This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 15, #24, p. 25 (April 17, 2002). © Copyright Butler 2002.
The Seventh Circuit recently addressed the question of whether an independent insurance broker, who provided clients to the insured, was their intermediary, thus barring coverage and bad faith claims. (First Insurance Funding Corporation v. Federal Insurance Company, No. 01—2855 (7th Cir. March 28, 2002)).
The insured, First Insurance Funding Corporation (“First Insurance”), is an insurance premium finance company that provides loans to businesses to finance payment of their insurance premiums. First Insurance was insured by Federal Insurance Company (“Federal”) under a financial institution bond. Colesons Insurance Group (“Colesons”) is an independent insurance broker who provided clients to First Insurance for premium loans.
A dispute arose in connection with the fraudulent submission of finance agreements to First Insurance by individuals at Colesons. As a result of the submission of fraudulently altered premium finance agreements by Colesons, First Insurance was defrauded of over $4.3 million. Upon discovery of the fraudulent transactions, First Insurance sought indemnification for its losses from Federal under the terms of the financial institution bond. The bond provided coverage against losses resulting from certain fraudulent or dishonest conduct perpetrated against First Insurance.
Federal denied the claim based upon a policy exclusion that excluded coverage for fraudulent acts caused by any intermediary or finder. Federal argued that Colesons was an intermediary of First Insurance, and thus there was no coverage. The exclusion states in pertinent part as follows:
This bond does not directly or indirectly cover. . . loss caused by any agent, broker, factor, commission merchant, independent contractor, intermediary, finder or other representative of the same general character of the ASSURED.
The complaint alleged that Federal’s failure to indemnify First Insurance not only amounted to a breach of contract, but also an unreasonable and vexatious denial of coverage in violation of Section 155 of the Illinois Insurance Code. The district court dismissed the complaint and held that Colesons functioned as an intermediary or finder of First Insurance, thus implicating the policy’s coverage exclusion. The court further held that the coverage exclusion barred the bad faith claim, stating that the insured must have a “legitimate claim for coverage” before it could maintain an action for bad faith pursuant to the statute.
The Seventh Circuit upheld the dismissal based on the coverage exclusion and then turned its attention to First Insurance’s claims that Federal was liable for bad faith under Section 155 of Illinois Insurance Code for unreasonably and vexatiously denying its request for indemnification. Section 155 states in pertinent part as follows:
In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other costs, plus an amount not to exceed any one of the following amounts:
- 25% of the amount which the court or jury finds such party is entitled to recover against the company, exclusive of all costs;
- the excess of the amount which the court or jury finds such party is entitled to recover, exclusive of costs, over the amount, if any, which the company offered to pay in settlement of the claim prior to the action.
IL ST CH 215 § 5/155.
The 7th Circuit noted that Section 155 was intended to provide a remedy for “insureds who encounter unnecessary difficulties resulting from an insurance company’s unreasonable and vexatious refusal to honor its contract with the insured.” Korte Constr. Corp. v. Am. States Ins., 750 N.E.2d 764, 771 (Ill. 2001). Distinguishing such a scenario from the facts presented before it, the court determined that where there was no entitlement to coverage under a policy, no claim for bad faith would lie. The court stated, “[w]hen an insurer denies the claim of an insured because no coverage exists, the insurer has not failed to honor its contractual obligations under an insurance policy. As such, Illinois courts allow a cause of action to proceed under Section 155 only if the insurer owed the insured benefits under the terms of the policy.” Concluding that First Insurance did not have a legitimate claim for coverage, due to the exclusion, the Seventh Circuit affirmed, holding that First Insurance had no claim under Section 155.
First Insurance is important because, even in spite of an arguable entitlement to coverage, no claim for bad faith will lie after it is determined that there is no coverage under the policy.