I do not need to read how the number of cases lodged against brokers for professional negligence or malpractice is growing, although I have read such stories. I see this reality as I speak to brokers across the country. I am always asked the following question: “How do I protect myself against being sued for not providing information on an issue that I felt was outside the scope of my engagement with the client?”

This question usually follows a story about the broker who was successfully sued for failing to advise the client about some esoteric tax liability that the client incurred after implementing a new insured benefit program, or the broker who was sued for failing to consult with the client about a legal issue that was triggered by the type of coverage placed with the client. My response to the question — whether it’s asked in Ohio, New York, Florida, Georgia, California, Virginia or any of the other states I have visited — is always the same. Enter into an engagement letter with your client.

An engagement letter protects both you and your client. It protects your client in that the client has a better understanding of what issues you will and what issues you will not be addressing during the engagement. This knowledge will permit your client to engage other trusted advisers as necessary. In fact, the progressive broker will already have relationships with an accountant and an attorney who the broker can recommend to cover the issues that are outside the scope of the engagement as defined in the engagement letter.

From your point of view, the engagement letter is the first line of defense against a claim of professional negligence or malpractice. That is because the engagement letter sets forth the terms of the engagement, including who the parties are to the engagement and the scope of services the broker will be providing the client. Additionally, if not required by the carrier, an engagement letter will assist you in making a claim for coverage under your errors and omissions policy. As a side note, if you are engaged in conduct that could characterize you as an ERISA fiduciary, you want to make sure your errors and omissions (E&O) policy has an ERISA fiduciary breach rider or purchase a separate policy to cover that potential liability.

The question now becomes: What should be in the engagement letter? Below is a general description of some of the basic issues that an engagement letter should address. Please note that the sample language below is for illustrative purposes only. You will need to give thought to the terms and conditions you choose to use in your engagement letters, as these may vary from letter to letter.

1. Specific identification of the client

Specifically identify the name of each client involved in the engagement. If a related party will not be your client, clearly state that in the letter. When working with ERISA plans, remember that the plan is a separate party from the employer sponsoring the plan. Also, remember that it is the plan administrator, which may or may not be the employer, who should engage you for providing services to the plan.

2. Description of the scope and nature of the services to be provided

Describe precisely what professional services you will provide to the client as well as those services that are outside the scope of the engagement.

3. When appropriate, identify the professional standards applicable to the engagement

This may prove helpful in showing that you and your client are in agreement regarding what professional standards apply to the engagement. This provision will be necessary if you wish to receive a delegation of ERISA fiduciary authority for purposes of the engagement. For example, if you are holding yourself out as an expert in the selection of private exchanges for employer clients, you wish to be the designated ERISA fiduciary for purposes of that selection as a business matter. A broker who accepts the ERISA fiduciary responsibility may have a leg up on those who do not for this purpose. That said, extreme caution should be taken before you take on any role beyond that of a traditional broker/consultant as you will be under a different standard of care should you take on the other role. In terms of ERISA, the fiduciary standard is as the courts have said “the highest known under the law.”

4. Identify any unique or unusual terminology associated with the engagement

This may avoid a dispute between you and your client regarding the meaning of certain terms and how they apply to the particular engagement. For example, if there is a term of art within the industry that is descriptive of the services you will be providing, but that might not be understood by the client, make sure to define that term in the engagement letter.

5. Spell out the client’s responsibilities

Doing so can prevent disputes regarding the scope of the client’s responsibilities. Should the client fail to cooperate with you, or fail to perform assigned tasks, this language will support your defense should a claim later develop. For example, clearly indicate that you will rely on the information provided by the client in making any recommendations and that you will not accept any liability incurred by your client that is based on faulty information provided to you by the client or an authorized agent of the client. You will also want to make it clear that the client is under an ongoing duty to update or supplement information it has provided you. This is only one example of any number of responsibilities your client may have as part of the engagement. The bottom line is that the engagement letter should clearly state each of those responsibilities.

6. Set forth your fees and describe what expenses will be incurred by the client

Specify the fees you will be charging the client under the engagement. If you are going to earn a commission in addition to billing the client an hourly rate for consultative services, then clearly indicate that in the letter, including an explanation of the commission as well as the hourly rate. Be sure to include any hidden costs or expenses such as “float” (earnings on client monies held by the broker pending ultimate distribution of those monies) or “revenue sharing” and how those costs and expenses will be handled. While this is particularly important when dealing with ERISA-governed plans, it can be even more so under state law when dealing with a non-ERISA client.

7. Describe any method for resolution of disputes

There are various alternative resolution programs that permit parties to resolve conflicts outside of the courts. A key alternative dispute resolution mechanism is binding arbitration, although there are others. If you want to require arbitration, specify who will conduct the arbitration (e.g., the American Arbitration Association) and what rules will apply. Note that non-clients may assert claims, and they may not necessarily be bound by the alternative dispute resolution clause of the engagement language. Note as well that, while binding arbitration clauses are generally enforceable, the laws governing their enforceability may vary from state to state. Therefore, you may wish to consult an attorney prior to inserting an arbitration clause into your standard engagement letter.

8. Severability clause

Your engagement letter needs to include a severability clause that reads something like: "If any part or provision of this agreement should be held void or invalid, the remaining provisions shall remain in full force and effect." This language ensures that the rest of the agreement remains enforceable even if a court refuses to enforce, for example, the arbitration clause. If there is no severability clause, a court could hold that the entire agreement (including your contractual right to fees) is void.

9. Set forth any limitations on your liabilities

If you intend to limit your exposure to the client with respect to damages you will be liable for under the agreement, make sure to spell out exactly what that limitation of liability is in the engagement letter. This can be accomplished by stating a fixed dollar amount or a multiple of your annual fees earned under the engagement. You may also wish to describe the type of damages and limit those to “reasonably foreseeable losses” that are incurred by the client, while expressly excluding those types of damages you will not be held liable for under the terms of the engagement.

10. Indemnification

Very generally, indemnity is when one party agrees to cover all or a portion of the costs and legal damages incurred by another party due to claims made against that party by an unrelated party where the claims are caused by the original party’s actions or inactions. For example, the broker fails to forward premiums for a policy covering a client’s employees. One of the client’s employees incurs a claim that is not covered due to the failure of the broker to remit the premium in timely manner. Employee sues the broker’s client for the benefit and wins. Under a typical indemnification provision, the broker would agree to pay the costs incurred by the client employer in defending the employee’s claim as well as the loss incurred by the client employer (i.e., the amount of the benefit paid to the employee that would have been paid by the insurer had the broker remitted the premium), but only to the extent those costs and the loss were incurred due to the broker’s negligence, breach of the agreement or willful misconduct. Thus, in this example, the broker would have to indemnify the employer only if the broker’s failure to remit the premium to the insurer breached the terms of the engagement or was otherwise negligent.

Conclusion

The nature of the broker’s role in the market is rapidly evolving into one that involves a high level of consultation with the client regarding various issues that are outside the scope of the insurance product itself. This evolution is readily apparent in the health insurance market where a client often relies on its broker to provide guidance on health care reform and its impact on the client. Indeed, a number of brokers have fully embraced this evolution within the health insurance market and are seeking to distinguish themselves from the rest of the market through various certification programs. Whether you are a broker who embraces the traditional role or one who is taking the evolutionary path, you need to make sure you are adequately protected, and the first line of defense is a solid engagement letter with your client.

James Napoli is a partner and ERISA practice group co-chair for Constangy, Brooks & Smith; he can be reached at jnapoli@constangy.com or (571) 522-6114.

Legal disclaimer: This blog entry is not intended to be, nor does it constitute legal advice. The above summary is not meant to be an exhaustive treatment of the subject matter and should not be relied on as such. Rather, this blog is meant to highlight a few standout issues and the related provisions of the ACA. You are encouraged to seek legal counsel to the extent necessary to assist you in understanding the legal issues raised in this blog or otherwise facing you in your practice.

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