Limitations on a Broker’s Duty
The California Court of Appeal was presented with an issue it described as an issue of first impression in California in Pacific Rim Mechanical Contractors, Inc v. Aon Risk Insurance Services West, Inc., et al, No. D058321 (Cal.App. Dist.4 02/28/2012). The case asked:
Does an insurance broker, after procuring a policy of insurance for a developer on a construction project, owe a duty to apprise a subcontractor that was later added as an insured under that policy of the insurance company’s subsequent insolvency?
A. The Construction Project and Insurance
The underlying litigation relates to a construction project (the project) in downtown San
Diego, which was completed in 2002. In June 1999 the project’s developer, cross-defendant Bosa Development California, Inc. (Bosa), engaged Aon as its insurance broker to obtain insurance for the project. Aon procured a general liability insurance policy (the policy) for the project with Legion Indemnity Company (Legion) at the request of its client, Bosa. Legion was solvent at the time it issued the policy.
In 2000 Bosa hired PacRim as one of several subcontractors to work on the project. The parties entered into a contract (the contract) in which Bosa agreed to provide PacRim with liability insurance through the policy for its work on the project. Aon, however, was not a party to the contract and PacRim was never its client. The policy was a unified, blanket insurance policy known as an Owner Controlled Insurance Program (OCIP) that provided liability insurance for every contractor and subcontractor on the project. The OCIP provided up to $25 million in liability coverage for ten years after the construction was completed – the duration of California’s 10-year construction defect statute of repose.
PacRim became an enrolled party in the OCIP by contacting Aon and providing all necessary paperwork, and in October 2000 Aon provided PacRim with a “Certificate of Liability Insurance,” indentifying PacRim as an insured, and Legion as the primary insurer.
In April 2002, during the construction project, the Illinois Department of Insurance obtained an order of conservation against Legion. In 2002, the construction project was completed. In April 2003, after the project was complete, the Circuit Court of Cook County, Illinois, entered an order of liquidation with a finding of insolvency against Legion. In April 2002 Aon informed Bosa that Legion had been placed into rehabilitation. However, according to PacRim, neither Bosa nor Aon notified PacRim of Legion’s financial condition.
PacRim alleged, with perfect hindsight, that had Bosa or Aon informed it of Legion’s “financial condition” PacRim “could and would have immediately suspended work and insisted that Bosa obtain alternative insurance coverage for the Project.”
B. The Construction Defect Lawsuit and PacRim’s Cross-complaint
In May 2009 the project’s homeowners association filed a complaint for construction defects against Bosa and its subcontractors, including cross-complainant PacRim. Bosa filed a cross-complaint against PacRim (and its other subcontractors) seeking indemnity. PacRim then filed a cross-complaint against Bosa and Aon for declaratory relief, breach of contract, negligence, fraudulent concealment, and negligent concealment. As against Bosa, PacRim alleged that Bosa breached the contract by failing to provide and maintain insurance as required by the contract. PacRim further asserted that Bosa breached the contract by “failing to provide the required written notice of a modification or discontinuation of the required coverage.”
As against Aon, PacRim asserted that it “owed a duty of reasonable care to procure and maintain [the insurance policy] in PacRim’s favor,” which Aon breached by negligently or intentionally failing to disclose “Legion’s deteriorating financial condition and eventual insolvency.” Thus, PacRim explains its “claims against [Aon] are negligence based, not contract based.”
Aon demurred to all of PacRim’s causes of action, alleging:
- PacRim expressly asserted in its cross-complaint it was not a party to the contract and thus Aon had no liabilities to it, and
- even if PacRim were a party to the contract, PacRim
- waived all rights of recovery against Aon for any coverage limitation or failure in the contract, and
- Aon had no affirmative duty to notify PacRim of Legion’s insolvency post-issuance of the policy.
The trial court sustained Aon’s demurrer with 10 days leave to amend. The trial court found it “unnecessary to impose” on Aon a “duty to notify an insured of an insurer’s post-issuance insolvency” because Bosa was contractually obliged to notify PacRim of Legion’s insolvency; and California precedent that addressed the issue of a broker’s duty was controlling in Aon’s favor. The trial court agreed. The duty of a broker is to use reasonable care, diligence, and judgment in procuring the insurance requested by its client.
The court entered a judgment of dismissal of PacRim’s cross-complaint against Aon because it sustained the demurrer as to all of the causes of action. PacRim elected to file this appeal instead of amending its cross-complaint.
The California Court of Appeal noted that insurance brokers owe a limited duty to their clients. That duty is only to use reasonable care, diligence, and judgment in procuring the insurance requested by an insured.
PacRim did not allege that Aon failed to use reasonable care in procuring the insurance policy from Legion. Moreover, PacRim did not allege that Aon assumed any additional contractual duties beyond procuring the insurance. Since the case was decided on a demurrer the court was required to assume all allegations in the suit were true.
PacRim asked the court to create a new legal duty of notification of Legion’s conservation order and insolvency after the policy is procured, and to apply that retroactively upon Aon.
The Court of Appeal concluded that Aon had no legal duty to provide notice of the discontinuation of coverage caused by Legion’s insolvency. That duty under Insurance Code section 677.2 rests with the insurer, Legion. Additionally according to PacRim’s own allegations, that duty rested with Bosa.
Because PacRim’s claims are based entirely on the allegation that Aon failed to satisfy a duty that California law does not recognize PacRim’s claims against Aon fail as a matter of law.
Public Policy Supports The Conclusion There Is No Duty To Notify of Insolvency
The Court of Appeal stated that it was unwilling to retroactively impose on Aon (and all other insurance brokers) the duty PacRim asked the court to impose because of considerations of public policy. The imposition of a duty requiring insurance brokers to inform an insured of “any adverse changes in the carrier’s financial capability” post-issuance of the insured’s policy is properly the function of the Legislature because it would fundamentally alter the nature and corresponding duties of insurance brokers, which would increase the costs of procuring insurance.
The duty PacRim asked the court to impose on brokers is unpredictable. What constitutes an adverse change in the insurer’s financial capability that triggers the proposed duty to notify the insured is exceedingly ambiguous and the scope of such a standard would take an unknown amount of time to define.
PacRim acknowledged that at least 10 states and Puerto Rico have elected to impose a statutory duty to notify an insured of a subsequent insolvency as soon as the agent or broker receives notice of that insolvency. California has chosen not to enact such legislation. The Court of Appeal refused to create a duty where the Legislature could have done so, but has not.
Imposing continuing duties of monitoring and notification upon the broker after issuance of the policy creates other practical difficulties. In the case of occurrence-based policies, the proposed common law notification duty could last indefinitely, well after brokers (and the client) may have ceased doing business. For example, in this case the Legion policy extended 10 years after completion of the project in 2002, more than 13 years after the policy was procured in 1999.
Although PacRim was an insured, and was given a certificate of insurance, it was not Aon’s client. Bosa was. The Court of Appeal concluded the trial court properly sustained Aon’s demurrer because it had no duty as Bosa’s insurance broker to inform PacRim of Legion’s insolvency.
When a party relies on an OCIP insurance contract that extends for ten years or more beyond the acquisition of the policy or the completion of a construction project it cannot rely on warnings from an insurance broker in all but ten states and Puerto Rico and should not rely in those eleven jurisdictions.
Construction defect suits after the completion of a construction project are almost a certainty regardless of the quality of the construction work.
A prudent contractor or subcontract protected by such a contract should check the solvency of the insurer annually by making a simple inquiry in Google, Bing, Yahoo, or the web site of the insurer. Ignorance is not bliss. Had PacRim done such an independent check it could have immediately suspended work and insisted that Bosa obtain alternative insurance coverage for the Project or if, as in this case, if it was declared insolvent after the completion of the contract it could have insisted that Bosa obtain alternative insurance coverage or buy its own. It did not protect itself and tried to pass that responsibility to Aon.
Barry Zalma, Esq., CFE, is a California attorney, insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud. Mr. Zalma serves as a consultant and expert, almost equally, for insurers and policyholders.
He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He recently published the e-books, “Zalma on Diminution in Value Damages – 2012,”“Zalma on Insurance,” “Heads I Win, Tails You Lose — 2011,” “Zalma on Rescission in California,” “Arson for Profit,” “Insurance Fraud,” and others that are available at www.zalma.com/zalmabooks.htm.
Mr. Zalma can also be seen on World Risk and Insurance News’ web based television program “Who Got Caught” with copies available at his website at http://www.zalma.com.