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H&R Block, Inc. v. American Internat'l Specialty Lines Ins. Co.: INSURANCE - prior acts coverage or not and class actions

United States Court of Appeals
No. 07-3156
H&R Block, Inc., *
Plaintiff - Appellant, *
v. * Appeal from the United States
* District Court for the
American International Specialty * Western District of Missouri.
Lines Insurance Company; Lexington *
Insurance Company, *
Defendants - Appellees. *
Submitted: May 14, 2008
Filed: November 14, 2008
Before LOKEN, Chief Judge, BEAM and BYE, Circuit Judges.
LOKEN, Chief Judge.
This diversity action raises an insurance coverage issue of first impression:
whether class actions filed against nationwide tax preparer H&R Block (Block)
asserting a variety of statutory and common law claims arising out of Blocks Refund
Anticipation Loan (RAL) program are excluded from prior acts coverage under
professional liability claims made insurance policies because other class actions
1The HONORABLE SCOTT O. WRIGHT, United States District Judge for the
Western District of Missouri. On the question we consider on appeal, Judge Wright
followed the earlier ruling of the HONORABLE ORTRIE D. SMITH, United States
District Judge for the Western District of Missouri, who later recused from the case
when he inherited stock in one of the parties.
asserting similar claims were filed prior to the policy periods. The district court1
granted summary judgment to the insurers, American International Specialty Lines
Insurance Co. (AISLIC) and Lexington Insurance Co. (Lexington). Block
appeals. Under Missouri law, which governs this dispute, [t]he rules of contract
construction govern insurance policies. Blair v. Perry County Mut. Ins. Co., 118
S.W.3d 605, 606 (Mo. banc 2003). Reviewing the courts interpretation of the
policies and its grant of summary judgment de novo, we affirm. Todd v. Mo. United
Sch. Ins. Council, 223 S.W.3d 156, 160 (Mo. banc 2007) (standard of review).
I. Background
When the Internal Revenue Service encouraged the electronic filing of federal
income tax returns in the late 1980s, Block developed and offered to its clients an
electronic filing service, Rapid Refund, and soon added the RAL program for clients
who did not want to wait for their refund checks. RALs are short-term loans
processed by Block, funded by third-party banks, and repaid with the borrowers
refund proceeds. Block processed more than 15,000,000 RALs from 1993-1996. Not
surprisingly, this marketing success spawned a flurry of consumer class action
lawsuits in state and federal courts, resulting in this coverage dispute.
Blocks Professional Liability Coverages. During the years in question,
Block and its affiliates obtained ,000,000 in annual primary professional liability
insurance coverage from affiliated insurers under four identical claims made policies
that were fronted by Block, meaning that Block and its affiliates administered
claims, paid amounts due under the policies, and reinsured the primary insurers for
2Use of a follow form clause is advantageous . . . because it . . . . allows an
insured to have coverage for the same set of potential losses (and with the same set of
exceptions) in each layer of the insurance program. Allmerica Fin. Corp. v. Certain
Underwriters at Lloyds, 871 N.E.2d 418, 426 (Mass. 2007).
their entire ,000,000 exposure. The policies also required Block to pay a Self-
Insured Retention of ,500 per wrongful act, a provision that generated sharp
dispute in the district court but is not an issue we need consider on appeal.
On top of this primary coverage, Block purchased excess professional liability
coverage. Evanston Insurance Company provided ,000,000 in annual excess
coverage from August 1992 to August 1998. In May 1996, Block purchased the two
additional layers of excess coverage here at issue. Between May 1996 and August
1997, AISLIC provided ,000,000 of second-layer excess coverage, and Lexington
provided ,000,000 of third-layer excess coverage. Between August 1997 and
August 1998, AISLIC provided both the second- and third-layer excess coverages,
again with a ,000,000 total limit. The excess policies followed form, meaning
that the coverages and exclusions were the same as those in the primary policies.2
The primary and excess policies were claims made policies. They covered
errors, omissions or negligent acts (referred to as wrongful acts) committed in the
conduct of Blocks Specified Operations, which were defined as [t]he performance
of tax services, including, but not limited to . . . processing applications for refund
anticipation loans. The policies basic coverage was for claims first made . . . while
this Policy is in effect . . . based on a wrongful act that occurred while this Policy was
in effect, provided Block notified the primary insurer of the claim while this Policy
is in effect. By contrast, occurrence policies generally provide coverage for an
event that occurs during the policy period, regardless of when a claim is asserted.
Wittner, Poger, Rosenblum & Spewak, P.C. v. Bar Plan Mut. Ins. Co., 969 S.W.2d
749, 752 (Mo. banc 1998).
Relevant to this appeal are two provisions that extended this basic coverage to
include Prior Acts -- claims based on a wrongful act that occurred before the
policys effective date, provided that Block had no knowledge of the prior wrongful
act on the effective date of this Policy, nor any reasonable way to foresee that a claim
might be brought, and Reported Acts -- claims first made after the policy period
ended provided Block has reasonable knowledge that a wrongful act occurred and
a claim might be made, and reported [t]he suspected wrongful act and what loss
or damage may result during the policy period.
The Class Action Litigation. The first class action complaint on behalf of
RAL program clients was filed in 1990. When Block purchased second- and thirdlayer
excess coverages from AISLIC and Lexington in May 1996, eleven class action
lawsuits had been filed in various state and federal courts across the nation, asserting
a variety of statutory and common law damage claims based on allegations that Block
failed to adequately disclose finance charges, charged usurious and unconscionable
interest rates, failed to disclose it received kickbacks from the lending banks, misled
clients as to the nature of the RAL loans, and breached a fiduciary duty to its clients
by peddling imprudent, high-interest loans. One recent case was a nationwide class
action filed in the Western District of Missouri in November 1995 asserting causes of
action under the federal Truth in Lending Act, state statutes prohibiting unfair or
deceptive acts and practices, state usury statutes, and common law fraud and negligent
misrepresentation. No class had been certified, two complaints had been dismissed
with prejudice, one case settled for ,000, another settled for 0,000, and the rest
were still pending. Block disclosed all this litigation to AISLIC and Lexington before
they issued excess professional liability policies in May 1996.
Eleven more class actions were filed in federal and state courts between May
1996 and August 1998, when the AISLIC and Lexington excess policies were in
effect. The fact allegations and legal theories in these suits mirrored those of the prior
suits. By far the most significant was a state-wide class action filed in a Texas state
court in August 1996. More than six years later, when the trial judge certified a class
and ruled that Block had intentionally violated a fiduciary duty to all class members,
Block settled the case by giving each participating class member discount coupons on
future Block services and paying ,900,000 to plaintiffs attorneys. Other class
action cases filed during the policy periods settled for .5 million, 1,000,
0,000, 5,000, ,700, and 0.
Procedural History. Blocks primary insurers -- who had no financial stake
in the issue -- agreed with Block that the class action lawsuits filed between May 1996
and August 1998 were covered by the primary policies. Block received ,000,000
in primary policy proceeds for each annual policy period. Applying the same
coverage provisions in the primary policies, the excess liability insurers -- Evanston,
AISLIC, and Lexington -- denied additional coverage on multiple grounds. Block
then commenced this diversity action seeking a declaratory judgment that the insurers
must defend and indemnify Block up to the excess policies limits for RAL suits filed
during the applicable policy periods. After two years of discovery, the parties filed
cross motions for summary judgment on various issues.
Applying the Prior Acts coverage provision, the district court ruled in an
interlocutory order that the AISLIC and Lexington excess policies provided no
coverage for RAL class action claims based on wrongful acts committed before the
effective date of the policies because in May 1996, when the first two policies began,
at least four class action complaints had been filed. The court explained:
The Primary Policies . . . provided coverage for claims based on
wrongful acts occurring before the effective date of the policy if [Block]
both (1) lacked knowledge of the wrongful action and (2) lacked a
reasonable way to foresee that a claim might be brought. The clause
does not require [Block] to know the identity of the person(s) presenting
the claim. On this record [Block] had reason to know that additional
claims would be filed by somebody when it obtained coverage.
The court did not apply this reasoning to Blocks claims against Evanston because it
began providing excess liability coverage in 1992. The court also ruled that the excess
insurers have no duty to defend, only to reimburse Block for costs incurred in
defending covered claims, subject to the policy limits (an issue Block concedes). The
court did not issue a final judgment, commenting the parties have more work to do.
After Evanston and Block entered into a separate settlement, AISLIC and Lexington
renewed their summary judgment motions, which the district court granted on the
basis of its prior construction of the Prior Acts provision. This appeal followed.
II. Discussion
The claims made policies provided coverage for Prior Acts if Block had no
knowledge of the prior wrongful act on the effective date of this Policy, nor any
reasonable way to foresee that a claim might be brought. Block argues that this
provision should be construed to provide coverage for prior acts unless Block could
reasonably foresee a specific claimant making a claim based on a specific alleged
wrongful act known to Block before the inception of the policy. Applying this
standard, Block asserts that all class action lawsuits filed during the policy periods fall
within the Prior Acts coverages because it did not know before May 1996 (a) the
identity of the plaintiffs in those cases, (b) the specific wrongful acts upon which
those plaintiffs based their claims, (c) which tax season was involved, or (d) at which
facility or in which jurisdiction the alleged wrongdoing took place. AISLIC and
Lexington argue that the RAL lawsuits filed before May 1996 alleged the same facts
and legal theories and therefore gave Block both knowledge of the wrongful acts and
a reasonable basis to foresee that additional class action claims might be brought.
In most cases that have considered this issue under the prior acts provisions of
claims made policies, the insured knew during the prior policy period that specific
individuals considered themselves wronged; the question was whether the insured had
reasonable notice that a claim based on those grievances would later be asserted. In
Wittner, Poger, for example, the court held that a law firm had reasonable notice of
a likely claim when a client wrote letters complaining that the firms negligence
caused financial injury when a case was dismissed. The clients claim was not
covered under a subsequent claims made policy, the court explained, because this
prior knowledge gave the firm a basis . . . to believe that a claim might arise. 969
S.W.2d at 753. Likewise, in City of Brentwood v. Northland Ins. Co., 397 F. Supp.
2d 1143, 1148 (E.D. Mo. 2005), the court held that an insured had a basis to believe
its prior act could give rise to a claim when an employees charge of discrimination
was pending before federal and state employment discrimination agencies at the
inception of the policy period. By contrast, in Fremont Indem. Co. v. Lawton-Byrne-
Bruner Ins. Agency Co., 701 S.W.2d 737, 742-43 (Mo. App. 1985), the court held
there was prior acts coverage because a clients prior letter to a regulatory agency
requesting an investigation did not give the insured reasonable notice of a likely claim
when all facts known at the policys inception indicated that the matters raised in the
letter were resolved.
A more unusual case -- one on which Block relies -- was Redeemer Covenant
Church of Brooklyn Park v. Church Mut. Ins. Co., 567 N.W.2d 71 (Minn. App. 1997).
Before the claims made policys inception, the insured church was sued by seven
members who alleged sexual abuse by a former pastor. During the policy period,
eight more lawsuits alleging similar abuse were filed. The court held that these later
claims were covered prior acts because, at the policys inception -
[n]o claims had been filed for 15 months, and none of the [later]
claimants had indicated any intent to file a claim. While [the church]
was aware of [the pastors] abuse and that the abuse had led to lawsuits,
it had no knowledge that any 1991 claimant proposed to sue [the church]
for having negligently hired or supervised [the pastor].
Id. at 78. The principle reflected in this decision is surely sound, for the very purpose
of insurance is to protect against the risk of unknown but not unexpected loss. For
example, a claim that a Block agent negligently prepared a clients tax return would
qualify for Prior Acts coverage even though Block had been sued for the same type
of negligence by other clients prior to the policys inception. Cf. Allmerica Fin. Corp.
v. Certain Underwriters at Lloyds, 871 N.E.2d 418, 430 (Mass. 2007). The difficult
question in this case is how to apply this principle to class actions. The parties do not
cite, and we have not found, any case considering whether one or more pre-policy
class action claims preclude prior acts coverage of similar class action claims first
asserted during the policy period.
The Prior Acts provisions covered claims based on a wrongful act that
occurred before the effective date of the Policy, provided that Block had no
knowledge of the prior wrongful act on the effective date of this Policy, nor any
reasonable way to foresee that a claim might be brought. The policies defined
wrongful acts as errors, omissions or negligent acts that cause a loss for which
Block is legally required to pay. Block portrays the uncertified, pre-policy class
actions as simply individual lawsuits by the named plaintiffs seeking damages for
specific wrongful act(s) done to them. But this ignores the realities of the modern
consumer class action. To be sure, a named plaintiff lacks standing to represent a
purported class unless he or she became a member of the class, here, by entering into
a separate RAL transaction with Block and a lending bank. But to be certified, the
purported class must satisfy the court that there are questions of law or fact common
to the class that predominate over any questions affecting only individual
members. Fed. R. Civ. P. 23(a)(2), (b)(3). In other words, class action plaintiffs
must allege and undertake to prove that each class member was injured by the same
wrongful act or acts.
When a product or service has been sold nationwide, like the RAL program,
even if the prior class action was limited to clients in a particular jurisdiction, claims
based on uniform aspects of the RAL program and on causes of action recognized in
most or all jurisdictions (such as violations of federal statutes or allegations of
common law fraud, breach of contract, or breach of fiduciary duty) put Block on
reasonable notice that other contemporaneous clients will assert the same claims
alleging that the same wrongful acts infected their individual transactions. Indeed,
in this case, the nation-wide class action filed in the Western District of Missouri in
November 1995 put Block on notice that, if the class was certified, every RAL client
who did not opt out had already asserted claims for the wrongful acts alleged.
Block asserts that construing the Prior Acts provision in this manner renders the
coverage illusory. We disagree. Even a claims made policy with no prior acts
coverage is not illusory, that is, hopelessly or deceptively one-sided, if the
insurance premium were correspondingly small. Truck Ins. Exch. v. Ashland Oil,
Inc., 951 F.2d 787, 790 (7th Cir. 1992). Here, the policies provided limited Prior Acts
coverages. The doctrine of illusory coverage applies only when part of the premium
is specifically allocated to a particular type or period of coverage and that coverage
turns out to be functionally nonexistent. United Fire & Cas. Co. v. Fid. Title Ins.
Co., 258 F.3d 714, 719 (8th Cir. 2001) (internal quotation omitted). There has been
no such showing in this case.
Block further argues that AISLIC and Lexington created an unconscionable gap
in coverage by denying Prior Acts coverage for claims for which Block could not have
obtained Reported Acts coverage in an earlier policy period. This argument has more
force. By limiting coverage to claims made and reported during the policy term, a
claims made policy allows the insurer to more accurately fix its reserves for future
liabilities and compute premiums with greater certainty. F.D.I.C. v. St. Paul Fire &
Marine Ins. Co., 993 F.2d 155, 158 (8th Cir. 1993); see Lexington Ins. Co. v. St. Louis
Univ., 88 F.3d 632, 634 (8th Cir. 1996). Liability policies are typically written for
one-year periods, and the delay between the occurrence of a wrongful act and the
assertion of a claim arising out of that act may be considerable. By offering Prior Acts
and Reported Acts coverages, the claims made insurer enables the insured to maintain
continuous liability coverage through a succession of one-year policies, even if it
changes insurers. That benefit should be real, not imaginary.
For this reason, we agree with Block that the Prior Acts and Reported Acts
policy provisions should be read together, perhaps even in pari materia. Thus, when
a series of claims made policies contains these provisions, prior knowledge should not
preclude Prior Acts coverage under the policy in effect when a claim is asserted if that
knowledge, timely reported, would have been insufficient to obtain Reported Acts
coverage under the policy in effect when the wrongful act occurred. But the insured
must report the claim during the proper policy period. It may not transfer Reported
Acts coverage to subsequent policies with larger policy limits by failing to report the
wrongful acts until the subsequent policies are in effect and then claiming Prior Acts
coverage under those policies. See Wittner, Poger, 969 S.W.2d at 754.
In this case, Block simply asserts, without analysis or citation to authority, that
the Reported Acts coverage under the policies requires substantially more
(unavailable) knowledge and concreteness than the district court said was sufficient
to bar prior-acts coverage. We reject as unproved the contention that Block could
not have invoked the Reported Acts provisions of its prior excess policy with
Evanston by reporting that the claims asserted in the nation-wide class action filed in
the Western District of Missouri were reasonably likely to result in the future assertion
of the same wrongful acts by other clients. Instead of submitting such a report, Block
purchased two additional layers of excess liability coverage in May 1996 -- before the
expiration of Evanstons first-layer policy on August 20, 1996 -- and claimed
coverage of the additional class actions predictably filed between May 1996 and
August 1998 only under the Prior Acts provisions of its excess policies. We note that
Reported Acts coverage would have required reporting what loss or damage may
result if such future claims were to be asserted. In this case, the potential losses or
damages would have been difficult to forecast, and Evanston might well have denied
Reported Acts coverage for that and other reasons. But if Block had filed claims
under the Reported Acts provision of the prior policy, as well as claims under the
Prior Acts provisions of the excess policies here at issue, its assertion of an
unconscionable gap in coverage if the excess insurers denied all coverage would be
far more persuasive.
3Given this conclusion, we need not consider an issue extensively debated by
the parties on appeal, whether the nor joining the two conditions limiting Prior Acts
coverage should be read in the disjunctive, as Block reads it, or in the conjunctive, as
Block contends the district court read it.
On this record, we agree with the district court that the class action lawsuits
filed on behalf of RAL program clients prior to the inception of the excess liability
policies here at issue gave Block both knowledge of the prior wrongful acts on which
later class action claims were based and a reasonable way to foresee that such future
claims might be brought. Cf. Intl Surplus Lines Ins. Co. v. Mfrs. & Merchs. Mut. Ins.
Co., 661 A.2d 1192, 1193-95 (N.H. 1995).3 Accordingly, prior acts coverage was
properly denied.
The judgment of the district court is affirmed.


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