Policyholders and other insureds expecting their liability insurer to defend them against a lawsuit may be shocked to learn the policy has vaporized just when they need it most.
This nightmare scenario can arise when the insurance policy is declared void ab initio on the grounds it was predicated on concealed information or false representations by the insured. See Koral Indus., Inc. v. Security-Connecticut Life Ins. Co., 802 S.W.2d 650 (Tex. 1990) (per curiam) and TIG Ins. Co. of Mich. v. Homestore, Inc., 40 Cal. Rptr. 3d 528 (Cal. App. 2006).
Rescission may impact insureds other than those responsible for the representations or omissions, with devastating consequences. In Homestore, liability coverage was rescinded for the company and all officers and directors because of false statements made in insurance applications and a Form 10-Q signed by three former officers. Similarly, under New York law, an "insurer may rescind an insurance policy as to all insureds—even those insureds with no knowledge of any misrepresentation." Continental Cas. Co. v. Marshall Granger & Co., 921 F. Supp. 2d 111, 119-20 (S.D.N.Y. 2013).
Rescission and Intentional Misrepresentations
The circumstances justifying rescission, and the extent to which it affects everyone covered by the policy, are determined by the policy terms and applicable state law. In Texas and some other states, an insurer may avoid a policy for misrepresentation only if it can establish reliance on a false material representation made with intent to deceive. See Mayes v. Massachusetts Mut. Life Ins. Co., 608 S.W.2d 612, 616 (Tex. 1981) (Texas common law); Medicus Ins. Co. v. Todd, 400 S.W.3d 670, 679 (Tex. App. 2013) (Mayes is not superseded by statute); and Cutter & Buck, Inc. v. Genesis Ins. Co., 306 F. Supp. 2d 988, 997 (W.D. Wash. 2004) (Washington statute bars rescission unless misrepresentation made with deceptive intent), aff'd, 144 Fed. Appx. 600 (9th Cir. 2005).
The Fifth Circuit Court of Appeals, applying Texas law, held that an insurer had not proven intent to deceive where the insured, who spoke limited English, relied on others to fill out her application and testified she had no knowledge of untrue statements in the application. Parsaie v. United Olympic Life Ins. Co., 29 F.3d 219, 220-21 (5th Cir. 1994). In Pennsylvania, rescission is authorized on proof that "the policy was issued in reliance on false and fraudulent statements" and the applicant "must have been aware of their falsity." Berkley Assur. Co. v. Campbell, No. 00129, 2017 Phila. Ct. Com. Pl. LEXIS 110 (C.P. Apr. 18, 2017) (quoting Kearns v. Phil. Life Ins. Co., 585 A.2d 53, 55 (Pa. Super. 1991)). Knowingly making a false representation, however, can give rise to a "presumption that it was made with intent to deceive," Cutter & Buck, 306 F. Supp. 2d at 1004, which cannot be overcome by the insured's unsupported denial of deceptive intent. Tudor Ins. Co. v. Hellickson Real Estate, 810 F. Supp. 2d 1211, 1218 (W.D. Wash. 2011).
Rescission and Unintentional Misrepresentations
In many other states, even an unintentional misrepresentation may void a policy. In Mississippi, for example, "[w]hether the misrepresentation was intentional, negligent, or the result of mistake or oversight is of no consequence." Fireman's Fund Ins. Co. v. Great Am. Ins. Co., 822 F.3d 620, 645 (2d Cir. 2016) (quoting Fifth Circuit). See also Homestore, 40 Cal. Rptr. 3d at 532 (applying California statute stating, "Concealment, whether intentional or unintentional, entitles the injured party to rescind.") and Marshall Granger, 91 F. Supp. 2d at 119 (innocent misrepresentation, if material, will support rescission). Alabama law permits rescission based on misrepresentations that are fraudulent, material to risk acceptance, or affect policy terms or rates. In re HealthSouth Corp. Ins. Litig., 308 F. Supp. 2d 1253, 1270 (N.D. Ala. 2004). Likewise, in Illinois, rescission based on a false statement in an application is allowed if it was made with the intent to deceive or it materially affects the risk. Essex Ins. Co. v. Galilee Med. Ctr., 815 F.3d 319, 322 (7th Cir. 2016) (citing Ill. Ins. Code § 154). And New York law authorizes rescission of a policy that "was issued in reliance on material misrepresentations." H.J. Heinz Co. v. Starr Surplus Lines Ins. Co., 675 Fed. Appx. 122, 127 (3rd Cir. 2017).
Rescission universally requires a material misstatement, which may be established by evidence the insurer would have charged a higher premium, altered the scope of coverage, or declined to issue the policy had it been apprised of the true facts. See Campbell, 2017 WL 1423147 at *13; Galilee Med., 815 F.3d at 324; H.J. Heinz, 675 Fed. Appx. at 128; National Union Fire Ins. Co. v. Sahlen, 999 F.2d 1532, 1536 (11th Cir. 1993) (Fla. law); and Robinson v. Reliable Life Ins. Co., 569 S.W.2d 28, 28-29 (Tex. 1978). The court in Cutter & Buck, 306 F. Supp. 2d at 1003, held that information requested by the insurer is presumed material.
Rescission and Innocent Insureds
Where rescission is sought because of the misstatements or omissions of one or more coinsureds, an "innocent insured" can retain coverage if the policy includes an effective severability clause, which limits rescission to only those insureds who made or had knowledge of the misrepresentations. See Wedtech Corp. v. Federal Ins. Co., 740 F. Supp. 214, 218 (S.D.N.Y. 1990) and Atlantic Permanent Fed. S&L Ass'n v. American Cas. Co., 839 F.2d 212, 215 (4th Cir. 1988). A severability clause has two primary components: (1) each insured is viewed as a separate insured, and (2) one insured's statement or knowledge is not imputed to another insured. HealthSouth, 308 F. Supp. 2d at 1280-81.
A nonimputation provision may negate rescission based on innocent misrepresentations, even if state law or the policy might otherwise allow rescission on that basis. Id.; see Atlantic Permanent, 839 F.2d at 215 (barring rescission against "innocent insureds" where the policy provided it "shall not be voided or rescinded and coverage shall not be excluded as a result of any untrue statement in the [application] form, except as to those persons making such statement or having knowledge of its untruth"). A severability clause can also limit the type of information on which an insurer may rely to rescind a policy. See, e.g., HealthSouth, 308 F. Supp. 2d at 1281 (insurer could not rely on statements outside insurance application to negate a severability clause).
Interpreting and enforcing severability provisions vary among jurisdictions, and the result often turns on specific language or placement of the terms in different sections of the policy. In Marshall Granger, the court held an "innocent insureds" provision applied only to certain exclusions and was not a severability provision that would preclude rescission against insureds who had no knowledge of misrepresentations in the application. 921 F. Supp. 2d at 124.
Inaccurate Information in the Application
Short of rescission, coverage for specific risks may be denied because the insured did not provide sufficient information in the application for initial coverage or renewal. For example, a pollution liability policy renewal application might ask, "Are you aware of any known contamination, circumstances, incidents, or events for any Covered Location, not already reported to the [Insurer] that may reasonably be expected to give rise to a claim under the policy?"
The application answers are then incorporated into the policy, which expressly excludes claims arising from conditions "not disclosed in writing to the Company in the Application." Determining when information rises to the level to require inclusion in the application is sometimes difficult and is a task too often overlooked, especially in the renewal process.
Prior Knowledge
Similar concerns are often raised by "prior knowledge" exclusions in legal malpractice and other E&O policies. See, e.g., OneBeacon Ins. Co. v. T. Wade Welch & Assocs., No. H-11-3061, 2014 U.S. Dist. LEXIS 85486 (S.D. Tex. June 24, 2014) (concluding the relevant standard was "what an objectively reasonabl[e] attorney would expect given the subjective knowledge of the particular attorney involved") and Fidelity Nat'l Title Ins. Co. v. Houston Cas. Co., No. 6:11-cv-1438-Orl-28DAB, 2012 U.S. Dist. LEXIS 141590 (M.D. Fla. Sep. 28, 2012) ("[A] subjective test applies only to the 'knowledge' aspect of the application question, while an objective test applies to the 'might reasonably be expected to give rise to a claim' component.").
Federal courts in Florida have addressed the prior knowledge exclusion in determining the duty to defend with mixed results. See, e.g., Farbstein v. Wesport Ins. Corp., No. 16-cv-62361-BLOOM/Valle, 2017 U.S. Dist. LEXIS 125990 (S.D. Fla. Aug. 9, 2017) (complaint against lawyer alleged facts triggering "prior knowledge" exclusion, negating insurer's duty to defend or indemnify) and Diamond State Ins. Co. v. Boys' Home Ass'n, 172 F. Supp. 3d 1326, 1338-40 (M.D. Fla. 2016) (insurer had duty to defend when neither allegations nor extrinsic evidence "unequivocally establish that Boys' Home subjectively knew of facts from which a reasonable professional might expect a claim").
Conclusion
Confronted with potential rescission or restriction of insurance coverage, it is essential to review the terms of the policy, in particular any severability clause, and determine the law of the governing jurisdiction. Better yet, confirm when applying for initial coverage or policy renewals that you are giving your insurer accurate and complete information; after you have been sued is not the time to discover errors in your application. This requires, in most organizations, effective communication among departments to ensure accurate reporting of property locations and values, changes in business operations, incidents and potential claims, and other information that is important—or might later become important—to an insurer's underwriting or response to claims.
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