Ensuring Adequate Coverage
Learn How to Make Errors and Omissions Insurance Work for You.
Commercial real estate companies typically endure the annual renewal of their errors and omissions insurance. Considered a mundane task by most, the process begins about 90 days before the current policy expires. The office manager usually transfers information from last year’s application to the new one, making a few changes. The broker in charge reviews it, signs it, and sends it back to the insurance agent. About two weeks before the policy expires, the agent calls the office manager advising that the renewal proposal is in and that the premium looks good compared to the expiring premium and recommends renewing the policy.
Familiar as that routine is, commercial real estate companies have good reasons to place some extra effort into the insurance process. Some companies may be avoiding potentially profitable activities for fear of liability. With a creative approach to the placement of E&O liability insurance, they may be able to partially or fully insure that risk, making it possible to undertake previously frowned-upon ventures. Defensively, companies already may be involved in activities that previously were not insurable — but now E&O insurance may be available.
It is important to understand that E&O liability policies vary greatly. Real estate professionals should sit down with their insurance agents to discuss any proposed policies in detail, making sure that salient points that matter the most to their company are covered. Some of the issues to examine are outlined below.
Who Is Insured?
Most policies include the company as the "first named insured." That is the entity with which the insurance company will deal most directly on notifications, claims communications, and premium payment issues.
The insured also should include all partners (and spouses) if the company is a partnership; individuals (and spouses) if the company is a sole proprietorship; members and managers if the company is a limited liability company; executive officers, directors (working within their duties for the company), and stockholders (with respect to their liability as stockholders); and all employees or independent contractors while working on the company’s behalf. All former employees, partners, and agents also should be included under the definition of named insureds.
Some policies require that joint ventures specifically be named and insured under separate policies. E&O insurance is available to cover activities that usually are fairly specific in nature and limited in scope and duration, such as joint ventures.
In fact, insurance is available for any deal on a transaction-by-transaction basis. However, unless the transaction is very large, this probably is an inefficient way of procuring insurance. While no alternative may exist if a joint venture or other limited-duration entity is conducting the transaction, it usually is better to carry insurance for all transactions throughout the year. Two reasons exist for this. First, insurance companies that provide E&O insurance have minimum policy premiums that often are larger than the respective premium generated by a single transaction. Second, an underwriter likely will be suspicious of a broker who ordinarily does not see the value in E&O insurance but wants it for a particular deal. The underwriter may assume that the insurance company is being adversely selected against — being asked to insure a hazardous deal without being asked to insure the innocuous ones.
What Is Covered?
The insuring agreement at the beginning of a policy states that the insurance company will pay for "acts, errors, and omissions." The end of the policy defines these terms. It should include any negligent act, error, or omission in the rendering of or failure to render professional services.
The policy’s definition of professional services should include the specific services that a company’s members perform or advice that they give. Examples of these activities are those performed by brokers, agents, employees, salespeople, personal assistants, consultants, counselors, appraisers, property managers, leasing agents, mortgage brokers, or auctioneers. Real estate developers probably are not listed as covered professional services, although some insurance companies now do provide coverage for development activities.
The policy also should cover notary public activities and membership of any formal real estate accreditation, standards review, or similar real estate board or committee if those exposures apply to any of the named insureds.
Every real estate E&O policy provides coverage on a claims-made basis. Essentially, this means that the insurance company only will pay for claims that are made to it while it remains the insurance company, or for a limited time after the policy or policies expire, if the company has paid an additional premium for an extended reporting period.
In addition, the actual or alleged negligent act, error, or omission that gives rise to the claim must occur after the policy’s retroactive date. That can be the first day that the company bought coverage from that insurance company, the first day of its current policy, or it can be negotiated out of the policy, giving the company full coverage for prior acts no matter how long ago they occurred. However even without a retroactive date, there is no coverage for ongoing suits or suits anticipated when the original policy is secured.
What Is Not Covered?
The exclusions and definitions sections of the preprinted policy form explain what conditions are excluded from coverage, along with any alterations made by the endorsements attached to the end of the policy. Below are a few problematic exclusions, along with some solutions available to eliminate or reduce the negative impact of those exclusions.
For pollution, including asbestos, radon, and lead, coverage usually is available under separate pollution liability policies for errors and omissions relating to the existence of pollution in properties, which serves to devalue that property. Coverage is not commonly available for the subsequent devaluation of surrounding properties that were not actually polluted.
For example, a real estate professional brokered the sale of a shopping center that was adjacent to an automobile service center. Subsequently the center was found to have leaking underground storage tanks that contaminated the ground under the service center and the shopping center. The estimated cleanup cost for the service center was determined to be $250,000. The garage owner’s response was immediate and decisive — bankruptcy.
The estimated cleanup cost of the shopping center land was $1.4 million because the contamination had spread into the underground water table and permeated the entire parking lot, including the area under an out-parcel bank.
Obviously the new owner was unhappy about the real estate broker’s lack of research and/or alleged lack of disclosure pertaining to the investigation of all reasonable pollution exposures in the area and the owner sued. A well-designed pollution insurance policy could have protected the real estate broker from the impending litigation.
Some, but not all, of the risks connected with securities regulation such as blue-sky laws, the Employment Retirement Income Security Act, or the Securities Exchange Act can be transferred to an insurance company that is willing to provide securities E&O liability insurance. While actual violations of these or similar specific laws likely will be uninsurable, the gray-area claims that allege such wrongful acts as misrepresentations of prospective returns or misuse of funds could trigger insurance coverage for defense costs and/or actual damages.
Coverage to protect a company from part of this exposure can be purchased either by endorsement to an E&O policy or through separate policies. There is a landslide of litigation activity designed to protect the public from discrimination arising from housing, business opportunities, employment, and access to quality of life.
For instance, a real estate professional sells a property to a child day-care center in a neighborhood that is in transition from residential to commercial use. The adjacent neighbor rezones and lists his personal residence and contiguous duplex for sale as commercial property. The same broker gets the listing and gets an offer from an adult day-care and halfway house for AIDS patients. The objections of the owner, residential neighbors, and adjacent child day-care center all are based on discriminatory beliefs, and the ensuing litigation places the real estate broker squarely in financial harm’s way. A properly endorsed E&O policy will provide defense cost coverage and some coverage sublimit for judgments, if any are rendered against the broker.
The insurance industry traditionally has avoided providing coverage for development activities due to their speculative nature and the possibility of conflict of interest if a developer serves as his own real estate broker. Recently, some limited coverage has become available for claims arising from what are considered wrongful acts committed by developers. This coverage is provided by endorsement, often with sublimits of coverage less than the limits that a policy provides for other claims.
Years ago, a developer of the land surrounding a new interstate intersection sold land to a fast-food hamburger franchise. As a condition of the transaction, the developer represented to the franchise that none of the restaurant’s competitors would be sold land at that intersection. Six months after the closing, the developer sold the land across the street to a fast-food chicken franchise.
The hamburger franchise immediately filed for an injunction to stop the sale but was not successful. The developer took the position that the chicken restaurant and the hamburger restaurant were not competitors because they focused on different types of food. The hamburger franchise sued. At that time, coverage for development activities was not available and the claim went uninsured based upon the "development" exclusion.
A more current E&O policy, with coverage added for development activities, would provide a defense for this claim. Some of the judgment costs likely would be insured, and some likely would be covered. For example, the court may place a value on the "exclusivity promise," and the insurance company may pay that amount, although not much precedent currently exists.
The insurance industry long has been willing to provide insurance for construction management activities. However, its cost was prohibitive because insurance companies charged premiums based on the total cost of the work and treated the developers like general contractors or architects/engineers. The only risk-transfer alternative available to developers was to build their indemnification into the construction contracts.
Examples of the origins of claims that could result from wrongful acts of construction managers include improper construction or construction delays. As with development coverage, this coverage now is available by endorsement with coverage sublimits.
Real estate professionals involved in the syndication, operation, or administration of corporations, joint ventures, general or limited partnerships, or real estate investment trusts should communicate clearly and early with their insurance agents and attorneys. Some of the related risk can be transferred by the purchase of director’s and officer’s liability insurance policies. In some cases, the risk may be transferred to an insurer that provides securities E&O liability insurance.
E&O insurance policies typically exclude any coverage for claims to indemnify a third party for liabilities that were assumed by their policyholders in contracts. Thus, companies should be careful when they agree to indemnify anyone for anything. They may find themselves responsible for liabilities that were not theirs under common law, and for which their insurance company will not protect them.
For example, if a company indemnifies a real estate broker for a consultation in a transaction, the E&O policy will not respond if it exclusively was the fault of the outside broker that leads to a claim. The company still will have to pay, but its insurance company will invoke the contractual liability exclusion of the policy.
Many real estate agents own property as well as buy and sell it. What they do not realize is how exposed they are to risk when they mix the two roles. Further, those who carry E&O insurance do not realize how well insulated their insurance companies are from any conflict of interest claims that arise.
Some creative ways exist to obtain total or partial coverage for claims arising from the sale, leasing, or management of properties in which a named insured has any ownership interest, or any other financial interest, usually greater than 10 percent of the property or transaction value. However, without such special treatment, a policy probably will not cover claims on properties in which any named insured has an ownership interest.
Insured vs. Insured.
Coverage typically will not apply whenever two or more named insureds under the same E&O policy litigate against each other. For example, if two subsidiaries or franchisees find themselves insured on the same policy, they deal at great risk when they give and accept referrals from each other. If a claim arises based upon representations made during the referral process, then they have a common-law course of action between them that will not be covered by insurance. Also, note that agents and the agency are on the same policy, thus excluding suits arising from internal matters.
Finding the Best Coverage
Insurance has been called a foreign language. To obtain the coverage they need, companies must understand the language their insurance company is using to protect their assets.
As the above examples indicate, all E&O liability policies are not created equal. Companies need to determine their needs by hiring a risk manager or using an insurance agent to take an introspective view of their organization. Risk managers receive no compensation from any party other than the client, and they hold no duty of loyalty to any party. Insurance agents or brokers usually receive their compensation from the insurance company in the form of commissions, and they hold certain duties of loyalty to both their client and to the insurance company.
After deciding whom to use, companies should begin the process of obtaining proposals. A risk manager can coordinate the acquisition of proposals from various insurance companies, by way of the companies’ agents or brokers. Companies working directly with an agent or multiple agents should provide them with consistent specifications and tell them to advise of any deviations from the specifications that are included in their proposals.
Premiums vary according to the size of the company, the complexity of the operations, the coverages purchased, and the past claims history. Minimum premiums are available for as low as $500 per year. If premium quotations are too high for a company’s budget, it should consider higher deductibles or retentions. A retention differs from a deductible in the area of control. The insurance company typically controls the entire claims process and seeks reimbursement from the policyholder for deductibles. Conversely, the policyholder controls the claim and involves the insurance company after the retention has been exceeded.
All real estate professionals are exposed to the risk of a professional error or omission. The greater extent to which they present themselves as professionals, the higher the level of expertise to which the public may hold them.
This time-consuming process represents a use of a company’s resources in terms of insurance premiums and time. However, it is much more efficient for a company proactively to undertake this investigation at the time it purchases a policy, than to get a similarly revealing education from an insurance company’s claims adjuster or an attorney after a claim occurs.