Customer Funds Exclusion Case

In the case of Charles E. Bethel II and Jennifer Kalsow Frantz vs Darwin Select Insurance Company (available here) the 8th US Circuit Court of Appeals in St. Louis has upheld a ruling against the insured on a coverage dispute revolving around coverage over misused escrow funds.

St. Paul Minnesota based Zen Title LLC purchased an errors and omissions policy in 2007 from Darwin Select Insurance Company (which was purchased by Allied World Insurance Company in 2008). Zen’s E&O policy included a standard grant of coverage agreeing to defend and indemnify the insured for any negligent act, error, omission, misstatement, misleading statement, neglect or breach of duty… in the performance of or failure to perform Professional Services. The policy also included a standard customer funds exclusion – excluding any claim arising from any loss, disappearance, pilferage or shortage of, or commingling or improper use of, or failure to segregate or safeguard, any client or customer funds, monies, or securities.

Zen Title had been acting as an agent of United General Title Insurance Company, which terminated their contract in August 2007 and sued over misuse of escrowed funds. When Zen tendered this claim to their insurer, Darwin, for defense the company declined to provide coverage.  The matter was settled in 2009 and in 2011.  Minority owners of Zen sued Darwin to recover their expenses since they were not part of the misuse and therefore should have been protected under the “innocent insured” provision. Darwin argued otherwise.

The lower court ruled in Darwin’s favor and the district appeals court upheld it – citing that the policy language excluded coverage for allegation of fraud altogether, regardless of guilt.

This case highlights a number of title agent insurance issues that all firms should be aware of:

– First of all, it is important to understand and read the title agent errors and omissions insurance policy closely.  While the exclusion in question is common, many policies contain additional exclusions that are not as commonplace.  Since each insurance company has their own policy wording, it is important to engage with an experienced broker who will be able to explain and compare each option.

– Secondly, from a risk management perspective, strong internal controls are imperative.  This case shows how owners of a company – even minority shareholders – can become entangled in legal issues they have nothing to do with.  Simple protocols, independent oversight and verifiable procedures can quickly detect fraud before it becomes a bigger issue.

– Thirdly, it is important for title agencies to understand what insurance policies are needed.  Errors or mistakes in a title agent’s, abstractor’s or escrow agent’s professional services are covered by E&O insurance.  Theft of money by an employee of the firm would be covered by fidelity insurance (Crime insurance).  A firm needs to understand the risks they face and what insurance policy can protect them.

When looking for title agent insurance, this case highlights the need to understand all aspects of the firm’s operations and insurance requirements. Contact to discuss better protecting your firm from the rising tide of litigation risk.