John Henry Pelt and John Kyle Pelt v. State Board of Insurance ( 1995 )

TEXAS COURT OF APPEALS, THIRD DISTRICT, AT AUSTIN



NO. 03-94-00495-CV



John Henry Pelt and John Kyle Pelt, Appellants

v.

State Board of Insurance, Appellee



FROM THE DISTRICT COURT OF TRAVIS COUNTY, 331ST JUDICIAL DISTRICT NO. 91-6615, HONORABLE F. SCOTT MCCOWN, JUDGE PRESIDING

John Henry Pelt and John Kyle Pelt, doing business under the trade name Aztec General Agency, sued for judicial review of a final order issued by the State Board of Insurance. The order revoked licenses held by the Pelts under the Texas Insurance Code. See Tex. Ins. Code Ann. arts. 1.14-2 (Surplus Lines Insurance), 21.07-1 (Legal Reserve Life Insurance Agents; Examination; Licenses), 21.07-3 (Managing General Agents' Licensing Act), 21.14 (Licensing of Local Recording Agents and Solicitors), 21.15 (Revocation of Agent's Certificate) (West 1981 & Supp. 1995). The trial-court judgment affirmed the agency order. We will affirm the trial-court judgment.

THE CONTROVERSY

In January 1986 the Pelts purchased all the capital stock of American Surety Company, a foreign corporation not authorized to do business in Texas. John Henry became chairman of the board of directors, while John Kyle became a director and secretary of the corporation. Aztec General Agency, an agency managed and controlled by the Pelts, entered into a "fronting arrangement" or agency agreement in which American Surety gave Aztec authority to act in American Surety's behalf. From March 1986 to August 1987, the Pelts, through Aztec, placed with American Surety approximately 260 payment and performance bonds, including several bonds issued on public-works projects. American Surety's resulting liability totalled about twenty million dollars.

In September 1989 the State Board of Insurance ⁽¹⁾ initiated against the Pelts a disciplinary action, alleging they placed surety bonds in an ineligible surplus-lines insurer, ⁽²⁾ committed various acts of misrepresentation, misappropriation, fraud and dishonesty in violation of the Texas Insurance Code, and violated article 5160 of the Texas Revised Civil Statutes by placing public-works bonds in a surplus-lines insurer. Act of May 26, 1989, 71st Leg., R.S., ch. 1138, § 38, 1989 Tex. Gen. Laws 4693, 4704 (Tex. Rev. Civ. Stat. Ann. art. 5160, since amended). After a hearing on August 24, 1990, the Commissioner revoked the Pelts' licenses. The Commissioner later modified his order to suspend the Pelts' licenses for a twelve-month period. The Pelts appealed the order of suspension to the three-member panel of the Board. On March 25, 1991, the Board revoked the Pelts' licenses. The Pelts sued for judicial review in district court. After a trial de novo, ⁽³⁾ the district court affirmed the Board order.

In four points of error, the Pelts complain the trial court erred in revoking their insurance licenses because there was no evidence to support the court's conclusions that: (1) American Surety was an ineligible surplus-lines carrier; (2) the Pelts violated article 5160; (3) the Pelts gave false financial statements with the intent to deceive; and (4) the Pelts demonstrated a lack of trustworthiness and competence or were guilty of fraudulent and dishonest acts.

DISCUSSION AND HOLDINGS I.

As a threshold matter we must address the Board's cross-point of error regarding the appropriate manner and scope of review. House Bill No. 2, which became effective while the Pelts' suit was pending in the trial court, changed the manner and scope of review from trial de novo to substantial-evidence review. See Act of May 27, 1991, 72d Leg., R.S., ch. 242, § 1.02, 1991 Tex. Gen. Laws 939, 941 (Tex. Ins. Code Ann. art. 1.04(f) (West Supp. 1995)) (hereinafter "H.B. No. 2").

The Board argues the trial court was confined to a substantial-evidence review, citing section 13.30 of H.B. No. 2: "Except as provided by Subsection (b) of this section, this Act takes effect September 1, 1991." Id. § 13.30. The Pelts argued the effective date was controlled by section 13.08, which provided as follows:

The changes made by this Act to the application of the Administrative Procedure and Texas Register Act (Article 6252-13a, Vernon's Texas Civil Statutes) and to the participation of State Board of Insurance staff members in rate proceedings apply only to proceedings before the State Board of Insurance commenced on or after January 1, 1992. Proceedings commenced before January 1, 1992, are governed by the law as it existed immediately before the effective date of the Act, and that law is continued in effect for that purpose.

Id. § 13.08 (emphasis added). The Board urges that the use of the conjunctive "and" instead of the disjunctive "or" evidences the legislature's intention to modify and limit both clauses preceding the phrase "in rate proceedings"; the first clause being that which refers to "changes made by this Act to the application of [APTRA]" and the second clause being "participation of State Board of Insurance staff members." To bolster its argument, the Board asserts that rate reform was the main thrust of the extensive changes made to the Insurance Code by H.B. No. 2. We note, however, that rate reform comprised only a portion of the revisions. ⁽⁴⁾

The Board argues further that at the time disciplinary action was brought against the Pelts, license revocation proceedings were initiated before the Commissioner, and were then appealed to the Board, unlike rate hearings which were initiated before the Board. In its brief, the Board states: "Surely, if the legislature had intended to exclude from substantial evidence review all actions currently pending before the agency, it would have tied the effective date in section 13.08 to the inception of the administrative proceeding--that is, to the commencement of the action at the agency level."

We are unconvinced that the plain meaning of section 13.08 dictates that "changes in the application of [APTRA]" are limited solely to those changes involving rate proceedings, although the section is not completely clear. See E.A. Driedger, Legislative Drafting, 27 Canadian Bar Rev. 291 (1949), reprinted in 1A Norman J. Singer, Statutes & Statutory Construction 645, 653-54 (5th ed. 1993) (ambiguity may be avoided by repeating qualifying word or rearranging words). The second clause would not make sense without the phrase "in rate proceedings" or a similar phrase, while the first clause standing alone requires no modification. We hold that because this proceeding began in the Board before January 1, 1992, the "law as it existed immediately before the effective date of this Act" governs. Thus, de novo review was required. We overrule the Board's first cross-point of error.

II.

In their first point of error, the Pelts complain there is no evidence to support the trial court's conclusions of law numbers 2 through 8 ⁽⁵⁾ because the statutory framework as it existed in 1986 and 1987 granted the surplus-lines agent, rather than the Board, the authority to determine whether the surplus-lines insurer was "eligible." ⁽⁶⁾ The Pelts argue that by adding sections 3A and 17A and amending section 8 of article 1.14-2 of the Insurance Code in 1987, ⁽⁷⁾ the Legislature intended to end self-regulation, and thereafter authorized the Board to determine the eligibility and suitability of surplus-lines insurers. The State Board of Insurance responds it has always possessed authority to determine the eligibility and suitability of surplus-lines insurers and to promulgate rules in that regard pursuant to article 1.14-2 of the Insurance Code. Tex. Ins. Code Ann. art. 1.14-2 (West 1981 & Supp. 1995).

We disagree with the Pelts' theory that the Board was without authority to supervise and regulate surplus-lines insurers. The Board possessed express rulemaking authority before the enactment of the 1987 amendments. See Tex. Ins. Code Ann. art. 1.04(b) (West 1981) (Board authorized by Insurance Code to "determine policy, rules, rates and appeals, but otherwise it shall execute its duties through the Commissioner of Insurance as herein provided, in accordance with the laws of this state and the rules and regulations for uniform application as made by the Board"); see also id. § 1.04(c).

Section 1 of article 1.14-2, which sets forth the purposes of the article, refutes the Pelts' theory that the determination to place insurance with an unauthorized carrier rests solely with the surplus-lines agent in that it requires surplus-lines insurers to follow certain guidelines and submit required reports to the Board. Tex. Ins. Code Ann. art. 1.14-2, § 1 (West 1981 & Supp. 1995). ⁽⁸⁾ The statute provides further that surplus-line agents be "qualified, licensed and supervised." Id.

Moreover, article 1.10, section 7 provides expressly that one of the Board's duties is to order sanctions after notice and hearing if a licensee "is found to be in violation of, or failed to comply with, specific provisions of the Code or any duly promulgated rule or regulation of the State Board of Insurance." Tex. Ins. Code Ann. art. 1.10, § 7 (West 1981). Under this authority, the Board "may cancel or revoke any permit [or] license." Id.

The Pelts assert that "the State Board of Insurance is an agency with limited authority" which may not act unless given authority to act by the Legislature in "clear and unmistakable terms." See Key W. Life Ins. Co. v. State Bd. of Ins., 350 S.W.2d 839, 848 (Tex. 1961) (Board only empowered to determine whether form submitted for its approval meets specific standards prescribed by statute); Board of Ins. Comm'rs v. Guardian Life Ins. Co., 180 S.W.2d 906, 908 (Tex. 1944) (Board without authority to require greater reserves than those mandated by statute). Key Western and Guardian Life are distinguishable. Both refer to statutes that prescribe explicitly what the Board could and could not do in its regulation. In the present cause, the legislature granted specific powers and duties, but provided only general guidelines for the Board to follow in carrying out the specific powers and duties, implicitly leaving to the Board the promulgation of rules necessary to fill the interstices.

For example, section 7 of article 1.10 expressly grants the Board a specific power to impose sanctions on licensees for specific code violations. We must therefore ascertain the full extent of that power "with due regard for the rule that the Legislature generally intends that an agency should have by implication such authority as may be necessary to carry out the specific powers delegated, in order that the statutory purpose might be achieved." Sexton v. Mount Olivet Cemetery Ass'n, 720 S.W.2d 129, 137 (Tex. App.--Austin 1986, writ ref'd n.r.e.).

Section 3 of article 1.14-2 provides that insurance may be procured from unauthorized insurers provided the insurer is an eligible surplus-lines insurer under section 8 of article 1.14-2. Tex. Ins. Code Ann. art. 1.14-2, § 3(a)(2) (West 1981 & Supp. 1995). Section 8, governing the eligibility of surplus-lines insurers, mandates that "[a] surplus lines agent shall not knowingly place surplus lines insurance with financially unsound insurers"; "[a]n insurer shall not be eligible unless it has capital and surplus or its equivalent that is adequate in relation to its premium writings and the exposure it assumes"; "[t]he unauthorized insurer must be of good repute"; and the management of an unauthorized insurer must be competent and trustworthy. ⁽⁹⁾ Id. § 8 (a), (b), (c). Section 8, however, does not require that the State Board "determine the actual financial condition or claims practice of any unauthorized insurer." Id. § 8(f). ⁽¹⁰⁾

By necessary implication, the Board must have sufficient authority to implement section 8 of article 1.14-2, including the authority to determine the meaning of the word "eligible." Because the Legislature required that surplus-lines insurers have "adequate" capital in order to be "eligible," it necessarily gave the Board discretion to determine the meaning and content of those terms. See Railroad Comm'n v. Highway Ins. Underwriters, 124 S.W.2d 413, 414 (Tex. Civ. App.--Austin 1939, no writ). In promulgating Board Order Number 38530, the Commission acted in harmony with the general objectives of article 1.14-2. See Gerst v. Oak Cliff Sav. & Loan Ass'n, 432 S.W.2d 702, 706 (Tex. 1968) (critical factor in determining whether agency has exceeded its rulemaking authority is whether rule harmonizes with general objectives of the statute); see also State Bd. of Ins. v. Deffebach, 631 S.W.2d 794, 798 (Tex. App.--Austin 1982, writ ref'd n.r.e.).

We conclude the Board was authorized to determine the eligibility of surplus-lines insurers during the time the Pelts were placing bonds with American Surety. Therefore, if any evidence supports the Board's conclusion that the Pelts placed insurance with an ineligible surplus-lines carrier, we must overrule their first point of error. See In re King's Estate, 244 S.W.2d at 661.

The evidence shows that John Henry wrote to the surplus-lines division of the Board on February 20, 1986, requesting that American Surety be placed on the Board's list of unauthorized insurers. John Henry's letter contained a financial statement of American Surety's purported worth as of January 31, 1986. On March 24, 1986, Richard Schoeter, the division director, replied that American Surety could not be placed on the unauthorized insurers list until American Surety provided a certified financial statement by an accredited accounting firm, and biographical information on its officers. On May 19, 1986, the Pelts sent a "Report of Certification" written by Carlos W. Simmons, American Surety's counsel in the Turks and Caicos Islands, stating that Simmons had examined American Surety's balance sheet as of January 31, 1986 "in accordance with generally accepted standards including such tests of the records and other procedures as we considered necessary in the circumstances." He added that the certification was "in conformity with generally accepted examination principles applied on a basis consistent with that required by the Registrar of Companies." Schoeter responded, stating that American Surety could not be recognized as an eligible insurer because the Board still lacked the information requested.

Additionally, Schoeter informed the Pelts that he had received information that the Pelts had placed a bond with American Surety; Schoeter requested an explanation within ten days. When Schoeter did not receive a reply, he sent another letter dated July 15, 1986, requiring an explanation as to why bonds were being placed with American Surety and requesting that no new bonds be placed. The Pelts forwarded this letter to their attorney in Texas, Hector De Leon. De Leon replied to Schoeter's letter by inquiring why the Pelts could not continue to issue bonds. Schoeter answered that the Pelts had failed to meet the requirements of article 1.14-2 and the Board-approved rules pertaining to this section. On August 1, 1986, the Pelts provided the Board with a "Report of Examination" prepared by certified public accountants Dohm & Wolff, which stated that the financial statement previously provided to the Board, purporting to assess American Surety's financial position as of January 31, 1986, did "not present fairly the financial position of American Surety . . . in conformity with generally accepted accounting principles." By August 1987 the Pelts had placed over 260 bonds with American Surety totalling approximately twenty million dollars. Dohm & Wolff found substantial mistakes in the first financial report sent to the Board. For example, the Pelts listed American Surety's assets as $3,836,085, while Dohm & Wolff found only $3,125,735 in assets. The Pelts calculated their liabilities to be only $757,992, while Dohm & Wolff calculated total liabilities to be $2,626,416.

Subsequently, the Board appointed Edward E. Kubala to supervise American Surety and later appointed R.B. Ashworth as conservator to take control of the company. At this point, the Board's financial examiners determined that certain items listed as assets by the Pelts were either non-existent or were not registered in American Surety's name. For example, American Surety had listed approximately one hundred letters of credit issued in favor of Aztec General Company or other companies owned and operated by the Pelts. Even if these letters of credit had been issued in American Surety's name, they could not be considered assets without a corresponding liability because the money under the letters of credit became available only upon a failure on the bond. ⁽¹¹⁾

American Surety also listed as an asset certain real estate the Pelts valued at $1,300,000, encumbered by a deed-of-trust lien securing a debt in the amount of $732,743. However, the Aztec Financial Services actually owned the real estate. The lien was later foreclosed and the property sold at a trustee's sale for $281,250, leaving a substantial deficiency owing.

American Surety also listed as an asset an oil and gas lease, claimed to be worth $499,500, assigned to American Surety by Aztec Financial Services. The lease had a primary term of two years and so long thereafter as oil or gas was produced in paying quantities. There was no indication that the lease had ever produced any income. Taking these and other discrepancies into account, the Board ascertained the Pelts' total assets were actually worth only $637. At the same time, the Board discovered American Surety's liabilities had dramatically increased due to pending lawsuits.

We conclude the trial court ordered the Pelts' licenses revoked on the basis that they had written insurance in an ineligible surplus-lines insurer. The court could reasonably conclude from the evidence that assets worth $637 were inadequate in relation to premium writings of approximately twenty million dollars. We overrule the Pelts' first point of error.

In light of our disposition of the Pelts' first point of error, it is unnecessary to reach their remaining points. We affirm the trial-court judgment.

John Powers, Justice

Before Justices Powers, Kidd and B. A. Smith

Affirmed

Filed: August 16, 1995

Do Not Publish

1.   Now the Texas Department of Insurance. See Act of May 27, 1991, 72d Leg., R.S., ch. 242, § 1.02, 1991 Tex. Gen. Laws 939, 941 (Tex. Ins. Code Ann. art. 1.01A, since amended).

2.   An eligible surplus lines insurer is an unauthorized carrier that may provide coverage to a citizen of the state who cannot, after diligent effort, obtain coverage from authorized carriers. Surplus lines insurers are subject to the requirements of article 1.14-2 of the Insurance Code. Tex. Ins. Code Ann. art. 1.14-2, § 3 (West 1981 & Supp. 1995) & § 5 (West 1981).

3.   The appellate record reflects that the trial court tried all issues of fact and law, receiving and weighing evidence, finding facts, and applying the law as in an ordinary civil case. In short, the trial court decided the controversy after a trial de novo. See Administrative Procedure and Texas Register Act (APTRA), 64th Leg., R.S., ch. 61, § 19, 1975 Tex. Gen. Laws 136, 146-47 (Tex. Rev. Civ. Stat. Ann. art. 6252-13a, § 19(c), (e), since repealed and codified at Tex. Gov't Code Ann. § 2001.173 (West 1995)). In addition, however, the appellate record indicates that the trial court required the Board to transmit to the trial court a copy of the agency record, to which the court apparently confined its review in arriving at a decision, "other than by trial de novo," to affirm the agency decision. That is to say, the trial court affirmed the agency decision after "substantial-evidence" review as prescribed in APTRA § 19(d), (e), since repealed and codified at Tex. Gov't Code Ann 2001.174 (West 1995). In its judgment, the trial court declared that the "court is of the opinion that both substantial evidence and a preponderance of the credible evidence supports [sic] revocation of any and all insurance-related licenses held by the Pelts." Judicial review by trial de novo and substantial-evidence review are, of course, inherently antithetical in their manner and scope of review. See Railroad Comm'n v. Entex, Inc., 599 S.W.2d 292, 298 (Tex. 1980); Southern Canal Co. v. State Bd. of Water Eng'rs, 318 S.W.2d 619, 622-25 (Tex. 1958). We therefore regard as surplusage that part of the trial-court judgment that refers to substantial-evidence review.

4.   In fact, H.B. No. 2 is described generally as "An Act relating to the regulation of the insurance industry, the punishment for certain criminal offenses relating to the business of insurance, maintaining motor vehicle financial responsibility, and creating certain offenses." Id. at 939.

5.   Conclusions of law 2 through 8 provide as follows:

2. At the time the Pelts placed the surety bonds with American Surety Company, as described in Finding of Fact Nos. 9 and 12, American Surety Company was not an eligible surplus lines carrier, because it did not have capital and surplus, or its equivalent, that was adequate in relation to its premium writings and the exposure it assumed, as contemplated in Tex. Ins. Code Art. 1.14-2, § 8(a).

3. At the time the Pelts placed the surety bonds with American Surety Company, as described in Finding of Fact Nos. 9 and 12, American Surety Company was not an eligible surplus lines carrier, because it did not have competent or trustworthy management, as contemplated in Tex. Ins. Code Art. 1.14-2, § 8(c).

4. At the time the Pelts placed the surety bonds with American Surety Company the State Board of Insurance was authorized to determine the eligibility of surplus lines carriers and to promulgate rules and regulations for surplus lines carriers, pursuant to Tex. Ins. Code Arts. 1.04(b), 1.14-2, §§ 1 and 8.

5. At the time the Pelts placed the surety bonds with American Surety Company, as described in Finding of Fact Nos. 9 and 12, American Surety Company had not been deemed an eligible surplus lines carrier by the State Board of Insurance, as contemplated in Tex. Ins. Code Art. 1.14-2, §§ 1 and 8.

6. The Pelts knowingly placed surplus lines insurance with a financially unsound insurer in violation of Tex. Ins. Code Art. 1.14-2, § 8(a).

7. American Surety Company was not authorized to transact the business of insurance in the State of Texas, as contemplated in Tex. Ins. Code Art. 1.14-1.

8. Because American Surety Company was neither authorized to transact the business of insurance in the State of Texas, nor eligible to act as a surplus lines carrier, the Pelts violated Tex. Ins. Code Art. 1.14-1, §§ 2 and 3, which prohibit engaging in unauthorized insurance.

6. We are constrained in reviewing no evidence points to consider only the evidence and inferences that tend to support the findings and disregard all the evidence and inferences to the contrary. Weirich v. Weirich, 833 S.W.2d 942, 945 (Tex. 1992); Garza v. Alviar, 395 S.W.2d 821, 823 (Tex. 1965). See generally William Powers, Jr. & Jack Ratliff, Another Look at "No Evidence" and "Insufficient Evidence," 69 Tex. L. Rev. 515 (1991). If any evidence supports the finding, we must overrule the point and uphold the finding. In re King's Estate, 244 S.W.2d 660, 661 (Tex. 1951).

7.   Section 3A provides that "[t]he State Board of Insurance may promulgate rules to enforce this article. The board shall monitor the activities of surplus lines agents to the extent necessary to protect the public interest." Tex. Ins. Code Ann. art. 1.14-2, § 3A (West Supp. 1995).

The amendments to section 8 set forth monetary guidelines for capital and surplus requirements instead of requiring only that capital and surplus be "adequate." See Act of June 3, 1987, 70th Leg., 1st C.S., ch. 1, sec. 5.04, § 8, 1987 Tex. Gen. Laws 1, 17-18 (Tex. Ins. Code Ann. art. 1.14-2, § 8, since amended).

Section 17A provided in part that "[i]f a surplus lines agent violates Section 8 of this article or a rule, regulation, or order adopted under that provision, the State Board of Insurance may assess a penalty against that agent as provided by Section 7, Article 1.10, of this code." See Act of June 3, 1987, 70th Leg., 1st C.S., ch. 1, sec. 5.05, § 17A, 1987 Tex. Gen. Laws 1, 18 (Tex. Ins. Code Ann. art. 1.14-2, § 17A, since amended).

8.   Section 1 of article 1.14-2 provides as follows:

Insurance transactions which are entered into by citizens of this state with unauthorized insurers through a surplus lines agent as a result of difficulty in obtaining coverage from licensed insurers are a matter of public interest. The Legislature declares that such transaction of surplus lines insurance is a subject of concern and that it is necessary to provide for the regulation, taxation, supervision and control of such transactions and the practices and matters related thereto by requiring appropriate standards and reports concerning the placement of such insurance; by imposing requirements necessary to make such regulation and control reasonably complete and effective . . . . In order to properly regulate and tax such unauthorized insurance within the meaning and intent of . . . [the article], the Legislature herein provides an orderly method for the insuring public of this state to effect insurance with unauthorized insurers through qualified, licensed and supervised surplus line agents in this state and under reasonable and practical safeguards so that such intent that the coverage is not procurable from duly licensed, regulated insurers conducting business in this state.

Tex. Ins. Code Ann. art. 1.14-2, § 1 (West 1981) (emphasis added).

9.   Pursuant to its rulemaking authority, the Board promulgated Board Order Number 38530 regarding the eligibility and suitability of surplus lines insurers. See 88 Tex. Reg. 4759 (1980) (proposed) and 15 Tex. Reg. 770 (1981) (adopted), since amended and codified at 28 Tex. Admin. Code §§ 15.7, .8, .13, .23 (1995). Order Number 38530 followed generally the language in article 1.14-2, section 8 concerning eligibility. In addition, section 8 provided as follows:

[T]he suitability of each unauthorized insurer underwriting or proposing to underwrite surplus lines risks in Texas is subject to the continuous scrutiny and discretion of the State Board of Insurance. . . . In order to establish the suitability of any unauthorized insurer for writing surplus lines insurance, the commissioner may request information from the surplus lines agent concerning an unauthorized insurer. The information requested may include but is not limited to recent financial statements, domestic trust agreements, powers of attorney, and biographies of the owners and the management.

10. The Pelts claim section 8(f) evidences the legislature's intent to allow self-regulation of the surplus-lines insurance industry in 1986 and 1987, while the Board interprets section 8(f) to be a disclaimer of any liability to purchasers of surplus-lines insurance that relied on the Board's determination of eligibility. See Tex. Ins. Code Ann. art. 1.14-2, § 7 (West 1981). We believe the Pelts infer too much from the section.

11. Principals on the surety bond were required to obtain letters of credit as collateral; if American Surety became liable on a bond, the letters of credit would cover the loss.