The United States District Court for the Central District of California, applying California law, has held that, where an attorney enters into an agreement with his client to toll the applicable statute of limitations for a potential malpractice claim, the attorney’s denial, in an insurance policy application, of awareness of circumstances that could result in a claim constitutes a material misrepresentation warranting denial of coverage.  Blum Collins LLP v. NCG Prof’l Risks, Ltd., No. CV 12-8996 FMO (CWx) (C.D. Cal. July 31, 2014)

While at a prior law firm, the insured attorney represented a client in a property dispute.  In September 2007, the client and attorney dissolved their relationship through an agreement providing that “[the attorney] agree[d] to furnish [the underlying claimant] with time to evaluate her assertions [of malpractice] and her potential damages without filing an action during the time period her appeal rights are in place[,]” and suspending the applicable statute of limitations.  The trial court in the property dispute entered judgment against the client in October 2007, and the judgment was affirmed on appeal in January 2009.  In February 2009, a representative of the client emailed the attorney asserting that the attorney’s malpractice caused the adverse judgment against the client.

Meanwhile, in July 2008, after moving law firms, the attorney applied for professional liability coverage.  On the application, the attorney answered “no” to the following question: “After enquiry, are any persons listed in Supplement 1 aware of any circumstances, allegations, tolling agreements or contentions as to any incident which may result in a claim being made against the Applicant or any of its past or present Owners [or] Partners . . . ?”  Supplement 1 was not attached to the application.

The insurer subsequently issued a professional liability policy to the attorney’s firm.  In pertinent part, the policy excluded coverage for: (1) “any Claim arising out of any Assured’s activities as a . . . partner, officer, director or employee of any . . . corporation, company or business other than that of the Named Assured”; (2) “any Claim made by or against or in connection with any business enterprise . . . which is owned by any Assured of which is directly or indirectly controlled, operated or managed by any Assured in a non-fiduciary capacity”; (3) “any Claim arising out of any acts, errors or omissions which took place prior to the effective date of this insurance, if any Assured on the effective date knew or could have reasonably foreseen that such acts, errors or omissions might be expected to be the basis of a Claim[.]”

The insured tendered the matter for coverage in March 2009.  The insurer denied coverage for the claim citing, inter alia, “material misrepresentations and omissions in the [insureds’] policy application.”

In the coverage litigation that followed, the court held that the attorney made a material misrepresentation in the insurance application, warranting a denial of coverage for the client’s claim.  In holding that the application misrepresentation was material, the court maintained that, when the signer of a policy application falsely represents that he or she did not know of any act by relevant parties that could give rise to a claim, such a false statement is deemed material as a matter of law.

The attorney disputed that there were misrepresentations on the application because, at the time of the application, he allegedly did not believe that any circumstances existed “which may result in a claim.”  The court concluded otherwise, holding that the phrase “assertions [of malpractice] and . . . potential damages” in the attorney-client tolling agreement “clearly” constituted notice to the attorney of a potential claim.  The court also rejected insured’s arguments that the insurer’s failure to attach a listing of the firm’s attorneys as “Supplement 1” to the application prevented the attorney from answering the question accurately and that the named insured law firm had no duty to disclose circumstances related to the tolling agreement because the attorney entered into the agreement while at his prior firm.  In support, the court noted that the policy application asked for information pertaining to a claim that might arise against the applicant firm or “any of its past or present Owners [or] Partners.”

The court also rejected the insured’s argument that the insurer had waived its right to assert its coverage defenses.  The court concluded that, where an insured files a breach of contract action before a carrier asserts an affirmative claim based on misrepresentations in an insurance application, the insurer can avoid coverage through cross-claims and affirmative defenses asserted in the insureds’ suit, and it does not waive its rights simply by failing to file its own suit.

Finally, the court held that the policy’s prior-knowledge exclusion and exclusions for “any Claim arising out of any Assured’s activities as a . . . partner, officer, director or employee of any . . . corporation, company or business other than that of the Named Assured” and “any Claim made by or against or in connection with any business enterprise . . . which is owned by any Assured of which is directly or indirectly controlled, operated or managed by any Assured in a non-fiduciary capacity” independently precluded coverage.