Legal And Ethical Dilemmas Between Insurer & Insured By John W. Reis, Cozen O Connor, Charlotte, North Carolina

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1 Legal And Ethical Dilemmas Between Insurer & Insured By John W. Reis, Cozen O Connor, Charlotte, North Carolina Most states adhere to the doctrine that, as between an insurer and its insured, the insured s rights to pursue a claim against a third party tortfeasor prevail over the rights of the insurer. Most states also allow the parties to alter that common law principal with written agreements. Such an agreement, if properly drafted, will address many of the legal and ethical dilemmas between and insurer and insured. However, too often procuring such an agreement is itself a dilemma. This article is intended to provide guidance on what can happen when such an agreement is not in place and how best to secure such an agreement to avoid such problems. I. The Made Whole Doctrine A.Defined The so-called made whole doctrine holds that, as between a subrogated insurer and its insured, the insured has the right to be made whole first when both are attempting to collect from a third party. Florida Farm Bureau v. Martin, 377 So. 2d 827, 831 (Fla. 1st DCA 1979) ( Since subrogation is an offspring of equity, equitable principles apply, even when the subrogation is based on contract, except as modified by specific provisions in the contract. In the absence of express terms to the contrary, the insured is entitled to be made whole before the insurer may recover any portion of the recovery from the tortfeasor. ); Lyon v. Hartford Accident and Indemnity Company, 25 Utah 2d 310, 480 P.2d 739, 744 (Utah 1971). The doctrine is easy to state but can be difficult to apply and address when instituting a subrogation claim. Perhaps the best way to understand the doctrine is to understand its exceptions. The two key exceptions are that the doctrine does not apply (1) if the insured s legally recoverable damages do not in fact exceed what the insurer paid and, (2) if the tortfeasor has funds to pay both the insurer and the insured for the total recoverable damages. B. Exceptions 1. When Actual Recoverable Damages Are Less Than The Claim The made whole doctrine only applies if the insured s actual legally recoverable damages exceed the amount paid by the insurer. That was the holding in Tampa Port Authority v. M/V Duchess, 65 F.Supp.2d 1299 (M.D. Fla. 1997). In that case, the Tampa Port Authority (TPA) obtained a judgment for $151,642 plus prejudgment interest against a vessel owner that had damaged a pier owned by the TPA. Westchester had insured the TPA for that same pier and had paid the TPA $338,117 for the damages to the pier, but TPA wanted its $75,000 deductible and also wanted what it claimed were damages additional to what it was paid, plus its attorneys fees, interest and costs. The damages of $151,642 were assessed after a bench trial. The court also found that in light of the fact that Westchester had paid TPA $338,117 on its claim for this damage, reserving a right to subrogation, the court s judgment would be awarded to Plaintiff Tampa Port Authority and its subrogee Westchester Fire Insurance Company, rather than just to plaintiff TPA. Westchester filed a motion to modify the judgment to state that Westchester, not TPA, is entitled to recover the full $151,642 plus prejudgment interest from M/V DUCHESS. The Court granted Westchester s motion, holding that although the insured has the right to be made whole first, the insurer here was entitled to the full judgment amount because (1) the judgment in favor of the insured constituted full recovery for

2 purposes of determining whether the insurer was entitled to subrogation and, (2) the insured was not entitled to recover its attorney fees and costs prior to its insurer recovering any damages through subrogation where the insurer actively participated in all aspects of the litigation. 2. Limited Fund Situation In the case of Schonau v. GEICO General Insurance Company, 903 So.2d 285 (Fla. 4th DCA 2004), Florida s Fourth District Court of Appeal limited the impact of Florida s made whole doctrine. The case essentially holds that the made whole doctrine that the insured has the right to be made whole first cannot be used by an insured as a sword to sue a subrogated insurance carrier that recovers before the insured is made whole, except under certain limited fund circumstances. The plaintiff in Schonau was an insured that sued its subrogated insurer after the insurer settled a subrogation claim against a tortfeasor. Plaintiff claimed her insurer should have paid her all of her unreimbursed damages before having the right to collect proceeds from the tortfeasor. The court agreed that an insured has the right to be made whole first. However, the court affirmed dismissal of her claim because the insurer did nothing to impair her from independently recovering from the tortfeasor if she had chosen to do so. The nutshell holding is that an insured does not have an affirmative right to sue its subrogated insurer for settlement proceeds received by the insurer unless there is a showing that the insured was impaired in its ability to be made whole, either because the tortfeasor s available funds are limited or because the subrogated insurer did something that impaired the insured s ability to be made whole. None of those circumstances where shown in the case. Schonau is an example of no good deed going unpunished. GEICO fully paid its insured, Ms. Schonau, everything due Ms. Schonau under the policy. GEICO then wrote to Ms. Schonau to advise that it intended to sue the tortfeasor to get back not only what it paid her the collision benefits of $8, and her car rental limits of $ ($9, total) but also her $ deductible and her out-ofpocket car rental expenses above the $600 limit. She had incurred $4,000 in rental car expenses, thus left with $3,400. GEICO then obtained recovery from the tortfeasor s insurance carrier for a total of $9, and gave Schonau the $ difference to reimburse her for her $100 deductible and a portion of her unreimbursed rental car bill. She still had over $3,000 in unpaid car rental expenses and she was unhappy about it to the point of hiring a lawyer. Schonau s attorney elected to sue GEICO in a class action lawsuit for violating the made whole doctrine and collecting on her behalf without paying her all of her unpaid losses first. Schonau cited to Florida Farm Bureau v. Martin, 377 So.2d 827 (Fla. 1st DCA 1979), a case holding that an insurance carrier has no right to recover prior to the insured s right of recovery, unless the insurer has obtained an assignment or loan receipt. Though there was apparently no such loan receipt or assignment executed, the Schonau court limited Martin s holding to the scenario where the tortfeasor s funds were limited. The court noted that the made whole doctrine is only a defense used by insureds to protect the insured s direct recovery from a tortfeasor, where the insured s own insurer makes a subrogation claim upon the insured s recovery. The court cited the case of Paulson v. Allstate Ins. Co., 263 Wis. 2d 520, 665 N.W.2d 744 (Wisc. 2003) in holding that the doctrine creates no cause of action in and of itself. In Paulson, two insurance companies settled despite the fact that the tortfeasor s damages were not all paid. Although Paulson recognized that under certain circumstances a plaintiff must be made whole before an insurer has a right to subrogation, it held that the situation only applied where there was a limited pool of money. Paulson, 665 N.W.2d at 750. II. Agreements Between Insured And Insured

3 Many of the cases discussed above show what can happen if the insurer and insured have not set forth, in writing, which party can sue for what once the claim has been paid. The best way to avoid such dilemmas is to obtain a written agreement between the parties. Such written agreements can come in the form of what is called a Subrogation Loan Receipt, Subrogation Assignment or some other form of agreement with varying titles. A.Subrogation Loan Receipts And Assignments There is a difference between a subrogation loan receipt and an assignment of subrogation rights. The two will be discussed separately. 1.Loan Receipts Historically, the loan receipt arose out of a commercial setting involving shippers and carriers. The purpose of the loan receipt agreement was to promptly supply the shipper with money from his insurer, to the extent of the compensation to which the insured was entitled as a result of property loss suffered and to preserve to the insurer a claim against the carrier to which the insurer would become subrogated upon payment of the loss. American Chain & Cable Co., Inc. v. Brunson, 157 Ga. App. 833, 278 S.E.2d 719 (1981). The Supreme Court of the United States has approved such agreements as a means of obtaining, prompt settlement for loss (which is essential to actual indemnity and is demanded in the interest of commerce). Id. at 278 S.E.2d 720; Luckenbach v. McCahan Sugar Refinery Co., 248 U.S. 139, 146, 39 S.Ct. 53, 54 (1918). a.what Is It? A loan receipt is an agreement whereby the insurer extends a loan without interest to its insured, repayable only in the event and to the extent of any net recovery that the insured may obtain from any person or entity responsible for causing the loss. In essence, it creates a legal fiction where, for the convenience of the insured, the insurer advances money which, if the insured is not successful in recovering against the tortfeasor, the insurer is liable to pay under the insurance policy. Ratcliff v. Smith, 298 S.W.2d 18 (Ky 1957); Green v. Johns, 86 Ga. App. 646, 72 S.E.2d 78 (1952). In Georgia, the usual circumstances under which a loan receipt agreement is executed involves 1) a loss, 2) a claim, whether in the form of a proof of loss, or otherwise and, 3) a payment in the form of a "loan" to an insured by his insurer for property damage resulting from a tortious act by a third party. American Chain & Cable Co., Inc. v. Brunson, 157 Ga. App. 833, 278 S.E.2d 719 (1981). The insured is the owner of the cause of action that arises from the tortious act and, in essence, he or she accepts payment from the insurer as a loan and agrees to repay it from any recovery achieved by prosecuting the cause of action against the tortfeasor. Hall v. Helms, 150 Ga. App. 257, 257 S.E.2d 349 (1979). If the insured were to prosecute the cause of action following execution of the loan receipt, to the exclusion of the insurer, the insurer would still retain the right to collect from the insured the amount which had been advanced under the loan receipt. Id. at 257 S.E.2d 350. The fact that the loan receipt is a legal fiction is not grounds to set it aside, as held in Aetna Freight Lines, Inc. v. R.C. Tway Co., Ky., 298 S.W.2d 293, 296 (Ky. Ct. App. 1957), which stated:

4 While it is clear that the difference between a loan of the type under consideration and an absolute payment is mere fiction, that ground alone is insufficient to declare the transaction a nullity. Rather, we will look to the purpose of the fiction created by the parties to the transaction. It is clear that purpose of the loan agreement was to insulate Continental from a prejudice, which juries frequently apply against insurance companies. Our courts have long been aware of this prejudice, as exemplified by our decisions in personal injury cases where the element of insurance has been improperly injected. The landmark case in the United States in which the Court held that sums paid over under such an agreement should be regarded as loans and not as absolute payment is Luckenbach v. W. L. [J] McCahan, Sugar Refining Co., 248 U. S. 139, 39 S. Ct. 53, 63 L. Ed. 170, in which Justice Brandeis said, It is creditable to the ingenuity of businessmen that an arrangement should have been devised which is consonant both with the needs of commerce and the demands of justice. As noted by the South Carolina Supreme Court in Phillips v. Clifton Mfg. Co., 204 S.C. 496, 30 S. E. (2d) 146 [157 A. L. R. 1255], The Luckenbach decision has been uniformly followed by state courts in passing upon the validity of loan receipt agreements * * * and we are in accord with these decisions. b.how It Arises In most states, the usual circumstances under which a loan receipt agreement is executed involves a loss, a claim (whether in the form of a proof of loss or otherwise) and a payment in the form of a loan to an insured by his insurer for property damage resulting from a tortious act by a third party. American Chain & Cable Co., Inc. v. Brunson, 157 Ga. App. 833, 278 S.E.2d 719 (1981); see, e.g., Rosenthal v. Scott, 150 So. 2d 433, 437 (Fla. 1961); State Farm Mutual Automobile Insurance Company v. Robbins, 237 So. 2d 208 (Fla. 4th DCA 1970). The insured is the owner of the cause of action that arises from the tortious act and, in essence, he or she accepts payment from the insurer as a loan and agrees to repay it from any recovery achieved by prosecuting the cause of action against the tortfeasor. Rosenthal, 150 So. 2d at 437; Robbins, 237 So. 2d at 208; Hall v. Helms, 150 Ga. App. 257, 257 S.E.2d 349 (1979). If the insured were to prosecute the cause of action following execution of the loan receipt, to the exclusion of the insurer, the insurer would still retain the right to collect, from the insured,the amount which had been advanced under the loan receipt. Hall v. Helms, 257 S.E.2d 350. c.does A Loan Receipt Assign The Insured s Cause Of Action To The Insurer? A typical loan receipt agreement does not assign the insured s cause of action to the insurer, but rather it is merely an agreement memorializing the loan of money. Loan receipts have become the agreement of choice in settlement of first-party claims that have subrogation potential. E.g., Gould v. Weibel, 62 So. 2d 47 (Fla. 1952). In Gould, the Florida Supreme Court has held it to be error to add a subrogated insurance carrier to a lawsuit filed in the name of the insured if a loan receipt has been executed. The defendant in Gould filed a motion to involuntarily add plaintiff s insurance carrier as a party plaintiff. Plaintiff had entered into a loan receipt with the carrier in an amount equal to plaintiff s damages. The trial court granted the motion and joined the carrier. The Florida Supreme Court reversed, noting that there was no good reason to have added the carrier and stating: No contention is here made that the substantive rights of the defendant will be prejudiced by the failure to join the insurers as parties plaintiff, nor that the defendant will be subjected to a second claim for the one wrong; and, indeed, such contentions could not be sustained. The judgments in the instant suits will

5 be final and conclusive and will bar any further action on the same claim by either the plaintiffs or the insurers, even though the insurers had not been joined as parties plaintiff. (Id. at 49). 62 So. 2d at 49. In some states, if what has been signed by the insured is an assignment but not a loan receipt, the suit no longer belongs to the insured and the suit must be filed in the name of the insurer as the real party in interest. d.real Party In Interest If the loan receipt agreement actually memorializes only a loan, and if it does not assign the insured s cause of action to the insurer, the insured remains the real party in interest. Rosenthal v. Scott, 150 So. 2d 433, 437 (Fla. 1961); State Farm Mutual Automobile Insurance Company v. Robbins, 237 So. 2d 208 (Fla. 4th DCA 1970); see also McCann v. Dixie Lake & Co., 44 Ga. App. 700, 162 S.E. 869 (1931); Green v. Johns, 86 Ga. App. 646, 72 S.E.2d 78 (1952) ; American Chain & Cable Co., Inc. v. Brunson, 157 Ga. App. 833, 278 S.E.2d 719 (1981). Ratcliff v. Smith, 298 S.W.2d 18 (Ky 1957); Aetna Freight Lines, Inc. v. R.C. Tway Co., Ky., 298 S.W.2d 293 (Ky. Ct. App. 1957). Some courts have held that if an assignment results from the language utilized in the purported loan receipt agreement, the real party in interest becomes the insurance company and suit must be prosecuted in its name. Frank Briscoe Co., Inc. v. Georgia Sprinkler Co., Inc., 713 F.2d 1500 (11th Cir. 1983). 2.Subrogation Agreements Subrogation agreements take on no particular form. They have been referred to from time-to-time as subrogation agreements, State Farm Mutual Automobile Insurance Company v. Robbins, 237 So. 2d 208 (Fla. 4th DCA 1970), and as subrogation assignments, Webb v. State Auto Mutual Insurance Co., 182 Ga. App. 425, 370 S.E.2d 492 (1988). A review of the case law in other jurisdictions indicates that insurers enter into subrogation agreements quite often, whereas with hindsight, they would rather have entered into loan receipt agreements with their insureds. Kurtz v. Parker Plumbing & Heating Co., 225 Ga. 31, 165 S.E.2d 729 (1969); Lindsey v. Samoluk, 236 Ga. 71, 223 S.E.2d 147 (1976); General Insurance Company v. Bowers, 139 Ga. App. 416, 228 S.E.2d 348 (1976). 3.Sample Loan Receipts Here is an example of an actual subrogation receipt deemed a true loan in Ratcliff v. Smith, 298 S.W.2d 18 (Ky 1957): Received from the Calvert Fire Insurance Company (hereinafter referred to as Company ) the amount shown above as a loan, ($2,000.00) without interest, repayable only in the event and to the extent of any net recovery the undersigned may make from any person, persons, corporation or corporations, or other parties, causing or liable for the loss or damage to the property described below, of from any insurance effected on such property, and as security for such repayment the undersigned hereby pledges to the said Company all his, its or their claim or claims against said person, persons, corporation or corporations or other parties, or from any insurance carrier or carriers, and any recovery

6 thereon, and hereby delivers to said Company all papers necessary to show his, its, or their interest in said property. Here is an attempted subrogation receipt in Kurtz v. Parker Plumbing & Heating Co., 118 Ga. App. 130, 162 S.E.2d 755 (1968), that was later in, Parker Plumbing and Heating Co. v. Kurtz, 225 Ga. 31, 165 S.E.2d 729 (1969), deemed an assignment and not a loan: Received of The Northern Insurance Company, the sum of Twelve-Thousand Seven Hundred Seventythree Dollars and Sixty-seven Cents ($12,773.67) in full settlement of all claims and demands of the undersigned for loss and damage by fire occurring on the 24th day of January, 1963, to the property described in policy no. H issued through the Decatur, Georgia agency of said company. In consideration of and to the extent of said payment, the undersigned hereby subrogates said insurance company, to all of the rights, claims and interest which the undersigned may have against any person or corporation liable for the loss mentioned above, and authorizes the said insurance company to sue, compromise or settle in the undersigned s name or otherwise and all such claims and to execute and sign releases and acquittances and endorse checks or drafts given in settlement of such claims in the name of the undersigned, with the same force and effect as if the undersigned executed or endorsed them. Warranted no settlement has been made by the undersigned with any person or corporation against whom claim may lie, and no release has been given to anyone responsible for the loss, and that no such settlement will be made nor release given by the undersigned without the written consent of said insurance company and the undersigned covenants and agrees to cooperate fully with said insurance company in the prosecution of such claims, and to procure and furnish all papers and documents necessary in such proceedings and to attend court and testify if the insurance company deems such to be necessary, but it is understood that the undersigned is to be saved harmless from costs in such proceedings. III. CONCLUSION The key to resolving difficulties between insurer and insured is a full and frank discussion up front about the possible recovery scenarios down the road. The more the insurer discloses to the insured, the more trust the insured will have in the insurer. The more trust the insured has, the more likely the insured will be to come to an agreement, in writing, that addresses those potential difficulties before they arise.