NJ Saving the Innocent Partner from Misrepresentations to the Carrier
First American Title Ins. Co. v. Lawson, 351 N.J. Super. 407 (App. Div. 2002)(PDF)
Student Contributor: Evan Kusnitz
NJ Underlying Legal Ethics Action
Facts: Three attorneys formed a law firm in New Jersey. In addition to engaging in the unauthorized practice of law in New Jersey, one of the attorneys, Wheeler, also misappropriated client funds. When another of the attorneys, Lawson, discovered the misappropriation and confronted the attorney engaged in this violation, Wheeler tried to explain his actions in light of the financial difficulties facing the firm and convinced Lawson to join in his scheme in order to pay off the firm’s liabilities.
In the meantime, the firm had been notified by the Office of Attorney Ethics that it would be conducting an audit of the firm’s books in response to several grievances. Shortly thereafter, Wheeler completed an application for malpractice insurance, along with two warranty statements, denying that he was aware of any actual or potential malpractice claims against the law firm.
Eventually, two title insurance companies were forced to make payment to several of the firm’s defrauded clients. These title insurers subsequently filed claims against the firm for reimbursement of monies paid as a result of the firm’s wrongful conduct. When the firm attempted to seek a defense and coverage from its malpractice carrier, the carrier filed a declaratory judgment action seeking to rescind its policy, given Wheeler’s misrepresentation to the carrier that he was unaware of potential malpractice claims.
Issue: May a malpractice carrier rescind a policy due to deliberate misrepresentations on its application?
Ruling:
- Equitable fraud provides that a party may rescind a contract where there is proof of (a) a material misrepresentation of a presently existing or past fact; (b) the maker’s intent that the other party rely on it; and (c) detrimental reliance by the other party. In the context of an application for insurance, an additional inquiry must be made into whether the insured knew that the information was false when completing the application.
- This rule applies even if the insurer might not have been diligent in investigating the background of the insured.
Lesson: A malpractice insurer may rescind a policy when the insured deliberately conceals information concerning known ethical and professional violations that may serve as the basis of legal malpractice actions.
EDITOR'S NOTE: The New Jersey Supreme Court affirmed the Appellate Division’s decision to allow the malpractice carrier to rescind its policy with regard to the liability of the partners who engaged in unlawful conduct, however, based on partnership law, it reversed the rescission of the policy with regard to the innocent partner. First American Title Ins. Co. v. Lawson, 177 N.J. 125 (2003)(PDF).
I think the ruling in this case makes sense because it provides recourse to a insurance provider who is defrauded. I think it would be interesting to know whether the insurance provider must first alert the insured that the insurance coverage is no longer going to be provided or whether the insurance provider can just cancel the insurance coverage without notice.
I agree with Ms. Neuman that the court made the correct decision in ruling that a malpractice insurer may rescind a policy when the insured deliberately conceals information concerning known ethical and professional violations because otherwise I think attorneys may abuse the policy and get away with materially misrepresenting facts.
I wondered if there by any chance have been any courts that have ruled contrary to this holding and don’t allow the insurer to rescind the policy in such circumstances.
I agree with the two of you. When someone knowingly tries to defraud an insurance company, that company should be able to rescind their contract. The attorney in this case committed a serious wrong by defrauding their clients. The insurance company should not be the ones who have to pay in order to make the clients whole again. When an attorney deliberately commits fraud, the insurance company should not have suffer the consequences. However, if the attorneys engaged in innocent mistakes or was negligent, then the insurance company should cover that. I feel that there is a fine line between negligence and fraud. When does negligence or mistakes turn into fraud?
Elaborating on Ms. Saini's point, I think the problem lies in her last question: "When does negligence or mistakes turn into fruad?". The problem here is that there are always going to be people who commit fraud and get away with it, and there are always going to be people who make mistakes or are simply negligent and get punished for it. The line here is very fine, and creating a bright line rule is always going to benefit some while being detrimental to others. If we had it any other way, where everyone would benefit, justice would never be able to be served!
I also agree with the ruling in this case. Just reading this brief had me stunned that this type of practice goes on. I think an insurance carrier should absolutely be able to rescind their coverage under these circumstances. I agree with Ms Saini's point that an insurance carrier should not be responsible for a law firm who deliberately defrauds their clients. Malpractice insurance is supposed to protect professionals in cases of negligence not deliberate misrepresentation. Furthermore, fraud is difficult to prove and carries with it a heavy burden. Therefore, I don't think that this ruling will lead to insurance carriers being able to escape having to pay judgments.