Many CPAs mistakenly believe their professional liability policy covers disputes between members of a firm. But as the following case illustrates, a claim by one insured against another typically falls outside the scope of most insurance policies.
When is a partner not a partner?
In September 1987, Brett Cleaver and Michael Beck asked Belfa Kay Montgomery to become a partner in their accounting firm. Montgomery hesitated at firstshe had stopped practicing as an accountant some years before and allowed her CPA license to lapse. Nevertheless, she was intrigued by the prospect of becoming a partner in the firm. She accepted the offer.
The firm changed its name to Cleaver, Beck, Blank, Stein & Montgomery and listed her as a partner on its letterhead.
Effective January 1, 1988, Montgomery was added as an insured to the firm's professional liability insurance policy. Cal Accountants Mutual Insurance Co. was the issuer.
The declaration page of the policy named the firm of Cleaver, Beck, Blank, Stein & Montgomery as the insured. The firm's individual partners, including Montgomery, also were listed.
Montgomery sues firm
On February 28, 1992, Montgomery filed a lawsuit against Cleaver, Beck and the firm. The firm subsequently tendered defense of the lawsuit to Cal Accountants Mutual, but the insurance company denied coverage, based on the policy's exclusion. It said the policy did not apply "to any claim or multiple claim made in part or whole by any insured or a present, former or prospective employer, proprietor, partner, officer, principal, director, owner, shareholder, employee or related individual of any insured ." The insurer submitted its denial of coverage to the trial court. The court granted summary judgment to Cal Accountants Mutual based on the language of the exclusion.
Montgomery eventually settled with the firm. It agreed to pay her $180,000. In the settlement, the parties also agreed Montgomery would attempt to collect damages only from Cal Accountants Mutual. In addition, the firm assigned to her any potential rights it had to sue and collect damages from the insurance company.
Trial court ruling appealed
Montgomery decided to appeal the trial court's summary judgment in favor of Cal Accountants Mutual. She contended the court had erred in its ruling because the policy exclusion did not apply to hershe was never legally a partner or a prospective partner of the firm. She claimed she sued the firm as an investor, not a partner.
Montgomery argued she was not a former partner of the accounting firmlegally, she could not have been, due to the expiration of her CPA license. In support of this claim, she relied on sections 5071 and 5072 of the state's business and professions code, which provide that each partner personally engaged in the practice of public accountancy in the state must be a licensee in good standing.
The California Court of Appeal disagreed. According to the court, Montgomery did not cite any authority for her argument that a partnership violating code section 5072 is void or nonexistent. Moreover, the code provided for discipline, the court said, if an unlicensed person was made a partner of a registered CPA partnership.
The evidence that Montgomery was a partner of the accounting firm, the court said, was undisputed. She identified herself as a partner and was so identified by the firm. Under the firm's direction, Cal Accountants Mutual insured Montgomery as a partner and "conclusively presume(d)" that Montgomery and the others listed on the policy's declarations page were partners. That she was unlicensed did not preclude her being a partner.
Montgomery also argued that her claim against the firm did not fall within the policy exclusion because she sued as an investor rather than as a partner. The policy excluded claims by the insured firm or any of its partners.
Again the appeals court disagreed. It ruled that "claim" was broadly defined to include any demand for money or services the insured received. Accordingly, the exclusion applied even though Montgomery sued the firm as an investor rather than as a former partner. Since the exclusion applied and the policy did not cover Montgomery's claim, the appeals court affirmed that the trial court had properly granted summary judgment in Cal Accountants Mutual's favor.
( Belfa Kay Montgomery v. Cal Accountants Mutual Insurance Co. , 61 Cal. App. 4th 854 (1998).)
Edited by Wayne Baliga, CPA, JD, CPCU, CFE, president of AON Technical Insurance Services.