Exclusion in Malpractice Policy Didn’t Apply When Former Client Joined Sanction Petition

Although the sanctions exclusion in a malpractice policy relieved the insurer of any duty to defend the insured lawyer against the opponents' petition for sanctions, it did not affect the insurer's obligation to provide a defense once the insured's own ex-client joined the sanctions proceedings and sought monetary recovery from the insured, the U.S. Court of Appeals for the Third Circuit held July 31 (Post v. St. Paul Travelers Insurance Co., 3d Cir., No. 10-3088, 7/31/12).

In an opinion by Judge Thomas L. Albro, the court decided that the ex-client's quest for sanctions amounted to a malpractice claim that triggered the insurer's duty to defend. The sanctions exclusion did not shield the insurer, it ruled, because the ex-client's potential recovery could not be confined to claims outside the coverage of the policy.

Troubling Discovery.

The coverage dispute between attorney Benjamin A. Post and his professional liability insurance carrier, St. Paul Travelers Insurance Co., grew out of a medical malpractice action in which Post represented Mercy Hospital-Wilkes Barre. Travelers insured the law firm of Post & Schell, where Post worked during most of the time he was defending Mercy.

Because the ex-client sought damages in addition to sanctions, and the facts it asserted stated a potentially covered malpractice claim, the sanctions exclusion did not shield the insurer from its duty to defend the lawyer.
Judge Thomas L. Albro

As trial began in the medical malpractice case, a risk manager testified for the plaintiffs that medical policies the defendants produced in discovery had been secretly redacted and that Post and another lawyer, Tara Reid, were responsible for the redactions.

These accusations prompted Mercy to change counsel immediately. Allegedly fearing the jury would believe that there had been a cover-up involving its lawyers, Mercy quickly settled with the plaintiffs for its insurance limits of $11 million.

After settling the medical malpractice case, Mercy made clear that it intended to sue Post and his firm for malpractice on the ground that his discovery misconduct had forced it to settle in order to avoid extensive uninsured exposure to punitive damages.

Advance and Withdraw.

Meanwhile, the plaintiffs petitioned for sanctions against Post, Reid, and others. From the outset, Mercy took an active part in the sanctions proceeding; after several months, the court ruled that Mercy had to file an answer to the sanctions petition if it wanted to continue participating.

In its answer, Mercy asserted that it had an important interest in the sanctions proceeding because the misconduct of its former counsel was at issue, and it claimed that Post and Reid had engaged in discovery violations without its knowledge. Accordingly, it joined in the plaintiffs' request, asking the court to sanction Post and Reid, to grant any other relief deemed just and equitable, and to award costs, attorneys' fees, and expenses.

Travelers took the position that it had no duty to defend Post against the sanctions petition because the malpractice policy contained an explicit exclusion for any “civil or criminal fines, forfeitures, penalties, or sanctions.”

Post sued Travelers in Pennsylvania federal district court, contending that Travelers was legally required to defend him and had breached the insurance contract by refusing to do so. Mercy was using the sanction proceeding to further its malpractice claim, which involved the same underlying facts, he asserted.

The district court held that Travelers was obliged to defend Post in the sanction proceeding despite the sanctions exclusion. The court of appeals agreed and remanded the case to the district court to calculate the amount of fees and expenses incurred by Post that Travelers must reimburse.

(The opponents ultimately withdrew their sanctions petition after Post sued their attorney for defamation and tortious interference. Mercy and Post filed proceedings against each other, but they agreed thereafter to discontinue their actions with prejudice.)

Sanctions Proceeding = Suit for Damages.

Post's policy with Travelers obligated the insurer to defend Post against any “claim” or “suit” for covered loss, and it defined “suit” as “a civil proceeding that seeks damages.” The court of appeals found that Mercy's request in the sanctions proceeding for costs, attorneys' fees, and expenses was sufficient to make the pleading a “civil proceeding that seeks damages” and thus a “suit” that Travelers had a duty to defend under the policy.

Items of damages in a malpractice claim include not only attorneys' fees paid by the client to the negligent attorney but also expenses that the client incurred to prosecute its malpractice claim against the attorney, the court reasoned.

“Because Mercy requested its attorneys' fees as an item of relief in its answer to the sanctions petition, the sanctions proceeding at that time became a 'civil proceeding that [sought] damages,' and thus a 'suit,' thereby triggering coverage under the Policy,” Ambro wrote.

The court also emphasized that when Mercy formally entered the sanctions proceeding and joined with the opponents against Post, it alleged facts potentially giving rise to a covered malpractice claim under the policy.

Mercy's pleading asserted, Ambro pointed out, that Post was its former counsel, that he failed to exercise ordinary skill or knowledge by improperly redacting or withholding discoverable information, and that his failure to exercise ordinary skill and knowledge subjected him to sanctions and liability for attorneys' fees. These assertions in essence stated the elements of a malpractice claim, the court said.

Beyond Exclusion.

Moreover, the court ruled that under the circumstances the sanctions exclusion did not relieve Travelers of the duty to defend.

“[B]ecause (1) Mercy sought damages in addition to sanctions, and (2) the facts admitted and alleged by Mercy in its answer to the sanctions petition stated a potentially covered malpractice claim, the Policy's sanctions exclusion does not shield Travelers from its duty to defend Post,” the court declared.

Under Pennsylvania insurance law, Ambro explained, the sanctions exclusion would excuse Travelers' duty to defend Post only if the possibility of Mercy's recovery could be restricted solely to sanctions. Mercy's potential recovery could not be confined only to sanctions, the court said.

No Bad Faith.

The court also held that Travelers breached its contract by not providing a defense to Mercy's threat of a malpractice action against Post.

The policy defined a “claim” as simply “a demand that seeks damages,” the court pointed out. It found that Mercy made such a claim at the latest when it faxed Post a letter that blamed him for exposing the hospital to potential uninsured punitive damages and forcing it to settle the medical malpractice action for full policy limits. Even though damages were not explicitly demanded in that letter, “it would be fantasy to believe … that Mercy would not be seeking damages from Post in the threatened malpractice suit,” Ambro said.

By the time Mercy sent the fax, the court explained, Mercy had terminated Post as counsel, told him that it would sue him and that it had hired outside counsel to do so, instructed him to report the claim to his insurance carrier, directed him to preserve relevant documents, and demanded production of documents and electronic data in connection with the threatened lawsuit.

The court agreed with the district court, however, that Post did not have any claim against Travelers for bad faith. “Because it performed what appears to be an adequate investigation, and because the sanctions exclusion in the Policy provided it a reasonable basis for denying coverage, Travelers did not engage in insurance bad faith,” Ambro stated.

Even if Travelers' claims processes were not ideal, the record did not indicate that its alleged mishandling of Post's claim was motivated by a dishonest purpose or ill will, the court added.

Dissent: No Duty to Defend.

Judge Thomas M. Hardiman concurred in part and dissented in part, arguing that Travelers owed no duty to defend any portion of the sanctions proceeding.

A former client may not pursue damages for malpractice merely by responding to a sanctions petition with averments that might, in a separate lawsuit, form the basis for a malpractice claim, Hardiman argued. Under the majority's reasoning, he said, Mercy could have obtained damages caused by Post's alleged negligence without ever proving the elements of malpractice to a judge or jury.

George A. Bochetto of Bochetto & Lentz, Philadelphia, argued for Post. Robert L. Byer of Duane Morris, Philadelphia, argued for Travelers.

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