From the March 2012 issue of American Agent & Broker •Subscribe!

Just the Facts

It’s expensive to lie to your insurer

When facts essential to a decision to insure or not insure a particular risk are misrepresented or concealed there is no basis for a contract of insurance and it can be, and should be, rescinded. In Mountain City Ford LLC v. Owners Insurance Co. and Auto-Owners Insurance Co. No. 2009-CA-002233-MR (Ky.App. 09/02/2011), the Kentucky Court of Appeals agreed.

Insurance agents and brokers who place insurance for businesses in which they hold financial interest will find that they are held to the duties of an agent for the insured rather than an agent for the insurer, even if the agent has an effective agency agreement with the insurer allowing it to bind insurance.

Ultimately, the issue resolved by the court was whether Mountain City Ford or Auto-Owners should bear the loss for $1.03 million paid in settlement to the original plaintiffs for injuries, including the death of Joey Kirk. These injuries were incurred in a motor vehicle accident between a Mountain City Ford vehicle driven by Rick Gussler and another vehicle driven by Paul Justice. Auto-Owners’ policy insuring Mountain City Ford was predicated upon an insurance application prepared by The Elite Agency (Elite) and signed by Mountain City, but the policy did not list Gussler as a driver.

All parties agreed that Auto-Owners never knew of Gussler’s existence as a driver of Mountain City vehicles. It was undisputed that Gussler was not listed anywhere on Mountain City’s application to Auto-Owners and the proof at trial was undisputed that had Gussler been listed, Auto-Owners would never have issued the policy to Mountain City Ford.

Related: Read Zalma's previous column "Valued Advice."

Mountain City Ford and Mountain City Chevrolet are two small dealerships in Inez, Ky., that are owned by James Booth; his daughter, Angela Wilson; and Craig Preece. When they purchased the dealerships they had separate garage insurance policies with Universal Insurance.

Elite is an independent insurance agency founded in 1989 by Jim Booth, Craig Preece, and two other investors. Elite entered into an agency contract authorizing it to write insurance contracts for Auto-Owners.

Auto-Owners is a regional insurance carrier headquartered in Michigan. Auto-Owners writes property and casualty insurance as well as other lines. In 2007, Auto-Owners had a regional office in Lexington, Ky..

Marlena Lafferty was a young insurance agent who worked in Elite’s Inez office. When she heard that Craig Preece, as co-owner of Elite and Mountain City, had suggested that Elite try to write insurance for the Mountain City dealerships, she began gathering information for an application to CarPac, another insurance company, to compare premium prices. Ultimately, she submitted the CarPac application on Oct. 19, 2007, for both Mountain City dealerships. Page 12A of the CarPac application was an "employee/non-employee list."

On the CarPac application, Lafferty identified all 27 dealership employees and clearly disclosed that Rick Gussler was a salesman who was "not licensed." Lafferty testified that this information came from emails with Mountain City Ford in the first half of October. She also testified that in a telephone conversation with Wellman, he told her both Rick Crum at the Chevrolet dealership and Rick Gussler at the Ford dealership were prohibited from driving dealership vehicles because they did not have driver’s licenses.

The Auto-Owners Application

Mark Grim was the only person who completed the Auto-Owners application for the Mountain City dealerships. He admitted that he only had one phone call with Wellman about the dealerships’ inventory but otherwise had no contact with the dealerships about the application. Grim testified that he never saw Lafferty’s revised page 12A of the final CarPac application that listed all 27 employees of the dealerships, their jobs, their driver’s license numbers, and whether they were furnished dealership vehicles. As a result, the list of 16 drivers Grim submitted to Auto-Owners was inaccurate, compared to the information the Mountain City dealerships had supplied to Lafferty for the CarPac application.

The Mountain City dealerships application was the first Grim ever submitted to Auto-Owners. He did not read Elite’s Agency Contract with Auto-Owners or its underwriting guidelines before preparing and submitting the application for Mountain City.

Grim calculated the premium for Auto-Owners based on total payroll for all employees except any clerical staff who never drove dealership vehicles. At the end of the year, Auto-Owners would audit the payroll and adjust the premium up or down. Even though Grim did not know Gussler, Gussler’s compensation was included as a salesman in the total payroll figures; therefore, Mountain City alleges on appeal that Auto-Owners did receive and did collect from Mountain City Ford the full premium for Gussler, regardless of whether he "drove" or not.

Abby Douglass worked as an underwriter in the Lexington underwriting office of Auto-Owners until January 2008. Elite never disclosed Gussler as a salesman without a driver’s license, even though such information was disclosed to CarPac. Unbeknownst to Craig Preece, Grim was uninformed about both Gussler being an employee and the Eligibility Guidelines of Auto-Owners.

Related: Read another column by Barry Zalma "Sell What You Know."

Lee Rademacher was the Kentucky vice president for Auto-Owners. Elite was awarded the agency contract from Auto-Owners for Lexington and Catlettsburg by his predecessor. Rademacher met with Grim and underwriter Amy Bradford in the summer of 2007 about Elite pursuing the insurance business of the dealerships for Auto-Owners. Claudia Clawson was the head underwriter for Auto-Owners in Lexington. She confirmed that coverage for Mountain City Ford was bound by Elite as agent when Mark Grim submitted the completed application, effective as of Nov. 9, 2007.

At trial, Auto-Owners defended Mountain City Ford and Gussler, but did so under a reservation of rights. Despite its misrepresentation coverage defense, Auto-Owners settled the claims for a total of $1.03 million and then pursued this action to void the policy and seek reimbursement from Mountain City and Elite under theories of material misrepresentation and negligence.

Auto-Owners sought rescission and reimbursement from the dealerships for material misrepresentation because Gussler was not listed on the list of "drivers" in the application prepared by Elite. Elite knew of the existence of the unlicensed salesman and had disclosed him on an application to another insurance company, CarPac, but omitted to inform Auto-Owners of his existence. At trial, the jury found against Mountain City but found that Elite was not liable for its failure to list Gussler on the drivers list on the application to Auto-Owners. Mountain City filed a motion for judgment notwithstanding the verdict, arguing that Elite was acting as Auto-Owners’ agent under Kentucky law and, thus, that the policy should not be voided ab initio.

The trial court denied Mountain City’s motion for judgment notwithstanding the verdict, holding that Elite was acting as the agent of Mountain City or as a dual agent for both Auto-Owners and the dealerships when it submitted the application for insurance coverage. Flener v. Pac. Indem. Ins. Co. (In re Miller), 267 B.R. 785 (Bankr. W.D. Ky. 2000) (applying Kentucky law), and State Farm Mutual Ins. Co. v. Crouch, 706 S.W.2d 203 (Ky. App. 1986), the court held:

The jury has made the factual finding to the effect that Richard Gussler was in fact a driver of insured vehicles; that the omission was material to the risk; and that the Auto-Owners would not have issued the policy of insurance had that fact been known.

Those facts, coupled with the extraordinarily close relationship between Mountain City Ford, and the Elite Agency, persuaded the Court of Appeal that Elite was acting either as the agent for Mountain City or at the very least, was acting in the capacity as a dual agent, for both Mountain City Ford and Auto-Owners in preparing and submitting the application for insurance, and then issuing a binder.

Under Kentucky law, whether an insurance agency is an agent for the insured or the insurer when preparing and submitting an application, given alleged material misrepresentations in an application, no one factor is determinative. Agency must be decided on a case by case basis.

Even if an agency was the insurer’s agent for binding purposes, it did not necessarily mean that it was the insurer’s agent during policy issuance.

The Court of Appeal concluded that Elite was Mountain City Ford’s agent. Specifically, the proof was that Craig Preece, as CFO for Mountain City, signed and verified the application as required by Auto-Owners, and he had the full opportunity to review the application, even though he testified that he did not read the application.

Related: Read the article "No Duty to Benefit Consult" by Barry Zalma.

The evidence also demonstrated extensive special circumstances to support a finding that Elite was acting as Mountain City’s agent during the application and policy issuance process. In fact, Mountain City and Elite had the long standing relationship where the companies shared common ownership. Given all this evidence, the Court of Appeal concluded that the special close relationship and circumstances between Elite and Mountain City Ford supported a finding that Elite was acting as Mountain City Ford’s agent when it bound coverage through Auto-Owners.

Furthermore, careful examination of the insurance treatises such as Couch on Insurance 3d, Vol. 3 (2009) § 45:1 reveals the general rule that where an agency is "independent" (represents many insurers) as opposed to a sole agent (represents one insurer exclusively), the broker acts as an agent for the insured in the application process. Couch notes that the courts often use the terms "broker" and "agent" interchangeably, but that there is an important distinction in that acts of a broker are imputed to the insured versus the acts of an agent, which are imputable to the insurer.

Lesson

An insurance agent or insurance broker is professionally obligated to professionally represent its principal (whether the prospective insured, the insurer, or both) and be certain that the facts stated in the application for insurance are correct and complete. Failure to do so can place the agent or broker in a position of being held responsible for losses suffered by the insured.

In this case the insurer acted with the utmost good faith—more than the insured was entitled to receive—by providing a defense and settling the case against the insured while reserving its right to recover from the insured. Because the agent also was an owner of the insured its negligence in not providing accurate information to the insurer was sufficient to allow the insurer to rescind and recover the money it paid for the defense of the insured and for the settlement with those suing the insured.

It would appear that the agent, Elite, will be sued by the dealer who is now faced with a judgment of more than $1 million and will probably seek indemnity from Elite for its negligence even though the jury found Elite was not liable to Auto Owners for failing to list the unlicensed driver it may be found liable to the insured for breach of its duty of care.

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