POLICY REFORMATION CLAIMS IN MASSACHUSETTS

INTRODUCTION

 

An insurance agent places a policy for a customer and in the process, makes a mistake – the dreaded error or omission – that invariably comes to light when a claim is made and the customer discovers that he or she has the wrong coverage, not enough coverage, or possibly no coverage.  The default reaction of the customer is to blame the agent, which promptly places its E&O carrier on notice.  The agent’s liability is reasonably clear, and thus, the expected outcome is that the case will settle and the customer will be made whole, or at least reasonably close to it.  This, indeed, is why agents purchase E&O coverage.

Under the right circumstances, however, the result of this hypothetical could be drastically different.  The agent’s error, while seemingly obvious, might be of no legal significance.  These circumstances depend heavily on factors such as the relationship between the agent and the insurance carrier, the nature of the error or omission, and the intent of the customer and the agent.   The policy may be subject to reformation, which would operate to provide the deficient or missing coverage to the customer and thereby eliminate the E&O claim.  Another possible outcome is that the carrier would be held vicariously liable for the acts or omissions of its agent, but this gets tricky and often requires cooperation from the aggrieved customer.  This memorandum will analyze the facts to consider when presented with an E&O claim, the applicable law, and the mechanisms available for successful pursuit of remedies to alleviate, or even nullify, the liability exposure of the negligent agent.

ANALYSIS

 

I. DEFINING THE RELATIONSHIPS.

Massachusetts generally recognizes that an independent insurance agent acts as either a broker, where he represents the interests of the insured, or as an agent, in which he represents the insurance carrier (typically through a written agency agreement). Dealing with claims on the “broker” side is far more problematic because the agent is considered a representative of the insured only.  M.G.L. c. 175, § 162; New England Acceptance Corp. v. Amer. Mfrs. Mut. Ins. Co., 4 Mass. App. Ct. 172 (1976).  Thus, any mistake made in the servicing of the customer’s account cannot be imputed to the insurer.  At best, it gives rise to a unilateral mistake, which is insufficient for a reformation claim.  An accurate rule of thumb is that if the agent acts in a broker capacity, absent specific evidence of fault on the insurance carrier, a claim of reformation or vicarious liability cannot stand.

If the agent acts as an “agent” of the insurance carrier, it would be worthwhile to obtain a copy of any written agency agreement that might be in place.  These agreements typically define the rights and responsibilities of the parties, and include important information such as whether the agent has binding authority and if so, any limitations that are placed on that authority.  These agreements sometimes include indemnity clauses as well, which may be of assistance.  Although these usually relate to business practices only, it is still worthwhile to examine them to determine if there is a contractual indemnity obligation running in favor of the agent.

II. DETERMINING WHETHER REFORMATION IS VIABLE.

Policy reformation is an equitable remedy.  It was first recognized in Massachusetts cases in the late 1800s and has been discussed by our appellate courts, in connection with an insurance contract, as recently as 1996.  For the reasons discussed above, an “agency” relationship between the agent and the insurer is required; a “broker,” by definition, represents the insured and has no authority to bind the insurer.

Our Appeals Court has held that an agent’s knowledge, acquired while acting within the scope of the agent’s actual or apparent authority, is imputed to the insurer even if such knowledge is not actually communicated to the insurer.  Southeastern Ins. Agency, Inc. v. Lumbermen’s Ins. Agency Co., 38 Mass. App. Ct. 642, 645 (1995), vacated on other grounds, 423 Mass. 1008 (1996).  Accordingly, any knowledge that the agent acquires, while acting within the scope of its authority, must be imputed to the carrier.  This knowledge gives the required foundation for a claim of policy reformation.

Where contracting parties have “an identical intention as to the terms to be embodied” in the contract, and the contract failed to reflect that intention, this is mutual mistake, and the contract is subject to reformation. Southeastern Ins. Agency, 38 Mass. App. Ct. at 646 (citing Franz v. Franz, 308 Mass. 262, 266 (1941) (citations omitted)).  A claim of mutual mistake must be supported by “full, clear, and decisive” evidence of a prior expressed agreement between the parties to the policy.  Caron v. Horace Mann Ins. Co., 466 Mass. 218, 225 (2013).  Therefore, parties’ independent mistakes regarding policy coverage, even if identical, are insufficient to elicit a claim of mutual mistake if the parties did not previously communicate their intentions to each other.

Because one of the primary functions of an insurance agent is to sell insurance on behalf of the company he represents, the agent can bind his company by commitments made by him for the issuance of policies, Shumway v. Home Fire & Marine Ins. Co., 301 Mass. 391, 394 (1938), and by representations that policies have in fact been issued.  See Merolla v. Talman & Johnson Ins. Agency, Inc., 354 Mass. 300, 302-303 (1968).  Indeed, under principles of agency law, the authority of an insurance agent to sell insurance, “unless limited by his principal,” includes the authority to do all acts which are incidental thereto or are reasonably necessary to effect such sales.  McQuade v. Springfield Safe Deposit & Trust Co., 333 Mass. 229, 233-234 (1955); Kaufman v. Leard, 356 Mass. 163, 167-168 (1969); Celucci v. Sun Oil Co., 368 Mass. 811 (1975).

The above-cited authorities establish that under certain circumstances, an authorized agent’s actions may be imputed to its principal (the insurance carrier), and a court may order the insurance contract to be reformed.  Although reformation is viable in theory, it is difficult to obtain in practice.  The facts of the case must be very specific and must demonstrate the existence of an express, mutual intent on the part of the agent and its customer.  It is not difficult to understand why insurance carriers are reluctant to reform their policies voluntarily; carriers frequently take the position that the customer’s lack of coverage, or lack of the proper coverage, is solely the responsibility of the agent and should be resolved through an E&O claim.

One example of how reformation would not work is where neither the customer nor the agent knew about the existence of a particular coverage, liability limit, or other distinguishing feature at the time when the policy incepted.  For instance, if neither the customer nor the agent knew, at the time of policy inception, that a particular endorsement was needed, the carrier will not be forced to reform the policy.  Reformation is limited to the specific situation in which both the customer and the agent had an identical intent and expressly communicated their intentions, but for some reason (usually an agent error or omission), the policy that issued did not reflect that intent.  Reformation would be viable, for example, if the customer and the agent discussed procuring a liability limit on a homeowners’ policy of $500,000, but the agent inadvertently failed to request that limit when submitting the application.  Another conceivable situation would be where the customer and agent agree to add a newly-purchased automobile onto an existing policy, but the agent misplaces the paperwork and fails to send it to the insurer within the time required (typically seven days).  In both of these examples, the mutual intent is present, but the policy itself does not reflect that intent.

There is one last caveat on reformation, and it concerns the scope of the agent’s authority.  The mutual mistake can only operate to reform a policy if the insurer would have accepted the risk had it been presented properly.  Using the example of the homeowners’ policy, if the carrier’s underwriting guidelines provided a maximum liability limit of $300,000, the mutual mistake will not advance a claim for reformation because even if the agent had requested the desired amount, the carrier would have rejected it.

III. ESTABLISHING WHETHER THE INSURANCE CARRIER MAY BE HELD VICARIOUSLY LIABLE FOR THE ACTS OR OMISSIONS OF ITS AGENT.

If reformation is not workable, there is still one way to implicate the insurer without any negative consequences to the insured.  The net effect of this strategy is the same: the carrier accepts the claim and provides the desired, but missing, coverage, and the agent faces no E&O exposure.  This can be accomplished where the agency relationship is such that the carrier is vicariously liable for the acts or omissions of its agent.  Once again, however, this will only work if the desired coverage is one that the carrier would have provided but for the negligence of the agent.  Successful pursuit of these claims also requires cooperation from the customer, as will be explained below.   

An insurance company is liable to a third party for the wrongful acts of its agent when the acts so committed, or the statements so made, are within the general or apparent scope of the agent’s authority, even if the agent exceeded his or her actual authority or disobeyed his or her principal’s general or express instructions. COUCH ON INSURANCE 3d, § 56:6 at 56-13.  That an agent may impose tort liability upon his principal has long been the established rule in Massachusetts; a principal “is liable for the torts of his agent committed within the scope of his employment.”  Reed v. A.E. Little Co., 256 Mass. 442, 448 (1926); Restatement (Second) of Agency §§ 257 cmt. a., 258; Makino, U.S.A. v. Metlife Capital Credit Corp., 25 Mass. App. Ct. 302, 313 (1988) (principal who allows agent to negotiate a subject as to which representations are usually made may be liable in tort for loss caused by his agent’s misrepresentations).

A disclosed principal is subject to liability upon contracts made by an agent acting within his authority or apparent authority, if made in proper form and with the understanding that the principal is a party.  Restatement (Second) of Agency, §§ 144, 159.  As noted by our Appeals Court:

[T]he insurer’s argument misapprehends the fundamental conceptual distinction between a principal’s liability for tortious acts of its agent and the principal’s contractual liability for enforceable promises made by its agent in the conduct of authorized transactions.  The former liability is exclusively vicarious, having been imposed by operation of law notwithstanding the principal’s lack of fault or involvement in the actionable transaction. The latter liability, by contrast, is effectively consensual and based upon the ancient principle (albeit a fiction) of the law that “qui facit per alium, facit per se,” i.e., the contractual act of the agent has the same legal effect as if done by the principal and makes the principal the actual party to and obligor of the undertaking.

Medeiros v. Middlesex Ins. Co., 48 Mass. App. Ct. 51, 56-57 (1999).

It may seem inherently unfair for an insurance carrier to face liability to the customer solely because of the negligent acts or omissions of its agent.  Indeed, when one is held vicariously liable for the negligence of another, it provides one of the rare instances in which our courts permit so-called common law indemnity.  This is frequently seen in the context of product liability claims, where an otherwise fault-free seller of a defective product is held liable to an injured person solely by virtue of its participation in the distribution scheme.  This phenomenon might lead one to question why it would be worthwhile to pursue a carrier on a vicarious liability theory, only to have the carrier assert a common law indemnity claim back against the agent.  The answer to this hypothetical is again found in the case law, and calls upon the general principles of agency.

In Massachusetts, the general rule is that “an insurer is not entitled to indemnity from its negligent agent, if, had the agent not been negligent, the insurer would have accepted and assumed the risk.”  Southeastern Ins. Agency, 423 Mass. at 1009-10.  For an insurer to seek indemnity from an agent, therefore, the insurer must prove bad faith or collusion on the part of the agent, or that the agent’s negligence was the proximate cause of the actual loss – in other words, that the insurer would have refused to accept the risk or would have cancelled the policy had the agent not been negligent.  Southeastern Ins. Agency, 38 Mass. App. Ct. at 642; see also Home Ins. Co. v. Columbia Ins. Agency, 5 Mass. App. Ct. (1977) (case remanded for further findings concerning whether insurer would have cancelled the policy had agent submitted accurate values concerning insured’s scheduled inventory).

In practice, however, the agent technically lacks standing to pursue such a claim. The negligent agent cannot implicate its principal on a vicarious liability theory, because this type of liability is designed solely to protect the rights of the injured third party.  For such a claim to work, in an E&O context, the customer himself must assert such a claim, and plead it under a vicarious liability theory in tort and/or a straightforward claim of breach of contract.  The carrier can then defend, but if the agent’s error was committed in the scope of the agency, the carrier will be liable.  If the carrier then seeks indemnity from the agent, under a common law theory, it will not succeed unless it proves that it would have rejected the risk had it been presented, or otherwise establishes that the agent has engaged in bad faith or collusion.

CONCLUSION

 

With any new E&O claim, exploring the possibility of reformation or vicarious liability of the insurance carrier should be part of the early strategy.  If it is established at an early stage that the agent was acting solely in a broker capacity, there is truly no need for further analysis (although the carrier could still face liability under other theories not discussed in this memorandum, such as waiver and estoppel).  If there was an agency relationship, careful analysis of the agreement will provide the information necessary to determine whether there was binding authority and if so, whether there were any restrictions imposed such as types of coverage or maximum limits.

If it is determined that the deficient or missing coverage was something that the agent had the authority to bind, the next step is to ascertain whether there were any other reasons why the carrier would not have accepted the risk.  Even though the agent may have binding authority, it is essential to establish that had the risk been presented properly, it would have been accepted by the carrier.

Once these facts are in place, the final step is to ascertain the intent of the customer and the agent.  Of course, the customer is going to claim that he wanted the coverage that is either deficient or missing.  That alone, however, is not enough to support a reformation claim.  The customer must have known about the coverage, intended for it to be included in the policy, and expressed this intent to the agent.  If he learns about it after the fact, such as through a denial letter issued by the carrier, there can be no claim of mutual mistake because the mistake did not exist at the time of contracting.  The agent’s knowledge and intent are equally important because a unilateral mistake does not provide a basis to reform.  Essentially, both the customer and the agent must have known about the coverage, intended for it to be included in the policy, and expressed their intentions to each other.  If they did, and the agent was working in an agency capacity for the carrier, and the carrier would have provided the coverage had it been asked, there is a viable reformation claim.

If reformation fails, depending on how cooperative the customer is, it is still possible to implicate the carrier on a vicarious liability theory.  The same basic facts needed for reformation would be used, but the mutual intent element is not nearly as critical.  Indeed, if acting within the scope of the agency, even a unilateral mistake by the agent can impose liability on the carrier.  If the carrier would have provided the coverage but for the agent’s mistake, it is unlikely to succeed on a common law indemnity action back against the agent because there would be no proximate cause.

At best, the carrier could claim that it is entitled to the premium attendant to furnishing the missing coverage, but that would frequently pale in comparison to an uninsured or underinsured loss.