It’s a Wrap! Insurance Brokers Have No Duty to Warn Contractors When Their Wrap Policy Insurers Go Insolvent After Placing Policy

By John Armstrong

A “wrap” policy or Owner Controlled Insurance Program (OCIP) is a relatively new and popular form of insurance for construction projects. To simplify, imagine an insurer selling a monster insurance policy covering all liability risks that the developer, general contractor, and subcontractor might have for a construction project. The idea is strength in numbers, as all parties may contribute to the purchase of such insurance policy or program and also waive subrogation/indemnity rights against each other. Think economies of scale, like the power of all the States of the United States or the economic power of the Economic Union versus any one individual state or country.

A constant problem in construction related claims is what happens when a liability insurer goes insolvent. Often, there is a complex claims process akin to a bankruptcy. California’s Insurance Guarantee Association may provide some help when the insurer goes insolvent but CIGA’s liability is capped regardless of policy limits and usually cannot be recovered against if there is any other insurance available for a loss. (This can have the added event of barring liability claims against a negligent subcontractor if the subcontractor’s only available policy for a loss is a loss covered by CIGA. Recovery must be had against CIGA or not at all.)

Recently, California’s Fourth District Court of Appeal in San Diego held that an insurance broker, Aon, who placed an OCIP covering a construction project had no legal duty to warn a subcontractor covered under the OCIP issued by Legion, which insurer became insolvent—even though the insurance broker learned that Legion was insolvent before the subcontractor work was completed. The sub argued that had the broker warned the sub that Legion (the OCIP insurer) was insolvent, the sub could have obtained other liability insurance for the eventual third party claim against the sub.

First, the court recognize that insurance brokers do have a legal duty to place insurance initially but do not have, in the absence of a contract, a continuing obligation to report on the insurance placed by the broker.

Second, the court rejected public policy arguments imposing an expanded legal duty on insurance brokers to warn their clients regarding changes in an insurer’s financial condition—especially since the Legislature and California’s Department of Insurance heavily regulated insurers brokers already and because most E&O policies covering brokers would exclude coverage for such claims (in California, courts look at whether insurance is available before expanding one’s common law liability).

Third, the court found that imposing such a legal duty to monitor insurance companies placed by brokers after issuance of a policy created practical difficulty for brokers.

The moral? If you’re insurance broker or if you adjust insurance broker D&O claims, this is a great case for your defense. If you’re a contractor or developer, self-monitor the wrap liability insurer so you can decide if you need additional insurance. Or see if your insurance broker will contractually agree to monitor for you and place other coverage if the wrap insurer goes belly up before construction is completed. 

 

 

Changes to Federal Diversity Law for Liability Insurance Companies Raises Federal Jurisdictional Problems for the Insurance Bar

By John Armstrong

Congress made significant changes to the laws allowing the removal of actions filed in local state courts to be removed to federal court. Two kinds of cases have historically been allowed to proceed in federal court—even if filed and served in state courts, namely, “subject matter jurisdiction” where a federal law or policy is the gravamen of the claim and “diversity jurisdiction” where the dispute involves more than $75,000 and all of the plaintiffs and all of the defendants are residents of different states.

Congress changed what are known as the “removal statutes,” namely Title 28 U.S.C. § 1332 and § 1441. Section 1332 makes every corporate insurer, as a matter of law, a “citizen” of the state in which the insured resides, as well as the state of the insurer’s corporate incorporation, and where the insurer’s principal place of business. This is important because insurers can no longer bring declaratory relief actions against their insurers in federal court, and because insurers can no longer remove insurance bad faith actions to federal courts

Some states, like Louisiana,  allow a tort victim to sue the defendant’s liability insurer directly. In response to a large number of federal suits filed in the federal courts in Louisiana, Congress expanded the definition of “citizenship” for insurance companies. Liability Insurance companies are now a resident of the state in which they are incorporated, where their principal place of business [the corporation’s “nerve center” where its chief executive operations take place], and are deemed a resident of the same state that their insureds reside in if:

1) There is a “direct action” against a liability insurer; and

2) The insured is not joined as a party-defendant.

See the problem? “Direct action” is not defined. If the insured sues the insurance company directly for declaratory relief or for insurance bad faith, does this mean that the insurer can no longer remove to federal court? If the insurer cross-complains against the insured, is the insured now “joined” as a party-defendant? If an insurer sues in federal court first, can the insured move to dismiss for lack of diversity? The answer? Only time will tell. The answer will depend on how each court faced with these issues decides it.

A purely literal interpretation seems to preclude an insurer from removing the insured’s declaratory relief or insurance bad faith action since the insured is not a “party-defendant” at the time of the attempted removal, and the action would be a direct against an insurance company. Though the Congressional history shows that Congress intended to limit victims from suing insurers in federal court, the plain language in the Act does not contain such a limitation.

Oddly, if the insurer sues the insured first, the insured may not be able to dismiss for lack of diversity jurisdiction, since a literal interpretation of the Act only makes a liability insurer a citizen of the same state as its insured when the insured is “not joined as a party-defendant.”

If the changes to the Act are read in view of the Congressional history, a court should interpret the Act as defeating diversity jurisdiction only in actions where state law allows a victim to sue the wrongdoer’s insurer directly, which interpretation is consistent with the text’s reference to applying where insureds are not joined as party-defendants.

It’s worth noting that changes don’t apply to property insurers, i.e., “non-liability” insurers. Or do they? What if a property policy provides a defense or indemnity for a certain kind of liability claim? Would the court look to the type of policy issued or to the insuring provision? Again, only time will tell. Now, the insurance bar is free to argue either way until we get some judicial interpretation of these new changes.

Changes to Federal Diversity Law for Liability Insurance Companies Raises Federal Jurisdictional Problems for the Insurance Bar

By John Armstrong

Congress made significant changes to the laws allowing the removal of actions filed in local state courts to be removed to federal court. Two kinds of cases have historically been allowed to proceed in federal court—even if filed and served in state courts, namely, “subject matter jurisdiction” where a federal law or policy is the gravamen of the claim and “diversity jurisdiction” where the dispute involves more than $75,000 and all of the plaintiffs and all of the defendants are residents of different states.

Congress changed what are known as the “removal statutes,” namely Title 28 U.S.C. § 1332 and § 1441. Section 1332 makes every corporate insurer, as a matter of law, a “citizen” of the state in which the insured resides, as well as the state of the insurer’s corporate incorporation, and where the insurer’s principal place of business. This is important because insurers can no longer bring declaratory relief actions against their insurers in federal court, and because insurers can no longer remove insurance bad faith actions to federal courts

Some states, like Louisiana,  allow a tort victim to sue the defendant’s liability insurer directly. In response to a large number of federal suits filed in the federal courts in Louisiana, Congress expanded the definition of “citizenship” for insurance companies. Liability Insurance companies are now a resident of the state in which they are incorporated, where their principal place of business [the corporation’s “nerve center” where its chief executive operations take place], and are deemed a resident of the same state that their insureds reside in if:

1) There is a “direct action” against a liability insurer; and

2) The insured is not joined as a party-defendant.

See the problem? “Direct action” is not defined. If the insured sues the insurance company directly for declaratory relief or for insurance bad faith, does this mean that the insurer can no longer remove to federal court? If the insurer cross-complains against the insured, is the insured now “joined” as a party-defendant? If an insurer sues in federal court first, can the insured move to dismiss for lack of diversity? The answer? Only time will tell. The answer will depend on how each court faced with these issues decides it.

A purely literal interpretation seems to preclude an insurer from removing the insured’s declaratory relief or insurance bad faith action since the insured is not a “party-defendant” at the time of the attempted removal, and the action would be a direct against an insurance company. Though the Congressional history shows that Congress intended to limit victims from suing insurers in federal court, the plain language in the Act does not contain such a limitation.

Oddly, if the insurer sues the insured first, the insured may not be able to dismiss for lack of diversity jurisdiction, since a literal interpretation of the Act only makes a liability insurer a citizen of the same state as its insured when the insured is “not joined as a party-defendant.”

If the changes to the Act are read in view of the Congressional history, a court should interpret the Act as defeating diversity jurisdiction only in actions where state law allows a victim to sue the wrongdoer’s insurer directly, which interpretation is consistent with the text’s reference to applying where insureds are not joined as party-defendants.

It’s worth noting that changes don’t apply to property insurers, i.e., “non-liability” insurers. Or do they? What if a property policy provides a defense or indemnity for a certain kind of liability claim? Would the court look to the type of policy issued or to the insuring provision? Again, only time will tell. Now, the insurance bar is free to argue either way until we get some judicial interpretation of these new changes.