The U.S. District Court for the Eastern District of Pennsylvania, applying Pennsylvania law, has held that an insurer is estopped from denying coverage for a legal malpractice action after defending the action for over a year without a reservation of rights, despite knowledge of the facts upon which it ultimately relied to deny coverage.  However, the court also held that the insurer was not estopped from denying coverage for a subsequent action seeking disgorgement of the insured attorney’s fees because the insurer timely reserved rights with respect to the disgorgement action. Westport Ins. Corp. v. McClellan , 2020 WL5961047 (E.D. Pa. Oct. 8, 2020).

An attorney referred a medical malpractice claimant to New Jersey attorneys and collected a referral fee.  The claimant then sued the referring attorney as well as the attorneys who had represented her in the medical malpractice case for legal malpractice.    The referring attorney held a professional liability policy, which, upon his retirement, had been endorsed to provide coverage for claims arising out of wrongful acts occurring before the end of the policy period and reported to the insurer during a “Non-Practicing Extended Reporting period(s): From 11/19/2013 To: Unlimited.”  The insurer provided a defense for the legal malpractice action without issuing a reservation of rights letter, advising that it would do so “[i]f coverage issues arise.”

Although she did not do so in her original complaint, the claimant ultimately demanded disgorgement of the referral fee.  At this point, the insurer reserved its right to deny coverage for disgorgement based on the policy’s loss definition.  The claimant subsequently filed a separate disgorgement action per the direction of the judge in the legal malpractice action, and the insurer defended that action subject to a reservation of rights with respect to coverage for any disgorgement.

The insurer filed this action, seeking a declaratory judgment that (1) the policy did not provide coverage for the disgorgement of the referral fee; and (2) the policy did not provide coverage for the original legal malpractice action because the Non-Practicing Extended Reporting Period option only provided coverage until the attorney resumed practice of law.

On cross-motions for summary judgment, the court ruled that the insurer was estopped from denying coverage for the legal malpractice action because it had provided a defense for more than a year without a reservation of rights, despite the claims handler’s knowledge that the attorney had returned to the practice of law.  In so holding, the court concluded that the failure to timely report a claim is a “coverage defense” that an insurer must assert in a reservation of rights letter to prevent estoppel.  However, the court held the insurer was not estopped from denying coverage for the disgorgement action because, even assuming that the insurer should have anticipated that the claimant might seek disgorgement of the referral fee, the attorney did not suffer “actual prejudice” as a result of any reliance on the insurer’s conduct because he received notice of the insurer’s reservation of rights before the disgorgement action was even filed.