NBA-CLS Newsletter Online: Agency Law Viewed Through the Lens of Insurance Brokers

Agency Law Viewed Through the Lens of Insurance Brokers

By Donald O. Johnson, Esq.[1]

Agency Law Is Part of the Legal Analysis in Many Commercial Law Transactions

Common law agency rules focus on the legal relationships between principals, agents and affected third parties. The introduction to the Restatement (Third) of Agency explains: "[T]he common law of agency encompasses the legal consequences of consensual relationships in which one person (the 'principal') manifests assent that another person (the 'agent') shall, subject to the principal’s right of control, have power to affect the principal’s legal relations through the agent’s acts and on the principal’s behalf." Restatement (Third) of Agency at 3 (2006). These common law rules of agency play an important role in the analysis of laws governing many aspects of commerce in the United States, such as the Uniform Commercial Code and corporate governance laws. They play an especially important role in the analysis of insurance broker liability — a role that the remainder of this article examines.

Insurance Brokers Are Necessary Participants in Most Commercial Insurance Transactions

The insurance industry has developed a broad array of insurance policies that provide coverage for the wide range of significant risks that commercial entities constantly face. Such policies include: commercial property, business interruption and extra expense, inland marine, commercial general liability, excess liability, umbrella liability, directors and officers liability, errors and omissions liability, employment practices liability, products liability, products recall, and fidelity policies. Because of the proliferation of the types of policies available in the insurance market and the various coverage limitations and exclusions that these policies contain, insurance brokers are necessary participants in most businesses’ purchase of commercial insurance.

Insurance brokers have specialized knowledge about the insurance products on the market and about the insurance companies offering those products. Businesses that use brokerage services give insurance brokers substantial information about the risks that they face. Consequently, insurance brokers frequently play a significant role in, among other things, identifying the type of policies that a business wants, negotiating the terms and conditions of coverage with insurance companies, selecting one or more insurance companies to write the coverages, collecting premiums from insureds, and notifying insurance companies about property and business interruption losses suffered by insureds and liability claims made against insureds.

Insurance Brokers Are Different Than Insurance Agents

Although some people mistakenly use the terms “insurance broker” and “insurance agent” interchangeably, an insurance broker’s relationship with an insurance applicant or the named insured generally is different than an insurance agent’s relationship with such parties. Insurance brokers usually represent the insurance applicant or the insured, not insurance companies. They are not employed by insurers, although they may receive commissions from insurers based on their placement of insurance with those companies. In contrast, insurance agents represent insurance companies. Insurance agents usually are employed by insurers who pay them a salary and who may pay them a commission based on their insurance sales. These distinctive relationships sometimes are imposed by state statute. For example, California Insurance Code § 33 defines “insurance broker,” stating: “‘Insurance broker’ means a person who, for compensation and on behalf of another person, transacts insurance other than life with, but not on behalf of, an insurer.” See also Cal. Ins. Code § 1623 (West 2008). California Insurance Code § 31 defines “insurance agent,” declaring, in pertinent part: “‘Insurance agent’ means a person authorized, by and on behalf of an insurer, to transact all classes of insurance other than life insurance.” In some states, the distinction is the product of state common law.

The various names used in the insurance industry to refer to different types of insurance brokers contributes to the confusion that people outside of the industry often have about the distinction between insurance brokers and insurance agents. For example, among other designations, some insurance brokers are called “independent insurance agents” and some others are called “surplus lines agents.” An independent insurance agent is a synonym for an insurance broker who deals with multiple insurers admitted to sell insurance in the state for typical risks but who, as noted, is independent of all of the insurers. Asurplus lines agent is an insurance broker who deals with insurers that the state department of insurance has not admitted to sell insurance in the state but that sells insurance for risks for which there is no normal insurance market available in the state at issue. The confusion caused by the sometimes overlapping terminology used to refer to insurance brokers and insurance agents and the underlying agency relationships between insurance brokers and the parties with whom they deal can have significant legal consequences when insurance brokers become involved in litigation commenced by dissatisfied insurance applicants, insureds, additional insureds, insurers, or third parties.

The Dual Agency Problem - Analysis of the Particular Purpose of the Broker’s Act

Notwithstanding the fact that statutes in some states and the common law in some other states pronounce that insurance brokers are agents of insurance applicants and insureds, agency law may cause a different result in some situations. As the Supreme Court of South Dakota recently concluded, “[s]tatutes regulating licensing and defining agents, brokers and solicitors, are not intended to change or to exclude the general laws of agency.” North Star Mut. Ins. Co. v. Rasmussen, 734 N.W.2d 352, 361 (S.D. 2007) (internal quotation marks and citations omitted) (“Rasmussen”); see also Oakland- Alameda County Coliseum, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburg, P.A., 480 F. Supp. 2d 1182, 1196 (N.D. Cal. 2007) (“an agency relationship can exist outside the formal provisions in the [California] Insurance Code”).

Based on agency law, the vast majority of states, if not all, recognize the concept of dual agency; namely, that an insurance broker can be an agent of the insurance applicant or the insured for some purposes (e.g., negotiating policy terms) and the agent of the insurer for other purposes (e.g., collecting and transmitting premiums). See, e.g., Astenjohnson v. Columbia Cas. Co., 483 F. Supp. 2d 425, 462 (E.D. Pa. 2007) (applying Pennsylvania law) (“Astenjohnson”). The Astenjohnson court summarized the applicable agency principles, which, essentially, are the same in all states:

21. “The basic elements of agency are ‘the manifestation by the principal that the agent shall act for him, the agent’s acceptance of the undertaking and the understanding of the parties that the principal is to be in control of the undertaking.’” 22. Apparent authority is the “power to bind a principal which the principal has not actually granted but which he leads persons with whom his agent deals to believe that he has granted,” for instance where “the principal knowingly permits the agent to exercise such power or if the principal holds the agent out as possessing such power.” 23. If a court determines an individual or entity is an agent of another, the actions and knowledge of the agent are binding on that person, the principal. Id. at 461 (internal citations omitted); see also Restatement (Third) of Agency §§ 1.01, 2.01, 2.03, 3.03, 7.03 (2006).

Given that, under agency law, an agent’s actions and knowledge bind the principal, agency law analysis is critical in insurance coverage cases in which an insurance broker’s actions play a significant part in a dispute between the insurance applicant or insured and the insurer about the existence of coverage for a particular loss or claim. Whichever party the court determines is the principal with respect to the broker action in question will be bound by that action. See, e.g., L.A. Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co., 67 Cal. Rptr. 3d 917, 923-24 (Cal. Ct. App. 2007); Matter of Temple Constr. Co. v. Sirius Am. Ins. Co., 40 A.D.3d 1109, 1111 (N.Y. Sup. Ct. App. Div. 2007). The agency question also is important in claims brought against an insurance broker because the answer will determine whether an insurance applicant, an insured, an insurer, or a third party potentially has a cause of action against the broker.[i]

Actions by Insurance Applicants and Insureds Against Insurance Brokers

The typical causes of action that insurance applicants or insureds bring against insurance brokers include breach of contract and negligence actions for: (1) failure to procure requested insurance; (2) failure to procure the appropriate insurance; (3) failure to provide the insurer with timely notice of a claim or a suit; (4) failure to provide accurate information about the insurance applicant in the application for insurance; and (5) failure to investigate the financial stability of the insurer.[ii]

Potential Broker Defenses to Actions by Insurance Applicants and Insureds

Potential defenses to the above-mentioned actions that insurance applicants or insureds sometimes bring against insurance brokers include establishing that: (1) no coverage for the insurance claim would have existed under the requested policy even if the broker had procured it (i.e., the broker can raise the same coverage defenses that the insurer could have raised if the policy had been issued); (2) the requested coverage was unavailable in the insurance market; (3) the broker did not assume a duty to advise the insurance applicant about which coverages to purchase and did not charge a fee for such service; (4) the broker was not the insurance applicant’s or the insured’s agent with regarded to the alleged wrongful act; (5) the insurance applicant or the insured was contributorily or comparatively negligent (e.g., supplied inaccurate information, failed to read the policy); and (6) the statute of limitations expired.[iii]

Determining Which Entity the Broker Represented With Regard to the Act in Question

Determining which entity the broker represented with regard to a particular action by the broker sometimes can be difficult. The determination depends upon a number of factors. Among other factors, courts consider: (1) the existence of a written contract detailing the broker’s duties and scope of authority; (2) communications between the broker and the applicant or insured and between the broker and the insurer; (3) the identity of the entity that hired and paid the broker for the services at issue; (4) whose interests the broker was trying to protect; (5) the nature of any past dealings between the broker and the insurance applicant or insured or between the broker and the insurer; (6) the complaining entity’s reliance, if any, on the broker to act in its behalf; and (7) any applicable state statutes concerning broker representation.

The Astenjohnson case illustrates the application of some of these factors in determining who a broker represents in a particular situation. In that case, the insured contended that an asbestosis exclusion in its commercial liability policies was inapplicable because the exclusion was ambiguous and the insured did not understand its alleged function when it purchased the policies. With respect to the broker’s negotiation of the policy provisions, the insured alleged that broker was the agent of the insurer. Astenjohnson, 483 F. Supp. 2d at 461-62.

The court disagreed, observing that the insured hired the broker to obtain the best available coverage for it, placed minimum restrictions on the broker’s insurance acquisition efforts, and trusted the broker to represent the insured’s best interest in the broker’s dealings with insurers. Id. at 462. The court, therefore, concluded that the broker was the insured’s agent during the negotiations for the placement of the policies and that the broker’s knowledge and understanding of the policies, including the asbestosis exclusion, was imputed to the policyholder. Id.

Conclusion

Insurance applicants and insureds often rely upon insurance brokers to help them obtain adequate insurance coverage, submit claims to insurers. and provide other services. Although state statutes and case law may indicate that insurance brokers represent insurance applicants and insureds, as opposed to insurance companies, the common law of agency — and, especially, the principle of dual agency — may change that result in particular situations.

Therefore, when insurance applicants, insureds, insurers, insurance brokers, and/or third parties become involved in insurance coverage litigation in which an insurance broker’s actions play a key role, these parties and their counsel should evaluate the facts of the case and the law of the relevant jurisdiction carefully to determine the scope of the duties and obligations, if any, that the insurance broker owed to the complaining party and the likelihood that that party can establish that the insurance broker breached its duty to, or contract with, the complaining party. In other areas of law in which agency law principles will impact the result of a legal dispute, the parties and their counsel should undertake a similar principal/agent analysis.

References

[1] Donald O. Johnson, J.D., LL.M., CPCU is an attorney at D. O. Johnson Law Office, PC. He represents clients in insurance coverage and other commercial litigation. He also is General Counsel of the National African-American Insurance Association (a/k/a NAAIA), a member of the Chartered Property and Casualty Underwriters (CPCU) Society’s Diversity Committee, and a Director of the Society’s District of Columbia Chapter. Additional information about Don can be obtained at www.dojlaw.com.

[i] This article focuses on potential broker liability to insurance applicants and insureds. It should be noted, however, that some broker actions can make them liable to insurers (e.g., failure to remit premiums). Courts, occasionally, also hold brokers liable to third parties for breach of contract under a third-party beneficiary theory. See e.g., Flattery v. Gregory, 498 N.E.2d 1257 (Mass. 1986).
[ii] Some states, such Florida, consider the relationship between an insurance broker and an applicant or insured to be a fiduciary relationship, which gives rise to a heightened duty of care on the part of the broker, and recognize a claim against brokers for breach of fiduciary duty. See e.g., Moss v. Appel, 718 So. 2d 199, 202 (Fla. Dist. Ct. App. 1998). Other states, such as Maryland, do not recognize a separate tort action for breach of fiduciary duty. See Teamsters v. Willis Corroon Corp. of Maryland, 802 A.2D 1050, 1052 n.1 (Md. 2002).
[iii] Some states have specific statutes of limitations that pertain to insurance brokers. See, e.g., R.I. Gen. Laws § 9-1-14.1 (2008); 735 Ill. Comp. Stat. Ann. 5/13-214.4 (West 2008).