Month: May 2017

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The Economic Loss Rule is Alive and Well for Insurance Licensees

When professionals of all types are sued by their clients for errors and omissions (E & O), the plaintiffs frequently assert both tort and contract claims against the defendants. This is particularly true when insurance policyholders or putative policyholders sue their insurance agents. Torts that are usually asserted include claims of actual fraud, constructive fraud, negligence and breach of fiduciary duty.  In addition, plaintiffs virtually always claim breach of contract.

In very general terms, a typical E & O case against an insurance agent is filed when the policy holder, after suffering a loss, experiences one or more of the following: (a) discovery that a policy was not procured at all (a putative policy holder); (b) the insurance company denies a claim in whole or in part; or (c) the insurance company concludes that the nature of the insurance policy procured by the agent did not conform to the needs of the policy holder.

The following is a brief description of typical tort claims made against insurance agents.  Under Virginia law, proof of a claim for actual fraud requires that the defendant knowingly made material false statements of fact upon which the plaintiff reasonably relied to his/her detriment.  Proof of a claim for constructive fraud requires that the defendant unintentionally made false statements upon which the plaintiff reasonably relied to his/her detriment. Proof of a claim for negligence requires that the defendant did not meet the standard of care in his/her industry or profession.  Finally, proof of a claim for breach of fiduciary duty requires that the defendant put his/her financial interests above those of the plaintiff.

Defending these claims includes attacking the tort claims at the pleading stage. Apart from claims of actual fraud, the Supreme Court of Virginia has ruled that only claims for breach of contract by an insurance agent are viable.  In Filak v. George, 267 Va. 612 (2004), the Court affirmed the trial court’s dismissal of tort claims against an insurance agent in an E & O case. The Court cited the “economic loss rule” and stated: “The primary consideration underlying tort law is the protection of persons and property from injury, while the major consideration underlying contract law is the protection of bargained for expectations…  Thus, when a plaintiff alleges and proves nothing more than disappointed economic expectations assumed only by agreement, the law of contracts, not the law of torts, provides the remedy for such economic losses.” 267 Va. At 613.

Dismissal of tort claims is important because of the impact such dismissal has on potential damages that may be awarded. In addition to the fact that contract damages, in general, are much narrower than tort damages, punitive damages cannot be recovered in a contract case.

One federal court has disregarded the Supreme Court of Virginia’s ruling in Filak. In Cincinnati Ins. Co. v. Ruch, 940 F. Supp2d 338 (2013), the United States District Court for the Eastern District of Virginia permitted a negligence claim to proceed against an insurance agent despite Filak. This court noted the decision in Filak but ruled that the economic loss rule should not apply.  Importantly, federal courts do not make substantive Virginia law and many Virginia trial courts have refused to follow Ruch, noting that only the Supreme Court of Virginia has the last word on establishing Virginia law.

In conclusion, absent viable claims of actual fraud, insurance agents defending E & O cases may rely on those cases proceeding only on breach of contract claims. While the economic loss rule can be complicated as applied to professionals other than insurance agents, it is alive and well in the insurance agent E & O world.

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Changes to Virginia Law on Tenant Rights After Foreclosure

The Code of Virginia addresses the rights of tenants after foreclosure of residential properties.  The current law incorporates the federal Protecting Tenants at Foreclosure Act (PTFA). Under current law, and subject to certain requirements, a tenant can remain in the property for the remaining lease term if the tenant complies with the requirements of the lease, including by paying market value rent.

In Virginia, these rights will change effective July 1, 2017. Under the new law, a tenant’s lease automatically terminates at the time of foreclosure. After foreclosure, the tenant can remain in the property as a month-to-month tenant as long as the tenant continues to pay rent as set forth in the original lease. The new owner can terminate the lease by giving 30 days’ written notice prior to the next rent due date or notice as otherwise required by the terms of the original lease. The new statute does not specifically address a tenant’s right to terminate the lease, but under existing Virginia law, a tenant can terminate a month-to-month lease by providing 30 days’ written notice.

This Virginia statutory change gives banks and lending institutions more options following a foreclosure. The change alleviates the concern that an owner after foreclosure will be stuck with a tenant claiming a lifetime lease of the property for below market rent. Now, the new owner can terminate any existing lease on 30 days’ notice—rather than being forced to wait until expiration of the full term of the lease. In the alternative and subject the existing tenant’s own right to terminate the lease, the new owner can continue to collect rent and evict tenants who fail to pay rent.

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Federal Contract Blacklisting Rule Repealed

On March 27, 2017, President Trump repealed the “Fair Pay and Safe Workplaces” regulations issued by Department of Defense (DOD), General Services Administration (GSA), and National Aeronautics and Space Administration (NASA).  These “Blacklisting” regulations required contractors to disclose federal employment and labor law violations when bidding, to comply with pay transparency obligations, and to limit employee pre-dispute arbitration agreements.

Contractors that modified their terms and conditions to incorporate the “Fair Pay and Safe Workplaces” obligations should consider removing those requirements. Indeed, it is a good practice for contractors to review their subcontract and purchase order terms and conditions annually.

Subcontractors and vendors should also review subcontracts and purchase orders for terms and conditions that are not consistent with current law. However, even in the absence of the “Fair Pay and Safe Workplaces” regulations, contractors should remain cautious about compliance with the Davis-Bacon Act, and other social and employment programs to avoid sanctions.

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Exit Strategies in Real Estate Investments

Sooner or later your colleagues will approach you about investing in a development deal or similar venture if they have not already done so.  The investment vehicle for such a project will typically be in the form of a limited liability company (“LLC”).  Before getting involved in an LLC investment in commercial real estate, you should carefully consider your exit strategies if the real estate venture (or the management thereof) does not meet your expectations.  Many statutes are flexible and accommodate all sorts of exit arrangements.  However, in the absence of an express agreement setting forth such mechanisms, statutes do impose a number of restrictions on an LLC member’s right to exit.  The exit terms, along with most other important terms and conditions governing the LLC, are typically found in a document called the “operating agreement.”  It benefits both the investor group and the management group to negotiate and document exit terms in the operating agreement at the earliest stages of the venture.

Some exits are planned by investors as a component of the original investment decision, while others are emergency exits for when things begin to unravel.  It is generally better to expressly provide for exit rights in the operating agreement rather than relying on restrictive statutory default provisions.  If a particular investor wants to cash out of the project, exit mechanisms should be in place to enable him or her to do so, with minimum difficulty.  Furthermore, if one of the investors dies or receives an offer to have their ownership interest purchased, the remaining investors may desire to have a right to purchase the exiting member’s ownership interest in the project.

Some of the standard exit mechanisms that investors may want to consider for the operating agreement include the following: (i) drag-along rights (whereby the initiating member can require the sale of an entire venture), (ii) tag-along rights (whereby the non-initiating member can insist on the sale of the entire venture), and (iii) buy-sell arrangements (whereby the right to sell or buy the others’ interests and the conditions pertaining to that right are predetermined).

Buy-sell arrangements, which tend to cause the least amount of disruption to other investors and any lenders financing the project are, generally, the preferred exit mechanism for investors.  Careful investors will typically craft the mechanisms by which investors may exercise their right to sell their own ownership interests or buy the ownership interests of others, including the (i) method and content of notice required, (ii) rights of first refusal, (iii) valuations and price calculations of ownership interests, and (iv) timing within which such transfers must occur.  Such exit strategies will be critical (i) in the event of death, disability, or bankruptcy filing of one of the investors or (ii) if one investor simply desires to transfer its interest and/or disassociate itself from the project.

When you are just starting out, this part of the process may not seem important, but being organized and hammering out these exit mechanisms early on can save you a lot of complications and money down the road.  If you are uncertain as to what to include in your agreement with the other investors, consulting your attorney and accountant before entering a deal should be viewed as preventative maintenance that may address important issues before potential conflicts arise.

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