American Electric Power Co. v. Affiliated Insurance Co., No. 07-31061 (5th Cir. January 21, 2009), see American Electric Decision
One of the quickest ways a company can lose coverage for its subsidiaries is to fail to make sure that the definition of "Insured" includes all the types of legal entities used to form the subsidiaries. In this case, the policy in question covered the named insured "and any subsidiary corporation now existing or hereafter created or acquired." [My emphasis]. However, like many businesses in this modern age, the parent company formed a number of subsidiaries as "limited liability companies" or "LLC's," which are not corporations. No coverage for the non-corporation subs.
The policy issued to American Electric Power Co. (AEC) covered employee theft (but this issue concerns every type of insurance on the market). AEC acquired a company, CWS, and added it and its subsidiaries to AEC's insurance program. Two subsidiaries of CWS were LLC's, one of which was found to have an employee theft problem. Usually, AEC's insurance would not cover a new acquisition for pre-acquisition losses, but the Affiliated policy contained a "prior loss" clause that covered earlier losses if those losses would have been covered under an earlier policy. A Chubb policy would have covered the losses (if discovered and reported at the time), but Affiliated denied coverage because the definition of "Insured," quoted above, would not have covered an LLC subsidiary.
AEC protested that ample evidence showed that CWS intended to cover all of its subsidiaries, including LLC's. However, the court found the term "corporation" to be unambiguous and refused to consider "parol evidence," i.e., evidence outside of the policy itself. AEC argued that "LLC" really means "limited liability corporation," but the court pointed out that the legal distinctions between an LLC and a corporation are significant. There are reasons that companies take advantage of the different types of business forms, and courts will not ignore the legal distinctions to obtain a favorable result for an insured in an insurance dispute.
Finally, AEC asked the court to "reform" the policy to reflect CWS's original intent to cover all of its subsidiaries. Obtaining reformation is usually an uphill battle because the court is asked to rewrite an unambiguous contract, which courts avoid in all but the most glaring cases. In this case, reformation is even more difficult because Affiliated was not a party to the Chubb contract. It is one thing to reform a contract when both parties to the contract are before the court; Affiliated can't speak for Chubb, so the remedy is out of the question. The court upheld Affiliated's denial of coverage.
When I review a client's insurance program, definition of "Insured" is one of the first things I evaluate. This is not always easy when the client is a master limited partnership with a corporate general partner that itself has subsidiaries in exotic organizational forms. However, the effort is absolutely necessary, as this case shows. The business types are precisely defined in the law, so it is usually easy for an insurer to show that an LLC is not a corporation. Moreover, failure to qualify as an insured is a show stopper. No degree of coverage is allowed.
Risk Managers, check your policies.
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