast, Evanston faced few (if any) obstacles in rescinding,
especially once it learned in December 2017 that Donisthorpe had pleaded
guilty. Perhaps Donisthorpe’s misconduct was also “complex” and “difficult to
evaluate.” Id. But this doesn’t explain the delay after Evanston sent the
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reservation-of-rights letter—by then, Evanston had all the information it needed
to rescind. Putney’s immediacy requirement required Evanston to promptly
exercise its rights no later than when it “discover[ed] the fraud.” Putney, 120 P.
at 723. Still, Evanston did not try to rescind until June 2018, five months later.
Putney and common sense tell us that this was too late.
Because the undisputed facts establish that Evanston waited too long to
rescind the policy, we hold that the district court did not err in concluding that
Putney effectively barred Evanston’s rescission claim. 7
II. Exclusion P
We turn now to Exclusion P and whether the district court erred by not
applying it according to its unambiguously broad terms. We hold that the
district court so erred.
In New Mexico, unambiguous contract provisions are applied, not
interpreted. Richardson v. Farmers Ins. Co., 811 P.2d 571, 572 (N.M. 1991)
(citing McKinney v. Davis, 503 P.2d 332, 333 (N.M. 1972)). Though New
Mexico courts generally interpret exclusionary language narrowly, they do not
apply this principle “to override the clear and unambiguous terms of an
exclusion.” Grisham v. Allstate Ins. Co., 992 P.2d 891, 894 (N.M. Ct. App.
1999) (citations omitted). Insurance clauses are ambiguous only if they are
7
At oral argument, Evanston’s counsel conceded that the adverse-interest
exception is moot if Evanston’s rescission was untimely. Because we hold that
rescission was untimely, we do not reach this exception.
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“reasonably and fairly susceptible of different constructions.” Knowles v.
United Servs. Auto. Ass’n, 832 P.2d 394, 396 (N.M. 1992) (quoting Sanchez v.
Herrera, 783 P.2d 465, 469 (N.M. 1989)). The New Mexico Supreme Court has
twice read “arising from” in an exclusionary clause to be unambiguous. Lopez
v. N.M. Pub. Sch. Ins. Auth., 870 P.2d 745, 747 (N.M. 1994); Askew v. Miller
Mut. Fire Ins. Co. of Tex., 522 P.2d 574, 575 (N.M. 1974).
Applying these straightforward principles of New Mexico law, Exclusion
P is unambiguous. The exclusion bars coverage for any claim “[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. The only
phrase susceptible to potential ambiguity is “arising out of.” 8 But as stated
above, New Mexico courts provide a clear answer about that phrase’s meaning:
“[T]he words ‘arising out of ’ are very broad, general and comprehensive terms,
ordinarily understood to mean ‘originating from,’ ‘having its origin in,’
‘growing out of ’ or ‘flowing from.’” Krieger v. Wilson Corp., 131 P.3d 661, 666
(N.M. Ct. App. 2005) (citing Baca v. N.M. State Highway Dep’t, 486 P.2d 625,
628 (N.M. Ct. App. 1971)). This broad reading of “arising out of” applies
equally to exclusionary clauses. See, e.g., Baca, 486 P.2d at 628; see also Am.
Nat’l Prop. & Cas. Co. v. United Specialty Ins. Co., 592 F. App’x 730, 742
8
The parties do not discuss whether Exclusion P’s other phrasal verb,
“based upon,” applies here. Because we need not define “based upon” to reach
our conclusion, we express no opinion on its plain meaning.
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(10th Cir. 2014) (unpublished) (“[W]e have every reason to suppose that New
Mexico law applies the same broad definition of ‘arising out of ’ in the
exclusion context as in the coverage context.”).
True, the New Mexico Supreme Court has not weighed in on that phrase’s
precise meaning. But we expect that the New Mexico Supreme Court would
adopt the meaning uniformly used by the New Mexico Court of Appeals. E.g.,
Krieger, 131 P.3d at 666; City of Albuquerque v. BPLW Architects & Eng’rs,
Inc., 213 P.3d 1146, 1153 (N.M. Ct. App. 2009). Indeed, we have noted the
same when sitting in diversity and applying New Mexico law. See Am. Nat’l
Prop. & Cas. Co., 592 F. App’x at 741 (remarking that under New Mexico law,
“‘arising out of ’ is not facially ambiguous just because it appears in an
exclusion”). We conclude that Exclusion P is unambiguous.
Because the unambiguous plain language controls, we apply Exclusion P
as written. Richardson, 811 P.2d at 572. Here, the class-action negligence
claims arose out of Donisthorpe’s commingling. “In determining the
applicability of [an] exclusion, [the] focus must be on the origin of the
damages, not the legal theory asserted for recovery.” Lopez, 870 P.2d at 747
(citations omitted). Within their negligence claims, the class-action plaintiffs
incorporate allegations that track the admissions from Donisthorpe’s guilty
plea. They allege that Desert State and Bennett mismanaged client accounts and
failed to monitor the company’s financial health, in turn causing the former
clients to suffer financial damage. And they accuse Bennett of “exercis[ing]
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little to no oversight of” Donisthorpe. App. vol. 1, at 76. The legal theory
undergirding the class-action claims is Bennett’s alleged negligence, but the
origin of the damages arises out of Donisthorpe’s commingling. In other words,
the claims “originate from, have their origin in, grow out of, [or else] flow
from” Donisthorpe’s misconduct. Krieger, 131 P.3d at 666 (cleaned up).
Exclusion P must apply, excluding coverage for the class-action negligence
claims against Moya and Bennett.
In concluding otherwise, the district court exceeded its authority by
looking beyond Exclusion P’s text. It began by correctly finding Exclusion P
unambiguous. This conclusion should have ended the court’s analysis, and it
should have applied the exclusion as written. Yet it pressed on, noting that New
Mexico courts hadn’t specifically addressed whether exclusions like
Exclusion P “reach[] the type of negligence which [Desert State’s former]
clients have alleged” in the class-action complaint. Evanston, 434 F. Supp. 3d
at 1105. It proceeded to survey how courts in other jurisdictions had
approached the question. A clear majority view emerged: Similarly drafted
provisions exclude coverage for negligence claims arising out of intentional
misconduct, even if the negligent individuals did not commit that misconduct.
The minority approach, adopted by only New York and Pennsylvania, provides
that “negligence claims against insureds do not necessarily ‘arise out of ’ other
insureds’ related and excluded acts.” Id. at 1112 (citation omitted).
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In predicting that the New Mexico Supreme Court would join the
minority, the district court cited the principle that policy exclusions are
generally read narrowly. It relied on four cases—each involving ambiguities—
to conclude that New Mexico wouldn’t read Exclusion P “broadly to cover
claims that Evanston Insurance could have foreseen and could have expressly
disclaimed.” Id. (citing Rummel v. Lexington Ins. Co., 945 P.2d 970 (N.M.
1997); United Nuclear Corp. v. Allstate Ins. Co., 285 P.3d 644 (N.M. 2012);
King v. Travelers Ins. Co., 505 P.2d 1226 (N.M. 1973); and Knowles, 832 P.2d
394). And the court faulted Evanston for writing “stronger exclusionary clauses
in other insurance contracts,” which proved that Evanston could “clarify the
issue, if [it] wanted, with the stroke of a pen.” Id. at 1112 & n.42 (citing
Thames v. Evanston Ins. Co., No. 13-CV-425-PJC, 2015 WL 7272214 (N.D.
Okla. Nov. 17, 2015)). 9
9
That Evanston has drafted a different exclusionary clause does not show
that the Desert State clause is somehow deficient. See O’Brien v. Progressive N.
Ins. Co., 785 A.2d 281, 290 (Del. 2001) (“The fact that Progressive chose to
make a clear policy provision [clearer] as a remedial measure to this litigation
may not be used as evidence of an admission of either ambiguity or acceptance
of Appellants’ interpretation of the policy.”); Tzung v. State Farm Fire & Cas.
Co., 873 F.2d 1338, 1341 (9th Cir. 1989) (“We reject the Tzungs’ reliance on
the revised policy for its negative inferences. Not only do we believe that
accepting such an argument would discourage remedial action and thereby
violate public policy, but we also believe that even though the revised policy
excludes all forms of third-party negligence[,] it does not mean that the former
policy does not exclude some forms of third-party negligence . . . .” (citation
and footnote omitted)).
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The district court made four mistakes by choosing this course. First, the
four cases on which the court relied involved ambiguous contract terms. Unlike
for unambiguous terms (like in Exclusion P), which courts apply without
interpreting, Richardson, 811 P.2d at 572, courts “construe ambiguous language
and . . . give it sensible construction.” State v. Johnson, 954 P.2d 79, 85 (N.M.
Ct. App. 1997) (citations omitted). Because those four cases applied the distinct
analytical framework for ambiguous terms, the district court erred in basing its
Erie prediction on them. Second, the court applied the narrow-construction
principle “to override the clear and unambiguous terms of an exclusion”—
exactly what Grisham instructs New Mexico courts not to do. 992 P.2d at 894
(citations omitted). Third, the court also cited Baca and American National
Property & Casualty Co., yet seemingly neglected both when predicting that
the New Mexico Supreme Court would narrowly read Exclusion P. Finally,
though the court recognized that Exclusion P was unambiguous and “arising out
of” was broad, it abandoned Exclusion P’s plain language by refusing to apply
it as written.
We predict that, consistent with the majority view, the New Mexico
Supreme Court would construe Exclusion P as applying to the class-action
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negligence claims. Thus, Evanston does not have a duty to defend Moya and
Bennett under the policy. 10
CONCLUSION
On rescission, we affirm the district court. But we reverse the district
court’s ruling on Exclusion P and remand the case with instructions to enter
judgment for Evanston and against Moya and Bennett.
10
Because we conclude that Exclusion P applies, we do not address
whether the no-prior-knowledge condition also precludes coverage for Moya
and Bennett.
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21-2145, Evanston Insurance Company v. Desert State Life Management, et al.
TYMKOVICH, Circuit Judge, concurring.
I am pleased to join the bulk of the majority opinion. But I would conclude that
Evanston properly rescinded the insurance contract after timely notice and investigation
of the underlying facts and circumstances.
The district court held that Evanston waited too long to rescind its insurance
policy. The court relied on Putney v. Schmidt, where the New Mexico Supreme Court
held that a party seeking contract rescission must “immediately, upon discovering the
fraud,” return whatever it received under the contract. 120 P. 720, 723 (N.M. 1911). If a
party fails to act immediately, it affirms the contract despite the fraud. Id. Since
Evanston waited six months after learning of Donisthorpe’s fraud to return Desert State’s
insurance premium and rescind the insurance policy, the district court found it flunked
the immediacy requirement.
But importantly, Evanston also sent Desert State a “reservation of rights” letter
shortly after discovering evidence of the fraud in late 2017. In a letter dated January 5,
2018, Evanston stated,
After careful consideration, Evanston has agreed to provide
you a defense for claims asserted against you in the lawsuits
filed by DSLM’s clients, under a full and complete
reservation of rights . . . It appears from the Plea Agreement
that Mr. Donisthorpe knew of facts, situations or incidents
that might afford grounds for a claim against DSLM at the
time he applied for the insurance on behalf of DSLM. Based
on these admissions, his responses on the application
constitute material misrepresentations that could provide
grounds to rescind the Policy entirely. Evanston will
continue to investigate this matter, as indicated above, under
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a full and complete reservation of rights. Evanston reserves
all rights, terms and conditions of the Policy referred to above
including, but not limited to, the right to deny coverage based
upon the Policy provisions quoted above or seek rescission of
the Policy based on fraud or material misrepresentation.
Evanston’s Reservation of Rights, Evanston Ins. Co. v. Desert State Life Mgmt., No.
1:18-cv-00654-JB-KK (D.N.M.), ECF # 106-1 at 1–12 (filed Aug. 9, 2019) (emphasis
supplied). Evanston maintains this was enough to satisfy the immediacy requirement, but
the district court did not address the argument. New Mexico courts have not addressed it
either.
In my view, a reservation of rights letter promptly issued and followed by a
reasonable investigation (if necessary) satisfies the immediacy requirement. The
investigation must last no longer than necessary to establish a firm basis for rescission. If
the investigating party needlessly stretches its investigation, it would fail the immediacy
requirement.
In New Mexico, a “[m]isrepresentation of a material fact, even if innocently made,
will entitle the party who has justifiably relied thereon to rescind the contract.” Ledbetter
v. Webb, 711 P.2d 874, 877 (N.M. 1985). But when a party discovers the fraud, it must
“immediately” restore the value received (here, the insurance premium) to preserve the
right to rescind. Putney, 120 P. at 720. If it does not act immediately and “play[s] fast
and loose,” New Mexico law treats its behavior as affirming the contract instead. Reed v.
Rogers, 141 P. 611, 613 (N.M. 1914) (quoting Grymes v. Sanders, 93 U.S. 55, 62
(1876)).
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The term “immediately,” however, does not accurately describe what the
requirement demands. The New Mexico Supreme Court applies Putney’s “immediacy”
requirement in a fact-sensitive manner. For example, the Supreme Court found a six-
month delay between a party’s discovery of fraud and its rescission attempt sufficiently
immediate. The court recognized that the party needed to “employ counsel and explore
the possibilities of salvaging this transaction,” and noted the party was “in a position . . .
complex and difficult to evaluate.” Agnew v. Landers, 278 P.2d 970, 978 (N.M. 1954).
I see one primary justification for the immediacy requirement: the doctrine
encourages prompt investigation and resolution of conflicts arising from contract fraud.
Put differently, it vindicates the principle that “[t]he law will not permit a party to sit idly
by and await the results which, if favorable, he will receive the benefit of, but if
unfavorable, ask rescission.” Yucca Min. & Petroleum Co. v. Howard C. Phillips Oil
Co., 365 P.2d 925, 928 (N.M. 1961). When a party sleeps on its rights, the immediacy
requirement takes them away.
The common law of various other states also establishes an immediacy
requirement, or something close to it. Courts in these states also treat the requirement as
fact sensitive. See, e.g., Danto v. Charles C. Robbins, Inc., 230 N.W. 188, 190 (Mich.
1930) (“[A] person claiming to be defrauded must elect to rescind, or not, immediately
after he discovers the fraud. By waiting more than a reasonable length of time after he
discovers the fraud, he condones it.”); Long v. Int’l Vending Mach. Co., 139 S.W. 819,
820 (Mo. Ct. App. 1911) (the immediacy requirement allows for “a reasonable time . . .
to do the things necessary in order to rescind”); Cont’l Cas. Co. v. Marshall Granger &
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Co., 6 F. Supp. 3d 380, 394 (S.D.N.Y. 2014) (“An insurer need not, however, make a
rushed and uninformed decision; it is entitled to a reasonable period of time in which to
investigate the potential basis for rescission.”).
In my view, a timely reservation of rights letter paired with a prompt investigation
satisfies the immediacy requirement under New Mexico law. It encourages prompt
investigation and resolution of contract fraud, and it punishes those who sleep on their
rights. It follows that the requirement should reward a reservation of rights: such notice
invites the scrutinized party into the process of resolving a simmering dispute and brings
the conflict—and perhaps other relevant facts—to the surface.
The immediacy requirement also necessarily mitigates potential prejudice to the
party suspected of fraud. By requiring a prompt investigation, the requirement makes it
more likely that exonerating facts will be brought to the surface, either by the
investigating party or the suspected party. And it prevents the suspected party from
falling into a false sense of security. See, e.g., Illinois State Bar Ass’n Mut. Ins. Co. v.
Corgeis Ins. Co., 821 N.E.2d 706, 717–18 (Ill. App. Ct. 2004) (“As stated above, the
right of rescission must be exercised promptly . . . This reservation-of-rights letter made
[the insured] aware . . . that [the insurer] was not waiving anything.”) (internal citations
and quotations omitted).
Of course, a reservation of rights is not a blank check for the investigating party to
meander. Nor will a late-arriving reservation of rights letter do the trick. Finding
otherwise would cut against the goal of swiftly resolving fraud disputes and preventing
the suspected party from falling into a false sense of security. That is why the reservation
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must be issued quickly and the subsequent investigation must last no longer than
necessary. And in keeping with common law developments, “quickly” and “no longer
than necessary” must be interpreted with an eye to the relevant facts of each case. These
facts include, but are not limited to, the complexity of the underlying fraud, external
circumstances bearing on the investigation’s timeliness, and a showing of prejudice due
to the delay by the party suspected of fraud.
Based on the record in this case, I have little trouble concluding Evanston satisfied
the immediacy requirement.
According to the district court, the Desert State clients offered as an undisputed
material fact (and Evanston did not object) that Evanston concluded Donisthorpe made
material misrepresentations on the applications when it discovered Donisthorpe’s guilty
plea. Summary Judgment Order, Evanston Insurance Co. v. Desert State Life Mgmt.,
No. 1:18-cv-00654-JB-KK (D.N.M.), ECF # 180 at 5 (filed Mar. 23, 2020). While I
recognize that reasonable minds might differ on when Evanston “discovered the fraud,” I
read the district court’s order to find that Evanston “discovered the fraud” in early
December and accept that finding.
From there, I have little trouble concluding that Evanston satisfied the
requirement. The immediacy requirement was triggered in early December. Evanston
issued its reservation of rights about one month later and began to investigate whether
Donisthorpe’s plea gave sufficient grounds for rescission. And about five months after
tolling the requirement, it rescinded. Like the New Mexico Supreme Court, I find that
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length of time unremarkable. See Agnew, 278 P.2d at 978 (finding that a six-month delay
between a party’s discovery of fraud and its rescission passed the immediacy
requirement).
Here, the facts do not suggest that Evanston dragged its feet and there is no
showing of prejudice from the investigation. I therefore would have accepted Evanston’s
rescission of the insurance contract.
6