When we meet with a law firm’s management committee to review the malpractice insurance proposals we’ve obtained for their firm, one topic of discussion is the difference in policy language among the competing insurers.

It’s usually a short discussion.

Several years ago, there were material differences in policy language from insurer to insurer, but increasing competition has pressured the insurers with narrower policy language to broaden it in order to remain viable ‘players’ in the legal malpractice insurance market.

As a result, today there are few material differences in breadth of coverage among the major legal malpractice insurers. However, one important area of difference is in coverage for intentional and criminal acts.

Many attorneys don’t pay attention to this, because they’re confident that no one in their firm will intentionally commit a wrongful act, let alone a criminal one. However, the fact they may not do so doesn’t mean that a plaintiff won’t allege that they did so, i.e., to pressure them.

If that happens, then the breadth – or narrowness – of a firm’s malpractice policy language will determine whether or not it will be covered. If a firm’s policy doesn’t cover such claims, it could be exposed to potential judgments or settlements, and perhaps defense costs.

Insurers “lump in” criminal acts with dishonest, intentionally wrongful, fraudulent, and malicious act or omissions. “Intentionally wrongful acts” are intentional torts that arise out of the rendering of professional services, such as wrongful use of civil proceedings, abuse of legal process, defamation, etc. Dishonest, fraudulent, malicious acts, etc., have their common dictionary definition.

All policies exclude these acts, but most then give back some coverage, although not to the same degree.

Let’s look at examples, from the narrowest to the broadest coverage:

Narrowest Coverage

Old Republic Insurance Co.:

“This POLICY does not apply to:

(b) any CLAIM arising out of a dishonest, criminal, malicious or deliberately fraudulent act or omission of an INSURED.”

No defense, no indemnification, no coverage, period, even for “innocent insureds”.

Slightly Less Narrow Coverage

Hartford Insurance Co.:

“This insurance does not apply to claims: 1. arising out of any dishonest, fraudulent, criminal or malicious act, error, omission, or personal injury committed by, at the direction of, or with the knowledge of an Insured.

This exclusion does not apply to an Insured who did not personally commit or participate in committing the any of the knowingly wrongful acts, errors, omissions, or personal injury…”

The exclusion adds personal injury (as defined) to the list of excluded acts, and doesn’t offer a defense to the accused, but then deletes the exclusion for ‘innocent insureds’, and thus will both defend and indemnify them.

Less Narrow Coverage

Travelers Insurance Co.:

“Criminal, Dishonest, Fraudulent Or Malicious Conduct This policy does not apply to any Claim based upon or arising out of any criminal, dishonest, fraudulent or malicious conduct, or other willful violation of laws, committed by any Insured or by anyone with the consent or knowledge of any Insured, provided that this exclusion will not apply to:

1. any Insured Person who did not participate in or have knowledge of such conduct or violation; or
2. the Company’s duty to defend, or to pay Defense Expenses for, any Claim for malicious prosecution or abuse of process.”

This exclusion, like Hartford’s, doesn’t offer a defense to the accused, but then deletes the exclusion for ‘innocent insureds’, i.e., will both defend and indemnify them. However, the coverage is broader than Hartford’s in that doesn’t exclude claims for personal injury, and exception #2 adds the duty to defend claims of malicious prosecution or abuse of process, i.e., exempts them from the exclusion for “malicious conduct”.

Narrow/Broad Coverage

Hanover-Pro Direct

“This policy does not apply to:

1. a) any claim arising out of your dishonest, criminal or fraudulent act, error or omission.

However, we will provide for the defense of claims alleging personal injury arising out of your performance of professional services;

 INNOCENT INSUREDS

In the event that coverage under this policy would be excluded, suspended or lost because of a dishonest, criminal, malicious, or fraudulent act, error, or omission by one or more of you, we will cover any other of you who did not participate in, acquiesce in or fail to take appropriate action when you discovered the conduct, provided that you complied with all other policy provisions.”

This insurer will defend the accused through adjudication, but only for personal injury (as defined) arising out of the rendering of legal services.

It will also defend and indemnify ‘innocent insureds’, i.e., even if the accused insured is found responsible for the criminal act or omission.

Markel Insurance Co.:

“This insurance does not apply to Claims:

1. Arising out of an illegal, dishonest, fraudulent, criminal, knowingly wrongful, or malicious act, error or omission, or an intentional or knowing violation of the law.., committed by, at the direction of, or with the knowledge of any Insured; however, for such Claims otherwise covered by this policy, the Company will provide a defense until such time as the act, error, or omission is found to be illegal, dishonest, fraudulent, criminal, malicious, or was an intentional or knowing violation of the law by trial, court ruling, regulatory ruling or admission;”

The insurer will defend both the accused and innocent insureds through adjudication, but it won’t indemnify ‘innocent insureds’, if the accused insured is found to have committed the act or omission.

Note that Hanover provides a narrow defense for the accused, but broad defense and indemnification of innocent insureds, while Markel does the opposite, i.e., provides a broad defense of the accused (and innocent insurdes) through adjudication, but no indemnification of innocents, if the accused insured is found responsible.

Broad Coverage

Zurich Insurance Co.:

“This policy shall not apply to any Claim based upon or arising out of, in whole or in part:
A. any intentional, criminal, fraudulent, malicious or dishonest act or omission by an Insured; except that this exclusion shall not apply in the absence of a final adjudication or admission by an Insured that the act or omission was intentional, criminal, fraudulent, malicious or dishonest;

V. CONDITIONS
D. PROTECTION FOR INNOCENT INSUREDS

Whenever coverage under this policy would be excluded, suspended or lost because of Section III — Exclusions, subsection A, the Company agrees that such insurance as would otherwise be afforded under this policy shall be applicable with respect to any Insured who did not personally acquiesce in or remain passive after having personal knowledge of such conduct…

The Company’s obligation to pay shall begin once the full extent of the assets of the responsible Insured have been exhausted and once the deductible as shown in the Declarations of the policy has been satisfied.”

The insurer will provide both the accused and innocent insureds a defense through adjudication, plus indemnification, absent a final adjudication or admission that the Insured committed the act or omission.

It then restores indemnification for ‘innocent insureds’, i.e., even if the accused insured is found responsible for the criminal act or omission, but only after that party has paid to the full extent of its assets.

Broader Coverage

Catlin Insurance Co.:

“This Policy does not apply to:

1. any Claim arising from, in whole or in part, a dishonest, fraudulent, criminal or malicious act or omission, committed by an Insured, or at the direction of an Insured or ratified by an Insured; however, the Insurer shall defend any Insured that is alleged to have committed such act or omission, but the Insured shall reimburse the Insurer for Claim Expenses if the commission of such act or omission is admitted by the Insured or otherwise established as a matter of fact in a civil, criminal, or alternative dispute resolution proceeding.

This exclusion will not apply to:

1. any Insured who did not participate in or have knowledge of such conduct or

violation; or

2. the Insurer’s duty to defend, or to pay Claim Expenses for, any Claim for

malicious prosecution or abuse of process”

This exclusion offers a defense to the accused Insured, but requires that Insured to reimburse the insurer if the Insured admits committing the act or omission, or it’s “otherwise established” that the Insured did it.

It then restores both defense and indemnification to ‘innocent insureds’, even if the accused insured committed the criminal or malicious act, and adds the duty to defend claims for malicious prosecution or abuse of process, i.e., exempts them from the exclusion for “malicious acts”. Here, it’s carving out an exception for claims that might arise out of the provision of legal services.

Aspen Insurance Co.:

“The Company will not defend or pay any claim:

Based on or arising out of any dishonest, intentionally wrongful, fraudulent, criminal or malicious act or omission by the Insured. The Company will provide the Insured with a defense of such claim unless and until such dishonest, intentionally wrongful, fraudulent, criminal or malicious act or omission has been determined by any final adjudication, finding of fact or admission by the Insured. Such defense will not waive any of the Company’s rights under this policy.

Upon establishment that the dishonest, intentionally wrongful, fraudulent, criminal or malicious act or omission by the Insured was committed, the Company will have the right to seek recovery of the claim expenses incurred from the Insured found to have committed such acts or omissions.”

This exclusion shall not apply to those Insureds who did not personally participate or personally acquiesce in or remain passive after having knowledge of such conduct. Each Insured must promptly comply with all provisions of this policy upon learning of any concealment.”

This exclusion offers a defense to the accused Insured, but rather than require the Insured to reimburse the insurer if the Insured admits committing the act or omission, or it’s “established” that the Insured did it, it merely gives the insurer “the right to seek recovery.” In this regard, it’s coverage is slightly broader than Catlin’s.

Aspen then restores both defense and indemnification to ‘innocent insureds’, but unlike Catlin, it doesn’t add the duty to defend claims of malicious prosecution or abuse of process, i.e., exempt them from the exclusion for “malicious acts”.

Broadest Coverage

Westport/Swiss Re

“IV. EXCLUSIONS

This POLICY shall not apply to any CLAIM based upon, arising out of, attributable to, or directly or indirectly resulting from:

H. any intentionally criminal, dishonest, malicious, or fraudulent:

1. act, error, omission; or
2. PERSONAL INJURY committed by an INSURED.

This exclusion applies to any INSURED who is adjudged or admits to have committed such acts. This exclusion does not apply to any INSURED who did not commit, know or acquiesce in such WRONGFUL ACT which is the basis of the claim.”

This exclusion is broad, in that it also excludes coverage for personal injury (as defined), but it offers a defense to the accused Insured through admission or adjudication, and neither requires reimbursement of those costs nor give the insurer the right to recover them, if the Insured admits or is adjudged to have committed the act or omission.

It also restores both defense and indemnification to ‘innocent insureds’.

CNA Insurance Co:

“This Policy does not apply:

A. Intentional Acts

to any claim based on or arising out of any dishonest, fraudulent, criminal, malicious act or omission or intentional wrongdoing by an Insured except that:

1. this exclusion shall not apply to personal injury;
2. the Company shall provide the Insured with a defense of such claim unless or until the dishonest, fraudulent, criminal, malicious act or omission or intentional wrongdoing has been determined by any trial verdict, court ruling, regulatory ruling or legal admission, whether appealed or not. Such defense will not waive any of the Company’s rights under this Policy. Criminal proceedings are not covered under this Policy regardless of the allegations made against any Insured;
3. this exclusion will not apply to any Insured who is not found to have personally committed the dishonest, fraudulent, criminal, malicious act or omission or intentional wrongdoing by any trial verdict, court ruling, or regulatory ruling;”

This exclusion offers a defense to the accused Insured, but neither requires reimbursement of those costs nor give the insurer the right to recover them, if the Insured admits committing the act or omission, or it’s “otherwise established” that the Insured did it.

However, it’s the only policy that exempts “criminal proceedings” from the defense obligation, thus excluding it completely.

It also exempts claims for personal injury (as defined) from the exclusion, and restores both defense and indemnification to ‘innocent insureds’.

The Federal Trade Commission (FTC) announced that Leucadia National Corporation has agreed to pay $240,000 in civil penalties to resolve allegations that it violated federal pre-merger reporting laws by failing to report a conversion of its ownership interest in Knight Capital Group, Inc.

Background

According to the FTC “in July 2013, Knight Capital consolidated with another financial services company, GETCO Holding Company, LLC to become KCG Holdings, Inc. That transaction converted Leucadia’s ownership interest in Knight Capital into nearly 16.5 million voting shares of the new entity, KCG Holdings, worth approximately $173 million.”

The FTC filed a complaint charging that Leucadia was required by law to report the transaction to U.S. antitrust authorities under the Hart-Scott-Rodino Act, which require parties to “notify the FTC and the Department of Justice of large transactions above certain dollar thresholds that affect commerce in the United States and otherwise meet the statutory filing requirements.”

Failure to Report

The FTC announcement stated that “Leucadia did not report the transaction, according to the complaint, because it thought that it qualified for an exemption applicable to institutional investors. Although Leucadia consulted experienced HSR counsel in connection with the transaction, their counsel erroneously concluded that the exemption applied. Leucadia made a corrective filing in September 2014, acknowledging that the acquisition was reportable under the HSR Act.”

Penalty

Although “Leucadia relied on the advice of counsel, the FTC determined to seek civil penalties because…Leucadia had previously violated the HSR Act in 2007, which led to a corrective filing in 2008.”

Note: the HSR Act provides that “any person, or any officer, director, or partner thereof, who fails to comply with the Act’s provisions shall be liable to the United Stated for a civil penalty of not more than $10,000 for each day during which such person is in violation of the Act.” (Paragraph 31). Leucadia’s filing was about 425 days late, which would yield a maximum fine of $4.25M.

LESSONS
Legal Malpractice

Assuming Leucadia’s assertion that it relied on faulty advice from counsel in failing to report the transaction to the FTC on time is true, it would be entitled to seek reimbursement from counsel for the penalties levied against it.

One way to do that would be to file a legal malpractice claim. If it did, would the law firm’s malpractice insurer indemnify it, i.e., reimburse Leucadia for the $240,000 penalty that it paid?

Legal Malpractice Insurance

If the law firm admitted to providing the faulty advice, it’s malpractice policy would hopefully respond, because all elements of a legal malpractice claim would have been satisfied: an attorney-client relationship existed, so the attorney owed a duty to Leucadia; the attorney breached that duty by misinterpreting the law; Leucadia’s incurred damages as a result, i.e., the $240,000 penalty; and the attorney’s improper advice was the proximate cause of Leucadia’s damages.

(Since the FTC stated that Leucadia’s prior violation of the HSR Act led it to seek civil penalties  for this violation, that can be argued to be a contributing cause, but if the attorney had given the proper advice, the FTC wouldn’t have levied a penalty.)

Unfortunately, legal malpractice policies wouldn’t cover this claim, i.e., the policy of Professionals Direct, which is owned by Hanover Insurance Co., a major legal malpractice insurer, excludes coverage for “any claim for fines, sanctions, penalties, punitive damages or any damages resulting from the multiplication of compensatory damages”.

Further, while the policy of CNA, the largest legal malpractice insurer, contains no such exclusion, the insuring agreement states that the insurer will “pay on behalf of the Insured all sums in excess of the deductible that the Insured shall become legally obligated to pay as Damages.” The words in bold type are defined in the policy: “Damages do not include: B. civil or criminal fines, sanctions, penalties or forfeitures, whether pursuant to law, statute, regulation or court rule.”

Gap in Coverage

The intent of legal malpractice policies is to not cover penalties levied against a law firm. In this case, the penalties were levied against the firm’s client, yet the wording of the policies excludes coverage.

Remedy

A law firm that handles matters that expose its clients to government penalties, should request that its malpractice policy be endorsed to provide coverage for claims that may arise out of those matters; this would entail altering the wording of that part of the policy that excludes coverage, i.e., an exclusion or the definition of “damages”.

Final Note

This coverage issue would be moot if Leucadia’s attorney was working for a law firm that has a Self-Insured Retention (SIR) of $250,000 or greater per claim on its malpractice policy, as many large firms do, because an insurer won’t handle a matter, and thus won’t make a coverage determination, until the SIR has been exhausted.

If the amount in question here, $240,000, fell within antitrust counsel’s SIR, then the law firm would handle the matter itself, and decide whether or not to reimburse Leucadia.

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This is the second in a series of posts that will analyze various aspects of legal malpractice cov-erage; today, we’ll examine the various types of legal malpractice insurance deductibles a law firm can purchase.

I. Legal Malpractice Insurance Deductible: Loss & Expense – the deductible applies to both indemnity payments (loss) and defense costs, i.e., legal fees (expense). This is the most common type of deductible, and is found in nearly all legal malpractice policies.

Once a legal malpractice claim is made, and the insurer decides that it’s covered and assigns defense counsel, the firm must pay all indemnity and defense costs until the deductible has been fully paid. Only then will the insurer begin paying. As a practical matter, the payments made by a firm are nearly always for defense costs, as few legal malpractice claims are settled without some defense costs first being incurred.

II. Legal Malpractice Insurance Deductible: Loss Only – the deductible applies only to any judgment or indemnity payment, but not to defense costs. It’s also called “First Dollar Defense”, because the insurer pays defense costs from the first dollar, rather than the firm paying those costs until its deductible is exhausted, as with the Loss & Expense Deductible above.

When a legal malpractice lawsuit is filed, defense costs are always incurred before an indemnity payment is made, and in many cases, no indemnity payment is made, be-cause the suit is dismissed with prejudice or defeated via a Motion for Summary Judgment.

In those instances, a law firm that has a Loss Only Deductible wouldn’t pay any de-ductible, making this an attractive coverage feature. However, insurers charge extra premium for this coverage. Here’s an example from a policy that we recently placed:

Deductible: $5,000
Deductible applied to loss only: Premium = $5,791
Deductible applied to loss and defense costs: Premium = $5,294

In this case, the insurer charged about $500 more – almost 10% – for the loss only deductible.

In our opinion, an additional charge of about 6% of the premium is fair in most cases. Anything less than that is inexpensive; anything more, as in the example above, is ex-pensive. At our recommendation, the firm declined the loss-only deductible option.

Note: the higher a firm’s deductible, the more insurers will charge for a “Loss Only” deductible, because the more they’ll pay for defense costs if the firm is sued.

III. Legal Malpractice Insurance Deductible: Annual Aggregate – the firm pays its per claim deductible – both loss and claim expenses – each time it incurs a claim, up to the annual aggregate, which is the maximum amount that it’s responsible for during the policy period.

After that, no further deductible applies, no matter how many additional claims the firm incurs during the rest of the policy period.

This may be an attractive coverage for firms that incur a high frequency of losses, depending on how much additional premium the insurers charges.

This is the first in a series of posts that will analyze various aspects of legal malpractice coverage. Today, we’ll examine how a firm’s legal malpractice insurance policy limits are af-fected by claim expenses, if it’s sued for malpractice.

First, note that many people erroneously use the term “de-fense costs”, when they actually mean “claim expenses”. “Claim expenses” is the term that most legal malpractice insurers use in their policy. Most of them define it very broadly, i.e., Markel Insurance Company: “fees charged by an attorney designated by the Company, and all other fees, costs, and expenses re-sulting from the investigation, adjustment and appeal of a “Claim”, “Suit”…”

Defense costs, a/k/a/ legal fees and costs, are the most common type of claim expense. Other examples are interest on judgments, the cost of appeal bonds, etc.

Claim expenses are either “inside” or “outside” the policy limit:

“Claim Expenses Inside the Limit” (COIL) means defense costs are deducted from the limit, leaving that much less for indemnity costs. A policy with this provision is known as an “eroding limits” policy. This is the narrowest coverage, and is standard in most legal malpractice policies.

“Claim Expenses Outside the Limit” (CEOL) means defense costs aren’t deducted from the limit, so the entire per claim limit is available for indemnity costs, and there is no limit on defense costs. This is the broadest coverage.

A firm whose coverage is ‘COIL’, could have its entire per claim limit wiped out by claim expenses, leaving it to fund any additional claim expenses and any settlement or judg-ment out-of-pocket. It thus needs to buy a higher policy limit than a firm whose policy has CEOL coverage. However, while a higher policy limit may offset a COIL policy’s “eroding limits”, it carries a higher premium.

Why doesn’t every firm avoid this by buying a CEOL policy? Because it often can’t: mal-practice insurers are reluctant to offer a policy without eroding limits, since it has no limit on defense costs, which exposes insurers to potentially millions of dollars in such costs.

Most policies have CEIL. A law firm can request a policy with CEOL, but the insurer may not provide it, and if it does, it will raise the premium, perhaps beyond the firm’s budget.

A few insurers offer a modified version of CEOL, i.e., a policy with a separate limit for defense costs. Example: if a firm buys a policy with a $500K/$1M limit, it may receive a separate $500K limit for defense costs, leaving its entire per claim limit of $500K avail-able to pay any judgment or settlement. If defense costs exceed $500K, the separate limit will be used up, and any further defense costs will be paid out of the per claim limit; however, few claims incur over $500K in defense costs. Modified CEOL is less expen-sive than full CEOL, but isn’t widely available.