Legal malpractice coverage has a special significance in the California legal market, where attorneys must disclose to their clients if they do not hold professional liability insurance. See Cal. R. Prof'l Conduct 3-410. In the current legal malpractice marketplace, many policy options exist that vary in scope, coverage and price. Regardless of whether the application is for new coverage or renewal of an existing policy, accurate completion of the application is of the utmost importance.
The scope and extent of a legal malpractice insurance application varies between an initial application with a new insurer and a renewal application with an existing insurer. In an initial application, the focus is on identifying all information necessary to effectively weigh a firm's or attorney's malpractice risk to ensure an appropriate premium for the coverage.
The focus of a renewal application, on the other hand, is to determine if any information has changed since the last application, including the size of the firm, the geographic location of the practices, the types of cases handled and the risk of a legal malpractice claim during the policy period. Although a renewal application is typically shorter in length than an initial application, the consequences of erroneous information are no less significant.
The information provided in the application can be the basis of rescission of a policy in its entirety—even for attorneys who have done no wrong, who may not have seen the application or who are unaware of any erroneous responses.
The important point is that material misrepresentations in an insurance application can result in rescission of all coverage for the entire firm and its partners, even where one partner was at fault. This is especially true for application questions prefaced by the condition of "after reasonable inquiry of each attorney for which coverage is sought." This overarching principle applies across all types of liability insurance.
For example, in Federal Insurance Co. v. Homestore, Inc., 144 F. App'x 641, 647-48 (9th Cir. 2005), the Ninth Circuit applied California law in finding that the insurance policies at issue could be rescinded as to all insureds, even for those without knowledge of any misrepresentations. There, the court reviewed directors and officers liability policies, which the insurer rescinded based on a material misrepresentation in the insured's applications. Id. at 644. The insurers had required that the company submit its securities filings as part of its insurance applications, and one officer, the CFO, had signed those applications. Id. at 646. The court looked to the language of the policies and to Section 650 of the California Insurance Code in holding that the rescission applied to even those "innocent" directors and officers who had never seen the applications. Id. at 647-48.
Notably, rescission is a remedy that varies significantly by state. Section 650 of the California Insurance Code gives an insurer the right to rescind coverage as to all insureds under the policy.
California's take on the effect of material misrepresentations is similar to that in other states and is clarified by the plain language of the Insurance Code. California law generally requires that "[e]ach party to a contract of insurance shall communicate to the other, in good faith, all facts within his knowledge which are or which he believes to be material to the contract and as to which he makes no warranty, and which the other has not the means of ascertaining." Cal. Ins. Code § 332.
For instance, in Blum Collins LLP v. NCG Professional Risks, Ltd., Case No. CV 12-8996 FMO (CWx) (C.D. Cal. July 31, 2014) (Olguin, J.) (unpublished), the court granted the insurer's motion for summary judgment in an insurance coverage suit brought by an attorney and a law firm based on a material misrepresentation in the firm's insurance application.
In Blum Collins, the attorney completed the firm's malpractice insurance application but failed to disclose a potential legal malpractice claim. Indeed, the attorney responded "no" in response to a question asking whether any insured was aware of "any circumstances, allegations, tolling agreements or contentions" that could result in a claim against any applicant or past or present partner. At the time of the application, however, that attorney was party to a tolling agreement with a former client, which allowed the client time to evaluate her potential assertions of malpractice and damages arising from Mr. Collins' prior representation.
Subsequently, the former client brought suit against the attorney and the firm, and the firm tendered the suit to its malpractice insurer. After learning that the attorney had been aware of a potential claim at the time of the application, and had indeed entered into a tolling agreement with the former client, the insurer denied coverage to the attorney and to the firm.
In reaching its decision, the court found that the attorney's omission had been material, as it would have affected the insurer's decision to issue the policy, and that the application had plainly asked for potential claims against the firm or any of its partners or owners. The court's ruling indicates the importance of the legal malpractice insurance application and specifically pinpoints the importance of having accurate information for each and every attorney.
The California Insurance Code follows the rationale of Blum Collins and provides specific guidance for material misrepresentations. Under Section 331 of the California Insurance Code, "[c]oncealment, whether intentional or unintentional, entitles the injured party to rescind insurance." Section 359 further clarifies that "[i]f a representation is false in a material point, whether affirmative or promissory, the injured party is entitled to rescind the contract from the time the representation becomes false."
Generally, there are three kinds of questions that create the most significant risks for law firms when completing an application for insurance. Each has significant meaning to an insurer's underwriters and, therefore, is often material in the context of rescission claim.
First, any questions regarding the firm's and its partners' knowledge of risks are important. These application questions typically ask whether any claims have been made and even whether the firm or any partner is aware of circumstances that might give rise to a claim. Either an actual or potential claim can be material to an insurers' decisions regarding the issuance of a policy, potentially forming a basis for rescission.
Second, questions regarding the firm's size and geographic locations are important. While these may seem basic, it is important to verify the number of attorneys; the role each plays as a partner, associate, of counsel and/or staff counsel; and each attorney's full-time or part-time status.
Similarly, the existence of a practice, whether supported by an office or not, in differing geographic areas is an important consideration for an insurer. Claims arising out of conduct by an attorney or practice not correctly identified can give rise not just to a denial of coverage for the misidentified attorney or practice—but to rescission of the entire policy as to all attorneys for all claims.
Third, questions regarding the nature and scope of practice are important. Some insurers refuse to insure, or impose special exclusions and limitations on, certain specialty practice areas such as intellectual property, environmental law or securities. If a firm indicates on its application that it does not practice in a specific area, but in fact does, the policy could be subject to rescission for such a misrepresentation.
The bottom line is clear: Firms must spend real time on their legal malpractice insurance applications. They must ensure that every answer is accurate, complete and reliable as to every attorney, not just those signing the application. Any less creates too much risk and could result in rescission of all coverage.
As published in The Recorder.