A Lawyer Who Steals From His Client Is Not Entitled to Insurance Coverage
Insurer Has an Unquestioned Right to Select Whom it Will Insure
Often forgotten by courts in the United States is the fact that an insurance company is entitled to determine for itself what risks it will accept, and therefore to know all the facts relative to risks faced by the applicant. It has the unquestioned right to select those whom it will insure and to rely upon him who would be insured for such information as it desires as a basis for its determination to the end that a wise discrimination may be exercised in selecting its risks. (Robinson v. Occidental Life Ins. Co. (1955) 131 Cal. App. 2d 581, 586 [281 P.2d 39].)
The right of an insurer to select whom it would insure was presented to the Sixth Circuit Court of Appeal when asked to resolve a dispute between a lawyer and his insurer when the insurer sought to rescind a malpractice liability policy it issued to the lawyer. The insurer based its claim of rescission on the incomplete responses to questions on the applicable insurance applications. The Sixth Circuit affirmed the trial court’s grant of rescission in Continental Casualty Company v. Law Offices of Melbourne Mills, Jr., Pllc; Melbourne Mills, Jr, No. Nos. 10-5813/5814 (6th Cir. 04/13/2012).
Lawyer Melbourne Mills, Jr. was successfully sued for millions of dollars for legal malpractice. The trial court granted Continental summary judgment, holding that Mills’s failure to disclose an ongoing state bar association inquiry constituted a material misrepresentation when the policy renewal application specifically asked if “any attorney [was] subject to any disciplinary inquiry . . . during the expiring policy period.”
In 2010, the Kentucky Supreme Court issued an order which permanently barred Mills from the practice of law in Kentucky.
Mills and others represented a group of over 400 plaintiffs in a class action suit against American Home Products for injuries related to the use of the diet drug Fen-Phen. At the outset of the suit, it was agreed that the lawyers’ fees would be determined by contingency fee contracts, limited to 30% of the clients’ gross recovery. In May 2001, American Home Products agreed to settle the class action for almost $200 million. The plaintiffs in the action together received only $74 million, or 37% of the settlement. The lawyers received $53 % including Mills who received $23 million. The remaining 10% was used to establish The Kentucky Fund for Healthy Living, Inc. Mills served as a member of the Fund’s Board of Directors, for which he allegedly received a monthly compensation of $5,350.
In early February 2002, Mills learned that the Kentucky Bar Association (“KBA”) was investigating complaints filed against him in connection with the Fen-Phen class action. The Inquiry Commission Complaint stated that Mills was under investigation for fees obtained in settlement of certain claims regarding the use of Fen-Phen and other pharmaceuticals that were divided with other counsel not in his firm, as well as allegations concerning a paralegal in Mills’s office who was conducting the unauthorized practice of law as part of the work on the class action.
On February 11, 2002, Mills’s attorney, William Johnson, attended a hearing of the KBA’s Inquiry Commission with respect to an application for a subpoena duces tecum that was served on Mills.
In August 2003, Mills applied to renew his professional liability insurance with Continental for the 2003- 2004 year. Continental had insured Mills’s law office for many years prior to this application.
Question 3 of the application asked: “Are there any claims, or acts or omissions that may reasonably be expected to be a claim against the firm, that have not been reported to the Company or that were reported during the expiring policy period?” In response, Mills checked “NO.”
Question 4 of the 2003 application read: “Has any attorney been disbarred, suspended, formally reprimanded or subject to any disciplinary inquiry, complaint or proceeding for any reason other than non-payment of dues during the expiring policy period?” Again, Mills checked “NO.” According to Mills, at the time of the 2003 application, he did not know the status of the 2002 KBA investigation; in his own words, the case “lay in limbo for years at a time. Just nothing was done.”
In August 2003, Continental issued an insurance policy, entitled Lawyers’ Professional Liability Policy, to the Law Offices of Melbourne Mills, Jr. The policy contained various exclusions, including a Dishonesty Exclusion which stated:
This Policy does not apply . . . to any claim based on or arising out of any dishonest, fraudulent, or criminal or malicious act or omission by an Insured except that this exclusion shall not apply to personal injury. The Company shall provide the Insured with a defense of such claim unless or until the dishonest, fraudulent, criminal or malicious act or omission has been determined by any trial verdict, court ruling, regulatory ruling or legal admission, whether appealed or not. Such defense will not waive any of the Company’s rights under this Policy.
The Malpractice Suit
In 2005, the Fen-Phen class action members asserted legal malpractice claims against Mills and others in Abbott, et al. v. Chesley, et al. The Boone County Circuit Court determined that the attorneys “breached their fiduciary duties to the Plaintiffs when they paid themselves fees over and above the amount to which they were entitled to under their fee contracts with their clients.” As a result, the class plaintiffs were awarded $42 million. Continental initially provided Mills a defense in this case; however, Continental also fully reserved its rights, including the right to rescind the policy.
Because the trial court found that “Mills knew that a bar complaint had been filed against him in early 2002,” and the “KBA’s investigation was ongoing,” the district court held that Mills’s response to Question 4 constituted a material misrepresentation. The trial court noted that the “ongoing KBA inquiry into Mills’s actions with respect to the Fen-Phen Action is precisely the type of information Continental needed to evaluate its potential for current and future risk.”
In addition to the grant of summary judgment to Continental, a money judgment for $233,674.49 was entered against Mills, which was the amount of the defense costs Continental paid on his behalf in the initial class action.
On June 10, 2010, the same day that the money judgment was entered, the district court also granted Continental leave to file supplemental authority, namely:
(1) the May 20, 2010 Order of the Kentucky Supreme Court which disbarred Mills from the practice of law in Kentucky, and
(2) the August 27, 2009 Findings of Fact and Conclusions of Law of the Trial Commissioner, which the Kentucky Supreme Court used to reach its decision to disbar Mills.
The trial court took judicial notice of the Order of the Supreme Court disbarring Mills and the Findings of Facts.
Because Mills made a material misrepresentation in his malpractice insurance application with Continental, the policy was properly voided under Kentucky law. According to Kentucky statute, K.R.S. § 304.14-110, a misrepresentation voids an insurance policy if the misrepresentation is “material” to the acceptance of risk or if the insurance company would not have issued the policy if the true facts had been made known. Though this standard is disjunctive, Mills’s response to Question 3 was both a misrepresentation that was material to Continental’s acceptance of risk and, if Continental had known of the investigation against Mills, Continental would not have issued the policy or would not have issued the policy at that rate.
Mills’s answer to Question 3 of the 2003 application was a material misrepresentation. Question 3 of the application asked. Mills’s answer to Question 3 was a misrepresentation because in August of 2003, when he was filling out the application, Mills knew of not only the ongoing KBA investigation, initiated in February 2002 but unresolved at that time, but also all of the acts surrounding the Fen-Phen class action settlement negotiations, which reasonably could have – and ultimately did – lead to a malpractice claim. Even though the class action members did not bring the legal malpractice suit until 2005, in August 2003 Mills still knew that, collectively, the lawyers in the Fen-Phen class action paid themselves over $126 million. According to one uncontested document put forth by the class members, the lawyers were limited to fees of a little over $60 million. Mills knew that the clients had not been told all of the pertinent facts regarding the settlement offer and the fee splitting arrangement, and that the KBA had subpoenaed the financial records from the case as a result of the 2002 inquiry.
Mills was aware that he had engaged in conduct that led to the disbarrment of him and two of his co-counsel. Mills knew that his conduct was egregious and that his “acts” and “omissions” could have “reasonably be[en] expected” to lead to “a claim against the firm.” Mills was unquestionably required to disclose this information to Continental when filling out the policy renewal application.
Mills’s failure to disclose his actions in response to Question 3 was also material to Continental’s acceptance of risk. The lie had an impact on Continental’s decision to issue the policy at the rate that it did. A misrepresentation is material if there is sufficient evidence that the insurance company would not have issued the policy or would have issued a different policy if it had knowledge of Mills’s actions and omissions under.
Mills’s failure to disclose the circumstances surrounding the Fen-Phen class action and the ongoing KBA investigation was material to Continental, which likely would not have issued the policy, or would have issued a different policy, had it known of Mills’ acts and omissions during this time. The Sixth Circuit, therefore, affirmed the trial court’s order of rescission.
The conduct of ex-attorney Mills was reprehensible taking funds belonging to his clients and using them to pad his personal fortune. He then added insult to injury by attempting to get his insurer to pay his victims after obtaining the insurance by a calvilcade of lies.
By misrepresenting material facts in the application he breached the covenant of good faith and fair dealing and deprived his insurer of the right to make a reasonable and wise discrimination as to whether it wished to insure or not insured him. Had he told the truth the insurer would not have taken the risk it took. Rescission is an equitable remedy and it would simply be unfair for the insurer to be required to pay a multi-million dollar judgment on a policy it would not have written had the insurer been told the truth.
(c) 2012 – Barry Zalma
Barry Zalma, Esq., CFE, is a California attorney, insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud. Mr. Zalma serves as a consultant and expert, almost equally, for insurers and policyholders.
He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant.
If this post is interesting to you you might find useful his E-book, “Zalma on Rescission in California.” Mr. Zalma also recently published the e-books, “Zalma on Insurance Fraud – 2012”; “Zalma on Diminution in Value Damages – 2012,”“Zalma on Insurance,” “Heads I Win, Tails You Lose — 2011,” “Zalma on Rescission in California,” “Arson for Profit” and others that are available at www.zalma.com/zalmabooks.htm.