An unsettling insurance decision if you practice in a law firm of any size.

The month of April 2015 brought a declaration from a legal consultant that he anticipates seeing a 10,000 lawyer law firm within five years.  Trying to determine if there would ever be a law firm so big that from a conflicts perspective its operation was fundamentally unworkable might be an interesting intellectual exercise to undertake, but that’s not happening today.

Instead, I’m interested in a much more immediate, and scary, intellectual exercise: mulling the ramifications of a troubling insurance coverage opinion out of Illinois earlier this year holding that the failure of one lawyer of the firm to disclose a known client problem on a malpractice insurance renewal application meant that none of the lawyers of the firm had coverage.  Instead, the insurer was entitled to rescind the firm’s policy in its entirety.

The majority opinion in Illinois State Bar Ass’n Mut. Ins. Co. v. Law Office of Tuzzolino & Terpinas reads like a relatively straightforward application of insurance principles, including limits on how far protections for “innocent insureds” can go (not to questions of whether the actual formation of the contract should be undone) and basic contract principles that serve to justify rescission.  In as much as the decision is driven by one of the “partners” of the firm — Tuzzolino (who by the time of the decision had been disbarred) — failing to disclose a known dispute with a client that was likely to lead to a claim being made, a claim that was of large enough size that the insurer’s position that, had it been disclosed, the firm’s coverage would not have been renewed seems plausible, then, as unpleasant as the outcome may be for the innocent lawyer, Terpinas, and the client who won’t likely be recovering on his judgment against the firm, it doesn’t stand out as meriting much thought if you practice law outside of Illinois.

Reading the dissent, however, provides an unsettling glimpse into just how alarming the repercussions of this straightforward application of insurance law principles really are.  As the dissent speculates, the logic and rationale used by the majority, and the result in the case, would mean that lack of disclosure by one lawyer in a firm of 100 (or 10,000 for that matter) lawyers would obliterate coverage for all of them.  Lawyers who practice together in firms are likely more or less attuned to the many ways that their professional fates are tied inextricably with their colleagues, but the possibility that a decision by one of your colleagues to sit on knowledge about a mistake, or knowledge of a  seriously unhappy client who is set on doing something about their unhappiness, could result in rescission of your entire law firm’s malpractice coverage is not likely something you’ve spent much time thinking over.

The only slightly helpful thought for larger firms — and in turn for the “innocent” lawyers practicing in those firms — is that perhaps the end result would be different for a firm of much larger size than Tuzzolino & Terpinas even under the majority view.  As the size of the firm increases, one would expect the likelihood that the lack of disclosure of one claim could justify rescission of the policy altogether would decrease.  A more realistic (or maybe just an optimistic) analysis — in terms of what would constitute the status quo ante for a much larger firm with one undisclosed claim — is that, if the existence of the potential claim had been disclosed, the insurer would still have renewed the firm and provided coverage but just at a higher cost to the firm in terms of premium, deductible, or self-insured retention (or perhaps as to all three).