Brokers may be found liable for damages to third-party'intended beneficiaries'
Here is an unusual California case that an agents organization hasbeen trying to get “depublished” so it can't be cited as precedent.Could this case mark a new threat to agents and brokers? How muchmust they do to “to secure insurance policies for their clientsthat meet their clients' needs”–particularly when those needs mayinvolve a third party?)

In July 2000, a business hired a software company based in Indiato write a customized computer program for it. The contractobligated the software company to carry errors and omissionsinsurance and to compensate the business if the software companyfailed to deliver the promised software.

The business asked a retail insurance broker to arrange E&Oinsurance for the software company. The agent forwarded theinformation it received from the business to a surplus-linesbroker. The broker contacted an insurer that issued a policy forthe software company. Although the software company was an Indiancompany doing business in India, the policy excluded coverage forany claims arising from, or related to, work performed inIndia.

The software company failed to deliver usable software to thebusiness, which sued it for breach of contract. Based on theexclusion for work done in India, the software company's carrierrefused to defend or indemnify.

A trial court entered a $922,480 default judgment against thesoftware company. But without insurance coverage, the judgment wasuncollectible.

The business sued the surplus-lines broker for negligence inprocuring a policy that did not cover work done in India. Citingthe absence of any direct dealings between it and the business, thebroker demurred, claiming it owed no duty of care to the business.The trial court agreed and sustained the broker's demurrer withoutleave to amend. [Findlaw's dictionary defines demurrer as "a pleain response to an allegation (as in a complaint or indictment) thatadmits its truth but also asserts that it is not sufficient as acause of action."] The business appealed.

The issue before the appellate court was whether thesurplus-lines broker owned a duty of care to the plaintiff eventhough the two parties had no direct contact and were not inprivity of contract, and despite the fact that the plaintiff wasnot named on the policy.

The appellate court noted that In Biakanja v. Irving [49 Cal.2d647 (1958)], the California Supreme Court took up this question.The case involved a notary public who wrote a will that lackedsufficient attestation. The plaintiff, who was a beneficiary of thewill, therefore did not receive the estate she would have receivedhad the will been prepared properly. The high court consideredseveral factors to determine whether a duty of care existed: “Theextent to which the transaction was intended to affect theplaintiff, the foreseeability of harm to him, the degree ofcertainty that the plaintiff suffered injury, the closeness of theconnection between the defendant's conduct and the injury suffered,the moral blame attached to the defendant's conduct, and the policyof preventing future harm.” After weighing these factors, theSupreme Court held that the plaintiff could recover from the notarypublic, despite the absence of privity of contract.

In the case at hand, the appellate court concluded that thecomplaint's allegations contained several factors supporting thefinding of a duty of care. First was the extent to which thetransaction was intended to affect the plaintiff. The surplus-linesbroker said the transaction was primarily intended to affect thesoftware company, but the justices disagreed. Although the softwarecompany was the named insured, it bought the policy to meet arequirement in its contract with the plaintiff–specifically toprotect the plaintiff in the event the software company breachedits contract. Therefore, the insurance transaction greatly affectedthe plaintiff, the justices noted.

The second test under Biakanja was the foreseeability of harm tothe plaintiff. The surplus-lines broker argued that the harm wasnot foreseeable because no one intended for the software company tobreach its contract. According to the broker, if the breach ofcontract had been foreseeable, the plaintiff presumably would nothave awarded the software company the contract. The appeals court,however, found the plaintiff's response more convincing: “Insuranceexists to protect against unlikely, but nevertheless possible, andthus foreseeable, events.”

The third test was the degree of certainty that the plaintiffwould suffer injury. The surplus-lines broker argued that thecertainty of harm was minimal, especially since the softwarecompany did not contest the plaintiff's complaint, electing to haveits default entered instead. Since this was an appeal from ademurrer, the appellate court accepted the plaintiff's allegationthat it was injured in an amount at least equal to the $922,480default judgment. Moreover, to the extent the surplus-lines brokerargued that the damage award had little or no veracity because itwas taken by default, the appeals court said the surplus-linesbroker ignored the fact that the trial court held a prove-uphearing. Such a hearing provided some measure of substance to theplaintiff's claimed damages, the court said.

The appeals court also considered the moral blame attached tothe surplus-lines broker's conduct and the public's interest indiscouraging such conduct. The court said the surplus-lines brokervoluntarily assumed the responsibility of finding insurance for thesoftware company and was obligated to discharge that responsibilitycompetently, which it had failed to do. Moreover, said the court,imposing liability would have the salutary effect of encouraginginsurance brokers “to secure insurance policies for their clientsthat meet their clients' needs.”

The final and perhaps most problematic test, said the justices,was the degree of connection between the surplus-lines broker'sconduct and the plaintiff's injuries. The surplus-lines brokercontended that among all the parties involved, the connectionbetween it and the business was the most tenuous. The appellatecourt said that, in a sense, the plaintiff was a third-partybeneficiary of the software developer's insurance policy. The courtsaid the issue was whether the business was an intended third-partybeneficiary–to which the broker owed a duty of care–or merely anincidental third-party beneficiary, to which the broker owed nosuch duty.

The appellate court cited Jones v. Aetna Casualty &Surety Co. [26 Cal.App.4th 1717 (1994)], a case that it saidexplains that whether a third party is an intended or incidentalbeneficiary “involves construction of the parties' intent, gleanedfrom reading the contract as a whole in light of the circumstancesunder which it was entered.” In Jones, a landlord was obligated tomaintain rental income insurance at a tenant's expense. When theproperty was damaged and the tenant could not pay rent, thelandlord notified the insurance company, which failed to pay. Thetenant then sued the carrier for breach of the covenant of goodfaith and fair dealing, and claimed that he was being sued by thelandlord because the insurance company breached its obligations.The court held the tenant could not enforce the contract becausethe tenant was never an intended beneficiary of the contract. Thecourt said the fact that the tenant would have received somebenefit, had the insurer indemnified the landlord for loss ofrental income, only would have made the tenant an incidentalbeneficiary. In contrast, the plaintiff in the case at hand woulddirectly benefit if the insurance policy paid. Therefore it was notmerely an incidental beneficiary.

An intended beneficiary, the justices said, does not need to bespecifically named, as long as it is in the class of members thatthe insurance is intended to benefit. The court cited Harper v.Wausau Ins. Co. [56 Cal. App. 4th 1079 (1997)] as an exampleof a case involving intended beneficiaries. The case involved aninsurance policy containing a provision that expressly conferred abenefit directly on third parties who were injured on the insured'sproperty. “As an intended third party beneficiary,” the court inHarper said, “plaintiff had a right to enforce thecontract.” In the case at hand, the justices said that although theplaintiff was “not quite an intended beneficiary, it comes closeenough to being one that imposing a duty on (the surplus-linesbroker) is within the spirit of Biakanja.” Just becauseother parties, such as the retail insurance broker, had closerconnections to the plaintiff did not mean the surplus-linesbroker's connection was legally inadequate. The court noted thatthe plaintiff made the initial contact with the retail broker (whothen contacted the surplus-lines broker) because it considereditself the policy's intended beneficiary. Most important of all,the justices said, the contract between the plaintiff and thesoftware company called for such an insurance policy. The courtinferred that the retail broker notified the surplus-lines brokerof this when it relayed to it the information it received from theplaintiff.

Imposing on a party a duty of care to non-client third partiesdoes not require a reworking of accepted legal principles, said thecourt, particularly when, as here, the surplus-lines broker was aprofessional entity rendering specialized services. It cited otherstate cases in which accountants and real-estate brokers similarlywere held liable to third parties.

The lower court's judgment was reversed and the matter sent backto the trial court for further proceedings. In a footnote to thecase, the justices said: “We confine our analysis to the somewhatparticularized facts of this case. Nothing in our opinion suggeststhat in a more typical case (e.g., an automobile accident) aninjured third person has a cause of action against the at-faultparty's insurance broker for failing to secure coverage that mightcompensate the injured party for his damages.”

Business to Business Markets Inc. v. Zurich Specialties, 135Cal.App.4th 165, 37 Cal.Rptr.3d 295. 135 Cal.App. 4th 165, 37Cal.Rptr.3d 295, 2005 Daily Journal D.A.R. 14,875, 2005. CA.0011578 (www.versuslaw.com).

Don Renau is a retired agent and practicing attorney inLouisville, Ky. As an attorney, he consults for agencies andbusinesses in Kentucky. He also conducts P&C insurance trainingby line (non-CE credit) for agencies, either in person or by CD. Hecan be reached at [email protected] or at (502) 893-202.