Legal Malpractice Insurer Sues To Void Firm’s Policy Over Undisclosed Claim

Legal Malpractice Insurance

Malpractice Insurance Professional Liability

Law360 reported that Westport In-surance Corp. filed a lawsuit in Penn-sylvania federal court on 2/29/16, seeking to rescind a legal malpractice policy it issued to 150-lawyer firm Stevens & Lee PC, because the firm withheld material information from its malpractice insurance application.

Westport, which is owned by Zurich-based insurance giant Swiss Re, and is one of the US’ largest legal malpractice insurers, alleges that on the Securities Law supplement that was part of Stevens & Lee’s application, it “denied that any of its sec-urities clients had a claim or allegation of fraud, negligence or breach of duty asserted against it.” 

However, Westport claims that the firm failed to disclose an October 2011 class action suit accusing its now-bankrupt client AgFeed of making materially false and misleading statements to investors about its financial condition.

Westport issued a policy to Stevens & Lee in December, 2012, which had a $10M limit and an endorsement providing $5M coverage for punitive damages. However, if it had “been made aware of the class action securities lawsuit filed against AgFeed, it would have issued the policy under different terms and conditions”, i.e., a 29% higher premium, and no endorsement providing coverage for punitive damages.

Westport learned of the securities lawsuit when Stevens & Lee sought coverage for an adversary proceeding filed against it last July  in Delaware bankruptcy court, by the Trustee that represents the AgFeed Liquidating Trust, which was established by AgFeed’s Chapter 11 plan.

The suit claims that Buchanan Ingersoll & Rooney PC, Stevens & Lee PC, and attorney William Uchimoto failed to provide advice that would have alerted AgFeed and its board to a $239 million accounting scheme perpetrated by its China-based operations, which “materially and proximately caused harm to AgFeed, its investors and its creditors.”

The Trustee alleges that if the firms had properly advised Agfeed’s board of the ‘red flags’ raised by the Chinese units’ financial reports, it could have remedied and reported either the financial irregularities or the misleading data that was later provided to the SEC and investors.

Uchimoto was AgFeed’s outside general counsel from 2008 through January 2010, while working at Buchanan Ingersoll & Rooney, and took the account with him to Stevens & Lee.

According to the Trust’s complaint, AgFeed was created through a reverse-merger of a China-based hog and feed producer and a Nevada shell company, in September, 2010. “The use of the reverse-merger device allegedly allowed China-based businesses to raise money on U.S. stock exchanges and was utilized by Uchimoto and a notorious stock promoter (Wey).”

The Trust also alleges that by merging with the Nevada shell company, AgFeed was able to raise money based on financial statements that showed inflated profits. Former prin-cipals of the company allegedly used a variety of methods — such as faking in-voices for sales of feed and nonexistent hogs — to inflate its revenue from its China operations from 2008 through 2011. This led to action against the company by federal securities regulators, which resulted in an $18 million settlement.

Further, the Trust claims that Uchimoto and Stevens & Lee were aware that AgFeed’s published financial numbers might be inaccurate, and in some instances were inten-tionally false, as AgFeed’s China-based managers sought to inflate company earnings and stock prices.

However, rather than helping AgFeed mitigate the problems, Stevens & Lee and Uchi-moto allegedly told the board that “it should not disclose the fact that AgFeed had re-ceived credible evidence that its Chinese management had been keeping two sets of books and the false book had been used to generate the financial statements upon which the investing public relied.”

Westport is defending Stevens & Lee against the AgFeed Trust’s allegations under a reservation of rights. As noted, in late February it sued to void the policy.

“Because Stevens & Lee knew when it submitted the [policy’s] securities supplement to Westport that it contained false information, Westport seeks leave to rescind the policy so that the policy is void ab initio and of no force and effect,” the complaint said.

Alternatively, the insurer is asking the court for a declaratory judgment that it has no duty to defend or indemnify Stevens & Lee or Uchimoto for the claims filed against them by the Trust.

“The Trust’s lawsuit alleges that Uchimoto’s malpractice in representing AgFeed began before he started working at Stevens & Lee, and that Uchimoto knew or should have known of the claimed malpractice. Disputes exist between Westport, Stevens & Lee and Uchimoto regarding whether Westport has a duty to defend and indemnify them for the claims asserted in the Trust’s lawsuit,” the complaint said.

Analysis

#13 of Westport’s Securities Law Supplemental Application asks:
“To Applicant’s knowledge, has any securities or securities related client of the firm: Had any claim or allegation of fraud, negligence, or breach of duty asserted against it?”

It likely asked this question because such claims can lead to legal malpractice claims by the client against the firm, for not “keeping it out of trouble”.

Stevens & Lee apparently answered this question “No”, and Westport issued the policy, which included an endorsement providing $5M dollars of coverage for punitive damages, which otherwise wouldn’t be provided, because of this language in its legal malpractice policy:

I. INSURING AGREEMENTS
A. The Company shall pay on behalf of any INSURED all LOSS in excess of the deductible…

III. DEFINITIONS
 K. “LOSS” MEANS the monetary and compensatory portion of any judgment, award or settlement, provided always that LOSS shall not include:
   3. punitive or exemplary damages;

However, the firm’s “No” answer to #13 was apparently inaccurate, because, as noted,  Westport’s complaint alleges that the firm failed to disclose the October 2011 class action lawsuit against its client AgFeed.

Westport’s attempt to void the policy will rely on this provision:

V. CONDITIONS
 S. ENTIRE AGREEMENT

By acceptance of this POLICY, all INSUREDS reaffirm as of the effective date of this POLICY that (a) the statements in the application(s) and all information communicated by the INSUREDS to the Company, and all INSUREDS’ agreements and represent-ations, are true and accurate, (b) this POLICY is issued in reliance upon the truth and accuracy of such representations which are material to the Company’s issuance of this POLICY…

In other words, if the insured firm’s representations are untrue, then the insurer should be allowed to “unissue” the policy.

Note that Westport’s policy language isn’t as strong as that found in other legal mal-practice policies, such as CNA’s:

V. CONDITIONS
  L. Entire contract
  By acceptance of this Policy the Insured agrees that:

   4.the misrepresentation of any material matter by the Insured or the Insured agent
will render this Policy null and void and relieve the Company from all liability herein.

If the court won’t allow Westport to terminate the policy, it seeks to have the court relieve it of any obligation to continue defending the firm, because the Trustee’s suit alleges that “Uchimoto’s malpractice in representing AgFeed began before he started working at Stevens & Lee, and that Uchimoto knew or should have known of the claimed malpractice”.

The implication is that the firm didn’t disclose this on its application, which if true, means it made a second misstatement on its application, because Section III, #11 of the appli-cation asks:

A. After inquiry of each lawyer, is the Applicant, its predecessor firms or any lawyer pro-posed for this insurance aware of any fact or circumstance, act, error, omission or per-sonal injury which might be expected to be the basis of a claim or suit for lawyers or title agents professional liability?  

B. If yes, what is the total number of these potential claims?
*You must complete a claims supplement for each potential claim.

The law firm apparently didn’t complete a potential claims supplement for Uchimoto’s representation of AgFeed, because if it had, Westport would almost certainly have added a “Specific Claims Exclusion” endorsement to the policy, excluding coverage for any future claim arising out of Uchimoto’s representation of AgFeed. 

Conclusion

If the court denies Westport’s bid to terminate the policy, and denies its declaratory judgment motion that it shouldn’t have to cover Stevens & Lee and Uchimoto for the Trustee’s claim, will it have to cover them, or will it have other grounds for denying coverage?

Westport’s complaint alleges that the malpractice “began before (Uchimoto) started working at Stevens & Lee”, which was March, 2010, according to his LinkedIn profile.

It also states that Westport’s policy with Stevens & Lee began in December, 2012. However, the firm undoubtedly had coverage before that – it was founded in 1928 – and it wouldn’t switch from its former legal malpractice insurer to Westport unless Westport offered it prior acts coverage back to the date offered by its prior insurer, which likely was the date of its first continuous coverage, i.e., 20 or more years ago. This is also called “full prior acts coverage”.

Therefore, Westport couldn’t deny coverage to the firm based on the wrongful act(s) occurring prior to the inception of its coverage, given that it’s retroactive to many years ago, well before Uchimoto’s alleged malpractice in representing AgFeed.

However, while Stevens & Lee is covered for acts occurring years ago, each individual lawyer is generally covered only as far back as his/her first day of employment, which for Uchimoto was in March, 2010.

Therefore, if he committed malpractice prior to that, as Westport alleges, based on the AgFeed Trustee’s complaint, then he wouldn’t be covered under Stevens & Lee’s policy with Westport, but he would be covered under the policy of his prior firm, Buchanan, Ingersoll & Rooney, which employed him from 2/08 – 2/10, and is a co-defendant in the Trustee’s suit. This is because in legal malpractice policies, the definition of “Insured” includes ex-employees.

So, if the court denies Westport’s bid to terminate the policy, and denies its declaratory judgment motion that it shouldn’t have to cover the Trustee’s claim, then it will have to defend Stevens & Lee in this matter, and possibly indemnify it, but it wouldn’t have to defend or indemnify Uchimoto.

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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.