Contingent Commissions – Legal After All?

October 4, 2007

When New York Attorney General Eliot Spitzer (now Governor Spitzer) went after the major insurance brokerage firms for bid rigging a few years ago, he also attacked contingent commissions as part of the scheme to direct business, characterizing these payments as equivalent to kickbacks. In the subsequent settlements with the major brokers, the brokers agreed to forego contingent commissions in the future, casting a pall over the practice by the entire brokerage community, not just the majors.

Now a recent Appellate Division case, Hersch v. DeWitt Stern Group, Inc. (2007 NY Slip Op 06567, App. Div. 1st Dept., Sept. 6, 2007), has focused attention again on the propriety of contingent commissions. In the Hersch case, plaintiff had sued his broker for failing to obtain certain coverages, and several of the causes of action were based on breach of fiduciary duty for, inter alia, failing to disclose the existence of a contingent commission agreement. The Court found that the fiduciary duty causes of action should have been dismissed because contingent commissions are not illegal and, absent a special relationship, defendant had no duty to disclose the existence of the contingent commission agreement.

The Court based its finding that contingent commissions are not illegal on a 1985 Court of Appeals decision, Amusement Bus. Underwriters v. American Intl. Group (66 NY2d 878). The Court of Appeals in Amusement Bus. Underwriters, however, did not specifically hold that contingent commissions were legal. It was interpreting the terms of a contingent commission agreement, and the issue of the legality of the agreement does not appear to have been before the Court.

The Hersch Court’s finding that the broker had no duty to disclose the contingent commission agreement, also seems to fly in the face of a regulatory requirement for disclosure. Circular Letter 22 issued by the New York Insurance Department in 1998 imposes a regulatory requirement that all special or extra compensation arrangements between carriers and a broker must be disclosed to customers. The Hersch Court makes no mention of this requirement.

Given the significance of the issues it roils, the Hersch decision is remarkably short (three paragraphs). We will have to wait and see if the decision is appealed, but until the Court of Appeals rules otherwise, it appears that contingent commissions can once again be discussed openly in polite circles – at least in New York’s First Department.

What do you think?

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