Prior Loss Clause and Employee Theft at Subsidiary LLC of Acquired Corporation
In American Elec. Power Co. Inc. v. Affiliated FM Ins. Co., 2009 WL 130187 [C.A.5 ( La. )], the plaintiff American Electric Power Company and its subsidiaries (“AEP”) appealed from the district court's grant of summary judgment in favor of defendant-insurer, Affiliated FM Insurance Company (“Affiliated”).
Affiliated issued a policy covering AEP and its subsidiaries from loss due to employee theft or misconduct (the “Affiliated Policy”). Later that year AEP acquired another utilities conglomerate, Central & Southwest Corporation (“CSW”), and the Affiliated Policy was amended to include CSW and its subsidiaries as covered subsidiaries of AEP.
AEP then discovered losses that occurred in 1999—prior to the issuance of the Affiliated Policy—due to employee theft at two of CSW's subsidiary limited liability companies. AEP claimed that the losses should be covered under the Affiliated Policy's prior loss clause, which provided coverage for earlier losses if those losses would have been covered under a policy existing at the time. At the time of the theft, CSW was covered by a policy with Chubb Insurance Group. The parties agreed that the
Affiliated Policy covered the earlier losses if the Chubb Policy would have extended coverage at that time.
Affiliated determined that the 1999 thefts would not have been covered under the Chubb Policy, and thus denied AEP coverage under the prior loss clause. AEP filed suit in federal court.
Affiliated then moved for summary judgment. The Chubb Policy expressly covered CSW “and any subsidiary corporation now existing or hereafter created or acquired.” According to Affiliated, this language limited coverage to true corporations and excluded other subsidiary entities like the two LLCs at issue in the 1999 thefts. AEP responded that the term “corporation” was ambiguous and filed affidavits from both CSW and Chubb stating that LLCs were intended to be covered under the general heading of “corporation” in the Chubb Policy. Affiliated moved to strike the affidavits, alleging that they constituted impermissible parol evidence and raising several other evidentiary challenges. The district court determined that the term “corporation” was unambiguous and did not include LLCs. Thus, the court granted summary judgment and struck the affidavits as impermissible parol evidence.
AEP filed a motion for rehearing, claiming that the district court should reform the Chubb Policy to match the original intent of CSW and Chubb to include LLCs. The court declined to reform the policy and thus granted summary judgment. AEP appealed, claiming that the district court erred in (1) finding the policy unambiguous and (2) declining to reform the policy.
AEP first contended that the district court erred in finding the term “corporation” to be unambiguous and thereby excluding AEP's affidavits containing relevant parol evidence.
AEP also contended that the district court erred in finding the policy unambiguous. According to AEP, the term “subsidiary corporation” could be reasonably interpreted to include LLCs. AEP argued that the common understanding of “corporation” extended beyond its legal definition and included unincorporated entities like LLCs. In addition, AEP argued that the term must be construed in light of the overarching policy, and that interpreting the Chubb Policy to exclude LLCs would create an “absurd consequence-an inexplicable gap in insurance coverage” among CSW's subsidiary entities. The United States Court of Appeals, Fifth Circuit., disagreed, finding that the district court did not err in finding the Chubb Policy unambiguous and by excluding parol evidence. According to the court, the generally prevailing meaning of the term “corporation” did not include LLCs, and LLCs were statutory creatures defined in part by their contrast to corporate entities.
The court stated that the LLCs at issue here were created in Oklahoma, and Oklahoma law defined an LLC as “an unincorporated association or proprietorship.” The relevant Louisiana statute provided that “[n]o limited liability company organized under this Chapter shall be deemed, described as, or referred to as an incorporated entity, corporation, body corporate, [etc.].” Also, the instances in which courts referred to LLCs as limited liability corporations were merely imprecise and were clearly not intended to redefine the LLC, and these imprecise references did not alter the fundamental distinction between the two types of entities. Further, interpreting the term “corporation” to exclude unincorporated entities did not lead to an “absurd consequence” here.
Thus, the court held that the term “corporation” was clear and explicit and led to no absurd consequences in the context of the Chubb Policy, and the district court did not err in finding the policy unambiguous and by excluding parol evidence of the parties' intent.
AEP also contended that the district court erred in refusing to reform the Chubb Policy to include LLCs. The district court refused to reform the Chubb Policy because Affiliated—which was not a party to the original agreement—had no knowledge of any error in the Chubb Policy when it later assumed liability through the Affiliated Policy. On appeal, AEP contended that reformation was nevertheless appropriate and that prior case law stood for the proposition that reformation to correct mutual errors was proper even if such reformation prejudiced a third party.
The court found that the district court did not err in refusing to reform the Chubb Policy, as Affiliated assumed the coverage obligations set forth under the unambiguous terms of the Chubb Policy, and there was no indication that Affiliated knew or should have known of an informal understanding between Chubb and CSW regarding the meaning of “corporation.”
Also, the use of the term “corporation” was not the type of error that reformation was intended to remedy. The court therefore affirmed the district court's grant of summary judgment.