Court: Law firm can’t tap its insurers

Center City-based Pepper Hamilton L.L.P., accused of negligence in its representation of a failed student-loan company, may not collect from two of its malpractice insurers because the firm did not disclose that it might be the target of a lawsuit, New York state's highest court has ruled.

The loan company, Student Finance Corp., went bankrupt after disclosures that it had manipulated its books to hide student-loan defaults. Its former president and founder, Andrew Yao of Bryn Mawr, was sentenced to five years in federal prison in February after his conviction on charges that he had fraudulently obtained financing for his company.

Pepper Hamilton had ceased its representation of the company in 2002, based on concerns about its operations. But the firm was sued by the bankruptcy trustee, who alleged that Pepper Hamilton had failed to ferret out information about SFC's fraudulent finances and for allegedly furthering the deception.

In a 10-page opinion issued Oct. 20, the New York State Court of Appeals said the firm should have informed its insurance carriers, Executive Risk Indemnity Inc. and Twin City Fire Insurance Co., of the risk that it might be sued at the time it renewed its coverage.

"The law firm's knowledge of its client's fraudulent payments prior to its application for excess coverage coupled with the fact that a reasonable attorney would have concluded that the law firm defendants would likely be included in the litigation . . . create an obligation for the law firm to inform its insurers," the Court of Appeals said.

Robert Heideck, executive partner of Pepper Hamilton, said the firm had conducted itself properly at all times, and had not aided SFC's deception.

"We denied it then and we denied it now," he said.

A lower court, ruling in the same case last year, upheld Pepper's assertions, finding that the insurers were obligated to provide coverage and that there was no evidence there was anything wrong with the firm's legal work.

The latest decision turned on the narrow question of whether the law firm might reasonably have expected to be a defendant in a lawsuit and whether it should have reported that risk to malpractice insurers, even though the chances of a lawsuit succeeding were small.

New York's Court of Appeals concluded the firm had an obligation. The Appellate Division, just below the Court of Appeals, found that it did not.

Pepper settled with SFC bankruptcy trustee in 2007 for an undisclosed amount. Under the decision announced Oct. 20, it is still free to seek coverage from another insurer, Continental Casualty Co.

SFC, a Delaware-based company, was in the business of providing loans to students in trade schools, primarily trucking schools. It pooled some of these loans into certificates or securities that were then sold to investors. According to court documents in the case, Yao informed Pepper Hamilton partner W. Roderick Gagne in 2002 that his company was inaccurately representing the default rates on its loans to make them more attractive to investors.

A short time later, Pepper Hamilton ended its representation of the company. The company's bankruptcy trustee sued Pepper in 2005, alleging malpractice.

One of the criminal cases against Yao, in which he was accused of lying during bankruptcy proceedings, featured sensational testimony that he had given nearly $1 million in cash, a car, and a home in Scottsdale, Ariz., to a mistress, former Playboy centerfold Alexandra "Lexi" Karlsen, who testified against him.