Search




Fairfax, Virginia

10509 Judicial Drive, Suite 200,
Fairfax, Virginia 22030
703-246-0900
703-591-3673 (fax)
Map


Rockville, Maryland

33 Wood Lane,
Rockville, Maryland 20850
301-301-4161
Map


Meeting and Conference Facilities

Washington D.C.
1100 Connecticut Ave., N.W.,
Suite 340,
Washington D.C. 20036
202-296-4747
202-496-2800 (fax)
Map

Baltimore, Maryland
111 S. Calvert Street, Suite 2700,
Baltimore, Maryland 21202
410-625-5080
Map

Leesburg, Virginia
161 Fort Evans Rd NE
Leesburg, Virginia 20176
703-443-2550
Map


 
Judicial interpretation of "business enterprise" exclusions in lawyers professional liability policies

Written by David B. Stratton. Posted on 02/12/2011.

It is well-settled that courts will enforce "business enterprise" exclusions, sometimes also called "business pursuit" exclusions, in lawyers professional liability policies. The general approach taken has been to apply the plain meaning of the terms of the exclusions, with reference both to the reasons for such exclusions and the purpose of legal malpractice insurance.

One reason for business enterprise exclusions is that professional liability insurers do not wish to find themselves in the position of providing coverage for the business activities of insured lawyers. The underwriting of lawyers' professional liability insurance, including the premiums charged, is based on the nature of the law practice involved, and on the assumptions that when insured lawyers exercise their professional judgment they will be acting in their capacity as lawyers and that their judgment will not be clouded by the interests of another business in which the lawyers have a personal stake. Business enterprise exclusions are also meant to prevent collusive suits designed to shift a lawyer's business losses onto the malpractice carrier by characterizing the losses as attorney malpractice. The exclusions further avoid the circumstance where an insured so intermingles his business relationship with his law practice that the malpractice carrier would in effect be providing coverage for claims relating to the conduct of the businesss, rather than solely those arising out of the practice of law.

A. Cases in which business enterprise exclusions have precluded coverage

1. In Minnesota Lawyers Mutual Insurance Co. v. Antonelli, Terry, Stout & Kraus, LLP, Civil Case No. 1:08-CV-1020 (E.D. Va. Nov. 18, 2010), a declaratory judgment action, the Court granted the insurer's motion for summary judgment based on business enterprise exclusions in a Lawyers Professional Liability Insurance Policy.

The declaratory judgment action was instituted by the insurer as a result of an underlying lawsuit in which the insured law firm was sued by investors and the estate of an inventor who alleged that the law firm and lawyer had breached their fiduciary duties by giving advice to transfer the ownership of certain patents to a company called NTP. The transfer of the patents was allegedly intended to protect them from creditors.

NTP subsequently sued RIM for patent infringement for using the patented technology in its Blackberry system. RIM settled the suit for $612.5 million. Neither the estate of the inventor nor the investors received any portion of the settlement, and as a result they brought suit.

In its declaratory judgment action, MLMIC sought a declaration that it had no duty to defend the insured, relying in part on two business enterprise exclusions in the policy, and on a specific entity endorsement which had excluded any claims arising out of services to NTP. Exclusion 3 of the policy excluded from coverage "any claim arising out of professional services rendered by any insured in connection with any business enterprise: (a) owned in whole or in part; (b) controlled directly or indirectly; or (c) managed, by any insured, and where the claimed damages resulted from conflicts of interest with the interest of any client or former client or with the interest of any person claiming an interest in the same or related business enterprise."

Judge O'Grady of the Eastern District of Virginia granted summary judgment to MLMIC based on the business enterprise exclusions.

The Court as background observed that professional liability insurers frequently include business enterprise exclusions in their policies in order to avoid liability for an insured's business activities. Insurers calculate liability insurance rates on the assumption that insured attorneys act solely in a legal capacity, and that their professional judgment is unaffected by personal interests. Business enterprise exclusions diminish risk associated with an insured's decision to pursue business opportunities that may result in conflicts between the lawyers' best interests and those of his client.

The Court found that the claim arose out of professional services rendered by the insureds, because all the relevant counts arose out of the legal advice rendered by the defendant attorney. Second, the insureds rendered the advice "in connection with" an enterprise that the insured wholly or partially owned. The Court noted that "in connection with" has been given broad meaning, and that it has been recognized that the phrase has much broader meaning than "arising out of." The Court held that it was not necessary that the claim arise out of legal services rendered directly to an enterprise owned, controlled, or managed by an insured. "Rather, the claim must merely arise out of legal services rendered by insureds that relate to such an enterprise."

The Court also found that based on the allegations of the complaint, the professional services rendered were in connection with enterprises that the insured wholly or partially owned, directly or indirectly controlled, or managed.

The Court also found allegations of a clear case of conflict of interest that resulted in damage to the plaintiffs. Therefore, the Court found that all the conditions of the Business Enterprise Exclusion were satisfied, relieving MLMIC from its duty to defend the insureds. Because of this holding, the Court found that it was unnecessary to address the parties' arguments regarding the Specific Entity Exclusion.

This opinion was appealed to the Fourth Circuit. As of this writing, there has been no decision on appeal.

2. In Carolina Casualty Insurance Co. v. L.M. Ross Law Group, LLP, 108 Cal. Rptr. 3d 701 (April 19, 2010), the issue on appeal was whether the trial court erred in ruling that an insurer was entitled to recover from a law firm a sum that the insurer had paid to settle a legal malpractice action. An exclusion in a claims-made policy precluded coverage for a claim by any business enterprise owned or managed by an insured. The Court affirmed the trial court.

The Policy contained two business enterprise exclusions. Exclusion E provided that the insurer was not obligated to pay any damages or claims expenses in connectoin with a claim arising out of or in any way involving any insured's activities as an officer, director, partner, trustee or employee of a business enterprise other than Ross Law Group. Exclusion F provided that the insurer would not be obligated to pay any damages or claims expenses in connection with a claim by any business enterprise other than Ross Law Group "in which the Insured owns more than a 10 percent interest, or in which any Insured is an owner, partner, or employee, or which is directly or indirectly controlled, operated, or managed by any Insured . . . ." The Court rested its decision on Exclusion F, without finding the need to address Exclusion E.

The Court on appeal found that Exclusion F applied given the undisputed fact that Ross, an insured, was managing a business, named DEC, at the time the claim was made. The Court pointed out that Ross was, in effect, the real party on both sides of the anticipated malpractice claim. The potential for a collusive assertion of liability here was readily apparent.

3. In Continental Casualty Company v. Moser, No. 4:05CV00979 (W.D. Ark. 2006), the Court granted the insurer's motion for summary judgment in a declaratory judgment action concerning coverage under two lawyers professional liability policies. One or more lawyers in the law firm had acquired an ownership interest in a client's technology company through a separate corporation, without the client's knowledge. One of the lawyers improperly withdrew money from his law firm's client trust account to secretly invest those funds in the technology company. The client subsequently sued the lawyer and his law firm for breach of fiduciary, negligence, fraud, and under RICO.

The insurer asserted it has no duty to defend or indemnify the lawyer or the law firm because of provisions in the policies that unambiguously barred coverage. Among other things, the insurer relied on an exclusion which excluded coverage for a claim arising out of an insured's capacity as a director or manager of a business enterprise, and another exclusion which excluded coverage for a claim for legal services performed for an entity controlled by or managed by an insured. The insurer also relied on an exclusion for claims arising from dishonest or fraudulent acts.

In analyzing the Complaint, the Court relied, in part, on the case of Standard Fire Ins. Co. v. Proctor, 286 F.Supp. 2d 567, 572 (D. Md. 2003), to the effect that the mere allegation of negligence is not sufficient to establish in insurer's duty to defend; rather, it is the substance of the underlying claim, not its label, that controls in duty-to-defend and coverage cases. Coverage is not created under the professional liability insurance policies merely because the complaint labels the claim as "negligence" when the facts alleged constitute dishonest and fraudulent conduct. Id., at 571-72. The Court found that all of the client's claims arose out of allegations of dishonest acts or omissions by the insureds, and that the fraud exclusion unambiguously excluded coverage for those claims.

The Court went on to analyze the business enterprise exclusions in the policies. The Court also found that because the insured attorneys and law firm controlled the finances of the client's technology business, determined the client's compensation as president of the business, and conducted negotiations for the potential sale of the corporation, the insureds controlled the corporation. The claims arose out of services performed for the business. Therefore, all of the claims were also excluded by the business enterprise exclusion H.

4. In Continental Casualty Co. v. Adams, No. 3:CV-02-1122 (M.D. Pa. 2003), available at 2003 U.S. Dist. Lexis 16434, the Court considered cross motions for summary judgment as to whether the insurer breached a duty to defend officers and directors of a corporation named HSC in connection with negligence claims asserted against them arising out of a check kiting scheme involving an affiliate. The Court found that the claims were explicitly excluded under the CNA policy.

The CNA policy was a Health Care Executive Liability Insurance Policy that had been issued to HSC. The directors and officers of HSC were defined as "individual insureds" under the Policy. When two of the directors of HSC were sued by a bank which suffered about $1.6 million in losses due to the check kiting scheme, they each made claims under the Policy, seeking a defense.

In an ensuing declaratory judgment action, the question presented was whether an exclusion concerning "Outside Directorship - Charitable Organizations", relieved CNA of the duty to defend the directors, because they were also directors of the affiliate involved in the check kiting scheme, and because the operative complaint alleged that the directors were negligent officers and directors of all pertinent entities. The Court found that the following exclusion completely barred any coverage for the suit: CNA "shall not be liable to pay any loss in conection with any claim based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving any actual or alleged conduct by the individual insureds in the discharge of their duties as directors, officers, trustees, employees or volunteers of any entity other than the entity or charitable organization, even if directed or requested by the entity to serve as directors, officers, employees or volunteers of such entities."

5. In Coregis Insurance Co. v. Bartos, Broughal & DeVito, 37 F.Supp. 2d 391 (E.D. Pa. 1999), the insurer brought a declaratory judgment action to determine whether it had a duty to defend under a lawyers professional liability policy issued to the law firm BB&D. BB&D and a principal of the firm had been sued for alleged improper conduct in promoting, selling, and managing interests in four limited partnerships that were formed to own restaurants in Arizona. An attorney of BB&D was a general and limited partner in each of the four limited partnerships and directly and/or indirectly controlled, operated and managed the financial dealings of each of the limited partnerships. The claimants were clients of this attorney, and the attorney promoted and sold interests in these limited partnerships to the claimants.

Among other things, the claimants brought suit against the attorney and BB&D for legal malpractice, based on allegations of commingling funds between the limited partnerships, concealing or directing the concealment of material information concerning the true financial condition of the investments, failing to advise of the true state of financial affairs of the limited partnerships, breaching the duties of diligence, communication and loyalty, acting in an undisclosed conflict of interest situation, and other claims.

Coregis argued that the alleged conduct which forms the basis of the legal malpractice claims, fell within the "business enterprise" exclusions, and that it had no duty to defend the underlying suit. BB&D argued that the exclusions did not apply because the conduct that formed the basis of the complaint all occurred prior to the formation of three out of the four limited partnershps.

The Court agreed with the insurer, finding that the clear and ambiguous language of the exclusion did not require that the partnerships be in legal existence at the time the alleged malpractice occurred in order for the exclusion to apply. Further, the Court found, the exclusion applied to the claims because they arise out of or are in connection with a "business enterprise other than the named insured" in which one of the insureds is a partner and which is "directly or indirectly controlled, operated or managed by" one of the insureds "either individually or in a fiduciary capacity."

The Court also found Exclusion E excluded the claims. The plaintiffs' claims arose out of the attorney's conduct as an officer and director of the first limited partnership. Therefore, the claims arose out of or were in connection with an insured's activities as an officer or director of a corporation other than the named insured.

6. In Mt. Airy Insurance Co. v. Greenbaum, 127 F.3d 15 (1st Cir. 1997), Mt. Airy sought a declaratory judgment that it did not have a duty to defend the named defendants in an underlying legal malpractice action against them. The district court granted summary judgment to Mt. Airy, which ruling was appealed. In the underlying legal malpractice claim, the plaintiff sued three of the partners of the insured law firm for claims arising out of a real estate partnership they formed together. The client was a passive investor who entrusted the attorneys with management and oversight of the investment business affairs. The client brought suit against the attorneys for conversion of funds, breaches of fiduciary duty, fraud, legal malpractice, and other alleged wrongdoing. Mt. Airy brought a declaratory judgment action to establish that Exclusion G of its policy with the law firm precluded coverage for the claims against it and that the insurer had no duty to defend.

Exclusion G in the Mt. Airy policy precluded coverage for "any claim arising out of or in connection with the conduct of a business enterprise other than the Named Insured . . . which is owned by an Insured or in which any Insured is a partner, or which is directly or indirectly controlled, operated or managed by any Insured either individually or in a fiduciary capacity . . . ."

The insurer argued that because the plaintiff's claims involved losses connected with independent businesses owned, controlled, or managed by the Insureds, the claims are excluded. The attorneys argued that because at least some claims in the complaint alleged breach of fiduciary duty, Mr. Airy has an unqualified duty to defend, and that Exclusion G did not exclude all claims raised in the Complaint. The district court held that all claims were excluded by Exclusion G, and there was an appeal.

The First Circuit rejected the insured law firm's arguments on appeal. The law firm argued that Exclusion G was inapplicable because the plaintiff's claims arose out of an alleged breach of their fiduciary duty to the plaintiff as his lawyers rather than out of their roles as partners, officers, directors, shareholders or trustees of their joint business ventures with the plaintiff. The Court stated that the argument that the duty to defend is triggered by allegations of legal malpractice misses the mark:

"Exclusion G does not even come into play unless the allegations charge legal malpractice, because coverage under the policy is limited to malpractice. 'There will always be an attorney-client relationship when these exclusions are at issue. Absent an attorney-client relationship, the insuring agreement does not apply and the language of the specific exclusions does not come into play. [Defendants'] contention would create an illogical result; the policy exclusions would be rendered entirely meaningless and of no effect." Id., 127 F.3d at 19.

The law firm also argued that Exclusion G's requirement that the claim "arise out of or in connection with" the conduct of a controlled business enterprise should be interpreted to mean that the only acts excluded are those which are the proximate cause of the alleged loss. Their argument was that if attorney negligence, rather than the conduct of the business, was the proximate cause of the loss, the exclusion is inapplicable. The Court rejected that, reasoning that the argument ignored the plain language of Exclusion G which excludes coverage for "any claim" arising out of or in connection with the conduct of a business entity in which an Insured has an interest. The Court found that Exclusion G precluded coverage for any claim which arises out of or in connection with a business venture controlled, operated or managed by any insured or in which the insured has an interest as an owner or partner. The Court held that this includes all claims sounding in malpractice if the allegations charge wrongdoing in connection with a business in which the insured has such an interest.

The Court next considered whether an insured attorney played a role as an officer, shareholder, director, trustee or partner in every Business Entity about which the plaintiff complained. The Court found that one of the insured attorneys played a role or had an interest in each and every business venture about which the plaintiff complained. Thus, the Court found that Exclusion G in the Mt. Airy policy excluded coverage for all claims, and the insurer had no duty to defend.

7. In The Home Ins. Co. of Indiana v. Walsh, 854 F.Supp. 458 (S.D. Tex. 1994), the Court awarded summary judgment to The Home Ins. Co. based on business enterprise exclusions in a legal malpractice insurance policy. Two lawyers and one of their clients decided to acquire and develop adjoinging parcels of land. The lawyers were partners in the insured law firm, and also were owners of a savings and loan association. The purchase of the land was financed by bank loans personally guaranteed by the lawyers. The loans could not be paid off when due, and the lending institution went into receivership. The FDIC brought suit against the client on the loans and the two lawyers on their guarantees. The client filed a third-party complaint against the law firm and its former partners for legal malpractice. In the coverage action that followed, The Home Insurance Company contended that all of these claims arose from business transactions in which the lawyers were participants and as a result were excluded from coverage under the policy.

The Court held that the claims were precluded from coverage by exclusion (h) of policy, which stated that the coverage did not apply "to any claim based upon or arising out of the work performed by the Insured, with or without compensation, with respect to any corporation, fund, trust, association, partnership, limited partnership, business enterprise or other venture, be it charitable or otherwise, of any kind or nature in which any Insured has any pecuniary or beneficial interest, irrespective of whether or not an attorney-client relationship exists, unless such entity is named in the Declarations. . . ." Among other things, the Court stated that, "Even if [the lawyers] . . . Represented [the client] . . . In some legal matters, [the lawyers'] personal business pursuits trigger the exclusions. [The client's] loss, if any, was caused by Fidelity Federal's failure to fund the loan, not from any special risks inherent in the practice of law."

8. In Dukart v. National Union Fire Ins. Co., 1993 Del. Super. Lexis 244 (July 13, 1993), the Court granted summary judgment to National Union in a declaratory judgment action concerning whether a claim was covered by a lawyers professional liability insurance policy. The plaintiffs had entered into two partnerships with the insured attorney and others to develop real estate. The partnerships were not successful and the plaintiffs faced personal liability for partnership debts. The plaintiffs sued the insured attorney, alleging that he negligently failed to advise them of their risk of personal liability as general partners.

The parties filed cross-motions for summary judgment, on the issue whether the claim against the insured attorney fell within the business enterprise exclusion of the policy. The exclusion stated that:

"This policy does not apply to any claim made by or against or in connection with any business enterprise (including the ownership, maintenance or care of any property in connection therewith), not named in the Declarations, which is owned by any insured or in which any insured is a partner, or employee (except where he is an employee solely by virtue of having been retained to perform legal services) or which is directly or indirectly controlled, operated, or managed by any insured in a non-fiduciary capacity."

The plaintiffs argued that the exclusion did not apply because the malpractice occurred before their partnerships with the insured lawyer were formed.

The Court rejected that argument, stating that neither the language nor the purpose of the exclusion justifies the restrictive interpretation. The language does not require that the act of alleged malpractice or, for that matter, any other event, such as the accrual of the cause of action or the making of a claim, occur during the existence of the legal entity used to carry on the business enterprise. It simply defines the insured's relationship to the particular form of business enterprise in which the lawyer participates.

The Court observed that the purpose of the business enterprise exclusion is that there is an increased risk of loss and resulting claims when a lawyer renders professional services in connection with a business enterprise in which he is a partner. "Business partners may be tempted to collusively covert business losses into a malpractice claim covered by the professional liability insurance of the partner who is a lawyer."

The Court also observed that a lawyer who participates in a business activity is likely to lack the detachment that exists when the roles of lawyer and client are separate. Conflicts of interest may complicate a lawyer's relationship to business associates and affect the legal advice given in connection with their joint enterprise.

The Court concluded that even though the alleged act of malpractice in this case may have occurred before the partnership was formed, the plaintiffs' claim was nonetheless "made in connection with any business enterprise . . . , not named in the Declarations, . . . in which any insured is a partner." Summary judgment was granted to the insurer.


9. In Potomac Ins. Co. v. McIntosh, 167 Ariz. 30, 804 P.2d 759 (1990), rev. denied by 168 Ariz. 156 (1991), the issue on appeal was whether a lawyer's professional liability insurance policy covered an insured attorney's actions when dealing in a business context with his clients. The Court affirmed the trial court's grant of summary judgment based on the policy's business enterprise exclusions.

The insured attorney had orchestrated the formation of a limited partnership in which he was the general partner and the plaintiffs and others were limited partners. The insured attorney and his law firm had previously represented the plaintiffs in connection with various legal matters. Some time later, the partnership experienced financial difficulties, and the insured attorney resigned as general partner. The plaintiffs were substituted as general partner in the attorney's place. As a result of their investment in the partnership, the plaintiffs lost over $260,000.

The insurer filed a declaratory judgment action, seeking a declaration that no coverage existed under the attorney's malpractice policy for either indemnity or defense in connection with the plaintiffs' claims.

The attorney settled with the plaintiffs, assigning his rights under the policy, if any, to the plaintiffs. In connection with the agreement, a second amended complaint was filed by the plaintiffs, alleging a single count of attorney malpractice with damages. The plaintiffs were substituted as defendants in the declaratory judgment action.

The insurer moved for summary judgment, arguing that the attorney's activities were excluded from coverage by the terms of the policy. The policy included business enterprise exclusions, which stated that the policy does not apply:

"(b) to any claim made by or against any business enterprise not named in the Declarations . . . in which the Insured is a partner . . . or which is controlled, operated or managed by the Insured, either individually or in a fiduciary capacity . . .

"(c) to liability arising out of the Insured's services and/or capacity as: (1) an officer, director, [or] partner . . . of a business enterprise . . . ."

The insurer argued that the attorney was a general partner in the business enterprise which caused the losses, and that the plaintiffs claims arose solely in connection with the attorney's participation in that partnership.

The plaintiffs' in their cross-motion argued that the attorney "wore two hats" -- one as a general partner of the company, and the other as attorney for the plaintiffs and the partnership. They argued that they were only seeking recovery for the attorney's negligence committed in his role as an attorney, and that therefore the "business enterprise" exclusion does not apply.

On appeal, the plaintiffs argued that the attorney committed acts of malpractice in his capacity as an attorney. They claimed that the attorney negligently (1) failed to advise them of the risks inherent in an investment in a limited partnership; (2) failed to warn them of the existence of possible conflicts of interest; (3) induced them to sign the partnership documents without full disclosure of their effect; and (4) induced them to sign at least one personal guarantee for a partnership loan without disclosing to them the effect of such guarantee.

The Court rejected these arguments, reasoning that even assuming that the attorney may have been liable for negligent acts committed in his capacity as an attorney does not determine the question of whether that negligence falls within the coverage of the policy. In order to determine that question, the Court reasoned that the proper focus of the inquiry is on the proximate or direct cause of the plaintiffs' loss: attorney negligence or business reverses. Here, the Court concluded, that while the attorney's negligent acts as an attorney in inducing the plaintiffs to invest as limited partners and to guarantee partnership loans may be indirectly caused plaintiffs' loss, they were not the proximate cause. Rather, the direct and proximate cause was the limited partnership's inability to pay the load the plaintiffs had personally guaranteed, and the loss of statutory protection against partnership creditors after the plaintiffs were substituted as general partners after the attorney's resignation.

The Court explained that the business enterprise exclusion in a professional liability insurance policy prevents an attorney from being able to sue himself for professional errors that he committed while performing professional services for a business that he owned or controlled. The Court agreed with the court in Senger v. Minnesota Lawyers Mut. Ins. Co., 415 N.W. 2d 364 (Minn. App. 1987), which found that the mere existence of an attorney-client relationship will not be sufficient to bar the application of a relevant policy exclusion. "There will always be an attorney-client relationship when these exclusions are at issue. Absent an attorney-client relationship, the insuring agreement does not apply and the language of the specific exclusions does not come into play."

In this case, the policy at issue clearly provided that it does not apply to "any claim made by or against any business enterprise not named in the Declarations . . . In which the Insured is a partner . . . ." The claimed losses in this case resulted from a business enterprise in which the attorney was a partner. The business enterprise was not named in the declarations. Therefore, the Court held that the language of the business enterprise exclusion is unambiguous and precludes recovery here.

10. In Senger v. Minnesota Lawyers Mut. Ins. Co., 415 N.W.2d 364 (1987), the Court reversed the trial court's judgment that the insurer breached its duty to defend under its contract with the insured. In the underlying tort suit, two women who were considering the possibility of owning a diet center franchise, consulted with the defendant attorneys, seeking help in forming a corporation and raising funds to purchase a franchise. The attorneys at a subsequent meeting told the clients that they were not interested in lending them money, but were interested in applying for a franchise, investing in the business themselves, and employing the women in the business. The attorneys indicated that if they were investors, they could not act as the women's lawyers.

Later that month, the attorneys received approval for the franchise, and discussed employment agreements and stock options with the women. However, when the franchise was opened, only one of the women was hired.

Eventually, both women sued for tortious interference with prospective business opportunity, intentional misappropriation of business opportunity, negligent misrepresentations, breach of fiduciary duty, and attorney negligence. The insurer denied coverage, in part based on the business enterprise exclusions in the policy.

The relevant exclusions provide that the insurance did not apply to:

"(3) Any claim made in connection with any business enterprise, not named in the declarations, which is:

(a) Owned by the insured; or
(b) In which any insured is a partner or employee; or
(c) Directly or indirectly controlled, operated or managed by any insured. . . .
. . . .

(6) Any claim arising out of an insured's activities as an officer or director of an employee trust, charitable organization, corporation or business other than that of the named insured."

On appeal, among other things the insurer raised the issue whether the trial court erred in granting summary judgment on the insurer's duty to defend and indemnify the insured attorneys?

The insured attorneys argued that the business activities exclusions were not applicable because their liability flows from the attorney-client relationship. The Court disagreed:

"There will always be an attorney-client relationship when these exclusions are at issue. Absent an attorney-client relationship, the insuring agreement does not apply and the language of the specific exclusions does not come into play. Respondents' contention would create an illogical result; the policy exclusions would be rendered entirely meaningless and of no effect. The mere existence of an attorney-client relationship cannot be sufficient to bar the application of the relevant exclusions."

The Court continued on to find that the trial court erred in finding that the insurer breached its duty to defend, because the insured's tender of the defense contained an admission that "this action arises out of a business owned by [the defendant attorneys] . . . ." The insurer relied on this admission in denying defense of the claim, and the insured attorneys made no attempt to answer, correct, or modify their statement after the insurer denied coverage. The appellate court concluded that the policy clearly and unambiguously excluded claims "made in connection with any business . . .not named in the declarations" which is owned, directed, or controlled by the insured. An action which admittedly "arises out of a business owned" by the insured attorneys clearly fell within this policy exclusion.


B. Cases in which business enterprise exclusions were insufficient to bar coverage completely

1. In American Guar. Liability Ins. Co. v. Timothy S. Keiter, P.A., 360 F.3d 13 (1st Cir. 2004), the insurer brought a declaratory judgment action in federal court, seeking a declaration that pursuant to a "business enterprise" exclusion in a lawyers' professional liability policy, it had neither a duty to defend nor a duty to indemnify the insured lawyer, who had been sued in state court for legal malpractice and breach of fiduciary duty. The district court denied the insurer's summary judgment motion, finding a duty to defend, and the insurer appealed. On appeal, the First Circuit affirmed the finding of a duty to defend.

In this case, the attorney was originally retained by a client to represent him in connection with the development of his handyman business concept, "Rent-A-Husband." The attorney incorporated the business, and in exchange was issued 25% of its common stock. A year later, the attorney incorporated Rent-A-Husband, Inc. for the client, for the purpose of promoting and selling Rent-A-Husband franchises. This time, the lawyer's wife received 25% of the common stock. In the following year, the client got a book contract for a "how-to" book, and the attorney represented him in negotiating the contract. On the attorney's advice, the book contract was set up so that all book royalties would go to Rent-A-Husband, Inc., and none would be paid directly to the client. The next year after that, the client divorced, and the shares of the two corporations were considered marital property and were divided evenly.

Subsequently, the client sued the lawyer for legal malpractice, based on negligence in representing the two corporations. The complaint alleged that the attorney was professionally negligent in preparing certain franchise documents, prosecuting a trademark application for Rent-A-Husband, negotiating the sale of a franchise, drafting the closing documents for the sale of a franchise, and drafting the documents for the purchase of a trademark. There was also a breach of fiduciary duty claim based on the attorney's representation in negotiating the book contract with Rent-A-Husband, Inc. The latter count turned out to be very important, since it concerned only the second corporation, Rent-A-Husband, Inc., in which the attorney's wife had an express ownership interest, but the attorney did not.

In the coverage action, the insurer argued that the claims all fell within the scope of the business enterprise exclusion in the policy, which provided that the coverage did not apply to:

"any claim based upon or arising out of the work performed by the Insured, with or without compensation, with respect to any corporation, fund, trust, association, partnership, business enterprise or other venture, be it charitable or otherwise, of any kind or nature in which any Insured has any pecuniary or beneficial interest, irrespective of whether or not an attorney-client relationship exists, unless such entity is named in the Declarations. For purposes of this policy, ownership of shares in a corporation shall not be considered a "pecuniary or beneficial interest" unless one Named Insured or members of the immediate family of the Named Insured own(s) 10% of the issued and outstanding shares of such corporation."

The insurer's argument was that the attorney's ownership in the first corporation brought all but the last count within the exclusion; and the attorney's wife's ownership interest in Rent-A-Husband, Inc. brought the last count within the exclusion. The First Circuit rejected that argument and found that the insurer had a duty to defend. The court found an ambiguity in the exclusion, under which one plausible reading of the exclusion was that a Named Insured must have a beneficial interest in a corporation. Under Maine law, the attorney did not have a beneficial interest arising out of his wife's ownership of Rent-A-Husband, Inc. stock. Nothing on the face of the complaint alleged that the attorney was a beneficiary under his wife's will or under a trust she executed for his benefit. Under Maine law, a non-owner spouse does not, absent a divorce situation, acquire by virtue of the marital relationship alone an interest, beneficial or otherwise, in the owner-spouse's property. This rule resolved the case, and the court affirmed the district court's judgment finding a duty to defend.

2. In Ross v. Ohio Bar Liability Ins. Co., 706 N.E.2d 867 (Oh. App. 1998), the Court affirmed a trial court's ruling that claims against an attorney were not barred by business enterprise exclusions, because the claims of professional negligence arose only from services rendered as legal counsel to two individuals.

3. In Morris v. Valley Forge Ins. Co., 305 Ark. 25 (1991), the Court reversed the trial court's award of summary judgment to an insurer in a declaratory judgment action concerning whether coverage under a lawyers professional liability policy was excluded by business enterprise exclusions. The Court found that there were disputed issues of fact concerning the application of the business enterprise exclusions that necessitated a trial.

The insured attorney had represented the plaintiff, a former client, in a divorce action. The two were also friends and business associates in various investment ventures. The attorney sold a motel, owned by his company, to a company owned by the client. The attorney did not inform the client that the motel was already encumbered by a substantial lien, nor did the attorney provide clear title upon the client's completion of the purchase payments. The bank holding the lien foreclosed on the motel, and the client lost both the property and his investment.

The former client brought suit for legal malpractice, and received a jury verdict against the attorney. Following judgment, the insurer, Valley Forge, filed a declaratory judgment action contending that the policy did not provide coverage. The insurer moved for summary judgment, arguing among other things that the attorney's acts fell within the policy's business enterprise exclusions. The trial court granted summary judgment.

On appeal, the Supreme Court of Arkansas reversed. The business enterprise exclusions at issue stated that the policy would not cover:

"B. the performance of professional services for a business enterprise not named in this policy, owned by an insured or their spouse, a business enterprise in which an insured or their spouse is a partner, or a business enterprise which is controlled, managed or operated by an insured or their spouse.

"C. A claim arising out of the insured's activities as a lawyer and:

1. an officer, director, employee or trustee of a business enterprise not named in this policy, charitable organization, or a pension, welfare, profit-sharing, mutual or investment fund or trust . . .
unless such entity is a client of the insured and the claim relates solely to such lawyer/client relationship."

The appellate court reasoned that the pivotal question with regard to both of these exclusions was whether the attorney was acting in the interests of his own company when he arranged the sale of the motel. The court found that the application of the exclusions depended on the real nature of the transaction: was the attorney acting on behalf of his company or was he arranging a deal for his client as his attorney, or both? The court stated that these questions depended on credibility determinations both of the lawyer's testimony and the client's testimony. Accordingly, summary judgment in favor of the insurer was reversed.

4. In Niagara Fire Ins. Co. v. Pepicelli, 821 F.2d 216 (3d Cir. 1987), the Third Circuit reversed the district court's finding on summary judgment that there was no coverage under a law firm's policy for claims alleging negligence and breach of contract in the law firm's representation of a company called Perma Tread Corp.

A principal shareholder of the law firm also was the owner of a business called World of Tires, Inc. World of Tires entered into a purchase agreement with Perma Tread to buy a tire recapping plant. Pursuant to the terms of the agreement, World of Tires obtained fire and hazard insurance for the tire recapping plant. Before the final closing date for the transaction, a fire destroyed almost all of the assets being purchased by World of Tires.

After the fire, Perma Tread hired the insured law firm to collect compensation for the loss from the fire insurance company. It was recognized that all the proceeds of the insurance would go to Perma Tread. The insured law firm submitted a proof of claim to the fire insurance company, but a settlement of the claim was not reached.

The law firm then filed suit against the fire insurance company, naming World of Tires as the Plaintiff. Perma Tread hired separate counsel, intervened as a plaintiff in the fire insurance action. However, the trial court issued a directed verdict against Perma Tread because by the time it intervened, its claim was barred by the one-year contractual limitation on actions under the fire insurance policy. The trial resulted in a verdict against World of Tires and for the fire insurance company.

At that point, Perma Tread and its shareholders initiated a malpractice action against the insured law firm, for failing to name it in the initial complaint against the fire insurance company. The malpractice insurer then filed a declaratory judgment to determine coverage. The lawyers liability insurance policy at issue stated, among other things, that the policy does not apply:

"f) to any claim arising out of any insured's activities as an officer or director of any employee trust, charitable organization, corporation, company or business other than that of the Named Insured;

"g) to any claim made by or against or in connection with any business enterprise (including the ownership, maintenance or care of any property in connection therewith), not named in the Declarations, which is owned by any insured or in which any insured is a partner, or employee or which is directly or indirectly controlled, operated or managed by any insured in a non-fiduciary capacity; . . . ."

Niagara Fire Insurance argued that the policy's exclusions relieved it of the duty to defend and indemnify the insured. The district court granted Niagara's summary judgment motion, and on appeal, the Third Circuit reversed.

The Third Circuit found that both the insurer and the district court ignored a crucial distinction: The exclusions speak of excluded claims, and thus the character of the specific legal claims, rather than the malpractice suit's general factual background, must be analyzed to determine the exclusion issue. The Court pointed out that the claims made by Perma Tread deal only with negligence and breach of contract in the insured law firm's representation of Perma Tread, and resolution of the claims would affect only the interests of Perma Tread and the Law Firm. Significantly, neither the actions of the interests of World of tires, or the lawyer who owned it, were at issue in the malpractice suit. Therefore, the Court concluded, the malpractice claims are not omitted from coverage by the two exclusions, "f" and "g", which are designed to exclude business risk and collusive suits from coverage under the policy.

The Court explained that Perma Tread's malpractice claims did not arise out of any insured's activities as an officer or director of World of Tires. The Court also concluded that the malpractice claims were not made "in connection with" World of Tires. The Court read "in connection with" in the context of the purpose of exclusion "g", which was to prevent collusive suits whereby malpractice coverage could be used to shift a lawyer's business loss onto his or her malpractice carrier. The Court stated that if one were to read "in connection with" to include Perma Tread's claims within the exclusion, the phrase would have no discernable limit. The Court further criticized the district court, which interpreted "in connection with" as meaning "traceable to." The Court pointed out that not only did World of Tires not have an interest in the outcome of the malpractice suit, it also was only a nominal party in the fire insurance litigation, where Perma Tread was the real party in interest. Accordingly, the Third Circuit found that Perma Tread's malpractice claims were covered under Niagara's policy.