New Hampshire Supreme Court Overturns Rescission of Insurance Policy

In its recent decision in Great American Insurance Co. v. Christy, 2012 N.H. LEXIS 126 (N.H. Sept. 28, 2012), the Supreme Court of New Hampshire had occasion to consider whether an “innocent insured” provision in a legal malpractice policy precluded rescission of that policy, despite clear evidence that at least one insured failed to disclose information material to the risk in the policy application.

The insured law firm, Christy & Tessier, P.A., included attorneys Robert Christy and Thomas Tessier, partners for over forty-five years.  In 2001, Tessier was retained by a cousin to handle the probate administration of his aunt’s estate.  Over a five-year period, Tessier fabricated numerous documents as part of a scheme to misappropriate funds from the estate as well as from his cousin’s own personal bank accounts.  While there was no evidence that Christy was aware of these thefts, Christy did falsely notarize various documents Tessier, not knowing that these documents assisted Tessier in perpetuating his scheme.  In all, Tessier misappropriated over $1.5 million combined from his aunt’s estate and from his cousin’s personal accounts.  The scheme was discovered in 2006, and Tessier’s cousin asserted a claim against Tessier in October 2006.  In April 2007, Tessier entered into a settlement agreement with his cousin whereby he agreed to repay his debts pursuant to a payment plan.  In September 2007, however. Tessier advised that he would be unable to pay his debt.  It appears that Christy was unaware of the claim or of the settlement.

Christy & Tessier were insured under successive professional liability policies issued by Great American Insurance Company (“GAIC”) from 2001 to 2007.  The firm submitted an application for a renewal for the 2007-2008 policy period on May 22, 2007, which was subsequent to Christy’s settlement agreement.  Question 6(a) of the application asked:

After inquiry, is any lawyer aware of any claim, incident, act error or omission in the last year that could result in a professional liability claim against any attorney of the Firm or a predecessor Firm?

The application was completed and signed by Robert Christy, who answered “No” in response to this question. Notably, the application contained the following acknowledgment near the signature line:

The undersigned proprietor, partner, member, or officer, acting on behalf of the applicant, and all other proposed Insureds, hereby declares after diligent inquiry that the above statements are true and that no material facts have been suppressed or misstated.

Christy testified that he when completing the application, he asked Tessier whether he was aware of any information that should be disclosed, and Tessier told him there was none.  GAIC sought a rescission of the 07-08 policy when it subsequently learned of Tessier’s misappropriations and the settlement, as well as Christy’s improper notarizations.

Following a hearing, a trial court granted GAIC’s demand for rescission of the policy, concluding that the firm’s response to question 6(a) was false since Tessier knew of a claim against him as early as 2006.  The trial court concluded that Christy’s lack of knowledge was not a defense, explaining that:

[e]ven though Christy’s answer to the question and his subsequent declaration on the application were unwittingly false, the question on the application did not pertain solely to Christy’s knowledge but rather to the knowledge of ‘any lawyer’ at the law firm …  Accordingly, Tessier’s knowledge was imputed to Christy and the other insureds.

As such, and having concluded that the misstatements were material to GAIC’s decision to issue the policy, the trial court agreed that GAIC was entitled to a rescission of the policy.

On appeal, the Supreme Court of New Hampshire expressed its concern in imputing Tessier’s knowledge to Christy.  The court found support for its concern in the following “innocent insured” provision in the policy:

B.  Waiver of Exclusion (Innocent Insured) and Breach of Conditions: Whenever coverage under any provision of this policy would be excluded, suspended or lost

                                                *          *          *

2.   because of non-compliance with Section VII, Claims, subsection A, Notice of Claims relating to the giving of notice to the Company with respect to which any other Insured shall be in default solely because of the default or concealment of such default by one or more Insureds responsible for the loss or damage otherwise insured hereunder,

the Company agrees that such insurance as would otherwise be afforded under this policy shall apply with respect to each and every insured who did not personal participate in committing one or more of the acts, errors or omissions described in either such exclusion or such condition … .

While this provision, on its face, was limited to giving notice of claims to GAIC, and served to protect one insured in the situation where another insured conceals information, the court observed a broader principle in the policy to protect innocent insureds.  The court believed Christy was precisely such an innocent insured when completing the policy application as Tessier withheld information that should have been disclosed.

GAIC pointed out that the application inquired whether any prospective insured was aware of facts that that could give rise to a claim, not just whether Christy was aware of such facts.  GAIC further argued that the innocent insureds language in the policy did not apply to the policy application.  The court did not agree, explaining:

It is not clear, however, that the policy provision excluding imputed knowledge to innocent insureds does not apply to giving notice on the Shortform Application.  Thus, in the absence of language specifically imputing knowledge to innocent insureds of false statements made on the Shortform Application, the contract read as a whole is ambiguous.

In light of this ambiguity, the New Hampshire Supreme Court concluded that the lower court erred as a matter of law on the issue of rescission.  The matter was, however, remanded for further findings on whether application of any other coverage defenses operated to preclude coverage.

Ninth Circuit Affirms Rescission of Professional Liability Policy

In its recent decision in Tudor Ins. Co. v. Hellickson Real Estate, 2012 U.S. App. LEXIS 19904 (9^th Cir. Sept. 21, 2012), the United States Court of Appeals for the Ninth Circuit, applying Washington law, examined whether an insurer was entitled to rescission of a professional liability policy based on the insured’s failure to have disclosed several pending administrative complaints in the policy application.

Tudor Insurance Company successfully obtained summary judgment on its claim for rescission of a professional liability policy it had issued to Hellickson Real Estate.  Tudor demonstrated that at the time the policy was issued, Hellickson had been notified by state authorities of at least ten complaints filed against it with the Washington Department of Licensing.  Hellickson, however, failed to disclose these complaints in its application. Tudor learned of these misrepresentations when during the policy period, Hellickson sought coverage for a disciplinary proceeding brought by the Department of Licensing.  After learning of these prior complaints, Tudor advised that it was rescinding the policy and it also advised that it would not be providing Hellickson with a defense in connection with the disciplinary proceeding. 

On appeal, the Ninth Circuit began its decision by observing that under Washington law, an insured is presumed to have intended to have deceive the insurance company if it knowingly makes a false statement.  See, Ki Sin Kim v. Allstate Ins. Co., 153 Wn. App. 339, 223 P.3d 1180 (Wash. Ct. App. 2009).  It is the insured’s burden to prove it had no intention to deceive.  The court agreed that all elements necessary for rescission were present.  First, it concluded that Hellickson had knowingly misrepresented the existence of the pending administrative complaints.  In this regard, the court held that the insured’s “professed misinterpretation” of the application, in and of itself, was insufficient to raise a question of fact as to whether its false statement was made knowingly, particularly since the application language was clear and unambiguous.  The court also agreed that that the insured failed to rebut the presumption of its intention to deceive Tudor, since it failed to present “more than a scintilla of evidence” regarding its intention.  Finally, the court agreed that Hellickson’s misrepresentations were material in nature and that Hellickson.  At most, explained the court, Hellickson raised an argument that there was no misrepresentation.  The court readily dismissed this argument, noting:

… the Hellicksons revealed nothing to Tudor about the existence of the DOL investigations, but instead disclosed only a listing agency fine that they averred had been "handled through appeal" and "reduced or dropped" with "no claims made." As the district court discerned, Tudor's failure to investigate that incident does not create a factual question about whether numerous and ongoing disciplinary investigations by the state licensing authority prompted by a slew of complaints against the Hellicksons for misrepresentation, negligence, incompetence, and malpractice were material to Tudor's risk.

Hellickson argued in the alternative that even if Tudor was otherwise entitled to rescind the policies, it was estopped from doing so as a result of having wrongfully denied coverage for the Department of Licensing proceeding. Specifically, Hellickson claimed that under Washington law, if an insurer wrongfully denies coverage, then it is estopped from relying on coverage defenses, which necessarily includes the right to rescind a policy.  The court disagreed with this assessment of the law, explaining:

This argument is untethered from Washington state case law, which establishes only that an insurer who refuses to defend a policyholder in bad faith may be estopped from disputing the scope of coverage provided by a valid contract. See Am. Best Food, Inc. v. Alea London, Ltd., 168 Wn.2d 398, 229 P.3d 693, 696 (Wash. 2010). The Washington courts have never held that such an insurer may be estopped from disputing the very legitimacy of the contract. To the contrary, the courts have consistently ruled that policyholders who render their contracts void by their own fraud may not pursue claims of bad faith against the insurer. See Ki Sin Kim, 223 P.3d at 1189 (citing, inter alia, Mutual of Enumclaw Ins. Co. v. Cox, 110 Wn.2d 643, 757 P.2d 499, 504 (Wash. 1988)).

New York’s Highest Court Addresses Rescission of Policy to Additional Insured

In its recent decision in Admiral Ins. Co. v Joy Contractors, Inc., 2012 NY Slip Op 4670 (N.Y. June 12, 2012), the New York Court of Appeals, New York’s highest court, considered whether a general liability policy can be rescinded to the detriment of an innocent additional insured.

Admiral Insurance involved coverage for liabilities associated with the collapse of a tower crane in Manhattan in March 2008.  The collapse resulted in numerous deaths and injuries, and caused significant property damage as well as the destruction of an entire building.  The policy’s named insured, Joy Contractors, had been operating the crane at the time of the collapse.  It was insured under a primary general liability policy issued by Lincoln, and a $9 million follow-form excess liability policy issued by Admiral.  Immediately following the incident, Joy gave notice to both Lincoln and to Admiral.  Several entities, including the project’s general contractor and the building’s owner, qualified as additional insureds under Joy’s policies.

Admiral initially issued a reservation of rights with respect to several grounds.  Included among these grounds was the right to rescind its policy on the basis that Joy had represented in its application that it specialized in drywall installation, that it did not perform building exterior work.  Admiral later denied coverage to Joy, and the additional insureds, on the basis of a residential construction exclusion in its policy.  It also took action to rescind the policy on the basis of the misrepresentation.  

As it related to rescission, the intermediate appellate court held that a policy could not be rescinded to the detriment of innocent additional insureds.  The appellate court relied primarily on the decisions in Lufthansa Cargo, AG v New York Mar. & Gen. Ins. Co., 834 N.Y.S.2d 659 (1st Dep’t 2007) and BMW Fin. Servs. v Hassan, 710 N.Y.S.2d 607 (2nd Dep’t 2000), lv denied 717 N.Y.S.2d 547 (2000), both of which addressed rescission to the detriment of an additional insured.  In BMW, the named insureds under an auto liability policy represented that they would be the primary drivers of a vehicle and that their children would be additional drivers, when in fact, the children were the primary drivers.  The court held that this misrepresentation should not operate to the detriment of BMW, named as an additional insured under the policy.  Likewise, in Lufthansa, the named insured represented that a certain employee would not be operating an insured truck, but it was that very same excluded driver that was operating the insured truck at the time of an accident.  The court held that Lufthansa, as an innocent additional insured, should not be affected by the named insured’s misrepresentation.

The New York Court of Appeals found BMW and Lufthansa distinguishable from the facts before it.  In both instances, the misrepresentations did not go to the fundamental nature of the risk being insured.  More specifically, the misrepresentations in those cases did not “deprive the insurer of knowledge of or the opportunity to evaluate the risks for which it was later asked to provide coverage — i.e., the risk of damages arising from automobile theft (BMW) and accident (Lufthansa).” Such misrepresentations were materially different than the named insured misrepresenting the entire nature of the risk to be insured, i.e., drywall installation as opposed to exterior building work employing the use of tower cranes.  As the court observed, “Admiral evaluated the risk of, and collected a premium for, providing excess insurance for interior drywall installation, not the obviously much greater risk presented by exterior construction work with a tower crane at a height many stories above grade.” 

Ultimately, the Court of Appeals held that the innocent “additional insured” decisions in BMW and Lufthansa, and the decisions on which those two cases were based, cannot have the effect of allowing coverage for an additional insured on a policy that is deemed never to have existed as a result of rescission.

California Court Denies Rescission of Insurance Policy

In its recent decision in Thompson v. Navigators Ins. Co., 2012 U.S. Dist. LEXIS 60122 (S.D. Cal. Apr. 30, 2012), the United States District Court for the Southern District of California considered whether an insurer was entitled to rescission of a general liability policy issued to a contractor based on misrepresentations concerning the nature of work it would be performing.

Like most rescission cases, the insurer, Navigators, did not learn of the grounds for rescission until its insured, TBI, was named as a defendant in an underlying lawsuit.  TBI had been hired to repair a roof on a commercial structure that had been damaged in a fire.  During the course of the repair work, an employee of another contractor was injured when he fell through a hole in the roof.  After receiving notice of suit, Navigators rescinded the policy based on material misrepresentations made in the policy application.  In the ensuing coverage litigation, Navigators claimed that if it was not entitled to rescission, that in the alternative, coverage was unavailable on other grounds, including the ground that coverage was limited to the insured’s work on residential structures.  The court considered each of these issues on motion for summary judgment.

Navigator’s first basis for rescission was based on TBI’s response to an application question asking whether the insured engaged in “structural demolition.”  TBI answered “no” to this question.  The invoice for the work in the underlying matter, however, stated that TBI was performing “demo roof.”  TBI argued that all contractors necessarily perform some degree of “demo” work when they remove existing parts of structures to complete their jobs.  Such work, TBI contended, is different than the industry understanding of “demolition,” which is demolition and removal of an entire structure.  The court concluded, based on this argument, and because Navigators failed to provide a satisfactory definition in response, that “demolition” as used in the application was ambiguous, and as such, summary judgment was unavailable on this particular alleged misrepresentation.

The court concluded similarly with respect to the application question asking whether there had been or would be “[r]oofing performed by the applicant.”  TBI answered “no” to this question.  TBI conceded that its contract in the underlying matter involved work on a roof.  It nevertheless contended that within the construction industry, roofing generally refers to installation of the waterproofing system, such as shingles.  TBI was not performing this type of work, but instead was performing framing on which waterproofing later would be installed.   Navigators, on the other hand, pointed to the fact that the policy application stated that “[a]ll roofing work must be subcontracted,” thus indicating that any work performed in connection with a roof, whether relating to waterproofing or framing, would not be covered if performed by the insured.  In light of the competing proposed definitions, the court found the term “roofing” to be ambiguous, and thus denied summary judgment on this misrepresentation as well.

The court also rejected Navigators argument that rescission was proper based on TBI’s representation in the application that it performed 100% residential work, and that the project giving rise to the underlying action was a commercial building.  Navigators argued that this misrepresentation was material, since it would have charged a higher premium had it known that TBI was performing work on commercial projects.  The court, however, found a question of fact as to whether Navigators actually would have charged a higher premium.

Finally, Navigators argued that rescission was proper based on TBI’s response to a question as to whether it would perform any repair or remediation of fire damage.  TBI answered no to this question.  While the underlying project was, in fact, repair of a roof that had been damaged by a fire, TBI argued that this misrepresentation was not material, and pointed to inconsistencies in Navigators’ underwriting guidelines as to whether the company would insure such work.  These inconsistencies, the court held, precluded a grant of summary judgment in Navigator’s favor.

Having held that summary judgment was inappropriate on rescission, the court turned to Navigator’s argument that the underlying matter did not fall within the policy’s scope of coverage, which was limited to work on residential structures.  The policy’s declarations identified TBI’s business as “CONSTRUCTION OF RESDIENTIAL PROPERTY NOT EXCEEDING THREE [sic].”  Navigators contended that the declarations defined the policy’s scope, and that as such, TBI’s work on a commercial structure was not within the policy’s coverage.  The court, however, found the policy ambiguous on this point, noting that, “it is not completely clear that the unfinished phrase ‘Carpentry – Construction of Residential Property Not Exceeding Three’ excludes all coverage for commercial property in all situations.”  For instance, explained the court, “TBI may have believed that carpentry was permissible on any type of building but ‘construction’ work was limited to residential property not exceeding three stories.”   More significantly for the court, the policy did not clarify the scope of coverage within the insuring agreement or by endorsement.  In other words, the identification of TBI’s business in the policy declarations, in the absence of any further reference to this in the remainder of the policy, did not definitively define the policy’s scope of coverage, at least for the purpose of summary judgment.

Notwithstanding the court’s ruling against Navigators on rescission and on the scope of the policy’s coverage, the court rejected TBI’s argument that by having rescinded the policy, Navigators was precluded from arguing coverage defenses.  Thus, Navigators was not barred from arguing scope of coverage and other applicable exclusions at trial.

7th Circuit Holds No Coverage for Restitution Claim Under D&O Policy

In its recent decision in Ryerson Inc. v. Federal Ins. Co., 2102 U.S. App. LEXIS 7372 (Apr. 12, 2012), the United States Court of Appeals for the Seventh Circuit, applying Illinois law, had occasion to consider whether an underlying suit seeking rescission of a fraudulent transaction triggered coverage under a directors and officers liability policy.

The underlying facts in Ryerson involved the insured’s allegedly fraudulent sale of a number of subsidiaries to EMC Group.  EMC later sued Ryerson, seeking rescission of the sale and restitution of the purchase price on the theory that Ryerson withheld certain material information concerning one of the subsidiaries.  EMC claimed that Ryerson fraudulently concealed this information in an effort to induce the sale.  EMC also alleged causes of action for breach of contract and breach of warranty.  Federal Insurance Company denied coverage to Ryerson, and Ryerson subsequently settled the matter with EMC for $8.5 million.

Federal’s policy provided coverage for “all LOSS for which [the insured] becomes legally obligated to pay on account of any CLAIM … for a WRONGFUL ACT … .”  Federal argued that “loss” does not and cannot include restitution.  The court agreed, stating that allowing coverage for such claims would, in essence, encourage fraud.  Citing to a number of cases, including its seminal decision in Level 3 Communications, Inc. v. Federal Ins. Co., 272 F.3d 908 (7^th Cir. 2001), the court explained that:

If disgorging [the proceeds of ill-gotten gains] is included within the policy’s definition of “loss,” thieves could buy insurance against having to return money they stole.  No one writes such insurance.

The court further explained that regardless of whether the for restitution claim is based on fraud or an innocent mistake is of no consequence.  Rather, the key determination is whether the claim is for compensatory damages or for return of “something that belongs of right not to [the defendant] but to the plaintiff.”  As such, the court noted, it was not a relevant consideration that EMC styled its complaint as one for damages:

EMC was seeking to recover a profit made at its expense by Ryerson’s fraud, which means that if the insurance company were liable to Ryerson, Ryerson would get to keep profits of fraud.  Having to surrender those profits was not a “loss” to Ryerson within the meaning of the insurance policy … .

The court acknowledged that in some instances, a judgment or settlement in a fraud case can include a combination of restitution and damages, the latter of which may be covered.  For instance, the EMC complaint initially sought recovery “transaction costs,” which the court agreed “would not be restitution because Ryerson gained nothing from the money that EMC paid its lawyers and accountants to handle the acquisition [of the subsidiary group].”  The court nevertheless concluded that because the underlying settlement made no effort to allocate as between restitution and such transaction costs, Ryerson forfeited any right it may have had for such amounts.