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Lincoln Gen. Ins. Co. v. U.S. Auto Ins. Servs., Inc.

United States Court of Appeals, Fifth Circuit

May 18, 2015

LINCOLN GENERAL INSURANCE COMPANY, Plaintiff - Appellant Cross-Appellee
v.
U.S. AUTO INSURANCE SERVICES, INCORPORATED, CSI AGENCY SERVICES, INCORPORATED; ALPHA PARTNERS, LIMITED, Defendants - Appellees Cross-Appellants, GAMMA GROUP, INCORPORATED, JAMES DOUGLAS MAXWELL, also known as Doug Maxwell; JAMES THORNTON MAXWELL, also known as Jim Maxwell, Defendants - Appellees

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Appeals from the United States District Court for the Northern District of Texas.

For Lincoln General Insurance Company, Plaintiff - Appellant Cross-Appellee: Wade Crosnoe, Thompson, Coe, Cousins & Irons, L.L.P., Austin, TX; Bradford King Burdette, William N. Radford, Thompson, Coe, Cousins & Irons, L.L.P., Dallas, TX; David B. Winter, Zelle Hofmann Voelbel & Mason, L.L.P., Dallas, TX.

For U.S. Auto Insurance Services, Incorporated, Defendant - Appellee Cross-Appellant: Alan B. Rich, Law Office of Alan B. Rich, Dallas, TX; John William Arnold, Bailey, Crowe & Kugler, Dallas, TX.

For Gamma Group, Incorporated, Defendant - Appellee: Alan B. Rich, Law Office of Alan B. Rich, Dallas, TX; John William Arnold, Bailey, Crowe & Kugler, Dallas, TX.

For Csi Agency Services, Incorporated, Defendant - Appellee Cross-Appellant: Alan B. Rich, Law Office of Alan B. Rich, Dallas, TX; John William Arnold, Bailey, Crowe & Kugler, Dallas, TX.

For Alpha Partners, Limited, Defendant - Appellee Cross-Appellant: Alan B. Rich, Law Office of Alan B. Rich, Dallas, TX; John William Arnold, Bailey, Crowe & Kugler, Dallas, TX.

For James Douglas Maxwell, Defendant - Appellee: Alan B. Rich, Law Office of Alan B. Rich, Dallas, TX; John William Arnold, Bailey, Crowe & Kugler, Dallas, TX.

For James Thornton Maxwell, Defendant - Appellee: Alan B. Rich, Law Office of Alan B. Rich, Dallas, TX; John William Arnold, Bailey, Crowe & Kugler, Dallas, TX.

Before DAVIS, DENNIS, and COSTA, Circuit Judges.

OPINION

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GREGG COSTA, Circuit Judge

A party that obtains a multimillion dollar judgment at trial usually leaves the courthouse happy. The Plaintiff in this case, Lincoln General Insurance Company, is an exception. After a bench trial, the district court awarded Lincoln $16.5 million on its tortious interference claims against CSi Agency Services, Inc. and Alpha Partners, Limited. The conduct that led to that judgment involved the diversion of funds from a reinsurance arrangement involving insurer Lincoln and a claims administrator named U.S. Auto Insurance Services Company.

Despite being awarded a large judgment, it is Lincoln who raises the vast majority of ostensible errors in this cross appeal. Lincoln contends that the district court erred in dismissing other claims and Defendants before trial. The other claims are for breach of contract, breach of fiduciary duty, conversion, and derivative liability based on theories of alter ego and aiding and abetting. The Defendants are U.S. Auto, a number of affiliated companies, and Doug and Jim Maxwell, the father-son team associated with these entities.

The only error asserted by the parties who lost at trial, CSi and Alpha, is that the

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tortious interference claims are time barred.

I.

This case arises from a complicated series of transactions often called " fronting arrangements" in the insurance industry.[1] A nonparty to this lawsuit, State and County Insurance Co. (S& C), fronted auto insurance policies. That means the policies were issued in S& C's name but it bore no risk. Lincoln was the party incurring the insurance risk as it reinsured 100% of S& C's liabilities under policies issued from 2003 through 2007. This departed from a previous agreement Lincoln signed with S& C in 2002, which allocated just 45% of the liabilities to Lincoln and the remainder to another reinsurer who is not involved in the current dispute.

U.S. Auto, a company entirely owned and operated by Doug Maxwell, served as the managing general agent for S& C pursuant to a General Agency Agreement. As managing general agent, U.S. Auto's responsibilities included issuing policies in S& C's name; collecting and handling the premiums paid by the insureds; and investigating, adjusting, and paying any claims. The General Agency Agreement required U.S. Auto to set up a " Premium Trust Account" to manage the money from these various transactions, although U.S. Auto had the " privilege of retaining [its] commission[]" prior to depositing any collected money into the trust account. U.S. Auto hired Gamma Group, Inc., another entity owned by Doug Maxwell, to assist with handling the claims. During the relevant time period, U.S. Auto's only business involved the auto policies issued by S& C and reinsured by Lincoln.

The agreements between the parties provided for the following. As the nominal issuer of the policies, S& C would receive a small percentage off the top of the premiums collected. U.S. Auto would receive 20.6% of what remained as compensation for its administrative work. The parties anticipated that actual payouts on claims to the insureds--labelled " incurred losses" --would amount to 69.4% of the remaining collected premiums. This percentage is the " target loss ratio." As an incentive, U.S. Auto could receive an additional commission based on any amount the target loss ratio exceeded actual losses. In other words, if claims paid on the policies ended up being less than the anticipated 69.4% of premiums, U.S. Auto as the claims handler would receive that difference. The remaining 10% of premiums was expected to go to Lincoln as its profit for bearing the risk. Lincoln's actual receipt of its 10% margin thus depended on paid claims not exceeding the expected 69.4% figure; if claims paid exceeded that target loss ratio, the additional amount needed to pay claims would come out of the 10% otherwise owed to Lincoln.

Because the profit of the parties depended so heavily on the target loss ratio and the amount of incurred losses, the agreements detailed the accounting techniques used to compute those numbers. One difficulty they addressed was the uncertainty in calculating incurred losses, which may be paid even after a policy has expired so long as the event triggering the claim occurred during the policy period. The formula to calculate incurred losses thus included an adjustment based on projected " incurred but not reported" losses. By making an adjustment for IBNR, the accounts would more accurately reflect the

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amount ultimately paid out for claims, and thus how much profit the parties would make.

As things turned out, actual losses for all relevant years fell below the target loss ratio of 69.4%. This should have resulted in all parties making money. Instead, Lincoln lost millions. The reasons why gave rise to this lawsuit.

During the first four years it acted as managing general agent, U.S. Auto transferred approximately $50 million to CSi Agency Services and Alpha Partners, two companies owned by Doug Maxwell and his father, Jim Maxwell. The transfers to CSi were purportedly made pursuant to a contract for the purchase of information technology and management services. No contract exists to support the transfers between U.S. Auto and Alpha. After receiving inflated management fees, Alpha and CSi distributed the money to Doug Maxwell and Jim Maxwell. All told, roughly $30 million flowed to Jim Maxwell and $20 million to Doug Maxwell.

Transfers of these vast sums would obviously lead to a shortfall at some point in the future. Doug Maxwell recognized this. But in reasoning reminiscent of a Ponzi scheme, he hoped that U.S. Auto would obtain funds through future business with other reinsurers that would allow it to replenish the depleted accounts needed to cover Lincoln's liabilities under the auto policies.

That future business never materialized and, by 2006, the Premium Trust Account ran out of funds to pay the claims for which Lincoln was liable. This required Lincoln to fund a zero balance account, which is so named because it automatically receives funds from another account when a check is presented for payment but does not otherwise receive funds (thus, the balance is always zero). U.S. Auto misused this zero balance account to pay 100% of the claims due under the 2002 agreement, even though Lincoln was only responsible for 45% of those liabilities.

In April 2007, U.S. Auto stopped issuing policies under the S& C name. It transferred all new business to Santa Fe Auto, another entity operated by Doug and Jim Maxwell. Around this same time, U.S. Auto " ran out of money" and " unilaterally" changed the formula used to calculate its commissions on the S& C policies for which Lincoln was on the hook. ROA 4566. As discussed previously, those additional commissions would be earned by U.S. Auto only if incurred losses fell below the 69.4% target loss ratio, and the agreements adjusted incurred losses upwards to accommodate for incurred but not reported losses. U.S. Auto removed incurred but not reported losses from the commission calculations, thereby creating the illusion of smaller incurred losses. This benefited U.S. Auto because it made the incurred loss ratio fall further below the target loss ratio, thereby inflating U.S. Auto's commission. But it came at Lincoln's expense, because when claimants eventually reported those losses, the money to pay them was not in the trust account.

In response to this conduct, Lincoln filed a lawsuit in 2007 against U.S. Auto, Gamma Group, Santa Fe, Alpha, CSi, Doug Maxwell, and Jim Maxwell. The parties agreed to settle in 2009, voluntarily dismissing the case without prejudice and signing a Memorandum of Understanding stating " [i]n the event that the parties are not able to complete all of the actions required under this [agreement] . . . Lincoln's sole remedy shall be to refile the lawsuit." ROA 156.

Lincoln had to take that step as the settlement soon collapsed. S& C then assigned Lincoln its claims against U.S.

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Auto, which led to Lincoln asserting in this suit both its own claims and those of S& C.

The procedural history of this lawsuit is perhaps as convoluted as the parties' business relationships. Lincoln alleged several different causes of action against the Defendants, including breach of fiduciary duty, tortious interference with contract, misappropriation and conversion of funds, and liability based theories of alter ego and aiding and abetting. After the Defendants filed a motion to dismiss the claims relying on alter ego liability, Lincoln withdrew all those claims except the one against Doug Maxwell. On the Doug Maxwell claim, Lincoln filed a six-page response on the merits. The district court, however, granted the motion in its entirety, dismissing even the claim against Doug Maxwell on the belief that it was also withdrawn. Lincoln made no effort in the district court to correct this mistake. The amended complaint it later filed did not assert an alter ego theory of liability against Doug Maxwell.

After discovery, the parties filed cross motions for summary judgment. The district court partially granted the Defendants' motion, holding that: (1) the breach of fiduciary duty claims failed because none of the Defendants owed Lincoln a fiduciary duty; (2) the conversion claims failed because of the economic loss rule; and (3) the tortious interference claims against Gamma, Santa Fe, and Jim Maxwell failed because the evidence did not establish that they actively participated in any tortious conduct. Lincoln sought clarification of the grant of summary judgment on the fiduciary duty claims, inquiring whether that ruling included a holding that U.S. Auto and Doug Maxwell owed no fiduciary duty to S& C, which had assigned its claims to Lincoln. The court responded by explaining its view that no duty was owed--to S& C or Lincoln--relating to the handling of the premiums before they were placed into the Premium Trust Account. That holding defeated the all the fiduciary duty claims because U.S. Auto's diversion of funds to the related entities occurred prior to the transfer of remaining premiums into the trust account.

After these summary judgment rulings, only the following claims remained for a bench trial: breach of contract against U.S. Auto and tortious interference against CSi and Alpha. Two noteworthy events took place before trial. First, the parties stipulated that U.S. Auto breached the contract by not paying Lincoln $16.5 million under the Reinsurance Agreements or General Agency Agreements,[2] so the trial would focus on the remaining claims for tortious interference. Second, just before trial, Jim Maxwell revealed the existence of a new entity called ZVN. ZVN apparently succeeded CSi and inherited CSi's liability. Though ZVN was not (and is not) a party to the present case, ZVN signed a stipulation agreeing that any judgment against CSi would be applicable to ZVN.

The district court then held a three-day bench trial. Because of the stipulation, the district court did not make a formal finding on Lincoln's breach of contract claim. It did find that Alpha and CSi tortiously interfered with the Lincoln--U.S. Auto contracts, which required a finding that U.S. Auto breached the agreements. The final judgment awarded Lincoln General

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$16.5 million--the damages for breach of contract specified in the stipulation--against Alpha and CSi on the ...


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