$9M Malpractice Verdict Against IP Firm Spawns Battle Over Insurance Coverage

Malpractice Insurance Professional Liability

A small technology company, fearful that it may be unable to collect a $9M malpractice judgment that it won from an IP law firm, urged an appeals court to rule that the firm has a $10 million malpractice policy to cover the award.

Underlying Case

We previously wrote about Protostorm, LLC, which in 2000 invented an online game that enabled real-time delivery of targeted ads to players, and tracking and reporting of those ads’ effectiveness.

The company hired the now-defunct Arlington, VA law firm of Antonelli Terry Stout & Kraus (ATS&K) in 2000 to obtain a patent on its invention, only to discover in 2007 that the USPTO had deemed its patent application “withdrawn”, and no patent had been awarded.

Protostorm sued ATS&K and several of its attorneys in 2008, and was awarded $6.975M in compensatory damages and $1M in punitive damages by a jury in 2014. District Court Judge Chen later added over $1M in pre and post-judgment interest to the award, and denied defendants’ post-trial motion to set aside the verdict.

Defendants appealed to the Second Circuit, which denied the appeal, and upheld the District Court’s award to Protostorm.

 Malpractice Insurance

During litigation of the underlying case, it was revealed that ATS&K had a legal malpractice insurance policy with Minnesota Lawyers Mutual (MLM), which would cover the matter.

That policy incepted in October 25, 2006, and had “prior acts coverage” retroactive to before ATS&K was retained by Protostorm. However, while it provided a limit of $10 million for acts occurring during that or future policy periods, i.e., on or after October 25, 2006, the limit for acts occurring before then was $5M.

Insurer Files Suit

In October, 2015, Protostorm, concerned about being able to collect its award, filed a motion – which the District Court approved – to register the judgment in federal district courts, state courts in California, Florida, Texas, etc., “and in such other jurisdictions as Protostorm may determine…that the judgment debtors’ assets have been or may be found”. It subsequently registered the judgment in Minnesota.

That prompted MLM to file a declaratory judgment action in Virginia federal court, seeking a ruling that its coverage was limited to $5M.

Per MLM’s filing, “Protostorm’s (motion) stated that there were substantial insurance coverage issues, including issues relating to the amount of ATS&K’s available insurance limits, and indicated an intention to litigate…Prior to this time, neither Protostorm nor anyone else had asserted that any controversy existed with regard to insurance limits.”

In other words, MLM’s position from the time it was notified of the claim had been that its coverage obligation was limited to $5M, because ATS&K’s failure to apply for the patent occurred in 2001 – 2003, i.e., before October, 2006, and it wasn’t aware of any opposition to that position, until Protostorm filed its motion to register the judgment in other jurisdictions.

Faced with the possibility of litigation over its policy limits, MLM filed a pre-emptive lawsuit, asking the court to intervene by granting its motion for summary judgment that its coverage obligation was limited to $5M.

“The only negligent acts that caused damages occurred prior to January 2003, since after that date, nothing anyone did made any difference — the loss of patent rights was irremediable…Any ‘concealment’ of any such damage after 2003 was in no way the cause of the harm to Protostorm. Thus, as a matter of law, under the limits of liability endorsement, the policy limits for the Protostorm claim were $5 million.” 

It further argued that:

  • It was undisputed that the absolute due date for ATS&K to file a patent application before Protostorm lost its patent rights was Sept. 27, 2001. The firm could have filed a new patent application at the very latest by 2003, but didn’t.
  • Throughout its litigation with ATS&K, Protostorm never asserted that any of its damages came from anything other than the loss of its right to patent its invention, which occurred between 2001 and 2003. Since MLM’s policy clearly stated that the limit for any claim arising out of action before October, 2006, was $5M, that limit must apply to Protostorm’s claim.
  • Protostorm had argued during the trial that ATS&K’s concealment of its malpractice began in 2001 and continued through 2008, and the jury did find that the firm had concealed its mistakes, and thus awarded Protostorm punitive damages.

    However, this concealment rose directly from ATS&K’s failure to file the correct patent application, which indisputably occurred before October, 2006.
  • Even if concealment of malpractice could constitute a claim that arose during the coverage period, it’s considered to be a dishonest act, which is excluded from coverage.

Protostorm Responds

Protostorm, presumably having been assigned ATS&K’s rights under the policy, filed its own motion for summary judgment, which claimed that ATS&K’s policy provides up to $10 million in coverage.

“…the undisputed facts establish that the underlying lawsuit meets the definition of ‘claim’ under the policy, and while the lawsuit undeniably arises in part from acts, errors and omissions occurring before Oct. 25, 2006, the lawsuit also undeniably arises in part from acts, errors and omissions occurring after that date.”

Protostorm disputed MLM’s position that ATS&K’s wrongful acts occurred between 2001 – 2003, arguing that the jury in the underlying case determined that ATS&K had continued to represent Protostorm until 2007, and its claim was based in large part on ATS&Ks conduct during those years, i.e., it’s failure to communicate with Protostorm, and its failure to disclose that the application did not protect Protostorm’s patent in the U.S. As a result, $10M in coverage should be available under MLM’s policy.

Court Ruling

U.S. District Judge Cacheris ruled in MLM’s favor, granting its motion for summary judgment that the policy it underwrote for ATS&K had a limit of $5M, not $10M.

The court found that the $5M limit applied, because Protostorm’s claims predated the increase to a $10M policy limit in October 2006. “Based on the evidence presented to the jury and the jury’s verdict, all of the elements necessary for the accrual of the malpractice cause of action were present by early 2003, at the latest.”

Further, the judge stated that a recent Virginia Supreme Court decision clarified that the phrase “arising out of” an act, error or omission in an insurance policy was to be broadly construed, i.e., there needed to be a particular fact that had a causal relationship with a cause of action. In this case, there was: the cause of action arose out of ATS&K’s failure to prosecute the patent, which occurred at the very latest in 2003. Even if the firm continued to cause harm — like concealing the status of the patent — the very first acts started while the $5 million policy applied.

Judge Cacheris rejected ATS&K’s arguments that the higher limit applied, because the claims did not truly arise until after the firm’s representation of Protostorm ended after October 25, 2006.

He agreed with MLM’s attorney, who stated during oral argument: “A claim comes into being when there’s damage…It doesn’t get continued for purposes of a clause like this in a policy because there’s more damage in the future.”

The judge opined that courts have typically rejected arguments that the terms of a malpractice insurance policy can be stretched if the attorney keeps representing the wronged client. “Several cases interpreting claims-made insurance policies have reached the same conclusion when faced with the argument that the continuation of an attorney-client relationship carries the malpractice claim into the temporal scope of the policy’s coverage.”

Appeal

Protostorm appealed Judge Cacheris’ decision to the Fourth Circuit.

In their opening brief, Protostorm and ATS&K asserted that the Judge applied an improperly narrow interpretation of the phrase “arising out of”, which flouts Virginia precedent establishing that the phrase requires only that an act have some substantial connection with a legal cause of action.

They further argued that the judge ignored evidence presented in the underlying case that established that ATS&K engaged in misleading conduct after Oct. 25, 2006, when  the limit of its policy with MLM increased to $10M.

“In the malpractice lawsuit at issue here, but for Protostorm’s repeated elicitations of evidence in the [district court] concerning acts, errors and omissions that allegedly occurred in 2007 and 2008, Protostorm would have lost the claim — i.e., the lawsuit— and the one cause of action asserted within it.”

“The applicable limit under the policy is [$10 million] because Protostorm’s claim arises, in part, from acts, errors and omissions that occurred after October 25, 2006.”

Analysis
The appeals court will almost certainly affirm the District Court’s ruling, because the plain meaning of “arising out of” is “come into being”, and Protostorm’s claim against ATS&K “came into being” when ATS&K failed to designate the US for patent protection, when it filed the patent application.

In that case, Protostorm will be faced with trying to collect a judgment of over $9M (including post-judgment interest, which is continuing to accrue), when defendants’ sole collectible asset appears to be its malpractice insurance policy, which has a $5M per claim limit.

However, the news is much worse that that for Protostorm, because ATS&K’s insurance policy almost certainly has “eroding limits”, which means defense costs are subtracted from the per claim limit, which leaves that much less to pay any settlement or judgment.

Since this matter spanned nearly nine years, and included a trial and appeal, total defense costs are likely between $2 million and $3 million.

If we split the difference, and use $2.5 million as a benchmark, then there’ll be $2.5 million left on ATS&K’s $5 million policy to satisfy the judgment.

Further, as mentioned in Part III of our coverage of the underlying case, ATS&K essentially shut down in April, 2015, so it doesn’t have ongoing cash flow. Further, its assets have likely been removed, Protostorm failed in its attempt to have ATS&K attorneys Brundidge and Bailey declared jointly and severally liable for the judgment, and Protostorm has no recourse against ATS&K’s former equity partners. 

Therefore, unless Protostorm is able to uncover additional collectible assets, it’ll likely have to settle for the $2.5 million left on ATS&K’s policy, which will be further reduced by its attorneys’ contingency fee, and its own fees and costs.

The bottom line is that Protostorm will wind up with about $1.5 million. That’s not an inconsiderable sum, given that all of it will apparently go to Peter Faulisi, Protostorm’s co-founder, and the only individual plaintiff, but it will likely seem to be a frustratingly small payoff, given the size of the judgment, not to mention the potential royalties that might’ve been earned, if Protostorm had been awarded a patent.

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About Curtis Cooper

Curtis Cooper is principal of Lawyers Insurance Group – Broker For Great Law Firms, which helps attorneys optimize their malpractice coverage. Contact him by phone: (202) 802-6415, or email: ccooper “at” lawyersinsurer.com.