Laws Need to Be Changed to Clear Up Compliance Confusion on Multi-State Risks
Excess line brokers have been making news in the New York courts lately.
In two separate cases, former insureds of Legion Indemnity Company sought to hold the excess line broker liable for losses and defense costs otherwise payable by the now insolvent insurer. As one might expect, two New York judges, faced with very similar cases, of course came to diametrically opposed conclusions.
While New York Insurance Law imposes a duty on every excess line broker to use due care in the selection of a financially secure excess line insurer, neither of these cases turned on that specific issue. In both cases the courts analyzed whether the excess line broker provided proper disclosure to the insured regarding the non-admitted status of the insurer and otherwise complied with the excess line laws.
In East Coast Management Ltd., vs. Genatt Associates Inc., the plaintiff pursued four causes of action: negligence, declaratory relief, breach of contract and fraud. On cross motions for summary judgment, the court analyzed the facts and law and found as follows:
The insured was in fact advised that Legion Indemnity was not licensed since the insured acknowledged it had signed a notice to that effect.
Genatt did not comply with the applicable provisions of the insurance law.
The Genatt employee who purportedly signed the affidavit containing the three required declinations from licensed insurers denied having signed the affidavit and denied obtaining the declinations.
The failure of Genatt to comply with the strict provisions of the insurance law was evidence that it failed to act with due care.
Genatt breached its contract.
The court granted the plaintiff’s motion on the causes of action for negligence and breach of contract and declared that an insurance broker which breaches its duty “by not obtaining proper insurance becomes liable to the extent the carrier would have been.”
While the court did not express in detail why these conclusions were reached, it might be surmised that the court felt the insured’s risk could have been placed with a licensed carrier had that effort been made. If so the insured would have had guaranty or security fund protection if the insurer became insolvent.
Suit for damages issue
The court did not address one particular legal issue upon which a number of prior cases turned. The legal question is whether violation of the insurance laws creates a private right of action. A private right of action means an insured can sue for damages based upon a violation of the insurance law. If not, the right to enforce the law is solely within the authority of the Superintendent of Insurance. Genatt intends to appeal the court decision on this basis.
In the second case the private right of action question was prominently addressed. In Polly Esther’s South Inc. et al vs. Bogdanoff et al, similar but not identical causes of action were brought against Kaye Insurance Associates Inc. and a successor broker. The alleged breach of duty to exercise reasonable care, breach of contract and failure to comply with applicable provisions of the insurance law also arose out of an excess line placement with the now insolvent Legion Indemnity. The plaintiff did not specifically allege the declinations in the affidavit were false, but did assert that proper disclosure and explanations regarding the risks associated with coverage by a non-admitted carrier were not made.
While the court did not clearly state it found any statutory or regulatory violations, it made the following findings:
No private right of action is set forth in the statute.
While it is permissible to imply a private right of action, it is not permissible unless doing so would be consistent with the legislative scheme in creating the statute.
Since the legislature provided authority administratively to enforce the applicable statute(s), no private right of action should be implied in this case.
The court also held:
Violation of the applicable statute (Â§ 2118 of NY Insurance Law) does not constitute negligence per se, but is evidence of some negligence.
Other than the possible failure to comply with Insurance Law Â§ 2118 the plaintiff offered little evidence of common law negligence.
The plaintiff failed to demonstrate the existence or attributes of a “special relationship” that would have raised the duty owed by the broker.
The insured ratified the selection of Legion Indemnity by not objecting to this choice, once it received a Notice of Excess Line Placement.
The insured received the Notice of Excess Line Placement and countersigned it on May 10, 1999.
The three-year negligence statute of limitations ran from May 10, 1999 and the plaintiff’s negligence action was therefore time barred.
The six-year breach of contract statute of limitations did not time bar plaintiff’s action but the defendants fulfilled the oral agreement to obtain coverage.
The court therefore, granted the summary judgment motions of both defendants, dismissing all claims.
Both ways now
Okay, now one court says an excess line broker can be liable and another says no private right of action, no liability. So what can the insurance and legal communities take away from this confusion?
The first lesson is, where there is an insurer insolvency, trouble follows close behind. If the carrier is gone, claimants and insureds want to know, ‘Whom can I get to pay my losses?’ Aside from excess line brokers, Price Waterhouse Coopers, as successor to Coopers and Lybrand, was recently held liable for almost $200 million in damages and interest arising out of the Ambassador Insurance Company’s insolvency of the early 1980s.
The highest Pennsylvania court recently allowed insureds to directly tap the reinsurers of Legion and its affiliates without demonstrating traditional prerequisites such as express cut-through endorsements or written evidence of an intent to create a third party beneficiary relationship.
The foregoing logic applies in non-insolvency situations as well. When an insured is denied coverage, the question is: who might be responsible for the loss? Brokers beware. When a state is not paid excess or surplus line taxes due, this can also become a nightmare for the broker.
For brokers, an additional lesson from these cases is: be in compliance with each formality of the E&S law. What are often treated as minor administrative errors by a typical brokerage, can lead to lawsuits administrative proceedings and expose brokers to dire consequences. If an excess line broker testifies that the declinations set forth in a sworn statement are false, is that negligence or is it intentional conduct which would let the broker’s own errors and omissions insurer deny coverage?
Come to grips
Many insurance professionals are not able to completely come to grips with the panoply of legal exposures existing in the E&S market place. On the broker’s side of the market, obtaining the license means an assumption of additional legal duties that should not be taken lightly. On the compliance side, the message is to dot the “i’s’ and cross the “t’s.”
The recent advent of full non-resident E&S licensing increases the risk of non-compliance. On multi-state risks, where should the broker file and comply? Is the answer to file and comply in every state where there is risk exposure? The entire industry hopes that is not the right answer but still it shouldn’t surprise anyone that each state involved might want the tax revenue associated with such a risk.
While complying with the E&S laws in the insured’s home state is certainly a good faith effort, other states where the insured maintains operations are not necessarily precluded from seeking payment of the E&S tax. The broker has a compelling argument that the state has no jurisdiction to demand a filing or tax payment when the transaction was accomplished completely outside that particular state’s borders. However, it becomes a tougher argument, practically speaking, if the broker has a non-resident E&S license in that state because the state has leverage even if it misinterprets its own law.
There is no other issue in the E&S market more in need of attention from legislators and regulators. E&S brokers need the assurance that complying in the insured’s home state prevents allegations of violations of other states’ E&S laws. To obtain the agreement of the states to a one-state filing approach, the states will need to create a mechanism to assure each state nevertheless receives taxes due on the risk exposure allocated to each state.
Thirty-six states have statutes which essentially state that a person who places an E&S risk in that state without complying with the E&S law may be held liable for any losses that the insurer fails to pay.
Many states also have criminal statutes that can apply. Most brokers are unaware that Â§109 of the New York Insurance law states every violation of its provisions is a misdemeanor unless it is a felony.
A number of states have criminal statues that directly apply to conducting an insurance business without a license, statutes that could be construed to apply to non-compliant surplus line transactions. In other states, other criminal statues can be interpreted to apply.
The message in all of this is to diligently comply with the E&S insurance law of the appropriate state to avoid potential administrative, liability and criminal exposures. Compliance is relatively easy to accomplish with insureds whose risk exposures are all in a single state. As to multi-state risks, there is no single method to comply and brokers are exposed to legal problems and will continue to be until the laws are changed or reinterpreted.
As to transactions with risk exposures in multiple states, the industry must pursue a consistent and uniform system either legislatively or as a matter of uniform interpretation agreed to by state regulators.
Daniel F. Maher is Executive Director of the Excess Line Association of New York. He can be reached at email@example.com