Pitts By and Through Pitts v. American Sec. Life Ins. Co.

• Decision Date: 21 May 1991
• Docket Number: No. 90-1170,90-1170
• Citation: 931 F.2d 351
• Parties: Gregory PITTS, a Minor, By and Through His Father and Next Friend, George PITTS, Plaintiff-Appellee-Cross-Appellant, v. AMERICAN SECURITY LIFE INSURANCE COMPANY, Defendant-Appellant-Cross-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 351

931 F.2d 351

Gregory PITTS, a Minor, By and Through His Father and Next

Friend, George PITTS, Plaintiff-Appellee-Cross-Appellant, v. AMERICAN SECURITY LIFE INSURANCE COMPANY,

Defendant-Appellant-Cross-Appellee.

No. 90-1170.

United States Court of Appeals, Fifth Circuit.

May 21, 1991.

Thomas D. Bourdeaux, Bourdeaux & Jones, Meridian, Miss., for defendant-appellant-cross-appellee.

Lawrence E. Abernathy, III, Laurel, Miss., for plaintiff-appellee-cross-appellant.

Appeals from the United States District Court for the Southern District of Mississippi.

Before CLARK, Chief Judge, RONEY ¹ and DUHE, Circuit Judges.

DUHE, Circuit Judge.

American Security Life Insurance Company contends that the district court erred in holding it liable for the payment of benefits to Gregory Pitts under a group employee insurance policy. It claims that the policy was void ab initio because the employer made material misrepresentations that prevented the formation of a valid contract. We affirm.

Kenneth T. McKenzie was the founder and sole proprietor of a plumbing business. Later he included his two sons, Patrick L. McKenzie and Kenneth D. McKenzie, as partners in the business. In addition, he employed his sister, Diane McKenzie Rose, as secretary and bookkeeper.

Kenneth D. McKenzie left the business in 1974 to establish his own company, United Plumbing Company. Meanwhile, the other family members continued in the original business, eventually incorporating it as McKenzie, Inc. For its employees and their families, the company provided a health insurance policy underwritten by Lincoln National Life Insurance Company. The agent who sold this policy was George Melichar.

In 1983, Kenneth T. McKenzie, an insured on the Lincoln National policy, began to suffer with serious health problems. His wife, a dependent on the same policy, also had health problems. The couple's significant medical expenses resulted in large claims against Lincoln National. In 1985, the insurer doubled its premiums for employees of McKenzie, Inc.

As Kenneth T. McKenzie's health worsened, so did the finances of McKenzie, Inc. The company thus sought less expensive health coverage. Company officers called George Melichar, the agent who had sold the company its Lincoln National policy. Melichar arranged for the company to purchase a new group policy with American Security Life Insurance Company. That policy, numbered 8148 and issued on July 26, 1985, is the subject of this case.

The policy required that one hundred percent of the full-time employees--those working at least thirty hours per week--must be included in the group and that the employer must pay one hundred percent of all employee premiums. It also specified that the insured group must consist of at least ten employees; otherwise, American Security could terminate the policy.

By October 1985, McKenzie, Inc. tottered on the brink of dissolution. A surety took over the company's primary contract, and several employees left. In fact, only four employees remained as insureds under the group policy. American Security notified McKenzie, Inc. that its group coverage would soon end under the terms of the policy.

Members of the McKenzie family were extremely concerned about losing health coverage for Kenneth T. McKenzie and his wife. In an effort to avoid termination of the policy, Diane McKenzie Rose told Melichar that McKenzie, Inc. planned to merge with United Plumbing. Together, she said, the two companies would have the ten employees required for continued coverage.

According to Diane McKenzie Rose, both Melichar and American Security approved of this solution. American Security contends, however, that it learned only that McKenzie, Inc. planned to change its name to United Plumbing Company. On November 19, 1985, United Plumbing assumed policy 8148.

Diane McKenzie Rose submitted a list of ten purported employees of United Plumbing. The testimony at trial revealed that not all of these individuals were employees of United Plumbing pursuant to the definition of an employee under the policy. Moreover, some of the individuals listed were not employees of either McKenzie, Inc. or United Plumbing. The minimum requirement of ten employees was clearly not fulfilled.

One of the ten individuals listed was Gregory Pitts, the plaintiff in this case. Pitts was a bona fide employee of United Plumbing when that company assumed the policy in November 1985. American Security argued at trial that if it had known of the misrepresentation implicit in the list of ten purported employees, it would have cancelled the policy in December 1985.

In late January 1986, Gregory Pitts was seriously injured in an accident. United Plumbing submitted claim forms for his medical expenses, and American Security promptly paid these expenses under the terms of the policy. American Security notified United Plumbing, however, that it intended to increase its premium rate beginning in August 1986. ² It planned to increase the rate per month for each employee from $126.22 to approximately double that amount.

Still suffering from financial difficulties, the McKenzie family decided to seek less expensive coverage. The new policy, of course, would not have included Gregory Pitts, who had been totally disabled by the accident. If policy number 8148 were terminated, Gregory's father, George Pitts, would thus have been faced with virtually insurmountable medical expenses.

Desperate to keep the policy in force, George Pitts agreed to pay the entire amount of the increase if United Plumbing would continue to pay the original amount of the premiums. The testimony at trial revealed that United Plumbing paid American Security the entire new amount of premiums for August, September, and October of 1986. For all three months, George Pitts reimbursed United Plumbing for the amount of the increase and paid the original premium amount for Gregory Pitts.

After three months, George Pitts could no longer sustain the financial burden of paying about $1,500 per month to keep the American Security policy in effect. From November 1986 through March 1987, he paid United Plumbing $126.22, the original amount of the monthly premium before American Security had increased its rate. For five months, American Security received from United Plumbing a check for $126.22 per month--a mere five percent of what the policy originally required. American Security held these checks instead of cashing them. Finally, in March 1987, American Security decided to terminate the policy effective June 30, 1987. Pursuant to the terms of the policy, the insurer extended benefit payments for three months after notice of termination.

After giving notice of termination, American Security cashed the five checks it had received from United Plumbing from November 1986 through March 1987. The insurer rationalized that since it had already paid over $100,000 in medical benefits, it could properly keep the premium payments--even though they were inadequate to keep the policy in force--to recoup some of its losses on the policy.

Just before the end of the three-month period of extended benefit payments, George Pitts sought injunctive relief against American Security in a Mississippi state court. Pitts claimed that since his son's right to benefits had vested, American Security could not terminate the policy. American Security removed the suit to federal district court.

The district judge granted partial summary judgment on Pitts's request for punitive damages. American Security then filed a third-party action against its insurance agent, Melichar, claiming that Melichar had colluded with members of the McKenzie family to defraud the insurer. After a bench trial, the judge exonerated Melichar.

The judge found that Pitts was entitled to continued benefits under the policy but not to attorney's fees. He concluded that Pitts was injured before cancellation of the policy and that he had a reasonable expectation of benefits under the policy. Applying the theory of equitable estoppel, the judge also concluded that by accepting premium payments for only one employee for five months, American Security effectively agreed to provide coverage to a group of less than ten employees.

Applicable Law

This matter is governed by the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), 88 Stat. 829, as amended, 29 U.S.C. Sec. 1001, et seq. (1988). ERISA creates federal causes of action for recovery of benefits under employee welfare and pension plans. See 29 U.S.C. Sec. 1132(a)(1)(B) (1988).

In enacting ERISA, Congress broadly preempted state law, including all laws, decisions, rules, regulations, and other state acts having the effect of law. Mackey v. Lanier Collection Agency & Serv., Inc., 486 U.S. 825, 108 S.Ct. 2182, 2191, 100 L.Ed.2d 836 (1988); Pilot Life Ins. Co. v. Dedeaux, 481 U.S. 41, 107 S.Ct. 1549, 95 L.Ed.2d 39 (1987). Congress intended for courts to fashion a federal common law governing employee benefit plans. See In re HECI Exploration Co., 862 F.2d 513, 523 & n. 18 (5th Cir.1988).

This development of federal common law, however, may be informed by state law. Id. at 523 & n. 19. Any such application of state law must, of course, be consistent with the policy of the federal statute. Id.; Pennzoil Co. v. Federal Energy Regulatory Comm'n, 645 F.2d 360, 385 (5th Cir.1981), cert. denied, 454 U.S. 1142, 102 S.Ct. 1000, 71 L.Ed.2d 293 (1982). The district court in this case recognized its mandate to fashion a federal common law consistent with the policy of ERISA.

The Insurance Contract: Void or Voidable?

American Security argues that its policy number 8148 was void ab initio, or null from the beginning, because employees of McKenzie, Inc. made material misrepresentations that prevented the formation of a valid contract. The Mississippi Supreme Court has held that a material misrepresentation of fact made by an employer in applying for insurance may invalidate...