Going for Broker: Recent Developments in Insurance Broker Liability

Brokers have a duty to obtain and use that degree of skill and knowledge that brokers of ordinary ability possess and exercise for clients. See e.g., President v. Jenkins, 814 A.2d 1173, 1185 (N.J. Super. Ct. App. Div. 2003). A broker must possess reasonable knowledge of policy types, terms and conditions, and available coverage. If a broker purports to have advanced skills, a heightened standard applies. If a broker fails to perform his or her duties with appropriate skill and care, liability may result.

A broker's duties vary depending upon the scope of the representation. However, it is not always easy to determine whether a broker represents the policyholder or the carrier. Although brokers often are considered the policyholder's representative, they may be dual agents. For example, Chubb Insurance Company's Web site lists numerous brokers as its agents. See eg, http://www.chubb.com/cgi-bin/agentlookup/ziplookupmore_v2.cgi. Courts analyzing the agency issue consider many factors, including contract terms, the parties' communications, who pays the broker, applicable state statutes, and the broker's status as a registered agent of the carrier.

If the broker is the policyholder's agent, the scope of the broker's representation is determined by the terms of any contract, the broker's representations about his or her skill level and the anticipated work, and what information the broker has about the policyholder. Courts have found that brokers have a duty to provide advice regarding the adequacy of coverage, faithfully negotiate and procure coverage, disclose material facts to insurers, and provide notice of claims to insurers. See e.g., Sinex v. Wallis, 611 A.2d 31, 33 (Del. Super. Ct. 1991); Int'l Brotherhood of Teamsters v. Willis Corroon Corp. of Maryland, 802 A.2d 1050, 1057 (Md. 2002) (“Teamsters”); Royal Ins. Co. of Am. v. Cathey Daniels, Ltd., 684 F. Supp. 786, 792 (S.D.N.Y. 1988); Stevenson Ins. Assocs., Inc v. Cohen, 228 So.2d 118, 120 (Fla. Dist. Ct. App. 1969). These duties are neither exhaustive nor necessarily present in all broker relationships. The facts of each case determine the broker's duties.

Negligent Procurement Liability

Negligent procurement liability is premised on the theory that the broker has a duty to faithfully procure requested insurance. The broker breaches that duty if he or she fails to obtain available coverage. In past cases, brokers have faced liability for not obtaining proper policy limits or coverage for requested risks, and improperly aligning multiple policies so that coverage gaps exist. See e.g., Teamsters, 802 A.2d at 1052; Kinns v. Schulz, 516 N.Y.S.2d 817 (N.Y. App. Div. 1987). Brokers now are facing negligent procurement allegations in new and different contexts.

Procurement Liability Relating to Insurer's Solvency. The concept that brokers may be liable for certain events relating to insurer solvency is not new. See e.g., Bordelon v. Herculean Risks, Inc., 241 So.2d 766, 771 (La. Ct. App. 1970). However, allegations are increasing that brokers failed to investigate the financial stability of underwriting insurers, and placed insurance with an insurer the broker knew or should have known was financially unsound. In Al's Cafe, Inc. v. Sanders Insurance Agency, 820 A.2d 745, 751 (Pa. Super. Ct. 2003), the court expanded a broker's duties in this area: “[A]n insurance agent's/broker's recognized duty to act with reasonable care, skill, and judgment extends to selection of the insurer and ascertaining whether it is reputable and financially sound and informing the insured of findings if investigation reveals evidence of financial infirmity, but the agent/broker nonetheless intends to place a policy with the insurer.” Id.

There, an agent and two brokers secured a policy from a surplus lines insurer with a poor financial rating, but did not advise the policyholder of the rating. When the policyholder presented a claim, it learned that the insurer was in liquidation. After the policyholder recovered part of its loss from a state guaranty fund, it sought the remainder from the agent, who joined the two brokers as third-party defendants. The court rejected the defendants' argument that they had no duty to predict the insurer's solvency relying, in part, upon Pennsylvania common law which imposes a duty of care on those who supply information for the guidance of others. The court also relied upon insurance statutes which preclude placement with a nonadmitted insurer unless the “nonadmitted insurer [then] is of good repute and financial integrity.” 40 Pa. Cons. Stat. '991.1605(a)(1) (West 2003).

Another policyholder, Safety-Kleen Corporation, recently alleged that its broker negligently failed to notify Safety-Kleen of its insurer's deteriorating financial condition. Safety-Kleen was legally required to provide evidence of financial assurance in connection with certain hazardous waste facilities. Safety-Kleen Corp. v. MIMS Int'l Inc., No. 03-640 (D.S.C. Apr. 23, 2003). A surety bond from an approved company met this requirement, but the carrier experienced financial problems. The policyholder could not secure replacement bonds and fell out of compliance with federal environmental laws, incurred penalties, and waived certain Bankruptcy Code rights. The policyholder sued its broker on the ground that the broker had a continuing duty to advise regarding the insurer's financial condition so that replacement coverage could be obtained without undue expense and interruption.

Another recent case also involved allegations of a continuing duty to advise regarding financial conditions. A contractor sued its broker alleging that the broker failed to obtain proper coverage and notify it of a coverage lapse. Dalleo v. River Constr., Inc., No. 01-2397, 2003 U.S. Dist. LEXIS 6697 (E.D. La. Apr. 17, 2003). The broker had not notified the policyholder that its primary insurer was in liquidation until after a claim was made. The court did not decide the case on the merits because of a statute of limitations issue. However, it remains to be seen how far courts will go in expanding brokers' duties.

Procurement Liability Relating to Business Interruption Coverage. Insurance recovery under business interruption and contingent business interruption insurance became a high priority following the losses many companies suffered after the 9/11 terrorist attacks. The recent computer virus and worm attacks and the Northeast's recent electrical power outage have highlighted corporations' need for adequate business interruption insurance. Given the increasing importance of this coverage, there may be an increase in negligent procurement allegations involving business interruption insurance.

A pending World Trade Center case involving negligent procurement issues associated with business interruption insurance may be a sign of the times. In Wyndham International, Inc. v. ACE Bermuda Insurance Company, Case No. 02-7779 (Tex. Dist. Ct. filed Sep. 4, 2002), a hotel that suffered revenue loss following the terrorist attacks alleged that its broker negligently failed to procure the same coverage in 2001 that existed the prior year. The policyholder alleged that its previous policy had contingent business interruption coverage that would have covered losses associated with the terrorist attacks, but that the 2001 policies may not have contained similar coverage.

In another World Trade Center case that may evolve to include negligent procurement allegations, a tenant filed a complaint against its landlord's insurer, claiming that the landlord's policy covered more than $280 million in tenant improvements that were destroyed when the 7 World Trade Center building caught fire and collapsed. Citicorp Inc. v. Industrial Risk Insurers, Case No. 02 CV 7318 (S.D.N.Y. filed Sept. 10, 2002). The insurer denied coverage, contending it informed the broker that it would not name Citicorp as a loss payee. Although the broker was not an originally-named defendant, the insurer's position suggests that broker liability issues could become a part of this case.

In Archer Daniels Midland Company v. AON Risk Services Inc. of Minnesota, Case No. 97-2185 (JRT/RLE), 2002 WL 31185884 (D. Minn. Sept. 27, 2002) (“Archer Daniels“), another recent negligent procurement case involving flood-related losses, a corporation sued its broker for breach of contract, breach of fiduciary duty, and broker malpractice, alleging that the broker failed to obtain contingent business interruption coverage in a Differences In Conditions policy. The jury ruled in the policyholder's favor with a $16.5 million verdict. A federal appeals court affirmed the decision. Id. at *11.

Disappearing Defenses

At the same time that brokers are facing new negligence charges, courts are taking away some defenses. For example, in Aden v. Fortsh, 776 A.2d 792, 803-04 (N.J. 2001) (“Aden“), the Supreme Court of New Jersey held that a broker could not assert comparative negligence as an affirmative defense where a policyholder failed to read the policy. In that case, a policyholder asked his broker to acquire insurance to cover a condominium. The broker obtained and gave the policyholder a policy that provided only $1,000 of coverage for damage to the condominium's interior. Later, a fire caused about $20,000 in damage. The policyholder sued the broker, alleging negligent procurement. The broker contended that it was not liable because the policyholder failed to read the policy, which stated the coverage limits. The court rejected this defense, stating that a broker who holds himself or herself out as having insurance expertise is not just “an 'order taker' who is responsible only for completing forms and accepting commissions.” Id. at 803. The court concluded that it was the broker's duty “to ensure that the policy he was procuring for [the policyholder] provided a sufficient amount of dwelling coverage. …” Id. The court noted that, even if the policyholder had read the policy, he would have been entitled to assume that $1,000 in dwelling coverage was sufficient. Id.

Similarly, the court in Archer Daniels took away a defense when it refused to allow the broker to present evidence that the policyholder would not have been able to obtain coverage had the insurer known about certain alleged criminal conduct of the policyholder. The appellate court affirmed this ruling, which was based “on the groun[s] that 'relevant case law provides [ ] that an insured does not have an affirmative duty to disclose risks to an insurer'” and that the probative value of such evidence was outweighed by its prejudicial effect. Archer Daniels, 2002 WL 31185884 at *4.

Conclusion

Brokers frequently play a central role in identifying the types of policies required and selecting a carrier to write the coverage. The law requires brokers to exercise a certain degree of skill in these acts. When a broker fails to investigate the financial condition of the underwriting insurer, or fails to obtain the requested scope of coverage, the broker may be liable. The United States' recently weakened economy and new emerging risks, such as terrorist acts and computer viruses, increase the likelihood that allegations against brokers will increase, and courts may continue to expand the scope of a broker's duties and attendant liabilities.

Brokers long have had certain duties toward policyholders, including the duty to use reasonable skill and care in procuring insurance. Procuring appropriate coverage can be a daunting task for applicants unfamiliar with the intricacies of insurance. The myriad types of policies available and the differing coverages they contain present numerous pitfalls for the unwary. Many companies, even those with risk managers, rely upon brokers to select policy types and carriers, and to notify carriers of losses. Given policyholders' reliance on brokers, there is a standard of care brokers must meet.

The convergence of several events recently created a hard insurance market and increasing allegations of broker negligence in the procurement area. The weakened economy has generated more insolvencies, and policyholders increasingly are learning that they purchased insurance from an entity that is bankrupt. Recent decisions suggest that brokers now have a continuing duty to investigate a carrier's financial soundness. Also, the terrorist attacks of September 11, 2001, computer worms, and the Northeast power outage have caused interruptions in many businesses, leading to lost profits and other damages. Thus, negligent procurement allegations in the context of business interruption insurance also have been on the rise.

The Standard of Care

Brokers have a duty to obtain and use that degree of skill and knowledge that brokers of ordinary ability possess and exercise for clients. See e.g., President v. Jenkins , 814 A.2d 1173, 1185 (N.J. Super. Ct. App. Div. 2003). A broker must possess reasonable knowledge of policy types, terms and conditions, and available coverage. If a broker purports to have advanced skills, a heightened standard applies. If a broker fails to perform his or her duties with appropriate skill and care, liability may result.

A broker's duties vary depending upon the scope of the representation. However, it is not always easy to determine whether a broker represents the policyholder or the carrier. Although brokers often are considered the policyholder's representative, they may be dual agents. For example, Chubb Insurance Company's Web site lists numerous brokers as its agents. See eg, http://www.chubb.com/cgi-bin/agentlookup/ziplookupmore_v2.cgi. Courts analyzing the agency issue consider many factors, including contract terms, the parties' communications, who pays the broker, applicable state statutes, and the broker's status as a registered agent of the carrier.

If the broker is the policyholder's agent, the scope of the broker's representation is determined by the terms of any contract, the broker's representations about his or her skill level and the anticipated work, and what information the broker has about the policyholder. Courts have found that brokers have a duty to provide advice regarding the adequacy of coverage, faithfully negotiate and procure coverage, disclose material facts to insurers, and provide notice of claims to insurers. See e.g., Sinex v. Wallis, 611 A.2d 31, 33 (Del. Super. Ct. 1991); I nt'l Brotherhood of Teamsters v. Willis Corroon Corp. of Maryland , 802 A.2d 1050, 1057 (Md. 2002) (“Teamsters”); Royal Ins. Co. of Am. v. Cathey Daniels, Ltd. , 684 F. Supp. 786, 792 (S.D.N.Y. 1988); Stevenson Ins. Assocs., Inc v. Cohen, 228 So.2d 118, 120 (Fla. Dist. Ct. App. 1969). These duties are neither exhaustive nor necessarily present in all broker relationships. The facts of each case determine the broker's duties.

Negligent Procurement Liability

Negligent procurement liability is premised on the theory that the broker has a duty to faithfully procure requested insurance. The broker breaches that duty if he or she fails to obtain available coverage. In past cases, brokers have faced liability for not obtaining proper policy limits or coverage for requested risks, and improperly aligning multiple policies so that coverage gaps exist. See e.g., Teamsters, 802 A.2d at 1052; Kinns v. Schulz, 516 N.Y.S.2d 817 (N.Y. App. Div. 1987). Brokers now are facing negligent procurement allegations in new and different contexts.

Procurement Liability Relating to Insurer's Solvency. The concept that brokers may be liable for certain events relating to insurer solvency is not new. See e.g., Bordelon v. Herculean Risks, Inc. , 241 So.2d 766, 771 (La. Ct. App. 1970). However, allegations are increasing that brokers failed to investigate the financial stability of underwriting insurers, and placed insurance with an insurer the broker knew or should have known was financially unsound. In Al's Cafe, Inc. v. Sanders Insurance Agency , 820 A.2d 745, 751 (Pa. Super. Ct. 2003), the court expanded a broker's duties in this area: “[A]n insurance agent's/broker's recognized duty to act with reasonable care, skill, and judgment extends to selection of the insurer and ascertaining whether it is reputable and financially sound and informing the insured of findings if investigation reveals evidence of financial infirmity, but the agent/broker nonetheless intends to place a policy with the insurer.” Id.

There, an agent and two brokers secured a policy from a surplus lines insurer with a poor financial rating, but did not advise the policyholder of the rating. When the policyholder presented a claim, it learned that the insurer was in liquidation. After the policyholder recovered part of its loss from a state guaranty fund, it sought the remainder from the agent, who joined the two brokers as third-party defendants. The court rejected the defendants' argument that they had no duty to predict the insurer's solvency relying, in part, upon Pennsylvania common law which imposes a duty of care on those who supply information for the guidance of others. The court also relied upon insurance statutes which preclude placement with a nonadmitted insurer unless the “nonadmitted insurer [then] is of good repute and financial integrity.” 40 Pa. Cons. Stat. '991.1605(a)(1) (West 2003).

Another policyholder, Safety-Kleen Corporation, recently alleged that its broker negligently failed to notify Safety-Kleen of its insurer's deteriorating financial condition. Safety-Kleen was legally required to provide evidence of financial assurance in connection with certain hazardous waste facilities. Safety-Kleen Corp. v. MIMS Int'l Inc., No. 03-640 (D.S.C. Apr. 23, 2003). A surety bond from an approved company met this requirement, but the carrier experienced financial problems. The policyholder could not secure replacement bonds and fell out of compliance with federal environmental laws, incurred penalties, and waived certain Bankruptcy Code rights. The policyholder sued its broker on the ground that the broker had a continuing duty to advise regarding the insurer's financial condition so that replacement coverage could be obtained without undue expense and interruption.

Another recent case also involved allegations of a continuing duty to advise regarding financial conditions. A contractor sued its broker alleging that the broker failed to obtain proper coverage and notify it of a coverage lapse. Dalleo v. River Constr., Inc., No. 01-2397, 2003 U.S. Dist. LEXIS 6697 (E.D. La. Apr. 17, 2003). The broker had not notified the policyholder that its primary insurer was in liquidation until after a claim was made. The court did not decide the case on the merits because of a statute of limitations issue. However, it remains to be seen how far courts will go in expanding brokers' duties.

Procurement Liability Relating to Business Interruption Coverage. Insurance recovery under business interruption and contingent business interruption insurance became a high priority following the losses many companies suffered after the 9/11 terrorist attacks. The recent computer virus and worm attacks and the Northeast's recent electrical power outage have highlighted corporations' need for adequate business interruption insurance. Given the increasing importance of this coverage, there may be an increase in negligent procurement allegations involving business interruption insurance.

A pending World Trade Center case involving negligent procurement issues associated with business interruption insurance may be a sign of the times. In Wyndham International, Inc. v. ACE Bermuda Insurance Company, Case No. 02-7779 (Tex. Dist. Ct. filed Sep. 4, 2002), a hotel that suffered revenue loss following the terrorist attacks alleged that its broker negligently failed to procure the same coverage in 2001 that existed the prior year. The policyholder alleged that its previous policy had contingent business interruption coverage that would have covered losses associated with the terrorist attacks, but that the 2001 policies may not have contained similar coverage.

In another World Trade Center case that may evolve to include negligent procurement allegations, a tenant filed a complaint against its landlord's insurer, claiming that the landlord's policy covered more than $280 million in tenant improvements that were destroyed when the 7 World Trade Center building caught fire and collapsed. Citicorp Inc. v. Industrial Risk Insurers, Case No. 02 CV 7318 (S.D.N.Y. filed Sept. 10, 2002). The insurer denied coverage, contending it informed the broker that it would not name Citicorp as a loss payee. Although the broker was not an originally-named defendant, the insurer's position suggests that broker liability issues could become a part of this case.

In Archer Daniels Midland Company v. AON Risk Services Inc. of Minnesota, Case No. 97-2185 (JRT/RLE), 2002 WL 31185884 (D. Minn. Sept. 27, 2002) (“Archer Daniels“), another recent negligent procurement case involving flood-related losses, a corporation sued its broker for breach of contract, breach of fiduciary duty, and broker malpractice, alleging that the broker failed to obtain contingent business interruption coverage in a Differences In Conditions policy. The jury ruled in the policyholder's favor with a $16.5 million verdict. A federal appeals court affirmed the decision. Id. at *11.

Disappearing Defenses

At the same time that brokers are facing new negligence charges, courts are taking away some defenses. For example, in Aden v. Fortsh , 776 A.2d 792, 803-04 (N.J. 2001) (“ Aden “), the Supreme Court of New Jersey held that a broker could not assert comparative negligence as an affirmative defense where a policyholder failed to read the policy. In that case, a policyholder asked his broker to acquire insurance to cover a condominium. The broker obtained and gave the policyholder a policy that provided only $1,000 of coverage for damage to the condominium's interior. Later, a fire caused about $20,000 in damage. The policyholder sued the broker, alleging negligent procurement. The broker contended that it was not liable because the policyholder failed to read the policy, which stated the coverage limits. The court rejected this defense, stating that a broker who holds himself or herself out as having insurance expertise is not just “an 'order taker' who is responsible only for completing forms and accepting commissions.” Id. at 803. The court concluded that it was the broker's duty “to ensure that the policy he was procuring for [the policyholder] provided a sufficient amount of dwelling coverage. …” Id. The court noted that, even if the policyholder had read the policy, he would have been entitled to assume that $1,000 in dwelling coverage was sufficient. Id.

Similarly, the court in Archer Daniels took away a defense when it refused to allow the broker to present evidence that the policyholder would not have been able to obtain coverage had the insurer known about certain alleged criminal conduct of the policyholder. The appellate court affirmed this ruling, which was based “on the groun[s] that 'relevant case law provides [ ] that an insured does not have an affirmative duty to disclose risks to an insurer'” and that the probative value of such evidence was outweighed by its prejudicial effect. Archer Daniels, 2002 WL 31185884 at *4.

Conclusion

Brokers frequently play a central role in identifying the types of policies required and selecting a carrier to write the coverage. The law requires brokers to exercise a certain degree of skill in these acts. When a broker fails to investigate the financial condition of the underwriting insurer, or fails to obtain the requested scope of coverage, the broker may be liable. The United States' recently weakened economy and new emerging risks, such as terrorist acts and computer viruses, increase the likelihood that allegations against brokers will increase, and courts may continue to expand the scope of a broker's duties and attendant liabilities.