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Lawyers Lose Coverage Case Because Of Involvement In Another Entity


Every year, when I receive my legal malpractice insurance application, there is always a question on whether I am an officer or director of an outside entity.

In this case, one member of the law firm was involved in an outside entity, a corporation, American Gulf Insurance, LLC, that allegedly fraudulently induced certain investors to invest in the company. The plaintiffs, in the underlying case, sued the law firm for fraud and legal malpractice. The plaintiffs alleged that the lawyers negligently advised them to invest in the entity. Howard Fensterman, one of the name partners of the law firm, was allegedly an owner of American Gulf Insurance. Fensterman allegedly had more than a passive role in the entity.

Normally, this would be an easy case. An accusation of negligence would require the insurance company, Lloyds of London, to defend the lawyers. Here, however, because one lawyer was a member and arguably a promoter of the entity, there was no coverage.

The court quotes the two exclusions in the policy:

“There are various exclusions under the Policy, two of which are relevant here. Exclusion IV(F) excludes from coverage “any Claim arising out of any Insured’s activities as a trustee, partner, officer, director or employee of an employee trust, charitable organization, corporation, company or business, other than that of the Named Insured.” Exclusion IV(G) excludes from coverage

any Claim made by or against or in connection with any business enterprise (including ownership, maintenance or care of any property in connection therewith), not named in Item 1 of the Declarations, which is owned by any Insured or which is directly or indirectly controlled, operated or managed by any Insured in a nonfiduciary capacity; however, this Exclusion only applies to any Claims made by or against any business enterprise in which an Insured has an ownership interest equal to or greater than:

(1) 5% of the issued and outstanding voting stock of the shares in any business enterprise which is publically traded; or
(2) 10% if the shares in the business enterprise are closely or privately held.”

The court held that the claims arose out of the lawyer’s activities as a trustee, officer or partner of the entity. Thus, there was no coverage for legal malpractice. In sum, the membership of one lawyer in the entity proved disastrous for the lawyers and the firm. This is a tough case, but the case appears to have been correctly decided. From the insurance company’s perspective, a lawyer who is a member of an outside entity that is also a client poses a greater risk of liability. The insurance company believes that a lawyer who starts doing legal work for an outside entity that he owns or is an officer of is a greater risk to be sued for malpractice or fraud. The idea is that the self-interest of the lawyer may come into conflict with his normal professional judgment. Insurance companies do not want to receive the bad results of self-interested judgments by lawyers.

Finally, I note that these are merely allegations of wrongdoing against the lawyers, and, as such, are not proven.

Edward X. Clinton, Jr.



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