By Barry Zalma, ESQ., CFE, owner, Zalma InsuranceConsultants

The Coventry First case should cause great concern to allinsurance agents and brokers. In People ex rel Cuomo v.Coventry First LLC, No. 115 (N.Y. 06/30/2009), New York found,on the basis of a pleading issue where the court was required totake the language pleaded to be true, a fiduciary relationshipwhere one had never existed before. A fiduciary relationship existsbetween two persons when one of them is under a duty to act for orto give advice for the benefit of another upon matters within thescope of the relation, such as a trustee or executor.

Although Coventry First deals with sellers of life settlementcontracts, different from viatical contracts, New York hasestablished that a fiduciary relationship exists between the sellerand the buyer of a life settlement contract. If courts across thecountry follow this decision and expand it from its narrow holdingto apply to all insurance agents and brokers–imposing on them afiduciary duty, including the disclosure obligations that go withsuch duties–it will expand the potential scope of brokers' civilliability for a broader range of conduct.

Related: Read Barry Zalma's July column “Never lieon a COI.”

The New York decision appears to reverse a number of judicialprecedents relieving brokers from fiduciary liability for what theydo in obtaining insurance for their clients. It also could renderbrokers subject to liability for a wide range of alleged errors andomissions in the conduct of their businesses by imposing afiduciary duty on the agent or broker rather than the obligation tofulfill the much less stringent general duty of care of all othercontracting parties.

Life settlement contracts

In recent years, a variation on viatical insurance has developedin the U.S., selling life settlement contracts that are basicallyunregulated. Viatical contracts involve a policy seller who suffersfrom a catastrophic or life-threatening illness or condition thatis regulated by the state. In life settlement contracts, investorsbuy from life settlement providers insurance policies from policyowners for cash, ultimately receiving the policy benefits when theinsureds die.

For example, a company holding a policy insuring the life of aretired executive decides to sell the policy to avoid payingpremiums. The company contacts a life settlement provider, whichbuys the life insurance policy from the company for an amountexceeding the surrender value offered by the insurer, calculatingthat the value of the death benefits exceeds the purchase price,transaction costs and continued premiums.

The life settlement industry claims it employs a competitiveauction model. The policy owner–or the owner's financial advisor oragent–will often hire a broker to solicit competing bids for thepolicy from life settlement providers.

The attorney general's suit

In October 2006, the attorney general of New York Statecommenced an enforcement action against Coventry First LLC; itsparent corporation, Montgomery Capital Inc.; its executive vicepresident Reid S. Buerger; and an affiliate, The Coventry GroupInc. (collectively “Coventry First”), alleging fraudulent andanti-competitive conduct. The attorney general alleged that thelife settlement provider defendants engaged in bid-rigging bypaying substantial, concealed commissions to life settlementbrokers, who in return persuaded their clients to acceptdefendants' offers rather than higher bids from rival lifesettlement providers.

The attorney general also claimed that defendants concealed ascheme of “gross offers,” where brokers were allowed to determinehow much of a purchase price paid by defendants they would keep andhow much they would pass on to the policy seller. The attorneygeneral also alleged falsification of documents.

The attorney general sought damages “on behalf of the owners oflife insurance policies who have been damaged by the schemes” andinjunctive relief preventing further misconduct. Defendants movedto dismiss plaintiff's complaint pursuant to CPLR 3211 (a) (7).Relevant to the appeal, the Supreme Court (the New York trialcourt) denied defendants' motion to compel arbitration and allowedthe attorney general's breach of fiduciary duty cause of action toproceed, along with two others. The appellate division reinstatedthe common law fraud cause of action, dismissed by the SupremeCourt, and otherwise affirmed (52 AD3d 345). The same court thengranted leave to appeal further, certifying the question of whetherSupreme Court's order, as modified by the appellate division, wasproperly made. The Court concluded the order was properly made.

On appeal, defendants challenged the appellate division'sdecision insofar as it allowed the attorney general's sixth causeof action, alleging inducement of breach of fiduciary duty, toproceed.

Claim of fiduciary relationship

The attorney general claimed that defendants “aided and abetted,participated in, and benefitted from” the life settlement brokers'breach of fiduciary duties to their clients. The court, therefore,needed to determine if the facts concerning life settlementbrokers, as alleged by the attorney general, fit within the legaltheory of fiduciary duty. Noting that “[A] fiduciary relationship'exists between two persons when one of them is under a duty to actfor or to give advice for the benefit of another upon matterswithin the scope of the relation'” (EBC I Inc. v. Goldman Sachs& Co., 5 NY3d 11, 19 [2005], quoting Restatement [Second]of Torts ? 874, Comment a). It exists only when a person reposes ahigh level of confidence and reliance in another, who therebyexercises control and dominance over him.

According to the attorney general, life settlement brokers holdthemselves out as working to obtain the highest purchase price fortheir clients' policies. A promise to obtain for a client the“highest possible” offer–in contrast to, for example, simply“obtain[ing] requested coverage for [a client] within a reasonabletime or inform[ing] the client of the inability to do so… [with] nocontinuing duty to advise, guide or direct a client to obtainadditional coverage” (Murphy v. Kuhn, 90 NY2d 266, 270[1997] [citations omitted])–would, if made in a manner that theclient could reasonably rely upon, suggest a fiduciary duty.

The allegations of the suit describe a set of circumstances inwhich life settlement brokers, by claiming relationships with largenumbers of other financial institutions and professionals, and bypersistently representing that they seek the highest possible offerfor their clients' life insurance policies, hold themselves out tobe highly skilled experts and are on notice that their clientsespecially rely on their advice. The sale of life insurancepolicies is alleged to be a relatively new and largely unregulatedindustry–one in which even sophisticated clients rely on what theytake to be expert advice when seeking offers on policies they wishto sell. These allegations comport with the legal theory offiduciary duty.

The court concluded that the attorney general's allegationssufficiently state a claim that defendants knew the life settlementbrokers' conduct constituted a breach of fiduciary duty.

Defendants' only argument is that they could not have had therequisite knowledge because the current case was the first time afiduciary duty on the part of life settlement brokers had beenannounced in this jurisdiction. Rejecting the argument, the courtnoted that the attorney general's complaint cited a Life SettlementInsurance Assn. white paper, published in 2006, which states thatthe life settlement broker “has a fiduciary role to represent theseller by law…the bottom line is that the broker's job is to fullyrepresent the interests of the policy seller.” The complaint wasalso accompanied by an exhibit of e-mails between Coventry Firstexecutives who refer to the fiduciary duties of life settlementbrokers.

The court rules required it to accord the attorney general thebenefit of every possible favorable inference on a motion todismiss, found it had no option but to conclude that the attorneygeneral sufficiently alleged defendants' knowledge of the lifeinsurance brokers' fiduciary duties.

By claiming a fiduciary duty, the life settlement industrydestroyed its own argument and may have, by implication, forced allinsurance brokers and agents into a fiduciary relationship theynever accepted.

Agents or brokers concerned about the imposition of fiduciaryrelationships should consult with their lawyers to create acontract with each of their clients establishing the duty of care,and obtaining an agreement from the insured that the broker is nottaking on a fiduciary relationship.

Barry Zalma, Esq., CFE,is a California attorney specializing in insurance coverage,insurance claims handling and fraud who serves as a consultant andexpert for insurers and policyholders. He founded Zalma InsuranceConsultants in 2001 and serves as its senior consultant. Herecently published an e-book, “Insurance Fraud,” which is availableat his website, www.zalma.com.Contact the author or access his free insurance fraud newsletter at[email protected].