Down to Cases: Avoid Litigation by Explaining Coverage in Writing

Insurance agents and brokers are invariably sued by insureds who have a loss not covered by the policy. With the advantage of 20/20 hindsight, and the motivation of a large out-of pocket loss, the insured will argue that the agent promised or should have provided the coverage needed.
In Tennessee, insureds are charged with reading the policy delivered to them and it is not sufficient to claim that "I trusted my agent" when filing suit for a loss not covered by the policy. In the case that follows, the agent was sued because the named-peril policy issued to the insured did not cover theft. After a theft loss, the insured claimed the agent represented that the policy contained theft coverage. The agent denied the representation.
Although the agent succeeded on appeal, the lawsuit and appeal could have been avoided if the agent had explained the limitations of the coverage in writing. A named-peril policy provides very limited coverage and the letter could have been a brief recitation of the perils listed in the policy and a statement that no other coverages were available. If the insured was not satisfied with the coverage stated in a clear and short letter, the agent would have been in a position to sell an "all risk" or "direct risks of physical loss" policy that would have cost the insured more and gained the agent a larger commission.
As you read the following case, consider how the litigation could have been avoided by a professional agent communicating carefully with the insured.
In Finchum v. Patterson, the Court of Appeals of Tennessee dealt with a case where a business engaged in installing automobile accessories and stereo equipment claimed the policy sold to them did not provide the coverage ordered. The court held that equitable estoppel is not applicable against the insurance agent because the insurance company, not the agent, denied coverage under the policy and charged the insured with knowledge of the terms of the insurance contract they signed, which clearly excluded losses from theft.
The broker, Tina Davenport Patterson, operated the Tina Davenport Shelter Insurance Agency, through which she sold insurance policies underwritten by the Shelter Insurance Co. In approximately July 2000, Jeff and Michelle Finchum contacted Davenport, with whom Michelle became acquainted during school, to discuss a new insurance policy for their company, Shockwave. Finchum eventually decided to purchase a commercial fire insurance policy with a liability limit of $10,000, as well as a garagekeepers liability policy that would cover damage to or theft of a customer's automobile while it was in the plaintiffs' possession. Both policies were underwritten by Shelter. Under the commercial fire policy, Shockwave was covered for loss of or damage to the building, such as permanently installed machinery, fixtures and appliances, as well as loss or damage to business personal property, such as furniture, machinery and stock. The policy also included a provision addressing the covered causes of loss, which stated:
"Covered Causes of Loss means the following:
1. Fire.
2. Lightning . . .
8. Vandalism, meaning willful and malicious damage to, or destruction of, the described property.
We will not pay for loss or damage caused by or resulting from theft, except for building damage caused by the breaking in or exiting of burglars." (Emphasis in original.)
The court concluded from the clear and unambiguous language of the policy that it specifically excluded coverage for theft losses.
In the early morning hours of May 10, 2002, thieves threw a rock through the front window of the Shockwave store to gain entry. Once inside, they stole or damaged almost $12,000 worth of equipment and merchandise. One of the items damaged was a 1991 Toyota "show truck" in Shockwave's showroom, which was used to demonstrate products.
After the break-in, in completing a proof of loss form for her insurance claim, Finchum prepared a sworn statement listing all items that were stolen or damaged, including the value of each item. She then gave the proof of loss form to Davenport, who notarized it and sent it to Shelter.
Finchum later received a telephone call from an insurance adjustor for Shelter, informing her that Shelter would not pay for the damage to the Toyota show truck because the insurance company had not been told that the truck was located in the store. Subsequently, Shelter denied coverage for any of the theft loss or damage at Shockwave, citing the exclusion for theft in the policy.
Finchum testified that based on this July 2000 conversation and in reliance on her understanding that the commercial fire policy provided theft coverage, she purchased both the commercial fire policy and the garagekeepers liability policy from Davenport. Finchum was asked on cross examination whether she ever read the terms of the commercial fire policy. She responded, "I did not go through all of these. I looked at the cover sheet." When asked whether she ever read her policies, Finchum replied, "No, I don't. I trust my agent."
After the plaintiffs' case in chief, Davenport testified. She said that in her July 2000 conversation with Finchum regarding the commercial fire policy and the garagekeepers liability policy, Finchum did not request theft coverage. Moreover, Davenport said, she never represented to Finchum that the commercial fire policy provided such coverage. Davenport testified that the only theft coverage she and Finchum discussed pertained to the garagekeepers liability policy, which covered, inter alia, theft of a customer's vehicle while in the plaintiffs' possession. Davenport denied telling the plaintiffs after the break-in that the loss due to theft would be covered by the commercial fire policy. She explained that she visited the store after the break-in only to evaluate the damage to determine whether there was any vandalism, which the fire policy might have covered, or damage to a customer's vehicle, which the garagekeepers' policy might have covered.
The trial court issued its decision on Feb. 15, 2007. In its memorandum opinion, the trial court found that Finchum received the Shelter commercial fire policy but never read the portion excluding theft coverage. The trial court noted that the terms of the commercial fire policy excluded theft coverage, but found that Davenport represented otherwise to the plaintiffs. The trial court further found that "the Plaintiffs relied upon this representation to their potential detriment." Regarding the conduct of Davenport after the break-in, the trial court stated:

The actions of [Davenport] after the loss did not in themselves bind the company or estop the denial of coverage. These post-loss actions simply confirm that [Davenport] believed that there was coverage. It was clear that the loss was a theft, and there was no reason to prepare an inventory, prepare a claim form, or take photographs if there was no coverage for theft. The Plaintiffs relied on the agent's direction to have the glass replaced, and the Plaintiffs bound themselves to pay for the work on the assurance that there would be coverage.
The trial court found that Davenport represented to the plaintiffs that the commercial fire policy included theft coverage. It found that the policy excluded theft coverage, but that the plaintiffs did not read the exclusion, relying instead on the representation of Davenport. It also found that Patterson told Finchum after the break-in that the loss was covered. A final order was entered on April 3, 2007, in which the trial court concluded that the findings of fact supported an award of judgment in favor of the plaintiffs on an estoppel theory.
The agent appealed the order: "We surmise that the Plaintiffs may have relied on an agency theory of recovery: 'One who purports as agent to enter into a contract, upon which the principal is not bound because the agent has contracted without authority or in excess of his or her authority, is personally liable for the damage thus occasioned the other contracting party.'"
In order to pursue a cause of action against an agent instead of the principal, the court, by reference to prior decisions of Tennessee courts, held the plaintiff must have been ignorant of the lack of authority and have acted upon the faith of the express or implied representations that the professed agent had the authority assumed. If an agent, acting on behalf of a principal, contracts with a third party in excess of the agent's authority, the agent impliedly warrants that he has the authority to make the contract and is liable to the third party for damages for loss caused by breach of that warranty, unless the person who purports to make the contract gives notice to the third party that no warranty of authority is given.
In this case, the commercial fire policy stated that its terms "can be amended or waived only by endorsement issued by Shelter Insurance Co. and made a part of this policy." Finchum admitted that she received the policy. The terms of the policy unambiguously excluded coverage for damage or loss due to theft, and stated clearly that only Shelter had authority to alter or amend the terms of the policy. This language was clear notice to the plaintiffs that Davenport did not the authority to alter the provision in the policy excluding coverage for damage or loss due to theft. Moreover, the plaintiffs did not allege that Davenport misrepresented that she had authority to alter the policy. They asserted only that they did not read the policy. The appeals court concluded, therefore, that the trial was wrong and reversed the decision.
Barry Zalma, Esq., CFE, is a California attorney specializing in expert witness testimony and consulting with plaintiffs and defendants on insurance coverage and claims handling. He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He can be reached at zalma@zalma.com. He also publishes the free Zalma's Insurance Fraud Letter every two weeks at www.zalma.com.