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December 11, 2012 Articles

Business Interests Outside Law Practice May Preclude Duty to Defend

The business enterprise exclusion in lawyers' professional liability policies may absolve the carrier of both its duty to defend and its duty to indemnify.

By Anthony Corleto and Samuel Reich

Attorneys frequently enter business ventures that have some connection to their practice of law and that may be co-located at their law offices. It is not uncommon to find real-estate attorneys with interests in a mortgage company, a title company, or a real-estate brokerage. However, when the attorney fails to make clear his or her role in a transaction, he or she risks ethical complaints, charges of malpractice, and charges under state “unfair business practice” laws. Real-estate transactions are particularly problematic: Over-leveraged and under-qualified borrowers faced with foreclosure and loss of investment opportunity may sue those involved in the transaction to recover their actual or perceived loss. Patterns of conduct also may give rise to claims under state unfair-business-practice laws. In any event, if the complaint alleges that an individual participating in a transaction is an attorney, the legal-malpractice carrier may be called on to defend at substantial cost. However, depending on the underlying circumstances, the carrier may have no obligation to defend.

The “business enterprise exclusion” issued with many lawyers’ professional-liability policies is designed to avoid the transfer of loss from an attorney’s companion business to his or her professional liability policy.

The Coverage and the Exclusion
As a starting point, lawyers’ professional-liability policies generally afford coverage on an indemnity basis:

The Company agrees to pay on behalf of the Insured all sums in excess of the deductible that the Insured shall become legally obligated to pay as damages and claim expenses because of a claim that is both first made against the Insured and reported in writing to the Company during the policy period by reason of an act or omission in the performance of legal services by the Insured or by any person for whom the Insured is legally liable.

The indemnity agreement concludes with qualifying clauses based on prior knowledge and other coverage.

Of equal if not greater importance, the defense clause typically provides:

The Company shall have the right and duty to defend in the Insured’s name and on the Insured’s behalf a claim covered by this Policy even if any of the allegations of the claim are groundless, false or fraudulent.

Our focus arises outside the insuring agreement and the indemnity clause. The typical business-enterprise exclusion precludes indemnification or defense for:

Any claim arising out of an INSURED’S activities as an officer, director, [or] partner, . . . of any company, corporation, operation, organization or association other than the NAMED INSURED.

From What Business Does the Tortuous Activity Arise? 
In a perfect world, the attorney would take the same kind of precaution that he or she would counsel a client with multiple business interests to take: set up separate entities, respect the separate identity and organizational formalities of each, and insure each separately. It is all too common that the attorney fails to heed his or her own advice or better judgment, manages things on the fly, and ends up with a problem.

The claims professional presented with a scenario that implicates the other business interests of an attorney begins with the question: Where does the tortuous activity stem from? If it arises out of the operation of a business venture other than that of the named insured, the exclusion is implicated. The more difficult question is: What course of action should be taken if that claim is intertwined with the practice of law?

An example of this can be found in a pair of cases from the Eastern District of Pennsylvania. In Coregis Ins. Co. v. LaRocca, 80 F. Supp. 2d 452 (E.D. Pa. 1999), the insured attorney, LaRocca, was sued for his role in a failed real-estate investment scheme. LaRocca was one of three trustees of the New Gretna Realty Trust, which was in the business of acquiring real estate to be developed and sold. LaRocca was also one of 16 partners in New Gretna Realty, and he held a 7.5 percent interest in that company. The underlying lawsuits arose out of competing lien rights of financiers and investors in the real-estate project. The lawsuits alleged that LaRocca was negligent in his conduct both as an attorney and as a partner and trustee in the real-estate enterprise. Recognizing the potential implication of the business-enterprise exclusion, LaRocca sought coverage for claims based on his conduct as an attorney and as a partner and trustee in a realty business enterprise.

LaRocca’s lawyers’ professional-liability policy contained the typical exclusion for activities arising from ventures outside his law practice:

Any claim arising out of an INSURED’S activities as an officer, director, [or] partner, . . . of any company, corporation, operation, organization or association other than the NAMED INSURED.

The LaRocca court found the exclusion to be clear and unambiguous, and found that LaRocca was acting as an “officer” and “partner” of a business enterprise other than the named insured within the meaning of the exclusion. In reaching these conclusions, the court found that the underlying malpractice claims against LaRocca were not based solely on his legal representation of the realty trust, but were closely intertwined with his role in the realty trust as both a partner and trustee, and overlapped LaRocca's role as legal counsel to the realty trust. The court construed the exclusion broadly, expressly finding that because the underlying claims simultaneously involved legal and business decisions by LaRocca in conjunction with an organization other than the insured law practice, the exclusion was operative. Further, the court held that because a denial of benefits under the policy did not breach the insurance contract, there was no duty to defend.

In Coregis Ins. Co. v. Bartos, Broughal & DeVito, LLP, 37 F. Supp. 2d 391 (E.D. Pa. 1999), the court held that the malpractice claims arose out of, or were in connection with, a business entity other than the named insured, which was owned by a named insured, and that regardless of the fact that the other entity “was not in legal existence” on the date of the alleged malpractice, the conduct at issue related to the business of that nascent enterprise, and thus was excluded. The court further ruled that the malpractice claims could not be segregated where the conduct of the named insured “forms part of an 'ongoing scheme of deception and misappropriations.’”

The Western District of Washington has also enforced a similar exclusion against an attorney’s claims for coverage. In Corbello v. Moore et al., No. C10-5357BHS (W.D. Wash. Apr. 20, 2011), the attorney’s client invested in a new business, which he formed with two other individuals and in which the attorney accepted a 25 percent share. After one of the individuals embezzled the investment, the investor sued the attorney for malpractice in forming the entity and in failing to advise him about the conflicts of interest presented by his relationship with the other business partners.

The insurer, Continental Casualty Co., sought a declaration that the policy does not cover, based on the following exclusion:

. . . any claim based on or arising out of an Insured's capacity as

1. a former, existing or prospective officer, director, shareholder, partner or manager of a business enterprise or charitable organization (if the above are not named in the Declarations). . . .

The court held that because the malpractice claim encompassed the attorney’s dealings with the principal of the entity and other interested parties, both before and after he became a shareholder, the exclusion was operative.

The Connecticut Appellate Court recently applied the business-enterprise exclusion to preclude coverage for claims against an attorney, related to a subprime lending scheme. In Lancia v. State Nat'l Ins. Co., 134 Conn. App. 682 (Conn. App. Ct. 2012), the insured attorney also had interests in a mortgage-brokerage company. The attorney was named in four civil suits that sought recovery for a predatory and fraudulent lending scheme that targeted minorities in a depressed economic community. Two of the underlying complaints also claimed legal malpractice. When the claims were presented to the carrier, the attorney was also responding to an investigation by the state attorney general. The carrier declined to defend. The attorney initiated a declaratory judgment.

The Connecticut Appellate Court found the business-enterprise exclusion operative based on the involvement of ventures other than the insured law office. Finding the underlying complaints to be “devoid of any allegations … not predicated on his role as a mortgage broker …” the court concluded that the conduct from which the claims arose was inextricably intertwined with the attorney’s conduct as owner or principal of the mortgage brokerage.

Two conclusions can be drawn, with general application across various jurisdictions: (1) The business enterprise exclusion is generally found to be clear and enforceable and (2) when properly invoked, a denial of benefits (defense) based on the business-enterprise exclusion does not breach the policy. The latter point has significant implications from a claim-handling perspective: When the business enterprise exclusion is properly invoked, the carrier may avoid the costly route of defending under a reservation of rights while prosecuting a declaratory judgment.

Keywords: professional liability litigation, business enterprise exclusion, legal malpractice, professional liability insurer

Anthony Corleto is a partner, and Samuel Reich is an associate, of Wilson Elser Moskowitz Edelman & Dicker, LLP in Stamford, Connecticut.