United States: LLPs And Professional Malpractice Insurance: Grading The Mortgage Grader Decision

A limited liability partnership (LLP) is first a general partnership that makes a special election for LLP status, thereby achieving limited liability for the partners.1 Many states, including New Jersey and Kentucky, require that, in order for a law firm to elect LLP status, it must have in place malpractice insurance or similar protections for clients.2 The rules as to the maintenance of malpractice insurance are, however, generally silent as to the consequences when that requirement is not satisfied.

The Dispute and Decisions

The New Jersey Supreme Court, in Mortgage Grader Inc. v. Ward & Olivo ,3 addressed the question of what happens when the required malpractice insurance is no longer maintained. As detailed below, it held that, under its rule allowing law firms to organize as LLPs, that insurance need not be maintained during the "winding up" of the firm, and the "conversion" of an LLP into a general partnership for failure to maintain insurance is not an available remedy.

This dispute involved an allegation of malpractice by Mortgage Grader arising out of allegedly deficient advice delivered by Olivo; there is no allegation that Ward had any involvement with the file. After the (allegedly) deficient advice was rendered: (a) Ward withdrew from the firm; (b) the firm proceeded to wind-up its affairs; and (c) the firm allowed its malpractice coverage to lapse. That process commenced in June 2011; the malpractice insurance lapsed in August 2011.4 It was not until October 2012 that Mortgage Grader fi led its complaint.5

Ward, in addition to defending on a procedural basis, sought dismissal on the basis that he was a partner in an LLP and thereby shielded from personal exposure on partnership obligations.6 The trial court rejected that assertion, finding that Ward & Olivo had continued collecting fees even as it allowed its malpractice coverage to lapse. From there, applying Rule 1:21-1C(a)(3), the trial court observed that "'[t]he condition precedent to attorneys operating as an LLP is [maintaining] malpractice insurance.'"7 The firm having been still operating as it collected fees but allowing its malpractice coverage to lapse, the trial court held that Ward & Olivo reverted to a general partnership and that Ward lost the benefit of an LLP election.

The Appellate Division reversed that determination, finding (a) the N.J. Partnership Act did not impose the loss of limited liability as a consequence of the failure to have insurance; and (b) likewise the New Jersey Supreme Court, in adopting Rule 1:21-C(a)(3), did not impose a similar consequence. As to the first point:

The Legislature has been aware of Rule 1:21–1C since 1996. The Legislature has decided not to amend the UPA to require an LLP to revert to GP status as a sanction for failing to purchase a tail insurance policy when attorneys practice as an LLP. Therefore, our interpretation of the available sanctions is supported by a long period of legislative acquiescence by failing to amend the UPA.

Thus, if attorneys practice as an LLP, and the LLP fails to maintain malpractice insurance as required by the court rules, then the Supreme Court may terminate or suspend the LLP's right to practice law or otherwise discipline it. As currently written, however, the court rules do not authorize a trial court to sanction a partner of an LLP for practicing law as an LLP without the required professional liability insurance by converting an otherwise properly organized LLP into a GP.8

As to the second point:

Our Supreme Court has chosen to discipline attorneys without malpractice insurance that are organized as professional corporations, rather than dissolve their corporate structure. See , e.g. , In re Aponte , 215 N.J. 298, 298–99, 72 A.3d 243 (2013) (censuring an attorney for failing to maintain liability insurance while practicing as a professional corporation in violation of R. 1:21–1A(a)(3)); In re Muldoon , 213 N.J. 79, 61 A.3d 145 (2013) (same); see also In re Tiff any , 217 N.J. 519, 520, 90 A.3d 1254 (2014) (disbarring an attorney for, among other things, violating the rule requiring professional corporations to file a certificate of insurance with the Clerk of the Supreme Court).9

From there an appeal to the New Jersey Supreme Court was filed. It would hold that: (a) the obligation to maintain malpractice insurance does not apply during the windingup phase ( i.e. , after dissolution); (b) deprivation of the liability shield afforded by LLP status is not an available remedy for failure to maintain malpractice insurance; and (c) for purposes of determining whether the firm had in place malpractice coverage, the focus is upon the time of the attorney's actions, not the fi ling or resolution of the client's claim. These points will be reviewed seriatim .10

Footnotes

1 See , e . g ., REV. UNIF. PART. ACT §1001(a), 6 (pt. 1) U.L.A. 239 (2001) ("A partnership may become a limited liability partnership pursuant to this section."); KY. REV. STAT. ANN . §362.1-931(1) ("A partnership may become a limited liability partnership pursuant to this section."); id ., §362.1-306(3) (limited liability consequent to LLP status); IND. CODE §23-4-1-45(a) ("To qualify as a limited liability partnership, a partnership under this chapter must do the following."); N.J. CODE §42-1A-47(a) ("A partnership may become a limited liability partnership pursuant to this section."). With respect to the historical development of the LLP, see Robert Hamilton, Registered Limited Liability Partnerships: Present at the Birth (Nearly) , 66 U. COLO. L. REV . 1065 (1994–1995). See also Christine Hurt & D. Gordon Smith, BROMBERG AND RIBSTEIN ON LIMITED LIABILITY PARTNERSHIPS, THE REVISED UNIFORM PARTNERSHIP ACT, AND THE UNIFORM LIMITED PARTNERSHIP ACT (2001), at §1.01 (2016 ed.).

2 In New Jersey, that is Rule 1:21-1C, Limited Liability Partnerships for the Practice of Law . See also Kentucky SCR 3.022, Forms of Practice of Law , and SCR 3.024, Requirements of Practicing Law in Limited Liability Entities ; Massachusetts Supreme Judicial Court Rule 3:06: Use of Limited Liability Entities ; Nebraska SCR

3-201, Permissible business organizations; name restrictions; membership professional liability; insurance required; dissolution . 3 Mortgage Grader, Inc. v. Ward & Olivo, LLP , 139 A3d 30 (2016). This column incorporates aspects of a previously published discussion of this case through the decision of the Appellate Division. See Thomas E. Rutledge, Potential Problems with the LLP Structure for Professional Firms , 6 THE TRANSACTION LAWYER 1 (April 2016).

4 See Mortgage Grader, Inc. v. Ward & Olivo, LLP , 438 N.J. Super. 202, 206; 102 A3d 1226, 1228 (N.J. Super. Ct. 2014).

5 Id.

6 438 N.J. Super. at 207; 102 A3d at 1228.

7 438 N. J. Super. at 208; 102 A3d at 1229.

8 438 N.J. Super. at 211–212; 102 A3d at 1231 (citation omitted).

9 438 N.J. Super. at 212; 102 A3d at 1231.

10 Justice Albin wrote separately to concur in part and dissent in part. That opinion is considered below as part of the critique of the Mortgage Grader decision.

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