Insurance professionals spend a lot of time looking for ways toavoid errors and omissions exposures. They are careful to hire theright people, provide training and put management systems in placeto ensure quality work. But a few overlook what is perhaps the mostobvious avoidance mechanism: not taking on someone else'sliabilities.

When an insurance agency or brokerage firm buys another firm orsome of its business, the acquiring firm may become heir to thepurchased 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 formalitiesto try to establish that the purchasing company is liable formistakes made by the acquired company. Properly structuring anacquisition transaction can be the proverbial stitch in time thatsaves nine, or perhaps even $900,000.

E&O policies typically afford coverage for claims that ariseout of a brokerage firm's insurance placements made on behalf ofthat firm's customers. Coverage may not extend to claims against anacquiring firm that arise out of pre-acquisition transactions madeby the purchased firm, or claims might not be covered due to aretroactive date.

The case of the painter's predicament
A Delaware court case, decided just over a year ago, illustratesthe point.

A young boy living in an apartment became ill and testedpositive for lead poisoning. The apartment owner hired Kniceley, alicensed lead abatement company, to remove the paint and any dust,and to repaint the premises. Kniceley hired a subcontractor tohandle the lead removal, and once the job was done, thesubcontrator 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 leadpoisoning.

Kniceley had obtained liability insurance coverage fromCumberland Insurance, through Downes Insurance Associates. In 2006,the year after the insurance placement in question, Downes sold itsP&C insurance business to the Harrington Insurance Agency perthe terms of an asset purchase agreement.

Two months later, the injured boy's legal representative filedsuit against the landlady, who cross-complained two years lateragainst Kniceley and his subcontractor. Cumberland Insurance deniedcoverage for the claim, based on the “total pollution exclusion” inits policy. Kniceley reached a settlement with the property ownerin 2011 for $350,000 plus interest and costs. The landlady'sinsurer, Farm Family Casualty Co., then sued Downes and Harrington(having received an assignment of rights from Kniceley), and alsoCumberland, asserting that the Cumberland policy did cover theoriginal claim, despite the pollution exclusion.

Let's reflect on how a tragic event—a boy permanently injured bylead poisoning—morphed into an E&O claim against the HarringtonAgency:

• Though it committed no error at all in any insurance placement,Harrington is one of five parties in an E&O/coveragelawsuit
• There is no hint as to whether Downes & Associates didanything wrong, either—no evidence that Kniceley asked forpollution coverage or that it would have been available at a pricethat Kniceley would have agreed to pay
• There are nine parties involved in the litigation describedabove, no doubt each of them having its own legal counsel.

Pre-trial motions for summary judgment were presented to thejudge by each of the defendants, primarily based on the Delawarestatute of limitations. Harrington requested permission to state abreach of contract claim against Downes, and to have summaryjudgment entered on that claim, as the terms of thepurchase-of-assets contract, including its 157-word indemnityprovision, were disputed, though Harrington and Downes disagreed asto their legal interpretation.

How did the judge decide the case? Here is a summary:

• Some of Farm Family's claims against Harrington, as assignee ofKniceley's claims, are in the wrong court and have to be re-filedin the Delaware Chancery Court. Winner: no one.
• Farm Family's remaining claims against Harrington are barred byDelaware's three-year statute of limitations, which began to runwhen the first liability policy with a total pollution exclusionwas delivered to Kniceley. Although Delaware law has a narrowexception to the three-year rule in cases where the alleged erroris “inherently unknowable” to the plaintiff, the delivery of thepolicy. Winner: Harrington
• In a separate opinion in the case, the court found Cumberland'spollution exclusion to be unambiguous and upheld Cumberland'sdenial of coverage, though noting that courts are not unanimous asto whether lead paint poisoning is “pollution” as defined in suchexclusions. Winner: Cumberland.
• The indemnity provisions in the purchase-of-assets contractbetween Harrington and Downes is clear and enforceable. Downes mustindemnify Harrington for all liability and reasonable attorney'sfees and costs incurred in the litigation. Winner: Harrington.

Together, these rulings seem to be an excellent result of theHarrington Agency, which is free of liability in the case and fullyindemnified 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 atfault,” can be time and money-consuming. When a court makesdispositive rulings based on the law or well-written contracts allparties benefit, procedurally, though some of their oxen are gored,substantively.

The best defense
And how might the Harrington Agency avoided the utterly unexpectedtrip down the rabbit-hole of someone else's alleged error? Even themost careful due diligence can't catch every legal land mine. Theindemnity clauses in the asset purchase contract proved to be thesecond-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 & VoluckLLP, and serves as director of the firm's Western RegionProfessional Liability Practice Group. He also is chairman of theboard at the Insurance Educational Association.