Opinion ID: 65377
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Heading Rank: 4

Heading: Factory Mutual breached its contract with Kimberly-Clark when it denied Kimberly-Clark its share of the surplus distribution

Text: The policy contract is clearly labeled a mutual insurance contract. The policy is silent as to the board's discretion over the distribution of excess surplus, but states that [t]his policy is issued by a mutual company having special regulations lawfully applicable to its organization, membership, policies, or contracts of insurance. It also states that [t]he insured by accepting this policy hereby becomes a member of this Company and subject to the provisions of its charter and by-laws, with power to vote at its meetings. Section 5 of Factory Mutual's Charter states: [E]ach natural person, partnership, association, corporation or legal entity insured on the mutual plan by the Corporation shall be a member of the Corporation during the term of its policy, but no longer, and at all meetings of the members shall be entitled to one vote either in person or by proxy; provided, however, that where there is more than one insured under any policy, such insureds shall nevertheless be deemed to be a single member of the Corporation for all purposes. The Corporation may issue policies which do not entitle the insured to membership in the Corporation nor to participate in its surplus. (emphasis added). Finally, section 10 of Factory Mutual's charter states: Upon termination of the membership of any member, all his or its right and interest in the surplus, reserves and other assets of the Corporation shall forthwith cease. In sum, Factory Mutual and Kimberly-Clark's contract (1) is a mutual insurance policy; (2) acknowledges the special regulations applicable to mutual insurance companies; and (3) grants policyholders an entitlement as a member for all purposes, which includes (4) rights and interests in the surplus until the policy's termination (unless the policy states otherwise, which is not the case here). Courts consistently describe mutual insurance contracts as creating certain settled expectations between the parties. As the Wisconsin Supreme Court noted: Every policy-holder [of a mutual insurance company] knows, or ought to know, that he will remain a member so long as he remains a policy-holder and no longer. He knows, or ought to know, that as soon as his membership relation is established he becomes possessed of an equitable interest in the assets of the company consisting of all accumulations prior to his time, and such as may be added thereto during his membership, but which cannot be realized on in possession in the absence of a necessary distribution of the surplus on account of the company going out of business, or in some proper way. Huber v. Martin, 127 Wis. 412, 105 N.W. 1031, 1039 (1906); see also Fid. & Cas. Co. of N.Y. v. Metro. Life Ins. Co., 42 Misc.2d 616, 248 N.Y.S.2d 559, 565 (N.Y.Sup.Ct. 1963). The Supreme Court in Pennsylvania Mutual Life Insurance Co. v. Lederer described the mutual company in this way: In a mutual company, whatever the field of its operation, the premium exacted is necessarily greater than the expected cost of the insurance, as the redundancy in the premium furnishes the guaranty fund out of which extraordinary losses may be met, while in a stock company they may be met from the capital stock subscribed. It is of the essence of mutual insurance that the excess in the premium over the actual cost as later ascertained shall be returned to the policy holder. 252 U.S. 523, 525, 40 S.Ct. 397, 64 L.Ed. 698 (1920); see also Nat'l Chiropractic Ins. Co. v. United States, 494 F.2d 332, 334 (8th Cir.1974); Thompson v. White River Burial Ass'n, 178 F.2d 954, 957 (8th Cir. 1950); Keystone Mut. Cas. Co. v. Driscoll, 137 F.2d 907, 911 (3d Cir.1943). Basically, the settled expectations when entering a contract with a mutual insurance company are: (1) the policyholders pay premiums into a common fund to cover contingencies, and (2) if there is an accumulated excess of capital beyond what is necessary to cover contingencies (i.e., excess surplus), the insurance company returns the excess in surplus distributions to the policyholders. This essential aspect of the mutual insurance company's relationship with its policyholders is so-called insurance at actual cost or insurance at cost. See White River Burial Ass'n, 178 F.2d at 957 (To say that an essential of mutual insurance is that the excess of premiums received over the actual cost of insurance shall be returned to the policyholders is but another way of saying that the essential of mutuality is insurance at cost.). We have stated that [t]he furnishing of insurance to members at cost is the chief aim and function of a mutual insurance company, and any company which does not return to the policyholders or members the excess of the premium over the cost cannot be said to be a mutual insurance company. Am. Ins. Co. of Tex. v. Thomas, 146 F.2d 434, 436 (5th Cir.1945). Texas courts also agree with describing the mutual insurance company's purpose as providing policyholders insurance at cost. See Mercury Life & Health Co. v. Hughes, 271 S.W.2d 842, 845 (Tex.Civ.App.1954) (While the [mutual insurance] policyholders do not receive dividends, they get other equally valuable benefits. It is the duty of the directors to operate the company as economically as possible and furnish insurance to its policyholders as near actual cost as possible.). Other authorities unanimously agree in describing the purpose of a mutual insurance company as providing insurance at cost. See, e.g., Mut. Fire Ins. Co. of Germantown v. United States, 142 F.2d 344, 347 (3d Cir.1944); Fid. & Cas. Co. of N.Y., 248 N.Y.S.2d at 566 (The distribution of divisible surplus is in reality an adjustment of the premium in retrospect of the amount found to have been actually necessary to cover the contingencies which materialized and it effects a reduction in the cost of the insurance.); Dryden v. Sun Life Assurance Co. of Can., 737 F.Supp. 1058, 1062-63 (S.D.Ind.1989); C.J. Simons & Co. v. Am. Mut. Liab. Ins. Co., 107 N.J.Super. 209, 257 A.2d 743, 745 (1969); McQuade v. Thacher, 23 Misc.2d 643, 198 N.Y.S.2d 715, 718 (N.Y.Sup.Ct.1960). See generally RUSS & SEGALLA, 1 COUCH ON INS. § 1:32 (The object [of mutual insurance] is to provide insurance protection at cost.). Consequently, because they contracted for at cost insurance, policyholders who contribute to a surplus are equitably entitled to a share of any announced surplus distribution as a proportionate return on their prior contributions to the accumulated capital stock. See, e.g., In re MetLife Demutualization Litig., 495 F.Supp.2d 310, 313 (E.D.N.Y.2007); RUSS & SEGALLA, 3 COUCH ON INS. § 39:18 (As a general rule, the `surplus' of a mutual company belongs equitably to the policyholders who contributed to it, in the proportion in which they contributed.). Consistent with these authorities, we have stated, in a diversity case involving Texas law, that: Dividends normally belong to the stockholders, which in a mutual company are the policyholders, but the insured though not a stockholder may by contract be allowed to participate. This share in profits more naturally belongs to the insured than to the beneficiary, and is a return to him of a part of his premium which the year's results have shown was not necessary to have been paid to maintain the insurance with its legal reserve. Union Cent. Life Ins. Co. v. Williams, 65 F.2d 240, 243 (5th Cir.1933). Similarly, Rhode Island has defined mutual insurance company to mean[ ] a corporation in which shares are held exclusively by members to whom profits are distributed as dividends and members are both the insurer and the insured in a health insurance act. R.I. GEN. LAWS § 27-66-4(9) (emphasis added). Here, Factory Mutual's surplus distribution was apportioned based on past contributions, and therefore policyholders who contributed, like Kimberly-Clark, should be entitled to a share. Because the right to the surplus is dictated by contract and is the policyholder's equitable right based on past contributions, the corporate board has no competing right to the surplus assets once they announce the surplus to policyholders. The Kentucky Supreme Court has stated: [W]here the company is a mutual, being conducted on the plan of giving the cheapest safe insurance to its members, all surplus ought to belong to the members, the policy holders. For in a purely mutual company there are no stockholders, and no one else therefore to whom the surplus could go than its policy holders. And it should in equity go to those who had contributed it. The officers of such a corporation being paid salaries for their services have no interest as such in the surplus. U.S. Life Ins. Co. v. Spinks, 96 S.W. 889, 894 (Ky.1906) (emphasis added); see also Carlton v. S. Mut. Ins. Co., 72 Ga. 371, 1884 WL 2172, at  (June 10, 1884); RUSS & SEGALLA, 3 COUCH ON INS. § 39:37. Like a trustee, the board manages and holds the funds until the funds are distributed to the insured-beneficiary, at which point it no longer has a competing interest over the funds. Summarizing these principles, Russ & Segalla, 3 Couch on Insurance § 39:40, concludes: Although the legal title to the property of a mutual company is held by the company, the property is held for the benefit of its members, policyholders, and stockholders. The funds of the company are to be treated as a trust fund for the members. . . . Each member has the same proportionate interest that every other member possesses. Policyholders are entitled to participate in the annual surplus of the company and if there is an inequitable distribution of surplus a policyholder may sue to obtain his or her proportionate share. The right to share in a surplus may, however, be restricted to current policyholders. (footnotes omitted); see also Huber, 105 N.W. at 1032. Accordingly, a corporate board has the discretion to manage the timing, amount, and method of a surplus distribution but once a distribution's timing, amount and method is declared, the distribution funds no longer constitute the company's property; instead, the funds become the joint asset held by the members who are policyholders at the distribution's operative date. The Wisconsin Supreme Court stated: All this results in a necessity that some definite time be adopted when the rights of individuals become fixed, after which may be applied the arithmetical process by which they become known. In deference to such necessity, the rule has become settled as to stock corporations that a dividend belongs to those who own the stock when it is declared. Complete analogy exists between rights of members in a mutual insurance company and stockholders in a stock company in and to such a surplus. Declaring a dividend is nothing but authoritatively deciding to distribute some or all of the surplus. We therefore think it entirely logical to apply the foregoing well-established rule, and to hold that on March 19, 1906, [the dividend distribution] became separated from the corporate assets and became the property of the several members then existing, payable to each on demand when the amount to which he was entitled had been ascertained. Zinn v. Germantown Farmers' Mut. Ins. Co., 132 Wis. 86, 111 N.W. 1107, 1108 (1907) (emphasis added) (citations omitted). As the Wisconsin Supreme Court acknowledged, there is a complete analogy between the rights of members in a mutual insurance company and stockholders in a stock company in and to such a surplus. Id. As this court has stated in the analogous context of stockholder dividends: Under the law of Texas, a declaration of dividends creates a debt owed by the corporation in favor of each stockholder which cannot be rescinded. Although the declaration of this dividend provided that the sums thereunder were payable to the stockholders of record at such times and in such installments during the year as the directors saw fit, the liability of the company accrued as of the date of the declaration. C.I.R. v. Cohen, 121 F.2d 348, 349 (5th Cir.1941) (footnote omitted). In short, when a distribution is declared, the company becomes liable to pay the policyholders because they collectively own any announced distribution from the surplus. Because the corporate board controls the timing of the distribution, it necessarily establishes some definite time . . . when the rights of [policyholders] become fixed and the distributed funds are owned by those policyholders who have rights at that time. Zinn, 111 N.W. at 1108. The parties dispute the date when rights of the policyholders became fixed for the distribution, i.e., the distribution's operative date. Factory Mutual contends the operative date that fixes the rights of the policyholders is the date the corporate board declared its approval of the distribution (i.e., the declaration date), which was October 9. Kimberly-Clark contends the operative date was the date of record or the record-date as described in the public notices to members describing the distribution details, which is September 30. [7] Factory Mutual's contention is without merit. Again, the complete analogy between stockholders in stock companies and mutual insurance policyholders, as to the distribution of a surplus, is useful. The distribution materials specifically establish the record date as September 30, 2003, and on that date Kimberly-Clark was a policyholder in good standing. The declaration date is important only because the company incurs liability to pay its promised distribution on the declaration date. However, we have defined the record date as the operative date one uses to determine the set of stockholders who can participate in a stock corporation's dividend distribution, i.e., the stockholders of record. See, e.g., Caruth Corp. v. United States, 865 F.2d 644, 648 (5th Cir.1989) (In general, dividend income is taxed to the shareholder who, on the record date, owns the stock with respect to which dividends are paid and who is entitled to receive the dividend.); Cohen, 121 F.2d at 349 (noting that the company incurred its liability to pay dividends on the declaration date to the stockholders of record). See generally BLACK'S LAW DICTIONARY 423 (8th ed.2004) (defining record date to mean the [t]he date on which a stockholder must own shares to be entitled to vote or receive a dividend.  Also termed date of record ). The relevant state statutes also emphasize the importance of the record date as the operative date to ascertain the stockholders of record for a capital distribution in stock corporations. See TEX. BUS. CORP. ACT ANN. art. 2.26 (describing the record date as determining which shareholders have rights to a stock dividend); R.I. GEN. LAWS § 7-1.2-614(a)(2) (same). Accordingly, the record date is the effective date to determine which stockholders can partake in the distribution even though the company accrues its liability to pay the announced distribution to those stockholders of record on the declaration date. See, e.g., Cohen, 121 F.2d at 349. In accordance with these general principles and the complete analogy, as to the right to receive surplus distributions, between stockholders and mutual insurance policyholders, Kimberly-Clark, as a policyholder of good-standing on the record date, was entitled to participate in the distributed surplus. Factory Mutual's final argument against according Kimberly-Clark its share is based on the fact that Kimberly-Clark did not renew its policy before it expired, which the board had established as a condition precedent for participating in the distribution. The Kentucky Court of Appeals and a New York court, the only courts to directly confront this issue, barred the conditioning of surplus distributions on future renewal by relying on the general principles underlying mutual insurance we described above. See Mut. Ben. Life Ins. Co. v. Davis, 115 Ky. 404, 73 S.W. 1020, 1021 (Ky.Ct.App.1903); Wells v. Metro. Life Ins. Co., 171 Misc. 878, 13 N.Y.S.2d 22, 25-26 (N.Y.City Ct.1939); see also Aetna Life Ins. Co. v. Hartley, 67 S.W. 19, 21, opinion modified on other grounds, 68 S.W. 1081 (Ky.1902). We agree with these authorities. [8] As we noted earlier, once a surplus distribution is announced, the policyholders on the record date own the surplus and the corporate board no longer has any rights or interests in the distributed amounts. Accordingly, Kimberly-Clark, as a policyholder of record, owned a share of the surplus, and Factory Mutual cannot then disentitle Kimberly-Clark based its subsequent failure to renew its policy  presumably, Kimberly-Clark could have changed its mind and decided to renew its policy on October 1, which is after the distribution's record date. As a practical matter, Factory Mutual's eligibility rules effectively bar any return of excess capital to members on the record date who no longer need insurance or cannot afford to renew their insurance, thereby directly contravening members' equitable rights to a distribution from a surplus that was created, in part, by their past contributions. Conditioning a right to a distribution on renewal would add a new condition to the policy that substantially limits and encumbers a policyholder's rights to a surplus distribution without any contractual basis and undermines the settled expectation that mutual insurance provides insurance at cost. In this case, Factory Mutual declared a $325 million distribution from excess surplus funds as a return to policyholders and it apportioned the distribution based on the policyholders' contribution to the accumulated capital stock, i.e., their past premiums. Factory Mutual segregated this amount from its capital stock on October 9, 2003, for existing policyholders of the record date: September 30, 2003. Once Factory Mutual's corporate board segregated the $325 million from the surplus and marked it for distribution to existing members on the record date, those existing members became entitled to the whole amount based on their equitable share as calculated pursuant to the board's formulas. The corporate board also became liable to follow through with the distribution on the date of declaration. Furthermore, after declaring the surplus, the board could not then condition a policyholder's right to a share of the distribution on a future, post-record-date act, such as policy renewal, because the board no longer had any competing interests or rights to the distribution funds. Since Kimberly-Clark was a policyholder on the record date, it equitably owns a share of the distribution calculated pursuant to the board's formula whether or not it had renewed its policy before the policy's expiration. Therefore, the district court properly awarded Kimberly-Clark its properly calculated share of the distribution. For these reasons, we AFFIRM the district court's judgment.