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Cincinnati Insurance Co. v. Desert State Life Management

United States District Court, D. New Mexico

September 26, 2019



         THIS MATTER comes before the Court on Defendant Cameron Graham’s Motion to Dismiss Plaintiff’s Complaint for Declaratory Judgment (ECF No. 11). The Court, having considered the motion to dismiss, briefs, pleadings, relevant law and otherwise being fully advised, concludes that the motion to dismiss should be denied.


         On a motion to dismiss, the court assesses the legal sufficiency of the allegations contained within the four corners of the complaint. Archuleta v. Wagner, 523 F.3d 1278, 1281 (10th Cir. 2008). Rule 8 requires the complaint to contain "a short and plain statement of the claim showing that the pleader is entitled to relief." Fed.R.Civ.P. 8(a)(2). The court accepts as true all well-pleaded facts, viewing them in the light most favorable to the nonmoving party and allowing all reasonable inferences in favor of the nonmoving party. Archuleta, 523 F.3d at 1283. The court "should disregard all conclusory statements of law and consider whether the remaining specific factual allegations, if assumed to be true, plausibly suggest the defendant is liable." Kansas Penn Gaming, LLC v. Collins, 656 F.3d 1210, 1214 (10th Cir. 2011). The complaint "does not need detailed factual allegations, " but “a formulaic recitation of the elements of a cause of action will not do." Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007).

         If on a motion to dismiss matters outside the pleadings are presented to and considered by the court, the motion generally must be treated as one for summary judgment. Fed.R.Civ.P. 12(d). Under Rule 12(d), a court has broad discretion to refuse to accept the extra-pleading materials and resolve the motion solely on the pleading itself. See Lowe v. Town of Fairland, 143 F.3d 1378, 1381 (10th Cir. 1998). Reversible error may occur if a court considers matters outside the pleadings but fails to convert the motion to dismiss into a motion for summary judgment. Id.

         No conversion is required, however, when the court considers information that is subject to proper judicial notice or documents incorporated into the complaint by reference and central to the plaintiff’s claim, unless their authenticity is questioned. See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322 (2007) (“[C]ourts must consider the complaint in its entirety, as well as other sources courts ordinarily examine when ruling on Rule 12(b)(6) motions to dismiss, in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice.”); Geinosky v. City of Chicago, 675 F.3d 743, 745 n.1 (7th Cir. 2012) (“A motion under Rule 12(b)(6) can be based only on the complaint itself, documents attached to the complaint, documents that are critical to the complaint and referred to in it, and information that is subject to proper judicial notice.”); Pace v. Swerdlow, 519 F.3d 1067 (10th Cir. 2008) (explaining that court may properly consider on motion to dismiss documents central to plaintiff’s claim and referred to in complaint, where document’s authenticity is not in dispute); Tal v. Hogan, 453 F.3d 1244, 1264 n.24 (10th Cir. 2006) (noting that no conversion is required when a court takes judicial notice of its own files and records and facts that are matter of public record). The documents, however, “may only be considered to show their contents, not to prove the truth of matters asserted therein.” Tal, 453 F.3d at 1264 n.24 (quotations omitted).

         The following facts are those set forth in the complaint in the light most favorable to Plaintiff, as well as the facts set forth in the exhibits attached to the complaint that are documents referred to in Plaintiff’s complaint and central to Plaintiff’s claim or are facts subject to judicial notice. The Court will not convert Defendant’s motion to dismiss into one for summary judgment.


         A. State Court Litigation

         Desert State Life Management, Inc., (“Desert State”), is a New Mexico non-profit corporation that provided trustee and representative payee services to its clients. Compl. ¶¶ 4, 10. Paul Donisthorpe was at all relevant times the Chief Executive Officer (“CEO”) and Director for Desert State. Id. ¶ 6. It appears undisputed that Liane Kerr is Donisthorpe’s spouse. Compare Def.’s Mot. 4, ECF No. 11, with Pl.’s Resp., ECF No. 19 (failing to dispute point).[1] Helen Bennett is a former director of Desert State. Compl. ¶ 44.

         On May 31, 2017, the Financial Institutions Division (“FID”) filed suit against Desert State and others in a New Mexico state court. Id. ¶ 11. The FID alleged that its investigation and analysis of Desert State’s banking and client account records led it to believe that from 2006 through the time of its investigation, more than $4 million in trust investment account funds managed by Desert State were transferred out of investment accounts for trusts and out of the accounts of Desert State and into accounts controlled in whole or in part by Donisthorpe. Id. ¶ 12. In an August 4, 2017 Order, the state court appointed Christopher Moya, FID’s Acting Director, as Receiver for the receivership estate of Desert State. Id. ¶ 5.

         On November 27, 2017, a Criminal Information was filed against Donisthorpe in federal court alleging that from 2006 through 2016 Donisthorpe, the sole owner and operator of Desert State, knowingly and unlawfully schemed to defraud clients by taking and converting approximately $4.8 million of client funds from Desert State client trust accounts to himself for his own use. Id. ¶¶ 13-14. The same day, on November 27, 2017, Donisthorpe entered a Plea Agreement and pled guilty to wire fraud and money laundering. Id. ¶¶ 15-19. In the plea agreement, Donisthorpe admitted that from 2009 through 2016 he knowingly and intentionally obtained money and property by means of materially false and fraudulent pretenses and representations by transferring client funds from individual client accounts ultimately to accounts for his own use. See id.

         Numerous lawsuits followed by former Desert State clients. See Id . ¶¶ 20, 46. Among them, Cameron Graham, as the trustee for Andrew Graham, (“Graham”), id. ¶ 7, filed a class action suit (the “Graham Class Action Litigation”) on behalf of himself and others similarly situated against Desert State, Donisthope, and Bennett. Id. ¶ 20(g). The other lawsuits were consolidated and dismissed without prejudice on July 24-25, 2018, to permit them to pursue their claims through the Graham Class Action Litigation. Id. ¶ 20(h).

         B. Insurance and the federal lawsuit

         On April 16, 2012, CEO Donisthorpe signed a proposal to obtain a policy of insurance from Plaintiff The Cincinnati Insurance Company (“Plaintiff” or “Cincinnati”) for Desert State. See Compl. Ex. 3, ECF No. 1-3 at 55-58. Donisthorpe sought renewals of insurance from Cincinnati in April 2013 and April 2016. See Id . at 49-54. Cincinnati issued a Non-Profit Organization Blue Chip Policy Number BCN-0007591 for insurance (“the Policy”) to Desert State with a policy period from April 17, 2016 to April 17, 2019. Compl. ¶¶ 1, 21, ECF No. 1; Compl. Ex. 3, ECF No. 1-3 at 4 of 58. The continuity date listed in the Policy is April 17, 2012. Compl. Ex. 3, ECF No. 1-3 at 4 of 58.

         On March 28, 2017, Helen Bennett notified Cincinnati by email of wrongful acts under the Policy, specifically about allegations that Donisthorpe had been stealing money from client accounts for his own personal use. See Compl. ¶ 44. On April 17, 2018, Cincinnati cancelled the Policy. Compl. ¶ 21; Compl. Ex. 4, ECF No. 1-4. Bennett and Desert State sought coverage from Cincinnati for coverage and defense. Compl. ¶ 47. Donisthorpe did not seek coverage for any of the lawsuits and Cincinnati has not defended Donisthorpe. See Id . ¶¶ 50, 56. On September 5, 2018, Cincinnati notified the FID and Moya that it was denying coverage to Desert State and Donisthorpe for the Graham Class Action Litigation, as well as to for the other lawsuits that had been dismissed. Id. ¶ 54. The letter also advised that Cincinnati would defend Desert State for the Graham Class Action Litigation under a reservation of rights to the withdrawal of the defense upon a judicial determination that it has no duty to defend or indemnify Desert State. Id. ¶ 55.

         On October 22, 2018, Plaintiff filed a declaratory judgment action before this Court under the Court’s diversity jurisdiction seeking a determination that the Policy does not cover any loss and defense costs incurred by Desert State and Donisthorpe. Id. ¶¶ 2, 8. Plaintiff named Desert State, Moya, Donisthorpe, and Graham. Compl. ¶¶ 4-7. At the time Cincinnati filed its declaratory judgment action, only Graham was the named party in the Graham Class Action Litigation. See Graham Class Action Compl., ECF No. 19-1. The complaint, however, stated that Graham “will fairly and adequately protect the interests of the Class that he seeks to represent.” Id. ¶ 57.

         Cincinnati asserts that Donisthorpe and Desert State, when answering questions in the application form for the policies, answered negatively to questions in the proposals whether the organization or anyone proposed for insurance was aware of any fact, circumstance, or situation that could result in a claim being filed against the organization or was aware of any act, error, or omission giving a reason to suppose might afford valid grounds for a future claim. See Compl. ¶ 25. Cincinnati claims that Donisthorpe and Desert State also did not disclose any fact, circumstance or situation in response to question 4 of the Prior Knowledge/Warranty Declarations and warranted as true that there was no fact, circumstance or situation indicating the probability of a claim or action. Id. Based on the admissions in Donisthorpe’s plea agreement, Cincinnati contends that he knew at the time he signed the application that he had committed acts of wire fraud and money laundering and had made other materially false and fraudulent representations, so his representations in the applications were false and the proposal contained material nondisclosures. See Id . ¶¶ 26-27. Cincinnati states that it relied on the material false statements, representations, omissions, and warranties, and that it would not have issued the Policy had the correct information been disclosed. See Id . ¶¶ 27-31.

         Following the filing of the federal complaint, the plaintiffs in the Graham Class Action Litigation filed an amended complaint. See Pl.’s Mot., Ex. A, ECF No. 11-1. The Amended Complaint added four new plaintiff/class representatives and added Kerr, among other defendants. Compare Id . at 1-4, with Class Action Compl., ECF No. 19-1 at 1-2. The current claims in the Graham Class Action Litigation as relevant to the parties in this case are for negligence and gross negligence against Desert State, Donisthorpe, and Bennett (Claim 1), breach of fiduciary duty against Desert State, Donisthorpe, and Bennett (Claim 2), conversion against Desert State and Donisthorpe (Claim 3), violations of the New Mexico Uniform Trust Code against Desert State, Donisthorpe, and Bennett (Claim 4), violations of the New Mexico Unfair Practices Act against Desert State, Donisthorpe, and another, (Claim 5), violations of the New Mexico Uniform Voidable Transactions Act against Desert State, Donisthorpe, Kerr, and others (Claim 6), and unjust enrichment against Kerr (Claim 10). See Am. Compl. 22-32, ECF No. 11-1. Cincinnati is not a party to the Graham Class Action Litigation. See Id . at 2-4. The state court lawsuit does not allege Bennett knew of Donisthorpe’s diversion of funds or that she intentionally participated in the diversion, but rather that she exercised little to no oversight of the actions of Donisthorpe or Desert State and failed in her duties as the director of Desert State. See Id . at 15-17.

         Subsequently, Defendant Graham (“Defendant” or “Graham”) filed a motion to dismiss the declaratory judgment action (ECF No. 11). Defendant offers multiple reasons for why the Court should dismiss this case. Defendant argues the Court should decline to exercise its discretion to consider this case because it would not settle the issue of Cincinnati’s insurance obligations and is better left for the state court. He contends that a judgment would not bind approximately 77 former clients who have not been named in this federal action, nor would it bind Bennett and Kerr. Graham also contends that, should the Court reach the merits, the Court should dismiss the complaint on numerous grounds. First, Defendant asserts Plaintiff has no right to avoid its obligations under the policy because it failed to promptly return the premiums Desert State paid. Defendant additionally contends Cincinnati cannot avoid its coverage duties because of Bennett’s and Donisthorpe’s wrongs, and accordingly, it must provide coverage for Desert State’s vicarious liability for those wrongs. Defendant argues that the various contractual provisions upon which Cincinnati relies do not cancel its obligation to provide Desert State coverage.

         C. The Policy terms

         According to the Policy, in consideration of the payment of premiums and “in reliance on all statements in the ‘proposal’ and all other information provided”, Cincinnati agreed to “pay on behalf of the ‘insureds’ all ‘loss’ which they shall be legally obligated to pay resulting from any ‘claim’ first made during the ‘policy period’ … for a ‘wrongful act.’” Compl. Ex. 3, ECF No. 1-3 at 6 of 58. Cincinnati also agreed to the duty to defend the insureds against any such claim. Id. As relevant here, the Policy defined “insureds” as the “organization;” “Directors, officers and trustees;” and “Employees, volunteers and members”. Id. at 8 of 58. The Policy further defined “Directors, officers and trustees” to mean “[a]ll persons who were, now are, or shall become a duly elected or appointed director, officer or trustee of the ‘organization’…” and the “lawful spouse … of a director, officer or trustee, but only to the extent such person is a party to any ‘claim’ solely in such person’s capacity as a spouse … of a director, officer or trustee … and only if the ‘claim’ seeks damages recoverable from … property transferred from the director, officer or trustee to the spouse….” Id. The named insured is Desert State. Id. at 3 of 58.

         Cincinnati relies on the following Policy provisions when seeking a declaration that it has no duty to defend or indemnify the lawsuits and demands and that the Policy does not provide coverage for and Cincinnati has no duty to defend or indemnify any of the “claims” emanating from the facts, circumstances, and situations admitted by Donisthorpe in his plea of guilty. See Compl. ¶¶ 59-87.

         1. Warranty Declaration 4 Exclusion (Count I)

         Paragraph 4 of the April 16, 2012 proposal states:

No fact, circumstance or situation indicating the probability of a claim or action against which indemnification would be afforded by the proposed insurance is now known by any person(s) or entity(ies) proposed for this insurance other than that which is disclosed in this Proposal. It is agreed by all concerned that if there be knowledge of any such fact, circumstance, or situation, any claim ...

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