Special in-depth reportage

Federal Judge Rules Unfiled Side Agreements Illegal

By: Brad Cain

The Central District of California has ruled that the side agreement used by Zurich American Insurance Company in a large deductible program is “illegal and void as a matter of law” because it was never filed with the California Insurance Commissioner. Federal Court Judge Ronald Lew granted a California employer a key win in its on-going battle over the terms and conditions in an unfiled side agreement to its workers’ comp policy. The Department of Insurance says it agrees.

California law requires forms, endorsements, collateral agreements and side agreements to be filed with the WCIRB and approved by the California Department of Insurance.

“This is a precedential decision so this affects all these other cases that are on-going in California,” — attorney Nick Roxborough

“We are pleased the court upheld California’s regulatory process and recognized the insurance commissioner’s critical role in reviewing workers’ compensation policies and endorsements used by insurers. The Court correctly determined that insurers may not use ancillary agreements that modify the obligations of the parties unless they are filed in accordance with California law,” says California Department of Insurance spokeswoman Nancy Kincaid about the decision in American Zurich v. Country Villa. “We laud the court’s refusal to enforce an illegal agreement that, as noted by the court, would circumvent the statutory structure and allow an insurer to enforce contract terms that bypass the governmental review process.”

The immediate ruling applies to the workers’ comp policy and side agreement that Zurich had with Country Villa Service Corp., but the impact could be widespread.

“Although the department cannot comment on specific enforcement activities, we continue to monitor the decisional law in this area,” says Kincaid. “In appropriate circumstances, and when an unfiled agreement modifies the obligations of the parties, the Department will take all necessary action against those insurers that fail to comply with California law.”

Consistent With Other Decisions

The decision of the federal court in the Country Villa case is consistent with unpublished rulings handed down by state courts in California and New York that dealt with the arbitration provisions of these agreements. Many California employers are locked in legal disputes with Zurich and other major carriers over the terms and conditions contained in similar side agreements that were never filed.

The California Department of Insurance has already said that carriers can’t universally impose arbitration and choice of law provisions in these unfiled agreements. Attorneys associated with this case and others say the ruling takes this one step further. “This is a precedential decision so this affects all these other cases that are ongoing in California,” says attorney Nick Roxborough (see photo), who successfully argued the Country Villa case and has represented a number of employers in disputes with carriers over side agreements to large deductible policies.

Roxborough says the ruling came in a case where Zurich sued Country Villa Service Corp. to collect over $1 million in additional fees allegedly allowed in a side agreement to the large deductible policy the nursing home had with the carrier. “They had sued us in federal court saying that per the side agreement they were entitled to all of this extra money based on these formulas, all these accounting, and actuarial things,” he says. “We asked them to show us their actuarial data and how it’s reasonable and they didn’t. Now they don’t have an agreement that is enforceable.”

Roxborough maintains that Country Villa has millions on deposit with Zurich to cover their deductible portion of the claims incurred under the policy. “We have more on file with them than their own adjusters think they need to settle the claims, and yet they sued for over a million dollars more in loss fund money,” he tells Workers’ Comp Executive. “With this side agreement being thrown out their cross-complaint has no basis anymore because it is founded upon a written complaint that now the court has said is void and unenforceable as a matter of law.”

Applied Underwriters

The federal court’s ruling also buoys Carmel attorney Larry Lichtenegger. He is representing employers in several cases against Applied Underwriters over its use of unfiled reinsurance participation agreements (RPAs),

“In my opinion … this decision will spell the end of Applied’s sale of the RPA as presently constituted,” –Attorney Larry Lichtenegger

“While previously, Applied’s insured’s have had to rely on breach of contract and fraud claims against Applied to recover for Applied’s mal-treatment, the decision in American Zurich v Country Villa validates many insured’s who believed they were buying insurance that had been reviewed and approved by the Insurance Commissioner,” Lichtenegger tells Workers’ Comp Executive. “The RPA, and the IDAs in American Zurich case are both collateral agreements affecting premium payments which Judge Lew effectively described as endorsements which Insurance Code section 11658 requires to be filed.”

Lichtenegger says the American Zurich decision upholds the contention that as the RPA was never filed with CDI, Applied’s failure to file it with the Department voids the Agreement. “In my opinion, if adopted by other courts, this decision will spell the end of Applied’s sale of the RPA as presently constituted,” he maintains.

Long Standing Disputes

The fight over unfiled side agreements dates back years and includes legislative action as well as action by the California Department of Insurance to require carriers to file the agreements. The department says such agreements must be filed with the Workers’ Compensation Insurance Rating Bureau and then the CDI for approval before they can be enforceable, but that is in dispute in many ongoing legal battles.

Updated regulations are in the works.

The side agreements tend to cover a host of issues from dispute resolution provisions to cost containment provisions and may be signed after the underlying workers’ comp policy is already in effect. CDI issued a notice to carriers in 2011 that such agreements must be filed and took enforcement action that year against Zurich for its use of unfiled deductible agreements. That enforcement action was ultimately settled whereby Zurich agreed not to force employers to comply with the arbitration and choice of law provisions in its side agreement. The settlement did not address the other provisions that are often contained in the side agreements.

In the Country Villa case, the agreement modifies the duties of the insured and carrier under the underlying policy. Zurich’s incurred deductible agreement (IDA) states that it “governs the structure and operation of and the duties and obligations of each party to this Program and supersedes any Deductible endorsements to the Policy(ies), prior communications, negotiations, participating plans or letters of election.”

Currently, the department is updating the regulations governing workers’ comp policy forms and endorsements to clarify that side agreements must be filed. That update is now in its second revision and is expected to be finalized shortly. (For past coverage see CDI Drafts.., CDI Proposes… and Large Deductible…)

‘Illegal and Void.’

Both actions by the department – the 2011 notice and the on-going rulemaking – were cited by Judge Lew in finding Zurich’s side agreement in the Country Villa case is “illegal and void as a matter of law.” The ruling came on a motion for partial summary judgment by Country Villa to have the “incurred deductible agreement” declared void and unenforceable under California law because Zurich failed to file the IDA with the Bureau and failed to attach the IDA to the policies.

The IDA was entered into after the effective date of Country’s large deductible policy but was effective retroactively to the policy start date. The document stated that “this agreement governs the structure and operation of and the duties and obligations of each party to this Program and supersedes any Deductible endorsements to the Policy(ies), prior communications, negotiations, participating plans or letters of election.”

The court noted that Zurich stipulated that the document was never filed with the Bureau and was not approved by the Department before it was issued and entered into by Zurich and Country Villa. The court rejected Zurich’s argument that the IDA did not need to be filed or attached because the IDA was only a financial agreement. It argued that insurance code sections 11658 and 2268 did not apply. The court disagreed.

“In light of the statutory and regulatory language; the highly regulated nature of California’s workers’ compensation insurance scheme; the language of the Policies and IDAs; the analogous facts and persuasive reasoning of Ceradyne, Source One, and Monarch; and the Commissioner’s interpretation of Sections 11658 and 2268, the Court finds that the IDAs are subject to Section 11658’s filing requirements and Section 2268’s attachment requirements,” Judge Lew wrote. Lew referenced the three similar court cases that reached virtually the same conclusion – that the side agreements had to be filed and attached and were not mere financial agreements that did not fall under the regulations.

Equitable Enforcement Rejected

The court also rejected Zurich’s request to enforce the IDA even if it was found to be illegal under the notion of equitable enforcement to avoid any unjust enrichment.

“First, there is no risk of Country Villa’s unjust enrichment because an insurer’s issuance of an illegal contract, even if it results in enrichment to the insured, does not result in unjust enrichment because the insured did nothing wrong, and the insurer should have known its own legal duties,” Lew wrote. “Second, refusing to enforce the IDAs is not an unduly harsh penalty on Zurich, because Zurich knew or should have known its filing requirements under California law, and enforcing the IDAs would encourage illegal activity. Furthermore, because Country Villa remains liable to Zurich under the policies, attached endorsements, and California law, refusing to enforce the IDAs is not unduly harsh.”

Lew also refused to just sever portions of the IDA and enforce the rest of the provisions, noting that it would be “nonsensical” because the entire IDA was required to be filed. “As such, the IDAs, along with their Specifications, are void as a matter of law and unenforceable in their entirety,” he concluded.


Applied Underwriters was once but is no longer an affiliate of Berkshire Hathaway. Applied’s management bought it. Berkshire Hathaway bears no responsibility for any of the events which have transpired involving Applied Underwriters’ or its subsidiaries including California Insurance Company.