Corporate Parent's Attempt to Disregard the Separate Nature of Its Wholly Owned LLC In Order to Support Insurance Claim Is Rejected by Federal Court
Businesses with wholly owned subsidiaries usually take care to treat them as separate entities, in order to maintain each subsidiary’s liability shield. But in a Sixth Circuit case last month, the parent company argued the opposite – that the separate nature of its wholly owned LLC should be disregarded. In order to recover on an insurance policy that did not list the LLC as a named insured, the parent contended that the LLC’s loss was actually a direct loss to the parent. The court disagreed. Tooling, Mfg. & Techs. Ass’n v. Hartford Fire Ins. Co., No. 10-2480, 2012 WL 3931802 (6th Cir. Sept. 11, 2012).
Background. The Tooling, Manufacturing & Technologies Association is a Michigan trade association, and is the sole member of TMTA Insurance Agency, LLC, a Michigan LLC. The Agency sells insurance policies to the Association’s members. The Association’s principal revenue source is insurance commissions paid to the Agency, and the Association receives the entire benefit or loss from the Agency’s operations.
The Association hired Mark Tyler to be the Agency’s general manager. The Agency has no employees, and Tyler was paid and employed by the Association. Id. at *1.
In 2003 the Association purchased an employee fidelity insurance policy from Hartford Fire Insurance Company. The policy covered the Association and six other named insureds, but not the Agency. Shortly thereafter Tyler began diverting commission payments that were due to the Agency.
The thefts, totaling $715,000, came to light in 2007. The Association notified Hartford and filed a claim against the policy. Hartford refused to pay and the Association brought an action in state court seeking a declaratory judgment and damages. Hartford removed the case to federal district court on the basis of diversity jurisdiction. The trial court found for Hartford, and the Association appealed.
Under the policy, Hartford promised to pay for loss or damages resulting directly from theft by an employee of the insured. There was no dispute that there was a theft or that Tyler was an employee of the Association, but Hartford refused to pay the claim on the grounds that (1) the Agency is a separate entity under Michigan law, (2) the Agency was not a named insured under the policy, and (3) the policy only applied to direct losses by an insured, and any loss to the Association was indirect. Id. at *3.
The Court’s Analysis. The court’s first question was whether the Agency was covered by the policy. If so, the Association would be entitled to recover under the policy. The policy did not name the Agency as an insured, but the Association argued that the close relationship between the Association and the Agency essentially erased any difference between the two for purposes of the insurance policy. In short, the Association claimed that the injury to the Agency was equivalent to an injury to the Association. The Association also pointed out that the only reason the Agency was created as a separate entity was to satisfy Michigan’s state insurance licensing requirements. Id. at *4.
The court looked first to the language of the policy, which stated that it was for the benefit only of the named insureds. The Agency was not a named insured (although six other related entities were listed as named insureds). The Agency was treated as a separate legal entity under the policy and for the purpose of being licensed to receive insurance commissions.
The court also reviewed the history of a separate lawsuit in state court, in which the Association had sought recovery of the commissions from Tyler and in which Tyler had counterclaimed for unpaid commissions. Tyler’s counterclaim did not include the Agency, and the Association argued in state court that the Agency was a separate entity and that there were no grounds for Tyler’s claim against the Association. The Association’s separate treatment of the Agency in that lawsuit supported the conclusion that the Association and the Agency should be treated separately under the Hartford policy. The court also recognized that Michigan’s LLC statute treats LLCs as separate from their members. Id. at *5 n.6; see Mich. Comp. Laws § 450.4504(2).
The court therefore held that the Agency had no rights or benefits under the policy and that the policy did not cover any of the Agency’s losses due to the theft. Tooling, Mfg. & Techs. Ass’n, 2012 WL 3931802, at *5. But that conclusion did not resolve the case, because the court still had to determine whether the Association’s theft-related loss of income from the Agency resulted directly from Tyler’s theft. If so, the Association’s loss would be covered by the policy.
The court reviewed the two contending interpretations used by courts in various jurisdictions: (a) “direct” means immediate or without anything intervening; or (b) “direct” means proximately caused by the originating action, which the court saw as a more flexible standard.
The Court of Appeals rejected an unpublished opinion from the Michigan Court of Appeals which held that in the context of a property damage insurance policy, the word “direct” means “immediate” or “proximate.” Acorn Inv. Co. v. Mich. Basic Prop. Ins. Ass’n, No. 284234, 2009 WL 2952677, at *2 (Mich. Ct. App. 2009). Because it was an unpublished opinion, the Acorn opinion would have no precedential value in Michigan courts, but courts in the Sixth Circuit will follow unpublished state court opinions on points of state law unless the court is convinced that the highest court of the state would decide otherwise. Tooling, Mfg. & Techs. Ass’n, 2012 WL 3931802, at *8. The Tooling court determined that the Michigan Supreme Court would not follow Acorn, ruled that “direct” in the policy means immediate or without anything intervening, and concluded that the Association’s loss of income from the Agency was not a direct result of Tyler’s theft, under the policy.
The court therefore affirmed the district court’s ruling that Hartford’s insurance policy did not cover the Association’s loss from Tyler’s thievery.
Comment. The Association’s attempt to disregard the separate nature of the Agency and treat the Agency’s loss as a direct loss of the Association was doomed by the Association’s own actions. The Association formed the Agency under state law as a separate entity, licensed the Agency under the state insurance authority as a separate entity, and claimed the benefit of the Agency’s separate existence as a defense against Tyler’s counterclaim in the state court lawsuit.
Those are all normal and reasonable actions, and only worked against the Association because of its attempt to assert an inconsistent position in its suit against Hartford.
The Washington Court of Appeals ruled this week that a limited liability company’s directors and officers (D&O) insurance policy did not cover a claim by a lender against the LLC’s manager on the manager’s guaranty of the LLC’s debt. Sauter v. Houston Cas. Co., No. 66809-9-I, 2012 WL 1699447 (Wash. Ct. App. May 14, 2012).
S-J Management, LLC, a Washington LLC, entered into a loan agreement with Commerce Bank in 2008. Michael Sauter, the LLC’s CEO and manager, signed the loan documents on behalf of the LLC as its manager, using “Michael J. Sauter, Manager of S-J Management, LLC.”
As was required by the loan agreement, Sauter also executed and delivered to the lender a guaranty of the LLC’s borrowings. Sauter’s guaranty appeared to be in his personal capacity – it referred to him as “Michael J. Sauter,” and that was how he signed it.
Later the LLC could not repay the loan, and the lender demanded payment from Sauter on his guaranty. The LLC agreed to indemnify Sauter, but it was insolvent and could not indemnify him. The LLC tendered the lender’s demand on Sauter’s guaranty to Houston Casualty Company, the D&O policy insurer. Houston Casualty denied coverage.
Sauter sued Houston Casualty for declaratory relief and damages, to enforce the policy. The trial court ruled on summary judgment that the D&O policy did not provide coverage for Sauter’s obligation on the guaranty.
The Court of Appeals ruled, in a nutshell, that the D&O policy applied only to acts performed by a manager in his official capacity as a representative of the LLC, that the D&O policy did not insure against losses incurred when a manager acts in his personal capacity, that Sauter’s guaranty was executed in his personal capacity, and that therefore the policy did not cover the lender’s claim against Sauter.
Kevin LaCroix’s post on his blog The D&O Diary, here, provides a more detailed description of the court’s analysis, as well as a good discussion of D&O policies and the kinds of disputes that can arise when there is a question whether the officer was acting in an insured capacity.
Sauter had argued that he executed the guaranty “because he was SJM’s CEO and Manager,” and because the loan agreement required the LLC to obtain a guaranty from Sauter. Sauter, 2012 WL 1699447, at *5. The court found his purpose to be unavailing. The dispositive issue was that Sauter was acting in his personal capacity when he executed the guaranty, and D&O insurance only covers officers and managers when they act in a representative capacity, on behalf of the entity.
The case should remind us that good intentions are not enough to transform the undertaking of a personal obligation, which is intended to benefit an entity, into an action in a representative capacity on behalf of the entity. One’s purpose in acting does not determine the capacity in which one acts, when the act consists of signing a written guaranty in one’s own name with no indicia that the guarantor is signing in a representative capacity.