Lawyer: Never Lie to Your Insurer

More Than Two Million Judgment Against Client for Neglect to Protect Client Should Have Been Reported

Insurance is a contract where the parties are compelled, by an unwritten covenant of good faith and fair dealing, to do nothing to deprive the other of the benefits of the contract. To fulfill the covenant the insured must honestly represent to the insurer the facts it requests so that it can make a wise discrimination on the risks it wishes to take. When an insured misrepresents material facts when applying for insurance an insurer has the right to rescind the policy or declare the policy void because of material misrepresentations.

In Imperium Insurance Company v. Shelton & Associates, Professional Association, A Mississippi Professional Association; Jason L. Shelton, No. 16-60728, C/w 16-60730, United States Court Of Appeals For The Fifth Circuit (August 30, 2018) Imperium sought to rescind the legal malpractice policy issued to Shelton individually and the firm.

FACTS

In January 2013, Jason Shelton applied for legal-malpractice insurance on behalf of himself and his law firm, Shelton & Associates (collectively, the “Shelton Defendants”). In the application, Shelton represented that he and his attorneys were not aware of any “legal work or incidents that might reasonably be expected to lead to a claim or suit against them.” Relying on Shelton’s application, Imperium Insurance Company (“Imperium”) issued a claims-made insurance policy. During the policy year, two malpractice suits were filed against Shelton and his firm by former clients.

Following discovery, in a single opinion, the district court granted summary judgment in favor of Imperium in both cases.

The insurance policy at issue in these appeals is a claims-made policy. The policy provides coverage for malpractice claims arising out of “wrongful acts” committed by the insured. The policy excludes, however, coverage for claims arising out of wrongful acts occurring prior to the effective date of the policy if the insured “knew or could have reasonably foreseen” that the wrongful act for which coverage is sought “might be expected to be the basis of a claim.”

Imperium claims that Shelton’s answer on the application about known claims was a material misrepresentation that entitles Imperium to rescind the policy.

In September 2010, AFC filed a motion for summary judgment against Tyler. A state-court hearing on the motion was set for March 21, 2011. AFC served notice of the motion and hearing to a former Shelton attorney who was no longer with the firm. AFC discovered its mistake and re-served the notice on Shelton & Associates on February 2, 2011. The Shelton Defendants claim, however, that they did not actually receive the notice.

On March 21, 2011, the state court held its hearing on AFC’s motion for summary judgment. No one from Shelton & Associates showed up at the hearing. The state court granted AFC’s motion for summary judgment, specifically “noting that no reply or response whatsoever has been filed by [Tyler] in opposition” to summary judgment. The judgment against Tyler was entered, setting the amount at around $2.9 million, plus interest at the highest legal rate.

The state court found that the Shelton Defendants, and thus Tyler, had received proper notice of the summary-judgment motion and hearing. The Shelton Defendants appealed the state court’s decision to the state appellate courts.

On January 8, 2013, less than a year later, Shelton filled out his application for malpractice insurance with Imperium. He represented in his application that, after inquiry, neither he nor any of his attorneys were “aware . . . of any legal work or incidents that might reasonably be expected to lead to a claim or suit against them.”

On April 4, 2013, the Mississippi Supreme Court affirmed the judgment against Tyler, expressly rejecting the Shelton Defendants’ arguments that they had not received proper service; the state supreme court also called attention to the Shelton Defendants’ poor handling of the litigation.

ANALYSIS

Mississippi law applies in this diversity case. Under Mississippi law, if an applicant for insurance is found to have made a misstatement of material fact in the application, the insurer that issued a policy based on the false application is entitled to void or rescind the policy. To establish that, as a matter of law, a material misrepresentation has been made in an insurance application, (1) it must contain answers that are false, incomplete, or misleading, and (2) the false, incomplete, or misleading answers must be material to the risk insured against or contemplated by the policy.

A material misrepresentation must be established by clear and convincing evidence. Whether the misrepresentation was intentional, negligent, or the result of mistake or oversight is of no consequence

Imperium argues that when Shelton filled out the application, Shelton and the attorneys in his firm were (1) aware of legal work that (2) might reasonably be expected to lead to a malpractice claim. With respect to Shelton’s awareness, Imperium points to Shelton’s representation of Paul Tyler in the state-court lawsuit filed against Tyler by AFC. When Shelton resumed representation of Tyler in October 2007, Shelton knew that no one had responded to AFC’s requests for admissions and that there was a pending hearing on AFC’s request to have those admissions deemed admitted.

The Fifth Circuit held that, under the facts outlined above, every reasonable attorney aware of the facts would know that such facts “might reasonably be expected to lead to a claim or suit.”

First, even though a prior attorney failed to respond to the discovery requests, the Shelton Defendants had months to rectify Tyler’s failure to respond to AFC’s request for admissions. They did nothing. Instead, they waited until half a year after the entry of judgment against Tyler, which was a full three years after Tyler failed to respond to the discovery requests. The Mississippi Supreme Court, in particular, found “damning” the statements of the Shelton attorney at the hearing to have the requests admitted.

Knowledge of the rejections of their arguments about lack of service would put any reasonable attorney on notice that a malpractice claim “might reasonably be expected.” Any reasonable attorney would know that a judgment of $2.9 million entered against his client due to his failure to respond to, or even show up at a hearing for, a dispositive motion would be reasonably likely to lead to a malpractice claim. This conclusion is especially apparent when, as here, the state court has rejected all of the attorney’s arguments in defense.

Shelton made a misrepresentation when he represented that he was not aware of any “legal work or incidents that might reasonably be expected to lead to a claim or suit.”

A fact is material if it might have led a prudent insurer to decline the risk, accept the risk only for an increased premium, or otherwise refuse to issue the exact policy requested by the applicant.

Here, the record reflects that Imperium introduced deposition evidence from the insurance agent who procured the insurance policy for Shelton. The agent testified that, had Imperium known of the Tyler facts, “it would have either resulted in approval pending an incident exclusion, higher premium or a denial to write the risk at all.”

In sum, because Shelton made a material misrepresentation in his application for insurance by failing to disclose the potential Tyler claim, Imperium is entitled to rescind the policy.

ZALMA OPINION

It is difficult to understand why the Shelton defendants failed to report the potential claim to Imperium and lied on the application since the potential for the suit was obvious. When a state Supreme Court finds a lawyer’s actions “damning” while affirming a judgment against the client the fact of a potential malpractice suit should be as obvious as yellow snow plow working after a blizzard. Not only was Shelton negligent in the representation of its clients it was either intentionally fraudulent or negligent in protecting its own interest.


© 2018 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  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. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

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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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