Law Firm Entitled to Coverage for Claim Alleging Failure to Transfer Client Materials and to Notify Clients of Departing Attorneys

Applying Massachusetts law, a federal district court has held that an insurer owed a duty to defend based on allegations regarding a law firm’s failures to notify clients of an attorney’s departure and to transfer client materials.  Governo v. Allied World Ins. Co., 2018 WL4685566 (D. Mass. Sept. 28, 2018).  In reaching this determination, the court determined the alleged conduct satisfied the policy’s definition of “Legal Services Wrongful Acts.”

The insured, a law firm, sued a competing law firm for allegedly taking the insured’s proprietary databases and hardware when several of the insured’s former employees joined the competing law firm.  The competing law firm then filed a counterclaim against the insured.  The counterclaim asserted a cause of action for intentionally interfering with the competing law firm’s contractual and/or advantageous business relationships with clients by refusing to transfer client files.  It also asserted a cause of action for ERISA violations.  The insured tendered the counterclaims to its insurer, which denied coverage.  The insured then brought suit against the insurer for wrongfully refusing to provide the insured with a defense.  The insurer filed a motion to dismiss, contending that the counterclaim did not trigger coverage because the alleged acts did not constitute “Legal Services Wrongful Acts,” as required by the policy.  The insurer also argued that an ERISA exclusion, an insured-v-insured exclusion, and an exclusion related to misappropriation barred coverage.

The court held that, even though the ERISA exclusion applied to one of the causes of action, the insurer owed a duty to defend the entirety of the counterclaim under Massachusetts’s “complete defense” rule because the allegations in the other cause of action were “reasonably susceptible” to an interpretation that the services alleged arose out of a lawyer’s specialized knowledge or skill and were thus covered.  The court noted that the cause of action for interfering with business relationships alleged that the insured had refused to release client file materials and property of transferred clients to the competing law firm.  The court explained that professional and ethical rules impart a duty upon lawyers to return client files and notify clients of the departure of attorneys.  Further, it noted that a lawyer’s professional knowledge is required to determine what client materials must be released.  Thus, despite the business dimension of the termination and transition of client relationships, the court ruled that coverage was implicated as to that cause of action because the proper client notification of an attorney’s departure and the release of client files were essential to a law firm’s maintenance of client relationships and its professional and ethical responsibilities.

The court also concluded that the insured-v-insured exclusion did not bar coverage for the counterclaim.  The court held that the insured’s former employees did not constitute “Insureds” under the policy because they were not sued for acts or omissions that allegedly occurred while they were at the insured firm.  Instead, they were sued for actions taken after they left the insured’s employ.

Finally, the court ruled that the exclusion for conversion and misappropriation did not bar coverage.  The court rejected the insurer’s argument that the insured’s retention of client files and its refusal to provide them to the former employees constituted conversion or misappropriation.  The court held that neither conversion nor misappropriation were alleged in the counterclaim.  Instead, the court determined that the counterclaim focused on issues of professional responsibility and interreference with contractual or business relationships.  Such conduct could not be characterized as conversion or misappropriation, according to the court.

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