The California Court of Appeal, Second Appellate District, affirmed summary judgment in favor of the insurer in a coverage action, applying a policy exclusion precluding coverage for legal malpractice claims made by an entity managed by the insured at the time the potential claim was reported to the insurer.
Carolina Casualty Insurance Company issued a legal malpractice policy to the L.M. Ross Law Group, a two-person firm whose sole equity partner is Leonard M. Ross. Although a "claims-made" policy, the policy expressly provided coverage for claims made after the policy expired as long as the law firm provided written notice to Carolina of the facts and circumstances of a potential claim prior to expiration of the policy. Under these circumstances, any claim made after the policy's expiration, but arising out of the reported facts and circumstances, would be deemed to have been made when notice of the potential claim was given.
In 2005, four days prior to the expiration of the Carolina policy, the law firm reported a potential legal malpractice claim arising out of its handling of a production and distribution agreement relating to certain entertainment video tapes and DVDs for a firm client, Diversified Entertainment Co. ("DEC"). DEC waited two years after the policy expired before suing the law firm for legal malpractice, alleging the law firm provided improper legal advice which resulted in damages in excess of $800,000 (the "DEC action"). The law firm tendered the action to Carolina, which agreed to defend the law firm under a reservation of rights.
The DEC action was settled for $250,000. Carolina contributed $175,000 to the settlement, while the law firm contributed $75,000.
Carolina initiated a coverage action for declaratory relief on the issue of coverage for the DEC action and sought reimbursement of the $175,000 it contributed to the settlement. The law firm cross-complained, seeking reimbursement of the $75,000 it contributed toward the settlement.
The parties filed cross-motions for summary judgment. Carolina argued Exclusion F of the policy precluded coverage because of Leonard Ross' dual role in the law firm and DEC. Exclusion F precluded coverage for any malpractice claim "by or in connection with any business enterprise [other than the named insured law firm] ? which is directly or indirectly controlled, operated, or managed" by Ross Law Group or one of its partners or employees ?" The exclusion also precluded coverage for any malpractice claim by or in connection with any business enterprise (other than the law firm itself) in which the firm or its partners or employees own more than a 10 percent interest.
Among other things, Carolina submitted undisputed evidence that Ross managed DEC when DEC's potential malpractice claim was reported by the law firm to Carolina. Although Ross no longer managed DEC by the time the DEC action was filed, Carolina argued that Exclusion F applied because the DEC claim was made for purposes of coverage in 2005, while Ross was manager of DEC. The law firm, on the other hand, insisted that the exclusion applied only to conditions existing when the claim is actually asserted, not when a potential claim is first reported.
The trial court agreed with Carolina, finding the policy language to be clear and unequivocal. On appeal, the Court of Appeal also agreed with Carolina, concluding that "[n]othing justifies interpreting the language in Exclusion F insofar as it relates to an insured's status at the time a claim is made in a manner that is inconsistent with the coverage and notice provisions of the policy." The Court of Appeal went on to note that Exclusion F could have been drafted to cover the specific situation here, but was not. Reading the policy as a whole, the appellate court had "no doubt" the law firm "would reasonably expect Exclusion F to apply in the circumstances presented by this case."
Indeed, such an interpretation is not inconsistent with the anti-collusion purpose of Exclusion F. In 2005 – just four days before the policy expired – the insured law firm in which Ross was the sole equity partner, ensured it would have coverage against a malpractice claim that might be filed by DEC, a business entity managed by Ross. Leonard M. Ross was, in effect, the real party on both sides of the anticipated malpractice claim. The potential for collusion was, in the Court's opinion, "readily apparent." The fact that Ross' role with respect to DEC subsequently changed did not alter Carolina's legitimate interest in protecting itself from such sham or collusive claims.
Additionally, it was undisputed that the Leonard M. Ross Revocable Trust owned a majority interest in DEC at all relevant times. While the trust was not an insured, and thus, its ownership interest in DEC did not trigger Exclusion F, the Court of Appeal noted that Ross was both the settlor and the trustee. A settlor with the power to revoke a living trust effectively retains full ownership and control over any property transferred to that trust. For this reason, California law does not distinguish between property owned by a revocable trust and property owned by the settlor of such a trust during the lifetime of the settlor.
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This opinion is not final. Though it has been certified for publication, it may be modified on rehearing, or granted review by the Supreme Court of the State of California. Should any of these events occur, the opinion would be unavailable for use as authority in other cases.
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