Insurer Has No Obligation To Cover Law Firm Losses In Email Scam

Law firms in New York and across the country are being targeted in counterfeit check schemes that, according to the federal government, typically have the following elements: Scammers send e-mail to a law firm, claiming to be overseas and seeking legal representation to collect delinquent payments from third parties in the U.S. The law firm thereafter receives a signed retainer agreement, invoices reflecting the amounts owed, and a check payable to the firm. The firm is instructed to remove the retainer fee, plus any other fees associated with the transaction, and wire the remaining funds to banks in Korea, China, Ireland, or Canada. By the time the check is determined to be counterfeit, the funds already have been wired overseas.

A law firm that fell victim to such a fraud recently sought coverage from its professional liability insurance carrier for its losses. In a well-reasoned decision, a trial court in New York has ruled that the firm was not entitled to defense or indemnity from its carrier.

Background

The plaintiff in the case, the law firm of Lombardi, Walsh, Wakeman, Harrison, Amodeo & Davenport, P.C., brought suit seeking a judgment declaring that its professional liability insurance carrier, American Guarantee and Liability Insurance Company, was obligated to defend and indemnify it in an underlying action brought against the firm by Berkshire Bank. The action by Berkshire involved an overdraft of an account maintained by the firm.

According to the firm, on February 11, 2009, Robert Wakeman, a member of the firm, received an email from an Albert Chang of Taiwan in which Chang represented himself to be the chairman and chief executive officer of Asia Pacific Microsystems, Inc. Chang was inquiring as to whether the firm was interested in taking on Asia Pacific as a client for the purpose of collecting delinquent accounts in North America. After further email exchanges, the firm sent a retainer agreement to Chang. On February 22, 2009, Wakeman received an email from Chang in which Wakeman was advised that Asia Pacific had determined to retain the firm. In the same email, Chang informed Wakeman that a customer of Asia Pacific had agreed to make a partial payment on its delinquent account. Chang asked for information needed for the customer to forward the payment to the firm and Chang also told Wakeman that the retainer fee should be deducted from the payment.

On February 24, 2009, the firm received a DHL package containing a Citibank check for $384,700. The check was payable to the firm as attorney for Asia Pacific on account of Pelham Machinery Company. On that same day, the firm set up an account in its own name at Berkshire Bank and deposited the check. On February 25, the firm, at the request of Asia Pacific, instructed Berkshire Bank to wire $223,200 of the funds to a bank in South Korea; the funds were transferred the following day. Also on February 26, and again at the request of Asia Pacific, the firm instructed Berkshire Bank to wire $131,460 to the same account in South Korea. The remaining funds were transferred to another account of the firm at Berkshire Bank as a retainer. On February 27, the firm was informed by Berkshire Bank that the $384,700 check was counterfeit and that it had been returned unpaid by Citibank. That same day, Berkshire Bank sent a letter to the firm demanding immediate payment of $384,700 based on the overdraft of the account.

The firm subsequently sent a letter to American Guarantee requesting, in connection with the demand by Berkshire Bank, a defense and coverage under the firm’s professional liability policy. American Guarantee disclaimed on the ground that the claim by Berkshire Bank was not based on any alleged breach of a professional duty as a lawyer. Thereafter, the firm negotiated a settlement of the action by Berkshire Bank, and brought a declaratory judgment action against American Guarantee. The parties moved for summary judgment.

The Court’s Ruling

In its decision, the court observed that the American Guarantee policy provided coverage to the firm for claims based on an act or omission in its rendering, or failing to render, legal services for others. The court noted that legal services was defined in the policy as those services performed by the firm “as a licensed lawyer in good standing, arbitrator, mediator, title agent, notary public, administrator, conservator, receiver, executor, guardian, trustee or in any other fiduciary capacity but only where the act or omission was in the rendition of services ordinarily performed as a lawyer.” As the court pointed out, in denying coverage, American Guarantee had reasoned that the bank’s claim was based simply on a breach of the account agreement in failing to cover the overdraft and did not involve any alleged breach of a professional duty as a lawyer.

The firm argued that coverage under the policy had been triggered because the complaint in the action brought by Berkshire Bank alleged that the firm had performed legal services. The firm also contended that, at a minimum, the insurer had actual knowledge of facts establishing a reasonable possibility of coverage. In particular, it asserted that, during the course of events leading to the loss, Asia Pacific was a client of the firm and in handling funds of a client the firm was acting in a fiduciary capacity given that the handling by lawyers of client funds was governed by strict rules and, thus, ultimately was the responsibility of the lawyer. Thus, viewed from the perspective of whether the firm was performing legal services, the firm argued that there was a reasonable possibility of coverage.

The court declared, however, that the question of whether the Berkshire Bank claim was based on some act or omission of the law firm in providing those legal services brought “a different answer.”

As the court explained, the Berkshire Bank complaint asserted causes of action for breach of contract (the account agreement), breach of warranty, and breach of the right of charge back. Although the complaint recited the facts of the relationship between the law firm and Asia Pacific, as well as how the counterfeit check came to the law firm and was handled by it, “none of those factual allegations were necessary to establish any element of any cause of action alleged.” Rather, the court continued, the causes of action were all factually based on the relationship between the firm and Berkshire Bank as depositor and banker. The court then ruled that the attorney-client relationship between the firm and Asia Pacific “merely furnished the circumstances under which the claim by Berkshire Bank arose and the claim itself was not based, or claimed to be based, on any act or omission of Lombardi, Walsh in providing ‘legal services.'” Consequently, the court concluded, there were no facts that suggested a reasonable possibility of coverage.

Conclusion

Law firms certainly should conduct as much due diligence as possible before engaging in transactions with parties who are handling their business solely via e-mail, particularly those parties claiming to reside overseas, and the failure to do so can be costly. That is especially true because, as the decision in the Lombardi, Walsh case makes clear, firms are unlikely to find coverage for losses they incur in these kinds of situations under a professional liability insurance policy.
For Further Information
For further information about insurance coverage for losses in email scams, or about insurance coverage issues in general, please contact Mr. Rivkin (at (516) 357-3269 or via email at [email protected]), or your regular Rivkin Radler attorney.