California Court of Appeal Limits Insurance Brokers’ Duties to Third Parties

May 7, 2013

Insurance LawA developer borrows millions of dollars to construct a building. The loan contract between the developer and the lender requires the developer to obtain specified insurance coverages naming the lender as a loss payee. The developer obtains the required coverages through an insurance brokerage, which issues certificates of coverage listing the lender and the lender’s successors and assignees as loss payees or additional insureds. However, as construction progresses, the developer, running low on funds to complete the project, replaces the insurance with another policy that does not provide the coverages specified in its loan agreement.

After a loss occurs, the lender learns of the new insurance policy, which the new insurer asserts does not cover the loss. The lender looks for someone to sue to recover the damage to the building which provides collateral for its loan. The insurer is an obvious target, but the insurer’s coverage defense is strong and likely to prevail. The lender could sue developer but by now the developer is insolvent and judgment proof. Can the lender recover from the developer’s insurance broker?

This was the dilemma facing the lender (and the court) in Travelers Property Casualty Co. v. Superior Court (Michael M. Braum), __ Cal.App.4th __, __ Cal.Rptr.3d __, 2013 WL 1638157 (2d Dist., Apr. 17, 2013). More than 20 years ago, in Nowlon v. Koram Ins. Center, Inc. (1991) 1 Cal.App.4th 1437, 2 Cal.Rptr.2d 683 (Nowlon ), the California Court of Appeal stated, “the duty of the broker or insurer, which is incurred in the procurement or issuance of an insurance policy, runs not only to those who contracted for the insurance policy but also ‘runs directly to the class of potential victims of the insured.’” Id. at p. 1447. However, the Nowlon court made the statement in the context of an accident victim’s negligence per se action against the insurance broker for the defendant whose negligence allegedly caused the accident. The broker had placed the defendant’s liability coverage with an unlicensed insurer that had since become insolvent. The accident victim alleged that the broker’s violation of a California statute prohibiting general insurance brokers from placing coverage with insurers not licensed to do business in California constituted negligence per se. In holding that the victim should be allowed to allege a negligence per se cause of action because the victim was a member of the class the licensing statute was designed to protect, the court made its broad statement about the scope of a broker’s duties.

Surprisingly, Travelers v. Superior Court (Michael M. Braum) is the first California decision expressly to limit the Nowlon court’s statement about the broad duty of reasonable care that brokers owe to third parties. The court refused to apply Nowlon’s reasoning outside the context of a negligence per se claim based on a broker’s violation of a statute designed to protect third parties.

In so doing, the Travelers court focused on the slippery slope that would result from construing the Nowlon language to impose a duty on insurance brokers “to anticipate the desires of any potential victims of the insured, and to use reasonable care, diligence and judgment to procure the insurance which those victims may ultimately desire the insured to possess.” California law, the Travelers court explained, simply does not allow the insured’s victim or loss payee to sue the insured’s broker “any time a claim is denied pursuant to an exclusion or limitation in the policy for which the insured reasonably contracted.”

Under Travelers, a third party claimant can recover against an insurance broker only if (1) the broker violates a statute intended to protect the claimant, or (2) the claimant is a third party beneficiary of the brokerage agreement. Accordingly, the court of appeal ordered the trial court to enter summary judgment for both the broker and the insurer.