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Midwest Commercial Funding LLC v. Cincinnati Specialty Underwriters Insurance Company

United States District Court, E.D. Wisconsin

July 12, 2019




         Midwest Commercial Funding, LLC, purchased commercial property insurance from Cincinnati Specialty Underwriters Insurance Company.[1] During the winter of 2016, one of the covered properties sustained a loss caused by water lines that froze and burst. Midwest filed a claim under the policy, which Cincinnati denied based on an exclusion for water damage caused by frozen pipes. Cincinnati also threatened to rescind the policy on the ground that Midwest misrepresented its interest in the property when it applied for the insurance. Cincinnati alleges that it issued the property policy believing that Midwest owned the property. In fact, Midwest had only a security interest. Cincinnati alleges that had it known Midwest did not own the property, it would not have issued the property policy. Instead, it would have told Midwest that it needed “forced place” insurance.

         Following the denial of coverage, Midwest filed this suit for breach of the insurance contract and bad faith against Cincinnati. Cincinnati filed a counterclaim for rescission of the policy and a declaration of no coverage. In addition to suing Cincinnati, Midwest sued Marsh & McLennan Agency, LLC-the insurance brokerage firm that assisted Midwest in procuring the policy-and CSU Producer Resources, Inc.-the broker that placed the policy with Cincinnati. Midwest asserts claims against these parties that are best described as back-ups to its main claim against Cincinnati. Midwest alleges that Marsh and CSU Producer Resources violated several provisions of Wisconsin's insurance code in procuring the policy for Midwest, which resulted in the creation of an illegal insurance contract. Under Wisconsin law, if a policy is illegal and the insurer does not pay a claim or loss payable under the policy, then the insured may look to any person who assisted in the procurement of the policy for payment, provided that the person knew or should have known that the policy was illegal. See Wis. Stat. § 618.44. Midwest contends that if the Cincinnati policy is found to cover the loss at issue in this case and is also found to be an illegal policy, then Marsh and CSU Producer Resources will be jointly and severally liable with Cincinnati for payment of the loss.

         In addition, Midwest brings an alternative claim for professional negligence against Marsh. This claim relates primarily to Cincinnati's counterclaim for rescission. Midwest alleges that Marsh should have advised it that because it held only a security interest in the property, the type of insurance it needed was forced-place insurance. Thus, argues Midwest, if Cincinnati succeeds on its rescission claim, Marsh will be liable for making it whole. Midwest also contends that a forced-place policy would have contained a more favorable freeze exclusion than the Cincinnati property policy, and that therefore Marsh may be liable for negligence even if Cincinnati is not entitled to rescind the property policy.

         Each party has filed a motion for summary judgment on certain claims and issues, which I address in this order.

         I. BACKGROUND

         Midwest manages property, develops real estate, and lends money to other entities and individuals for use in rehabilitating or managing real estate. In August 2014, Midwest loaned money to an entity known as RNTSDU Investments, LLC. At the time, RNTSDU owned a commercial property located at 1442 N. Farwell Avenue in Milwaukee, Wisconsin. The property served as collateral for the loan. The terms of the loan required RNTSDU to maintain property and liability insurance on the property and to provide proof of such insurance to Midwest.

         In late 2014 or early 2015, RNTSDU failed to provide proof of insurance for the Farwell property. Midwest notified its accounting firm, Matrix Enterprises, Inc., that it needed to secure its own insurance for the property. Midwest and Matrix then contacted Midwest's insurance broker, Richard Niestrom of the Marsh agency, to obtain coverage for the Farwell property.

         Due to the frequency with which Midwest would purchase and sell real estate, Niestrom was frequently asked to add or remove properties from the schedule of insured properties that was attached to Midwest's existing policies. Thus, when Midwest informed Niestrom that it needed insurance for the Farwell property, he added that property to Midwest's existing commercial property policy, which had been issued by Berkley Regional Specialty Insurance. It appears that Niestrom simply assumed that Midwest owned the property. He did not ask Midwest about its ownership interest in the property, and he does not claim that anyone at Matrix or Midwest specifically told him that Midwest owned the property.

         The misunderstanding about Midwest's interest in the property caused Niestrom to procure the wrong kind of insurance for the Farwell property. According to Cincinnati and CSU Producer Resources, when a lender needs insurance for real property held as collateral for a loan, the proper type of coverage to obtain is “forced place” insurance. This is insurance that a lender takes out on a property after the borrower fails to maintain required coverage. Ordinarily, the lender will charge the borrower for the cost of the insurance. See Patel v. Specialized Loan Servicing, LLC, 904 F.3d 1314, 1316- 17 (11th Cir. 2018). Here, Niestrom added the Farwell property to Midwest's existing property policy instead of procuring a separate forced-place policy.

         Because the Berkley policy to which Niestrom added the Farwell property was expiring in April 2015, Niestrom also began searching for a new insurer to provide property and casualty insurance to Midwest. Because of the risks involved in Midwest's business, Niestrom could not obtain property and casualty insurance from an ordinary “admitted” insurer. Instead, Niestrom needed to access what is known as the “surplus lines” insurance market.

         To understand surplus-lines insurance, some background on insurance regulation is helpful. Most states heavily regulate typical insurers, such as by approving their rates, examining the terms of their policies, and monitoring their financial solvency. The insurers that are subject to such extensive regulation in a state are known as “admitted” or “authorized” insurers. See Richard R. Spencer, Jr., Surplus Lines Insurers and Guarantee Funds, 10 Seton Hall Leg. J. 93, 96 (1986). The goal of such regulation is consumer protection. See Congressional Research Service, Surplus Lines Insurance: Background and Current Legislation (July 22, 2010) (summary page). Such extensive regulation, however, creates barriers to entry into the insurance market and reduces the types of policies available for consumers to purchase. Id. When a consumer has an insurance need that cannot be met by an authorized or admitted insurer, the state will allow that consumer to purchase insurance from certain unauthorized or nonadmitted insurers. These are surplus-lines insurers, and they are regulated differently than admitted insurers. Id. While admitted insurers are regulated directly, surplus-lines insurers are typically regulated indirectly through insurance brokers who are licensed by the state to place surplus-lines insurance. See id.; Joseph A. Kilbourn & Jeffrey M. Winn, Excess, Surplus Lines and Reinsurance: Recent Developments, 25 Tort & Ins. L.J. 288, 304 (1989). Although nearly any insurance could be sold on a surplus-lines basis, in general such insurance covers unusual risks that the admitted insurance market is unprepared or unable to accept. See Spencer, 10 Seton Hall Leg. J. at 96.

         Because Niestrom could not find an admitted insurer that would issue commercial property and casualty insurance to Midwest, he contacted CSU Producer Resources, which places insurance with Cincinnati Specialty Underwriters Insurance Company, a surplus-lines insurer. CSU Producer Resources acted as what might be described as a “wholesale broker” in the transaction. A wholesale broker places business brought to it by a retail broker-which in this case was the Marsh & McClennan Agency-with an insurer, often a nonadmitted insurer. See Crusader Ins. Co. v. Harry W. Gorst Co., No. B182480, 2016 WL 1494110, at *1 (Cal.Ct.App. June 1, 2006); (last viewed July 11, 2019). Essentially, when a retail broker has a risk that it cannot place with an ordinary insurer, it contacts a wholesale broker, which will usually have specialized expertise and access to surplus-lines insurers. In this case, CSU Producer Resources was what might be described as a “captive” wholesale broker, in that it placed policies exclusively with Cincinnati. CSU Producer Resources was in the same corporate family as Cincinnati, performed underwriting and collected premiums for Cincinnati, and had binding authority from Cincinnati.

         When Niestrom turned to CSU Producer Resources, he worked primarily with Thomas Berryman, who was CSU Producer Resource's underwriting supervisor. Berryman did not hold a license as a surplus-lines broker or agent in Wisconsin. However, once Niestrom and Berryman agreed on the policies to purchase for Midwest, CSU Producer Resources used the surplus-lines license number of Scott Hintze, its director of underwriting, to formally place the insurance with Cincinnati. Hintze's name and license number are printed on the declaration pages of the policies, where he is identified as the “broker” for the transaction. See, e.g., ECF No. 49-3 at p. 2 of 467.

         After the policies were procured, copies were sent to Niestrom as Midwest's agent. Niestrom states that he forwarded the policies to Midwest in July 2015. Midwest denies having received copies of the policies at that time. The policies went into effect on April 29, 2015, with the Farwell property listed as a covered property under the commercial property policy.

         On April 27, 2015, Midwest initiated foreclosure proceedings against RNTSDU and the Farwell property. On October 28, 2015, Midwest obtained a judgment of foreclosure with a three-month redemption period. On December 19, 2015, during the redemption period, Midwest received notice that gas and electric service had been turned off at the Farwell property. That same day, Midwest contacted the utility company and demanded that gas and electric service be restored. However, the utility refused to turn the power back on. Between December 21, 2015 and January 15, 2016, Midwest repeatedly called and emailed the utility in an attempt to get gas and electric service restored. Among other things, Midwest submitted a commercial application to transfer the account into Midwest's name, paid an unrelated bill on a different property that the utility had sent to the wrong address, provided documentation necessary to show that Midwest had filed a foreclosure action against the owner of the Farwell Property, and ensured that the utility company had access to the property in order to restore power. According to Midwest, the utility company dragged its heels. Finally, on January 9, 2016, the utility company sent a crew to the Farwell property to restore the gas and electric, but the crew did not have everything that it needed to turn the electricity back on.

         The utility crew returned to the property on January 15, 2016 and discovered standing water in the electrical room. Sometime between the crew's two visits to the property, a water line in the building froze and burst. Midwest contends that the water damage in the building was extensive, and that the total loss was more than $2.5 million, the limits of the Cincinnati policy.

         After discovering the loss, representatives of Midwest searched its records to find copies of the Cincinnati policies but could not locate them. Midwest believes that it did not receive copies of the policies before the loss occurred. After the loss, Niestrom filed a claim with Cincinnati on Midwest's behalf.

         Another company within the Cincinnati family-Cincinnati Insurance Company- adjusted Midwest's claim. On March 11, 2016, it sent Midwest a letter in which it formally denied Midwest's claim on the ground that the loss fell within a policy exclusion for water damage caused by freezing. See ECF No. 49-8. The exclusion stated in relevant part that Cincinnati would not pay for water damage caused by frozen and burst pipes unless the insured “[did its] best to maintain heat in the building or structure.” ECF No. 49-3 at 24. Cincinnati Insurance Company concluded that Midwest did not do its best to maintain heat in the building.

         In its March letter, Cincinnati also informed Midwest that it was investigating the facts surrounding Midwest's application for the insurance to determine whether the policy should be rescinded. Cincinnati stated that because Midwest had only a security interest in the property, it should have obtained forced-place insurance rather than property insurance. Cincinnati asked Midwest to provide it with information about its communications with Marsh at the time it applied for the policy. Cincinnati stated that if it determined that misrepresentations were made when the policy was procured, it would consider rescinding the policy. Cincinnati stated that it “specifically reserve[d] the right to rescind the policy” after it completed the investigation. ECF No. 49-8 at 6. However, Cincinnati did not attempt to formally rescind the policy until August 2, 2016, when it filed its counterclaim in this action and included a count for rescission.


         Summary judgment is required where “there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.R.Civ.P. 56(a). When considering a motion for summary judgment, I view the evidence in the light most favorable to the non-moving party and must grant the motion if no reasonable juror could find for that party. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248, 255 (1986).

         At the outset, I note that no party has moved for summary judgment on the central coverage issue in this case, i.e., whether Midwest used its best efforts to maintain the heat in the Farwell property. Instead, each party moves for summary judgment on other issues, which I discuss in turn.

         A. Whether Cincinnati May Rely on Policy Exclusions

         Midwest moves for summary judgment on its claim for breach of contract on the ground that Cincinnati is barred from denying coverage based on policy exclusions, including the freeze exclusion. This is so, Midwest contends, because Midwest did not receive a copy of the policy before the loss occurred. Midwest's position is based on a case decided by the Wisconsin Court of Appeals holding that “an insurer may not deny coverage based on limitations or exclusions in a policy, even if clearly stated, where the insured was not otherwise informed of such provisions.” Kozlik v. Gulf Ins. Co., 268 Wis.2d 491, 503 (Ct. App. 2003).[2] Cincinnati contends that it is not barred from denying coverage based on the policy exclusions because it (or CSU Producer Resources) provided copies of the policy to the Marsh & McClennan Agency-Midwest's agent in the insurance transaction-before the loss. Midwest, in turn, contends that notice to its agent was not sufficient and that, to enforce the policy exclusions, Cincinnati was required to provide copies of the policy directly to Midwest or ensure that Marsh provided copies to Midwest.

         In Kozlik, the insured was a person who rented a car from Enterprise Rent-A-Car. When the driver went to the Enterprise office to rent his car, he purchased accident insurance. The Enterprise employee who handled the rental transaction did not provide the driver with a copy of the insurance policy. Later, the driver used the rental car while intoxicated and caused an accident in which he was killed. When his estate made a claim under the rental insurance, the insurance company denied coverage based on a policy exclusion for losses caused by intoxicated driving. The Wisconsin Court of Appeals held that because Enterprise did not provide the driver with a copy of the policy before the loss, the insurance company could not deny coverage based on an exclusion.

         Kozlik was not a case in which copies of the policy were provided to an insured's agent. The insured was a natural person who procured the insurance without the assistance of an agent. Here, in contrast, Midwest is a corporation and thus can act or receive notice only through its agents. See Hensel v. Hensel Yellow Cab Co., 245 N.W. 159, 163-64 (Wis. 1932). And, unlike in Kozlik, Midwest was represented in the insurance transaction by an insurance broker-the Marsh & McClennan Agency-that did receive copies of the policy. Under general principles of agency law, a principal is charged with knowledge of matters learned by an agent within the scope of the agency. See, e.g., Johnson v. Associated Seed Growers, 240 Wis. 278, 282-83 (1942). This is true even if the agent does not actually communicate the knowledge to the principal. See Admiral Ins. Co. v. Paper Converting Mach. Co., 339 Wis.2d 291, 312 (2012). Thus, by providing the policy to Marsh, Midwest's agent for insurance matters, Cincinnati satisfied the rule of Kozlik requiring notice to the insured of the policy's exclusions.

         Moreover, the rule of Kozlik is based on the premise that “it would be unjust to permit an insurance company to accept premiums and then deny liability based on an exclusion of which the insured was not aware because the insurance company had not informed him or her of the exclusion or given him or her the means to ascertain its existence.” 268 Wis.2d at 502-03 (emphasis added). In the present case, there is no dispute that Marsh acted as Midwest's agent with respect to the insurance at issue and that Midwest could have asked Marsh to provide it with a copy of the policy had anyone at Midwest wanted to review it. Thus, in providing the policy to Marsh, Cincinnati gave Midwest the “means to ascertain” the existence of the freeze exclusion. Accordingly, Cincinnati is not barred from denying coverage based on the exclusion.

         In any event, even if Cincinnati could not enforce the policy exclusion unless Marsh forwarded the policy to someone at Midwest, there is a genuine factual dispute over whether Marsh did so forward the policy. Niestrom states in his declaration that his regular practice was to forward copies of newly issued policies to an insured after he finished reviewing them. Decl. of Richard Niestrom ¶ 15, ECF No. 62. He states that he followed this practice with respect to the Cincinnati policies and delivered them to Midwest no later than July 2015, when he met with representatives of Midwest to “go through the [Cincinnati] policies.” Id. Midwest denies that Niestrom actually provided it with copies at that time, but Niestrom's declaration is sufficient to prevent entry of summary judgment for Midwest on the question of whether Niestrom provided copies of the policy to Midwest before the loss. For this reason, Midwest is not entitled to summary judgment on its claim against Cincinnati for breach of contract.

         B. Rescission

         Both Midwest and the Marsh & McClennan agency move for summary judgment on Cincinnati's claim for rescission. They contend that Cincinnati did not comply with two statutory provisions that restrict an insurer's ability to rescind a policy. First, they point to Wis.Stat. § 631.11(1)(a), which states that “[n]o representation or warranty made by a person other than the insurer or an agent of the insurer in the negotiation for an insurance contract affects the insurer's obligations under the policy” unless it is stated either in the policy, a written application that is made part of the policy by amendment or endorsement, or a written communication from the insurer to the insured within 60 days after the policy's effective date. Second, Midwest and Marsh point to Wis.Stat. § 631.11(4)(b), which provides that an insurer may rescind a policy only if the insurer notifies the insured of its intent to rescind the policy within 60 days of “acquir[ing] knowledge of sufficient facts to constitute grounds for rescission of the policy.”

         In the present case, Cincinnati does not dispute that it did not satisfy these statutory provisions. Cincinnati does not contend that Midwest or Marsh made a statement about Midwest's owning the Farwell property that was included in the policy.[3] Cincinnati does not contend that any such statement was included in the application for the policy or that the application was incorporated into the policy by amendment or endorsement. And it does not contend that the statement was included in a written communication to Midwest within 60 days of the policy's effective date. Likewise, Cincinnati does not contend that it provided notice of its intent to rescind the policy within 60 days of learning sufficient facts to support its rescission claim.

         Instead, Cincinnati argues that its rescission claim satisfies a different provision of the Wisconsin Statutes, Wis.Stat. § 631.11(1)(b). Under this provision, no misrepresentation by an insured constitutes grounds for rescission of the policy unless the insured knew or should have known that the representation was false and either (1) the insurer relied on the misrepresentation or the misrepresentation was material or made with intent to deceive, or (2) the fact misrepresented contributed to the loss. However, Cincinnati's argument that it satisfies § 631.11(1)(b) misses the point of Midwest's and Marsh's motions for summary judgment on the rescission claim. They do not dispute that a genuine factual dispute exists as to whether Cincinnati can prove the elements of a misrepresentation claim under § 631.11(1)(b). Rather, they contend that, to rescind the policy, Cincinnati must also satisfy ยง 631.11(1)(a) and ...

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