With my apologies to Vince Lombardi, I must dissent from his oft-quoted advice that "the best defense is a good offense." In the civil justice system, the best defense is one that someone else pays for.
This quarterly column is usually about avoiding E&O exposure, but even the best preventative measures will only make an insurance professional bullet resistant, not bulletproof. Just as the unlucky policyholder doesn’t expect the joy rider to collide with his new Camaro, his insurance agent can’t anticipate everything. E&O claims are going to happen. They may be bogus or righteous, but one thing is certain: They are expensive to defend against.
Whether on the defense or offense, someone has to pay the price of admission to the courthouse. The litigants themselves pay that price, or most of it, and the unfortunate truth is that the price can be higher than the value of winning or the risk of losing—not always, but often enough that a victory at trial may be a Pyrrhic one.
Here’s the problem: By the time the case reaches the courthouse steps, it’s usually too late to pass the financial burden of achieving vindication, or trying to, to someone else. Insurance agents and brokers know this instinctively; it’s one of the biggest selling points of liability insurance.
The greatest benefit under a liability insurance policy is the right to be defended against a covered claim at the insurer’s expense, regardless of the actual outcome. Being defended by an insurer levels the playing field, giving the defendant the opportunity to get his or her day in court without the financial burden of paying the fees and costs of getting there, other than the agreed upon deductible. Note that being defended doesn’t make the decision to go to trial free from costs; insurance brokers and other professionals bear the very real cost of lost business while sitting next to their defense counsel for a week (or more). That is a type of business interruption that even insurance does not cover.
Although the broker’s own liability coverage is usually the best way to pass the fees and costs of litigation to someone else, there are other, less reliable options that should be considered supplements to one’s own insurance.
Contractual indemnity clauses
Contractual indemnity clauses
Appointed agents’ contracts with insurers often contain indemnity clauses, which can stipulate that the insurer pays for its agent’s defense. Here’s the catch: These clauses are usually reciprocal, and don’t kick in until it has been determined that the agent or the insurer was at fault. Because the finding of fault occurs at the end of trial, the parties already have trod the long, expensive road before any of them can claim entitlement to be indemnified.
Even when the verdict comes in, there is no guarantee that it will resolve who pays for whose defense. A general verdict is often just a number, preceded by a dollar sign, without a rationale or specific finding of degrees of fault. It can leave the defendants as much in the dark as they were before the verdict, other than knowing that they are jointly and severally liable to pay a sum certain to the plaintiff if the verdict stands up against post-trial legal challenges.
State laws may further restrict the application of indemnity agreements. Some states prohibit a contract from indemnifying a party against the consequences of his "active" fault, gross negligence, or some other term describing improper conduct. Other laws turn one-way indemnity agreements into reciprocal ones when the indemnity is dependent on who is the prevailing party at trial.
Contractual indemnity is clearly not a one-size-fits-all solution to the problem of funding one’s defense. It can be useful in many instances, but how it will apply turns on the facts of the case and the controlling law.
In some states, California among them, a defendant who is only passively at fault (who erred by omission rather than affirmatively acting to cause the harm) may obtain implied indemnity from defendants who are actively at fault. This remedy shares the same defect as the reciprocal indemnity clause, in that the parties don’t know who owes indemnity to whom until the end of the case, after the horse has left the proverbial barn. Still, it is better to assert this potential right of recovery at the outset of the case, and to await the decision of 12 good citizens, rather than lose the right through inaction.
Implied indemnity is not based on contractual clauses or legal relationships, such as agency. Where it exists, it is a statutory or judicial recognition that a party who actively causes the plaintiff harm should bear the entire burden of that harm, and should not share it with those who merely neglected to stop the actively liable party.
Imagine that a lone gunman enters a bank and randomly shoots three people, and that the security guard who should be on duty at the time arrives too late to stop the shooting. That is a classic case for implied indemnity—the active wrongdoer and the passively responsible guard. So the gunman should pay for everything, right?
In a moral sense, yes, but not in a legal one. First, the three injured patrons are still entitled to recover their damages, or at least their out-of-pocket damages, from any and all defendants who are found liable, regardless of degree. (Note: Not all states follow this rule.) Second, while the security guard may have implied contractual indemnity as against the gunman, how many gunmen actually carry high enough limits of liability to pay for the damages that they cause, or are independently wealthy? The implied indemnity right is only as strong as the active wrongdoer’s available resources. Third, implied indemnity does not necessarily include the passively responsible party’s defense fees and costs, which brings us back to the theme of getting someone else to pay for one’s defense.
Insurance professionals in E&O cases are rarely pitted against lone gunmen, but the analogy holds in less dramatic settings, where, for example, a wholesale broker has advised the producer of a change in coverage terms upon renewal, and the producer, who has the direct contact with the policyholder, fails to advise him of the change. That may be a more feasible setting for implied indemnity, and the producer may even have adequate E&O limits to make the argument worthwhile.
Additional insured: myth or legend?
Additional insured: myth or legend?
Additional insured status under another party’s liability insurance policy can be a great way to pass the litigation buck, but it, too, is not a panacea. For the insurance agent or broker, there may not be many contracting parties who are willing to offer a free ride on their own E&O policies for the right to do business together.
Insurance professionals know that a contractual clause that requires Party A to name Party B as an additional insured on Party A’s liability policy doesn’t automatically make it so. Absent certain blanket endorsements that are more commonly seen in the construction industry than in the insurance context, nobody is added as an insured on another’s policy without an endorsement being issued. Even a certificate of insurance that states Party B is an additional insured isn’t worth the ACORD form it’s written on unless the certificate issuer has actual binding authority to add insureds, or the insurer endorses Party B onto the policy.
Being an additional insured has its advantages—no premium to pay, a direct contractual relationship with the other guy’s insurer and no annoying phone calls as renewal approaches or cards on your birthday. It also has its drawbacks—you don’t get to choose the insurer, Party A’s other claims can reduce the amount of coverage available to you, and you may have to pay a higher deductible than you have on your own policy.
Additional insured status also can have surprising consequences. Because Party A and Party B are now both insureds under the same policy, a claim between the two of them is now an "Insured v. Insured" claim, which may be excluded from coverage. Other exclusions and provisions may also be triggered, depending upon whether they apply to "any" insured, "the" insured, "all" insureds, or other qualifying language.
It’s good practice to see the actual policy under which you, as Party B, will become an insured, so you know exactly what rights your new status will and will not confer.
The civil justice system has been described as "the least efficient way ever devised to move money from Point A to Point B." Surely, the system accomplishes something more than that, but even in a case that reaches a defense verdict that becomes a final judgment and is affirmed on appeal, the transfer of money is a major part of what occurs.
In writing on avoiding E&O exposures, my usual theme is that your best defense is the one that you never have to assert, because you have avoided an E&O pitfall. Can you really avoid them all, even the baseless ones that are brought against the only perceived deep pocket in the room? For those cases, where the system’s ability to move money is demonstrated, please take steps to ensure that the smallest amount of money in motion will be your own.