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Evanston Insurance Co. v. Desert State Life Management

United States District Court, D. New Mexico

January 16, 2020

EVANSTON INSURANCE COMPANY, Plaintiff,
v.
DESERT STATE LIFE MANAGEMENT; Christopher Moya, in his capacity as Receiver for the receivership estate of Desert State Life Management; Paul A. Donisthorpe; L. Helen Bennett; Liane Kerr; Ayudando Guardians, Inc., a New Mexico Nonprofit Corporation, on behalf of seven protected persons; Joseph Perez; Christine Gallegos, individually and as Guardian of Victor Baldizan, an incapacitated adult; Scott K. Atkinson, as Guardian Ad Litem for Vincent Esquibel, Jr., an Incapacitated Person; and Charles Reynolds, as Conservator for J.W., an Incapacitated Person, and Cameron Graham, as trustee for Andrew Graham, Christopher Moya; Ascending Hope, LLC; CNRAG, Inc.; and Decades, LLC, Defendants.

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          Ann Maloney Conway, Elisabeth Anne Millich, Sheehan & Sheehan, P.A., Albuquerque, New Mexico and Joseph Borders, McJessy, Ching & Thompson, LLC, Chicago, Illinois, Attorneys for the Plaintiff.

          Maureen Sanders, Sanders & Westbrook, P.C., Albuquerque, New Mexico, Attorney for Defendant Helen Bennett.

          Paul J. Kennedy, Kennedy, Hernandez & Associates, P.C., Albuquerque, New Mexico, Attorney for Defendant Liane Kerr.

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          Kevin Arthur Graham, Daniel Ross Rubin, New Mexico Regulation and Licensing Department, Santa Fe, New Mexico, Attorneys for Defendant Christopher Moya.

          Joseph Goldberg, H. Jesse Jacobus, III, Frank T. Davis, Jr., Freedman Boyd Hollander Goldberg Urias & Ward P.A., Albuquerque, New Mexico, Attorneys for Defendants Cameron Graham, Joseph Perez, Christine Gallegos, Scott Atkinson, and Charles Reynolds.

          John C. Anderson, United States Attorney, Brandon Fyffe, Assistant United States Attorney, United States Attorney's Office, Albuquerque, New Mexico, Attorneys for the United States of America.

         MEMORANDUM OPINION AND ORDER

         JAMES O. BROWNING, UNITED STATES DISTRICT JUDGE.

         THIS MATTER comes before the Court on the Plaintiff's Motion for Summary Judgment, filed July 25, 2019 (Doc. 89) ("MSJ"). The Court held a hearing on September 5, 2019. The primary issues are: (i) whether, under the Professional Liability Insurance Policy for Specified Professions issued to Desert State, filed July 25, 2019 (Doc. 89-5) ("Insurance Policy"), the Defendants can satisfy the condition precedent to coverage that prior to the effective date of the policy, no insured party had knowledge of facts, circumstances, situations or incidents which would lead him or her to conclude that a claim was likely; (ii) whether the Insurance Policy's misappropriation of funds exclusion bars coverage; and (iii) whether Defendant Paul Donisthorpe's misrepresentations on the Application render the Insurance Policy ab initio. The Court concludes that: (i) the Defendants have satisfied all conditions precedent for coverage under the Insurance Policy; (ii) the Insurance Policy's misappropriation of funds exclusion does not exclude coverage for all claims; and (iii) the Insurance Policy is not void ab initio. Accordingly, the Court denies the MSJ.

         FACTUAL BACKGROUND

         The Court draws the factual background from the parties' assertions of undisputed material fact in their summary judgment motion papers. See MSJ at 3-9;[1] Former Clients of Desert State Life Management's Response in Opposition of Plaintiff's Motion for Summary Judgment ¶¶ 1-16, at 3-5, filed August 8, 2019 (Doc. 98) ("Client Response");[2] Defendant Desert State Life Management's Response to Motion for Summary Judgment ¶¶ A1-4, B1-5, at 3-5, filed August 8, 2019 (Doc. 99) ("Moya Response"); Defendant L. Helen Bennett's Response to Plaintiff's Motion for Summary

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Judgment ¶¶ 1-6, at 3, filed August 8, 2019 (Doc. 100) ("Bennett Response"); id., ¶¶ 1-8, at 3-4;[3] Plaintiff's Reply to Helen Bennett's Response to Plaintiff's Motion for Summary Judgment ¶¶ A-B, at 4-5, filed August 22, 2019 (Doc. 113) ("Reply to Ms. Bennett"); and Plaintiff's Combined Reply to Moya's and to the Former Clients of DSLM's Respective Responses to Plaintiff's Motion for Summary Judgment ¶¶ A-E, at 3-4, filed August 23, 2019 (Doc. 116) ("Combined Reply").[4]

         1. The Underlying Class-Action Claims Against Donisthorpe and Desert State.

         Desert State Life Management is a New Mexico nonprofit trust corporation that acted as a trustee for disabled individuals. See MSJ at 3 (asserting this fact) (citing New Mexico Secretary of State Corporate Records at 2 (dated July 23, 2019), filed July 25, 2019 (Doc. 89-1) ("Corporate Records")); Client Response at 1;[5] Moya Response at 1;[6] Bennett Response ¶ 1, at 3

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(not disputing this fact).[7] Paul A. Donisthorpe was the Chief Executive Officer of Desert State. See MSJ at 3 (asserting that Donisthorpe was the CEO of Desert State) (citing New Mexico Secretary of State Corporate Records at 2, filed July 25, 2019 (Doc. 89-1) ("Corporate Records")).[8] Desert State provided trustee services and representative payee services to more than seventy-five clients. See MSJ at 3 (stating that Desert State provided trustee payee services) (citing Amended Plea

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Agreement ¶ 10a, at 5 (dated February 21, 2019), filed July 25, 2019 (Doc. 89-2) ("Plea Agreement")).[9]

         On November 27, 2017, Donisthorpe pled guilty to a two-count federal felony information charging him with wire fraud and money laundering. See MSJ at 15 (stating this fact) (citing Transcript of Plea Hearing 21:13-22 (taken November 27, 2017) (Court, Donisthorpe), filed July 26, 2019 (Doc. 90-1) ("Plea Tr.")).[10] From at least 2009 through 2016, Donisthorpe violated a duty of trust to Desert State clients by transferring client funds from individual client investment accounts to accounts he controlled, thus converting those client funds to his own use. See MSJ at 3 (stating this fact) (citing Plea Agreement ¶ 10(b), at 6).[11] Donisthorpe made the fraudulent transfers knowing that he was not entitled to the funds, knowing that the clients were not informed of the transfers, and knowing that the clients would not have approved of the transfers if they had been informed. See MSJ at 3 (stating this fact) (citing Plea Agreement ¶ 10(c), at 6-7).[12] Donisthorpe presented false and fraudulent investment and disbursement reports to the Desert State board of directors and presented materially false and fraudulent documents to the New Mexico Regulation and Licensing Department — Financial Institutions Division to conceal the fact that he had fraudulently obtained client funds. See MSJ at 3 (stating this fact) (citing Plea Agreement ¶ 10(c), at 6-7).[13] Donisthorpe spent the illegally obtained funds on personal items including business ventures, his home mortgage, the mortgage for a vacation home, vehicles, credit card expenditures, and IRS debts. See MSJ at 3-4 (stating this fact) (citing

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Plea Agreement ¶ 10(d), at 7).[14] In his plea agreement, Donisthorpe also admitted to violating federal statutes. See Bennett Response ¶ 7, at 4 (stating this fact) (citing Plea Agreement ¶ 10(c)); Reply to Ms. Bennett at 3-4 (not disputing this fact). At the plea hearing, Donisthorpe reaffirmed his guilt, stating:

I was in fact in charge of a trust company here in Albuquerque named Desert State Life Management and was responsible for assets of accounts therein. And from the period of time from 2009 to 2016, I did knowingly and intentionally obtain money and property through materially false and fraudulent pretenses and representations, transferring these funds to an account that I controlled personally. I presented — I basically presented false and materially incorrect investment and distribution, unfortunately, to these clients, and I do admit that I fraudulently obtained client funds through this scheme. I spent these monies on personal assets, including other business ventures, a home mortgage and other expenditures that had no relation to these accounts.

MSJ at 4 (stating this fact) (quoting Plea Tr. at 17:18-18:16, at 5).[15] The Honorable Laura Fashing, United States Magistrate Judge for the United States District Court for the District of New Mexico, finding Donisthorpe competent and his guilty plea to be knowing, voluntary, and supported by sufficient evidence, adjudged Donisthorpe guilty of wire fraud and money laundering. See MSJ at 4 (stating this fact) (citing Plea Tr. at 22:2-7, at 7).[16] On June 27, 2019, the Court sentenced Donisthorpe to 144 months in prison, ordered him to pay $6,834,952.46 in restitution and imposed a $4,812,857.00 money judgment against him. See MSJ at 4 (stating this fact) (quoting Judgment as to Paul A. Donisthorpe (dated February 22, 2019), filed in this case June 27, 2019 (Doc. 89-4) ("Judgment")).[17]

         Donisthorpe's embezzlement scheme generated multiple demands for restitution and lawsuits by Desert State's former clients, and all of these matters are now consolidated into a proposed class action: Graham v. Desert State Life Management, No. D-202-cv-2018-04655 (Second Judicial District Court, County of Bernalillo, State of New Mexico, filed June 20, 2018). See MSJ ¶ 9, at 4-5 (stating this fact) (citing Amended Class Action Complaint (filed in state court December 17, 2018), filed in federal court July 25, 2019 (Doc. 89-4) ("Client Complaint")).[18] The Client Complaint's

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allegations mirror the admissions from Donisthorpe's guilty plea. See MSJ at 5 (stating this fact) (citing Client Complaint ¶¶ 30-31, at 5).[19] The Client Complaint alleges that Donisthorpe and Desert State diverted at least $4,900,000.00 from Desert State clients. See MSJ at 5 (stating this fact) (citing Client Complaint ¶ 48, at 7).[20] In addition to suing Donisthorpe and Desert State for conversion, Desert State's former clients also sue Donisthorpe, Desert State, and former director and defendant Helen Bennett for negligence, breach of fiduciary duty, and violating the New Mexico Uniform Trust Code, N.M. Stat. Ann. §§ 46A-1-01 through 46A-1-113. See MSJ at 5 (stating this fact) (citing Client Complaint ¶¶ 151-171, at 23-25).[21] The Client Complaint also seeks disgorgement of the benefits that Donisthorpe's ex-wife, Defendant Liane Kerr, wrongly received as a result of Donisthorpe's theft. See MSJ at 5 (stating this fact) (citing Client Complaint ¶¶ 178-187, 206-213, at 26-27, 31-32).[22]

         The Client Complaint alleges ten claims. See Client Complaint ¶¶ 151-213, at 27-32. Claim 1 is for negligence and gross negligence against Desert State, Donisthorpe, and Ms. Bennett. See Client Complaint ¶¶ 151-156, at 27-28. Claim 2 alleges breach-of-fiduciary duty against Desert State, Donisthorpe, and Ms. Bennett. See Client Complaint at 28-29. Claim 3 alleges conversion against Desert State and Donisthorpe. See Client Complaint ¶¶ 162-166, at 28. Claim 4 alleges violations of the New Mexico Uniform Trust Code against Desert State, Donisthorpe, and Ms. Bennett. See Client Complaint ¶¶ 167-171, at 29. Claim 5 alleges violations of NMUPA against Desert State, Donisthorpe, and Ms. Bennett. See Client Complaint ¶¶ 172-177, at 29-30. Claim 6 alleges violations of the New Mexico Uniform Voidable Transactions Act, N.M. Stat. Ann. §§ 56-10-14 through 56-10-29, against Desert State, Donisthorpe, Spectrum Capital Markets, LLC,[23] Corazon Cattle Co., LLC,[24] Corazon-Pitchford,[25] Liane Kerr, and Paul A.

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Donisthorpe, LLC. See Client Complaint ¶¶ 178-187, at 30-32. Finally, Claim 10 alleges unjust enrichment against Ms. Kerr. See Client Complaint ¶¶ 205-213, at 31-32.

         2. The Insurance Policy Between Desert State and Evanston Insurance.

         On October 10, 2016, Donisthorpe, in his capacity as Desert State's Chief Executive Officer, applied for professional liability insurance coverage from Evanston Insurance. See MSJ at 5 (stating this fact) (citing Application for Specified Professions Professional Liability Insurance and Service and Technical Professional Liability Insurance at 1 (dated October 10, 2016), filed July 25, 2019 (Doc. 89-6) ("Application")).[26] In the Application, Donisthorpe answered the following question negatively:

Is the applicant or any principal, partner, owner, officer, director, employee, manager or managing member of the Applicant or any person(s) or organization(s) proposed for this insurance aware of any fact, circumstance, situation, incident or allegation of negligence or wrongdoing, which might afford grounds for any claim such as would fall under this proposed insurance?

MSJ at 5-6 (stating this fact) (quoting Application at 3); Bennett Response at 3.[27] The Policy's Insuring Agreement for Professional Liability Coverage provides:

The Company shall pay on behalf of the Insured all sums in excess of the Deductible amount stated in Item 5.A. of the Declarations, which the Insured shall become legally obligated to pay as Damages as a result of a Claim first made against the Insured during the Policy Period or during the Extended Reporting Period, if exercised, and reported to the Company pursuant to the

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Section Claims A., Claims Reporting provision,

By reason of:
1. A Wrongful Act; or
2. A Personal Injury;
In the Performance of Specified Professional Services rendered or that should have been rendered by the Insured or by any person for whose Wrongful Act or Personal Injury the Insured is legally responsible,
Provided:
a. The entirety of such Wrongful Act(s) or Personal Injury(ies) happens during the Policy Period or on or after the applicable Retroactive Date stated in Item 5.A. of the Declarations and before the end of the Policy Period; and
b. Prior to the effective date of this Coverage Part the Insured had no knowledge of such Wrongful Act(s) or Personal Injury(ies) or any fact, circumstance, situation or incident, which may have led a reasonable person in the Insured's position to conclude that a Claim was likely.

MSJ at 7 (quoting Insurance Policy at 15).[28] The Insurance Policy defines "insured" persons to include past or current Desert State officers and directors, as well as "any past or current employee." Moya Response ¶ B3, at 4 (stating this fact) (quoting Insurance Policy at 14); Combined Response at 3 (not disputing this fact). Under Exclusion P, the Insurance Policy excludes coverage for "`any claim... [b]ased upon or arising out of any conversion, misappropriation, commingling or defalcation of any funds or property.'" MSJ at 8-9 (quoting Insurance Policy at 20).[29]

         3. The Investigations into Donisthorpe and Desert State.

         Evanston Insurance first received notice of circumstances likely to give rise to claims triggering coverage in March, 2017, when Ms. Bennett reported that Donisthorpe had mismanaged and stolen funds belonging to former Desert State clients. See Client Response ¶ 1, at 3 (stating this fact) (citing Claim-E0400944-Note27 at 1 (dated March 29, 2017), filed July 26, 2019 (Doc. 92-1) ("Evanston Memo")); Combined Reply ¶ III.a, at 3.[30] After Evanston Insurance heard from Ms. Bennett, Evanston Insurance first considered rescission of the Insurance Policy. See Client Response ¶ 2, at 3 (stating this fact) (citing Evanston Memo; Deposition of Glenn Fischer 101:22-102:3 (taken June 25, 2019), filed July 26, 2019 (Doc. 92-2) ("Fischer Depo.")); Combined Reply ¶ III.b, at 4.[31] Shortly after Evanston Insurance received Ms. Bennett's

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report, Evanston Insurance received several claims from individuals who once were Desert State's clients that corroborated Ms. Bennett's report. See Client Response ¶ 3, at 3 (stating this fact) (citing Letter from Daniel Dougherty Letter to Emily Lukes (dated June 30, 2017), filed July 26, 2019 (Doc. 92-3); Letter from Corbin Hildebrandt to Evanston Insurance (dated May 25, 2017), filed July 26, 2019 (Doc. 92-4); Ayudando Guardians Inc., et al. v. Desert State Life Mgmt., et al., No. D-202-cv-2017-03997, Complaint for Damages Due to Negligence, Gross Negligence, Breach of Fiduciary Duty, Fraud, Employee Dishonesty, Embezzlement, Employee Misconduct, Unfair Practices Act Violations, and Punitive Damages (Second Judicial District Court, County of Bernalillo, State of New Mexico (filed in state court June 6, 2017), filed in federal court July 26, 2019) (Doc. 92-6) ("Ayudando Complaint")); Combined Reply ¶ III, at 3-4 (not disputing this fact). In addition, at least one lawsuit related to Donisthorpe's and Desert State's conduct was filed. See Client Response ¶ 7, at 4 (stating this fact) (citing Ayudando Complaint); Combined Reply ¶ III, at 3-4 (not disputing this fact). Around the same time, Evanston Insurance hired James H. Johansen, of Butt Thornton & Baehr P.C. to provide a coverage opinion regarding the policy in relation to the notice of circumstances that Ms. Bennett provided, and the claims made against its insureds. See Client Response ¶ 7, at 4 (stating this fact) (citing Fischer Depo., 87:13-88:10; Plaintiff Evanston Insurance Company's Second Amended Privilege Log at 3 (undated), filed July 26, 2019 (Doc. 92-7)); Combined Reply ¶ III, at 3-4 (not disputing this fact).

         Approximately one month after it hired counsel to provide it with a coverage opinion, on July 24, 2017, Evanston Insurance sent Desert State a Notice of Nonrenewal of the Insurance Policy. See Client Response ¶ 8, at 4 (stating this fact) (citing Notice of Nonrenewal (dated July 24, 2017), filed July 26, 2019 (Doc. 92-8)); Combined Reply ¶ III, at 3-4 (not disputing this fact). Before issuing the Notice of Nonrenewal to Desert State, Denise Butler, a Professional Insurance Underwriter for Markel West Insurance Services, had a discussion with a claims representative for Evanston Insurance about rescinding the Insurance Policy. See Client Response ¶ 9, at 4 (stating this fact) (citing Deposition of Denise Butler at 51:11-18 (taken June 25, 2019), filed July 26, 2019 (Doc. 92-9) ("Butler Depo.")); id. at 53:18-54:25; Combined Reply ¶ III.d, at 4.[32] Evanston Insurance took no action to rescind the Insurance Policy or to notify its insureds that it was considering rescinding the policy before its June 4, 2018, letter. See Client Response ¶ 10, at 4-5 (stating that Evanston Insurance took no "timely" action to rescind its Insurance Policy or to notify its insureds) (citing Butler Depo. 52:5-53:2);[33]

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Combined Reply ¶ III, at 3-4 (not disputing this fact).

         Based on the statements that Donisthorpe made at his plea hearing, Evanston Insurance formally concluded that Donisthorpe made material misrepresentations on the Application. See Client Response ¶ 12, at 4 (stating this fact) (citing Letter to the Acting Receiver of Desert State Life Management (dated June 4, 2018)), filed June 26, 2019 (Doc. 92-10); Fischer Depo. at 75:24-76:6 & 101:22-102:11); Combined Reply ¶ III, at 3-4 (not disputing this fact). Discovery also revealed that Evanston Insurance does not have any evidence or basis to believe that any of its insureds, aside from Donisthorpe, committed fraud or participated in Donisthorpe's scheme. See Client Response ¶ 14, at 4 (stating this fact) (citing Fischer Depo. at 23:12-18; 50:2-11; 103:20-104:14); Combined Reply ¶ III, at 3-4 (not disputing this fact). Donisthorpe is the only insured under the policy that Evanston Insurance believes made any material misrepresentations to Evanston Insurance. See Client Response ¶ 16, at 4 (stating this fact) (citing Fischer Depo. at 50:2-11; id. at 101:22-103:19); Combined Reply ¶ III, at 3-4 (not disputing this fact).

         On June 4, 2018, Evanston Insurance offered to rescind the Insurance Policy based on the material misrepresentations made in the Application for the Insurance Policy and tendered to Desert State the premium that Desert State paid for the Insurance Policy plus interest. See MSJ at 9 (citing Letter from James H. Johansen to the Acting Receiver of Desert State Life Management at 2 (dated June 4, 2018), filed July 25, 2019 (Doc. 89-7) ("Letter")).[34]

         PROCEDURAL BACKGROUND

         Evanston Insurance filed its original complaint on July 10, 2018. See Complaint for Rescission and Declaratory Judgment, filed July 10, 2018 (Doc. 1). Evanston Insurance has since filed three amended complaints to add and drop Defendants — most recently on February 15, 2019, when it added Ascending Hope, LLC, CNRAG, Inc., and Decades, LLC, as Defendants and dropped its claims against Ayudando Guardians, Inc. See Third Amended Complaint for Rescission and Declaratory Judgment, filed February 15, 2019 (Doc. 44) ("Third Complaint"). Evanston Insurance seeks the Insurance Policy's rescission in Count I of the Complaint. See Third Complaint ¶¶ 46-55, at 10-11. In Count II, Evanston Insurance requests a declaration that it has no duty to defend or indemnify claims arising from Donisthorpe's actions. See Third Complaint ¶¶ 56-59, at 10-11. Evanston Insurance now moves for summary judgment on Counts I and II. See MSJ at 16-17.

         1. The MSJ

         Evanston Insurance filed for summary judgment on July 25, 2019, and first argues that the Defendants cannot meet their burden of showing that they are insured under the Insurance Policy. See MSJ at 10-11. Evanston Insurance notes that, in New Mexico, the initial burden is on the insured to establish coverage under

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insurance policies, see MSJ at 10, and that a condition precedent to coverage under Policy Agreement is that "prior to the effective date of this Coverage Part the Insured had no knowledge of such Wrongful act(s) or Personal Injury(ies) or any fact, circumstance, situation, or incident, which may have led a reasonable person in the Insured's position to conclude that a Claim was likely," MSJ at 11. Evanston Insurance argues that there is no coverage under the Insurance Policy, because it

is beyond serious debate that a fiduciary who has over the course of several years stolen in excess of $4 million dollars from his disabled clients was aware of Wrongful Acts, facts, circumstances, situations and incidents which may have led a reasonable person in the Insured's position to conclude that a Claim was likely.

MSJ at 11.

         Evanston Insurance next argues that the Insurance Policy's Exclusion P, the misappropriation of funds exclusion, see MSJ at 12-14, bars coverage. According to Evanston Insurance, this exclusion bars coverage for any claim "`[b]ased upon or arising out of any conversion, misappropriation, commingling or defalcation of any funds or property.'" MSJ at 12 (quoting Insurance Policy at 8). Evanston Insurance notes that Donisthorpe's misappropriation is plainly evident. See MSJ at 12. Evanston Insurance also argues that courts interpret the term "`arising out of'" broadly in similar insurance policies. MSJ at 13-14 (quoting Insurance Policy at 8). In conclusion, Evanston Insurance argues that the Client Complaint asserts a conversion claim and that, because all other causes of action "flow from Donisthorpe's looting of DSLM client funds," the Client Complaint's claims are barred. MSJ at 14.

         Finally, Evanston Insurance argues that it is entitled to summary judgment because the Insurance Policy is void ab initio. See MSJ at 14-16. Evanston Insurance notes that, under New Mexico law, contracts "can be rescinded when it is discovered that during the formation of the contract, information material to the contract was withheld or misrepresented." MSJ at 14. Evanston Insurance asserts that it relied on misrepresentations that Donisthorpe made in the Application. See MSJ at 15. It points specifically to Donisthorpe indicating on the Application that he was not aware of any fact, circumstance, situation, incident or allegation of negligence or wrongdoing which might afford grounds for any claim. See MSJ at 15. Evanston Insurance argues that, in light of his subsequent guilty plea, "the only possible conclusion is that Donisthorpe withheld and/or misrepresented material facts." MSJ at 16.

         2. The Client Response.

         Several former Desert State clients filed a response to the MSJ on August 8, 2019. The former clients argue first that the Court should deny Evanston Insurance's MSJ for failure to comply with D.N.M.L.R-Civ. 56.1(b). See Client Response at 6-7. This rule requires that motions for summary judgment include a list of separately numbered paragraphs containing the undisputed facts and specific evidence supporting each fact. See Client Response at 6. The former clients argue that, because the Court has, in the past, denied a pro se plaintiff's motion for summary judgment because it did not follow this rule, the Court should also deny Evanston Insurance's MSJ. See Client Response at 7 (citing Foti v. Bernalillo Cty. New Mexico, No. CIV 14-0667 JB/SMV, 2015 WL 1640445 (D.N.M. Mar. 30, 2015) (Browning, J.)).

         The former Desert State clients attempt to rebut Evanston Insurance's argument that the insured cannot establish

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coverage under the policy in two different ways. First, they argue that whether the insureds have satisfied the condition precedent to coverage — that prior to the effective date of the Insurance Policy the insured had no knowledge of any fact, circumstance, situation or incident, which may have led a reasonable person to conclude that a claim was likely — is an entirely new claim, and that, because Evanston Insurance raised the argument for the first time after the close of discovery, the Court should reject it. See Client Response at 7. The former clients note that the United States Court of Appeals for the Tenth Circuit considers new arguments made in motions for summary judgment as requests to amend the complaint. See Client Response at 7. The former clients argue that the Court must deny the condition precedent argument where "`a late shift in the thrust of the case will prejudice the other party in maintaining his defense upon the merits.'" Client Response at 7-8 (quoting Evans v. McDonald's Corp., 936 F.2d 1087, 1090-91 (10th Cir. 1991)). The former clients apply Tenth Circuit precedent on the issue to this case and argue that the new argument will unfairly prejudice them, because "the window of opportunity for the parties to conduct discovery has closed, and Evanston's attempt to raise a new claim at this late stage of proceedings is unjustified." Client Response at 8.

         Second, the former clients dispute the merits of Evanston Insurance's condition precedent argument. See Client Response at 8-10. The former clients argue that, contrary to Evanston Insurance's assertions, Donisthorpe was not necessarily aware that what he was doing was a "Wrongful Act" as the Insurance Policy defines the term. See Client Response at 9. The former clients argue that, because Evanston Insurance's representative stated that Donisthorpe believed he could get away with the fraud if he eventually replaced the money, Donisthorpe's "knowledge and intent at the time he engaged in the conduct at issue raises a question of fact that should not be decided at summary judgment." Client Response at 9. Next, the former clients argue that, aside from Donisthorpe, there is no evidence that any other insured party participated or knew of the scheme. See Client Response at 9. The former clients say this fact is "critical," because the Insurance Policy "does not have any express language that allows Evanston to deny coverage to all insureds based on fraud committed by one of them." Client Response at 9. They argue that the Insurance Policy also does not have language permitting Evanston Insurance to impute the fraud of one insured to other insureds and note that this omission proved pivotal in a different case where Evanston Insurance attempted to deny coverage based on an applicant's fraudulent representations. See Client Response at 10 (citing Evanston Ins. Co. v. Watts, 52 F.Supp.3d 761, 769 (D.S.C. 2014) (Anderson, Jr., J)).

         The former clients next turn to Evanston Insurance's argument that Exclusion P denies coverage and argue that the Exclusion creates an ambiguity that must be resolved in favor of coverage. See Client Response at 10-13. The former clients note that there are no provisions in the Insurance Policy or caselaw in New Mexico explaining how to interpret "based upon or arising out of," Client Response at 10-11, but in New Mexico, ambiguities must be resolved in the insured's favor and in favor of coverage. See Client Response at 11. They argue that their claim against Desert State under the New Mexico Unfair Trade Practices Act, N.M. Stat. Ann. §§ 57-12-1 through 57-12-24 ("NMUPA"), does not arise out of Donisthorpe's fraud, because the claim alleges that Desert Stated "billed for services and work as though the services were professional and in the best

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interests of Plaintiffs ... when in fact professional services were not performed competently or not performed at all," and because it is possible to violate the NMUPA without committing an intentional tort, like fraud. Client Response 11-12. They similarly argue that their claims against Ms. Bennett for negligence, gross negligence, breach of fiduciary duty, and for violating the Uniform Trust Code are not based upon or arise out of Donisthorpe's actions. See Client Response at 12. The former clients assert that, based on New Mexico caselaw which suggests that an insured's fraud should not void coverage for other insureds, "the exclusionary language should only be read to bar coverage for Donisthorpe and not for other insureds." Client Response at 12. The former clients argue that their case is stronger, because there is no evidence that Ms. Bennett or any other insured knew about Donisthorpe's scheme. See Client Response at 12.

         Last, the former clients argue that insurance policy rescission is not appropriate in this case, because Evanston Insurance delayed for too long before attempting to rescind, and because the innocent insured doctrine prevents Donisthorpe's conduct from voiding his co-insureds' interests. See Client Response at 13. In support of their timeliness argument, the former clients note that, under New Mexico law, parties seeking to rescind contracts must promptly and immediately exercise this right. See Client Response at 13. The former clients argue that Evanston Insurance's delay in seeking rescission — six months after Donisthorpe's guilty plea and fifteen months after it first received notice of claims — was neither prompt nor immediate. See Client Response at 14. In support of their innocent insured argument, the former clients point to New Mexico caselaw and a case from the United States Court of Appeals for the Fourth Circuit which hold that fraudulent claims by an insurance applicant do not cancel coverage for innocent insureds. See Client Response at 15 (citing Evanston Ins. Co. v. Agape Sr. Primary Care, Inc., 636 Fed.Appx. 871, 876 (4th Cir. 2016) (unpublished) (per curiam); Delph v. Potomac Ins. Co., 1980-NMSC-140, ¶ 14, 95 N.M. 257, 620 P.2d 1282).

         3. The Moya Response.

         Defendant Christopher Moya, the receiver for Desert State's receivership estate, filed a response to the MSJ on August 8, 2019. See Moya Response at 1. Moya first argues that the Court should deny summary judgment, because parties may not make new claims in motions for summary judgment. See Moya Response at 5-8. Moya argues that the Third Complaint references "solely" the condition precedent "in the context of allegations of misrepresentation by DSLM," and "does not instead allege DSLM's knowledge of some wrongful act or personal injury as an independent grounds for denial." Moya Response at 5. Moya also asserts that this claim would unfairly prejudice him, because discovery is complete, dispositive motions have been filed, there is no opportunity for Desert State to either move for summary judgment on this claim or adequately defend itself from it, and trial is scheduled soon. See Moya Response at 6.

         On this issue, Moya argues in the alternative that the Court should deny summary judgment, because Evanston Insurance has not presented any admissible evidence that any person had knowledge attributable to Desert State. See Moya Response at 7. Moya notes that the MSJ merely states that "`it is beyond serious debate' that a `fiduciary' had knowledge of `Wrongful Acts, facts, circumstances, situations and incidents which may [have] led a reasonable person in the Insured's position to conclude that a claim was likely.'" Moya Response at 7 (quoting MSJ

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at 11). Further, Moya argues that, to the extent that Evanston Insurance is referring to Donisthorpe's knowledge here, Donisthorpe's actions were criminal, not covered, and thus not likely to result in a claim. See Moya Response at 7. Moya bolsters his argument by pointing to New Mexico insurance caselaw's doctrine of reasonable expectations, which suggests that courts should interpret an insurance policy in the same way a hypothetical reasonable insured would. See Moya Response at 8. Moya argues that, with this reading, the "provision would warrant that some knowledge other than this criminal activity was known — and not necessarily by Mr. Donisthorpe. DSLM can only speculate on this point, and Evanston cannot fairly demand DSLM to do so in defense of this motion." Moya Response at 8.

         Moya next argues that, contrary to Evanston Insurance's assertions, Desert State's claims arise from wrongful acts on the insureds' part. See Moya Response 9-11. He states that the Insurance Policy defines "wrongful act" as a "negligent act, error or omission in Specified Professional Services." Moya Response at 9. Moya says that it is undisputed that Donisthorpe's actions were not wrongful acts under the Insurance Policy, because they were intentional and criminal rather than negligent. See Moya Response at 9. Moya argues that, while claims based on Donisthorpe's actions are excluded from coverage, the Insurance Policy does cover the acts of others at Desert State. See Moya Response at 10. Moya argues: "But for the errors and omissions of [Ms. Bennett, Tom Rutherford, and Judy Mahar]," "some, if not all, of the losses now claimed by DSLM could have been avoided." Moya Response at 10. These individuals did not act intentionally, and Evanston Insurance, he argues, has not found any evidence that any other insured acted willfully, intentionally, or deliberately. Moya Response at 11. Any further limitation of fault, Moya asserts, is a factual issue that the Court may not decide at this litigation stage.

         Finally, Moya argues that the Court should deny summary judgment for Evanston Insurance with respect to its reliance on the Application's misrepresentations for two reasons. First, Moya directs the Court to N.M. Stat. Ann. § 59A-18-11(A), which states: "The insured shall not be bound by any statement made in an application for a policy unless a copy of such application is attached to or endorsed on the policy when issued as part thereof." Moya Response at 11. Moya then points to examples in other states where courts have interpreted similar laws strictly against insurers and asserts that the insurance broker which Evanston Insurance used did not attach a copy of Donisthorpe's Application to the issued policy. See Moya Response at 12. Second, Moya argues that, because Evanston Insurance has not offered any evidence that the misrepresentations in Desert State's Application were material, Evanston Insurance cannot win rescission at summary judgment based on material misrepresentations. See Moya Response at 13.

         4. The Bennett Response.

         Ms. Bennett, a former Desert State director, filed a response to the MSJ on August 8, 2019. She first argues that the Court should deny summary judgment for Evanston Insurance's claims regarding the Application's materially false representations, because Evanston Insurance's delay bars rescission, and Ms. Bennett is an innocent insured. See Bennett Response at 5. Ms. Bennett adopts the arguments made in the Former Clients of Desert State Life Management's Motion for Summary Judgment for Rescission and Declaratory Judgment and Memorandum in Support Thereof, filed July 26, 2019 (Doc. 92) ("Client

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MSJ"), regarding both Evanston Insurance's delay in seeking rescission and the innocent insured doctrine. See Bennett Response at 6. On the innocent insured doctrine, Ms. Bennett adds only that, because the adverse interest exception prevents imputing an agent's knowledge to the principal when the agent acts solely for his own benefit and against the principal's interest, Donisthorpe's knowledge should not be imputed to Desert State or to any other insured party. See Bennett Response at 6-7.

         Ms. Bennett next disputes Evanston Insurance's assertion that Exclusion P bars her defense. See Bennett Response at 7. She states that some of the claims against her are "negligence and negligent supervision claims." Bennett Response at 10. Ms. Bennett cites three New York cases suggesting that there is a duty to defend in similar situations where the underlying complaint alleges negligence or negligent supervision. See Bennett Response at 10-11 (discussing Watkins Glen Cent. Sch. Dist. v. Nat'l Union Fire Ins. Co., 286 A.D.2d 48, 732 N.Y.S.2d 70 (N.Y.App.Div. 2001); Murphy v. Nutmeg Ins. Co., 5 A.D.3d 358, 360, 773 N.Y.S.2d 413 (N.Y.App.Div. 2004); Gladstein & Isaac v. Phila. Indem. Ins. Co., 82 A.D.3d 468, 468, 918 N.Y.S.2d 92 (N.Y.App.Div. 2001)).

         Ms. Bennett furthers disputes Evanston Insurance's Exclusion P argument by analyzing the Insurance Policy's language. See Bennett Response at 12-16. She cites several New Mexico canons of insurance contract construction requiring, among other things, that ambiguities in insurance policies be construed against insurers, exclusionary clauses be narrowly construed, and coverage clauses be broadly construed. See Bennett Response at 8 (citing Sanchez v. Herrera, 1989-NMSC-073, ¶ 2, 109 N.M. 155, 783 P.2d 465, 469; Morton v. Great Am. Ins. Co., 1966-NMSC-206, ¶ 9, 77 N.M. 35, 419 P.2d 239; Knowles v. United Services Auto. Ass'n, 1992-NMSC-030, ¶ 7, 113 N.M. 703, 832 P.2d 394, 396; United Nuclear Corp v. Allstate Ins. Co., 2012-NMSC-032, ¶ 15, 285 P.3d 644, 649). She then argues that Exclusion J and Exclusion P of the Evanston Insurance policy create an ambiguity that the Court must resolve in favor of coverage. See Bennett Response at 9. Exclusion J, she notes, is written more broadly to exclude claims "based upon or arising out of, or in any way involving" the underlying bad conduct. Bennett Response at 12. She also notes that there is an exception to Exclusion J that adds back coverage for claims based on vicarious liability for "the conduct of another insured that constitutes a willful violation of any Statutes or Regulation." Bennett Response at 12-13. Bennett argues that this Exclusion expressly anticipates that some insureds may be held vicariously liable for other insureds' misconduct and restores coverage for them. See Bennett Response at 13. She argues that "the existence of these two provisions in the same insuring agreement applicable to the same claims made by Former DSLM clients, one of which provides coverage while the other excludes it, creates an ambiguity in the policy which must be read in favor of coverage for Bennett." Bennett Response at 14. Ms. Bennett argues that Exclusion J's language suggests that it is a "specific provision which overrides the general provision of Exclusion P," and that "[a]ny other interpretation would render the Exclusion J exception meaningless and contrary to settled principles of insurance policy interpretation." Bennett Response at 14. She supports her argument by asserting that this interpretation "accords with the reasonable expectations of the ordinary person," by reiterating that Exclusion P is ambiguous when read cumulatively with Exclusion J, and that Evanston Insurance has never alleged that she engaged in any knowing or criminal

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behavior. See Bennett Response at 15-16.

         5. The Reply to Ms. Bennett.

         Evanston Insurance filed a response to Ms. Bennett on August 22, 2019, and argued, first, that agency law's adverse interest exception does not apply to this case. See Reply to Ms. Bennett at 5-8. Evanston Insurance notes that courts using the adverse interest exception to prevent insurance policy rescissions do so only in cases of fidelity insurance policies — and this Insurance Policy is not a fidelity policy. See Reply to Ms. Bennett at 5. In further support of its argument, Evanston Insurance directs the Court to a case from the United States Court of Appeals for the Second Circuit, which rejected a similar argument to Ms. Bennett's, because "[a] principal may not disavow the act of an agent while simultaneously taking advantage of the benefits of the fraudulently procured bargain." Reply to Ms. Bennett at 6 (quoting Pereira v. Aetna Cas. & Sur. Co., 186 F.3d 196, 207-08 (2d Cir. 1999), and citing Restatement (Second) of Agency § 282 cmt. h). Finally, Evanston Insurance notes that the policy contains a clear, unambiguous imputation clause that provides that Donisthorpe's statements in the Application are imputed to all insureds. See Reply to Ms. Bennett at 8.

         Next, Evanston Insurance argues that the Insurance Policy's Exclusion J and Exclusion P do not create ambiguities. In regard to Exclusion P, Evanston Insurance argues that courts "across the country have overwhelmingly found that such exclusions apply to both intentional and negligent conduct," and directs the Court to several such cases. Reply to Ms. Bennett at 9-10.

         Last, Evanston Insurance argues that exceptions to policy exclusions like the one in Exclusion J do "not create coverage nor modify a separate stand-alone exclusion barring coverage." Reply to Ms. Bennett at 11. Further, Evanston Insurance argues that the Insurance Policy is not "rendered ambiguous simply because there is some overlap in two policy exclusions." Reply to Ms. Bennett at 12.

         6. The Combined Reply.

         Evanston Insurance filed a joint reply to Desert State's former clients and to Moya on August 23, 2019. Evanston Insurance first apologizes for failing to adhere to D.N.M.LR-Civ. 56.1(b), but noted that its evidence was either the Insurance Policy or public records. See Combined Reply at 6. It argues that denying its motion for failing to adhere to D.N.M.LR-Civ. 56.1(b) "would exalt form over substance." Combined Reply at 6.

         Evanston Insurance next dives into the substantive arguments. In response to Moya and the former clients' arguments about making a new claim, Evanston Insurance notes that its "original complaint and every subsequent amended complaint not only quoted the full text of the condition precedent but also asserted that the failure to satisfy the condition barred coverage" and argues that its briefs satisfied the notice pleading requirement. Combined Reply at 7.

         Evanston Insurance then advances its argument that, because Donisthorpe had knowledge of circumstances that could give rise to claims, the other insureds cannot meet their burden of establishing coverage under the second condition precedent. See Combined Reply at 11. It first notes that the Insurance Policy's definition of "insured" includes "[a]ny past or current principal, partner, officer, director, trustee or shareholder of the Named Insured... solely while acting on behalf of the Named Insured and within the scope of their duties." Combined Reply at 8. Evanston Insurance argues that, because of the word "any" in the definition, Donisthorpe's

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knowledge is imputed to the rest of the insureds. See Combined Reply at 8-9. It then argues that Moya's and the former clients' argument that Donisthorpe had no knowledge of "Wrongful Acts" under the policy "strains credulity," and "ignores the common-sense conclusion" that, because Donisthorpe was aware of his embezzlement, his colleagues were negligent in failing to discover it or implement preventative controls. Combined Reply at 9. Of Donisthorpe's knowledge, Evanston Insurance says that a "reasonable person" aware of the same circumstances "would conclude that a Claim was likely," and directs the Court to Tenth Circuit precedent suggesting that the insureds' subjective belief is irrelevant. Combined Reply at 10-11 (citing Cohen-Esrey Real Estate Servs. v. Twin City Fire Ins. Co., 636 F.3d 1300, 1303, 1304 (10th Cir. 2011)). Evanston Insurance concludes its Reply by arguing that the term "arising out of" in Exclusion P is not ambiguous, and that "it is beyond reasonable debate" that the underlying claims arise out of Donisthorpe's illegal commingling and misappropriation. Combined Reply at 12.

         7. The Sept. 5, 2019, Hearing.

         The Court held a hearing on the MSJ and other motions on September 5, 2019. See Clerk's Minutes at 1, filed September 5, 2019 (Doc. 127). The Court quickly turned to the MSJ and suggested that all parties address the MSJ's three arguments sequentially. See Transcript of Motion Hearing at 4:3-20 (Court) (taken September 5, 2019), filed October 3, 2019 (Doc. 139) ("Tr."). The Court then allowed Evanston Insurance to make an opening statement. See Tr. at 4:20-22 (Court).

         a. Argument Regarding the Policy's Condition Precedent to Coverage.

         Evanston Insurance began argument on the MSJ by discussing the Insurance Policy's second condition precedent to coverage, which conditions coverage on the insured having no knowledge of wrongful acts that are likely to lead to a claim. See Tr. at 5:16-6:16 (Borders). After the Court asked Evanston Insurance how it could show that at least some of the insureds did not have knowledge, see Tr. at 6:4-7 (Court), Evanston Insurance argued that the definition of "insured" suggests that it means "any insured," which distinguishes it from innocent insured cases, Tr. at 6:8-7:6 (Borders). Evanston Insurance then cited Miller v. Monumental Life Ins. Co., 761 F.Supp.2d 1123 (D.N.M. 2009) (Browning, J.), for the proposition that excluding language in an insuring agreement does not shift the burden of establishing coverage to the insurance company. See Tr. at 7:7-8:8 (Borders). It then argued that Donisthorpe cannot show that he did not know about circumstances likely to lead to claims under the Insurance Policy, see Tr. at 8:20-9:6 (Borders), and directed the Court to Copeland-Williams, for further proof, see Tr. at 9:7-18 (Borders).

         Moya then argued in opposition to Evanston Insurance's position. See Tr. at 10:20-25 (Court, Rubin). Moya first argued that "the so-called condition precedent" is a new argument. Tr. at 11:6-7 (Rubin). See Tr. at 11:4-12:10 (Rubin). He noted that "there was mention of negligence in the application, not in the policy," and that the Court cannot conflate the two documents. Tr. at 16:3-4 (Rubin). After the Court asked about the Insurance Policy's language, see Tr. at 12:19-21 (Court), Moya stated that there are not enough facts before the Court to decide who had what knowledge, see Tr. at 13:6-8. Moya then cited Redux, Ltd. v. Commercial Union Insurance Co., 1995 WL 88251 (D. Kan. Feb. 7, 1995) (Lungstrum, J.), to argue that, under the Insurance Policy's language, the burden to show knowledge

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shifts to the insurance company. See Tr. at 13:23-14:23 (Rubin).

         Ms. Bennett then argued in response to Evanston Insurance. See Tr. at 16:17-18 (Court, Sanders). She first read the Insurance Policy's definition of "insured" to the Court. See Tr. at 16:22-17:15 (Sanders). Pressed on how Evanston Insurance's arguments fail, Ms. Bennett pointed to the phrase "[t]he Company shall pay on behalf of the Insured ..." in the Insuring Agreement's first line as evidence that the Court should not read "the Insured" as "any Insured." Tr. at 18:8-20:8 (Sanders, Court). Ms. Bennett then noted that Exclusion J uses both "the Insured" and "any Insured," which she argued is evidence that "every time the word `insured' is used in the policy, it doesn't mean everybody all together." Tr. at 20:25-21:7 (Sanders). In response to a question from the Court about cases supporting and opposing her reading of "insured," Ms. Bennett stated that cases involving a duty of good faith and fair dealing support her reading, and that she does not recall seeing any supporting Evanston Insurance's reading. See Tr. at 22:3-23:10 (Sanders).

         The former Desert State clients then argued in response to Evanston Insurance. See Tr. at 24:3-4 (Court, Davis). The former clients first argued that the Court should dismiss the motion for failing to follow D.N.M.LR-Civ. 56.1(b). See Tr. at 23:5-25:21 (Davis). On "the actual dispute," Tr. at 25:23 (Davis), the former clients argued that Evanston Insurance is presenting a new claim, because Evanston Insurance never took the position that Insurance Policy creates a condition precedent. Tr. at 25:22-26:10 (Davis). They noted that the Insurance Policy explicitly states certain conditions precedent to coverage and thus "Evanston clearly knows how to create a condition precedent to coverage if they wanted to do so." Tr. at 26:11-13 (Davis). After expressing agreement with the other Defendants' arguments on this subject, the former clients then argued that the innocent insured doctrine should apply to this situation for public policy reasons, because other courts have applied the doctrine in similar circumstances with ambiguous ...


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