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?
- 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).