A deal for one business to purchase another’s property, a building with existing damage, and a certificate of insurance added up to legal trouble for an Illinois insurance agency.
Two oil refining companies negotiated for the sale and purchase of certain refining facilities. During negotiations, an explosion damaged one of the facilities in Nevada. The seller had purchased property insurance on the refinery from one of the AIG companies, through the Illinois insurance agency.
The seller had defaulted on a loan and had others outstanding. Still, after the explosion, the two companies signed a purchase agreement. They would hold one closing for a Louisiana refinery and a second for the damaged facility. The second closing would occur only after the property had met certain stated conditions.
The buyer loaned almost $14 million to the seller. In exchange, they gained access to two of the seller’s bank accounts, and the seller agreed to monitoring of its finances by a financial advisor. The buyer and insurance agency later disputed whether the loan agreement gave the buyer a claim on the business income insurance proceeds from the explosion loss. (Another creditor had first claim on payments for damage to the facility.)
The buyer paid $30 million in borrowed funds at the first closing for the Louisiana property. Three of the seller’s owners and officers became employees of the buyer, though they continued to do work for the seller and were paid by them (one served on the boards of both.) Subsequently, the financial advisor began making regular reports on the seller’s finances to the buyer.
Before the closing, the buyer’s attorney asked his counterpart with the seller (one of the three new employees) to name the buyer as a “lender’s loss payee” on the insurance policy covering the explosion damage. The insurance agency issued a certificate of insurance naming the buyer as lender’s loss payee. However, they did not send an endorsement request to AIG because the policy was due to expire within a week.
Shortly after the closing, AIG began issuing business income loss payment checks totalling $5.5 million, made payable only to the seller. Rather than forwarding those payments to the buyer, the seller used them to meet overdue financial obligations. The financial advisor included these payments in its periodic reports.
The buyer’s chief financial officer later testified that he was unaware that the seller was receiving business income loss payments. He forwarded the financial reports to the lender that financed the purchase but did not review them himself. Once he learned of the payments, the buyer’s counsel asked the insurance agency to have the buyer named on all business income loss payments. AIG endorsed the policy retroactive to the closing date, but by then it had already paid all of the business income proceeds and the seller was bankrupt.
Eventually, the buyer cancelled the purchase of the Nevada facility because the seller was unable to meet the required conditions. The buyer sued AIG and the insurance agency for failing to pay them the business income loss proceeds. The suit against AIG was dismissed. The agency moved for judgment in its favor based on the law, but the court refused because the facts were in dispute.
The insurance policy appeared to automatically cover loss payees named on certificates of insurance. The judge also found that the policy’s provisions did not “preclude (the buyer) from attaining an interest in insurance proceeds for a loss that occurred before it became a lender’s loss payee.” Indeed, the standard Insurance Services Office Loss Payable Provisions Endorsement does not contain such a restriction.
The judge’s opinion showed that the agency had a stated procedure for handling certificate of insurance requests that required policy changes. Unfortunately, the agency did not follow its procedure, and the problems followed from that mistake. Had it sent the request to AIG when it issued the certificate, AIG would have made the checks payable to the buyer.
This case is a good example of what can go wrong when an agency deviates from its normal practice. It is axiomatic that the one situation where a procedure is not followed is the one that causes trouble. This agency learned a costly lesson.