Don’t Make Promises You Can’t Keep
Insurance is nothing more than promises between the insurer and the insured. The insured makes promises to pay premium, keep doors locked, protect the property from further loss, and in some cases to maintain burglar alarms, fire alarms, and sprinkler systems while the insurer promises to pay indemnity in case of a loss if the promises made by the insured had been kept. Failure of either to keep the promises made can cause a breach of the insurance contract and damage the one who failed to keep the promise.
American Way Cellular, Inc. (American Way), appealed from a judgment entered after the trial court granted summary judgment in favor of Travelers Property Casualty Company of America (Travelers). American Way filed suit against Travelers, alleging that American Way was entitled to policy benefits following a fire loss at its place of business located in Van Nuys, California (the premises).
The trial court determined that Travelers had no obligation to pay benefits to American Way, holding that an “[e]ndorsement” contained in the policy issued by Travelers “requires as a condition of insurance that the insured premises contain automatic sprinklers” and it was undisputed that the premises did not have an automatic sprinkler system. The trial court found in favor of Travelers on its cross-complaint for declaratory relief and reimbursement of a $250,000 good faith advance payment against American Way. American Way appealed and in American Way Cellular, Inc., v. Travelers Property Casualty Company Of America, California Court of Appeal, http://www.metnews.com/sos.cgi?0513//B234188, (5/30/2013) contending that the judgment must be reversed. American Way also argued that it was entitled to coverage because the “provisions requiring [American Way to] maintain the protective devices or services listed cannot require [American Way] to maintain something that does not exist.”
A & J is a licensed insurance broker for property insurance. USASIA Insurance Services, Inc. (USASIA), is an insurance agent of Travelers.
Ali Sheibani is the owner of American Way. Sheibani contacted Ali Derakhshanfar, who was an insurance broker and “principal” of A & J, regarding liability and property coverage. On September 25, 2007, A & J submitted a commercial insurance application (application) on behalf of American Way to USASIA with the notation, “Please see the attached [ACORD] app for above insured. This is a new venture. No losses in the history. Please give us a quote as soon as possible. If you have any questions feel free to contact us.” In the box entitled, “FIRE PROTECTION (Sprinklers, Standpipes, CQ/Halon Systems),” the application indicated that American Way had “SMOKE DETECTORS/FIRE EXTING./SPRINKLERS.” Based on the application a policy was eventually issued by Travelers.
Travelers issued a commercial property policy to American Way effective October 10, 2007, to October 10, 2008 (2007 policy). The 2007 policy contained a “Protective Safeguards Endorsement For Sprinklered Locations and Restaurants” (Endorsement), which stated:
“As a condition of this insurance, you are required to maintain the protective devices or services listed . . . .” An exclusion section stated, “We will not pay for loss or damage caused by or resulting from fire if, prior to the fire, you: [¶] a. Knew of any suspension or impairment in any protective safeguard listed in the Schedule above and failed to notify us of that fact; or [¶] b. Failed to maintain any protective safeguard listed in the Schedule above, and over which you had control, in complete working order. [¶] If part of an Automatic Sprinkler System is shut off due to breakage, leakage, freezing conditions or opening of sprinkler heads, notification to us will not be necessary if you can restore full protection within 48 hours.”
American Way received a copy of the 2007 policy. Upon expiration of the 2007 policy, Travelers issued a renewal policy with effective dates of October 10, 2008, to May 10, 2009 (2008 policy). The provisions in the 2008 policy were identical to those contained in the 2007 policy and contained an identical Endorsement
THE FIRE AND SUBSEQUENT INVESTIGATION
On October 11, 2008, a fire occurred at the premises, which occupied the southwest section of a “warehouse-type building.” While investigating Travelers issued a “good faith” advance payment to American Way in the amount of $250,000. Pacific Rim concluded that the fire originated in the interior of the east side of the building where an area was under construction. The adjuster noted that there was no automatic sprinkler system installed in the premises. Fire protection in the building consisted of an alarm system, which functioned at the time of the incident, and several fire extinguishers.
On November 11, 2008, Travelers sent a letter to American Way stating that the claim “may not be covered by the policy” and that it was investigating the claim subject to a full reservation of all rights and defenses. On February 20, 2009, Travelers issued a denial letter stating that “there was no fire suppression sprinkler system installed in the building at the time of the loss.
THE COMPLAINTS AND CROSS-COMPLAINTS
American Way filed a complaint seeking declaratory relief against Travelers, USASIA, and A & J. After much law and motion a Second Amended Complaint (SAC) was filed that alleged that Travelers had a duty to conduct inspections of the premises, write the policy, insure the premises, and procure the policy requested by American Way.
Travelers demurred to the SAC’s bad faith and negligence causes of action. The trial court sustained Travelers’s demurrer to the SAC’s bad faith cause of action without leave to amend but overruled it as to the cause of action for negligence. Travelers filed a cross-complaint against American Way, alleging causes of action for declaratory relief and reimbursement.
TRAVELERS’ MOTION FOR SUMMARY JUDGMENT
Travelers filed a motion for summary judgment against American Way on Travelers’ cross-complaint and American Way’s SAC; and against A & J on its cross-complaint against Travelers. In support of its motion for summary judgment, Travelers submitted the following evidence.
1. Allyson Delgado, a general adjuster employed by Travelers, declared that after Travelers was notified of the fire, it issued a “good faith” advance payment to American Way in the amount of $250,000. Subsequently, Travelers was informed by Pacific Rim that there was no automatic sprinkler system installed in the premises.
2. The 2008 policy contained the Endorsement that required American Way to have an operating fire sprinkler system on the premises.
3. On November 11, 2008, Travelers sent American Way a reservation of rights letter.
4. In A & J’s response to request for admissions, it admitted under oath that it was “not acting as an agent of TRAVELERS for the purpose of procuring insurance for [American Way]” and it “acted as an insurance broker for [American Way] for the purposes of procuring insurance at” the premises.
5. In response to interrogatories, A & J stated that Hilda Castellanos, a principal of American Way, informed an employee of A & J that the premises were “equipped with a sprinkler system . . . [and based upon] the information obtained from [American Way], [A & J] prepared the application package and submitted it to USASIA.”
6. Derakhshanfar’s deposition where he testified that A & J “only represent[ed] the insured”; that A & J had never represented or been an agent of Travelers; that A & J had never represented to anyone that it was an agent of Travelers; and that in obtaining commercial property insurance, A & J went “through [a] general agent.” He also testified that the broker agreement between A & J and USASIA was terminated by USASIA because of American Way’s lawsuit against USASIA.
7. An e-mail from USASIA to Travelers stated that USASIA terminated its relationship with A & J because A & J incorrectly stated on American Way’s application that the premises were equipped with automatic sprinklers.
On April 20, 2011, the trial court granted Travelers’ motion for summary judgment against American Way and A & J “in its entirety.” In addition, the trial court held that Travelers demonstrated that it owed “no legal duty to [American Way] to investigate and verify information provided to it by [A & J].” The trial court entered judgment in favor of Travelers and against American Way in the amount of $305,205, which included $250,000 in damages and prejudgment interest.
The court of appeal noted that an insurer does not have the duty to investigate the insured’s statements made in an insurance application and to verify the accuracy of the representations. (Mitchell v. United National Ins. Co. (2005) 127 Cal.App.4th 457, 476.) Rather, it is the insured’s duty to divulge fully all he or she knows. And “[i]nsurance companies and brokers have no affirmative duty to advise their insureds to procure particular or different kinds of coverage than they obtained.” (Ray v. Valley Forge Ins. Co. (1999) 77 Cal.App.4th 1039, 1049.) The evidence showed that A & J filled out the application based on information it received from American Way, then submitted it to USASIA. In turn, Travelers relied on the representations in the application when it issued the policies.
To succeed on a theory of negligence against Travelers, American Way needed to prove that A & J, which wrote the application indicating that the premises were equipped with automatic sprinklers, acted negligently as the agent of Travelers. Although an insurer, as a principal, may be vicariously liable for the torts of its agent if the insurer directed or authorized the agent to perform the tortious acts, or if it ratifies acts it did not originally authorize, it has no duty for the actions of a broker.
Ostensible agency can only be established intentionally or by want of ordinary care of the principal that causes or allows a third person to believe the agent to possess. Ostensible agency cannot be established by the representations or conduct of the purported agent; the statements or acts of the principal must be such as to cause the belief the agency exists.
The Court of Appeal concluded that the Endorsement was a condition precedent to coverage. A condition precedent refers to an act, condition or event that must occur before the insurance contract becomes effective or binding on the parties. In general, conditions neither confer nor exclude coverage for a particular risk but, rather, impose certain duties on the insured in order to obtain the coverage provided by the policy. The Endorsement’s requirement of automatic sprinklers was a condition of coverage.
This is a case of first impression where there are no California cases interpreting protective safeguards endorsements similar to the one at issue, the Court of Appeal sought guidance in cases from other jurisdictions that hold the insured’s failure to comply with similar endorsements precluded coverage. United Capitol Ins. Co. v. Kapiloff (4th Cir. 1998) 155 F.3d 488, 496; Goldstein v. Fidelity & Guar. Ins. Underwriters (7th Cir. 1996) 86 F.3d 749, 753-754; Mangiacotti v. U.S. Liability Ins. Co. (Mass.App., Aug. 31, 2004, No. 03-P-454) 2004 WL 1933611; Tuscany Bistro, Inc. v. Sirius America Ins. Co. (N.J. Super.Ct.App.Div., Aug. 12, 2011, No. L-994-05) 2011 WL 3517000; Indian Harbor Ins. Co. v. Randolph Partners, LLC-740 Series (N.D. Ill., Aug. 10, 2010, No. 08 C 629) 2010 WL 3155974.
Applying these authorities, all of which refused coverage because of a failure to fulfill a condition precedent like the protective safeguards endorsement, the court of appeal concluded that American Way was precluded from coverage because it failed to maintain an automatic sprinkler system under the terms of the Endorsement.
The court of appeal concluded that the Endorsement required American Way to have a functioning, operational sprinkler system during the period of coverage. “Maintain” in the endorsement means that the insured is required to have a functioning, operational system. American Way’s application stated that automatic sprinklers existed on the premises and the policies were issued with that understanding.
Regardless of how the incorrect information was transmitted to Travelers, as relevant to a coverage determination, the policy containing the Endorsement required American Way to maintain an automatic sprinkler system, which it did not.
Protective safeguards endorsements have existed in first party property policies in California for more than a century. That this is the first case interpreting the need to maintain protective safeguards is not surprising because the condition was clear and unambiguous. The insured, when it acquired the policy, promised to protect the property with an operational fire sprinkler system. The promise convinced the insurer that the risk was less than to real property not protected by a sprinkler system. Normally, the endorsement also gives the insured a discount on the premium charged.
Although the court of appeal cited to a rescission case, Mitchell v. United National Ins. Co., supra, it was not asked to rescind the policy. Under California law, the material misrepresentation that there was a functioning sprinkler system would have allowed Travelers to rescind the policy from its inception as United National was authorized to rescind the policy issued to Mitchell.
This case teaches is that an insured should never lie on an application for insurance nor should it allow its agent to lie.
© 2013 – Barry Zalma
Barry Zalma, Esq., CFE, has practiced law in California for more than 40 years as an insurance coverage and claims handling lawyer. He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally, for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.
He founded Zalma Insurance Consultants in 2001 and serves as its only consultant.
Mr. Zalma recently published the e-books, “Zalma on Insurance Fraud – 2013”; “Zalma on California Claims Regulations – 2013″; “Rescission of Insurance in California – 2013;” “Random Thoughts on Insurance” a collection of posts on this blog; “Zalma on Insurance Fraud – 2012″; “Zalma on Diminution in Value Damages – 2012,”“Zalma on Insurance,” “Heads I Win, Tails You Lose — 2011,” “Arson for Profit” 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 programing, http://wrin.tv.