Insurance professionals spend a lot of time looking for ways to avoid errors and omissions exposures. They are careful to hire the right people, provide training and put management systems in place to ensure quality work. But a few overlook what is perhaps the most obvious avoidance mechanism: not taking on someone else’s liabilities.
When an insurance agency or brokerage firm buys another firm or some of its business, the acquiring firm may become heir to the purchased company’s liabilities, along with its customer lists.
Even if the transaction is structured as a purchase of assets, rather than a continuance of the acquired agency under a new name, a sufficiently aggrieved plaintiff may look behind the formalities to try to establish that the purchasing company is liable for mistakes made by the acquired company. Properly structuring an acquisition transaction can be the proverbial stitch in time that saves nine, or perhaps even $900,000.
E&O policies typically afford coverage for claims that arise out of a brokerage firm’s insurance placements made on behalf of that firm’s customers. Coverage may not extend to claims against an acquiring firm that arise out of pre-acquisition transactions made by the purchased firm, or claims might not be covered due to a retroactive date.
The case of the painter’s predicament
A Delaware court case, decided just over a year ago, illustrates the point.
A young boy living in an apartment became ill and tested positive for lead poisoning. The apartment owner hired Kniceley, a licensed lead abatement company, to remove the paint and any dust, and to repaint the premises. Kniceley hired a subcontractor to handle the lead removal, and once the job was done, the subcontrator reported to Kniceley that the apartment was lead-free. Five months later, in August 2005, the boy’s condition grew worse, and he sustained serious physical and other impairments due to lead poisoning.
Kniceley had obtained liability insurance coverage from Cumberland Insurance, through Downes Insurance Associates. In 2006, the year after the insurance placement in question, Downes sold its P&C insurance business to the Harrington Insurance Agency per the terms of an asset purchase agreement.
Two months later, the injured boy’s legal representative filed suit against the landlady, who cross-complained two years later against Kniceley and his subcontractor. Cumberland Insurance denied coverage for the claim, based on the “total pollution exclusion” in its policy. Kniceley reached a settlement with the property owner in 2011 for $350,000 plus interest and costs. The landlady’s insurer, Farm Family Casualty Co., then sued Downes and Harrington (having received an assignment of rights from Kniceley), and also Cumberland, asserting that the Cumberland policy did cover the original claim, despite the pollution exclusion.
Let’s reflect on how a tragic event—a boy permanently injured by lead poisoning—morphed into an E&O claim against the Harrington Agency:
- Though it committed no error at all in any insurance placement, Harrington is one of five parties in an E&O/coverage lawsuit
- There is no hint as to whether Downes & Associates did anything wrong, either—no evidence that Kniceley asked for pollution coverage or that it would have been available at a price that Kniceley would have agreed to pay
- There are nine parties involved in the litigation described above, no doubt each of them having its own legal counsel.
Pre-trial motions for summary judgment were presented to the judge by each of the defendants, primarily based on the Delaware statute of limitations. Harrington requested permission to state a breach of contract claim against Downes, and to have summary judgment entered on that claim, as the terms of the purchase-of-assets contract, including its 157-word indemnity provision, were disputed, though Harrington and Downes disagreed as to their legal interpretation.
How did the judge decide the case? Here is a summary:
- Some of Farm Family’s claims against Harrington, as assignee of Kniceley’s claims, are in the wrong court and have to be re-filed in the Delaware Chancery Court. Winner: no one.
- Farm Family’s remaining claims against Harrington are barred by Delaware’s three-year statute of limitations, which began to run when the first liability policy with a total pollution exclusion was delivered to Kniceley. Although Delaware law has a narrow exception to the three-year rule in cases where the alleged error is “inherently unknowable” to the plaintiff, the delivery of the policy. Winner: Harrington
- In a separate opinion in the case, the court found Cumberland’s pollution exclusion to be unambiguous and upheld Cumberland’s denial of coverage, though noting that courts are not unanimous as to whether lead paint poisoning is “pollution” as defined in such exclusions. Winner: Cumberland.
- The indemnity provisions in the purchase-of-assets contract between Harrington and Downes is clear and enforceable. Downes must indemnify Harrington for all liability and reasonable attorney’s fees and costs incurred in the litigation. Winner: Harrington.
Together, these rulings seem to be an excellent result of the Harrington Agency, which is free of liability in the case and fully indemnified against liability and expenses.
The court’s decisions were based on legal issues. In my view, that’s a good thing. Intensely fact-based issues, such as “who’s at fault,” can be time and money-consuming. When a court makes dispositive rulings based on the law or well-written contracts all parties benefit, procedurally, though some of their oxen are gored, substantively.
The best defense
And how might the Harrington Agency avoided the utterly unexpected trip down the rabbit-hole of someone else’s alleged error? Even the most careful due diligence can’t catch every legal land mine. The indemnity clauses in the asset purchase contract proved to be the second-best protection. The best defense is the one you never need. The second-best defense is the one someone else pays.
Louie Castoria is a partner at Kaufman Dolowich & Voluck LLP, and serves as director of the firm’s Western Region Professional Liability Practice Group. He also is chairman of the board at the Insurance Educational Association.