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Continental Casualty Co. v. Coregis Insurance Co.

March 31, 2000

CONTINENTAL CASUALTY COMPANY,
PLAINTIFF-APPELLEE,
V.
COREGIS INSURANCE COMPANY,
DEFENDANT-APPELLANT.



The opinion of the court was delivered by: Justice Burke

MODIFIED ON DENIAL OF REHEARING November 15, 2000

Appeal from the Circuit Court of Cook County. Honorable Ronald Riley, Judge Presiding.

Defendant Coregis Insurance Company (Coregis) appeals from an order of the circuit court granting summary judgment in favor of plaintiff Continental Casualty Company (Continental) on its complaint for contribution from Coregis and ordering Coregis to pay $2 million to Continental for funds, which Continental paid in behalf of Coregis' insured, Clark Nuber & Company (Clark Nuber), in settlement of a securities fraud class action against Clark Nuber, and denying its motion for partial summary judgment. On appeal, Coregis contends that the trial court erred in granting Continental summary judgment because: (1) the settlement was covered under a policy issued by Continental to Clark Nuber (Continental policy), since a claim was made during Continental's policy period, and a question of fact existed as to whether a provision of Continental's policy, "Exclusion O," applied; (2) a policy issued by Coregis to Clark Nuber (Corgeis policy) covered only the portion of the settlement which represented payment for Clark Nuber's liability for its audit of its client's (Midisoft Corporation) recognition of revenue for two original equipment manufacturers' (OEM) contracts and, therefore, the trial court erred in finding that its policy covered the entire settlement; (3) even if Coregis' policy covered the settlement, a genuine issue of material fact existed as to what amount, if any, of the settlement should be allocated to it; and (4) alternatively, if Coregis' policy covered the settlement, it was entitled to a declaration that Continental's policy also applied and to a pro rata allocation of the settlement. For the reasons set forth below, we affirm.

International Insurance Company issued a "claims made" accountants' professional liability policy to Clark Nuber, a certified public accounting firm with offices in Bellevue, Washington, for the policy period of June 4, 1993, to June 4, 1994. The policy was assumed by Mt. Airy Insurance Company, which later changed its name to Coregis Insurance Company. The policy provided, in part:

"If during the POLICY PERIOD, any INSURED first becomes aware of a potential CLAIM (i.e., any act, error or omission which might reasonably be expected to be the basis of a CLAIM against any INSURED under this policy), the insured must give immediate written notice of such act, error or omission to the Company during the POLICY PERIOD. Any CLAIMS subsequently made against any INSURED arising out of that act, error or omission shall be considered to have been made and reported during the POLICY PERIOD."

The policy also provided, under "Claims Expenses:"

"Two or more CLAIMS arising out of a single act, error or omission or a series of related acts, errors or omissions shall be treated as a single CLAIM."

Continental subsequently issued a claims made accountants' professional liability policy to Clark Nuber for the policy period of June 4, 1994, to June 4, 1995, which provided, in part:

"We will not defend or pay, under the Coverage Part, for:

O. Any wrongful act which happened prior to the 'effective date' shown on the declarations; if on such date you knew or could reasonably foresee that such wrongful act might be the basis for a claim."

Prior to the issuance of Continental's policy, Midisoft. a manufacturer of interactive multimedia software, retained Clark Nuber to audit its financial statements for fiscal years 1991, 1992, 1993 and for the first quarter of 1994. Clark Nuber audited Midisoft's December 31, 1993, year-end financial statements and reviewed its unaudited 1994 first quarter financial statements; it did not audit Midisoft's 1994 unaudited second, third or fourth quarter financial statements, nor its December 31, 1994, year-end financial statements.

In 1994, while Midisoft was in the process of planning a second public offering of its stock, the underwriter for the proposed public offering retained Coopers & Lybrand, an accounting firm, to assist in its "due diligence investigation." Coopers & Lybrand raised a question about Clark Nuber's "interpretation of relevant professional standards for the recognition of revenue" with respect to the financial statements audited by Clark Nuber in 1993. As a result, Clark Nuber sent Coregis the following letter, dated June 3, 1994, one day before Coregis' policy was to expire:

"Our firm has recently learned of circumstances which may result in a claim being made against our firm and/or certain shareholders of our firm. *** [W]e are hereby notifying Coregis to comply with the policy's requirement that we report the possibility of a claim within the current policy period. By making this report, we understand that any future claim arising out of these circumstances will be covered by the current policy even if the claim itself is asserted after the present policy expires. ***

A publicly held software development Company, Midisoft Corporation, is in the process of planning its second public offering. *** During the process, [a] question [was raised] about the interpretation of relevant professional standards for the recognition of revenue by such a company, and, in an effort to obtain clarification, advised the software company to request concurrence of the SEC for the company's past accounting practices in the recognition of such revenue. That question, in effect, raised a potential issue with respect to the financial statements audited by our firm for the fiscal year ending December 31, 1993, which were included in the annual SEC 10K filing. *** The company, with advice from both Coopers [& Lybrand] and our firm, has already discussed this issue with the SEC accounting staff. Our firm was told by one of the chief accountants last Friday, May 27, that the SEC accounting staff had concluded there was no problem. ***

*** However, since our current policy expires on June 4, we wanted to report these circumstances in the event that a future claim is asserted so that the current policy will cover it."

In November 1994, Midisoft retained Price Waterhouse as its auditor, replacing Clark Nuber. In July 1995, Midisoft announced that Price Waterhouse was restating Midisoft's 1994 first, second and third quarter financial statements, and its 1994 year-end and 1995 first quarter financial statements. Midisoft shareholders subsequently sued Midisoft in Seattle, Washington, alleging Midisoft issued false and misleading financial statements concerning the company's financial position.

On December 18, 1995, Midisoft shareholders also filed a securities fraud class action in Washington against Clark Nuber, entitled Jackson Smith, et al. v. Clark Nuber & Co., P.S. (the Smith action). The Smith complaint alleged that "Midisoft's publicly issued financial statements for the year ending December 31, 1993 as well as the quarters ending March 31, 1994, June 30, 1994 and September 30, 1994 including the financial statements included in Midisoft's Prospectus for its secondary offering of stock were materially false and contributed to the artificial inflation of Midisoft's stock price and thus caused the Class members damage when they paid an inflated price for Midisoft stock." The complaint further alleged that Midisoft overstated its revenue and earnings during all of 1993 and the first three quarters of 1994 as a result of improper accounting practices by Midisoft concerning revenue recognition, failure to provide adequate reserves for uncollectible accounts receivable, capitalizing, instead of expensing, software and advertising costs, and improper accounting for stock option compensation and the related tax benefit. The complaint also alleged that Clark Nuber participated "in the development of the accounting treatments essential to the irregularities in Midisoft's statements," and "falsely represented, in Midisoft's annual form 10-K which was filed *** for the year 1993, that Midisoft's financial statements complied with *** Generally Accepted Auditing Standards during the course of the audit," and assisted in developing the strategies for accounting for Midisoft's stock option plan, which in turn had become in part, the basis of Midisoft's quarterly reports to shareholders and press releases containing financial information."

On December 20, 1995, Coregis wrote to Clark Nuber and reserved its rights to decline to defend and/or indemnify Clark Nuber with regard to its work for Midisoft. In February 1996, Coregis agreed to participate in the defense of Clark Nuber in the Smith action, but reserved its "rights or defenses." On February 22 and 23, 1996, a court-ordered mediation was held in Seattle, Washington. According to Continental, in a letter dated February 23, 1996, "Coregis withdrew its reservation of rights [regarding the Smith action], acknowledged coverage under its policy for the complaint, and acknowledged that it received written notice of the claim on June 3, 1994." In November 1996, a final settlement was approved by the Washington court and judgment was entered; Continental paid $2 million in behalf of Clark Nuber, reserving its rights to pursue contribution from Coregis, and Coregis paid $200,000.

In December 1996, Continental filed a one-count complaint, seeking contribution from Coregis for the settlement amount it paid in the Smith action. Continental alleged that "all of the alleged wrongful acts by Clark Nuber occurred during Coregis' policy period" and notice of the claim was made and reported to Coregis during Coregis' policy period" pursuant to the "Reporting of Potential Claims" provision in Coregis' policy." Continental maintained that the June 3, 1994, letter sent by Clark Nuber to Coregis gave notice to Coregis and, since Coregis admitted that the Midisoft claim was made and reported during the Coregis policy period, the Smith settlement was covered under the terms of Coregis' policy. Continental also alleged that the damages flowing from Midisoft's "revenue problem" and "tax problem" arose as a result of the wrongful acts of Clark Nuber committed prior to June 4, 1994, during Clark Nuber's 1993 audit of Midisoft's ...


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