Published on:

Insured’s Prior Knowledge Of An Error Causes Coverage To Be Denied

One common story that I have observed over the years is that legal malpractice insurers frequently deny coverage on the basis that the attorney knew of his own error (or the possibility of a claim) prior to the policy period. The recently decided case, Synergy Law Group, LLC v. Ironshore Specialty Insurance Company, 2015 IL App (1st) 142070-U, is another unfortunate chapter in that story.

Legal malpractice policies are issued on a claims made basis. That means that the insurer agrees to cover any claims made during the policy period even if those claims result from an act that occurred before the policy period. However, the insurance policy always contains a clause that provides that there is no coverage if the Insured “had knowledge of the circumstances that gave rise to the Claim and reason to believe that a Claim might result” before the policy period.

In 2006, the attorney drafted a shareholders agreement for a company, GA, Inc. The agreement established a formula for repurchasing shares if either shareholder left the company. In 2008, Rena Zito, the minority (20%) shareholder left the company. GA exercised its option to repurchase her shares. GA offered the minority shareholder $56,335.47 for all of her shares. The minority shareholder responded that “under the formula established in the shareholders agreement, GA, Inc., owed [the minority shareholder] $56,335.47 per share” for a total of $1,126,707.40. Opinion ¶ 7.

According to the opinion, “GA, Inc., and Synergy then realized that Synergy had made an error in drafting the shareholders agreement. GA, Inc. intended the formula in the agreement to set the repurchase price for 20% of the corporation, but the agreement referred to the formula as setting the price per share. GA, Inc., tried to withdraw its exercise of the option to repurchase Zito’s shares. In 2008, Zito sued GA, Inc., for breach of the shareholders agreement.” Opinion ¶ 8.

Synergy handled the defense of the lawsuit. Opinion ¶ 9.  Synergy also created a new corporation, Gaston Advertising, LLC and changed the name of GA to “Paulina Street Furniture Rental.”

In March 2010, Synergy applied for malpractice insurance. On its application “Synergy answered ‘No’ to the question, ‘Are you any members o[r] employees of your firm aware of any fact, circumstance, or situation which might reasonably be expected to give rise to a claim?'” ¶ 10.

In August 2010, Zito obtained a judgment against GA on her claim for the value of her shares.

In September 2010, GA fired Synergy and demanded that Synergy reimburse GA “for any judgment entered against GA… in favor of Zito, for more than $56,335.47.”

On January 7, 2011, Synergy notified the insurer that Synergy might make a legal malpractice claim. Shortly thereafter, GA sued Synergy for legal malpractice.

Ironshore denied coverage. The Circuit Court agreed with Ironshore and held that there was no coverage because Synergy was aware, before it applied for insurance, that it had made an error in drafting the shareholders agreement. There was no coverage for the drafting error because Synergy knew that a claim might result from that error. After all, Synergy’s client had already been sued for the error in 2008.

Ironshore also denied coverage for another related lawsuit. Zito sued GA, the majority shareholder, Synergy and the attorney who allegedly drafted the shareholders agreement and implemented the plan to form a new corporation. Zito sued Synergy for fraud and aiding and abetting a breach of fiduciary duty.

Ironshore denied coverage for this lawsuit as well. The circuit court denied coverage on the ground that “a reasonable lawyer that has been accused of trying to fraudulently transfer the assets of his client in order to avoid paying a judgment would realize that a claim might result from that situation.”  Opinion ¶ 18. Thus, the circuit court held that there was no coverage and no duty to defend Synergy (or the responsible lawyer) on either claim.

The Appellate Court affirmed in all respects. It held that “all of the allegations in GA, Inc.’s complaint constitute a single claim against Synergy, within the meaning of the insurance policy, and all the alleged malpractice arose out of the initial error in drafting the shareholders agreement.” Even the later acts (alleged fraud and aiding and abetting a breach of fiduciary duty) arose out of the initial error.

The moral of the story is always the same: disclose any claim or possible claim as soon as possible. Here the lawyer knew there was an error that had caused a dispute and the dispute led to a lawsuit. A reasonable lawyer had to disclose that possible claim to the insurance company. If the lawyer had disclosed the error once it became apparent, he would have had coverage. Although he had a different insurance company for the policy year, that insurer would have had a duty to defend him for any claims that were asserted, even the second lawsuit that was filed.

Edward X. Clinton, Jr.