Law Firm Denied Coverage Due to “Fraud Exclusion”

Most professionals are governed by this universal rule: always act in the best interests of the client.  But, there is an unspoken footnote to that rule: unless the client engages in unethical, illegal or otherwise improper conduct. Make no mistake, when a professional cooperates in the client’s foul play, she is also exposed to liability and perhaps a denial of coverage due to a fraud exclusion existing in many professional malpractice policies.  This limitation became a reality for a Colorado law firm accused of assisting its clients in the commission of fraud.

In Hackstaff Law Group, LLC v. Hartford Cas. Ins. Co., 2013 U.S. Dist. LEXIS 81839 (D. Colo. June 11, 2013), the District Court of Colorado considered a claim for declaratory relief by a law firm that was denied coverage by its insurance carrier.  The law firm was retained to represent a series of investors who owned a minority interest in a company.  When the investors ran low on cash, they sought financing from third-parties in exchange for an interest in the company.  But, the investors were not authorized by the majority owners to negotiate shares of the company. 

The law firm initially resisted any involvement in the conveyance, noting that it was improper, but the clients persisted and the firm executed the conveyance materials.  Eventually, when the would-be buyers learned that the investors misrepresented their authority, the buyers sued the investors and the attorneys for assisting in a sham transaction.  You can guess how the story ends: the firm reported the matter to their carrier only to be denied coverage due to allegations of “fraud or dishonesty.” 

The District Court of Colorado considered the law firm’s bad faith action and sided with the insurer.  The court determined that the allegations of fraud in the plaintiff’s complaint were not covered under the policy’s fraud exclusion, and that the insurer therefore had no duty to defend.

Similar fraud exclusions exist in most professional malpractice policies.  Accordingly, this decision serves as a reminder to all professionals of the dangers of engaging in questionable/uncomfortable/risky behavior even when the professional subjectively believes to be acting in the interest of the client.  The professional cannot be pressured to follow the client across the line even if it means disengaging.


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