Legal Outline For California Agencies - Chapter 4

4/30/2013 by CompleteMarkets Editor

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LEGAL OUTLINE FOR CALIFORNIA INSURANCE AGENCIES

CHAPTER FOUR

LITIGATION, LIABILITY INSURANCE, AND DISPUTE RESOLUTION

4.1 Risks posed by litigation.

Litigation is a major threat to an insurance agency. Many potential claims are uninsurable in California, such as punitive damages claims. Substantial deductibles are often necessary to make coverage affordable. These facts of life make claim avoidance techniques a top priority.

This chapter will focus on the most frequent and dangerous customer and business claims agencies face.

It considers how claims can be avoided.

It also considers alternate methods of claims handling, which may be particularly useful when there are large deductibles that apply to defense costs.

4.2 Claims by clients for errors & omissions and related matters.

4.2.1 Theories of recovery.

Client claims typically fall into several categories, generally arising when a loss is not covered. Some claim the agent did not do what the client wanted. Some claim the agent did not advise the client as to what he should want. Finally, some claim the agent misrepresented facts to the client.

Legal theories used by clients include breach of contract (that the agent agreed to obtain the coverage), negligence (that the agent failed to meet the standard of care of a reasonable agent), and deceit (that the agent misled the client). Different theories carry with them different statutes of limitation, and permit differing defenses.

In a nutshell, an E&O claim can arise if the agent (a) promises or leads the client to believe that he will do something and then does not, (b) is negligent, (c) makes misrepresentations, or (d) the client claims the has done one of these things, the agent has no records to prove otherwise, and the judge or jury believes the client.

Breach of contract.

In simplified terms, a contract claim arises from an understandable agreement, for value, which is performed by one side, not performed by the other, and where damage is caused by the nonperformance.

For example, if an agent agrees to obtain particular coverage and fails without justification to do so, that agent may be liable for breach of an agreement to obtain coverage with the insured (though not on the contract of insurance). Troost v. Estate of DeBoer (1984) 155 Cal.App.3d 289, 202 Cal.Rptr. 47.

In the cases of an agent acting solely for a disclosed insurer (and not also as a broker acting for an insured), there is authority that only the insurer (as principal) and not the agent can be held for non physical damage for breach of contract or negligence. Walker v. Home Indemnity Co. (1956) 145 Cal.App.2d 318, 302 P.2d 361; Lippert v. Bailey (1966) 241 Cal.App.2d.376, 50 Cal.Rptr. 478; 4 Couch on Insurance 2d 26A:289.

An insurer may also be liable for the agent's representation that a claim would be covered, even if the policy does not cover it. Loehr v. Great Rep. Ins. Co. (1990) 226 Cal.App.3d 727, 276 Cal.Rptr. 667. This might eliminate the claim of the insured against the agent, although it also might give rise to a claim by the carrier against the agent.

Contract claims have a statute of limitations of four years from incurring damage for written contracts and two years for oral ones. C.C.P. Sections 337(1), 339, Walker v. Pacific Indemnity Co. (1960) 83 Cal.App.2d 513, 6 Cal.Rptr. 924. There is no defense of comparative fault, as in negligence claims. Punitive damages are not allowed.

Professional negligence.

A claim for negligence involves an agent's failure to meet the minimum standard of care of agents in the community (negligence), when he has a duty to act, if damage is caused by the negligence. See Kurtz, Richards, Wilson & Company, Inc. v. Insurance Communicators Marketing Corporation (1993) 12 Cal.App.4^th 1249, 16 Cal.Rptr.2d 259.

Negligence claims involving property damage have a statute of limitations of two years from the date of the damage. C.C.P. Section 339(1), Stark v. Pioneer Cas. Co. (1934) 139 Cal.App. 577, 582, 34 P.2d 781. The defense of comparative fault (contributory negligence) is available, and can reduce damages if the client is also at fault (for example, by failing to give the agent all the facts). Punitive damages are not allowed for simple negligence.

Cases involving legal malpractice have allowed no emotional distress recovery for simple negligence or breach of contract, if only economic damages result, since the emotional distress is no different than what is ordinarily experienced in litigation. Smith v. Superior Court (1992) 10 Cal.App.4^th 1033, 13 Cal.Rptr.2d 133; Merendo v. Superior Court (1992) 3 Cal.App.4^th 1, 4 Cal.Rptr.2d 87. This result may well apply to insurance agents as well as lawyers in cases involving simple negligence or breach of contract. 6 ALR5th 297.

Deceit.

Deceit claims - fraud or negligent misrepresentation - involve a misrepresentation (or a concealment or failure to reveal by one who has a duty to speak) of a material fact, or a promise made without intent to perform it. This deceit can be intentional (fraud) or negligent (negligent misrepresentation). It has to be done with the intent or knowledge that the other party will rely on it. The other party must in fact rely on it, the reliance must be reasonable, and damage must result to the client.

The statute of limitations for deceit is three years from the date that the client knew, or should have known, of the deceit. C.C.P. Section 338(d).

It may be a defense, depending on the facts of the individual case, that the client should have known better, or failed to investigate the facts himself.

Punitive damages may be awarded against an agent in a case of intentional deceit, although they require proof by clear and convincing evidence. Punitive damages against the agency for the acts of an employed agent may be awarded only if a director, officer, or managing director of the firm (a) knew of the unfitness of the employee and employed him in conscious disregard of others' rights, (b) authorized or ratified his conduct, or (c) was personally guilty of fraud, malice or oppression. Civil Code Section 3294.

Punitive damages cannot be covered by insurance under California law. Damages for intentional acts may or may not be covered by a particular liability policy, depending on exactly what was intended and the terms of the policy involved. If an agent makes a mistake, he should not make things worse by trying to cover it up, thereby possibly creating a fraud claim and damages which might not be covered by his E&O policy.

Other theories.

Agents may be charged with violation of Insurance Code Section 790.03, the unfair practices statute. However, the California Supreme Court has held that this section may be enforced only by the Department of Insurance, and not private parties.. Moradai-Shalal v. Fireman's Fund Ins. Cos. (1988) 46 Cal.3d 287, 250 Cal.Rptr. 116. However, a federal court applying California law recently allowed a suit for violation of a "twisting" statute. Kentucky Central Life Insurance Co. v. LeDuc (N.D.Cal. 1992) 814 F.Supp. 832. The Cartwright antitrust law has also been applied to the insurance business in one private case, Manufacturer's Life Insurance Co. v. Superior Court (Weil Insurance Agency, Inc.) (1994) 23 Cal.App.4^th 1629, ___ Cal.Rptr.2d ___; an earlier case said the opposite Chicago Title Ins. Co. v. Great Western Financial Corp. (1968) 69 Cal.2d 305, 322, 70 Cal.Rptr. 849.

Agents, unlike insurers, are probably not liable for the tort of bad faith for failure to pay policy benefits. The tort of bad faith, as opposed to the contractual violation of the implied covenant of good faith, could give rise to punitive damages. Gruenberg v. Aetna Insurance Company (1973) 9 Cal.3d 566, 108 Cal.Rptr. 480; Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 254 Cal.Rptr. 211; Tri Delta Eng. Inc. v. Ins. Co. of North America (1978) 80 Cal.App.3d 752, 146 Cal.Rptr. 4.

Agents in some other states have been held for a breach of a fiduciary duty to their clients, though that rationale does not appear to have been used in California.

4.2.2. Fact situations leading to claims.

Failure to obtain available coverage.

Failure to obtain coverage allegedly requested by the client is probably the most common basis for a claim against an agent or broker, and the easiest to assert. This may involve failure to obtain a particular policy, cover a particular peril, or cover a particular property.

Failure to inform when coverage not available.

If the producer is not able to obtain coverage, the client should be notified immediately. Failure to do so may subject the producer to deceit claims, in addition to contract or negligence claims.

Misstating facts in the application or misstating coverage.

Agents have been held liable for misstating facts in an insurance application. Kurtz, Richards, Wilson & Co. v. Insurance Communicators Mktg. Corp. (1993) 12 Cal.App.4^th 1249, 16 Cal.Rptr.2d 259, dealt with a false statement that the insured was not subject to Medicare provisions of TEFRA. Agents (and their carriers) have also been held liable for misstating policy provisions, though the insured did not check the policy. Clement v. Smith (1993) 16 Cal.App.4^th 39, 19 Cal.Rptr.2d 676.

Failure to advise what coverage the client should get.

The majority rule, and the rule in California, is that an agent has no duty to advise what coverage the client should obtain, unless the agent (a) agrees to advise the client, or (b) has a special relationship leading to a duty to advise. Ahern v. Dillenback (1991) 1 Cal.App.4^th 36, 1 Cal.Rptr.2d 239.

A special relationship can arise if the agent agrees to advise the client. An agent who agrees to give such advice should do so competently.

A special relationship has also been held to arise if the agent claims to be an expert under circumstances where the client could reasonably expect expert advice. Donald Ray Free v. Republic Insurance Co. (1992) 8 Cal.App.4^th 1726, 11 Cal.Rptr.2d 296.

Absent a special relationship, however, agents in California have been held to have no duty to advise a client as to the proper amount of coverage to obtain on real property, absent a special relationship. Jones v. Grewe (1987) 189 Cal.App.3d 950, 234 Cal.Rptr. 717 (dealing with liability limits, not property limits). They have been held not to have a duty to advise the client on additional coverage they might want, such as foreign uninsured motorist coverage, absent a special relationship. Ahern v. Dillenback , above.

Even if an agent has no duty to advise as to coverage, it would be wise for the agent make certain that the client has obtained a proper valuation of his property, knows the limits of coverage, and knows whether he has replacement value coverage. Written evidence of this should be in the agent's file. If a client declines recommended additional coverage, this fact should be confirmed to him in a letter.

Placing coverage with an insolvent carrier.

There is a California case holding that if a carrier is admitted in California, the producer is not liable for placing coverage with it. Wilson v. All Services (1979) 91 Cal.App.3d 793, 153 Cal.Rptr. 121. The rationale of the case is that it is the duty of the Department of Insurance to be sure the carrier is solvent.

For non-admitted carriers, coverage can be placed only through a surplus lines broker or special lines surplus line broker licensed in California, except for personal coverage and reinsurance. If an agent places coverage through a California licensed surplus lines broker, the same argument can be made that it is the duty of the surplus lines broker to insure that the non-admitted carrier is solvent. If the agent (not a surplus lines broker) himself places insurance with an insolvent nonadmitted carrier, he faces potential claims not only from the insured, but also from third parties. Nowlon v. Koram Ins. Center, Inc. (1991) 1 Cal.App.4^th 1437, 2 Cal.Rptr.2d 683.

Loss of markets and insolvency of carriers is a growing problem. If an agent must place coverage with a lower rated admitted carrier or a nonadmitted one, he should tell the client, and explain the reason why. He will protect himself, and hopefully contribute to educating the public.

4.2.3. Steps to take to avoid claims.

Professional liability carriers frequently publish checklists for their policyholders. The steps they advise may well exceed the standard of care required to avoid a negligence claim. They are offered to try to keep their insured out of trouble by taking additional steps. Such a checklist is included at the end of this chapter.

4.2.4. Steps to assist in defense of claims.

Keeping the client happy and informed is an important part of avoiding professional liability claims. The client whose telephone calls are returned, and who is kept informed of problems, is far less likely to file an action than one who is ignored. This is the experience of all professions, not just of insurance producers.

An important step an agent can take to assist his defense counsel is to maintain a written record.

A written record should be maintained of what the client asked the agent to do, and what the agent did in placing the policy. If an client declines recommended coverage, or if the coverage provided is less than the coverage that might have been obtained at a higher premium (such as not covering higher replacement costs), these facts should be confirmed to the client in writing. A substantial number of errors & omissions cases turn on the word of the client against the word of the agent on what coverage was requested.

Early notice of the claim to the agent's lawyer and any carriers that may be on the risk is also important. Under the typical claims made liability policy, failure to give prompt notice of the claim may result in lost coverage. In addition, the lawyer may help the agent develop any defenses he may have, and discover possible additional coverage.

4.2.5. Alternatives to having the Errors & Omissions Carrier conduct the defense.

There are possible steps that the broker-agent or his attorney may take to reduce the cost and exposure of an E&O defense. With larger deductibles, which in many cases apply to defense costs, these steps might be considered in an appropriate case.

Seeking defense and indemnity by agent from his carrier.

Frequently the claim is against the carrier and agent both. In these circumstances, the principal (the carrier) may be willing to defend, and possibly to indemnify, its agent. If there is no serious conflict of interest between the principal and agent, particularly where the carrier will indemnify the agent, the same attorney might represent both of them at the carrier's cost. In any event, the carrier's counsel can do a major portion of the work in the case, and the agent's counsel can benefit from it.

The agent should still notify his E&O carrier immediately, since otherwise he risks losing his claims made coverage.

Getting the client the coverage he wants.

Sometimes, the easiest solution for the agent is to convince the carrier to pay or compromise the insured's claim. The carrier's position may be arguably wrong. There may be other reasons why the claim should be paid even if it is questionable, as occurred for some of the coverage upgrades in the Oakland firestorm.

Coverage in policies other than E&O policies.

An E&O complaint may have a cause of action covered in other types of policies. All liability policies the agent has should be examined, including CGL policies, umbrella and excess policies, and even workers compensation and homeowners policies. If the events in question go back a few years, there may be old occurrence policies that apply, particularly in pollution claims.

For example, there could be a claim such as defamation that might be covered in a CGL policy as a "personal injury". Other policies may cover claims not covered by E&O policies; they might have lower deductibles than the E&O policy.

Since the duty to defend is broader than the duty to indemnify, another policy might contribute to the cost of the defense if there is a potentially covered cause of action, even if the possibility is remote. A court of appeals recently held that a workers compensation policy carried a duty to defend a civil action alleging emotional distress from a wrongful termination. La Jolla Beach & Tennis Club, Inc. v. Industrial Indemnity Co. (1993) 19 Cal.App.4^th 358, 23 Cal.Rptr.2d 656. This rather extreme case shows there frequently is no harm in pursuing marginal coverage theories.

Appointment of independent "Cumis" counsel when there is a reservation of rights and defense counsel can affect the outcome on coverage.

If there are potentially uncovered claims, if an E&O carrier that has a duty to defend the agent reserves its rights as to some claims, and if defense counsel can affect the outcome on the coverage issue, then the agent (within certain limits) has the right to have his own attorney defend the suit, at the expense of the carrier. Calif. Civil Code Section 2860.

The right to "Cumis Counsel" has sometimes been badly abused in the past. The right has now been limited by the Civil Code. In a proper case, however, a lawyer who does not regularly receive defense cases from the E&O carrier can sometimes do a more effective job for the agent than a regular member of the carrier's defense panel.

4.3 Business claims.

4.3.1. Trade secret claims.

The principal asset of any insurance agency is its "expirations" and good will. These trade secrets are protected by the California Trade Secret Act. Civil Code Section 3426 ff. The same may be true for a producer who joins an agency, and brings a book of business with him.

When a producer leaves an agency, there is a potential for litigation arising out of these trade secrets.

True covenants not to compete.

If a producer (or the agency) is selling all its interest in a business and its good will, under California law the seller may lawfully obtain a true covenant not to compete. This covenant can prevent the seller from competing with the buyer in the county or counties where the seller did business, so long as the buyer (or one taking title from the buyer) continues to do business in those counties. Bus. & Prof. Code Sections 16600-16602. It has been customary for these covenants to have a definite term, such as 5 years from the sale date.

Covenants against unfair competition.

If the seller is not selling all his interest in a business, a California antitrust statute provides that a contract restricting the right to engage in a lawful occupation is void. Bus. & Prof. Code Section 16600. It is unclear how far a covenant against unfair competition can go in light of this statute. There is a discussion of these covenants in Chapter 2.

It is reasonably clear that a departing producer may mail notices of his new address and telephone number. even if he has signed an agreement not to solicit them.

It is also clear that a producer cannot take written trade secret information belonging to the agency, or vice versa. It is not clear whether or not this applies to trade secret information that the non-owner remembers, or whether the nonowner can enter into a binding agreement not to use this remembered information.

It is also unclear whether an agreement not to solicit former customers, without mention of the use of trade secret information, is valid.

Even more difficult for the owner is the question of whether the former producer can be forbidden from accepting business from a former client, whether or not it is solicited. A contract for deferred compensation might provide, however, that the deferred commissions will not be paid if the producer accepts business from former clients whose premiums give rise to the deferred commissions.

Trade secret litigation is expensive and potentially dangerous for both sides. Violations of the trade secret laws can give rise to double damages in case of wilful and malicious misappropriation, Civil Code Section 3426.3, and reasonable attorneys fees in cases of bad faith, Civil Code Section 3426.4. Violations of the antitrust laws might give rise to treble damages and attorneys fees. Bus. & Prof. Code Section 16750.

4.3.2. Employment claims.

Agency employers are subject to the same kind of employment litigation that affects other employers. A clear employment agreement can reduce the danger of litigation for employer and employee both.

If the employment is for a specified term, or can be terminated only for cause, the agreement should say so. If not, the agreement should clearly state that it is terminable at will and without the need for a reason. If the agreement is terminable at will, the employer should be careful not to muddy the waters with other documents such as office manuals which contradict the employment agreement.

Even if an agreement is at will, the employer's right to terminate an employee is not unlimited. There are certain statutory limits to terminations. An employee cannot be terminated because of race, national origin, religion, sex, age, and in some instances because of handicap. The employee cannot be terminated for reasons violating statutory or constitutional public policy. Gantt v. Sentry (1992) l Cal.4^th 1083, 4 Cal.Rptr.2d 874. The courts are only beginning to define what these public policy reasons are.

Some employment cases are preempted by workers compensation as a remedy, which is subject to workers compensation insurance. Other claims involving pension rights may be preempted by ERISA, the 1974 Pension Reform Act.

If the employment agreement has an alternate dispute resolution clause, that clause will generally be enforced unless it can be set aside for the usual reasons other contracts can be avoided (fraud, mistake, etc.).

Employment law is rapidly developing, and this is not a complete exposition either of remedies or of defenses.

4.4 Incorporation.

Incorporation is one method of protection against claims. If a corporation is properly formed and maintained, the shareholder is not liable for the corporation's debts.

Incorporation does not protect an agent from that agent's own errors & omissions.

4.5. Alternate dispute resolution.

Alternate dispute resolution is another way of keeping litigation costs under control, in cases where the parties provided for it in a contract, or in which the parties agree to use it.

4.5.1. What is alternate dispute resolution?

There are basically two forms of alternate dispute resolution, mediation and arbitration.

Mediation is a non-binding process, where the opposing parties sit down with a mediator and try to reach a settlement. A contract can require mediation as a pre-condition to filing suit. However, mediation will not resolve the dispute unless both sides reach agreement.

Arbitration is a binding process, in which a non-judicial decision maker hears the evidence, and makes a decision. The arbitration agreement determines the scope of the arbitration, and the degree to which the decision is final.

Agreements to arbitrate disputes are enforceable under both California and U.S. law, unless they can be attacked for grounds for the revocation of any contract. 9 U.S.C.A. Section 1-16; C.C.P. Sections 1280-1288.8. They apply to discrimination claims as well as contract claims. Gilmer v. Intestate/Johnson Lane Corp. (1991) ___ U.S. ___, 114 L.Ed.2d 26, 111 S.Ct. 1647; Spellman v. Securities, Annuities & Ins. Servs., Inc. (1992) 8 Cal.App.4^th 452, 10 Cal.Rptr. 427. The Courts will give judgment based on the arbitration decision. C.C.P. Section 1286.

4.5.2. Different options for dispute resolution.

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