Do Agents Owe Clients Fiduciary Duty?

By Barry Zalma, ESQ., CFE, owner, Zalma Insurance Consultants

The Coventry First case should cause great concern to all insurance agents and brokers. In People ex rel Cuomo v. Coventry First LLC, No. 115 (N.Y. 06/30/2009), New York found, on the basis of a pleading issue where the court was required to take the language pleaded to be true, a fiduciary relationship where one had never existed before. A fiduciary relationship exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation, such as a trustee or executor.

Although Coventry First deals with sellers of life settlement contracts, different from viatical contracts, New York has established that a fiduciary relationship exists between the seller and the buyer of a life settlement contract. If courts across the country follow this decision and expand it from its narrow holding to apply to all insurance agents and brokers–imposing on them a fiduciary duty, including the disclosure obligations that go with such duties–it will expand the potential scope of brokers' civil liability for a broader range of conduct.

Related: Read Barry Zalma's July column “Never lie on a COI.”

The New York decision appears to reverse a number of judicial precedents relieving brokers from fiduciary liability for what they do in obtaining insurance for their clients. It also could render brokers subject to liability for a wide range of alleged errors and omissions in the conduct of their businesses by imposing a fiduciary duty on the agent or broker rather than the obligation to fulfill the much less stringent general duty of care of all other contracting parties.

Life settlement contracts

In recent years, a variation on viatical insurance has developed in the U.S., selling life settlement contracts that are basically unregulated. Viatical contracts involve a policy seller who suffers from a catastrophic or life-threatening illness or condition that is regulated by the state. In life settlement contracts, investors buy from life settlement providers insurance policies from policy owners for cash, ultimately receiving the policy benefits when the insureds die.

For example, a company holding a policy insuring the life of a retired executive decides to sell the policy to avoid paying premiums. The company contacts a life settlement provider, which buys the life insurance policy from the company for an amount exceeding the surrender value offered by the insurer, calculating that the value of the death benefits exceeds the purchase price, transaction costs and continued premiums.

The life settlement industry claims it employs a competitive auction model. The policy owner–or the owner's financial advisor or agent–will often hire a broker to solicit competing bids for the policy from life settlement providers.

The attorney general's suit

In October 2006, the attorney general of New York State commenced an enforcement action against Coventry First LLC; its parent corporation, Montgomery Capital Inc.; its executive vice president Reid S. Buerger; and an affiliate, The Coventry Group Inc. (collectively “Coventry First”), alleging fraudulent and anti-competitive conduct. The attorney general alleged that the life settlement provider defendants engaged in bid-rigging by paying substantial, concealed commissions to life settlement brokers, who in return persuaded their clients to accept defendants' offers rather than higher bids from rival life settlement providers.

The attorney general also claimed that defendants concealed a scheme of “gross offers,” where brokers were allowed to determine how much of a purchase price paid by defendants they would keep and how much they would pass on to the policy seller. The attorney general also alleged falsification of documents.

The attorney general sought damages “on behalf of the owners of life insurance policies who have been damaged by the schemes” and injunctive relief preventing further misconduct. Defendants moved to dismiss plaintiff's complaint pursuant to CPLR 3211 (a) (7). Relevant to the appeal, the Supreme Court (the New York trial court) denied defendants' motion to compel arbitration and allowed the attorney general's breach of fiduciary duty cause of action to proceed, along with two others. The appellate division reinstated the common law fraud cause of action, dismissed by the Supreme Court, and otherwise affirmed (52 AD3d 345). The same court then granted leave to appeal further, certifying the question of whether Supreme Court's order, as modified by the appellate division, was properly made. The Court concluded the order was properly made.

On appeal, defendants challenged the appellate division's decision insofar as it allowed the attorney general's sixth cause of action, alleging inducement of breach of fiduciary duty, to proceed.

Claim of fiduciary relationship

The attorney general claimed that defendants “aided and abetted, participated in, and benefitted from” the life settlement brokers' breach of fiduciary duties to their clients. The court, therefore, needed to determine if the facts concerning life settlement brokers, as alleged by the attorney general, fit within the legal theory of fiduciary duty. Noting that “[A] fiduciary relationship 'exists between two persons when one of them is under a duty to act for or to give advice for the benefit of another upon matters within the scope of the relation'” (EBC I Inc. v. Goldman Sachs & Co., 5 NY3d 11, 19 [2005], quoting Restatement [Second] of Torts ? 874, Comment a). It exists only when a person reposes a high level of confidence and reliance in another, who thereby exercises control and dominance over him.

According to the attorney general, life settlement brokers hold themselves out as working to obtain the highest purchase price for their clients' policies. A promise to obtain for a client the “highest possible” offer–in contrast to, for example, simply “obtain[ing] requested coverage for [a client] within a reasonable time or inform[ing] the client of the inability to do so… [with] no continuing duty to advise, guide or direct a client to obtain additional coverage” (Murphy v. Kuhn, 90 NY2d 266, 270 [1997] [citations omitted])–would, if made in a manner that the client could reasonably rely upon, suggest a fiduciary duty.

The allegations of the suit describe a set of circumstances in which life settlement brokers, by claiming relationships with large numbers of other financial institutions and professionals, and by persistently representing that they seek the highest possible offer for their clients' life insurance policies, hold themselves out to be highly skilled experts and are on notice that their clients especially rely on their advice. The sale of life insurance policies is alleged to be a relatively new and largely unregulated industry–one in which even sophisticated clients rely on what they take to be expert advice when seeking offers on policies they wish to sell. These allegations comport with the legal theory of fiduciary duty.

The court concluded that the attorney general's allegations sufficiently state a claim that defendants knew the life settlement brokers' conduct constituted a breach of fiduciary duty.

Defendants' only argument is that they could not have had the requisite knowledge because the current case was the first time a fiduciary duty on the part of life settlement brokers had been announced in this jurisdiction. Rejecting the argument, the court noted that the attorney general's complaint cited a Life Settlement Insurance Assn. white paper, published in 2006, which states that the life settlement broker “has a fiduciary role to represent the seller by law…the bottom line is that the broker's job is to fully represent the interests of the policy seller.” The complaint was also accompanied by an exhibit of e-mails between Coventry First executives who refer to the fiduciary duties of life settlement brokers.

The court rules required it to accord the attorney general the benefit of every possible favorable inference on a motion to dismiss, found it had no option but to conclude that the attorney general sufficiently alleged defendants' knowledge of the life insurance brokers' fiduciary duties.

By claiming a fiduciary duty, the life settlement industry destroyed its own argument and may have, by implication, forced all insurance brokers and agents into a fiduciary relationship they never accepted.

Agents or brokers concerned about the imposition of fiduciary relationships should consult with their lawyers to create a contract with each of their clients establishing the duty of care, and obtaining an agreement from the insured that the broker is not taking on a fiduciary relationship.

Barry Zalma, Esq., CFE, is a California attorney specializing in insurance coverage, insurance claims handling and fraud who serves as a consultant and expert for insurers and policyholders. He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He recently published an e-book, “Insurance Fraud,” which is available at his website, www.zalma.com. Contact the author or access his free insurance fraud newsletter at zalma@zalma.com.