California Appellate Court Rules that an Insurance Broker Does Not Owe a Duty to Advise an Additional Insured Subcontractor of the Carrier’s Later Insolvency

California Appellate Court Rules that an Insurance Broker Does Not Owe a Duty to Advise an Additional Insured Subcontractor of the Carrier’s Later Insolvency

March 6, 2012
Paul Schrieffer

Dear Clients and Colleagues,

In the recently published decision Pacific Rim Mechanical Contractors, Inc. v. Aon Risk Insurance Services West, Inc., 2012 Cal. App. LEXIS 232, No. D058321 (4th Dist., Div. 1, Feb. 28, 2012), a California state appellate court ruled that an insurance broker, after procuring an insurance policy for a developer on a construction project, did not owe a duty to apprise a subcontractor that was later added as an insured under that policy of the insurer’s later insolvency, absent a contractual duty to do so.  The appellate court noted that this was an issue of first impression in California.

The case involved a construction project in downtown San Diego.  In June 1999, the project’s developer, Bosa Development California, Inc. (“Bosa”), engaged Aon as its insurance broker to obtain insurance for the project.  Aon procured a general liability insurance policy for the project with Legion Indemnity Company (“Legion”).  Legion was solvent at the time it issued the policy.  The policy was a unified, blanket insurance policy known as an Owner Controlled Insurance Program (OCIP), which provided liability insurance for every contractor and subcontractor on the project.  (These policies are also referred to as “Wrap policies.”)

In 2000, Bosa hired Pacific Rim Mechanical Contractors, Inc. (“PacRim”) as one of several sub-contractors to work on the project.  Bosa agreed to provide PacRim with liability insurance for PacRim’s work on the project. Aon was not a party to the contract and PacRim was never its client.  PacRim was added as an additional insured in October 2000.

In April 2002, during the construction project, the Illinois Department of Insurance obtained an order of conservation against Legion.  In April 2002, Aon informed Bosa, the developer, that Legion had been placed into rehabilitation.  The project was completed in 2002.  In April 2003, an Illinois court entered an order of liquidation against Legion, with a finding of insolvency against Legion.

In 2009, the project’s homeowner’s association filed a construction defect action against Bosa and its subcontractors, including PacRim.  PacRim cross-complained against Aon for negligence, asserting that Aon owed a duty of reasonable care to procure and maintain insurance in PacRim’s favor.  PacRim alleged that Aon breach its duty by failing to disclose Legion’s deteriorating financial condition and eventual insolvency.  The trial court sustained Aon’s demurrer PacRim’s cross-claims, ruling that Aon did not owe PacRim a duty to notify it of Legion’s post-issuance insolvency.  The trial court then entered a judgment of dismissal in favor of Aon.

The California appellate court affirmed the trial court’s judgment.  The appellate court cited a line of cases holding that insurance brokers owe a limited duty to their clients, namely, to to use reasonable care, diligence, and judgment in procuring the insurance requested by an insured.  An insurance broker does not breach its duty to clients to procure the requested insurance policy unless: (a) it misrepresents the nature, extent or scope of the coverage being offered or provided; (b) there is a request or inquiry by the insured for a particular type or extent of coverage; or (c) the broker assumes an additional duty by either express agreement or by “holding itself out” as having expertise in a given field of insurance being sought by the insured.  PacRim, 2012 Cal. App. LEXIS 232, at *7 (citing Fitzpatrick v. Hayes, 57 Cal. App. 4th 916, 927 (1997)).  The PacRim court further explained, relying on Kotlar v. Hartford Fire Ins. Co., 83 Cal. App. 4th 1116 (2000), that under Cal. Ins. Code § 677.2, any duty to notify an insured of the discontinuation of coverage caused by the insurer’s insolvency rested with the insurer, not the broker.  Id. at **10-11.

The PacRim court also reasoned that another factor weighing in favor of not imposing a duty on the broker was that the developer, not the subcontractor (i.e., the additional insured), was the client of Aon, and Aon had only minimal contact with the subcontractor, and that was more than a year after Legion issued the policy.  Id. at **24-25.           

The subcontractor alleged that Aon not only had a duty to notify it of Legion’s insolvency, but its “deteriorating financial condition.”  The PacRim court explained that imposing such a duty would be impractical because it necessarily creates a “duty of monitoring,” and would present brokers with uncertainty as to when the notification duty arises.  Id. at **15-16.

The PacRim court further noted that creating such a new duty could expose agents and brokers to personal liability for claims that are not covered under their errors and omissions (“E&O”) policies.  Most E&O policies exclude coverage for claims made by an insured because the insurer with whom the agent or broker placed coverage is unable to pay an otherwise covered claim because of the insurer’s insolvency.

The PacRim court noted that another practical difficulty with imposing a continuing duty of monitoring and notification after the issuance of a policy is that, in occurrence-based policies, the duty could last indefinitely, well after brokers and the client may have ceased doing business.  In the PacRim case itself, the Legion policy extended ten years after the completion of the project in 2002, more than 13 years after the policy was procured in 1999.

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