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Former Hinshaw Attorney Loses Coverage Lawsuit For Alleged Ponzi Scheme

Todd A. Duckson v. Continental Casualty Company, 14-1465 MJD/JJK (D. Minn. 12 8 2014).

Lawyers often get into trouble with legal malpractice insurers when they become involved in outside businesses. Most legal malpractice policies exclude coverage of any lawsuit arising out of non-legal business activity. Here, an attorney became involved in the sale of interests of a real estate fund, known as Capital Solutions Monthly Income Fund LP.

Duckson was an attorney with Hinshaw & Culbertson, a law firm with its main office in Chicago, Illinois. Duckson sued Continental alleging that Continental breached its duty under a legal malpractice insurance policy to provide coverage to Duckson. In particular, Duckson alleged that Continental had a duty to defend him and indemnify him in response a lawsuit brought against Duckson and Hinshaw in California state court. The case is referred to as the Shoor action.

The Shoor action alleged that “Duckson made false or misleading statements or omissions about the Fund in his capacity as a Fund member and manager, as well as through a separate investment management company, Transactional Finance Fund Management, LLC, that he owned or controlled.”

Prior to the Shoor action, the Securities and Exchange Commission filed a civil case against Duckson, which resulted in a verdict finding Duckson liable for securities fraud. In another lawsuit, Duckson sought coverage for the SEC case, but he was unsuccessful on the ground that the insurance policy excluded the SEC’s claims for “ill-gotten gains,” fines, sanctions, penalties and forfeiture because those claims were excluded under the policy. Thus, the insurer had no duty to defend Duckson in the SEC case. The court summarized the allegations in the SEC case as follows:

According to the SEC,Duckson’s involvement in the fraudulent scheme started when he was an attorney at the Hinshaw law firm, doing securities work for the Fund. For example,Duckson, as the Fund’s outside counsel, participated in drafting a private placement memorandum (“PPM”) in March 2008 which allegedly misled investors as to the Fund’s financial condition. The SEC charged that as the Fund’s financial condition deteriorated after March 2008, the Fund lacked meaningful income-generating investments and began paying off existing investors out of proceeds from new investors, in classic Ponzi-scheme fashion. And, as these events unfolded, Duckson began taking on a business role, eventually controlling the Fund and profiting from its fraudulent operation. During or around the fall of 2008, while he was still at the Hinshaw firm, Duckson agreed to become the Fund’s investment advisor. In November 2008, Duckson used a company named Transactional Finance Fund Management, LLC (“TFFM”), which he owned and controlled, to serve as the Fund’s investment advisor. At the SEC trial Ducksontestified that as of October 26, 2008, TFFM was the general partner of the Fund and he had “total control over the Fund.” (Doc. No. 16-6, Menning Aff., Ex. F.) Around that time, Duckson announced his intention to leave the Hinshaw law firm at the end of 2008, which he did. In November 2008, however, after he took control of the Fund, Duckson participated in drafting another PPM to raise more money for the Fund. Like the earlier PPM in March 2008, this PPM, according to the SEC, fraudulently misrepresented the financial condition of the Fund.

The SEC claimed that Duckson’s fraudulent activity continued after he left Hinshaw on January 1, 2009. For example, it accused Duckson of preparing yet another fraudulent PPM in February 2009, that, among other things, failed to disclose to potential investors that the offering proceeds would not be sufficient for the fund to make new investments. And, the SEC accused Duckson of continuing the fraud by, for example, causing the Fund to stop paying investors in late 2009, but continuing to reap millions of dollars in fees through his investment advisory firm. Ultimately, after the jury verdict, Judge Frank ordered disgorgement of fees that TFFM (and thus Duckson) took in from November 2008 through March 2012, plus prejudgment interest, in the total amount of $2,960,771.

The Shoor action arouse out of the same alleged wrongful conduct. In November 2013, the Hinshaw law firm settled with the Shoor plaintiffs. The plaintiffs released all claims against Duckson for the period in which he was a Hinshaw employee. They did not release him for wrongful acts allegedly committed by Duckson after he left Hinshaw on January 1, 2009.

In the current case, Duckson alleged that the insurer was obligated to defend him and indemnify him in the Shoor action. However, the policy contained the following exclusion:

“the Policy does not apply to any claim based on or arising out of an Insured’s capacity as: 1. a former, existing or prospective officer, director, shareholder, partner, manager, member, or trustee of any entity including pension, welfare, profit-sharing, mutual or investment fund or trust, if such entity is not named in the Declarations.”

The court agreed that the language quoted above absolved the insurers from any duty to defend or indemnity Duckson. In so ruling, the court rejected Duckson’s claim that he was really performing legal work for the real estate fund. ¬†As the court noted, “the thrust of the claims against Duckson was not in regard to his work as a legal draftsman; rather, it was aimed at his fraudulent business activity as an owner, partner, manager and officer of the Fund and TFFM.”

The Bottom Line: Legal malpractice policies almost always exclude undisclosed outside business activities from coverage. It is not fair to an insurer to require it to insure against a claim for outside business activity because the insurer does not have the ability to evaluate the risks of such activity. This was an extreme case where a lawyer became involved, allegedly much too involved, in the operation of a real estate fund that allegedly raised money with a fraudulent private placement memorandum (PPM). How could a legal malpractice insurer ever evaluate the risks of undisclosed investment activity? In sum, this case shows why insurance companies include outside business exclusions in their policies. Large law firms also require lawyers to disclose outside business activities. The opinion does not discuss whether or not Hinshaw had such a requirement or whether Duckson complied with its requirements.

Edward X. Clinton, Jr.

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