Risk Management

Coverage complications of LLCs

Overlapping ownership interests can imperil coverage

By Donald S. Malecki, CPCU

When individuals begin to build business empires by owning sole proprietorships, forming partnerships or joint ventures (which are partnerships for a limited purpose), corporations or limited liability companies, one of the problems is ensuring that there are as few gaps in insurance protection as possible.

It is not an easy task to close gaps, even if individuals hire legal assistance and the most knowledgeable insurance broker on the block. It is no guarantee, of course, that coverage will apply anyway, particularly in situations culminating in litigation.

In one recent situation involving a limited liability company, an individual, referred to as "A," who was involved in various businesses, formed a limited liability company (LLC) with another person "B" and established a car wash. The LLC, comprised of "A" and "B," owned two-thirds of the premises upon which the car wash was located. Another individual "C" owned the other one-third under a different LLC.

For insurance purposes, the questions posed were (1) whether both limited liability companies needed a property and liability policy; and (2) how any claims would be handled among multiple insurers, assuming a covered loss or claim.

The LLC formed by "A" and "B" would presumably have shown two parties (partners) as managers of that LLC. Their respective management obligations (in relation to the car wash) also most likely would have been described in an operating agreement. A liability policy issued in the name of the "A" and "B" LLC would cover the entity as a named insured, and the partners in their capacities as managers of the LLC, as insureds.

As to the other LLC owned by "C," (the one-third owner of the premises), any observation here would depend on whether this individual had an ownership interest in the car wash or whether it had any responsibilities for the operations. If this LLC owned by "C" or its principal/manager had management or supervisory responsibility over the operations of the car wash, it definitely would have required liability coverage for that role.

Adding the second LLC "C" as an insured under the LLC owned by "A" and "B" would have worked only if the second LLC "C" were added as a named insured to that policy of "A" and "B," assuming an insurer would even do so. The problem with adding the second LLC "C" as an additional insured, instead as a named insured, is that coverage would apply only to the entity itself (the second LLC) and would also require careful language.

The individual "C" who owns the second LLC and one-third of the property would have no coverage individually. As a named insured, however, coverage should apply to both the second LLC "C" and its manager.

To the extent an insurer of the LLC owned by "A" and "B" were to refuse to add the second LLC "C" as a named insured, it would then be necessary for that latter entity to procure its own policy.

Administering claims

How claims would be administered would depend, in part, on how coverage applies. If both LLCs "A" and "B," and "C" were to be named insureds under the same policy, the insurer covering both entities would be obligated to defend and, absent any exclusion, pay claims on behalf of each of the named insureds.

The extent of liability attributable to each LLC and/or managers would depend on a variety of factors, including their respective obligations under the operating agreement clarifying the roles of those involved in running the car wash. Another factor in apportioning liability might be indemnity obligations agreed to and any statutes that might affect the rights of the parties to indemnify one another.

If the two LLCs were to maintain separate liability policies, the procedure would be similar. To the extent the second LLC and its manager have no responsibility for operations of the car wash, their liability would, in most cases, be limited to their vicarious liability, and liability for failure to observe/correct an obviously dangerous condition on the property, or allowing the conduct of some extremely hazardous activity.

Even those exposures make it wise for the second LLC "C" to either maintain its own liability policy or obtain named insured's status under the policy issued to "A" and "B." To the extent the second LLC "C" has responsibilities for operations of the car wash and is insured under its own liability policy, each insurer should defend its own named insured.

Liability of the second LLC "C" would not be limited to one-third based solely on ownership of its part of the property. The extent to which liability could be attributed to the second LLC would depend, in part, on the percentage of liability attributable to the conduct of those representing the LLC and the indemnity factors as discussed.

The bottom line is that if there is any potential for the second LLC to incur liability for anything other than its passive negligence (solely because it owns one-third of the property), it should maintain its own liability policy, unless the liability insurer of the LLC owned by "A" and "B" is willing to cover both of the LLCs as named insureds.

Shell game auto claim

A complex case that comes to mind involving an auto and different business entities, including an LLC, is Koons v. XL Insurance Co, et al., Civil Action No. 11-2956 (U.S. Dist. Ct. E.D. PA. 2012). An employee of Ches-Mont LLC was killed by a trash-disposal truck he had been operating.

The record owner of this truck at the time of the accident was Koons, individually, and as a sole proprietor doing business under the fictitious name of Miller Concrete, which was in the business of selling and installing underground storage tanks.

The purchase invoice identified the final user of the truck as Chesmont Disposal. Koons entered into a 36-month lease on the truck with No Fun Allowed, Inc., a trash-hauling company solely owned by Koons. Prior to the accident, No Fun Allowed, Inc., became Ches-Mont Disposal, Inc., an S-corporation wholly owned by Koons.

Then Koons acquired two partners, and Ches-Mont, Inc., was legally changed to a limited liability company, Ches-Mont Disposal LLC. Koons was the president of Ches-Mont LLC and a 35% owner and managing member of Ches-Mont Holdings LLC, which was the sole member of Ches-Mont LLC. Koons thus effectively owned 35% of Ches-Mont LLC.

Following the fatality, the estate of the decedent brought suit against Koons, individually doing business as Miller Concrete, which was the owner of the truck leased to Ches-Mont LLC, based on the owner's failure to maintain the truck. At the time of the accident, Koons was also president and owner of Ches-Mont LLC. However, neither he nor his limited liability company was named in the complaint as owner or officer.

The allegations were said to have been carefully drafted to avoid any reference to Ches-Mont LLC or its owners as a negligent entity or persons because, as the decedent's former employer, Ches-Mont LLC was statutorily immune from suit under workers compensation insurance.

At the time of the accident, Ches-Mont LLC was the named insured under both a commercial auto policy issued by XL Insurance America, Inc., "XL" and a commercial excess and umbrella policy issued by Greenwich, from whom Koons sought defense and the payment of damages on his behalf. Both insurers denied Koons protection.

From the court's perspective, there was no coverage under the commercial auto policy because the policy defined the term "insured" to include "the named insured, Ches-Mont LLC, as well as the named insured's partners, joint ventures, executive officers, employees, directors, stockholders or volunteers while acting within the scope of their duties as such."

Although there was no dispute that Koons was an executive officer and owner of Ches-Mont LLC, the court stated that Koons was not an insured, for purposes of the estate's action, because Koons was being sued in that action in his capacity as the owner of the trash-disposal truck, not in his capacity as an owner or officer of Ches-Mont LLC.

This case did not mention anything about whether Koons, as owner of the truck, maintained any auto liability insurance in its company name of Miller Concrete. One would have to assume that insurance was maintained but was inadequate and that the suit was an attempt to get more money.

The way the complaint was structured, it is doubtful that anything more could have been done insofar as insurance was concerned. When an individual is involved in many entities, however, care has to be exercised that exposures do not fall within the cracks, which can easily happen.

This is especially true today when individuals often get themselves involved in a variety of different business structures for tax and protection purposes, only to find themselves caught up in serious financial problems. Insurance producers also need to be careful to help determine how best to handle exposures of an insurable nature.