Sixth Circuit Sets Aside Melbourne Mills Malpractice Insurance in Fen Phen Case

 

RECOMMENDED FOR FULL-TEXT PUBLICATION

Pursuant to Sixth Circuit Rule 206

File Name: 12a0102p.06

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

_________________

CONTINENTAL CASUALTY COMPANY,

Plaintiff-Appellee,

v.

LAW OFFICES OF MELBOURNE MILLS, JR.,

PLLC;MELBOURNE MILLS, JR., (10-5813);

MILDRED ABBOTT, et al. (10-5814),

Defendants-Appellants.

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>,—–

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Nos. 10-5813/5814

Appeal from the United States District Court

for the Eastern District of Kentucky at Lexington.

No. 06-00272—Joseph M. Hood, District Judge.

Argued: January 20, 2012

Decided and Filed: April 13, 2012

Before: SILER, CLAY, and ROGERS, Circuit Judges.

_________________

COUNSEL

ARGUED: James A. Shuffett, Lexington, Kentucky, William T. Ramsey, NEAL &

HARWELL, PLC, Nashville, Tennessee, for Appellants. Richard A. Simpson, WILEY

REIN LLP, Washington, D.C., for Appellee. ON BRIEF: James A. Shuffett,

Lexington, Kentucky, William T. Ramsey, Kendra E. Samson, NEAL & HARWELL,

PLC, Nashville, Tennessee, for Appellants. Richard A. Simpson, WILEY REIN LLP,

Washington, D.C., for Appellee.

_________________

OPINION

_________________

ROGERS, Circuit Judge. This case involves whether a malpractice liability

policy is properly rescinded for incomplete responses to questions on the applicable

insurance applications. After lawyer Melbourne Mills, Jr., was successfully sued for

1

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millions of dollars for legal malpractice, his ostensible malpractice insurance carrier,

Continental Casualty Company, sought a judicial declaration that it was entitled to

rescind Mills’s insurance policy for the time period covered by the class action. The

district court granted Continental summary judgment, holding that Mills’s failure to

disclose an ongoing state bar association inquiry constituted a material misrepresentation

when the policy renewal application specifically asked if “any attorney [was] subject to

any disciplinary inquiry . . . during the expiring policy period.” On Mills’s appeal, there

are two alternative bases for affirming the judgment in favor of Continental: (1) Mills’s

negative response to a different question constituted a material misrepresentation in light

of the ongoing bar association inquiry which ultimately led to Mills’s disbarment, and

(2) the policy’s dishonesty exclusion clause bars coverage of any claim arising out of a

“dishonest, fraudulent, or . . . malicious act or omission.” In 2010, the Kentucky

Supreme Court issued an order which permanently barred Mills from the practice of law

in Kentucky. This order constituted a sufficient “regulatory ruling” under the dishonesty

exclusion clause to bar coverage. Each of these two bases supports upholding the

district court’s grant of summary judgment.

Continental sued below to rescind a malpractice insurance policy for the Law

Offices of Melbourne Mills, Jr., after Mills and other attorneys allegedly breached their

fiduciary duties during the negotiations of a large class action settlement. Mills and

others, including Shirley Cunningham and William Gallion, represented a group of over

400 plaintiffs in a class action suit against American Home Products for injuries related

to the use of the diet drug Fen-Phen. At the outset of the suit, it was agreed that the

lawyers’ fees would be determined by contingency fee contracts, limited to 30% of the

clients’ gross recovery. In May 2001, American Home Products agreed to settle the

class action for almost $200 million. The plaintiffs in the action together received only

$74 million, or 37% of the settlement, while the lawyers received the following: Mills

received $23 million; Cunningham received $26 million; Gallion received $30 million;

Stan Chesley received $20 million; and consultants and other counsel received $7

million. The remaining $20 million was used to establish The Kentucky Fund for

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Healthy Living, Inc. Mills served as a member of the Fund’s Board of Directors, for

which he allegedly received a monthly compensation of $5,350.

In early February 2002, Mills learned that the Kentucky Bar Association

(“KBA”) was investigating complaints filed against him in connection with the Fen-Phen

class action. The Inquiry Commission Complaint stated that Mills was under

“investigation” for “fees obtained in settlement of certain [claims regarding the use of

Fen-Phen and other pharmaceuticals] . . . [that] were divided with other counsel not in

your firm,” as well as allegations concerning a paralegal in Mills’s office who was

“conducting the unauthorized practice of law” as part of the work on the class action. On

February 11, 2002, Mills’s attorney, William Johnson, attended a hearing of the KBA’s

Inquiry Commission with respect to an application for a subpoena duces tecum that was

served on Mills.

In August 2003, Mills applied to renew his professional liability insurance with

Continental for the 2003– 2004 year. Continental had insured Mills’s law office for

many years prior to this application.

Question 3 of the application asked: “Are there any claims, or acts or omissions

that may reasonably be expected to be a claim against the firm, that have not been

reported to the Company or that were reported during the expiring policy period?” In

response, Mills checked “NO,” but made a notation to “See Schedule 2.” Schedule 2,

entitled E&O Claims, stated: “In addition to Melbourne Mills, Jr., the lawyers currently

serving in the firm include two of counsel partners, David L. Helmers and E. Patrick

Moores. The information regarding the of counsel attorneys is contained on the attached

attorney information sheet.”

Question 4 of the 2003 application read: “Has any attorney been disbarred,

suspended, formally reprimanded or subject to any disciplinary inquiry, complaint or

proceeding for any reason other than non-payment of dues during the expiring policy

period?” Again, Mills checked “NO,” but wrote that Continental should “See Schedule

3.” Schedule 3, entitled Disciplinary Proceedings, stated:

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During the current year no attorney has been disbarred, suspended,

formally reprimanded or subject to any disciplinary inquiry, complaint

or proceeding. In prior years, attorneys in the Firm have responded to

inquiries filed by all jurisdictions exercising jurisdiction and control over

attorney conduct. There have been no adverse findings regarding any

attorney or other party’s conduct.

According to Mills, at the time of the 2003 application, he did not know the status of the

2002 KBA investigation; in his own words, the case “lay in limbo for years at a time.

Just nothing was done.”

In August 2003, Continental granted an insurance policy, entitled Lawyers’

Professional Liability Policy, to the Law Offices of Melbourne Mills, Jr. The policy

contained various exclusions, including a Dishonesty Exclusion which stated:

This Policy does not apply . . . to any claim based on or arising out of any

dishonest, fraudulent, or criminal or malicious act or omission by an

Insured except that this exclusion shall not apply to personal injury. The

Company shall provide the Insured with a defense of such claim unless

or until the dishonest, fraudulent, criminal or malicious act or omission

has been determined by any trial verdict, court ruling, regulatory ruling

or legal admission, whether appealed or not. Such defense will not waive

any of the Company’s rights under this Policy.

In 2005, the Fen-Phen class action members asserted legal malpractice claims

against Mills and others in Abbott, et al. v. Chesley, et al. The Boone County Circuit

Court determined that the attorneys “breached their fiduciary duties to the Plaintiffs

when they paid themselves fees over and above the amount to which they were entitled

to under their fee contracts with their clients.” As a result, the class plaintiffs were

awarded $42 million. Continental initially provided Mills a defense in this case;

however, Continental also fully reserved its rights, including the right to rescind the

policy.

Continental sought a judicial declaration that it was entitled to rescind the

insurance policy granted to the Law Offices of Melbourne Mills, Jr., for the period

covering August 21, 2003 to August 21, 2004. The district court granted summary

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judgment in favor of Continental, holding that Continental was entitled to void the policy

because Mills’s 2003 application included material misrepresentations and omissions

regarding the ongoing KBA ethical inquiries. Because the district court found that

“Mills knew that a bar complaint had been filed against him in early 2002,” and the

“KBA’s investigation was ongoing,” the district court held that Mills’s response to

Question 4 constituted a material misrepresentation under section (2) of K.R.S. § 304.14-

110. This section provides that a misrepresentation prevents recovery under a policy if

it is “[m]aterial either to the acceptance of the risk, or to the hazard assumed by the

insurer.” The district court noted that the “ongoing KBA inquiry into Mills’s actions

with respect to the Fen-Phen Action is precisely the type of information Continental

needed to evaluate its potential for current and future risk.” The district court also

determined that Mills’s response to Question 4 satisfied section (3) of K.R.S. § 304.14-

110, which provides that a misrepresentation shall bar coverage if “[t]he insurer in good

faith would either not have issued the policy or contract, or would not have issued it at

the same premium rate . . . if the true facts had been made known to the insurer as

required . . . by the application for the policy.” In doing so, the district court relied

heavily on the testimony of a Continental employee who stated that disclosure of the

investigation would have led Continental to take “one of several potential restrictive

underwriting actions in order to address potential exposure.” Holding that Mills’s

response to Question 4 entitled Continental to rescind the policy, the district court

determined that it was not necessary to address whether Mills’s answer to Question 3

was a material misrepresentation or whether Continental was entitled to summary

judgment based upon exclusionary language in the policy.

In addition to the grant of summary judgment to Continental, a money judgment

for $233,674.49 was entered against Mills, which was the amount of the defense costs

Continental paid on his behalf in the initial class action.

On June 10, 2010, the same day that the money judgment was entered, the district

court also granted Continental leave to file supplemental authority, namely: (1) the May

20, 2010 Order of the Kentucky Supreme Court which disbarred Mills from the practice

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of law in Kentucky, and (2) the August 27, 2009 Findings of Fact and Conclusions of

Law of the Trial Commissioner, which the Kentucky Supreme Court used to reach its

decision to disbar Mills. The district court held that it could take judicial notice of the

Order of the Supreme Court disbarring Mills and the Findings of Facts because the

documents came under Fed. R. Evid. 803(8), the public records exception to

inadmissible hearsay. In the alternative, the district court determined that the documents

had the “guarantees of trustworthiness” which allowed them to be admitted pursuant to

Fed. R. Evid. 807. In allowing these documents to be included in the record, the district

court noted that it did not reach the issue of whether the dishonesty bar in the policy

voided Mills’s insurance, and “[s]hould an appellate court have reason to review the

additional grounds upon which Continental moved for summary judgment, these

documents could be essential to a complete record.”

Mills and the class members, who intervened to protect their ability to recover

against Mills, now appeal. They argue that Mills did not make a material

misrepresentation on the 2003 insurance renewal application, and thus the policy should

not have been rescinded. Mills and the class action plaintiffs also maintain that the

district court erred by allowing Continental to file supplemental authority that was both

a finding of fact and hearsay after the court had already granted summary judgment.

Because Mills made a material misrepresentation in his malpractice insurance

application with Continental, the policy was properly voided under Kentucky law.

Though the district court determined that the policy was void due to Mills’s response to

Question 4 of the 2003 application, Mills’s answer to Question 3 represented a material

misrepresentation, and provides an alternative basis for affirmance. According to K.R.S.

§ 304.14-110, a misrepresentation voids an insurance policy if the misrepresentation is

“material” to the acceptance of risk or if the insurance company would not have issued

the policy if the true facts had been made known. Though this standard is disjunctive,

Mills’s response to Question 3 was both a misrepresentation that was material to

Continental’s acceptance of risk and, if Continental had known of the investigation

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against Mills, Continental would not have issued the policy or would not have issued the

policy at that rate.

Mills’s answer to Question 3 of the 2003 application was a material

misrepresentation. Question 3 of the application asked: “Are there any claims, or acts

or omissions that may reasonably be expected to be a claim against the firm, that have

not been reported to the Company or that was reported during the expiring policy

period?” In response, Mills checked “NO,” but made a handwritten notation to “See

Schedule 2.” Schedule 2, entitled E&O Claims, stated: “In addition to Melbourne Mills,

Jr., the lawyers currently serving in the firm include two of counsel partners, David L.

Helmers and E. Patrick Moores. The information regarding the of counsel attorneys is

contained on the attached attorney information sheet.”

Mills’s answer to Question 3 was a misrepresentation because in August of 2003,

when he was filling out the application, Mills knew of not only the ongoing KBA

investigation, initiated in February 2002 but unresolved at that time, but also all of the

acts surrounding the Fen-Phen class action settlement negotiations, which reasonably

could have—and ultimately did—lead to a malpractice claim. Even though the class

action members did not bring the legal malpractice suit until 2005, in August 2003 Mills

still knew that, collectively, the lawyers in the Fen-Phen class action paid themselves

over $126 million. According to one uncontested document put forth by the class

members, the lawyers were limited to fees of a little over $60 million. Mills knew that

the clients had not been told all of the pertinent facts regarding the settlement offer and

the fee splitting arrangement, and that the KBA had subpoenaed the financial records

from the case as a result of the 2002 inquiry. In sum, Mills was aware that he had

engaged in conduct that led to the disbarment of him and two of his co-counsel. Mills

knew that his conduct was egregious and that his “acts” and “omissions” could have

“reasonably be[en] expected” to lead to “a claim against the firm.” Mills was

unquestionably required to disclose this information to Continental when filling out the

policy renewal application.

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Mills’s failure to disclose his actions in response to Question 3 was also material

to Continental’s acceptance of risk, K.R.S. § 304.14-110(2), and had an impact on

Continental’s decision to issue the policy at the rate that it did, K.R.S. § 304.14-110(3).

Mills incorrectly argues that K.R.S. § 304.14-110 requires that the insured make an

intentional misrepresentation; the plain language of the statute requires only that the

misrepresentation be “material.” According to Kentucky case law, a misrepresentation

is material if “the insurer, acting reasonably and naturally in accordance with the usual

practice of . . . insurance companies under similar circumstances, would not have

accepted the application if the substantial truth had been stated therein.” Mills v. Reserve

Life Ins. Co., 335 S.W.2d 955, 958 (Ky. 1960). A misrepresentation is material if there

is sufficient evidence that the insurance company would not have issued the policy or

would have issued a different policy if it had knowledge of Mills’s actions and omissions

under K.R.S. § 304.14-110(3). Therefore, many of the reasons that support a

determination of “materiality” under K.R.S. § 304.14-110(2) also support a holding that

Mills’s misrepresentation satisfied section (3) of the statute as well.

Mills’s failure to disclose the circumstances surrounding the Fen-Phen class

action and the ongoing KBA investigation was material to Continental, which likely

would not have issued the policy, or would have issued a different policy, had it known

of Mills’s acts and omissions during this time. Because Continental has a duty to defend

all claims against its insured, including non-meritorious claims, Continental has an

interest in all potential claims. This is “precisely the kind of information that

Continental [sought and] would need to evaluate its potential for current and future risk.”

Cont’l Cas. Co. v. Lampe & Hamblin, PLLC, No. 3:03CV604-H, 2004 WL 5708261,

at *4 (W.D. Ky. Nov. 1, 2004) (“Lampe”). In this case, that risk was amplified by the

enormity of the $200 million class action settlement. Mills had a duty to disclose this

information in response to Question 3, and when he did not, he affected Continental’s

opportunity to consider and weigh its options when issuing the Policy.

Peter Brinkman, underwriter for Continental, also testified that he could “state

without hesitation or qualification that an affirmative response to Question 3 . . . of the

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2003 application would have been material to Continental’s underwriting of policies

issued to the Firm.” Though the class members argue that the testimony of the insurance

company’s own employee is not sufficient for a finding of materiality, this is not correct.

In Lampe the district court applied Kentucky law and determined that a

misrepresentation was material solely on the basis of commonsense assumptions

regarding what would have an impact on the decision making process of a reasonable

insurance company. Underlying documents or employee testimony were not necessary

to support this determination. Id. at *2.

Both Mills and the class action members dispute the district court’s finding and

argue that an answer to Question 3 reflects the “subjective state of the applicant’s mind,”

and thus the question of materiality should be determined by a jury. However, in

reviewing a policy under K.R.S. § 304.14-110, this court has not hesitated to declare that

a misrepresentation was “plainly material.” See Cook v. Life Inv. Ins. Co., 126 F. App’x

722, 729 (6th Cir. 2005). In addition, while Question 3 is subjective, the ongoing

investigation by the KBA, as well as the circumstances surrounding the class action

settlement, meant that Mills knew that there was the potential for a “claim” against him,

and thus the only possible answer to Question 3 was “YES.” The purpose of K.R.S

§ 304.14-110 is to “encourage honesty . . . on the part of potential insureds and to

dissuade misrepresentations,” Progressive, 891 F. Supp. at 381; therefore, even if Mills

did not “know” that the Fen-Phen class action members would initiate a lawsuit against

him, he should have let Continental know of the possibility of a claim in light of the

complaints and inquiry. Mills’s reference to Schedule 2, which does not answer

Question 3 at all, further suggests that Mills understood and was trying to get around

Continental’s clear attempt to learn of any current and potential future risk.

Mills resurrects an argument raised in Lampe, comparing malpractice coverage

to Kentucky’s universal automobile liability insurance coverage and arguing that the

“expressed public interest” in legal malpractice insurance “outweighs any right of an

insurer to rescind an insurance contract.” Lampe, 2004 WL 5708261, at *3. The district

court in Lampe considered this argument carefully but rejected it, concluding “that a

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Kentucky court would not find public policy of the state so strongly in favor of lawyers

liability insurance coverage that it could outweigh an insurer’s right to rescission as is

the case with automobile liability coverage.” Id. at *3 -*4. In any event, Mills did not

make this argument during the proceedings before the district court and this court will

not review issues raised for the first time on appeal, because “[o]ur function is to review

the case presented to the district court, rather than a better case fashioned after a district

court’s unfavorable order.” DaimlerChrysler Corp. Healthcare Benefits Plan v. Durden,

448 F.3d 918, 922 (6th Cir. 2006). Accordingly, we need not consider this new

argument on appeal. See Post v. Bradshaw, 621 F.3d 406, 415 (6th Cir. 2010).

As a final argument, the Fen-Phen class action plaintiffs suggest, as best we can

understand, that if Continental had known of Mills’s ongoing investigation, and as a

result had cancelled or not renewed the 2001– 2002 policy, Mills could have purchased

a three-year extended reporting period (“ERP”), thus covering Mills during the time

frame encompassing the claims of the class action plaintiffs. However, this argument

makes little sense, as the opportunity for Mills to purchase the ERP would have expired

60 days after the hypothetical non-renewal or cancellation in 2002, and thus would have

occurred almost ten months prior to the 2003 misrepresentation that is at the crux of this

case.

Though not argued on appeal, the class action plaintiffs made a similar argument

below with regard to a potential ERP after the cancellation or non-renewal of the 2002–

2003 policy. However, in addition to not being adequately raised, this claim suffers

from the following weakness: such an ERP would have had to been purchased at 175%

of the premium rate. Thus, even under this speculation, Continental was deprived of the

ability to charge a higher premium due to Mills’s misrepresentation. Therefore, the

hypothetical existence of the ERP does not change the materiality analysis.

In sum, Mills’s response to Question 3 failed to disclose the circumstances

surrounding the Fen-Phen class action and the ongoing KBA investigation, and this

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information was material to Continental’s risk assessment. These conclusions are

sufficient to uphold the district court’s grant of summary judgment.

In addition, the policy could have been rescinded under the plain terms of a

clause in the policy excluding coverage for dishonest acts. The clause provides:

This Policy does not apply . . . to any claim based on or arising out of any

dishonest, fraudulent, or criminal or malicious act or omission by an

Insured except that this exclusion shall not apply to personal injury. The

Company shall provide the Insured with a defense of such claim unless

or until the dishonest, fraudulent, criminal or malicious act or omission

has been determined by any trial verdict, court ruling, regulatory ruling

or legal admission, whether appealed or not. Such defense will not waive

any of the Company’s rights under this Policy.

Although Kentucky law states that an insurance policy “should be liberally

construed” and “all doubts [should be resolved] in favor of the insureds,” this does not

mean that the clear terms should not be interpreted “according to their ‘plain and

ordinary meaning.’” K.M.R. v. Foremost Ins. Group, 171 S.W.3d 751, 753 (Ky. App.

2005) (citing Nationwide Mut. Ins. Co. v. Nolan, 10 S.W.3d 129, 131-32 (Ky. 1999)).

See also Scottsdale Ins. Co. v. Flowers, 513 F.3d 546, 564 (6th Cir. 2008). Policies

should reflect “the parties’ mutual understanding at the time they entered into the

contract and ‘[s]uch mutual intention is to be deduced, if possible, from the language of

the contract alone.’” K.M.R., 171 S.W.3d at 753 (quoting Nolan, 10 S.W.3d at 131.32).

In this case, the dishonesty exclusion clause can only be interpreted to mean that

the parties did not intend for the policy’s legal malpractice coverage to include acts that

were objectively fraudulent or dishonest. To the extent that the clause requires a court

or regulatory ruling, the requirement is satisfied by the May 20, 2010 Order of the

Kentucky Supreme Court which disbarred Mills from the practice of law in Kentucky.

Ky. Bar Ass’n v. Mills, 318 S.W.3d 89, 93 (Ky. 2010). After granting Continental’s

motion for summary judgment, the district court properly granted Continental leave to

file the disbarment order as supplemental authority. The Kentucky Supreme Court

ruling is within the plain language of Fed. R. Evid. 803(8), the public records exception,

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and thus is not inadmissible hearsay. Moreover, the class action members concede that

the Disbarment Order may be considered as part of the record, and that this court may

take judicial notice of it as part of our de novo review on summary judgment.

The Kentucky Supreme Court’s ruling determined that Mills had committed

“dishonest” and “fraudulent . . . act[s] or omission[s],” and thus is sufficient to bar

coverage under the dishonesty exclusion clause of the policy. In addition to other

violations, the Kentucky Supreme Court found that Mills violated S.C.R. 3.130– 8.3(c)

by deceiving his clients into accepting the individual settlement amounts

devised by a fraudulent method; misrepresenting to the Boone Circuit

Court that his clients had agreed to donate a substantial portion of the

total settlement received to charity; failing to inform the Boone Circuit

Court that he had contingent fee contracts with all of his clients which set

a specific fee; providing, or assisting in providing, false or misleading

information to the Boone Circuit Court about the fees and expenses . . . ;

and misappropriating, or participating in the misappropriation of, his

clients’ funds and the subsequent cover up.

Id. (emphasis added).

As the court found that Mills’s “participat[ed] in the misappropriation of . . .

clients’ funds,” Mills’s argument that he did not personally misappropriate funds, and

thus did not act fraudulently, is not persuasive. Even if he did not himself engage in the

misconduct, the Kentucky Supreme Court found that Mills’s acted dishonestly “by

failing to exercise professional judgment independent of his co-counsel.” Id. This

omission is covered by the dishonesty exclusion clause. Similarly, Mills’s assertion that

he did not act fraudulently because, unlike his colleagues, he was acquitted of criminal

charges, also fails because the dishonesty exclusion clause does not require a criminal

conviction to bar coverage. Therefore, the May 20, 2010 Order of the Kentucky

Supreme Court disbarring Mills from the practice of law is a sufficient basis for

precluding coverage under the policy’s dishonesty exclusion clause.

Because it is not necessary to rely on the August 27, 2009 Findings of Fact and

Conclusions of Law of the Trial Commissioner to affirm the district court’s grant of

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summary judgment, we do not address whether this document was inadmissible hearsay

and whether the district court erred by allowing Continental to file it as supplemental

authority. We also do not address whether Mills’s response to Question 4 warranted

rescission of the policy.

The judgment of the district court granting summary judgment to Continental is

affirmed.

 

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