By Lawrence T. Bowman, director, Kane Russell Coleman & LoganPC

A recent court case gives wholesale brokers good reason toreview the contractual language before signing an agreement with asurplus-lines carrier obligating the wholesale producer to policerisks—particularly when the broker doesn't have the opportunity toreview the applications being submitted or ensure the risks beingsubmitted comply with underwriting criteria.

In GeoVera Specialty Insurance Co. vs. Graham RogersInc., et al, the Eighth Circuit affirmed a ruling (onApril 13, 2011) by the U.S. District for the Eastern District ofArkansas that although insurance brokerage firm Graham Rogers Inc.(“Graham”) did not act negligently, it was liable to underwriterGeoVera Specialty Insurance Co. (“GeoVera”) based on the languagein the agreement between GeoVera and Graham—which placed the dutyon Graham to apply GeoVera's underwriting guidelines to allapplications of insurance submitted by retailers.

GeoVera and Graham entered into a surplus-lines brokeragreement that allowed GeoVera to tap into Graham's network ofinsurance agents. GeoVera also maintained an electronicresidential-homeowner-quoting and homeowner-insurance-processingsystem by which retailers, appointed by Graham, could submitapplications to GeoVera directly.

Graham entered into a retail-producer agreement with a retailinsurance agent. The retail producer submitted a homeowner'sinsurance policy application for the home of Mr. and Mrs.Balentine. GeoVera accepted their application and issued apolicy.

Read related: “E&O Basics: Why Your Clients Should Read TheirPolicies.

Soon after, the Balentines filed a claim with GeoVera for aresidential fire. During GeoVera's investigation of the claim, itwas discovered that the Balentines would not have qualified forcoverage under GeoVera's underwriting guidelines:

1. The insured's home was located on 6 acres of land, while theapplication stated it was on 5 or fewer acres. Insured lots may notexceed 5 acres under GeoVera's underwriting guidelines.
2. The Balentines had filed for bankruptcy, and the applicationstated they had not filed for bankruptcy in the previous 5years.
3. The application was not signed by the Balentines. Allapplications must be signed under the GeoVera underwritingguidelines.

After determining that the application's deficiencies could notbe attributed to the Balentines, GeoVera paid the Balentines inexcess of $780,000 on their claim.

GeoVera then filed claims against Graham asserting, among otherthings, breach of contract and negligence. Both GeoVera and Grahammoved for summary judgment. The U.S. District Court dismissedGeoVera's negligence claims against Graham due to the utter lack ofinvolvement in the underwriting process by Graham and alsodismissed GeoVera's contract claim against Graham. The EighthCircuit Court of Appeals affirmed the finding of no negligence infavor of Graham but reversed the breach-of-contract claim and foundin a strongly worded opinion that GeoVera could proceed with itsbreach-of-contract claim against Graham.

In this case, GeoVera and Graham agreed that Graham had “no partin submitting the Balentine's application.” GeoVera asserted,nonetheless, that the agreement placed a duty on Graham to “makecertain that only applications that complied with GeoVera'sunderwriting guidelines were submitted to GeoVera,” includingapplications submitted by the retailers appointed byGraham.

The issue decided by the Eighth Circuit Court of Appeals waswhether the agreement between GeoVera and Graham placed a duty onGraham to apply GeoVera's underwriting guidelines to applicationsfor insurance submitted by retailers. The Eighth Circuit agreedwith GeoVera that the agreement “placed a duty on Graham to applyGeoVera's underwriting guidelines to all applications for insurancesubmitted under the terms of the agreement, including thosesubmitted under the terms of the agreement including thosesubmitted by retailers appointed by Graham.” The Eighth Circuitremanded the case to the district court for further considerationof the breach-of-contract claim asserted by GeoVera against Graham.On remand, GeoVera moved again for summary judgment against Graham.After careful consideration, the district court granted GeoVera'smotion for summary judgment.

The district court followed the finding of the Eighth CircuitCourt of Appeals that concluded, “while retailers may help orassist Graham [Rogers] in applying the underwriting guidelines,Graham [Rogers] retained the ultimate duty to apply GeoVera'sunderwriting guidelines so that the risk to be insured fell withinthe acceptable underwriting guidelines.”

It was undisputed that Graham took no action to determine thatthe Balentines' residence fell within GeoVera's underwritingcriteria. Based on the undisputed record, the court found as amatter of law “that Graham breached its duty to apply GeoVera'sunderwriting guidelines to the Balentines' surplus-linesapplication.” The district court then awarded GeoVera $785,708.34in damages, the amount it paid the Balentines for damages coveredunder the homeowner's policy.

Lessons Learned

Surplus-lines property carriers like GeoVera sometimes do nothave extensive internal underwriting staffs. Increasingly, suchcarriers resort to computerized applications to be completed byretail producing agents. The surplus-lines carrier gains access tothe services provided by the retail producing agent and the retailproducing agent's customer base by entering into a contract with awholesale broker, such as Graham Rogers Inc.

There is no direct contract between the underwriting carrier andthe retail producing agent. Accordingly, the wholesale broker mayobligate itself, like Graham did, to submit applications for riskwhich fall within the underwriting criteria, even though thewholesale broker has no actual hand in the application process.This is a classic example of agreeing to perform a task withoutmaking sure that means or procedures exist to perform the task inthe first place.

Graham had no involvement whatsoever with the underwritingprocess, yet it obligated itself in contract to make sure the risksubmitted by the retail producer covered only those risks whichcomplied with GeoVera's underwriting guidelines.

The case exemplifies the vast difference between obligations intort and contract. No one was arguing that the wholesale broker didanything “wrong” or that they were negligent, but the fact remainsthat they obligated themselves in contract to the carrier to submitonly those risks which complied with underwritingguidelines.

It is time for all brokers to review their contracts withcarriers.

Lawrence T. Bowman, director of Kane Russell Coleman& Logan PC, practices in the areas of litigation,large loss subrogation, insurance, construction and intellectualproperty. He can be reached at [email protected].

Read related: “Invitedto a Lawsuit.”