Consider this scenario: A real estate developer plans a major construction project. The developer hires a large insurance brokerage to get liability coverage for the project. The broker arranges an owner controlled insurance program (also known as a “wrap-up”). Under this program, one commercial general liability insurance policy covers the developer and all of the contractors and subcontractors working on the project. The developer hires contractors and work commences. Before the project is complete, the insurance company providing the wrap-up runs into financial trouble and eventually becomes insolvent. The broker informs the developer of this but does not tell the contractors.
Did the broker have a legal obligation to tell the contractors that their insurer was going broke? At least one contractor thought so.
The case involved a residential development project in downtown San Diego. The year before construction started, the developer hired the broker to line up CGL coverage. At the developer’s request, the broker obtained a wrap-up program from Legion Indemnity Company. The program included liability limits of up to $25 million with coverage extending 10 years after the project’s completion. At the time (1999), Legion was solvent.
The developer then signed contracts with several construction firms. They obligated the developer to provide liability insurance for the contractors. To enroll in the wrap-up, contractors had to contact the broker and submit paperwork. In return, the broker gave them Certificates of Liability Insurance. Each certificate named the contractor as an insured and listed Legion as the primary insurer.
Eighteen months later and a few months before the project’s completion, Legion was in serious financial difficulty. The insurance department in its home state obtained court permission to safeguard the insurer’s assets, pending a decision about its fate. The broker notified the developer of this turn of events. However, neither the developer nor the broker told the contractors. The following year, the court declared Legion insolvent and ordered the insurance department to liquidate it. The wrap-up policy still had another nine years to go.
Six years later, the development’s homeowners association sued the developer and the contractors over alleged construction defects. The developer and the contractors sued each other, and one contractor also sued the broker. The contractor charged the broker with breaching its duty to obtain and maintain the insurance. It specifically stated the broker “negligently or intentionally” failed to inform the contractor of the insurer’s slide toward insolvency.
The broker asked to have the suit dismissed, claiming that it did not have a contract with the contractor. It also said that the contractor had waived all rights of recovery against it, and it had no legal duty to inform the contractor of the insurer’s troubles.
The trial court agreed. It said that the broker’s only legal duty was to use reasonable care in obtaining the insurance its client requested. The court dismissed the complaint, ruling that the broker had no obligation to advise the contractor of the insurer’s condition. The contractor appealed.
The appellate court ruled the same way. It agreed with the trial court that California law did not impose an obligation to notify an insured of an impending insolvency after a policy has been issued. In addition, the court rejected the contractor’s request that it impose on brokers a duty to notify an insured of any adverse changes in financial condition that could lead to insolvency. The duty, the court said, would be unpredictable because what constitutes an adverse change is ambiguous. If anyone had a duty to inform, it was Legion. The court also noted that many broker E&O policies contain insolvency exclusions, thus exposing the brokers to personal financial ruin.
The broker won this case in part because California law did not impose this duty on it. However, the opinion noted that several other states do impose the duty. Agents and brokers should determine the requirements for each state in which they write business. Even if the law does not impose the duty, a contract might. They should carefully review any contracts with insureds so they know exactly what their obligations are. Insurance markets present enough challenges for agents and brokers without the added burden of avoidable obligations.