Are the Shoemaker’s Children Barefoot: How Well Do You Know Your Own Lawyers’ Professional Liability Coverage?
LAWYERS’ PROFESSIONAL LIABILITY COVERAGE ISSUES RESPECTING “LEGAL SERVICES” AND “DAMAGES”
Robert P. Thavis Leonard, Street and Deinard
Minneapolis, MN 55402
INTRODUCTION
Mary Borja’s accompanying paper addresses perhaps the most common source of issues with respect to lawyers’ professional liability coverage — questions about timing of notice to the insurer. When the lawyer knew, or should have known, that a potential claim might be asserted affects not only notice requirements, of course, but also matters with respect to application disclosures and rescission. However, knowledge and notice issues, which for the most part apply without respect to the substantive scope of coverage provided in the policy,
are not the only issues that repeatedly give rise to disputes over coverage for claims against practicing lawyers. This paper will address two areas of coverage dispute which are more dependent on the scope of coverage provided by the policy, and therefore depend more on particular policy language. The first question is what qualifies as covered legal services, as opposed to (for example), uncovered business activities. The second is whether the relief being sought constitutes “loss” or “damage” covered under the policy.
Most of the “tough cases” addressing whether an underlying claim is based on covered professional services, versus uncovered business activities, contractual obligations or intentional acts, will arise in a mixed-acts scenario. A lawyer acting solely in a business capacity, and sued as a result, typically has no viable argument for coverage, just as a lawyer sued solely for alleged errors in professional services rendered to clients provides the insurer no viable argument against coverage. But what about the gray areas — mixed business or contract activities versus professional services, or intentional acts versus negligent acts?
The coverage danger created by a lawyer wearing more than one hat is illustrated in Darwin National Assurance Co. v. Hellyer, et al., United States District Court for the Northern District of Illinois, Case No. 3:10-cv-50224, Document No. 53, issued June 7, 2011. In that case, attorney Hellyer and his law firm sought coverage for an action commenced against them by former clients who
were beneficiaries of a trust also created by Hellyer. After a third party offered to purchase real estate owned by the trust, the trust beneficiaries sought advice from Hellyer. Eventually a limited liability corporation (LLC) formed by Hellyer and another actually entered into an agreement to purchase the real estate from the beneficiaries. Five years later the LCC and the beneficiaries entered into a new purchase agreement, at the same price, with the LLC providing a note secured by the mortgage and personal guarantees. (The beneficiaries had separate representation in that transaction.) Thereafter the LLC, unable to make its payments, obtained an increased bank loan which was conditioned on the subordination of the mortgage agreement. The beneficiaries sued, alleging that Hellyer acted as attorney for the beneficiaries in obtaining their consents to the subordination without the beneficiaries realizing their significance. The beneficiaries’ complaint alleged professional negligence and breaches of Hellyer’s legal obligations to his clients.
In addition to finding that Hellyer should have notified his insurer prior to the suit, the court also found that the business enterprise exclusion precluded all coverage because, according to the court, the entire malpractice claim was based on, arose out of and was a direct result of, Hellyer’s business interests in the LLC. Thus, although professional negligence was directly alleged, the court concluded that:
It is clear that the thrust of the allegations of negligence stem from the conflict of interest that Hellyer was laboring under as a result of his interest in [the LLC]. Within this context, it is reasonable to conclude that these allegations of failing to properly advise his clients are, at a minimum, either indirectly resulting from or in consequence of Hellyer’s business interests in [the LLC].
Id. at 5.
The Hellyer court’s focus on the “thrust” of the underlying allegations reflects an acceptance of a more and more common theme, at least in insurer arguments. Whether raised in the context of a business enterprise or contractual liability exclusion, a claim of no wrongful act, or public policy arguments not tied to particular policy language, insurers have increasingly begun arguing for the abandonment of the traditional test for determining a defense obligation (whether the underlying allegations create any possibility of any covered liability), in favor of an approach tied to whether or not the “general thrust” of the underlying complaint falls within coverage.
Although raised in a number of different contexts, and with respect to a number of different types of policies and policy provisions, the arguments all tend to be advanced based on a collection of the same cases. Some of those cases, at least according to insurers advancing these arguments, support the proposition that whether a claim “arises out of” an excluded activity should be determined by a broad approach to what constitutes “arising out of.” Moreover, the insurers’ argument typically takes the (in this author’s opinion untenable) position that if the
claim “arises out of” a blend of both covered activity and arguably uncovered activity, the uncovered activity “trumps” the covered activity, and coverage must be denied.
While in this author’s opinion they do not support the result for which they are proffered, cases advanced in support of this argument have included Pacific Ins. Co. v. Eaton Vance Mgmt., 369 F.3d 584 (1st Cir. 2004); American Legacy Foundation v. National Union Fire Ins. Co., 623 F.3d 135 (3d Cir. 2010). Data Specialties, Inc. v. Transcomp Ins. Co., 125 F.3d 909 (5th Cir. 1997); Baylor Heating & Air Conditioning, Inc. v. Federated Mut. Ins. Co., 987 F.2d 415 (7th Cir. 1993); May Dept. Stores Co. v. Federal Ins. Co., 305 F.3d 597 (7th Cir. 2002);
Cincinnati Ins. Co. v. Metro Prop, Inc., 806 F.2d 1541 (11th Cir. 1986); Waste Corporation of America, Inc. v. Genesis Ins. Co., 382 F. Supp. 2d 1349 (S.D. Fla. 2005), aff’d 209 F. App’x 899, 2006 WL 3505383 (11th Cir. 2006); American Cas. Co. of Retting, PA v. Hotel & Restaurant Employees & Bartenders Int’l Union Welfare Fund, 942 P.2d 172 (Nev. 1997); August Entertainment, Inc. v. Philadelphia Indem. Ins. Co., 146 Cal. App. 4th 565 (2007); Oak Park Calabasas Condo Ass’n v. State Farm Fire & Cas. Co., 137 Cal. App. 4th 557 (2006); St. Paul Fire & Marine Ins. Co. v. Briggs, 464 N.W.2d 535 (Minn. Ct. App. 1990);
Executive Risk Indem. Inc. v. CIGNA Corp., 976 A.2d 1130 (Pa. Super. 2009);
County, Indiana Superior Court Jan. 31, 2012); BOC Group, Inc. v. Federal Ins. Co., 2007 WL 2162437 (N.J. Super. A.D. 2007); Newman v. XL Specialty Ins. Co., Case No. C-1-06-781, 2007 WL 2982751 (S.D. Ohio Sept. 24, 2007).
As noted, the dominant test for determining the existence of a defense obligation is whether the allegations in the underlying complaint create any possibility of covered indemnity, and that test will result in a defense obligation whenever any pathway to covered liability can be found in the underlying allegations, regardless of the “general thrust” of the underlying allegations. Thus, innumerable decisions have found coverage without giving credence to, or even addressing, the question of whether any “arising out of” exclusionary language is broad enough to trump an independent alternate pathway to coverage set forth in an underlying complaint. Commentators, and a few courts, have also directly addressed, and rejected, this “arising out of” argument. See, e.g., Allen D. Windt, 3 Insurance Claims and Disputes 5th § 11.22A (March, 2012) (“Maybe if Columbus hadn’t discovered America the federal courts of appeals would not have been created in 1891; but it would be odd to say that the federal appellate judiciary ‘arise from’ Columbus’ voyages.”) See, Executive Risk Indem., Inc. v. CIGNA Corp., 976 A.2d 1130 (Pa. Super. 2009); Cincinnati Ins. Co. v. Metropolitan Properties, Inc., 806 F.2d 1541 (11th Cir. 1986); United Health Group, Inc. v. Columbia Cas. Co., 836 F. Supp. 2d 912 (D. Minn. 2011).
A second area that generates continued coverage disputes with respect to claims made under lawyers’ professional liability policies is the interpretation of the requirement in those policies that the covered claim must seek “loss” or “damage” as defined in the policy. Arguments over damage or loss can arise in a number of different contexts. The insurer argument can be an extension of the argument described above — i.e., that the activity isn’t covered because it arises out of a business activity, arises out of a contractual relationship, etc. In these scenarios, the typical argument seeks to apply a broad “but for” causation, that the recovery being sought is only what should have been provided to the claimant if there had been no actionable uncovered acts. The argument goes that if there had been no outside business activity, no breach of contract, etc., then there would have been no corresponding lawsuit against the insured lawyer. Thus, the argument continues, the relief being requested is not covered loss or damage, even if the lawsuit seeks a tort-based recovery.
Separate challenges include whether an underlying individual plaintiff’s complaint’s request for relief in the form of disgorgement, restitution, or penalties such as sanctions, constitute covered “loss” or “damage.” Insurers typically argue that relief characterized as disgorgement or restitution, as opposed to compensatory damages, does not constitute damage or loss, but rather the giving up of some ill-gotten gain, which some courts (Illinois courts in particular) have found
uninsurable. The cases frequently cited on these issues include those set forth below, with a disproportionate number of the principal cases for insurers in this area having come out of state and federal courts in Illinois. See, e.g., Level 3 Communications v. Federal Ins. Co., 272 F.3d 908 (7th Cir. 2001); Spirtas Co. v. Federal Ins. Co., 521 F.3d 833 (8th Cir. 2008); Callas Enterprises, Inc. v. Travelers Indem. Co. of America, 193 F.3d 952, 52 U.S.P.Q. 2d 1536 (8th Cir. 1999); United Western Grocers, Inc. v. Twin City Fire Ins. Co., 371 F. Supp. 2d 1234 (D. Hawaii 2005), rev’d on other grounds, 457 F.3d 1106 (9th Cir. 2006); St. Paul Mercury Ins. Co. v. Foster, 268 F. Supp. 2d 1035 (C.D. Ill. 2003); Haines v. St. Paul Fire & Marine Ins. Co., 428 F. Supp. 435 (D. Md. 1977); CIM Ins. Corp. v. Midpac Auto Center, Inc., 108 F. Supp. 2d 1092 (D. Hawaii 2000); Vigilant Ins. Co. v. Credit Suisse First Boston Corp., 10 A.D. 3d 528, 782 N. Y. Supp. 2d 19 (N.Y. A.D. 1 Dept., 2004) (but see General Cas. Co. of Wisconsin v. Wozniak Travel, Inc., 762 N.W.2d 572, 575 n.2, and 578 (Minn. 2009) (casting doubt on Callas); Ross v. Briggs & Morgan, 540 N.W.2d 843 (Minn. 1995); Continental Cas. Co. v. Donald T. Bertucci, Ltd., 399 Ill. App. 3d 775, 926 N.E.2d 833 (Ill. App. 1 Dist. 2010);
Continental Cas. Co. v. Law Offices of Melvin James Kaplan, 345 Ill. App. 3d 34, 801 N.E.2d 992 (Ill. App. 1 Dist. 2003); Ryerson, Inc. v. Federal Ins. Co., 2010 WL 6882694 (N.D. Ill. 2010); Petronet, LLC v. Hartford Cas. Ins. Co., No.
10-3675, 2011 WL 2960240 (D. Minn. July 21, 2011); North Plainfield Bd. Of Educ. v. Zurich American Ins. Co., 2008 WL 2074013 (D. N.J. 2008).
The insurers’ argument is not always a legitimate one. As the court noted in
Foster, damages measured by third parties’ loss, rather than the defendant’s improper gain, should not be deemed an uninsured restitution or award. Further, some states have held that a disgorgement of attorneys’ fees constitutes covered damages, or that sanctions proceedings can give rise to a defense obligation. Perl v. St. Paul Fire & Marine Ins. Co., 345 N.W.2d 209 (Minn. 1984). See, also, Post v. St. Paul Travelers Ins. Co., 691 F.3d 500 (3d Cir. 2012) (sanctions motions related to underlying malpractice claims for purposes of coverage).
One recurring sub-issue as to damage or loss arises when the underlying claim brought is not a private action, but a governmental, statutory or disciplinary enforcement action. In the environmental context, most states have now construed government claims seeking injunctive relief and restitution under CERCLA as claims seeking “damages.” Indeed, that is the rule even in Illinois. Outbound Marine Corp. v. Liberty Mut. Ins. Co., 607 N.E.2d 1204 (Ill. 1992). Yet insurers continue to argue that in other contexts, such as SEC civil enforcement actions or attorney disciplinary or sanctions proceedings, such relief is not covered. Even in states that accept that premise, however, the policyholder may still have arguments. For example, SEC enforcement actions may seek restitution or
disgorgement or penalties, and yet sums recovered based on an SEC claim can and do go into a Fair Fund used to compensate victims. 15 U.S.C. § 7246. The same is often true at the state level. See, for example, California’s Proposition 65, Health and Safety Code § 25249.5, et seq. An argument can be made that although ordinary “disgorgement” may not be covered, disgorgement or restitution or penalties that actually can end up being distributed as a compensatory recovery to victims should give rise to coverage.
Finally, some insurers have been known to argue that intentional acts exclusions and related provisions which preclude coverage under a professional liability policy apply to any act that was intended, even if the consequences of the intentional act were not intended. See Compaq v. St. Paul Fire & Marine Ins. Co., No. C3-02-2222, 2003 WL 22039551 (Minn. Ct. App. Sept. 2, 2003), which insurers have alleged supports that proposition. However, most courts have thoroughly rejected that argument. See, e.g., Eyeblaster, Inc. v. Federal Ins. Co., 2010 U.S. App. LEXIS 15152, No. Civ. A. 08-3640 (8th Cir. July 23, 2010);
Illinois State Bar Ass’n Mut. Ins. Co. v. Timothy J. Cavenagh, 2012 Ill. App. (1st) (4th Div., Nov. 1, 2012), Case No. 108 CH 44982; St. Paul Fire & Marine Ins. Co. v. Compaq Computer Corp., 539 F.3d 809 (8th Cir. 2008).
