Can Disputes Related To Procurement Of Federal Flood Insurance Policies Be Litigated In State Court?

flooded neighborhoodIt is well-established that claim processing and wrongful denial of coverage disputes involving federal flood insurance policies belong in federal court because they present substantial questions of federal law. The U.S. District Court for the Western District of North Carolina recently applied this rule when it denied the insureds’ motion to remand a case to state court in Henderson v. Nationwide Mutual Fire Insurance Company, 3:16-CV-419, 2016 WL 5415290 (W.D.N.C. Sept. 27, 2016). The Henderson Court, however, left open the question of whether disputes solely arising out the “procurement” of federal flood insurance policies likewise involve substantial questions of federal law or are matters of state law that can properly be determined by state courts. This is an issue on which courts around the country are divided.

The National Flood Insurance Program (“NFIP”) is a federal program pursuant to which persons can purchase Standard Flood Insurance Policies (“SFIPs”). SFIPs contain terms mandated by federal regulations. They can be purchased either directly from the Federal Emergency Management Agency (“FEMA”) or from private insurance companies known as “Write Your Own” or “WYO” carriers that are authorized by federal regulation to sell and administer SFIPs under their own names. 

The insureds in Henderson approached Nationwide, a WYO carrier, about purchasing a flood insurance policy for a storage building located near a small creek in the back of their lot. Nationwide issued the insureds an SFIP for the building, which was subsequently renewed over several years. A flood then damaged the storage building and destroyed its contents. Nationwide denied the resulting insurance claims on the grounds that the building was not eligible for coverage because it was not permanently anchored to the ground and offered the insureds a premium refund. The insureds filed suit in North Carolina state court alleging breach of contract and unfair and deceptive trade practice claims based, in part, on allegations that Nationwide wrongfully denied the insureds’ claims. Nationwide removed the case to federal court on the grounds that the suit raised a federal question, and moved to dismiss the insureds’ claims against it. The insureds responded by filing a motion to remand the case back to state court.

In their motion to remand, the insureds “concede[d] that the storage building was not covered under the policy,” and argued that the case was not about wrongful denial of coverage as much as it was about alleged misrepresentation in the procurement of the policy because Nationwide had allegedly “sold them a flood insurance policy when it knew or should have known that the structure at issue was not eligible for coverage under the SFIP because it was not permanently anchored to the ground.” Id. at 4.

The insureds’ remand argument was based on the distinction made by some courts between claims involving claims handling allegations, which are well-recognized as being preempted by federal law, and claims arising out of policy procurement issues. Id. at 5. In Houck v. State Farm Fire and Casualty Company, for example, the U.S. District Court for the District of South Carolina held that claims only involving policy procurement issues do not give rise to substantial questions of federal law and that such claims are matters of state law that can properly be decided by state courts. 194 F. Supp.2d 452, 461-62, 469 (D.S.C. 2002).

The Henderson Court recognized Houck’s holding, but denied the insureds’ motion to remand. It reasoned that its “focus for purposes of determining jurisdiction must be on the Complaint and not factual allegations in the [insureds’] Motion,” and that the complaint filed by the insureds contained allegations relating to claims handling, claim payment, and policy premiums, all of which implicate federal question jurisdiction. Therefore, the Houck rule did not apply to the case before it. Id. at 5. The court’s decision, however, suggests that it might follow Houck if presented with a case in the future with facts and allegations truly constituting “a simple procurement claim.” See id.

But Houck’s holding has been called into doubt by more recent cases decided after FEMA issued a WYO Program Bulletin in July 2009 stating in part:

FEMA previously understood and intended its regulations to preempt state law claims related to policy formation, renewal, and administration arising from allegations of WYO Company error as distinct from agent error (agent error is not subject to Federal Regulation . . .

. . . federal preemption should apply not just to claims handling activities, but also to policy administration. Specifically, preemption should apply to the nationally uniform and FEMA-mandated processes governing policy issuance and the administration of existing flood policies, including but not limited to rating, renewal, transfer, non-renewal, cancellation, or reformation. Insurance agent procurement disputes or any allegation of negligence on the part of the insurance agent related to procurement are not subject to preemption.

Davis v. Nationwide Mut. Fire Ins. Co., 783 F. Supp.2d 825, 833 (E.D. Va. 2011) (citing WYO Program Bulletin No. W-09038).

For example, in Davis v. Nationwide Mut. Fire Ins. Co., 783 F. Supp.2d 825 (E.D. Va. 2011), the U.S. District Court for the Eastern District of Virginia concluded “that federal law preempts state law not only with respect to policy interpretation and claims handling under the NFIP, but also with respect to policy issuance and administration,” including procurement-based claims such as the insurer purportedly selling the insured a more expensive policy than was necessary – which are identical to the procurement-based allegations that the Houck Court had previously held were matters of state law. Compare Davis at 831-832; with Hauck at 469.

Therefore, it is unclear based on Henderson whether North Carolina courts will follow the dichotomy between claims handling and policy procurement issues that the South Carolina federal court recognized in Hauck, or whether North Carolina’s courts will reject that dichotomy as did the Virginia federal court in Davis, when they are actually required to decide the issue. Indeed, despite the issuance of the July 2009 WYO Program Bulletin, courts around the country remain divided on whether procurement-based claims are preempted by federal law, or are properly considered matters of state law that can be determined by state courts, at least when they are not accompanied by other, independent questions of federal law. See, e.g., M & K Restaurant LLC v. Farmers Ins. Co., Inc., 29 F. Supp.3d 1204, 1226-30 (E.D. Ark. 2014) (noting that “[a]lthough some courts have decided this memorandum should be given deference such that procurement-based claims are preempted, other courts have addressed the memorandum and nevertheless concluded that procurement-based claims are not preempted” in finding that procurement-based state law claims are not preempted by federal law).

As such, it is clear that claims handling and wrongful denial of coverage cases relating to federal flood insurance policies belong in federal, not state, court. However, courts are divided on whether a simple procurement-based claim involving NFIP policies can proceed in state court under state law or is also preempted by federal law. The answer in any given case likely depends on which jurisdiction’s precedent applies, or, in the absence of any controlling precedent, on the particular nature of the purportedly procurement-based issue before the court.

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About The Property Insurance Law Observer
For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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