Surety

COLUMBUS, Ohio, April 2, 2020 /PRNewswire/ — The COVID-19 pandemic and the historic federal, state, and local government efforts to mitigate its spread has stopped the economy in its tracks. Social distancing and self-isolation may result in the US unemployment rate reaching record levels. The dialogue on business interruption insurance will continue, whether in the courts or to discuss a federal backstop. At the forefront of the issue of the ability of businesses to perform under stress is surety insurance. The insurer, as surety, is the party that guarantees the performance of another party, often a contractor or a construction project. The contract through which the guarantee is executed is a surety bond. As of December 31, 2019, there were 323 insurers that reported direct premium written for the surety insurance line of business. There are various types of surety insurance; however, the insurers that wrote performance bonds may see a rise in claim frequency and severity as a result of unemployment, constrained cash flows, and other phenomena impacting businesses. Direct premium written (DPW) for surety insurance for the 323 insurers was nearly $6.8 billion at year-end 2019. The top 20 writers, based on all types of surety insurance written, accounted for over $4.4 billion, 65 percent of the industry dollar volume. Surety insurance comprised approximately 17 percent of these top 20 insurers’ books of business and was but 3 percent of the books of business of all carriers writing some surety. Despite the diversification within many of the top 20, surety insurance constituted more than 90 percent of seven insurers’ total 2019 DPW. According to Joseph L. Petrelli, President and co-founder, Demotech, the first company to review and rate independent regional and specialty insurers, “By count, the 323 carriers writing surety insurance are nearly 13% of the Property and Casualty insurers reporting to the National Association of Insurance Commissioners. With respect to the impact of COVID-19 on surety insurers writing performance bonds, keep in mind that at the time the performance bonds were written, the economy was humming, competent contractors were likely to be at full capacity, with projects in their pipeline. COVID-19 and the response to mitigate the contagion changed everyone’s world. It is unlikely that insurers writing surety insurance will be spared from future discomfort.” A full article along with a chart of the top 20 writers of Surety Insurance by 2019 DPW can be found here. https://www.prnewswire.com/news-releases/demotech-investigates-impact-of-covid-19-on-surety-insurance-301034239.html

In response to the abrupt closing of the Lisbon Valley Copper Mine, Director John Baza of the Utah Division of Oil, Gas and Mining has signed an emergency order, according to a statement from the division. The order requires that the operator contains and/or reclaims any and all facilities at the mine to the extent necessary to immediately prevent any imminent threat of environmental harm. If the operator fails to take immediate action to ensure the environmental harms are mitigated, the division will undertake emergency actions to forfeit the full amount of the surety bond. A surety bond ensures monies are available to the division for reclamation in the event the company defaults on its permit. The emergency order will apply until the next Board of Oil, Gas and Mining Board Hearing scheduled for April 22. An inspector from the Bureau of Land Management inspected the site early Friday. A division inspector is now onsite. “Our main objective is to ensure the facility poses no threat to the surrounding environment and that there are no risks to public safety,” said a statement from the division. According to the operator’s annual report, the mine is 984 acres in size and includes four pits, one leach pad, approximately four water process ponds, and several buildings. On Monday, March 23, inspectors from the Division of Oil, Gas and Mining confirmed for the operator steps that will need to be taken to avoid potential off-site impacts. Any work that’s done can only be shutdown or reclamation related; no production work can occur. The surety that holds the bond for Lisbon Valley Mining Company has been contacted while a contractor develops a shutdown plan for the mine. The surety bond ensures money if available for reclamation work in the event a company defaults on its payment, according to the Division. The contractor, like the furloughed employees, is not being paid and has warned state officials “it will be hard to keep up their environmental protection measures if they can’t pay for supplies, fuel and wages,” but they will continue to work. The Division said it could fund the contractor as a stopgap measure and seek reimbursement later.

A captive insurance company (usually just referred to as a “captive” in short) is an insurance company that is set up to provide for the insurance needs of its owners, and them only. There are many types of captives, and they can be organized in many ways, most typically as corporations but also as LLCs and some other more exotic types of entities. A captive can be organized — and many are — as a Series LLC. That particular form of LLC is very complex, and consists of a larger LLC (called the “series organization”) which is then subdivided into many smaller units (called “protected series”). Very similar in many respects to a parent/subsidiaries structure, Series LLCs offer certain benefits in the captive insurance field when it comes to insurance licensing and capital requirements. In 2016, the National WW II Museum (New Orleans) ordered a steel truss canopy from Gava Steel, Inc., and paid about $3 million. To protect itself, the Museum obtained a bond in the same amount from Talisman Casualty Insurance Company, LLC, which is purportedly managed (which is different than owned) by Jeffrey Schaff of Louisiana. For whatever reason, Gava Steel didn’t perform as promised, and the Museum made a claim on Talisman’s bond. Claiming that no valid bond was ever issued, Talisman didn’t honor the bond. So, Museum sued Talisman in the Civil District Court of the Parish of Orleans. Talisman then removed the case to the U.S. District Court for the Eastern District of Louisiana. claiming diversity jurisdiction since Talisman was organized in Nevada and the Museum is in Louisiana. As an aside, federal law requires what is known as “complete diversity” of citizenship in order for diversity jurisdiction to apply, i.e., no plaintiff can be from the same state as any defendant. Where a party is an LLC, the court looks through the LLC to see where its members are located. Museum then filed a motion to remand the case back to the Parish of Orleans court, arguing that because Talisman was an LLC, and because its (undefined) owner is a resident of Louisiana, both the plaintiff and the defendant were located in Louisiana and so there was no complete diversity such as would support diversity jurisdiction in the federal court. Talisman made two arguments why complete diversity was present. The first argument was that because Talisman was a licensed captive insurance company, it should be treated as a corporation with its location in Nevada, instead of as an LLC where the jurisdiction of its owner (Schaff) would place it in Louisiana. Second, and most interestingly, Talisman argued that it was a Series LLC, that only protected cell #01 was potentially liable on the bond, and that cell #01 didn’t have any members at all, much less any members in Louisiana — other of Talisman’s protected cells might have Louisiana members, but not protected cell #01. To support this second argument, Talisman submitted an affidavit which said that protected cell #01 had no members. All this resulted in the opinion of the U.S. District Court that I shall next relate. The court took these arguments in reverse. As to Talisman’s argument that protected cell #01 had no members, that argument immediately backfired. The court pointed out that under long-standing law, if an LLC has no members, then it is “stateless”, and a stateless LLC cannot establish diversity of jurisdiction. Since Talisman had submitted an affidavit that protected cell #01 had no members, it had effectively shot itself in the foot on this issue. Talisman’s other argument, that even though it was organized as an LLC, Talisman should be treated as a corporation because it was a licensed captive insurance company, also fell on deaf ears. The court noted that 175 years ago, the U.S. Supreme Court allowed corporations to be treated as citizens for purposes of diversity citizenship, but since then the Supreme Court has consistently restricted business entities’ access to the federal courts by way of diversity jurisdictions, to which Talisman’s argument for an expansion of such jurisdiction clearly ran counter. Moreover, in footnote 2, the court pointed out that the Museum had sued Talisman generally, and not just protected cell #01, and Talisman did in fact have its only member in Louisiana such that complete diversity was destroyed. ANALYSIS What this case highlights is that there are many nuances about Series LLCs that are yet to be discovered. While it may be possible to structure things with a Series LLC that could not be so structured with any other form of business entity, all the ramifications of doing that are probably impossible to predict. Here, for whatever reason, protected series #01 was structured in a way that it did not have any “members” in the sense that an ordinary LLC typically would, but that ended up having a negative repercussion as it defeated Talisman’s attempt to move the case out of Louisiana state court and into the federal courts. Yes, Series LLCs are extremely versatile: They are also dangerous. As I have pointed out on numerous occasions, if an ordinary LLC is a Cessna 172 with few systems and controls, a Series LLC is a 747 with hundreds of systems and controls thus making it very easy for a fatal mistake to be made. Or, as my friend and colleague Tom Rutledge is so fond of pointing out, for most folks the creation of a Series LLC is like giving an Uzi to a three-year old. On a more practical note, Talisman’s argument that protected series #01 did not have any members is probably technically incorrect, for the reason that in the absence of members the series organization itself is the member, in this case being Talisman the main company. Thus, the court could probably have correctly held that protected series #01’s member was Talisman, and Talisman’s member was Schaff, and so therefore protected series #01 was located in Louisiana for purposes of testing diversity jurisdiction. An alternative construct would be that without members, protected series #01