An Explosive Texas Supreme Court Decision

This piece is ultimately about insurance underwriting for legal malpractice insurance. It begins, however, with a very unusual Texas Supreme Court decision, and a series of hypothetical paradigms based upon that case. The case was rather complicated, and the hypos are even more so. Here’s how the case went. A lawyer (L) who had put substantial time into an enormous case for virtually no fee at all, and a law firm (F1) that it seems ended up with a client it did not want and did not know it had.

Along with these odd problems, the case was about the relationship between the technicalities of contract law and the distribution of attorney fees. The judgment of the trial followed the verdict and entered judgment in accordance with the verdict, as did the Court of Appeals, but the “High Court” reversed and remanded.

In a 4-1-3 decision, in which one justice both concurred in part and dissented in part, the sharply divided Texas Supreme Court held that the “Of Counsel” lawyer, L, all the way through the Anglo-Dutch Petroleum case (sometimes C) who was, indisputably, involved centrally in preparing the case, was not entitled to anything more than a pittance of fees. The court’s decision was based on considerations from not only the rigors of ironclad law school contract law, a view entirely opposed to “Legal Realism” or any sort of legal pragmatism, the nature of fiduciary duties, and principles of legal ethics. Strangely, part of the implications of C as well as its explicit holding have what may be substantial implications on insurance underwriting practices.

This essay is organized in the following manner. This is the end of Part I. Part II will describe a little about the case to be discussed. Part III will make some remarks about a few relevant insurance topics. Part IV will focus on the idea of “the moral hazard.” Part V will set forth some hypotheticals which are variations of each other, and one of which is a variation of the situation in Anglo-Dutch. One of the variables is such that there is a sub-group of different variations on one single “story” without having any influence on its ending. Those involved in the “plot” of the variations can change without ending the resolution of the hypo. Thus, to some degree, the hypo(s) resembles another part of the fact pattern in Anglo-Dutch, but it is not intended to “track” this case. Part VI will set forth some insurance implication from Part V, and earlier parts; it will also set forth more particulars about the underwriting process.

As far as the insurance implications of Anglo-Dutch are concerned, Part VII concludes the essay. There will be a brief Part VIII, however, ruminating on the problems in Anglo-Dutch, other than its implications for underwriting.

II. The Historic Anglo-Dutch Petroleum Case

As already indicated, this essay is not about the details of the case. It is about its probable underwriting implications. Still some of its features and probable details must be sketched.

In Royal-Dutch, a relatively new and small-ish American drilling company was “run over” by one of the majors. The head of the company was “close” to L, who had done work for C and him in the past. L was “Of Counsel” to law firm (F1) that was the first on the list of named defendants in the case. L was its assignee. L had taken the case to F1, but it did not want C, for various reasons that are unimportant here. L did want it.

Now comes an important part of the case. L was “close” to F1. He used their equipment, did some work for them, and worked with them in various sorts of ways. To repeat, he was not a member of the firm or an employee of the firm. L decided to go forward.

Now comes a part of the case that is of increased importance. L sent a retainer letter to his friend the head of C, which he returned signed. Unfortunately, the letter was on the stationary of F1, and the text of the letter indicated that C was hiring F1. It was clear that C knew what the real relationship was, since its “head knocker” knew, and the company had worked with L for a long time. The fee was, in part, a contingency fee.

L either knew or figured out that he could not handle a case of this size, complexity, and amount by himself, so for several independent reasons, he sent it to F2, and he moved over with it, again, as “Of Counsel.” C and F2 arranged another contract for legal services and legal fees. It too involved a contingency fee. L was not designated explicitly as a party to the contract.

L worked his heart out on the case. It was tried to a jury, and C got a jury verdict of $75.5M + $9.8M for attorney fees, and the case eventually settled for $51M. The attorney fees were then paid. The problem was that F1 did not really do any more than a miniscule amount of work, if that, on the case; there was no contract between C and L, since he had written out the deal on the stationary of F1, and L had not been hired as an employee of F2. Remember two propositions: L had an attorney-client relationship with C, and C actually knew the nature of the true relationship; even though it was not expressed by a strict, rigorous, and very literalistic reading of the language of original contract and no outside facts where considered at all. Again, an entailment of a classical contract “rule” which was at least said by courts and some key scholars.

(Some might regard this as an unusual application of the “Read the Contract” doctrine—this time it applied to the drafter of the contract. This application of that doctrine seems like an understanding or interpretation of that scope of doctrine. It’s not like the drafter misread the contract s/he drafted, while the other signee did not. What happened here was that neither side understood its language; both parties intended something else, inconsistent with that language; one of the parties—the draftsperson—put in work, taking the original contract to be as the parties understood it; while the other signee accepted that work, also taking it that the work was being done pursuant to the joint original understanding. Interestingly, the dissent, the concurring opinion, reject precisely the consequences of a narrow and strict reading of the language of at least this contract.)

Except for a pittance, L got nothing for his services taken by themselves, even though he brought the case “in” to himself and perhaps  to F1, brought it to F2, worked very hard on the case for a long time—a fact which no one denied—and tricked no one at any time. No one contended that L was sneaky. Thus, there is no evidence that L was ever disloyal to C, in any way. The main arguments of the court were that L actually had no contract with C; he had no contract with F2, since that was not what the actual language of the first written contract actually said. L had blundered into activities which—in the abstract—might be minor breaches of a fiduciary to C, but one that caused no harm to C; and it did not matter whether C knew what the true nature of the relationship was.

Thus, while what L did might be a breach of a fiduciary duty, no one actually claimed that L was disloyal to C to any degree, or that C did not really understand who its lawyer actually was from the start of all its attorney-client relationships in the case. When one examines the Court’s majority decision it is clear the main reasoning rested upon two premises. First, the law requires the employment of strict interpretations of the language of unambiguous contracts, even when both parties know that the actual relationship and the obligations it carried with it, differed from the language of the contract. The precise language of the contract, and not actual context (to any decree) is what matters, said the Texas Supreme Court rules. Second, any decision favoring L in this case might encourage other lawyers to seek fees to which they are not entitled.

From the point of this essay, at least, the most important issues are these: what if L was not actually C’s lawyer at any time, or what if L actually should be adjudged to have been C’s lawyer for no compensation during all those grinding years? Who was C’s lawyer before F2 took over? Did L and C really think that L was to get no money or very little? Did F2 really think this? Was L permitted to, or invited to, review the F2C contract? Did F2 really think that L was to get nothing? Not even the Supreme Court believes this, since it awarded fees for the amount of time it inferred that L was “at,” “with,” or somehow “in” F1.

III. Some Insurance Dangers

This case has sizable unexpected results for insurance practices. The explicit decision and its implied conclusions will probably negatively affect important insurance underwriting processes and standards. If that happens, in Texas, there may be increases—substantial increases­—in the prices of liability insurance policies covering the professional functions of lawyers, i.e., “legal malpractice policies” aka “Errors and Omissions” (E&O) insurance for attorneys.

Significantly, the conclusions and arguments of the majority could very well—and predictably will—impact the “cost” of self-insurance, albeit costs which are self-absorbed by the insured, just as much as it would affect underwriting in the policy sales industry. Insurers themselves do not conduct the underwriting and risk analysis; the “pricing” of self-insurance is, to some extent, derived from analyses and calculations performed by insurers.

If the results of the Anglo-Dutch decision increase pricing that adversely affects insurance for Texas lawyers, it would predictably spread to other states. Purchasing lawyers will not be the only component of the industry affected. Underwriting itself will become much more uncertain, much more of a headache, and less prone—as it is—to guard against enormous and surprising insured events like those implicated in Anglo-Dutch.

IV. More About Pricing & Moral Hazards

The impact of Anglo-Dutch may very likely be a substantial—even dramatic—negative alteration of the components of underwriting for lawyer liability insurance. All of this has to do with the relationship between the antecedent gathering of information and risk estimation in the context of adjustment. What will happen is that carriers’ collection of reasonable, stable, objective, extensive, and reliable information will fall in significant ways.

There is now a completely new underwriting problem for professional liability insurance, which will become almost impossible to determine. It concerns the carriers’ inability to collect information about a significant set of relevant moral hazards. These concern firms commencing attorney-client relations, and how such attorney-client relationships can be imposed on firms. (Of course, all impositions are involuntary from the point of view of the victim. In this case, the victims are L, F1, and F2, with F1 being the least victimized. Of course, that might not be true at all in a different sort of situation.)

At least one of the crucial insurance questions “buried” here, concerns the ways in which attorney-client relations can be formed. The results in Anglo-Dutch imply that a law firm like L1 could be guilty of malpractice or breaches of fiduciary duties, even if it does not realize that someone or something are not its client. Given a lawyer like L, he might claim that he was not a lawyer of (or for) a person or thing, but that the law firm like F1 was its attorney. If these observations are true, then what has happened in Anglo-Dutch, entails that insurers cannot get information they need.
In any case, the problems discussed here are all in addition to an insurer obtaining supposedly available and/determinable information regarding firm and  individual lawyer performance. That information is already, at least sometimes, difficult to obtain or difficult to make certain it has been obtained. Underwriting information, now regarded as desirable by insurers, is often unknown, hence not reported by the firm applying for an insurance contract. If part of this information is known, it is hard for the firm to know its significance. There is little formal, statistically based risk analysis done for lawyer E & O insurance pricing. Most of every type of risk analysis depends on history.

The information under discussion is not subject to insured-by-insured or statistical standardization. An insurer’s gathering of reliable information to the needed degree, on its own, is impossible. The relevant information will be discussed shortly. Relying on the relevant information’s being accurately stated in applications for insurance is not possible. Given the majority holdings and arguments in the Anglo-Dutch case, the type of information under discussion herein, cannot, by its nature, be obtained. In addition, an insurance customer cannot provide it.

The information already under discussion abstractly pertains to a law firm’s somehow ending up in an attorney-client relationship, when it did not know that it was (or had) and when it had nothing authoritative to do with the formation of the relationship. This is especially dramatic when the firm has explicitly refused to enter into such a relationship with a given person and that person knows the firm has refused.

One important matter to think about, which is found in the hypo and specified shortly, is when someone without authority shoves the firm into an attorney-client relationship. It is important to remember that there are two types of “shoves”: accidental and deliberate.

V. The Underwriting Process

In a free market system, production and pricing is created in part by competition. This is true in any industry, more or less. Like any other similar industry, insurance policies are a kind of product—a sort of service product—and insurance markets are an industry. Government regulations do not affect many dimensions of the insurance underwriting, to the extent that they specify policy language and establish relatively uniform pricing. Similarly, they do not much affect risk analyses performed by insurers that are even close to being financially reasonable i.e., any insurers which have a rational and sensible outlook on their own profitability. This principle is especially true to the extent that insurance policies (product) are crafted nationally in accordance with relatively uniform language across various geographical markets.

This next part begins with discussing the idea of moral hazards. It then discusses the process of underwriting. It then returns more directly to the topic of how moral hazards may relate to the topic of underwriting. The relationship between events and patterns of events existing before an insurance policy is purchased and similar events first occurring after an insurance policy has been purchased are relevant to analyzing the hypotheticals. The more a pattern of preexisting events exists but cannot be known, and therefore their costs cannot be known, the harder the underwriting function is.
That which is not known cannot be analyzed. That which cannot be analyzed, cannot be part of risk calculation. That which cannot be thought about in calculating risk impedes and undermines the underwriting process.

A. Moral Hazard & Adverse Selection

Moral hazard is a crucial idea in virtually all insurance, including liability insurance. Determination of the existence of moral hazards is central to insurance underwriting. If something makes determining moral hazards impossible, at least with regard to groups—the larger, the worse—the more defective underwriting will be.

The meaning of this phrase occasionally has something to do with moral principles or rules of ethics and sometimes it does not. Historically, the idea of moral hazards pertained to what an insured might do as the result of having insurance and with intentional conduct after formation of the insurance contract. There are really two ideas here. One of them has to do with what changed in a person as the result of having insurance and the other is what will a person do before having insurance. Reasonable analysis requires that both dimensions be considered to some extent. Of course the more that is known about either of them, and especially about both of them, the better. The truth, of course, is that analysis that is even close to perfect cannot be had.

In the Nineteenth Century and earlier, critics of the very idea of insurance were most disturbed by moral hazards. The critics took it to be a vice in itself, a version of gambling, and that concern generated the idea of moral hazard. Something like “underwriters are gamblers,” was frequently heard. Of course, insurers, then and now have a mild concern with it. The evolved idea is that many moral hazard problems can be eliminated by certain exclusions and certain definitions.

Thus, virtually all insurance policies have general ideas which must be exemplified. CGL insurance, and its siblings, are like this. One sibling is undertaker’s liability insurance. That insurance is ordinary liability insurance to be found in a very specialized market. Performance bonds for employees in financial institutions are like this in relevant ways. The employee may be acting deliberately, but the bank, says, it is not. Even life insurance, which insures acts of suicide after the first two years, is like this. After all the beneficiary of the insurance has, presumably, done no wrong. In other words, to one degree or another, all insurance includes at least one dimension, and/or one approach or another to try to insure only “fortuitous” acts or omissions. The term “fortuitous” in the context of insurance means at least “not intentional,” or more broadly “accidental.” Professional liability insurance is like this. The idea of moral hazardness is a complex idea, much more than usually thought. This essay will focus on two simple parts: their relationships to risk analysis and pricing.

In any case, sometimes the phrase “moral hazard” refers to one form of intentional injurious conduct that is stimulated by the existence of insurance after the procurement of insurance, e.g., arson. This kind of conduct is generated by temptations­­— especially overwhelming temptation. It matches up with the evil intent, which is the historical foundation of moral hazard. It fits with many forms of insurance and liability insurance is one of them. This can be, and often is, called ex post facto moral hazard. It manifests itself after the formation of the insurance contract.

As already indicated, there are other forms of morally hazardous conduct, the cousins of ex post moral hazard. One of these can be called, and often are the ex ante moral hazard—the, before contract formation moral hazards. Both definitions apply to liability insurance. Ex ante moral hazard does not so much focus on relevant temptations of individuals, although it can from time to time. It is more likely devoted to groups, general or “universal” tendencies and inclinations. Many analysts believe that this kind of moral hazard is the natural result of human rationality. The idea is that the existence of insurance will make insureds less attentive to taking care to avoid risks. Some doctrines in the world of insurance do not think that this is systematic, although they seldom say so explicitly. It is easy to see that insurers do not share the view that if there is a completely inexorable will to pay less attention. Insurers manifest this belief by paying attention to, and trying to determine—the characters of their insureds. This has been true since the beginning of insurance at least 250 years ago.

Ex post moral hazard envisions at least some people to be inclined toward non-caring attitudes, including radical self-interest. Such people will give into temptation and perform immoral acts in order to benefit themselves. The example of arson has already been given. Such people will also take (or provide) less care once insurance is in place. This essay is principally a reflection and exposition of some main points about ex ante moral hazards—the ones concerning  in virtually all, if not all, the relevant parts of the world, before a contract of insurance is formed.

Ex ante moral hazard is quite different, and that is one of the topics this essay is concerning. The others are “adverse selection” and pricing. Like many other terms in insurance the phrases “moral hazard” and “adverse selection” are not strictly defined. However, they appear to be distinct. The idea of moral hazard seems to suggest intentional conduct (or something close to it), while adverse selection either does or does not include moral hazards, but if it includes them there is a second component:  conduct which is not deliberate or less deliberate and conduct which can only be grasped statistically. The former approach would conceive moral hazard as one set and adverse selection as a second set. The latter approach would conceive of adverse selection as a set and moral hazard as a subset.

One often used insurance textbook describes “adverse selection” this way:  “When people or organizations with above-average probabilities of loss[,] purchase insurance to a greater extent than people or organizations with below-average probabilities of loss, adverse selection occurs.” Notice that mere “adverse selection” does not require empirical investigation by an insurer.

In a (relatively) free market, a reduction of moral hazards will influence pricing; under traditional and current standard practices both of the forms already discussed will tend to keep it reasonable and stable. Influencing ex parte moral hazards will affect pricing more extensively than will controlling ex post moral hazard. Laws having a negative impact on determining moral hazards tend to undermine the essences of insurance.

This point includes liability insurance of all sorts. In theory, there could be first party insurance for law firms relevant here, such as credit insurance. It does not exist, but if it did, the discussion here would encompass it. As stated at the beginning, all discussions here focus on professional liability insurance for lawyers.

Given the reality of the moral hazard, underwriting must attend to it carefully. That matter will be explained later.

B. The Underwriting Process

The concept of underwriting is easy to grasp. Here is how Randall describes insurance: Insurance has been defined as “a system by which a risk is transferred by a person, business, or organization to an insurance company which reimburses the insured for covered losses and provides for the sharing of the costs of losses among all insureds.”
Now here is how he discusses underwriting:

“Underwriting can therefore be defined as the process of (1) deciding which risks are acceptable, (2) determining the premium to be charged and the terms and conditions of the insurance contract, and (3) monitoring each of those decisions.”

The practical, everyday steps may be much more complicated, since it involves statistics, stacks of computerized information, objective analysis, subjective “analysis,” discussions, tentative decision-making, reviews, and decisions. Of course, the larger the limits, the more complex the underwriting process.

The Randall textbook may be the best source of fundamental descriptions of the underwriting process. In Chapters I and II of his book, he emphasizes what might be called the intimate, extensive, and interlocking relationship among risk, information gathering, the provision of policies at all, and pricing. Even this book, designed to assist in making possible a “diploma” from a recognized training organization for those working in the insurance industry, or close to it, is relatively elementary, though uncontroversial. Curiously, the more advanced books for the same program do not mention the concept of or the fundamental pillars of adjustment at all.

As usual, reported cases can provide a bit of information about at least the concept of underwriting. As Randall says, underwriting is “the heart” of the insurance industry. The cases (more or less) recognize this, although they might express it better by saying that underwriting is “at or near the heart” of the industry.

To be sure, underwriting is a process that is “fundamental to the concept of insurance[.]” It pertains to “deciding which risks to insure and which to reject in order to spread losses over risks in an economically feasible way.”

In 2007, the Alaska Supreme Court characterized “underwrite” and “underwriting” this way: “the process by which an insurer measures a customer’s risk level to decide whether, and at what price the insurer will accept the risk of loss posed by that customer.” That court also observed that underwriting is “the function of securing and evaluating information and making decisions to accept or reject risks,” Obviously, if these activities cannot be performed, an insurer would decline to insure the customers specified risk or charge an enormous price for the insurance.

Thus, all discussions of insurance underwriting—including all cases, which actually discuss it—make it clear that the concept of risk is central to the idea of insurance itself, as is the concept of risk determination. Underwriting is wedded to risk assessment; they will be there for life; and nothing can come between them. Asserting “All underwriting involves risk assessment” is just like asserting “All bachelors are unmarried male adults.” Hardly any cases discuss this type of analogy (Why should they? It is seldom a litigation issue.) Instead, they simply mention it, and the same is true of law treatises and “hornbooks”—something which is a little more odd. This is certainly true of  the famous, just cited, virtual bible on insurance—almost universally used—discussed underwriting only in connection with insurance market activities and structures. Roughly, the Keeton treatise says not much more than insurers control underwriting. The textbook of Robert H. Jerry, contains only a few lines containing more observations:

It can be said, then, that a contract of insurance is an agreement in which one party (the insurer), in exchange for a consideration provided by the other party (the insured), assumes the other party’s risk and distributes it across a group of similarly situated persons, each of whose risk has been assumed in a similar transaction.

At least Jerry explicitly links insurance to risk and risk distribution.
The law review literature is similar, but there are occasional slightly more detailed and contain deeper insights:

“A reasonable insurer attempts, through underwriting, to reduce the role played by guesswork through an assessment of the risks it agrees to assume. Underwriting, however, requires the insurer to expend monies, up-front, on assessment. As a consequence, an insurer engaged in proper underwriting necessarily reduces the amount of profit realized from premiums collected on the policies it issues. In addition, proper underwriting screens out unacceptable risks before issuance of a policy. Therefore, the insurer does not realize any premium income from individuals who present an unacceptable because no policy is issued.”

(Many of the cases, which concern underwriting, also focus on post claims underwriting.) The Cady & Gages article occasionally shows up in reported cases.

The Cady & Gates paper is an extensive denunciation of “post claim underwriting” and “post policy sale [or acquisition]” underwriting. There are several cases also discussing this topic and one of them can be “translated” into a discussion of legitimate underwriting in general. Here is an objective and helpful “redo”:

“The term “underwriting” is a label commonly applied to the process, fundamental to the concept of insurance, of deciding which to insure and which to reject in order to spread losses over risks in an economically feasible way. Underwriting is to be accomplished—both as to information acquisition and decision-making as to policy issuance—approximately when the application is turned in, before a policy is issued, and therefore before a claim is filed. Insurers may ask for information before policy issuance, it may not do so after a claim is made. Post claim underwriting which arises after a claim is made is really a way to avoid paying a claim, or use whatever it can find to rescind or cancel the policy. This way of treating insured is patently unfair.”

This language characterized the general theory of underwriting quite well.

VI. Some Hypothetical(s)

In law, hypothetical examples are usually of two sorts. One of them might be called a “Temporally Fixed Hypothetical,” while the other might be called a “Historical Hypothetical.” The former of the two involves reflecting and/or arguing from a status fiction, “X is the grandson of Y. What, if any, legal relationship does X have with the second, or—perhaps, the third—wife of Y, assuming that X is not her son?” The Historical Hypo involves using a narrative and then asking what the fictional story implies about legal consequences. This paper will involve either one Historical Hypo and variations thereon or a number of them. Take your pick.

Consider a law firm, Fh. It might practice any kind of law; it might practice many sorts of law—anti-trust expert consultant, advice in zebra preservation litigation—or it might work on just one or two areas—say, various forms of family law, including child protection services and divorce litigation, for example, and/or insurance coverage matters. The “case” about to be discussed might fit virtually any of these categories, more or less, or it might fit into a “new” category only. The significant parts of the following hypos after Fh has turned the case down.

So, suppose Fh is approached by someone, Ch, that presents him, her, or itself for “client-hood.” It wants the firm to represent him in the litigation of an anti-trust case. Perhaps Fh is tempted, perhaps not. The twist of temptation makes no difference to the story, nor does the length of time Fh takes to make a decision  In any case, as meritorious as Ch has been over the years as a client, Fh refuses explicitly to take the case, for one reason or other. It might be his recent history of not paying fees on time. Or it might be that it does not think it wants to finance Ch’s case. Or it might be that Ch is difficult to deal with, dishonest sometimes, a bore, and/or a “boar.” Again, the reasons why Fh refuses to represent Ch in this case are of no relevance here.

The “story” in this hypo involves Fh being “stuck” with being counsel for Ch, even though it didn’t want to be—and in fact wanted not to be—and it  clearly stated this fact, in a face-to-face meeting with Ch, that it would not take that case. As just stated, Fh explicitly told Ch this very fact. (For the purposes of this hypo, it does not matter how many times Fh said this to Ch, and it does not matter whether Fh informed Ch of this decision in writing.) However, the firm ends up being Ch’s lawyer anyway. This result could come about in a variety of ways, because of a twist in the Anglo-Dutch case. Suppose that after this conference, someone who does not have authority to bind the firm, does so.

The next phase in outlining this general mist-of-a-hypo and its variations is to set up a number of ways this involuntary attorney-client relationship might happen (or result). This group of hypo-stories is extremely important. Setting aside the concrete fee distribution questions, the court’s arguments for its answers—contract law, the law of fiduciaries, the applicable ethical rules, and issues of equity and justice—the potential of the Anglo-Dutch decision on insurers pricing based upon risk analysis, is the most important component of the decision, and the only one really to insurance matters. Now the fun begins.

(1) We begin with an associate of the firm, Jack (J). He dispatches a communiqué to Ch. It might be a letter; it might be an email, it might be something else, like a notation on the back of an envelope, indicating that Fh would take the case after all, and Ch affirmatively responds to J who has worked for him many times. Ch sends J an affirmative copy of whatever he received, a box of discovery, and an indication of how the fee would work. It may or may not be charged in the usual way. It might for example, be a contingency fee, which Ch wanted all along, and Fh did not.

J, by some means or another, affirms the arrangement with Ch. He puts the time on an open “C-file,” or he has somehow been left in charge of the office while the firm’s partners have a firm meeting with another client, say, in zebra populated Africa. After a time the firm begins to wonder what Jack is doing. Being a “flexible” outfit, Fh asks no immediate questions.

J works on the C-case for a month or two. After such a span of time, the partners begin to become disturbed about what J is really doing, since he is not working on his assigned cases and he declines to take any new work assignments (“I’m too busy.”). At all times up to now and in every way, J’s arrangements, and his work were kept secret from the rest of Fh.

Maybe he was not turning in his billable hours. Perhaps no one noticed this. J was maximally industrious, and he had an erratic reputation regarding billing slips. They sometimes came in two months at a time.

Eventually, it becomes known to the management committee, that J does not appear to be genuinely busy on any work for the firm. That was unusual. One of the more skeptical (or even cynical) members of Fh’s management committee suggests that J is busy alright, busy writing the “Great American Novel.” After all, someone observed, he was talking about doing something like that more often than from time to time.

The cynical member is asked to inquire; she does so, and J does not answer, and (almost) immediately leaves the firm, taking all Ch’s documents with him, as well as his unbilled time. It probably would make no difference to the point of these hypos whether Lh lied or even got sued by Fh for “client stealing,” perhaps in conjunction with another file with which he makes off.

(2) The next hypo revolves around a legal assistant at Fh, Michelle (M). She might leave with J, or she might stay at the firm. In any case, no one knows what she is doing with regard to Ch. Perhaps she feels that Fh is making a bad decision, and she wants to keep the case there. One can imagine that Michelle hands the case to a lawyer she knows to oppose the firm’s decision, and she leaves immediately, maybe with J. She might continue working in the legal environment, or she might pass on to something else. She might even suddenly actually “pass on,” without anyone at Fh knowing what has happened. Months might elapse before Fh realizes what has happened. At that point, a variety of things might happen, but they need not be described here.

The only relevant difference between the J-case and this M-case is that Michelle is not a lawyer, though she drafted a letter-document in the name of the firm, something she had previously done many times, and Ch accepted it replying to her, although the response was addressed to the lawyer—or one of the lawyers—for whom she works.

(3) Consider M again. This time she generates a very simple letter for Larry, a lawyer at Fh, and sends it to Ch. He receives the letter, initials it in the designated place, and returns it to the lawyer, Larry (Lh) for whom M works. M and Ch believed, without any other evidence, that Fh had changed its collective mind and would render the earlier refused services after all.

The problem is that M misunderstood what Lh wanted regarding the letter—perhaps a form letter—to Ch. In fact, Lh wanted “a refusal letter”, but she mistook him and prepared an “acceptance letter.” M put the draft in a stack for Lh, and he signed it. For many years, Lh had had a strong relationship with M, who was a perfectionist; as a result, Lh simply signed the letter without inspecting it.
When Ch returned the letter with his initials on it, M followed routine procedure: she opened a file, numbered it, and opened a time account. It is obvious the M and Lh error is a mere accident, and without much blame.

(4) Now suppose M thought there were irregularities surrounding the letter. She thought she was asked to prepare and send that letter. Her thoughts did not change once the letter was returned. She might have even signed it for Lh, as she had done many times before. Perhaps she even initialed, again, as was their custom for years. M’s conduct was purely (perhaps weak-ish) negligence.

(5) M knew very well that there was a continuing problem surrounding Fh’s representing Ch. She concluded, however, that Lh had decided to flout Fh’s decision. Maybe, he was running short of work; her guesses about Lh’s reasons are not important. In any case, M reasoned to herself that Lh might be wise to make the representation happen, she knew he was a bit like “Dr. House,” the television character. In the alternative, she figured that Lh was about to leave Fh. M’s conduct is clearly reckless. She knew that her loyalty was with him and that she would be going with him. She kept all these matters secret.

(6) M had been a legal assistant for many years. Over time, she had taken a contract course from the local law school at night, once a week. At Fh, M had risen to what might be called the “Senior Legal Assistant with Authority.” In any case, M supervised all of the other assistants and provided needed training as well; sometimes even the lawyers at Fh called her the “Real Office Manager.” She even got Christmas and birthday cards to the same effect.

Michelle thought that Fh’s decision to refuse representation of Ch was a colossal mistake. She decided to force Fh to be Ch’s attorney. She did this by means of a formal-ish letter, etc., already standardized. This is obviously deliberate conduct.

(7) Consider the case of an “active” paralegal (P) employed by Fh for years. This is not even roughly the same as the M matter. Paralegals do not generally write and transmit communiqués as do legal assistants. If they do, then they are assistants as well as paralegals. The only twist might be that the paralegal had not (yet) passed the Bar or was not licensed, though he had completed law school. In this case, P wrote and letter and handled the reply and office the administration following just like M.

(8) Suppose Peter actually had a law degree but was not at the time of this affair a member of the Bar.

(9) Now, suppose that P was already a member of the State Bar, but had not told Fh about it.

(10) Now, expand on (9). P did not disclose having a license because he was working nights at another firm, or doing pro bono work for a hated group.

(11) Now imagine that there is a lawyer, Lh, whose office is in the same hallway as that of Fh. Lh is not employed by Fh. Occasionally Lh provides Fh some legal services, usually advice about lawyer conduct or professional liability insurance. Occasionally, his advice-providing role extends out to excess or umbrella insurance, and reinsurance, but all in the area of lawyer malpractice insurance. (A teaches these subject at a nearby law school of considerable distinction.) Fh provides Lh with some administrative services, such as sending out his bills for him and permitting him to use firm legal assistants and paralegals, from time to time. A has no right to take clients for Fh; he knows about Fh’s refusal to take the case; and he took it for himself. The conduct Lh is intentional with respect to Fh.
This looks like more or less a lead up to the Anglo-Dutch case? Think again. It is easy to see how the conduct of Lh could resemble the conduct of either M or P, on the surface, but there is a twist. Suppose Lh sent out a retainer agreement on Fh’s stationary, but with his address “down the hall” from the Fh quarters on Floor 15, with the intent of somehow “stealing” the client from Fh. All while concealing the only relevant facts from Fh, and fooling a customer about who was providing the legal services. A’s conduct would be outrageous and obviously sanction-able before a Disciplinary Committee of the Bar. He might even be liable in a lawsuit. Those are not the questions in this sequence. The question is whether A could.

(12)  Perhaps Ch might be passionate about obtaining legal services from Fh. Ch is in and out of the Fh office frequently. Ch walks away from Fh’s office with copies of his stationary. Somehow, Ch writes the Retention Letter and has it signed secretly by a lawyer at Fh. Ch then initials the letter and returns it. The pattern of conduct regarding files, file numbers, and setting up a computerized invoicing system happened in this case, just as they have happened in all of the other cases, (1)-(12). Thus, Ch has fraudulently set up an attorney-client relationship with Fh, and one of the lawyers at Fh commencing work on his case.

One is inclined to suppose that Ch cannot establish an attorney-client relationship in this way. This legal point surely prevents any case of Ch’s knowingly participating in the intentional conduct of someone else seeking to establish such a relationship. Does it? What about the lawyer within Fh helping Ch along? What if L had the fraudulent letter in his hands but did not read it, or did not read it carefully?

The point of all these stories, except for maybe (12), is to raise the question whether Fh would end up being legal counsel for Ch. An affirmative answer to this question is entailed by the majority decision in Anglo-Dutch, but these are questions underwriters of malpractice insurance for lawyers would like think about and utilize in making price calculations, not to mention whether to insure a firm and/or a single lawyer.

Notice that nothing in the hypos pertaining to lawyers, like J, Lh and A, have considered whether they have a right to attorneys for representing Ch. That is a different question than the one considered in this discussion. This article is about insurance implications only.

VII. Consequent Problems

There are two problems that arise from Anglo-Dutch. They concert two closely related areas, both of which are integral—indeed, central—to underwriting. The two problems are (1) ex ante moral hazards and (2) pricing independent of moral hazards. Post facto moral hazards—those involving covered temptations causing covered injuries—would not affect insurance underwriting, unless they were predictable, which they probably are not, and have never been thought to be, without information received before an insurance policy is issued. Moral hazards about which an insurer cannot know in advance of contract (or policy) formation undermines at least some rational underwriting decisions or a rational underwriting system.

Consider the hypos. There is not one of them which could be known in advance of the formation of the insurance contract for F, or any other first situated in anyway like F. Yet most of them are routine in law firms, and all of them could happen. Yet this is exactly what must be doable if underwriting is to be accurate. Unfortunately, Anglo-Dutch creates a situation in which the needed moral hazards, mostly discussed here, cannot be determined.

VIII. Some Conclusions Regarding Insurance Underwriting

In that case, L did not form a contract since what he sent was defective. In the end, he got paid next to nothing but what he did get paid hinged on the work he did while he was “at” F1. It seems to me that this makes F1 C’s lawyer. If that happened, then L’s unintended action created a situation in which F1 “became” C’s lawyers.

The trouble is that these kinds of errors and instances of sloppiness are not infrequent. If they triggered a firm’s systematically becoming counsel for someone, there are all sorts of things insurers need to know. This point is especially true when a law firm can become a lawyer for a person or entity and not know it. A situation like this is a lawsuit waiting to happen.

Insurers being unable to determine important facts like this one—may drive insurers from this market, discourage other insurers from entering the market, and—as already remarked—raise the prices of insurance for the remaining insurers. It is impossible to determine the price rises, at least from some considerable time, since considerable time will have to pass before history will “reveal” what needs to be done.

Significantly, insurers currently working in the “legal mal” or “Lawyers Professional Insurance” markets do not ask questions designed to reveal information regarding the moral hazards discussed here.

One policy asks if two or more lawyers are always assigned to supervise any firm lawyer actually heading up those working on a case, but that will not affect the J-case and it would do nothing to affect any of the M-cases or those of P.  They could do nothing at all regarding an A-case.

Another application asks if the firm shares space with another lawyer. That question would not help at all with A, since the law firm is not sharing space with him; it is renting space to him. This is not sophistry; there is actually an enormous difference. This discussion does not just indicate that insurers cannot now focus on pre-existing moral hazards. It also indicates that it cannot be done. The reason for this is that a firm itself cannot identify whether the sort of things set up in § III hypos can be known in advance. Even if they can, in theory, we know sometimes the rarity, difficulty, and expense of making sure that they are not occurring will probably make the insurance too expensive anyway.
Insurers cannot set up exclusions to deal with this sort of thing. First, the exclusion would be too vague. Second, the insurer would bare the burden of proof of both meaning and application.

It is not necessary to concentrate on moral hazards involving only tendencies and the impossibility of finding helpful empirical data. The idea of adverse selection points in the same direction. The complexities of moral hazards can be bypassed—although no insurance company ever does so—and instead one can start with adverse selection. The trouble is that the risks insurers are dealing with and agreeing to pay, cannot even be close to measured with information about what event or what patterns have occurred or might have occurred. Anglo-Dutch creates, or permits, a pattern of conduct and events that cannot be detected, much less measured during the underwriting process.

This means that pricing may sharply increase, so long as the markets are organized as they are now. Even the reorganization of the market by selling policies with substantial self-insured retentions only to pools, likely will not work, and almost certainly, nobody will want them: not lawyers, not intermediaries, not insurers.

IX. A Second Conclusion

What happened in this case, I conjecture, was rather odd. There was a jury trial, which means that extensive discovery. After the trial there was an appeal to a Court of Appeals. Up through it F1 and L, “together,” were winning. (L was F1’s assignee.) There was then an appeal to the Supreme Court where C won, but the case was remanded. So it looks like it will have to be tried again.

There were three parties, in effect, and two of them had an enormous amount of money that flowed from a “single” event, though one, which was complex and prolonged, and a third party to the case who got next to nothing.

Although having brought the case in, having transported it to F2, and having worked with it on the case for some time. There was probably at least one mediation and possibly more. There will now be more. During the pretrial period in the case, C offered to pay L nearly $300,000 for his work, but L had sued for $1M and refused C’s offer.

If I have understood correctly the contingent fees started as 20% for F1 (really) and 20% of whatever F2 recovered, where F2 itself had a contingency fee of 20%. As trial approached, F2 cut its fee to 16-2/3%, with trial counsel getting some percentage. (It is not clear to me that trial counsel accepted only 3.3%±. In the end, C’s legal fees were a little over $20M out of the $51M settlement recovery.

Presumably, if figured his way, L was probably to get 20% or F2’s 20%, although if might have been 20% of F2’s 16.66%±. (Of course, these numbers ignore expenses.) Why did this case not settle? Did L think he should get a lot more so he became intractable? Was he trying to get his legal fees covered? Pretty clearly L’s demand could easily be split 50-50 or 60-40 or something like that. Why did this not happen? C had itself offered just under $30M. Does this mean that F2 was the real problem? Or, maybe a coalition of F2 partners were the problem.

This could easily have ended if all sides were looking for their “Best Alternative to Negotiated Settlement.” So why on earth did this happen? The way things happened in this litigation is that the case was decided based on controversial principles of contract law. This outcome was probably unpredictable since C knew what the arrangement was to be. Maybe F2 did not know.

For abbreviations see below.
List of Abbreviations & Key Players

L Of Counsel Lawyer
F1 A Law Firm
C Anglo-Dutch Petroleum Case
F2 Law Firm 2
L1 A Lawyer
Ch ???
J Jack
Fh Law Firm where Larry works
Lh Larry
M Legal Assistant, Michelle
P Paralegal

A ???

Originally posted on 07/07/2016 @ 9:01 pm

Michael Sean Quinn, PhD, JD, CPCU, Etc

Michael Sean Quinn, PhD, JD, CPCU, Etc. (530)

One of Texas's leading insurance scholars, Michael Sean Quinn is a past chair of the Insurance Section of the State Bar of Texas and has a broad legal practice.

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