Covering the Disgorgement of Legal Fees Reprinted from Claims Journal, January 27, 2016

by | Jul 22, 2021 | Insurance Law

Typical legal malpractice policies do not provide coverage for the disgorgement of attorney’s fees that were received by the insured attorney during the representation that gives rise to the malpractice claim. However, recently the United States District Court in Louisiana found otherwise in Edwards v. Continental Cas. Co., 2015 WL 5009015 (W.D. La. filed Aug. 19, 2015).

In Edwards, the legal malpractice insurer, Continental Casualty Co. (Continental) declined to provide Thomas Edwards with a defense and coverage under his law firm’s professional services liability policy. Under the facts of the case, Edwards represented Andrew Schmidt (Schmidt) in a personal injury case against Cal Dive International, Inc. (Cal Dive). Schmidt was a commercial diver for Cal Dive who sued to recover for disabling injuries he sustained during a dive performed in the course and scope of his employment. One week before trial the parties settled the case. The settlement was to be funded through a lump sum payment to Schmidt with the balance to be used to purchase three annuity contracts administered by an insurance company. One of the annuities flowed to Schmidt, one of the annuities flowed to Edwards, and the third annuity flowed to Schmidt’s other counsel in the case. One year following the settlement, Cal Dive and its insurance company filed a lawsuit against Edwards alleging that it had been fraudulently induced into settling the case as a result of Schmidt’s alleged exaggeration and/or fabrication of the extent of his injuries during the lawsuit. Cal Dive sought to vacate the settlement agreement in its entirety and sought an order that all undisbursed funds on the three annuity contracts be refunded.

Edwards submitted the lawsuit filed by Cal Dive and its insurer to Edwards’ malpractice carrier. Continental, the legal malpractice carrier, declined coverage asserting (1) that Cal Dive did not allege an act or omission in the performance of legal services; and (2) the damages sought by Cal Dive were “legal fees” excluded by the policy.

The Continental policy expressly stated that damages did not include legal fees, costs and expenses paid or incurred or charged by any insured irrespective of whether claimed as restitution of specific funds, forfeiture, financial loss, set-off or otherwise. The policy defined legal services to mean services performed by an insured as a lawyer. Relying upon the terms of the policy, Continental argued that the Cal Dive lawsuit did not meet either of the two requirements necessary to trigger coverage: (1) that the claim in the underlying action arose by reason of an act or omission in performance of legal services; and (2) the recovery sought in the underlying action must fall within the definition of damages. Specifically, Continental contended that Cal Dive and its insurers sought only the return of legal fees paid to Edwards as part of the settlement which were excluded under the policy’s definition of “damages.” Additionally, Continental contended that Edwards did not commit an “act or omission in the performance of legal services” because the Cal Dive lawsuit only sought restitution of the legal fees paid to Edwards from the settlement which was because of the client’s conduct, not Edwards’ conduct.

The Court rejected Continental’s arguments. The Court found that Continental advocated an oversimplification of the issue. The case did not present as a “run-of-the-mill” attorney fee dispute. Clearly, Edwards was acting as a lawyer who performed legal services for Schmidt by representing him and negotiating the settlement. Unlike typical fee disputes that arise between clients and attorneys upon the resolution of a matter, the Cal Dive lawsuit involved an attempt to unwind and vacate an entire settlement agreement and all of the proceeds paid that Edwards had negotiated on behalf of Schmidt which were based upon the allegations of wrongdoing by Schmidt. But for Edwards’ attorney-client relationship with Schmidt, the Court found that the claims against Edwards would not have occurred.

Turning to the legal fees exclusion and the definition of damages under the policy, the Court found that the claim against Edwards was integral to and could not be divorced from the legal services he performed for Schmidt. Cal Dive and its insurer were not simply seeking a return of legal fees paid, they were seeking to unwind the settlement and to recoup the entirety of the proceeds paid in settlement against Edwards’ client as well as Edwards himself. Continental did not cite any case where the “legal fee” exclusion it was advocating had been applied under similar facts.

In reaching its conclusion that coverage existed, the Court in Edwards cited with approval the District Court of Puerto Rico’s determining in Citrus World, Inc. v. Ferraiuoli, Torres, Marchand & Rovira, P.S.C., 2014 WL 1007744, 16 (D. Puerto Rico, March 14, 2014). In Citrus World, a former client sued the insured lawyer for professional negligence. The malpractice insurer in Citrus World denied coverage based on the policy’s damages exclusion for the “return of legal fees.” However, the Court rejected the insurer’s argument finding that the return of or reimbursement for legal fees did not preclude coverage for either the fees paid by the lawyer’s former client to other counsel to remedy the lawyer’s alleged negligence or the fees paid by the former client to the lawyer. The Court in Citrus World reasoned that “fees paid in the underlying action can take on a different character . . . there are compensable damages flowing [from]” the act that forms the predicate for the claim. The Court in Citrus World reasoned that because attorney’s fees may be the only damages at issue on a claim against a lawyer, “it would make little sense to read out coverage of such claims from the professional liability policy.” The Court in Citrus World concluded that the critical issue as to whether or not damages should be excluded as “fee disputes” required a determination of whether the claim was a consequence of a business practice by the lawyer, in which the claim could be excluded, or a consequence of the actual practice of law, in which the claim would be covered notwithstanding the exclusion.