INSURANCE BROKER NEGLIGENCE:
Why a Handshake and a Smile Are Not Enough

By Michael Kline, Esq.

In the sophisticated world of insurance brokers and clients, litigation abounds, particularly in the area of broker negligence. Typical problems include employers claiming their brokers did not obtain the insurance they requested, brokers claiming they followed their clients’ instructions to the letter, and insurance companies seeking to place liability for inadequate coverage anywhere but at their doorstep. Our experience in this area has lead us to the inescapable conclusion that a vast majority of these lawsuits could be avoided by the simple act of documenting an insured’s coverage assumptions and/or demands prior to inception of the relevant policy.

All too often, both brokers and their clients rely on the proverbial handshake and a smile when placing coverage with insurers. When representing clients, a broker takes on the duty to (1) discharge with loyalty and good faith the trust imposed in him; (2) obey the instructions give to him by insured; and (3) exercise reasonable skill, care, and diligence in effecting the insurance. When an issue arises regarding exactly what instructions were given to the broker to procure an insurance policy, and when that issue encompasses oral communications between a broker and his client, a coverage dispute can quickly devolve into a “he said/she said” battle, and an expensive and time-consuming one at that.

The recent decision of Third Eye Blind v. Near North Entertainment only reinforces the need for brokers and their clients to document clients’ insurance expectations as early as possible. In Third Eye Blind, a popular rock band directed its broker to obtain a general liability insurance policy. Unbeknownst to the band, the policy contained an endorsement that potentially excluded coverage for claims that were ultimately brought by a fired band member. The claim was tendered to the insurance company. However, the insurance company refused to defend the claim based upon the policy endorsement.

After settling for $3MM, the band sued the insurance company for wrongful failure to defend and their broker for failing to inform them about the endorsement. The band settled with the insurer prior to trial. The broker thereafter obtained a dismissal, with the court finding that—due to its prior rulings that the policy was sufficient to provide coverage—the contention that the broker was negligent in obtaining inadequate coverage had no merit.

The Court of Appeals disagreed. It ruled that the broker’s liability was not dependent on an assumption that coverage was deficient, but rather upon the broker’s failure to tell the band that the endorsement would give the insurer a reasonable basis upon which to deny coverage, and that they should obtain an additional policy to ensure complete coverage. Simply stated, the Court held (for the first time in California) that a broker could be liable for negligence if a policy was not exactly what the client expected and/or requested—even if the policy ultimately provided coverage sought by the client.

In business, as in life, acting informally advances the development of interpersonal relationships (and future business) far more than the mandatory documentation
of demands and expectations. Yet, as anyone previously involved in litigation will admit, a paper trail tells a far more compelling story than an individual recitation of communications a jury may or may not believe actually took place.

Ordinary broker/insurer/insured transactions involve formal documentation such as letters of authorization, deal memos etc. But it shouldn’t stop there. Insured coverage demands should be documented from the beginning of any broker-insured relationship and again at each period of renewal. Doing so will insulate both broker and clients from expensive future conflicts founded in theories of insurance broker negligence.

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