Calif. Court of Appeals Overturns E&O Decision

December 3, 2002

In a significant victory for insurance agents and brokers, the Ninth Circuit Court of Appeals has overturned a lower court decision that had permitted an E&O insurer to deny coverage to an insurance broker by misconstruing an “insolvency exclusion” in the E&O policy.

IBA West—joined by the Big I state associations in eight other Western states in the Ninth Circuit—submitted an “amici curiae” brief urging the Court of Appeals to overturn the lower court’s decision, in part because its construction of the exclusion could arguably have gutted many E&O policies sold to insurance agents and brokers.

The opinion, issued Nov. 27 by the Court of Appeals in Conestoga Services v. Executive Risk Indemnity, expressly cites both that concern, and the involvement of the “friends of the court.”

Attorneys for Conestoga believe the involvement of the Big I state associations, and the amicus brief they submitted, played a key role in convincing the Court of Appeals that the lower court erred in summarily ruling in favor of the E&O insurer, said IBA West General Counsel Steve Young, who authored the brief.

The case has been sent back to the lower court for “reconsideration” in light of the appellate court’s opinion.

Since the opinion strongly suggests that Executive Risk had a duty to defend Conestoga in this case, it is probable that the parties will now reach an out-of-court settlement on the underlying E&O claims—assuming that Executive Risk does not bring or succeed in an appeal of the ruling, Young said.

At issue in Conestoga v. Executive Risk was the construction the lower federal court gave to an “insolvency exclusion” permitting an E&O insurer to deny coverage to a broker following the bankruptcy of the client to whom the broker had sold a surety bond.

The broker, Conestoga Insurance Services (formerly MacCready & Gutman), placed a surety bond with Frontier Pacific covering the workers’ compensation self-insurance obligations of Standard Brands Paints Co. The original amount of the bond, $5.7 million, was later reduced to $3.9 million, although the broker was allegedly negligent in transmitting the executed notice of the reduction.

After the paint company filed for bankruptcy—triggering the surety’s obligation—the surety then sued the broker to recover the difference between the original and reduced bond amounts. The broker then tendered defense to its E&O insurer, Executive Risk Indemnity.

However, Executive Risk refused to accept the defense, relying on a provision in the E&O policy that purported to exclude from coverage: “… any Claim … based on or directly or indirectly arising out of or resulting from the bankruptcy of, or suspension of payments or failure or refusal, in whole or in part, to pay by: […] (3) any bonding company or insurance company or reinsurance company, or (4) any self-insurance plan, insurance pool or reciprocal, captive insurance company, risk retention group or risk purchasing group.”

In granting Executive Risk’s motion for summary judgment, the District Court rejected the broker’s argument: 1) that the exemption was intended to apply to insolvent insurers, and 2) that ambiguities in the exclusion should be construed against the insurer (who wrote it) rather than against the policyholder (in this case, the broker).

Joining the broker on appeal as amicus parties were the “Big I” associations—representing independent insurance agents and brokers—in every state comprising the Ninth Circuit: Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon and Washington.

All nine associations joined together to file a single “amicus brief.”

E&O insurers would be wrongfully enriched—at the expense of insurance agents and brokers—and E&O policies for producers would arguably be rendered worthless, unless the lower court decision was reversed, IBA West and the other producer groups told the Court of Appeals.

“There would be no reason for an agent or broker to purchase an expensive E&O policy if it excluded situations where an insurer failed to pay policyholders’ claims,” Young said, a point echoed in the appellate court’s opinion.

A three-judge panel of the Ninth Circuit Court of Appeals heard oral argument on Nov. 6: Betty Fletcher, Johnnie Rawlinson, and Richard Arnold. In the federal system, the only higher court is the United States Supreme Court.

The appellate opinion was also heavily based on the panel’s determination that the lower court had erred in determining that the “cause” of the injury in the underlying case was the bankruptcy of the paint company, as opposed to the error of the broker in processing the executed paperwork reducing the amount of the bond.

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