The Contingent Nature of the Liability Protection Provided by the LLP Election

The Contingent Nature of the Liability Protection Provided by the LLP Election

      An LLP is first a general partnership that makes a special election for LLP status, thereby achieving Limited liability for the partners.  Many states, including New Jersey (and Kentucky), require that, in order for a law firm to elect LLP status, they must have in place malpractice insurance or similar protections for clients. In New Jersey, that is rule 1:21-1C, Limited Liability Partnerships for the Practice of Law.  The Kentucky rule is set forth at SCR 3.022, Forms of Practice of Law, and SCR 3.024, Requirements of Practicing Law in Limited Liability Entities. The rules as to the maintenance of malpractice insurance are generally silent as to the consequences when that requirement is not satisfied.

      Currently pending before the New Jersey Supreme Court Mortgage Grader Inc. v. Ward & Olivo, is a case squarely presenting these issues. Oral argument was held on February 1.

      This dispute involves an allegation of malpractice by Mortgage Grader arising out of allegedly deficient advise 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. See Mortgage Grader, Inc. v. Ward & Olivo, LLP, 438 N.J. Super. 202, 206, 102 A.3d 1226, 1228 (N.J. Super. Ct. 2014). It was not until October, 2012 that Mortgage Grader filed its complaint. Id.

      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. 438 N.J. Super. at 207, 102 A.3d at 1228. The trial court would reject 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), it was concluded that “‘[t]he condition precedent to attorneys operating as an LLP is [maintaining] malpractice insurance.’”  438 N.J. Super. at 208; 102 A.3d at 1229. The firm having been still operation 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 would reverse 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 likewise (b) 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. 438 N.J. Super. at 211-12; 102 A.3d at 1231 (citation omitted).

       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 Tiffany, 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). 438 N.J. Super. at 212; 102 A.3d at 1231.

      From there this appeal to the New Jersey Supreme Court was filed. Based upon published summaries of the oral argument, counsel for Ward argued that the LLP had insurance in place while it was practicing law, and that a change in the law requiring tail coverage could be applied only prospectively. Counsel for Mortgage Grader asserted that failure to have insurance in place effects the loss of the benefits of LLP statutes.

      One potentially disturbing aspect of the language used by the Court of Appeals and in the oral argument is the notion that the loss of LLP states and the treatment of the firm as a general partnership is some sort of conversion.  But it isn’t. An LLP is a general partnership that has elected into a special status – it is still a general partnership but for the rule of partner limited liability. See RUPA § 201(b), 6 (pt. 1) U.L.A. 91 (2001).

      This decision follows on at least two other cases where courts of had to consider what is the effect of no longer being an LLP.

      In Apcar Inv. Partners VI, Ltd. v. Gaus, 161 S.W.3d 137 (Tex. App.-Eastland 2005, no pet.), a partner was held to be personally liable on a lease executed by the partnership in its LLP name three years after failure to renew its initial LLP registration and rejecting “substantial compliance” argument based on the clear language of the LLP statute.

      Evanston Ins. Co. v. Dillard Dep’t Stores, Inc., 602 F.3d 610, 616 (5th Cir. 2010), involved a claim of trademark infringement by a law firm that had been an LLP. After the firm dissolved and allowed its LLP election to terminate, the judgment against the firm was entered. In response to the argument that the operative conduct took place while the firm was an LLP, and therefor that limited liability should apply, the court would rule that the debt was not incurred until the judgment against the partnership was entered, at which time the LLP registration had expired, and the partners thus were not protected from liability.  See also generally Elizabeth S. Miller, The Perils and Pitfalls of Practicing Law in a Texas Limited Liability Partnership, 42 Texas Tech L. Rev. 570, 571-75 (2011).

      There are at least two “take aways” from these cases, namely:

(a) the “contingent” nature of the limited liability shield provided by the LLP election should be considered in electing that form where limited liability is important; and

(b)  persons departing a professional firm organized as an LLP need to consider the potential lingering exposure should the firm either (i) continue but fail to maintain both of a valid LLP election and required insurance or (ii) dissolve and not maintain in place both an LLP election and tail insurance for a period sufficient to address potential claims that arguably accrued during their tenure at the firm.