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September 4, 2013

Legal Update
William L. Boesch, Regina E. Roman

Malpractice insurance coverage for lawyers caught in check scams

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The New Hampshire federal district court recently joined a growing handful of courts to consider whether a lawyer who unwittingly falls for a common type of e-mail scam can obtain coverage under his professional liability policy to restore money taken by the scammer.1 The New Hampshire court held that under the particular language of the policy before it, the lawyer was not entitled to coverage. The case is now on appeal to the First Circuit.

Other courts have split on this issue. The outcome in such cases, it has become clear, depends in part on variations in key language between different lawyer’s policies.

The scam at issue in the cases originates with a familiar kind of solicitation e-mail. A scammer purporting to be an overseas business e-mails to ask for the lawyer’s help in a collection matter involving a customer in the lawyer’s state. If the lawyer agrees, the scammer then reports that the customer has decided to make a payment on the debt, and will deliver a check to the lawyer. The “client” instructs that the lawyer should deposit the check, and prepare to wire funds to an overseas account on the client’s instructions.

The lawyer receives the check, deposits it in his client-funds account, and asks his bank to inform him when the check has cleared. Banks typically report a check as “cleared” once it has passed through the initial stages of interbank communications—but before the check has actually reached the originating bank and received confirmation as valid. Anxious to please his new “client,” the lawyer confirms that the check has cleared, and carries out the “client’s” wire-transfer instructions—often involving hundreds of thousands of dollars—only to learn hours or days later that the original check has been rejected by the originating bank as a forgery.

Notwithstanding its arguable complicity in creating the problem, the bank demands that the lawyer take responsibility for the loss of funds—citing the implied warranties of a check-depositor under the Uniform Commercial Code, and the terms of the lawyer’s depositor agreement with the bank. Often the bank’s remedial efforts include seizing funds in the lawyer’s bank accounts, including money belonging to the lawyer’s real clients held in his client-trust account.

If the lawyer turns to his professional liability insurer to defend and indemnify him, coverage may be disputed. The terms of lawyer policies typically limit their coverage to claims arising from a lawyer’s professional services as a lawyer—that is, activities and risks particular to the practice of law, rather than more generic commercial risks that are the province of business insurance. The insurer may argue that the risk of being duped by a bad check belongs in the latter category, rather than the former.

In the last decade, this issue has been litigated in eight jurisdictions. In the early decisions, insurers were successful in denying coverage. The lawyer’s policy in Bradford & Bradford, P.A. v. Attorneys Liability Protection Society, Inc.,2 defined the “professional services” for which coverage was provided as “services or activities for others as an attorney in an attorney-client relationship on behalf of one or more clients.” The court held that this definition was “precise in requiring the existence of an attorney-client relationship and actions performed on behalf of a client.” In a check-scam case, the court observed, there is no actual client, and no attorney-client relationship; the scammer merely poses as a client, and his “retention” of the lawyer is a fiction designed to get the lawyer’s assistance in passing the forged check. The fact that the lawyer in the case before it subjectively believed he had a client and was performing (or preparing to perform) legal work, the court held, was immaterial, at least under the policy language before it. The court awarded the insurer summary judgment of no coverage.3

A series of cases after Bradford reached the opposite result, finding in favor of coverage on remarkably similar facts—but on the basis of subtle but important differences in policy language. In Nardella Chong, P.A. v. Medmarc Cas. Ins. Co.,4 the policy defined professional services to include, among other things, services in a “fiduciary capacity” if of a sort “typically and customarily performed by an attorney.” The lawyer in Nardella Chong deposited the scammer’s forged check but did not wait for it to clear before giving the bank the scammer’s wire-transfer instructions. The bank honored the wire-transfer request because there were sufficient funds of real clients in the lawyer’s account to cover the transaction. When the fraud was discovered, the lawyer replenished the real clients’ funds, and sought indemnity from his professional liability insurer.

A Florida federal district court awarded summary judgment to the insurer, holding that the loss arose from the scammer’s fraud and from the lawyer’s “misfortune and bad luck,” and not from any act or omission in his professional services. But the Eleventh Circuit reversed, reasoning that if the lawyer had not replenished the real clients funds in the trust account, the clients would have had claims against him for mismanagement of the account, and such claims would fall within the “fiduciary” branch of the policy’s definition of professional services.

A New York state appellate court reached the same conclusion in Lombardi, Walsh, et al. v. American Guar. & Liab. Ins. Co.5 The lawyer in that case deposited the scammer’s check into a new account at his bank, one without funds of other real clients to cover the loss when the bank discovered it. The bank instead sued the lawyer, and he sought coverage for the suit under his professional liability policy. The policy was written to cover services “performed by an Insured as a licensed lawyer in good standing” and also services in a fiduciary capacity if “ordinarily performed as a lawyer.” The court held that the bank’s claim arose from the lawyer’s professional services. In the court’s view, it was sufficient for coverage purposes that “someone”—the imposter pretending to be a prospective client—purported to request the insured law firm’s services, and that the firm “was under the impression that it was legitimately retained and attempted to perform services as attorneys.” “Regardless of whether the imposter qualified as a ‘client,’” the court wrote, “the policy does not require an actual ‘client’; the policy only requires that [the lawyer] ‘render Legal Services for others,’ and the imposter fell within that broad category.”

Two federal district courts also recently found in favor of coverage based on the breadth of the subject policies’ definition of professional services. In O’Brien & Wolf, LLP v. Liberty Ins. Underwriters, Inc.,6 as in Nardella Chong, the law firm’s client-trust account held funds of real clients which the bank seized upon learning that the scammer’s check was fraudulent. The firm replenished the funds, and sought indemnity from its professional liability insurer. Its policy defined professional services to include “legal services and activities performed for others as a lawyer” as well as services in a “fiduciary capacity,” and further added that the policy covered all services in the context of an attorney-client relationship even if “such services could be performed wholly or in part by non-lawyers.” The court held that the law firm’s real clients would have had claims arising from the law firm’s management of the client-funds account, that such claims would have fallen within the definition of professional services, and that the law firm was entitled to indemnity for having paid to avoid such claims.

Similarly, in Stark & Knoll, L.P.A, v. Proassurance Casualty Co.,7 the policy covered “services rendered by an Insured as a provider of legal services in a lawyer-client relationship” or “activities of an Insured as a trustee… or in any other fiduciary capacity.” The court held that this definition applied to potential claims against the lawyer by “existing clients whose funds were improperly disposed of” when the bank seized accounts to cover its losses.

The recent no-coverage decision of the federal district court in New Hampshire, in Attorneys Liability Protection Society, Inc. v. Whittington, bucks the coverage-favoring trend of these other cases. Whittington involved the same policy as was at issue in the other no-coverage federal case, Bradford & Bradford. But unlike the South Carolina federal court in that case, and the courts in the other cases discussed above, the New Hampshire court avoided reaching the “professional services” issue altogether. Instead, it looked to an exclusion in the policy stating there would be no coverage for any claim involving “conversion” or “misappropriation” of “client or trust account funds or property, or funds or property of any other person held or controlled by an Insured in any capacity or under any authority.”

The court agreed with the insurer that the exclusion was written to apply even where the insured lawyer was in no way complicit in the misappropriation of funds. And the court agreed that claims arising from a lawyer e-mail scam involve the scammer’s misappropriation of funds belonging to the bank, and involve the lawyer’s exercise of “control” over the bank’s funds by directing the wire transfer on behalf of the fictional client. Thus, the exclusion applied, and there was no coverage.

As the Whittington matter makes its way to the First Circuit, other courts will likely continue to struggle with the difficult coverage questions presented by check-scam cases.

For questions regarding the information contained in this Alert, contact William L. Boesch or your regular Sugarman Rogers attorney.

This Alert was prepared for the clients and friends of Sugarman, Rogers, Barshak & Cohen, P.C. It is provided for educational and informational purposes only and is not a substitute for professional advice on your specific legal situation.

1 Attorneys Liability Protection Society, Inc. v. Whittington, 2013 WL 3289055 (D.N.H.) (LaPlante, J.).

2 2010 WL 4225907 (D.S.C.).

3 Two state trial courts earlier reached the same conclusion. Fleet Nat’l Bank v. Wolsky, Case No. 04-CV-5075 (Mass. Super. Ct. Dec. 6, 2006); Fidelity Bank v. Stapleton, Case No. 07A-11482-2 (Ga. Super. Ct. Jan. 14, 2009).

4 642 F.3d 941 (11th Cir 2011).

5 85 A.D.2d 1291 (N.Y. App. Div. 2011) (emphasis added). This decision was followed as binding authority by a New York trial court in Yudin & Yudin, PLLC v. Liberty Intern. Underwriters, Inc., 2012 WL 170978 (N.Y. Sup. Ct. 2012).

6 2012 WL 3156802 (D. Minn. Aug. 3, 2012).

7 2013 WL 1411229 (N.D. Ohio 2013).