Business Pursuits Exclusion Bars Coverage for Malpractice Claim

Summary of Minnesota Lawyers Mutual Insurance Company v. Antonelli, Terry, Stout & Kraus (E.D. Va., November 18, 2010):

Andrew Andros was an inventor who founded and managed several communications companies over the course of his life. Mr. Andros formed Telefind Corporation with the goal of developing and marketing text messaging technology. Mr. Andros received significant financial investment from a number of investors (the Richards Investors). In 1987, Telefind retained Donald Stout, a patent lawyer, for the prosecution of various patents relating to this technology. Before long, Stout was increasingly immersed in counseling regarding the strategy and operation of the company.

The Richards Investors provided money through a Panamanian corporation, Flatt Morris. Stout, acting as a trustee for Flatt Morris, entered a collateral trust and security agreement with Telefind. The collateral trust agreement authorized Stout to hold all of Telefind’s current and prospective intellectual property in trust for the benefit of Flatt Morris.

Stout continued to become more and more involved in the operations of Telefind. Eventually, Telefind began experiencing monetary troubles, and as a result, it Telefind’s rights to its intellectual property was vulnerable to seizure by a creditor. In order to protect the rights to this intellectual property against the creditor Stout devised a ruse whereby Telefind would transfer all rights to the technology to a different company. Pursuant to Stout’s recommendations, the rights to the technology was placed with a separate company, thereby protecting it from Telefind’s creditors. In short, Stout devised a scheme where all rights to the technology would be transferred to a company, and Andros and the Richards Investors would be required to disavow all ownership interests in the technology. Stout went so far as to have Andros execute an affidavit attesting as much. Interests in the patents were transferred to a company incorporated by Stout.

Notably, a subsequent patent infringement action was filed on behalf of the new company against RIM regarding RIM’s use of Telefind’s wireless texting technology in its Blackberry system. The patent infringement action resulted in a settlement with RIM paying over $600 million. When the Richards Investors and Andros’ surviving family contacted Stout regarding their interest in the proceeds of the RIM settlement, Stout denied the existence of any agreement confirming such an interest. Neither Andros’ estate nor the Richards Investors received any portion of the settlement.

As a result, the Richards Investors instituted a legal malpractice claim against Stout and his firm. Stout sought coverage under a professional liability policy issued by Minnesota Lawyers Mutual Insurance Company (“MLM”). MLM denied coverage contending that the complaint did not seek damages for the rendering of professional services and the business enterprise provision barred coverage.

Comparing the allegations of the complaint to the coverage grant of the subject policy, the court held that the duty to defend was indeed triggered. While the complaint did seek damages based upon the attorney’s clear malfeasance, the court held the advice offered by Stout to the plaintiffs regarding the protection of the wireless e-mail technology qualified as a professional legal service. As the duty to defend was triggered, the resulting inquiry was whether the business pursuits exclusion applied to bar coverage.

The court had noted that in order for the provision to apply, it must be established that a claim arose out of professional services rendered by the insureds, and the insureds must have rendered the services in connection with an enterprise that the insureds wholly or partially owned, directly or indirectly controlled, or managed. Finally, the alleged damages must have resulted from a conflict of interest between the insureds and some person claiming an interest in the same or related business enterprise.

The court previously concluded that the first condition was satisfied. In looking at the facts alleged in the complaint, the court concluded that Stout’s scheme to protect Telefind’s intellectual property from a creditor in a collection action constituted a business enterprise. The new company created by Stout for the purposes of protecting the intellectual property gave Stout complete control over his client’s assets. The court noted that the complaint’s allegations demonstrate that Stout managed and controlled the larger enterprise -- the scheme to transfer from the technology from Telefind to a separate company he created. In the end, given the egregious conduct alleged, it was clear that the business pursuits exclusion applied.

Impact: This case is interesting in that the court provides an exhaustive explanation of the facts alleged in the underlying malpractice claim. The actions taken by this attorney, if accurate, are beyond reprehensible. This is not a case where counsel simply failed to timely file a notice of appeal, but instead became increasingly involved in the business operations of his client to the extent that he was creating sham companies purely for the purposes of defrauding his client’s properties and interests.

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