Too often in today's economy, insurers are getting the short-end of the stick when the motor carriers they insure file bankruptcy. By the time the insured files bankruptcy - or possibly even before any financial problems arise - it is generally too late to protect your company from the effects of the insured's bankruptcy. Therefore, safeguards must be put in place beforehand in order to insulate an insurer from bankruptcy's often harsh consequences, including harmful effects on an insurer's collateral.

Truck insurers, especially those involved with "fronting policies," captives, or high dollar deductibles necessarily insist on collateral to secure the insured's obligations. This collateral can be found in several forms, including equipment, cash, or a letter of credit. A recent opinion issued in S-Tran Holdings, Inc. v. Protective Ins. Co., Delaware Bankruptcy Court, Adversary No. 07-51341, 2009 WL 3185771 (Del. 2009), suggests that one potential safeguard against bankruptcy is to require a standby letter of credit as collateral from the insured.

What is a standby letter of credit?

A standby letter of credit is essentially a guarantee of payment by the shipper's bank. Insurer's customer, Motor Carrier, must go to its bank and apply for a standby letter of credit. Upon approval of Motor Carrier's application, Motor Carrier's bank then sends the letter of credit to Insurer as collateral for Motor Carrier's obligations under the insurance policy. Upon the occurrence of a default of Motor Carrier, Insurer may contact Motor Carrier's bank to "draw down" on the letter of credit for cash.

Why is a letter of credit better than any other collateral?

Motor Carriers might prefer to put up cash, equipment, or other property as collateral. However, from the Insurer's perspective, a letter of credit might be preferred because it lacks all of the issues associated with liquidation of equipment (e.g. valuation, finding a buyer, etc.); a letter of credit is much more easily convertible to cash than would be equipment or other tangible property. Of course, if liquidity is the primary concern, why not have Motor Carrier simply put up a cash deposit as collateral? S-Tran Holdings demonstrates why.

In S-Tran Holdings, the bankrupt debtors were related entities, S-Tran Holdings, Service Transport, Inc., and Dixie Trucking Company, Inc. (collectively "Service Transport"), which were primarily motor carriers. Prior to the bankruptcy, as a condition for issuing various insurance policies, Service Transport's insurance company had required it to put up two forms of collateral: (i) a cash deposit and (ii) a letter of credit. When Service Transport allegedly defaulted under the agreements, the insurance company drew on the letter of credit and held the proceeds. Once the bankruptcy was filed, Service Transport sued the insurance company for turnover of the proceeds of the letter of credit, as well as breach of contract. The turnover claim, in other words, meant that Service Transport wanted to require the insurance company to give the letter of credit proceeds back to the bankruptcy estate so that a determination could be made as to how the letter of credit proceeds should be distributed. The Court held, in part, in favor of the insurance company, determining that the letter of credit and the proceeds therefrom are not part of the bankruptcy estate. On the other hand, the cash deposit was part of the bankruptcy estate, and therefore, subject to turnover.

How does all of this apply to you as a Truck Insurer?

In the example laid out above, if Motor Carrier is in bankruptcy and disputes monies owed to Insurer under the policy, then depending on the collateral, Motor Carrier (or its trustee) may have a right to control the collateral (i.e. the "stake') during the litigation. If the collateral is cash, equipment, or other types of property, then Motor Carrier (or its trustee) will likely control the stake throughout the course of the litigation. However, if the collateral is proceeds from a letter of credit, then such proceeds are not property of the estate, and Insurer would likely have the right to hold the stake during the course of litigation. As an example, the S-Tran Holdings adversary case has been ongoing for over two and a half (2½) years, and is still ongoing. The party that is entitled to hold the stake throughout such a period would certainly have an advantage.

Therefore, if you are an insurer determining what you will require as collateral in order to issue a policy, consider a letter of credit rather than cash or other collateral. If the insured later files bankruptcy, you just might be glad that you did.

The overwhelming majority of insurance policies covering motor truck liability are designed and supported by the Insurance Services Office, or ISO. Currently, there are three forms on the market for commercial auto risks:

1. Business/Auto

2. Truckers

3. Motor Carrier

Beginning in June, 2010, the ISO will no longer support the Truckers' policy. The Motor Carrier policy brings some changes that need to be addressed by every trucking company.

The Truckers' policy has always been based on motor carrier authority as provided through state and federal agencies. For example, the Truckers' policy references vehicles "being used pursuant to operating rights granted to you by a public authority".

The Motor Carrier policy, on the other hand, is based primarily on contract language. Therefore, we are moving from a system primarily based on things like "whose name is on the bill of lading?" and "whose name is on the side of the truck?" to a detailed analysis of the contracts in place between the parties. That change is most noticeable in two areas. First, in the "who is an insured" section of a Motor Carrier policy, lessors leased to the motor carrier are covered if the lease agreement does not require the lessor to hold the insured harmless as long as the vehicle is used in the scope of the insured's business as a motor carrier for hire. Thus, because most independent contractor lease agreements require the independent contractor to indemnify and hold harmless the motor carrier, the vehicle owner would likely not be insured under the motor carrier policy unless the owner is the driver. This is a big change from the historical system for insuring independent contractors through the motor carrier. Thus, the owner of the leased vehicle may be left out of the risk management plan.

Another area where this change is going to be evident is in the "other insurance" section. The Truckers' policy historically provided that coverage for a tractor was primary and the coverage for an attached trailer was excess. With the Motor Carrier form, when an auto is hired or borrowed by another motor carrier, the Motor Carrier policy is primary if there is a written agreement between the named insured and the lessee if the lease requires the named insured to hold the lessee harmless. On the other hand, if the lease does not require the insured to hold the lessee harmless, the lessor's insurance is excess.

From these developments it is apparent there will be a greater emphasis placed on written contracts and "formalities" in arrangements between trucking companies and independent contractors. One thing is sure: lawyers will have plenty to do until some of these questions are resolved.

He's Not My Employee! Or Is He? Engaging an independent contractor instead of hiring an employee can save costs, if done right. It can also multiply costs if done wrong. 

Misclassifying an employee as an independent contractor can cause a host of liability issues -back overtime pay, federal and state taxes, FICA contributions, penalties from the IRS, and exposure for workers' compensation, unemployment, and federal discrimination claims.

From time to time, courts give employers pointed reminders that simply calling someone an "independent contractor" does not make it so.

In January, the North Carolina Court of Appeals considered the situation of a trucking company that leased a truck to a third party and contracted with a driver to run the third party's trucking routes. The driver had to qualify with the third party under its driver training program, including its physical fitness test and its rules and regulations. As the court found, the third party had "exclusive control, possession, and use" over the company's truck and directed where and when the driver would make runs. The trucking company arranged with the driver to pay him a flat fee per mile based on the job assigned by the third party.

The court, however, found sufficient control by the trucking company to make the driver its employee instead of its independent contractor. It could refuse an assignment from the third party (although the court did not find it ever did so). It required the driver to report the truck's condition and to bring the truck in for repairs. It held the accident insurance policy for his driving. It paid for his gas. Ultimately, it had a right to end the relationship with the driver.

On this basis, the court found the trucking company employed the driver, owed him workers' compensation coverage, and was responsible for benefits owed to him following an accident -proving that improper classification as a contractor can be costly.

The IRS plans to audit at random 2,000 companies for each of the next 3 years, beginning in February 2010 - to determine compliance with workers classifications and employment tax rules. Carefully analyze your independent contractor arrangements, paying particular attention to your right to control his or her actions.

NEW FEDERAL REGULATORY GUIDANCE ON "PRINCIPAL PLACE OF BUSINESS"

On July 29, 2009, the FMCSA released a Notice of regulatory guidance relating to which locations may be designated as a "Principal Place of Business" by a Federal motor carrier.  This new guidance went into effect on August 12, 2009.  The notice is intended to answer questions related to 49 CFR 390.5, which defines a principal place of business as "the single location designated by the motor carrier, normally its headquarters...at which the motor carrier must make records required by [FMSC regulations] available for inspection."  The current definition of "principal place of business" was adopted in 1998 in order to allow motor carriers with multiple terminals and business locations to maintain records, such as driver records of duty status or vehicle maintenance records, at a location where activity related to the records took place rather than at a company's headquarters.  However, the FMCSA has still anticipated that in most cases, the "principal place of business" would be the same as a carrier's headquarters. 

The FMCSA now offers additional guidance:  (1) the "principal place of business" must be an actual place of business of the motor carrier; and (2) the "principal place of business" must contain offices of the carrier's senior most management or employees responsible for administration, management and oversight of safety operations and compliance with FMCS regulations.  If more than one location fits this definition, the carrier must consider the relative importance of the activities conducted at each location, and the time spent at each location by the carrier's management or corporate officers.  In addition to these factors, in determining whether a carrier has designated an appropriate location as its "principal place of business," the FMSCA will also consider: whether the location is operated, controlled, or owed by the carrier; whether operations relating to transportation regularly take place at the location; whether employees of the carrier report for duty at the location; whether any vehicles leased or owned by the carrier are maintained on the premises; and whether records required to be maintained by the FMCS regulations are on maintained on the premises.

A carrier cannot designate as its "principal place of business" a location where it is not engaged in business operations related to transportation.  Prohibited locations include post office or other mail box locations and offices of consultants, service agents or legal counsel.  Finally, a motor carrier with a single place of business, including a residence, must designate that location as its "principal place of business."  Sending the DOT to inspect at 1066 W. Addison, Chicago, IL is also a bad idea, although it worked for the Blues Brothers in outwitting John Candy.

Notwithstanding the foregoing, a carrier with multiple business locations may maintain some records at a location other than its "principal place of business" provided however that after a request has been made by the FMCSA, a carrier with multiple business locations must make all required records available at its "principal place of business" within 48 hours.  So having a "quick retrieve" system in place is a must if a carrier decides to implement a multiple location option.

By now, we have all heard about the planned rollout of CSA 2010 by the FMCSA. Designed to improve safety and accountability, CSA 2010 will make major changes to the ways the FMCSA and its state counterparts interact with motor carriers. Although the substantive regulations governing motor carriers will not change, motor carriers must be able to understand how the FMCSA could impact their day-to-day operations.

One of the most important changes CSA 2010 will make is the replacement of SafeStat with the Safety Measurement System ("SMS"). Unlike SafeStat, which relies primarily on the results of onsite inspections by DOT officials, SMS will combine data from a number of sources to determine a carrier's safety rating. Specifically, SMS will look at the following measurements:

• Unsafe Driving - i.e. traffic violations.
• Driver Fatigue - based on a review of driver logs.
• Driver Fitness - based on, among other things, a review of accidents caused by inexperience.
• Controlled Substances/Alcohol - results of random driver screening and a review of accidents caused by controlled substances.
• Vehicle Maintenance.
• Cargo Related - accidents occurring due to shifting or improperly secured cargo.
• Crash Indicators - a review of frequency of accidents based on accident reports.

Based on SMS, the FMCSA will evaluate a carrier's safety. However, the old "satisfactory" and "unsatisfactory" ratings will disappear. Instead, a carrier will receive a safety fitness determination ("SFD") that will determine what type of "intervention" is necessary. The most serious level of intervention will be an "unfit" suspension, which prohibits a carrier from operating.

Legally speaking, the shift from SafeStat to SMS/SFD will have several important results. First, it will affect "upstream" contracts that motor carriers enter into with shippers. Most of these contracts currently require motor carriers to maintain "satisfactory" safety ratings. However, with the end of SafeStat, the "satisfactory" rating will be obsolete. The language of the contracts will need to be revised.

Second, many carriers likewise have "downstream" contracts with owner-operators or leasing companies requiring the vehicles leased to meet certain federal safety standards or that all drivers obtain a certain safety rating. These contracts too will often have language that must be re-evaluated in light of the changes wrought by CSA 2010.

Finally, tariffs used by motor carriers (and we recommend that every carrier publish a tariff to define the terms of its relationship with other businesses) will also require re-evaluation, since these too speak of "satisfactory" ratings and use other terms consistent with current FMCSA procedures that will change with CSA 2010.

You'll be hearing much more about CSA 2010 in the coming months. As you do, think about how you need to adapt your company's legal documents to accommodate these changes.

In an effort to lessen the "tax gap" (the difference between the amount of income reported by taxpayers and the amount the IRS believes is due) the IRS has increased the amount of random employment tax audits. What does this mean for your business and what will the IRS be focusing on?

The tax audit will focus on the following:

1. Worker Classification. Are your workers classified as employees or independent contractors? If you have a number of workers classified as independent contractors you may face increased scrutiny. There is a twenty factor test that the IRS uses in determining whether employees are properly classified. Our attorneys can assist you in determining how best to classify your workers.
2. Fringe Benefits. Do you provide nontaxable fringe benefits to your employees? If your workers are considered independent contractors rather than employees, fringe benefits cannot be provided on a tax free basis.
3. Officer's Compensation. How are your key officers compensated? Are they paid a salary or percentage of profits from the business? Depending on how your business is organized (C Corporation, S Corporation, LLC, etc.) there may be tax benefits to paying a higher salary to a key officer or a lower salary with profit distributions to a business owner. The IRS will be reviewing these payment structures to determine whether the compensation being paid is reasonable.
4. Reimbursed Expenses. Do you reimburse business expenses for your employees? Do you have a written policy in place that complies with the Internal Revenue Code for such reimbursements? If not, these reimbursements should be categorized as additional income to the employee. This additional income must be reported and is subject to additional income and employment tax.

How do you protect yourself from these audits? Unfortunately, because the audit process is random, there are no proactive steps you can take to prevent an audit of your business. However, you can ensure that your policies and procedures are in compliance with the Internal Revenue Code and IRS rules as they relate to the proper classification of employees, reasonableness of compensation and proper internal policies.

While your firm may stand ready to assist you throughout the audit process, waiting until an audit is initiated to review your policies and procedures may be a costly mistake as taxes, interest and penalties may be unavoidable.

On September 3, 2009, the United States Court of Appeals of the Tenth Circuit (encompassing the Rocky Mountain states issued a major decision on the applicability of the MCS-90 Endorsement. In a unanimous opinion, the full Court held that the MCS-90 Endorsement only applies where the underlying insurance policy does not provide coverage for the motor carrier’s accident and the motor carrier’s insurance coverage is either not sufficient to satisfy the federally-prescribed minimum levels of financial responsibility or is non-existent.

Prior to this September 3 decision, both the United States District Court for the District of Utah and a three-judge panel of the Tenth Circuit followed the previous Tenth Circuit case of Empire Fire & Marine Ins. Co. v. Guaranty Nat’l Ins. Co. and held that the MCS-90 endorsement was triggered even though another insurance policy already provided coverage for the underlying accident.  Thus, even though the injured member of the public had already been protected by insurance coverage of at least $750,000, these courts concluded that the MCS-90 was triggered to provide an additional level of protection.

After the full court agreed to rehear the case, Carolina Casualty, the issuer of the MCS-90, supported by amicus curiae, the Trucking Industry Defense Association, argued that the MCS-90 endorsement simply functions as a surety bond (not insurance coverage) and thus applies only when other coverage is lacking. Accordingly, because other insurance coverage had already been provided to protect the injured motorist, Carolina Casualty and Amicus argued that coverage was not lacking and thus the MCS-90 endorsement should not be triggered to cover the underlying loss. In analyzing the issue, the Tenth Circuit agreed with Carolina Casualty and Amicus and remarked that “the surety concept flows naturally from the purpose and text of the governing regulatory provisions. Accordingly, the Court held that because another policy had already satisfied the minimum federally required amount of $750,000, the injured motorist was precluded from seeking additional recovery under the MCS-90 endorsement attached to the Carolina Casualty policy.

This decision is of major importance to the truck insurance industry. In situations where the motor carrier’s policy does not provide coverage (for example due to failure to schedule the vehicle on the policy), but where another policy (such as that of the truck’s lessor or owner-operator) covers the loss, plaintiffs in the Tenth Circuit will no longer be able to argue that the motor carrier’s MCS-90 should apply. Moreover, the impact of the Yeates case will reverberate beyond the Tenth Circuit.  Empire Fire had stood as the seminal case supporting an expansive interpretation of the MCS-90, and it had been relied on by numerous state and federal courts. Now that it has been overruled, insurers and motor carriers have ample room to argue that many pro-plaintiff MCS-90 cases across the country should be similarly overturned.

The Yeates case is also good news for motor carriers because an insurer who pays a judgment under the MCS-90 retains a right to seek reimbursement from the motor carrier. Conversely, if no payment is made under the MCS-90, the motor carrier is not liable for reimbursement to the insurer.

SML was honored to have played a role in this industry victory. Rob Moseley, Kurt Rozelsky and Matt Staab filed an Amicus Brief on behalf of TIDA, which was followed by the Court granting the Petition for Rehearing En Banc.

Fall brings thoughts of football with references to blitzes, post patterns and filling the gaps. Who's filling your gaps? In every risk management plan there are gaps that need to be accounted for. Two of the most common gaps that arise in the trucking industry are coverage for loading and unloading and misdelivery of liquid product. Each of these exposures could fall into the auto policy or the commercial general liability policy ("CGL"). Hopefully, at least one of your coverages picks these up. The gaps can be particularly problematic if you have different underwriters for the CGL and the auto policies.

Often, whether an exposure is an auto or CGL exposure will depend on whether the damage resulting is immediate or occurs over time.

At any rate, every trucking company should review their risk management plan with their insurance broker and make sure that the gap is being filled by either the auto carrier or the CGL carrier.