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In Washington, Coverage for Sole Proprietorship Must Include Broad Definition of "Insured"



I ran across a cautionary tale recently in a new Washington federal-court decision in Staheli v. Chicago Insurance Company. The lesson: in Washington, or any other community-property state, a liability policy covering a sole proprietorship must define "insured" broadly to cover the spouse of the proprietor. This is a cautionary tale for insurance agent/brokers as much as anyone, as failure to advise a client about this issue could create E&O exposure.

The facts of Staheli are pretty straightforward: Mrs. Staheli operated a psychological counseling business as a sole proprietorship, and was sued by one of her patients for professional negligence. Because Washington is a "community property" that Mrs. Staheli purchased only provided for the defense of the Named Insured, and according to the court "identified the 'Named Insured' as Mrs. Staheli in her capacity as sole proprietor of her psychology business." As a result, when the Stahelis demanded that the insurers provide a lawyer to defend Mr. Staheli, the insurers refused, and they were forced to hire a separate lawyer to defend the husband.

After the suit was settled (and the insurers paid the settlement) the Stahelis sued to recover the defense fees that they spent defending Mr. Staheli. The court ruled in favor of the insurer, however, finding the language of the policy clear as to who was an insured and who was not. While there is much to criticize about the court's decision from a public policy standpoint at least, the case serves as a cautionary tale to policyholders to read proposed policies carefully and to understand all legal risks before committing to a coverage program, and also to insurance brokers when advising clients about the realities of liability risk and limitations on coverage. It may have been possible in this situation to negotiate an endorsement broadening the definition of "Insured" or naming the marital community and all those in it as "additional insureds," in light of Washington's status as a "community property" state; alternatively, the therapist may have been able to shield marital assets from the suit through formation of a professional corporation to conduct the business.

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