D&O Insurer Dodges Coverage for $4.9M Embezzlement Scheme

January 4, 2023

A directors and officers insurer has no duty to defend a New Mexico financial organization from litigation filed after its former chief executive officer was convicted of stealing $4.9 million from clients, a federal appellate court ruled.

A panel of the 10th Circuit Court of Appeals decided Thursday that a wrongful acts exclusion in the professional liability policy barred coverage for negligence claims against directors of Desert State Life Management even though CEO Paul Donisthorpe acted alone when he embezzled the funds.

The policy clearly excluded coverage for claims “arising out of any conversion, misappropriation, commingling [of] or defalcation of funds or property.” The district court erred by failing to grant Evanston Insurance Co. summary judgment on that point, the panel said.

“Because the unambiguous plain language controls, we apply Exclusion P as written,” the opinion says, citing a previous case. “Here, the class-action negligence claims arose out of Donisthorpe’s commingling.”

Desert State, a trust corporation, managed finances for elderly and disabled clients. After a March 2017 investigation, state regulators declared the organization to be financially unsound. In August 2017, the state appointed Christopher Moya as receiver to wind down the corporation’s affairs.

In November 2017, Donisthorpe pleaded guilty to wire fraud and money laundering charges filed by the US Attorney’s Office in Albuquerque. He was sentenced to eight to 12 years in prison and ordered to pay $6.8 million in restitution and a $4.8 million money judgment.

A group of seven former Desert State clients filed a class-action lawsuit against Moya, Desert State and its directors. Moya asked Evanston to defend and indemnify the organization.

Evanston agreed initially to defend, under a reservation of rights. In June 2018, the insurer notified Moya that it planned to rescind the professional liability policy issued to Desert State because of misstatements by Donisthorpe when he filled out the application for insurance.

Evanston filed a lawsuit in the US District Court for New Mexico seeking to rescind the policy or, in the alternative, a declaratory judgment that it owed no coverage.

After a bench trial, US District Court Judge James O. Browning ruled that by failing to take action until six months after learning about Donisthorpe’s guilty plea, Evanston had forfeited its right to rescind the policy. Browning also ruled that the term “arising out of” in Exclusion P was ambiguous, so Evanston was required to defend and indemnify Desert State.

The judge surveyed decisions made by other courts and found that a majority had ruled that coverage was excluded by similarly drafted provisions, even if the negligent individuals did not commit the alleged misconduct. However, a minority approach, adopted by only New York and Pennsylvania, held that “negligence claims against insureds do not necessarily ‘arise out of’ other insureds’ related and excluded acts.”

The 10th Circuit panel agreed that Evanston had “sat on its rights” too long to rescind the policy, but disagreed with the trial court’s call on whether the exclusion was ambiguous. The opinion said even though the New Mexico Supreme Court has not ruled on the precise meaning of “arising out of,” the New Mexico Court of Appeals has ruled in similar cases that the term is not “facially ambiguous.”

“Because the unambiguous plain language controls, we apply Exclusion P as written,” the opinion says.

Donisthrope, now 67, is serving his time at the Federal Bureau of Prisons Englewood facility, a low-security institution in Littleton, Colorado. He is scheduled to be released on May 13, 2028.

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