Law and Insurance

Insurance Agent Held Liable For Faulty Procurement Even Though Insured Failed to Read Policy

Insurance Network of Texas v. Kloesel, #13-05-680 (Tex. App. April 3, 2008), See Kloesel Decision

A little over a month ago, I discussed a Houston Court of Appeals agent-liability decision that an agent wasn't liable for failure to procure requested insurance even though the agent told the policyholder (in direct response to a pointed question on the specific provision in question) that an exclusion would not bar coverage for damage to certain property.  The agent was wrong, and the insurer denied coverage.  See my discussion Houston Court of Appeals Exonerates Agent's Misstatement of Coverage. 

I thought this was an incorrect result.  The Houston court did not even discuss the agent's misrepresentation of the scope of the exclusion and instead focused of what was said in a certificate of insurance.  But surely policyholders must be entitled to rely on the greater expertise of insurance agents on the meaning and import of a particular policy provision, especially when the insured reads the policy, asks the agent about the suspect exclusion, and is told not to worry, the exclusion doesn't bar anticipated coverage.

The Kloesel decision goes the other way and should concern insurance agents.  The Kloesels wanted to procure insurance for the restaurant they owned.  They told their agent they wanted "full coverage" for "all things necessary for a restaurant . . . to stay in business and be protected."  They "wanted to be covered if someone got hurt in some way . . . if a customer got sick or if there was something wrong with the food."  The agent procured a policy that contained a communicable disease exclusion.  Then approximately 90 patrons contracted Hepatitis A transmitted from an employee handling food in the kitchen.  Lawsuits followed.

Insurer denied the claims which fell squarely within the communicable disease exclusion.  In the ensuing coverage litigation against the agent, the Kloesels admitted that they never read the policy and even saw summaries for two or three years before the incident that listed "Communicable Disease Exclusion".  The agent testified that he wasn't an expert in the restaurant industry and assumed that the insureds knew what communicable diseases were.  He thought they wanted food-poisoning coverage, which he got.  Otherwise, he said, he does not tell his customers what coverage they need.  "Only they know what is best for them."

The court upheld a jury verdict in favor of the Kloesels.  Key to the court's decision was the fact that the agent submitted a jury question asking if the Kloesels were contributorily negligent in failing to read and understand the policy terms, to which the jury answered "no."  The court concluded that the finder of fact was entitled to determine whether or not failure to read the policy contributed to the loss.

Of special note, the agent may have been doomed by his own insurance expert, who testified that the agent had no duty because insureds are deemed to read and understand their policies.  So far so good.  The expert then agreed on cross examination that the communicable disease exclusion "is not a desired coverage form" for a restaurant.  What if the Kloesels were your customers?  "It's possible" I would have looked for an alternative.  He also admitted that if he was going to procure coverage for a restaurant, he would want to get coverage for communicable disease.  With friends like that ...

It is also of interest that the court relied heavily on decisions from other states, like New Jersey and Maryland, that may not hold insureds to the same duty-to-read standards as Texas courts.  Thus, the Kloesel court relied on statements such as:

[W]hen [an agent] of repute is employed to effect an insurance against certain risks, the client is entitled to rely upon his instructions being properly carried out.  It is no answer for[the agent] to say: "I handed you the policy and you should have examined it and seen whether it gave you the protection you required." (Quoting Aden v. Fortsh, 776 A.2d 792, 805 (N.J. 2001);

Because "[a]n insured who hires and pays a professional [agent] does so to reduce, if not eliminate the risk that an inadequate policy would be procured," it stands to reason that "[i]nsurance consumers who instruct their [agents] to provide coverage [should be] entitled to have those instructions followed without regard to the insured's failure to detect the [agent's] negligent conduct. (Aden v. Fortsh at 806).

This is a far cry from the Omni Metals case, discussed last month. 

New Mexico Supreme Court Requires Insurers To Defend When They Have Actual Notice of a Suit; Not So in Texas

Garcia v. Underwriters at Lloyd's, London, Op. # 2008-NMSC-018 (N.M. March 13, 2008).  See Garcia Opinion.

Although Texas and New Mexico share a border, they appear to be on opposite poles of the insurance planet, at least on this issue.  The Supreme Court of New Mexico holds in the Garcia opinion that a liability insurer's duty to defend is presumptively triggered when it receives actual notice that a lawsuit has been filed against its insured, not, as under Texas law, when the insured forwards the suit papers and demands a defense.  To overcome the presumption that it must defend, the insurer has to prove that the insured turned down the insurer's offer of defense or was unresponsive or uncooperative.

The rule in Texas, recently reaffirmed by the Texas Supreme Court, is that an insurer is under no obligation to "gratuitously subject itself to liability" by offering to defend an insured who has not asked for a defense or forwarded suit papers to the insurer.  See National Union Fire Ins. Co. v. Crocker, 246 S.W.3d 603, 608 (Tex. 2008) (holding that additional insured was not entitled to a defense absent written demand on the insurer, even though the additional insured was unaware that his employer's policy would cover him as well and so did not request a defense, and the insurer was defending the co-defendant employer in the same lawsuit and knew the employee was covered and paying for his own defense).  See my discussion of the Crocker decision at Liability Insurer Has No Duty to Inform Additional Insured That Coverage Exists. 

The Crocker Court's rationale is that the policy typically states that the insured's actual demand and submission of the suit papers is a condition precedent in the policy, and the condition serves the essential purposes of (1) facilitating timely and effective defense and (2) triggering the duty to defend by notifying the insurer that a defense is expected.  If this rule seems somewhat overly protective of the insurer's interests, you are not alone.

The approach adopted in the Garcia decision is animated by the contrary policy of protecting the reasonable interests of insureds.  The facts in Garcia are a little messy, involving the vagaries of New Mexico probate process (indeed, the reason Lloyd's took no action to defend the insured's estate sued in a dram shop lawsuit was that its New York counsel misread New Mexico probate law and assumed the probate court had no jurisdiction over the tort action).  Moreover, the Court acknowledged that fact issues existed on whether the estate administrator adequately demanded a defense (apparently, the administrator also misunderstood New Mexico probate law and thought that he did not have the authority to demand a defense and instead urged Lloyd's to petition the probate court for the right to defend the estate -- at this point my teenage son would write "LOL").  In other words, the New Mexico Supreme Court did not have to make a new law.  It just wanted to.

The Garcia Court held that the burden of communicating about the defense should fall on the insurer.  The insurer knows, reasoned the Court, that most of the time insureds will want the benefit of a defense.

Why then should the insurer receive the benefit of a rule requiring written tender . . .?  Such a rule requires an insured to jump through meaningless hoops towards an absurd end: telling the insurer something it already knows.  Such a rule injects a degree of gamesmanship into the insurer-insured relationship without providing any valid corresponding benefit.  In fact, the only benefit of such a rule is to create a possibility--where none otherwise exists--for an insurer to escape an obligation it otherwise owes its insured.

(Quoting Federated Mut. Ins. Co. v. State Farm Auto. Ins. Co., 668 N.E.2d 627, 632-33 (Ill. App. Ct. 1996).

Nor does the insurer have to learn of the lawsuit from any particular source.  "We hold that, for the purposes of determining when an insurer's duty to defend arises, 'actual notice means notice from any source sufficient to permit the insurer to locate and defend the insured.'" (quoting Illinois Founders Ins. co. v. Barnett, 710 N.E.2d 28 (Ill. Ct. App. 1999)).  The Garcia Court found that a question of fact existed whether the administrator's letter constituted a rejection of a a defense (that was never offered) and sent the parties back down to the lower court for trial on this issue (at least there weren't sent into the jungle of New Mexico probate jurisdiction).

So which is the better approach?  The Garcia Court did not discuss the possibility that unscrupulous plaintiffs could collude with insureds to give the insurer just enough actual notice of the lawsuit to trigger the duty to defend and then obtain a monster default judgment before the insurer can find the insured and tender a defense.  Although this is possible, many jurisdictions, including Texas, have fairly forgiving procedures for overturning default judgments, particularly when the real party in interest, here, the insurer, has been unfairly excluded from participating. 

On balance, it is easier to picture instances of unfairness to the insured, as in Crocker, than to the insurer, particularly when the insured is unsophisticated and does not know of the available policy benefits.  Absolving the insurer of any obligations whatsoever unless the insured affirmatively demands a defense gives the insurer every incentive to keep mum even when the insurer knows that the insured is ignorant of its rights.  Additional insureds in commercial contexts often do not even know the identity of the insurer.  The rule adopted in Garcia seems less likely to lead to unfair results for either party and, when it does, is probably easier to fix through review procedures.

Kidnap and Extortion Policy Claim May Proceed For Loss of Insured's Business Due to Uzbekistan Government Shakedown

Interspan Distribution Corp. v. Liberty Ins. Underwriters, Inc., #H-07-CV-1078 (S.D. Tex., March 31, 2008)

If you are planning to open a business in Uzbekistan, think again, or at least don't go there without a good kidnap/ransom and extortion insurance policy, as this case shows.  Interspan operated a profitable tea importation business in Uzbekistan that unfortunately drew the attention of the oldest daughter of Uzbekistan's authoritarian ruler, Islam Karimov (her name is Gulnara Karimova).  It is apparently well known in international circles that Gulnara has a sweet tooth for seizing profitable enterprises through misuse of government power.  Interspan alleged in its complaint against Liberty that in 2006, Gulnara abducted, held hostage and threatened Interspan personnel and their relatives as part of a scheme to obtain control over its business, seize its assets, and force the company out of Uzbekistan.

So what did gentle Gulnara do?  "Hooded men with machine guns" burst into the house of Eskender Kiamilev, father of Interspan's principal owner, and carried him the Uzbeki jail.  Allegedly, the perpetrators were members of the Committee for National Safety, Uzbekistan's version of the CIA.  The same day, armed government agents Interspan's offices and warehouses in Tashkent. 

Here is where kidnap policy comes into play.  Interspan reported the kidnapping to Liberty, which called on Corporate Risk International (CRI), a global crisis-management firm.  Think of CRI as Russel Crowe in the 2000 movie "Proof of Life" (we will get to the Meg Ryan character in a minute, who has the charming name of Natasha Matkarimova, no relation to Gulnara).  CRI slipped into the shadows of Uzbeki night life and emerge with the story that Gulnara had Eskender arrested and the property seized to frighten and intimidate Interspan into surrendering the entire business to her.  However, CRI, with the help of the US Embassy, managed to extract Eskender from jail due to his status as a former Soviet diplomat.

Not to be deterred, Gulnara went after Mikhail Matkarimova, brother-in-law of Interspan's owner, but he had gone underground.  So she arrested Mikhail's wife, Natasha and had her dragged to the dungeon where, CRI reported, torture and rape awaited her unless Mr. Matkarimova turned himself in.  We are left to speculate whether CRI's Russell Crowe and Natasha fell in love while Mikhail spent 6 months in prison and was denied medical care for a bleeding ulcer.  The complaint against Liberty doesn't go there.

So what has all this got to do with law and insurance?  Interspan ended up turning over the business to Gulnara, after which Mikhail was granted amnesty (he had been tried and sentenced to 3 years probation, fined $10,000, and forced to work for the government for 2 years, kicking back 20% of his salary to the government).  Interspan submitted a claim for "Loss" of the entire business.  Although the policy covered Loss caused by kidnap/ransom or extortion, Liberty denied the claim basically on grounds that Interspan could not sufficiently show that its loss of the business was the result of kidnap or extortion.

The case has some interest to lawyers because the court had to wrestle with the US Supreme Court's decision in Bell Atlantic Corp. v. Twombly, 127 S.Ct. 1955 (2007) to raise the pleading standard that a plaintiff must meet to avoid a motion to dismiss under Rule 12(b)6.  The old pleading standard, articulated in 1957 in Conley v. Gibson, was that a complaint should not be dismissed unless it appeared beyond doubt that the plaintiff could prove no set of facts supporting a claim for relief.  The Twombly Court said this standard was too lenient and held that a complaint must show enough facts to move the claim for relief from the merely "speculative" level to the "plausible."  Courts are now trying to figure out just what that means.

In this case, however, the court denied Liberty's motion to dismiss based in no small part of the ample allegations supplied by CRI's report of Gulnara's past seizures of other businesses using the same hard-knuckled tactics and its report to Interspan that the government would back off if Interspan turned over the business.  As the court observed:

An expert analysis by a crisis-management company specializing in kidnapping, ransom, and extortion, stating that those abducted would be released in exchange for payment in the form of relinquishing the business assets is neither "factually neutral" nor a "formulaic recitation of the elements of a cause of action" (quoting Twombly).

We are not told how much Interspan was seeking.  Perhaps Liberty choked on the number.  Perhaps Liberty was just taking its shot at raising the Twombly bar as high as possible.  Whatever the reason, Liberty was bound to lose.  This movie had to have a happy ending.  I am looking for a sequel that hooks up Russell Crowe with Gulnara. 

Louisiana Supreme Court Agrees that "Flood" Exclusion Is Not Ambiguous

Sher v. Lafayette Ins. Co., No. 07-C-2441 (La. April 8, 2008), See Sher Decision.

"Flood" means flood.  In the latest in a string of defeats for Katrina property owners in New Orleans over the interpretation of the standard flood exclusion in property insurance policies, the Louisiana high court agreed with the Federal Fifth Circuit Court of Appeals in rejecting the interpretation that the exclusion does not apply to floods caused by levee failures due to negligent design.  (See In re Katrina Canal Breaches Litigation, 495 F.3d 191, 214 (5th Cir. 2007). 

Joseph Sher, owner and resident of a 5-unit apartment building, sought property and lost income coverage in the excess of $550,000 after Katrina flood waters had inundated the first floor of his building.  The insurer asserted that most of the damage was caused by poor maintenance and flooding that were excluded under the policy.  Specifically, the exclusion bars coverage for loss caused by "flood, surface water, waves, tides, tidal waves, overflow of any body of water, or their spray, all whether driven by wind or not."

The insurer offered to pay less than $3,000.  A trial court awarded Sher over $300,000, but the insurer appealed.  Insurer lost and appealed again.  The Supreme Court reversed.  On the key issue of the interpretation of the flood exclusion, the Court held that the term was capable of only one reasonable interpretation.

The plain, ordinary and generally prevailing meaning of the word "flood" is the overflow of a body of water causing a large amount of water to cover an area that is usually dry.  This definition does not depend on locality, culture, or even national origin - the entire English speaking world recognizes that a flood is the overflow of a body of water causing a large amount of water to cover an area that is usually dry.

This definition, the Court continued, does not distinguish between man-made and natural floods.  Therefore, the term is not ambiguous.  Moreover, the Court observed that even if such a distinction was supportable, no one could reasonably argue that Katrina flooding was not the result of a natural disaster.

For large commercial policyholders, alternative coverage should be available in, say, named-storm coverage.  Private homeowners probably have no alternative to the government-backed flood insurance program which has its own pitfalls. (see, for example, my discussion in Normal Legal Principles May Not Apply with Government Backed Insurance Program).  And here we are again at the beginning of another hurricane season.

U.S. Supreme Court Rejects Contractual Expansion of Judicial Review of Arbitration Awards

Hall Street Assocs., L.L.C. v. Mattel, Inc., No. 06-989 (U.S., March 25, 2008) See Hall Street Decision

In a landmark decision, the United States Supreme Court held that the increasingly popular practice of contracting for expanded judicial review of arbitration awards is not permissible under the Federal Arbitration Act (the "FAA").  This practice was seen as a way to obtain the benefits of arbitration while eliminating one of its drawbacks: limited judicial review.  The Hall Street decision may have the unintended consequence of driving parties away from arbitration.  Since expanded judicial review is now much less available, more parties may opt for traditional litigation with its right to appeal a bad result.

For a fuller discussion of this decision, see Client Alert, published by Thompson & Knight Appellate Practice Specialty Group.

Houston Court of Appeals Exonerates Agent's Misstatement of Coverage

Brown & Brown of Texas, Inc. v. Omni Metals, Inc., 2008 Tex. App. LEXIS 2065 (March 20, 2008), See Omni Metals Decision.

If this decision stands, then let the word go forth: customers and additional insureds, never, never rely on a certificate of insurance, insist in all cases on getting a copy of the named insured's policy, and read it carefully. 

The named insured, Port Metal Processing, Inc., stores large coils of steel for processing.  Its customer, Omni Metals, used Port's services over the years and continually asked Port to verify insurance coverage for Omni's products while stored with Port.  Port maintained a bailee's liability policy covering property of others stored in Port's facility, but the policy excluded coverage if Port charged a fee for storage, which it did.  Port obtained the policy from Transcontinental through an agent, Brown & Brown (actually, a predecessor named Poe & Brown -- this case was first appealed in 2000).

Now, here for me is the kicker.  Port's president actually read the policy, noticed the exclusion and asked the agent if the exclusion applied to Omni's product.  The agent said the exclusion only excluded property unrelated to Port's core business, and the steel coils were covered.  The agent issued a number of certificates of insurance over the years for Omni's benefit stating that Port purchased the bailee's liability policy covering "all risks" of direct physical loss to property.  The certificates also had the usual disclaimers the the certificate was informational and did not change the actual terms of the policy.

A fire destroyed Port's warehouse including Omni's product.  Transcontinental denied the claim, and all kinds of litigation followed.  This lawsuit was brought by Omni against both the insurer and agent (earlier litigation with Port had settled).  The trial court dismissed the case based on the exclusion.

One of the oddities of this case is that Houston state courts are subject to the co-extensive jurisdiction of two courts of appeal, in the the 1st and the 14th Districts (the 1st District used to be Galveston, but after the 1900 hurricane practically destroyed the city and other historical developments, the District was moved to Houston).  In 2000, Omni appealed the case, which the clerk randomly assigned to the 14th District.  The appellate court found that both the actual statements and the certificate were actionable misrepresentations and reversed and remanded back to the trial court for fact findings by a jury to determine if Omni relied on the alleged misrepresentations.

The jury brought a verdict favorable to Omni, and the insurer and agent appealed, this time drawing the 1st Court of Appeals.  Ignoring the legal findings of the 14th Court, the 1st Court held that Omni, as a stranger to the policy, could not, as a matter of law, have relied on any statements made to Port, and could not have relied on the certificate of insurance because of the Texas Supreme Court's statement in Via Net v. TIG Ins. Co., 211 S.W.3d 310 (Tex. 2006) that "those who take [certificates of insurance] at face value do so at their own risk."  Reversed and rendered that Omni take nothing.

This decision drew a vigorous dissent (see Dissent) regarding both the majority's disregard of the 14th District's "law of the case" (meaning that a legal decision made on appeal should not be reconsidered on a subsequent appeal of the same case), and its distortion of the Via Net decision, which addressed the applicable statute of limitations in a failure-to-procure insurance case.  Via Net had nothing to do with an agent's liability for misrepresentations in a certificate.

But neither the majority nor the dissent (nor the 14th Court for that matter) drew any distinction between the agent and the insurer, even though Transcontinental asserted that Poe & Brown was not its actual or apparent agent.  Based on the facts related, coverage under the policy is not the issue.   It is the law in Texas that an insurer will not be bound by misrepresentations in a certificate of insurance (barring liability for the agent's misrepresentations).  So I don't see how Transcontinental is on the hook here, unless Poe & Brown was the agent of the insurer (not Port's agent).  The key is the agent's liability for misrepresentation.

Poe & Brown knew that Port charged Omni for storage.  The agent also knew that Omni was asking Port about coverage.  And, asked point blank if the exclusion applied to Omni's product, the agent gave Port a false yet plausible explanation of the exclusion.  Both Port and Omni were justified in accepting the agent's explanation despite what they may have thought the policy said.  This is the dictionary definition of the tort of negligent misrepresentation.

I hope this panel of the 1st District Court of Appeals will reconsider the dissent's arguments.  If not, I hope the 1st District Court of Appeals will reconsider the decision en banc.  If not, I hope the Supreme Court considers the decision.  If not, never, never rely on a certificate of insurance or, for that matter, an agent's explanation of policy language.

Bear Stearns Bungled Insurance Coverage Before Collapse

Vigilant Ins. Co. v. The Bear Stearns Cos., 2008 N.Y. LEXIS 542 (N.Y. March 13, 2008).

No question, Bear Sterns blew it.  Sadly, however, Bear Stearns is not alone in failing to heed insurance policy obligations to get the insurer's consent before agreeing to a settlement. 

Bear Stearns purchased a professional liability policy from Vigilant that arguably would have covered some of an $80 million settlement with various government agencies over alleged improper conflicts of interest in its financial services business.  After extensive negotiations with the regulators, Bear Stearns signed a consent agreement acceding to entry of a judgment for injunctive and monetary relief, approximately $45 million of which was arguably covered under the liability policy.

Unfortunately, Bear Stearns did not notify Vigilant of the proposed settlement until after execution of the consent agreement.  Vigilant raised several defenses to coverage, including violation of a common policy consent provision:

The insured agrees not to settle any Claim, Incur any Defense Costs or otherwise assume any contractual obligation or admit any liability with respect to any Claim . . .

In the coverage lawsuit following Vigilant's denial, Bear Stearns argued that the settlement was in fact not final because it was subject to court approval.  The high court of New York rejected this argument.  The consent agreement was final as far as Bear Stearns was concerned.  It acknowledged that the SEC could present a final judgment to the federal court for signature and entry without further notice.  "In short," observed the Court, "Bear Stearns did everything within its ability to settle the matter and no further action was required on its part."

Bear Stearns was managing its own defense within a substantial retention.  This is very common.  But it is vitally important to keep the insurer informed both when lawsuits are filed and when settlement negotiations are under way.  Somebody, Bear Stearns' risk management or outside litigation counsel, dropped the ball on this one.