Claims against insurance brokers for negligence or breach

A look at trying the “case within a case” or the situation where the broker sides with the insurance carrier in the denial of a claim

2015 August

Many insurance disputes involve the question of whether a particular policy covers a given claim or loss. When an insurer disputes coverage, or the policy does not provide the anticipated coverage, then the broker may be liable for any “gap” in coverage – and, indeed, for the fees and expenses that the insured incurs in its fight with the insurer, win, lose, or draw. (See, e.g., Jones v. Grewe (1987) 189 Cal.App.3d 950, 954 [broker obligated to use “reasonable care, diligence, and judgment in procuring the insurance requested by an insured”]; Third Eye Blind, Inc. v. Near N. Entm’t Ins. Servs., LLC (2005) 127 Cal.App.4th 1311, 1325-26 [insured entitled to recover from broker fees incurred in litigation with insurer even though it prevailed in litigation].) In other words, an insured typically is entitled to recover from its broker what it would have recovered from the insurer “but for” the broker’s negligence or other breaches.

When the broker is sued for its professional negligence or other breaches, one question that should not be overlooked is the question of what evidence can be presented by the broker in defense against the insured’s damages claim. As explained below, the answer depends in part on the situation. In one common situation, the broker – like any defendant in a professional negligence case – tries the “case within a case.” In another situation, where the broker may have joined, implicitly or explicitly, with the insurer in arguing against coverage, the evidence available to the broker is more severely limited.

This usually calls for the insurer to try a “case within a case” – that is, present the claim that it had against the insurer and show what the result would have been but for the broker’s mistakes. The question then becomes what type of evidence the broker can offer to refute the insured’s damages claim. It should not be able to present evidence and arguments beyond what the insurer had available to it at the time the claim was resolved. Simply put, the broker should be precluded from presenting evidence or arguments that the insurer did not present in responding to the insured’s claim.

The “case within a case”

The question to be decided in a lawsuit against an insurance broker is not what the insurer should have paid in the theoretical and speculative world of evidence and arguments created by the broker after the insured’s losses. Rather, the issue is what the insurer should have paid in the real world of the evidence and arguments it actually presented. Putting it differently, what is relevant is not the case that a broker might like to try, but the case that the insurer was prepared to try.

California Civil Code section 3333 states: “For the breach of an obligation not arising from contract, the measure of damages . . . is the amount which will compensate for all the detriment proximately caused thereby, whether it could have been anticipated or not.” In an action against an insurance broker for professional negligence the measure of damages is “the loss of coverage which [the insured] would have received under the [ ] policy (or a like policy issued by another company), except for the negligence and fraud of [the broker].” (Greenfield v. Ins. Inc. (1971) 19 Cal.App.3d 803, 812. See also Couch on Insurance § 46:74 (3d ed. 2014) [“The proper measure of damages in an action against an agent for failure to procure insurance is the amount that would have been due under the policy if it had been obtained, plus any consequential damages resulting from the agent’s breach of duty. . . .”].)

In Greenfield, the insured purchased business interruption insurance and specifically asked his broker to procure coverage for mechanical breakdown of his automobile shredder. When the shredder broke down, the insurer told the insured that the loss was not covered. The court calculated damages for which the broker was liable by determining the number of days the shredder was down, multiplying it by the daily rate the requested insurance would have provided, and adding the amounts the insured expended to expedite repairs of the shredder.

This method of determining damages has been referred to as the “case-within-a case” or “trial-within-a trial” doctrine. It originated in attorney malpractice cases. For example, in a litigation-malpractice action, “the plaintiff must establish that but for the alleged negligence of the defendant attorney, the plaintiff would have obtained a more favorable judgment or settlement in the action in which the malpractice allegedly occurred.” (Viner v. Sweet (2003) 30 Cal.4th 1232, 1241.) In a transactional malpractice action, the plaintiff “must show that but for the alleged malpractice, it is more likely than not that the plaintiff would have obtained a more favorable result.” (Id. at 1244.)

As one court explained, “[b]ecause of the legal malpractice, the original target is out of range; thus, the misperforming attorney must stand in and submit to being the target instead of the former target which the attorney negligently permitted to escape. This is the essence of the case-within-a-case doctrine.” (Arciniega v. Bank of San Bernardino (1997) 52 Cal.App.4th 213, 231.) Further, “[w]here the attorney’s negligence does not result in a total loss of the client’s claim, the measure of damages is the difference between what was recovered and what would have been recovered but for the attorney’s wrongful act or omission.” (Norton v. Superior Court (1994) 24 Cal.App.4th 1750, 1758.)

This standard has been applied in malpractice actions against other professionals. For example, in Mattco Forge, Inc. v. Arthur Young & Co. (1997) 52 Cal.App.4th 820, the court applied the “trial-within-a trial” method in a suit against an accounting firm for professional negligence in providing accounting litigation support services in plaintiffs’ case. As that court explained:

The trial-within-a-trial method does not “recreate what a particular judge or fact finder would have done. Rather, the jury’s task is to determine what a reasonable judge or fact finder would have done . . . .” Even though “should” and “would” are used interchangeably by the courts, the standard remains an objective one.

(Id. at 840.)

“Under this format, it was precisely the jury’s role to step into the shoes of the arbitrators, consider the facts of [the plaintiff’s] underlying claims and ultimately determine their merits.” (Piscitelli v. Friedenberg (2001) 87 Cal.App.4th 953, 973-74.)

In sum, California law clearly dictates the evidence and arguments that the breaching professional can make in defending a professional-negligence claim. Pursuant to the mandate of that law, a professional is not free to manufacture a case that never existed before. (See Arciniega, 52 Cal.App.4th at 231 (the professional “must stand in and submit to being the target instead of the former target”); CACI 601 (citing Arciniega for this rule in its “Sources and Authority”).)

In assessing the “case-within-a case,” the jury should consider only the information that was available to the insurer at the time the coverage dispute was resolved and that the insurer was relying upon. This is the only information that the insurer would have had in defending against the insured’s claim. The insurer chose how to defend its position and how to try its case. Nothing in the law permits the broker to “redo” that or second guess the insurer. The broker certainly cannot use its breaches as an excuse to do so. Additionally, the insurer obviously did not have access to and would not have considered any events that transpired, documents that were created, or information that came to light after the coverage dispute was resolved. Nor could the insurer have presented new theories and evidence that it did not advance or properly disclose.

Switching sides

A more troubling circumstance arises when the broker is not simply negligent, but rather, actually sides with the insurer in asserting that a policy does not provide coverage. In such a situation, the broker may argue that there is no coverage for reasons that it never explained to its insured before the insured sought coverage – and those arguments may embolden an insurer in denying coverage or help the insurer prevail on its denial. When this happens, the broker should not be entitled to litigate even the “case-within-a case.” Having abandoned the most fundamental of duties that an agent owes to its principal – a duty of loyalty and undivided interest, the broker must bear the consequences.

It long has been a maxim of jurisprudence that, “For every wrong there is a remedy.” (Civ. Code, § 3523.) The remedy prescribed by the law applicable to an agent that switches sides during its agency should be that the agent cannot offer evidence or arguments challenging the issues as to which it abandoned its principal and joined forces with its principal’s adversary – the “gap” in its insured’s recovery for its losses.

An insurance broker is the agent of the insured and that “[w]hether or not the broker-insured relationship is a fiduciary one, a broker still has certain fiduciary duties” to the insured. (Hydro-Mill Co., Inc. v. Hayward, Tilton and Rolapp Ins. Associates, Inc. (2004) 115 Cal.App.4th 1145, 1158. See also Eddy v. Sharp (1988) 199 Cal.App.3d 858, 865 [under agency principles, an insurance broker has “not only a fiduciary duty but an obligation to use due care”].) At the very least, this fiduciary duty consists of the “avoidance of conflict of interest, self-dealing, excessive compensation, etc.” (Hydro-Mill, 115 Cal.App.4th at 1158.)

An agent owes a fiduciary duty to its principal. This duty imposes on the agent “a duty to act with the utmost good faith in the best interests of its principal.” (CACI 4100.)

Inherent in [the agent/principal relationship] is the duty of undivided loyalty the fiduciary owes to its beneficiary, imposing on the fiduciary obligations far more stringent than those required of ordinary contractors. As Justice Cardozo observed, “Many forms of conduct permissible in a workaday world for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive is then the standard of behavior.

(Wolf v. Superior Court, (2003) 107 Cal.App.4th 25, 30 (citation omitted). (See also Huong Que, Inc. v. Mui Luu (2007) 150 Cal.App.4th 400, 411 [when a principal-agent relationship exists, the agent assumes “a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the agency relationship”].)

An agent has a fiduciary duty to (i) “act loyally for the principal’s benefit in all matters connected with the agency relationship;” (ii) “not to deal with the principal as or on behalf of an adverse party in a transaction connected with the agency relationship;” and (iii) “act reasonably and to refrain from conduct that is likely to damage the principal’s enterprise.” (Restatement (Third) of Agency (“Restatement”), §§ 8.01, 8.03 & 8.10 (2006).)

When an agent deals with the principal on the agent’s own account, the agent’s own interests are irreconcilably in tension with the principal’s interests because the interest of each is furthered by action – negotiating a higher or a lower price, for example – that is incompatible with the interests of the other. If an agent acts on behalf of the principal in a transaction with the agent, the agent’s duty to act loyally in the principal’s interest conflicts with the agent’s self-interest. Even if the agent’s divided loyalty does not result in demonstrable harm to the principal, the agent has breached the agent’s duty of undivided loyalty. (Id., § 8.03, comment b; See also Huong, 150 Cal.App.4th at 416 [“The duty of loyalty embraces several subsidiary obligations,” including the duties “to refrain from . . . taking action on behalf of or otherwise assisting the principal’s competitors” and the duty “not to use or communicate confidential information of the principal for the agent’s own purposes or those of a third party”].)

Further, “[a]n agent’s duty to refrain from engaging in conduct may extend to conduct that, although it is beyond the scope of activity encompassed by the agency relationship itself, is nonetheless closely connected to the principal or the principal’s enterprise and is likely to bring the principal or the principal’s enterprise into disrepute.” (Restatement, § 8.10, comment b.) The agent’s fiduciary duty to a principal lasts throughout the duration of the agency relationship. (Id., § 8.01, comment c.)

When an insurance broker joins an insurer in arguing against coverage, it then may be acting in a manner adverse to the insured’s interests. Given a breach of its duties to its insured, it should not be able to argue against the insured’s damages claims by advancing the very arguments it made in breach of its fiduciary obligations. Such a remedy is warranted under the law.

In fact, the court imposed a similar sanction on a former agent in ABKCO Music, Inc. v. Harrisongs Music, Ltd. (S.D.N.Y. 2981) 508 F.Supp. 798, aff’d (2d Cir. 1983) 722 F.2d 988. In ABKCO, the plaintiff brought a copyright infringement action against George Harrison, claiming that Harrison had plagiarized “He’s So Fine” in writing the melody for “My Sweet Lord.” The trial court found that Harrison had subconsciously plagiarized the song and scheduled hearings to determine damages. Before the damages hearing, however, the plaintiff sold its copyright to “He’s So Fine” to Harrison’s former business manager. The manager had represented Harrison from 1970 until Harrison fired him in 1973. During this period the copyright claim was first asserted. Harrison claimed that the manager had breached his fiduciary duties to Harrison and therefore was disqualified from recovering as the new owner of the copyright.

The court found that the manager did not breach any fiduciary duties to Harrison while he was Harrison’s manager. However, in late 1975 and early 1976, when the copyright action was about to go to trial, Harrison made a settlement proposal to the original plaintiff. Unbeknownst to Harrison, the manager, who was then in post-firing litigation with Harrison, offered to purchase the copyright for substantially more than Harrison’s settlement offer. The plaintiff then rejected Harrison’s settlement offer, believing that the manager’s offer indicated that Harrison’s offer was too low.

The court found that the manager’s “intrusion into and interference with” Harrison’s settlement offer “were to the probable detriment” of his former client. The court found this was particularly true because the manager’s offer was regarded by the original plaintiff as highly credible because it was based on the manager’s “intimate knowledge gleaned from his former relationship to Harrison.” The court therefore held that the manager was not entitled to profit from his eventual purchase of the copyright to “He’s So Fine,” and that he was entitled only to reimbursement for the amount he paid for the copyright.

The Second Circuit affirmed the district court’s ruling. It held that there was no error in finding that the manager’s actions were improper. It stated that the manager pursued the purchase of the copyright armed with the intimate knowledge not only of Harrison’s business affairs, but of the value of [the copyright infringement] lawsuit – and at a time when this action was still pending. Taking all of these circumstances together, we agree that appellant’s conduct during the period 1975-78 did not meet the standard required of him as a former fiduciary.

. . . Indeed, the purchase, which rendered Harrison and ABKCO adversaries, occurred in the context of a lawsuit in which ABKCO had been the prior protector of Harrison’s interests. Thus, although not wholly analogous to the side-switching cases involving attorneys and their former clients, this fact situation creates clear questions of impropriety.

(Id., 722 F.2d at 995.)

The Second Circuit also rejected the manager’s argument that his breach of fiduciary duty should not limit his recovery for copyright infringement, stating:

An action for breach of fiduciary duty is a prophylactic rule intended to remove all incentive to breach – not simply to compensate for damages in the event of a breach.

(Id. at 995-96.)

The ABKCO courts’ conclusions are premised on the same principles that guide California courts. (See, e.g., Styles v. Mumbert (2008) 164 Cal.App.4th 1163, 1167 [“Few precepts are more firmly entrenched than the fiduciary nature of the attorney-client relationship, which must be of the highest character. So fundamental is this precept that an attorney continues to owe a former client a fiduciary duty even after the termination of the relationship. For example, an attorney is forever forbidden from using, against the former client, any information acquired during the relationship, or from acting in a way that may injure the former client in matters involving the former representation. These duties continue after the termination of the relationship in order to protect the sanctity of the confidential relationship between an attorney and client” (citations omitted)]; See also 1-18 California Courtroom Evidence § 18.28 [“The former client can, by objecting, prevent the attorney from stepping into the shoes of his adversary in order to safeguard his confidences” (citing Styles)].)

Therefore, when an insurance broker switches sides, the penalty may be a harsh one – but it is one warranted by a breach of the broker’s most fundamental duty of loyalty to its client. And, it should not matter whether the breach takes place during or after the brokerage relationship, or whether the insured and the broker are engaged in litigation. Indeed, in ABKCO, Harrison’s manager had been terminated before taking the harmful actions, and Harrison and his manager were in litigation when the manager made the offer to purchase the copyright.

Therefore, an insurance broker, like the manager in ABKCO, should be precluded from profiting from its violations of its duties to its principal, and should be precluded from attacking or disputing the quantum of the insured’s loss when the insured presents reasonable evidence of its loss. Such a result is consistent with the strong policy of removing all incentives for an agent to breach a fiduciary duty, let alone be rewarded by its breach of a fiduciary duty.