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June 2013

Policy Requirement That Insured Property Have Fire Suppression System Is Condition Precedent to Coverage

On May 30, Division One of the California Court of Appeal Second Appellate District affirmed the lower court’s ruling that it is an insured’s burden to establish satisfaction of a policy’s conditions precedent and that without an affirmative act by the carrier, an insurance agent is neither the actual or ostensible agent of the insurer.

In American Way Cellular, Inc. v. Travelers Prop. Cas. Co. of America, Travelers issued American Way successive property policies each containing a “Protective Safeguards Endorsement For Sprinklered Locations and Restaurants,” which stated, “As a condition of this insurance, you are required to maintain the protective devices or services listed . . . .” The endorsement listed “Automatic Sprinkler System, including related supervisory services” and stated that there was no coverage for fire damage if the insured failed to maintain the system, knew of its suspension or impairment, or if the system shut off due to breakage, leakage, freezing or damage. The application for insurance submitted by the insured’s agent through a broker indicated that American Way’s property had “Smoke Detectors/Fire Exting./Sprinklers.” 

After a fire damaged the insured property, Travelers discovered that the building did not have any sprinkler system installed. Consequently, Travelers sought reimbursement of its good faith payment of $250,000 and a declaration of no coverage. The insured asserted causes of action against its insurance agent, an insurance broker and Travelers for negligence, bad faith and declaration of coverage. Specifically, the insured argued that Travelers was liable for the agent’s negligence in stating in the insurance application that the property had a sprinkler system and that in any event the endorsement was vague and ambiguous as it dealt with the maintenance of a system and therefore did not impose a duty on the insured to install a system in a property that never had one.

Rejecting these arguments, the court first turned to the issue of whether Travelers could be held liable for the acts of the agent and/or broker. Preliminarily, the court held that an insurer had no affirmative duty to inspect a property or verify the truth and accuracy of an insured’s application. Citing Insurance Code §§33 and 1623, the court then pointed out that by definition an insurance broker did not transact insurance on behalf of an insurer and that an insurer is not liable for the broker’s acts or omissions. 

Turning to the acts of the agent who filled out and submitted American Way’s insurance application, the court noted that to be an insurance agent in California, an individual must have a valid license issued by the commissioner of insurance and must be authorized by an insurance carrier to transact insurance business on the carrier’s behalf. Moreover, pursuant to Insurance Code §1704(a), this authorization must be evidenced by a notice of agency appointment on file with the Department of Insurance. Given the lack of any such notice and the agent’s testimony that it had never been authorized to transact business on behalf of Travelers, the court held that an actual agency between Travelers and the agent had not been established. Likewise, the court held that there was no ostensible agency at issue because ostensible authority cannot be established by the representations or conduct of the purported agent; rather, the statements or acts of the principal must be such as to cause a reasonable belief that the agency exists. Here, the insured presented no evidence that Travelers had made any statements or committed acts causing American Way to believe an agency relationship existed between the agent and Travelers. Accordingly, Travelers was not liable for any conduct of the broker or agent and was entitled to rely on the representation in the application that the property had an automatic sprinkler system.

Turning to the protective safeguard endorsement, the court found the endorsement to be a condition precedent to coverage and because it was undisputed that the property did not have a sprinkler system, no coverage was available for the loss. The court rejected the insured’s argument that the endorsement’s use of the term “maintain” could reasonably be interpreted to mean that the insured only had a duty with regard to an existing system and did not have a duty to have a system installed. In so holding, the court distinguished this case from Holz Rubber Co., Inc. v. American Star Ins. Co. (1975) 14 Cal.3d 45, where the California Supreme Court determined that the term “maintain” described “only the insured’s duty with respect to the sprinkler system in existence when the policy was first issued.” Here, there was no evidence that American Way intended to install automated sprinklers in new construction as did the insured in Holz. Rather, the insured’s application for insurance stated that a system already existed at the property. Under these facts, the court held that the endorsement “required American Way to have a functioning, operational sprinkler system during the period of coverage.”

Click here for a copy of the opinion.

The opinion in American Way Cellular, Inc. v. Travelers Prop. Cas. Co. of America, (May 30, 2013) 216 Cal.App.4th 1040; 13 C.D.O.S. 5452; 2013 Cal.App.LEXIS 425, is not final.  It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court.  These events would render the opinion unavailable for use as legal authority.

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David L. Jones