523 F.3d 915 (9th Cir. 2008), 06-15622, James River Ins. Co. v. Hebert Schenk, P.C.

Docket Nº:06-15622.
Citation:523 F.3d 915
Party Name:JAMES RIVER INSURANCE COMPANY, a foreign corporation, Plaintiff Appellee, v. HEBERT SCHENK, P.C., Defendant-Appellant.
Case Date:March 18, 2008
Court:United States Courts of Appeals, Court of Appeals for the Ninth Circuit

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523 F.3d 915 (9th Cir. 2008)

JAMES RIVER INSURANCE COMPANY, a foreign corporation, Plaintiff Appellee,


HEBERT SCHENK, P.C., Defendant-Appellant.

No. 06-15622.

United States Court of Appeals, Ninth Circuit.

March 18, 2008

Argued and Submitted February 13, 2008.

Amended April 25, 2008.

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[Copyrighted Material Omitted]

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Steven Plitt and Joshua D. Rogers, Kunz Plitt Hyland Demlong & Kleinfeld, Phoenix, Arizona, for the defendant -appellant.

Martha E. Gibbs, Snell & Wilmer LLP, Phoenix, Arizona, for the plaintiff-appellee.

Appeal from the United States District Court for the District of Arizona; Frederick J. Martone, District Judge, Presiding. D.C. No. CV-05-01213-FJM.

Before: WILLIAM C. CANBY, JR., DAVID R. THOMPSON, and MILAN D. SMITH, JR., Circuit Judges.



The opinion filed on March 18, 2008 is amended as follows:

At Slip Op. p. 2540, line 33, to p. 2541, lines 1-2, replace Stewart, 817 P.2d at 49, we must conclude that Question 10(c) elicits a subjective determination.> with Employers Mut. Cas. Co. v. DGG & Car, Inc., 2008 WL 382934, at *2, --- P.3d ----, ---- (Ariz. Feb. 14, 2008), Question 10(c) is more appropriately viewed as eliciting a subjective determination.>

The petitions for panel rehearing and certification to the Arizona Supreme Court are DENIED.


MILAN D. SMITH, JR., Circuit Judge:

In this appeal we decide whether the district court erred in granting summary judgment to a professional liability insurer on a claim seeking a declaration of no coverage, and on counterclaims for breach

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of contract and bad faith under Arizona law. The insurer argued that it could permissibly refuse to provide for its insured's defense against a legal malpractice lawsuit because the insured failed to mention the possibility of the lawsuit in the insurance application. The district court agreed and held that Arizona Revised Statutes § 20-1109 permits a denial of coverage because the insured's omission constitutes legal fraud. The court rejected the counterclaims because the insurer provided for the malpractice defense. We reverse and remand for trial.


David and Cheryl Nolan and Tony and Shirley Wall formed a limited liability company in 2000 for the purpose of constructing and developing two commercial buildings. Due to poor management, the business failed shortly thereafter, resulting in a loss of over $2 million.

In November 2001, the Nolans retained attorney Jack Hebert (Hebert) from Defendant-Appellant law firm Hebert Schenk, P.C. (Hebert Schenk) to represent them in connection with negotiations and any litigation that might arise out of the failed business venture. On February 5, 2004, Hebert met with the Nolans to discuss the possibility of initiating litigation against the Walls. Hebert agreed to provide a tentative litigation budget and to return originals of certain loan documents to the Nolans. After the meeting the Nolans attempted to reach Hebert many times by telephone, but Hebert did not return their calls or otherwise communicate with them for a period of almost three months.

On April 19, 2004, Hebert Schenk applied for a professional liability insurance policy with Plaintiff-Appellee James River Insurance Company (James River). Question 10(c) of the application stated:

After inquiry, are any [lawyers within the firm] aware of any circumstances, allegations, Tolling [sic] agreements or contentions as to any incident which may result in a claim being made against the Applicant or any if [sic] its past or present Owners, Partners, Shareholders, Corporate Officers, Associates, Employed Lawyers, Contract Lawyers or Employees or its predecessor in business? .... If yes, please complete enclosed Supplement Number 6.

Supplement 6 stated, "This form is to be completed if the applicant or any lawyer [in the firm] is currently or has been involved in any claim or suit during the last ten years and [sic] indicated by a 'Yes' answer to question[ ] . . . 10(c)." Hebert Schenk responded to Question 10(c) in the affirmative and, in Supplement 6, listed several actual and potential claims against the firm, but did not disclose any information concerning a potential claim by the Nolans.

On April 27, 2004, approximately one week after the submission of the insurance application, the Nolans wrote a letter to Hebert indicating that they wished to terminate their relationship with his firm on the ground that his representation had been deficient. The letter stated in part:

Dear Jack:

It is time to bring your representation of us . . . to an end. It is certainly ironic that when Cheryl and I last met with you on February 5, you spent some time describing your interchange with Neil Thomson, reporting how you chastised him for abandoning his client. Without a doubt, you have abandon [sic] us as well. I have made no fewer than a dozen attempts to communicate with you since that meeting. I have not received a single call or email. This is despite your

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advice to us on 2/5, that we should file a lawsuit against Wall in order to secure some future recovery potential for our $2.264 million investment. As with the similar experience in the Spring of 2003, communication simply dried up. The least we were owed was some notice that you were unable to represent us and a referral to alternative counsel. If you truly believed that it was too late in the game and our best course was to take the loss and move on, we were owed that message, and some closure as well. For reasons we may never really understand, and could never be justified, you have stopped communicating and have failed to follow through on specific actions you recommended to protect our interests.

To "bring [the] matter to a close," the Nolans demanded that Hebert return their documents and waive $1,162.38 in legal fees. Hebert responded on April 29 by acknowledging his fault and stating that the Nolans' letter of complaint was "correct in every aspect." He also agreed to return the Nolans' documents and waive the fees.

Less than two weeks after this correspondence, James River faxed an insurance quote to Hebert Schenk. The quote required as a precondition to issuance of the policy "[u]pdated signatures of the application and of all of the application supplements." The quote also required a "no known claims and no known claims incidents statement." Hebert Schenk responded that it "ha[d] no known claims and no known claims incidents" to report.

In reliance on the representations made in the application and subsequent correspondence, James River issued a one -year professional liability insurance policy to Hebert Schenk on June 12, 2004. Section I(1)(a) of the policy provided:

We will pay on behalf of the "Insured" those sums in excess of the deductible the "Insured" becomes legally obligated to pay as "Damages" and "Claims Expenses" because of a "Claim" first made against the "Insured" and reported to [James River] in writing during the "Policy Period" by reason of a "Wrongful Act" in the performance of or failure to perform "Professional Services" by the "Insured" or by any other person or entity for whom the "Insured" is legally liable.

Section III(a)(1) of the policy excluded coverage for any "Claim" "[b]ased on or directly or indirectly arising from . . . [a] 'professional service' rendered prior to the effective date of the Policy if any insured knew or could have reasonably foreseen that the 'professional service' could give rise to a 'claim.' " Section III(a)(3) excluded coverage for any " 'claim,' suit, act, error or omission disclosed in the application for [the] Policy." The policy defined "Claim" as "a written demand for monetary damages arising out of or resulting from the performing or failure to perform 'Professional Services.' " "Professional Services" denoted "those services performed by the 'Insured' for others . . . as a lawyer." "Wrongful Act" was defined as "any actual or alleged act, error, omission . . . neglect or breach of duty in the performing of or failure to perform 'Professional Services.' "

On October 7, 2004, the Nolans, having retained new counsel, informed Hebert Schenk that they intended to assert legal malpractice claims against Hebert and the firm for the reasons articulated in the April 27, 2004 letter. Shortly thereafter, the Nolans filed claims for negligence and breach of fiduciary duty in Arizona Superior Court. Citing the insurance policy, Hebert Schenk demanded that James River provide for its defense. James River explained that it would provide for the defense

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while reserving the right to later deny coverage on the ground that the Nolans' claims were both reasonably foreseeable and undisclosed prior to the issuance of the policy. James River subsequently retained the firm of Jones, Skelton & Hochuli, P.C. to defend Hebert and Hebert Schenk and paid a total of $142,692.17 in legal fees.

While providing for Hebert's and Hebert Schenk's defense, James River filed an action in district court seeking (1) a declaration that the Nolans' malpractice claims are not covered by the insurance policy and (2) recoupment of the payments made for the defense. Hebert Schenk counterclaimed that James River breached the insurance contract by refusing to defend against the Nolan lawsuit. Hebert Schenk also counterclaimed that James River committed bad faith by engaging in a series of wrongful acts for the purpose of denying coverage.

James River moved for summary judgment on the declaratory judgment action and the counterclaims. In support of the motion on the counterclaims, James River submitted copies of billing records from Jones, Skelton & Hochuli to demonstrate that a defense had been provided. The district court granted both motions. Armed with new expert testimony, Hebert Schenk moved for reconsideration...

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