Insurance Liability: Don't Make an Error about an Omission

Article excerpt

In the late 1980s Canutillo Independent School District, which is a property-poor school system near El Paso, Texas, purchased a "School Leaders Errors and Omissions Policy" from National Union Fire Insurance Company. Prior to the purchase, a representative of National Union sent a letter to the district stating that the policy covered, among other things, "[a]lleged violations of federal or state constitutional civil rights."

Specifically, the policy expressly obligated National Union to defend the district and indemnify it for any damages that it became legally obligated to pay as a result of claims brought against it by third parties for any "Wrongful Act . . . of the Insured or of any other person for whose actions the Insured is legally responsible."

Yet the policy also included express exclusions for 1) "any claim involving allegations of . . . criminal acts or omissions," 2) "any claims arising out of. . . assault or battery," and 3) "any claim arising out of bodily injury to . . . any person."

In 1991 the parents of five second-grade girls alleged that Tony Perales, a health and physical education teacher at Canutillo Elementary School, had sexually abused their children. Perales was subsequently tried and convicted for sexual molestations of the five girls.

Notifying National Union of the abuse, the district requested the insurance company's legal defense for any potential lawsuits by the families of the victims. Before initiating litigation, the parents offered to settle all claims against the district for $30,000 per family, or a total of $150,000. When the district rejected the settlement, the families filed suit in federal court, as-setting both federal constitutional civil rights and state common law tort claims.

After securing an expert opinion from specialized private counsel, the company refused to assume representation, expressly relying on the policy's exclusions for claims arising out of criminal conduct, assault and battery, and bodily injury. Although its legal expert recommended that the insurance company file suit to obtain a declaratory judgment that its denial of coverage was proper, the company offered to defend the district on the condition that the district waive any bad-faith claims against it. The district, however, declined the offer and proceeded to defend the litigation without the insurer's representation.

The plaintiff parents amended their original complaint twice. The first amended complaint alleged five causes of action, including violation of the children's 14th Amendment rights, based on the district's failure to prevent Perales' sexual abuse; negligence and gross negligence, based on the same failure; and intentional infliction of emotional distress. The second amended complaint abandoned the federal constitutional civil rights claim and the state law tort claims against the district, seeking damages and injunctive relief from the district under Title IX, which is federal legislation prohibiting sex discrimination. The Title IX claim was based on the district's failure to prevent Perales' abuse and to implement grievance procedures as required under the Title IX regulations.

As a result of the amendments, the company again consulted its expert. He opined that the policy did not cover suits for money damages arising out of Perales' sexual abuse, but that it did obligate the company to defend the district on the basis of nonpecuniary claims asserted under Title IX. Thereafter, the company assumed the district's defense for the remainder of the litigation, while reserving the right to seek a declaratory judgment with respect to its duty to indemnify the district for any monetary settlement or award.

On the eve of the trial, the district settled with the plaintiff families for a total of $1,040,000. The district made an initial payment of $40,000, and the insurance company paid the remaining $1 million based on a condition in the settlement agreement reserving its right to recover this amount via a subsequent declaratory judgment suit. …