Banks, Insurance Agents Need Contracts Before Offering Service

July 2007
Cincinnati Business Courier

It is getting harder to sue banks and insurance professionals for negligence claims in the Ohio federal courts.

In the past year, the courts have applied the doctrine of economic loss in four separate decisions to eliminate negligence claims against banks and insurance brokers.

The basic doctrine of economic loss prevents plaintiffs from asserting tort (wrongful act) claims, like negligence, if they seek to recover economic benefits of an agreement gone bad. If the plaintiff has not suffered personal injury or physical property damage, then he must sue based on the terms agreed upon in the contract.

These four recent Ohio federal court decisions are significant because a negligence-based lawsuit is subject to an ambiguous standard of care (the watchfulness, attention, caution and prudence a reasonable person in the circumstances would exercise).

This standard exists regardless of whether the defendant was aware it had such a duty. Instead of this negligence standard, the federal courts have required plaintiffs who seek to recover economic losses to sue under contract, allowing the parties themselves to dictate the duties governing their relationship and limiting their liability.

These recent cases are a significant extension of Ohio's economic loss doctrine to professional malpractice claims. The doctrine arose in the product liability context, where courts prohibited recovery in tort when a product defect or failure caused damage only to the product itself. When a plaintiff merely alleges a product has failed to perform, he is left to contractual remedies typically limited to the manufacturer's warranty.

The most recent case to apply the economic loss doctrine to an insurance or bank negligence claim is Mafcote v. Genatt Associates, 2007. In this case, a paper manufacturer sued its insurance broker alleging that the broker negligently failed to obtain an insurance policy covering business interruption losses. A boiler accident at the paper manufacturer's plant disrupted the supply chain. The manufacturer's inability to produce paper required it to purchase a more expensive product from third parties to substitute for its own products to ensure customer orders could be fulfilled. The paper manufacturer claimed its insurance broker failed to obtain proper coverage for these purchases and this failure resulted in uninsured losses.

The paper manufacturer's claim against the insurance broker was rejected by U.S. District Court Judge Susan Dlott, who held that an insurance agent or broker cannot be sued by a policyholder for negligence unless the agent or broker committed an act or error that caused actual physical injury or property damage. The alleged failure to obtain proper insurance coverage does not satisfy a negligence claim.

Under Mafcote, an Ohio insurance agent or broker cannot be sued for negligent failure to obtain insurance or the right type of coverage. The alleged lost benefit of the insurance proceeds is pure economic loss that may not be recovered through a negligence claim. As such, the manufacturer in Mafcote was left to its contractual remedies even though it had no viable breach-of-contract claim. As a result, the insurance broker won a complete dismissal.

The Mafcote decision is an extension of Ohio law as applied from a recent banking negligence case, Pavlovich v. National City Bank. In the Pavlovich case, the federal court of appeals with jurisdiction over all Ohio federal cases held that Ohio law does not recognize a negligence claim against a bank for alleged failure to administer trust assets or safe-keep investments. Very simply, any losses arising from alleged mismanagement of investment accounts are economic losses. Like the Mafcote case, the court in Pavlovich limited the plaintiff to contractual remedies, and the bank won dismissal because the contractual remedies provided no relief.

The lesson to be learned is that insurance professionals and banks should have a written contract with customers prior to service. Agents or brokers often operate without such agreements, and banks often do not adequately limit their liability within their customer contracts. Without a sufficient contract, the insurance agent or broker is often left disputing the terms of an alleged oral contract in a lawsuit.

Likewise, the bank cases often leave the bank defending allegations that could have been eliminated by a clear limitation of liability in the contract. Proper use of a written contract dictates the scope of service to be provided and can be used to eliminate many claims. Rather than having a jury determine whether a bank or insurance professional met an ill-defined standard of care, these professionals can simply point to the terms of their contract.

In light of the favorable precedents in this area, all insurance professionals and banks should examine their engagement contracts to determine how best to eliminate future claims.