Applying Texas law, the United States Court of Appeals for the Fifth Circuit has held that an insured law firm’s dispute with its clients about the scope of the firm’s contingency fee award did not involve covered Loss.  John M. O’Quinn, P.C. v. Lexington Ins. Co., 2018 WL 5075485 (5th Cir. Oct. 18, 2018).

An insured law firm represented many clients as plaintiffs in product liability litigation, which resulted in a large settlement for the clients and $263.4 million in fees for the law firm.  The clients then pursued arbitration against the law firm, arguing that the firm had improperly deducted certain litigation expenses from the clients’ settlements, in addition to the firm’s agreed-upon 40% contingency fee.  The arbitration panel awarded the clients over $41 million, finding that some expenses the firm had charged against the clients’ settlements were inappropriate.

The law firm sought coverage for the fee dispute from its professional liability insurers.  In coverage litigation, the firm’s excess carrier argued that no coverage was available for the firm’s settlement because it did not constitute Loss, which was defined in the policy to exclude “fines, penalties, sanctions, . . . [or] reimbursement of legal fees, costs, or expenses.”  The district court agreed with the excess insurer, and the appellate court affirmed, holding that the insurer owed no coverage for the fee dispute.

First, the appellate court held that the arbitration award represented the firm’s return of fees the firm had improperly claimed as litigation expenses – i.e., the reimbursement of legal fees, costs, or expenses.  Such amounts are not covered Loss.  Likewise, the court reasoned, the policy’s exclusion for claims arising out of “the gaining of any profit or advantage to which an Insured is not legally entitled” also barred coverage because the fee award resulted from the panel’s conclusion that the firm had obtained a benefit to which it was not legally entitled.

Second, the appellate court held that the panel had entered an award for the clients based on the firm’s breach of fiduciary duty to sanction the firm for its misconduct in calculating its fees.  The appellate court held that the award was therefore uncovered loss in the form of a fine, penalty, or sanction.