Court May Not Change LLP to General Partnership

LLP In New Jersey Not Required to buy Tail Coverage on Winding Up

Lawyers did business as a limited liability partnership (LLP) for some years and then decided to wind up, dissolve, the partnership. After the LLP was dissolved and during the winding up period the LLP only existed to collect fees and pay bills and provided no legal services. The trial court tried to get the plaintiff insurance coverage – since a dissolved LLP has no assets – by converting the LLP to a general partnership (GP) that required continuing insurance coverage. The LLP appealed to the New Jersey Supreme Court.

In Mortgage Grader, Inc. v. Ward & Olivo, L.L.P., Supreme Court of New Jersey , — A.3d –—, 2016 WL 3434529 (June 23, 2016) one of the LLP law firm attorney’s client filed suit against attorney, attorney’s partner, and firm for damages arising out of attorney’s alleged legal malpractice in settlement of client’s patent infringement claims. The Superior Court, denied partner’s motion to dismiss for failure to state claim, determined that defendants failed to maintain requisite lawyers professional liability insurance during period of LLP’s dissolution and windup of LLP’s affairs, converted LLP to general partnership as sanction, and concluded that partner could be vicariously liable for attorney’s alleged malpractice. Partner appealed. The Superior Court, Appellate Division, 438 N.J.Super. 202, 102 A.3d 1226, reversed and remanded.

FACTS

In July 2009, Mortgage Grader hired Olivo of Ward & Olivo (“W & O”) to pursue claims of patent infringement against other entities. Mortgage Grader entered into settlement agreements in those matters. In exchange for one-time settlement payments, Mortgage Grader granted those defendant-entities licenses under the patents, including perpetual rights to any patents Mortgage Grader received or obtained through assignment, regardless of their relationship to the patents at issue in the litigation. It is those provisions of the settlement agreement that allegedly gave rise to legal malpractice.

On June 30, 2011, W & O dissolved and entered into its windup period. It is undisputed that W & O continued to exist as a partnership for the sole purpose of collecting outstanding legal fees and paying taxes. The next day, Ward formed a new LLP and began to practice with a new partner. W & O’s claims-made malpractice insurance policy ran through August 8, 2011. W & O did not purchase a “tail policy.”  Olivo sent Mortgage Grader a letter on May 10, 2012 on behalf of both Olivo Law Group, LLC and W & O, informing Mortgage Grader of the termination of legal services.

Mortgage Grader filed a complaint against W & O, Olivo, and Ward in October 2012. The complaint alleged legal malpractice by Olivo, claiming that the settlement agreements resulting from Olivo’s representation harmed Mortgage Grader’s patent rights. Ward filed an answer and subsequently moved to dismiss for failure to state a claim. Ward argued that the requirement in Rule 1:21–1C, which provides that a law firm organized as an LLP must purchase malpractice insurance, is silent as to tail coverage following its dissolution.

The Appellate Division concluded that the UPA did not provide that a law firm organized as an LLP converts to a GP if it fails to maintain malpractice liability insurance. The panel also noted that Rule 1:21–1C(a)(3) states that the only remedies for an LLP’s failure to maintain malpractice insurance are for this Court to terminate or suspend the LLP’s right to practice law or otherwise discipline it. Because of this, and the fact that the Legislature has never amended the UPA to require conversion of an LLP to a GP as a sanction for failing to purchase a tail insurance policy, the panel found that a trial court has no authority to convert an otherwise properly organized LLP into a GP in order to sanction a partner for practicing without malpractice insurance.

ANALYSIS

Mortgage Grader argues that law firms organized as LLPs in the windup period continue to exist as viable entities, and must therefore maintain professional liability insurance as required by Rule 1:21–1C(a)(3).

W & O maintained professional liability insurance during the entire time it was actively engaged in the practice of law, and after its policy lapsed, W & O existed solely to collect outstanding fees and pay taxes in an effort to wind up the partnership.

The New Jersey Constitution grants the Supreme Court jurisdiction over the admission to the practice of law and the discipline of persons admitted.

The Supreme Court could find no indication that the administrative activities characterizing a windup are included within the term “practice of law.”  A partnership’s existence continues during the windup period and is terminated when the winding up of its business is completed.  In that event, the partnership resumes carrying on its business as if dissolution had never occurred, and any liability incurred by the partnership or a partner after the dissolution and before the waiver is determined as if dissolution had never occurred

During the windup period, the LLP continues to exist, but only to wind up the partnership’s affairs. The UPA sets forth activities that do not constitute “transacting business”: “collecting debts or foreclosing mortgages or other security interests in property securing the debts, and holding, protecting, and maintaining property so acquired. In sum, the important distinction pertaining to LLP liability is the point in time at which an LLP enters dissolution, commences winding up its affairs, and thus ceases to engage in the business for which it was created.

The administrative activities conducted during the windup period are not the transacting of business for which a law-firm LLP was established. Accordingly, under the circumstances, where a law-firm LLP has entered the windup period and has ceased to provide any legal services, the windup period does not constitute practicing law and therefore no acts of malpractice could be committed during this period. A winding up LLP has no obligation to maintain insurance or tail coverage under New Jersey statutes.

Similarly, the date on which W & O incurred its alleged obligation to Mortgage Grader is also dispositive. Partnership obligations under or relating to a tort generally are incurred when the tort conduct occurs rather than at the time of the actual injury or harm.  A law-firm LLP incurs its obligation to a client on the date the alleged malpractice occurred. Here, W & O was a valid LLP with professional liability insurance coverage at the time of Olivo’s alleged malpractice.

Mortgage Grader, therefore, may not maintain a vicarious liability claim against Ward.

In addition the erroneous determination that W & O was still practicing law during its windup period, the trial court improperly relied on Rule 1:21–1C to convert W & O from an LLP to a GP. The Supreme Court also concluded that the statutes provide no support for the trial court’s conversion of W & O from an LLP to a GP.

The Supreme Court also declined to impose a tail requirement on attorneys who choose to practice as LLPs, particularly because a mandate to purchase tail coverage still would not fully protect the public from uninsured risks and that the mandate to purchase professional liability insurance does not include any requirement to purchase tail coverage.

In conclusion:

  1. neither Uniform Partnership Act (UPA), nor rule that incorporated UPA by reference, which required law firm organized as LLP to maintain lawyers’ professional liability insurance to cover claims arising out of performance of professional services by attorneys employed by LLP, required that firm maintain coverage upon dissolution of firm during windup period;
  2. partner was not vicariously liable for attorney’s alleged malpractice;
  3. Supreme Court, and not trial court, had exclusive authority to impose sanction for alleged violation of insurance mandate;
  4. conversion of LLP firm to general partnership was not authorized sanction for firm’s alleged violation of insurance mandate;
  5. UPA did not authorize conversion of LLP firm to general partnership for violation of insurance mandate; and
  6. even assuming that partner was not shielded from vicarious liability for attorney’s alleged malpractice, client was not obligated to serve affidavit of merit on partner.

ZALMA OPINION

E & O insurance for lawyers professional liability are usually, if not always, a claims made or a claims made and reported policy. The claims made policy only applies if a malpractice claim is made during the time the policy was in effect. If the firm dissolves and desires to be protected for claims made after dissolution it can purchase “tail” coverage that allows a claim to be made after the expiration of the policy and dissolution of the law firm. Tail coverage is not required in New Jersey. If the LLP is liable it can be held to pay a judgment but, since it is dissolved, it is judgment proof with no assets.

ZALMA-INS-CONSULT                      © 2016 – Barry Zalma

Barry Zalma, Esq., CFE, practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 49 years in the insurance business.  He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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