As part of the process of renewing or replacing legal malpractice insurance, law firms are typically required to complete an application. Law firms that treat the application as a formality and fail to give the application the proper amount of consideration, do so at their own risk. Indeed, an inaccurate response on the application can lead to severe consequences for the firm.
The types of questions on an insurance application vary based on a variety of factors. Typically, the first application for insurance from an insurer is likely to be much more extensive than an application for the renewal of a policy. In an initial application, the insurer often seeks background information regarding the firm’s practice that the insurer will use in deciding whether to issue a policy and in setting an appropriate premium for the coverage.
A renewal application, on the other hand, typically asks whether any information has changed from the time the firm submitted the initial application that may affect the nature of the risk insured by the insurance company, such as the size of the firm or its main practice areas. The renewal application will also ask whether the firm has anything else new to report regarding claims or potential claims.
While the applications may look different, the consequences for an incorrect answer can be the same for both initial and renewal applications. In particular, a misrepresentation on a policy application may justify the rescission of that policy, leaving the firm with no insurance coverage for a claim. Indeed, under California law, an insurer seeking to rescind a policy usually need only show that a misrepresentation was made and that the misrepresentation was material to the insurer’s decision to issue the policy. Notably, it is typically not a defense that the misrepresentation was unintentional.
Even more frightening is the fact that rescission typically applies to the policy in its entirety, and thus attorneys who did nothing wrong and who had no part in completing the application can lose coverage. Section 650 of the California Insurance Code specifically provides that, unless the policy states otherwise, “rescission shall apply to all insureds under the contract.”
The severe consequences of a misrepresentation were on display in a recent decision by the Illinois Supreme Court. In that case, the insured lawyer completed the firm’s malpractice renewal application but failed to disclose a potential legal malpractice claim in response to a question asking whether any attorney was aware of a circumstance that might give rise to a claim. The attorney’s partner was not aware of the potential claim.
Subsequently, the client brought suit against the attorney and the firm. As soon as the partner became aware of the suit, the law firm tendered the suit to the firm’s insurer.
After learning that the attorney was aware of the potential claim at the time of the application, the insurer rescinded the entire policy, denying coverage not just to the attorney and the firm, but also to the innocent insured, the attorney’s partner. Although the policy did contain an “innocent insured provision,” the court held that it only protected innocent insureds from the application of exclusions (such as an exclusion for claims based on intentional acts), not rescission of the entire policy for all insureds based on misrepresentations by a single attorney on the malpractice application.
The dissent expressed concern regarding the implications of the ruling, and particularly the “scope of the consequences resulting from the majority’s holding on other law firms and especially midsize and large firms.” The dissent further observed that “under the majority’s view, a material misrepresentation on an insurance application could cause rescission of the policy as to each and every attorney, despite their reasonable expectations of continued professional liability insurance coverage. Furthermore, as the size of the affected firm increases, so does the potential harm to the public.”
Although this case was decided under Illinois law, it is possible that a California court would reach a similar result based on the application of Section 650 of the California Insurance Code. To stay on the safe side, many firms will ensure that they devote the time and resources needed to thoroughly complete the application.
Although rescission can be based on any misrepresentation on an application, there are certain questions that commonly form the basis for rescission claims. Because of the importance of these questions to underwriting decisions, insurers may be able to demonstrate that a false or misleading answer had a material impact on their decision to insure.
First, questions regarding the firm’s knowledge of potential risks are important. Typically, these questions ask about claims that have been made and inquire whether the firm or any individual attorney is aware of circumstances that might give rise to a claim. Either an actual claim or a potential claim can be material to an insurer’s decision regarding the issuance of a policy, potentially forming a basis for rescission.
Next, insurers often rely on information regarding the size of the firm and its geographic locations in analyzing whether to issue a policy and in setting the premium. While these questions may seem mundane, it is important to verify the number of attorneys, the role each plays as a partner, associate, of counsel, staff counsel, and each attorney’s full-time or part-time status.
Finally, questions regarding the nature and scope of the law firm’s practice are important. Some insurers refuse to insure, or impose special exclusions and limitations on, certain practice areas such as intellectual property, environmental, or securities law. If a firm fails to list one of its practice areas on an application, the policy could be subject to rescission.
The lesson is clear: take the insurance application seriously. The potential inconvenience of confirming the total accuracy of an insurance application is greatly outweighed by the potential consequences of an inaccurate application.