The U.S. District Court for the District of New Jersey, applying New Jersey law, has held that a misappropriation of funds exclusion unambiguously barred coverage for an accounting firm under its professional liability policy based on the allegations in the complaint, regardless of the insured’s defense that a third party, not the firm, committed the misappropriation. Certain Underwriters at Lloyd’s, London v. Drosos, 2024 WL 2292343 (D.N.J. May 21, 2024).

An accounts receivable lender sued a hospital as a purported “account debtor” owing funds to the insured accounting firm payable to the lender under certain revenue purchase agreements. The hospital in turn filed a third-party complaint against the accounting firm, alleging that the insured misappropriated payroll funds and used those funds to enter into the revenue purchase agreements with merchant cash advance lenders. Prior to this lawsuit, the insured acquired a professional liability policy that excluded coverage for any sums “based upon or arising out of the actual or alleged theft, misappropriation, commingling, or conversion of any funds.” The insurer denied coverage for the third-party complaint based on the exclusion and brought a declaratory judgment action.

The court granted judgment to the insurer, holding that the misappropriation of funds exclusion barred coverage, including a defense, for the third-party complaint. The court explained that courts have interpreted the exclusion’s “arising out of” language to apply to any cause of action that originates from or shares a substantial nexus with the allegations that the defendant misappropriated funds. Accordingly, the court concluded that the exclusion barred coverage because all nine counts in the third-party complaint were intrinsically tied to the allegations that the insured wrongfully used the hospital’s fiduciary accounts to enter into revenue purchase agreements without the hospital’s authorization.

In holding for the insurer, the court rejected the insured’s argument that a carve-out to the exclusion—which applied if a claim alleged a negligent mishandling of funds where the actual theft, misappropriation, or conversion was committed by a third party—applied because, according to the insured, a bank misappropriated the funds rather than the accounting firm. The court firmly rejected the insured’s argument because the hospital did not allege any misconduct by the bank, alleged only that the accounting firm converted and misappropriated the hospital’s funds for its own gain, and the allegations of the complaint—not the “insured’s version of events”—determined the duty to defend.

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