When facts essential to a decision to insure or not insure aparticular risk are misrepresented or concealed there is no basisfor a contract of insurance and it can be, and should be,rescinded. In Mountain City Ford LLC v. Owners Insurance Co. andAuto-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 businessesin which they hold financial interest will find that they are heldto the duties of an agent for the insured rather than an agent forthe insurer, even if the agent has an effective agency agreementwith the insurer allowing it to bind insurance.

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

All parties agreed that Auto-Owners never knew of Gussler'sexistence as a driver of Mountain City vehicles. It was undisputedthat Gussler was not listed anywhere on Mountain City's applicationto Auto-Owners and the proof at trial was undisputed that hadGussler been listed, Auto-Owners would never have issued the policyto Mountain City Ford.

Related: Read Zalma's previous column "ValuedAdvice."

Mountain City Ford and Mountain City Chevrolet are two smalldealerships in Inez, Ky., that are owned by James Booth; hisdaughter, Angela Wilson; and Craig Preece. When they purchased thedealerships they had separate garage insurance policies withUniversal Insurance.

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

Auto-Owners is a regional insurance carrier headquartered inMichigan. Auto-Owners writes property and casualty insurance aswell as other lines. In 2007, Auto-Owners had a regional office inLexington, Ky..

Marlena Lafferty was a young insurance agent who worked inElite's Inez office. When she heard that Craig Preece, as co-ownerof Elite and Mountain City, had suggested that Elite try to writeinsurance for the Mountain City dealerships, she began gatheringinformation for an application to CarPac, another insurancecompany, to compare premium prices. Ultimately, she submitted theCarPac application on Oct. 19, 2007, for both Mountain Citydealerships. Page 12A of the CarPac application was an"employee/non-employee list."

On the CarPac application, Lafferty identified all 27 dealershipemployees and clearly disclosed that Rick Gussler was a salesmanwho was "not licensed." Lafferty testified that this informationcame from emails with Mountain City Ford in the first half ofOctober. She also testified that in a telephone conversation withWellman, he told her both Rick Crum at the Chevrolet dealership andRick Gussler at the Ford dealership were prohibited from drivingdealership vehicles because they did not have driver'slicenses.

The Auto-OwnersApplication

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

The Mountain City dealerships application was the first Grimever submitted to Auto-Owners. He did not read Elite's AgencyContract with Auto-Owners or its underwriting guidelines beforepreparing and submitting the application for Mountain City.

Grim calculated the premium for Auto-Owners based on totalpayroll for all employees except any clerical staff who never drovedealership vehicles. At the end of the year, Auto-Owners wouldaudit the payroll and adjust the premium up or down. Even thoughGrim did not know Gussler, Gussler's compensation was included as asalesman in the total payroll figures; therefore, Mountain Cityalleges on appeal that Auto-Owners did receive and did collect fromMountain City Ford the full premium for Gussler, regardless ofwhether he "drove" or not.

Abby Douglass worked as an underwriter in the Lexingtonunderwriting office of Auto-Owners until January 2008. Elite neverdisclosed Gussler as a salesman without a driver's license, eventhough such information was disclosed to CarPac. Unbeknownst toCraig Preece, Grim was uninformed about both Gussler being anemployee and the Eligibility Guidelines of Auto-Owners.

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

Lee Rademacher was the Kentucky vice president for Auto-Owners.Elite was awarded the agency contract from Auto-Owners forLexington and Catlettsburg by his predecessor. Rademacher met withGrim and underwriter Amy Bradford in the summer of 2007 about Elitepursuing the insurance business of the dealerships for Auto-Owners.Claudia Clawson was the head underwriter for Auto-Owners inLexington. She confirmed that coverage for Mountain City Ford wasbound by Elite as agent when Mark Grim submitted the completedapplication, 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 itsmisrepresentation coverage defense, Auto-Owners settled the claimsfor a total of $1.03 million and then pursued this action to voidthe policy and seek reimbursement from Mountain City and Eliteunder theories of material misrepresentation and negligence.

Auto-Owners sought rescission and reimbursement from thedealerships for material misrepresentation because Gussler was notlisted on the list of "drivers" in the application prepared byElite. Elite knew of the existence of the unlicensed salesman andhad disclosed him on an application to another insurance company,CarPac, but omitted to inform Auto-Owners of his existence. Attrial, the jury found against Mountain City but found that Elitewas not liable for its failure to list Gussler on the drivers liston the application to Auto-Owners. Mountain City filed a motion forjudgment notwithstanding the verdict, arguing that Elite was actingas Auto-Owners' agent under Kentucky law and, thus, that the policyshould not be voided ab initio.

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

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

Those facts, coupled with the extraordinarilyclose relationship between Mountain City Ford, and the EliteAgency, persuaded the Court of Appeal that Elite was acting eitheras the agent for Mountain City or at the very least, was acting inthe capacity as a dual agent, for both Mountain City Ford andAuto-Owners in preparing and submitting the application forinsurance, and then issuing a binder.

Under Kentucky law, whether an insurance agency is an agent forthe insured or the insurer when preparing and submitting anapplication, given alleged material misrepresentations in anapplication, no one factor is determinative. Agency must be decidedon 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 duringpolicy issuance.

The Court of Appeal concluded that Elite was Mountain CityFord's agent. Specifically, the proof was that Craig Preece, as CFOfor Mountain City, signed and verified the application as requiredby Auto-Owners, and he had the full opportunity to review theapplication, even though he testified that he did not read theapplication.

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

The evidence also demonstrated extensive special circumstancesto support a finding that Elite was acting as Mountain City's agentduring the application and policy issuance process. In fact,Mountain City and Elite had the long standing relationship wherethe companies shared common ownership. Given all this evidence, theCourt of Appeal concluded that the special close relationship andcircumstances between Elite and Mountain City Ford supported afinding that Elite was acting as Mountain City Ford's agent when itbound coverage through Auto-Owners.

Furthermore, careful examination of the insurance treatises suchas Couch on Insurance 3d, Vol. 3 (2009) § 45:1 reveals the generalrule that where an agency is "independent" (represents manyinsurers) as opposed to a sole agent (represents one insurerexclusively), the broker acts as an agent for the insured in theapplication process. Couch notes that the courts often use theterms "broker" and "agent" interchangeably, but that there is animportant distinction in that acts of a broker are imputed to theinsured versus the acts of an agent, which are imputable to theinsurer.

Lesson

An insurance agent or insurance broker is professionallyobligated to professionally represent its principal (whether theprospective insured, the insurer, or both) and be certain that thefacts stated in the application for insurance are correct andcomplete. Failure to do so can place the agent or broker in aposition of being held responsible for losses suffered by theinsured.

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

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