Fourth Circuit Finds Insured’s Participation in Investment Scheme Triggers Business Enterprise Exclusion Under Professional Liability Policy
On March 29, 2012, in an unpublished opinion, the United States Court of Appeals for the Fourth Circuit affirmed the judgment of the Eastern District of Virginia, holding that an insured’s activities as investor in companies for which the insured acted as legal counsel triggered the Business Enterprise Exclusion (“BEE”) contained in the professional liability policy issued to the insured, thereby precluding coverage.
In Minnesota Lawyers Mutual Insurance Company v. Antonelli, Terry, Stout & Kraus, LLP, the Antonelli firm and attorney Stout sought coverage for Ferguson v. Stout, a malpractice suit arising out of the alleged activities of the firm and attorney with respect to certain business entities they represented. According to the Ferguson complaint, inventor Andrew A. Andros formed Telefind Corporation in 1986 to develop and market wireless email technology (“WET”). In 1987, Andros and Telefind retained the Antonelli firm and Stout to perform patent prosecutions on its behalf; however, over time their role evolved from that of pure attorneys to equity investors to increasingly immersing themselves in counseling and managing Telefind’s strategy and operations.
Telefind received substantial financial backing from a group of outside investors (“Richards Investors”). The Richards Investors lent Telefind $6 million via a loan through Flatt Morris, S.A. The loan agreement stated Stout would serve as trustee for Flatt Morris and hold Telefind’s intellectual property in trust for Flatt Morris’s benefit. Over time, Stout and the Antonelli Firm acquired a majority equity share of Flatt Morris, including its Telefind assets.
Later, when it became necessary to protect the WET from Telefind’s creditors, Stout devised a legal strategy that he told the Richards Investors and Andros would legally protect Telefind’s interest in the WET, recommending placing the patents in a separate legal entity and stressing that their entire interest in the WET would be lost if they did not follow his advice. To implement the strategy, three employees of ESA Telecommunications (“ESA”), a company Telefind worked with previously, filed the WET patents in their names. Stout emphasized that for the strategy to be successful Andros and the Richards Investors could not have any documented direct ownership interest in the WET, assuring them they would continue to participate in any benefits associated with the WET. Andros and the Richards Investors disavowed their legal interest in the patents and the ESA employees assigned the patents to Stout. In 1992, Stout created NTP, Inc. to hold the WET patents.
Andros passed away in January 2001. Later that year, NTP filed a patent infringement action against Research in Motion Limited. RIM settled the suit in March 2006 for $612.5 million. The Ferguson complaint alleged the money was divided between Stout, his partners at the Antonelli firm, and others associated with NTP. When the Richards Investors and Andros’s surviving family contacted Stout regarding their interest in the proceeds of the RIM settlement, Stout denied the existence of any agreement conferring such an interest. Neither Andros’s estate nor the Richards Investors received any portion of the settlement. The Ferguson action ensued, asserting, on the bases of the above facts, claims of breach of fiduciary duty, breach of contract, unjust enrichment, and promissory estoppel. The Ferguson plaintiffs did not challenge NTP’s ownership of the WET patents, arguing only that the implicit understanding was that the Ferguson plaintiffs would receive a share of any WET profits.
The Antonelli firm and Stout notified their professional liability carrier, Minnesota Lawyers Mutual Insurance Company (“MLM”), of the Ferguson action. MLM filed a declaratory judgment action seeking a declaratory judgment that MLM was not obligated to defend the Ferguson action. Thereafter, the parties filed cross-motions for summary judgment. The district court granted MLM’s motion, finding that coverage for the Ferguson action was excluded by the policy’s BEE, which provided:
[This policy does not provide coverage for] 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.
The Antonelli firm and Stout appealed, arguing the Ferguson action was covered because (1) a number of terms within the BEE were ambiguous; and (2) even if the BEE applied to the Ferguson complaint on the whole, the Ferguson plaintiffs “might prove only the allegations falling within coverage without proving the allegations within the exclusion.”
The Antonnelli firm and Stout first argued that a number of terms within the BEE were ambiguous and therefore should be construed in their favor, contending that favorable construction would demonstrate that the Ferguson complaint did not fall within the BEE. Addressing each part of the BEE individually, the court rejected the argument:
Under the terms of the Policy, the BEE excludes coverage for claims (1) “arising out of professional services” (2) rendered “in connection with any business enterprise” (3) owned, controlled, or managed, by any insured, and (4) resulting “from conflicts of interest with the interest of any client or former client.”
There is no dispute that this case “aris[es] out of professional services” that Appellants provided to the Ferguson plaintiffs, thereby satisfying the first requirement of the BEE. Appellants counseled Andros and others to renounce their interest in the WET patents in order to avoid their creditors….
Further, and just as clearly, these “professional services” were rendered “in connection with [a] business enterprise,” meeting the second requirement of the exclusion. The phrase “in connection with” is a common insurance phrase that is given particularly broad scope. See, e.g., Goldman Paper Stock Co. v. Richmond, F. & P.R., 212 Va. 293, 296 (Va. 1971) (“in connection with” broader than “arising out of”); see also Coregis Ins. Co. v. Am. Health Found., Inc., 241 F.3d 123, 128-29 (2d Cir. 2001) (explaining “in connection with” encompasses more than causal connection); Metro. Prop. & Cas. Ins. v. Fitchburg Mut. Ins., 793 N.E.2d 1252, 1255 (Mass. App. 2003) (“In connection with” should “not be construed narrowly but [is] read expansively in insurance contracts.”) (collecting cases). Moreover, although the phrase “business enterprise” is not defined by the policy, there can be little dispute that it encompasses the various corporations involved here — Telefind, Flatt Morris, and NTP.
The Ferguson complaint also clearly meets the third requirement of the exclusion since it alleges that Appellants owned, controlled, or managed at least Flatt Morris and NTP. Stout served as a trustee for Flatt Morris, and Appellants eventually acquired a majority equity interest. Similarly, Stout helped incorporate NTP. NTP had no employees and Stout, other attorneys at the Antonelli Firm, and their families were among NTP’s few shareholders.
Finally, the asserted damages surely resulted “from conflicts of interests.” The defendant attorneys in this case allegedly obtained complete ownership and control of their clients’ assets and exploited those assets for personal benefit. This conduct violates any number of Virginia professional ethics rules….
Accordingly, the court found the allegations of the Ferguson complaint fell unambiguously within the BEE.
The appellants also argued that even if the BEE applied to the Ferguson complaint on the whole, because the Ferguson plaintiffs “might prove only the allegations falling within coverage without proving the allegations within the exclusion, the district court should have found a duty to defend.” For example, the appellants argued, the Ferguson plaintiffs might prove that appellants provided professional services by advising their clients how to avoid their creditors, but fail to show that these services were rendered “in connection with any business enterprise” or resulted “from conflicts of interest.” Essentially, the appellants argued that the Ferguson action could amount to only a claim for legal malpractice.
The court of appeals rejected the appellants’ argument, pointing out that Virginia’s potentiality rule required the court to examine the complaint and determine whether any potential judgment under that complaint would fall within the policy. Such a process, the court emphasized, does not disregard the actual allegations that are made:
In the Ferguson complaint, each cause of action is premised on an agreement between plaintiffs and Appellants that they would share any WET proceeds. As both parties acknowledged at oral argument, because the plaintiffs consented to every initial step of Appellants’ strategy, if Appellants had shared the WET proceeds with the Ferguson plaintiffs, there would be no loss for the Ferguson plaintiffs to recover. Without any potential loss, there can be no duty to defend. See Va. Elec. & Power Co. v. Northbrook Prop. & Cas. Ins. Co., 475 S.E.2d 264, 265-66 (Va. 1996) (explaining insurer has no duty to defend where there is no possibility that insurer will be required to indemnify insured). Thus because the breach of the agreement is central to any potential recovery, Appellants cannot obtain a defense by having a court assume plaintiffs will fail to prove the heart of their allegations. Rather, we must evaluate the Ferguson complaint presuming that plaintiffs will prevail. In doing so, we conclude that MLM has no duty to defend because the BEE applies.
The court also rejected the appellants’ reliance on authority finding a duty to defend where alternative allegations fall within the policy:
Appellants’ reliance on authority finding a duty to defend where some alternative allegations fall within the policy is also unavailing. Cases considering alternatively worded complaints do not look to any conceivable cause of action. They require that the complaint actually asserts the claim. See, e.g., Fuisz v. Selective Ins. Co., 61 F.3d 238, 245 (4th Cir. 1995) (avoiding intentional act exclusion because “each of the four causes of action” alleged “reckless disregard” in addition to “actual malice”). Given that the Ferguson complaint does not assert legal malpractice as an alternative theory, we will not infer such potential liability.
Thus, the court found that the BEE exclusion applied to exclude coverage for the Ferguson action.