Policy Exclusions Bar Coverage for Law Firm’s Alleged Misappropriation of Client Funds
The United States District Court for the Eastern District of Pennsylvania has held that an insurer has no duty to defend a lawsuit alleging that an insured law firm fraudulently induced its client to wire money to the firm and then transferred those funds to another party. National Liab. & Fire Ins. Co. v. Sternberg, 2025 WL 2214081 (E.D. Pa. Aug. 1, 2025).
The insured law firm purchased a lawyers professional liability policy that provided coverage for claims involving actual or alleged negligent acts, errors, or omissions in the performance of legal services for others by the firm. The policy excluded coverage for claims involving: (1) the destruction, diminution in value or loss of any property or asset, accounts, or of software, data, or other information in electronic form; (2) the firm’s conversion, misappropriation, embezzlement, commingling, defalcation, or ethically improper use of or disposal of funds or other property, whether held on behalf of clients or third parties; and (3) the loss or destruction, or any diminution in the value of any asset in the firm’s care, custody, or control, or arising out of the misappropriation of, or failure to give an account of, any asset in the firm’s care, custody, or control, including the commingling of funds.
One of the firm’s clients filed a lawsuit alleging that the firm had wrongfully and fraudulently induced it to purchase Covid-19 test kits and that the firm wrongfully and prematurely released the client’s funds held in escrow to purchase the kits. The firm tendered the lawsuit to its insurer for coverage. The insurer defended the firm under a reservation of rights but then filed a declaratory judgment action seeking a determination that there was no coverage for the lawsuit.
The firm moved to dismiss the coverage action. Denying the motion, the court concluded that the allegations in the underlying lawsuit were synonymous with the terms “misappropriation,” “embezzlement,” and “defalcation” included in the policy exclusions, even though the complaint did not use those terms. Because the policy excluded coverage for such claims, the court held that the insurer did not owe a duty to defend. The court further emphasized that, although the lawsuit involved the firm’s professional services as defined in the policy, it alleged serious illegal misconduct by the firm, not negligence, further negating any potential coverage. Because the underlying lawsuit was still ongoing, however, the court concluded that a determination of the duty to indemnify was not ripe for adjudication, despite its conclusion that the insurer did not owe a duty to defend, which it recognized is broader than the duty to indemnify.
