Legal Fees Exclusion Bars Coverage for Arbitration Award that “In Substance” Reduced Fees Owed to Insured Law Firm

The United States Court of Appeals for the Seventh Circuit, applying Illinois law, has held that an exclusion barring coverage for “claim[s] for legal fees, costs or disbursements paid or owed to you” applies to bar coverage for an arbitration award adjusting the amount of attorneys’ fees owed to an insured law firm. Edward T. Joyce & Assocs. P.C. v. Prof’ls Direct Ins. Co., 2016 WL 1085223 (7th Cir. Mar. 21, 2016).

The insured, a law firm, had won a large damages award in a securities-fraud class action. The insured subsequently retained another law firm to collect the damages award from the defendant’s insurers. The plaintiff class members believed the law firm should have handled the collection litigation itself under the terms of the original retainer agreement and took the insured to arbitration over the additional legal fees incurred by hiring the second law firm. The arbitrator found that the insured firm had breached its fiduciary duty to the class plaintiffs and ordered it to reimburse the class members for a portion of the legal costs incurred in the collection litigation, including a portion of the fees charged by the second law firm. The law firm’s professional liability insurer paid for the insured’s defense in the arbitration but denied coverage for the arbitration award.

In the ensuing coverage litigation, the district court granted summary judgment for the insurer, concluding that coverage for the arbitration award was barred as a sanction under a policy exclusion for “any claim for fines, sanctions, penalties, punitive damages or any damages resulting from the multiplication of compensatory damages.”

The Seventh Circuit affirmed, but on the ground that the arbitration award was excluded as a claim for legal fees. The appellate court disagreed with the district court’s categorization of the award as a sanction, holding that despite the arbitrator’s and state court’s use of the word “sanction” to describe the award, the award was crafted as a remedy to make the class members whole for a portion of the extra fees they incurred in the collection litigation. However, the court held that the legal fees exclusion applied both to the portion of the award constituting a refund of the insured’s fees and the portion of the second firm’s fees the insured was ordered to pay. Although part of the arbitration award was not directly an order for reimbursement of legal fees paid to the insured firm, “in substance” the award reduced the legal fees the insured firm was entitled to recover and was therefore excluded.