Coverage Denied due to Colleague’s Misrepresentations

Professionals maintain professional liability insurance to protect their assets. Provided that the insured and insurer comply with the obligations set forth in the insurance contract, the exposure arising from a malpractice claim shifts from insured to insurer. Yet, about the only thing worse than getting slapped with a malpractice suit is learning that your firm is not covered despite the professional’s belief that insurance was in place.  Consider the possibility that the actions of one of your colleagues could result in a firm-wide declination of coverage.  A scary thought. A recent decision demonstrates how the actions of one colleague could result in a denial of coverage for everyone.

In Illinois State Bar Ass’n Mut. Ins Co. v. Law Office of Tuzzolino and Terpinas, the Illinois Supreme Court ruled that an insurance company could rescind the entire malpractice policy for a Chicago law firm due to one partner’s false response on a renewal application.  In the underlying malpractice suit, one of the law firm defendant’s partners (“Partner A”) was tasked with filing a bankruptcy action for a client.  The suit was dismissed when he failed to timely file.  Instead of promptly reporting the error to the client and the firm’s malpractice insurer, Partner A allegedly lied to the client and represented that the suit was still pending.

Shortly after the client uncovered the truth about the action, Partner A attempted to renew his firm’s malpractice insurance policy.  He submitted a renewal quote and acceptance form to his insurance company on behalf of himself, his law partner (“Partner B”) and the entire firm.  One of the questions on the renewal form asked “[h]as any member of the firm become aware of a past or present circumstance(s) which may give rise to a claim that has not been reported?”  Partner A responded “no” and signed the verification indicating the information contained in the renewal application was “true and complete to the best of [his] knowledge.”

After the renewal application was submitted, Partner B learned of the impending malpractice claim against Partner A and promptly notified the firm’s malpractice carrier.  A malpractice suit was eventually filed against Partner A, Partner B and their firm. In turn, the malpractice insurance carrier filed suit against the firm and partners to rescind the policy based upon Partner A’s material misrepresentation.

The appeals court found that the “innocent insured” doctrine protected Partner B.  Partner B was therefore entitled to malpractice coverage even though Partner A was not.  However, the state high court disagreed, holding that the “innocent insured doctrine” is inapplicable in cases involving rescission and contract formation.  The court distinguished between applying the innocent insured doctrine to scenarios where the insured’s actions may trigger some exclusion in the policy as opposed to the instant scenario where the policy itself is voided through misrepresentation in the formation of the contract leading to rescission.

The court reasoned that in cases of rescission, the focus is the effect of a misrepresentation on the validity of the policy, not the innocence of other insureds.  The court’s decision was fatal to the insurance coverage for all insureds under the firm’s malpractice policy.

The potential impact of this decision on professionals is highlighted in a dissenting opinion that under the majority view “a material misrepresentation on an insurance application could cause rescission of the policy as to each and every attorney, despite their reasonable expectations of continued professional liability coverage.”  The decision also serves as a good reminder to properly detect and report potential claims promptly.  The process of applying for insurance should be treated as a serious and significant event, and a firm should carefully designate a representative who will act thoroughly and truthfully when interacting with the insurer because one dishonest or careless colleague could result in rescission for everyone.