The Fourth Circuit, applying Virginia law, has held that a negligent supervision exclusion in a lawyers’ professional liability policy bars coverage for a lawyer’s mismanagement of trust assets when acting as a trustee.  ALPS Prop. & Cas. Ins. Co. v. Higgerson, 2020 WL 1487836 (4th Cir. Mar. 24, 2020).

The insured lawyer was a trustee for several trusts.  In 2014, the beneficiaries sued the lawyer in state court, alleging that the lawyer had mismanaged trust assets and had collected excessive trustee fees, and raising claims of breach of fiduciary duty, conversion, and unjust enrichment.  The lawyer tendered the suit for a defense to an insurer pursuant to a lawyers’ professional liability insurance policy.  The insurer defended the lawyer in the state litigation but reserved the right to recoup defense costs for non-covered claims.

After the state court ruled in favor of the beneficiaries, the insurer filed a declaratory judgment action in federal court, contending that the policy did not cover the damages awarded and that the lawyer owed it the costs of his defense.  The district court held that the policy’s exclusion for “negligent supervision of client or trust account funds or property, or funds or property of any other person held or controlled by [the lawyer] in any capacity or under any authority,” barred coverage.  The insured appealed.

The Fourth Circuit affirmed the district court judgment.  First, the Fourth Circuit agreed that the negligent supervision exclusion, by its express terms, applied to stocks held by the lawyer in any capacity, including his capacity as trustee of the family trusts.  Second, the court also agreed that the lawyer’s conduct qualified as “negligent” within the meaning of the exclusion because the lawyer’s activities were found to be “‘reckless’ breaches of his fiduciary duties” in the underlying state court litigation, which necessarily encompassed, and surpassed, ordinary negligence.  Third, the court agreed that the negligent supervision exclusion did not render coverage illusory because the exclusion did not apply to (i) acts typically taken by lawyers acting within the context of a traditional attorney-client relationship, or (ii) other acts that lawyers can take in their capacities as trustees that do not involve supervision of trust assets.  Because the negligent supervision exclusion applied, there was no coverage under the policy for the lawyer’s acts as a trustee.