Expert Commentary

Fraud Rulings in California and Michigan

California and Michigan courts have ruled on insurers' duty to discover fraud. In California, the California Supreme Court held, in Barrera v. State Farm Mut. Auto. Ins. Co., 71 Cal. 2d 659, 79 Cal. Rptr. 106, 456 P.2d 674 (1969), that, under certain circumstances, an automobile liability insurer could not rescind its policy when it failed to investigate representations contained in the application.


Claims Practices
July 2012

The court pointed out that loss of the right to rescind did not leave the company remediless. After paying the injured person's claim, the insurer could sue the insured for damages for wrongful misrepresentation. Or, if the insured satisfies a judgment against him or her by the injured party, the insurer could defend on the ground of misrepresentations in the application.

The California Supreme Court put the burden of investigation on insurers and did not consider making the person who was at fault for the accident pay directly to the injured party. Courts, like the California Supreme Court in Barrera, feel sorry for the injured victims of the fraud perpetrator and place the initial burden on the insurer.

Michigan Considers the Issue

The Michigan Supreme Court was asked to decide whether an insurer can rescind an auto policy after an accident to avoid liability on the ground of fraud in the application for insurance, when the fraud was easily ascertainable and the claimant is a third party, in Titan Ins. Co. v. Hyten, 2012 Mich. LEXIS 801 (Mich. June 15, 2012).

Facts of the Case

McKinley Hyten's driver's license was suspended because of moving violations and accidents. From comments from her probation officer, she believed she would get her license back at a district court hearing scheduled for August 24, 2007. Hyten's mother, Anne Johnson, sought auto insurance for an auto she had "earmarked" for Hyten. An independent insurance agent told Johnson that Hyten could not be insured until her license had been restored.

Regardless, an application for insurance from Titan Insurance Company was filled out on Hyten's behalf and postdated to August 24, 2007. Hyten signed the application on August 22, 2007, checking the "No" box for the question: "Does the applicant's household have any unlicensed drivers or any drivers with a suspended or revoked driver's license?" The application stated that Titan would rely on the representations made in the application. The policy was effective August 24, 2007, providing personal protection insurance coverage for bodily injury of $100,000 per person and $300,000 per occurrence.

Hyten's driver's license was not restored until September 20, 2007. Titan was unaware of this fact. In February 2008, while driving the insured vehicle, Hyten collided with the vehicle of Howard and Martha Holmes, causing injuries to them. It was at this point that Titan learned that Hyten did not have a valid driver's license when the policy was issued. Expecting claims from the Holmeses, Titan sought declaratory judgment, stating that, had it been informed that Hyten's license had been suspended, it would never have insured Hyten. Pointing to the fraudulent representations in the application, Titan sought a declaration that it would not have to indemnify Hyten if the Holmeses prevailed in their action against Hyten.

The Holmeses' insurer, Farm Bureau Insurance Company, intervened as a defendant, and Titan, Farm Bureau, and Hyten each filed cross-motions for summary disposition. Relying on court of appeals' decisions holding that insurers can't avoid liability for fraud that was easily ascertainable, and concluding that whether a person possesses a valid driver's license is easily ascertainable, the trial court granted Farm Bureau's and Hyten's motions for summary disposition. The court of appeals affirmed.

Analysis

Insurance policies are subject to the same contract construction principles that apply to any other species of contract. Common law defenses may be invoked to avoid enforcement of an insurance policy, unless prohibited by statute. Titan asserted the fraud defense to avoid liability under the policy with Hyten.

Fraud

In Michigan, actionable fraud exists when the defendant made a material representation that was false at the time the defendant made it; the defendant knew that it was false or made it recklessly, without any knowledge of its truth and as a positive assertion; the representation was made with the intention that it should be acted upon by the plaintiff; the plaintiff acted in reliance on the representation; and he or she suffered injury as a result.

It is settled law in Michigan that, in the event of such a misrepresentation, plaintiffs would have a right of action for the damages caused thereby either at law or in equity. Silent fraud is a legal or equitable duty of disclosure in Michigan where "a fraud arising from the suppression of the truth is as prejudicial as that which springs from the assertion of a falsehood."

None of the different doctrines or types of fraud recognized in Michigan requires that the insurer prove that the fraud could not have been discovered through the exercise of reasonable diligence. In other words, insurers do not have to conduct an investigation of all assertions and representations made by their insureds to establish fraud.

Easily Ascertainable

The principal question presented to the Michigan Supreme Court was whether an insurer may rescind a policy for fraud in the application for insurance, when the fraud was easily ascertainable and the claimant is a third party. The court asked whether it should hold that it should place a burden on the insurer with respect to each of its thousands of policyholders to determine that the statements on every application are true. Rather, it asked whether the insurer is "entitled to give credence to its insured's honesty until it has actual notice that he is a scoundrel…. The short answer … is that a litigant cannot be held estopped to assert a defense, or to have waived his right thereto, because of facts he does not know."

However, when the insured seeks insurance benefits by committing fraud, even an easily ascertainable fraud will not preclude an insurer from availing itself of traditional legal and equitable remedies to avoid liability.

The injured parties argued that the "easily ascertainable" rule is required for the protection of third parties. In Michigan, there is no basis in the law to support the proposition that public policy requires a private business in these circumstances to maintain a source of funds for the benefit of a third party with which it has no contractual relationship. Absent insurance, the operator of the motor vehicle is personally liable for tort liability. By requiring an insurer to indemnify an insured despite fraud in obtaining an insurance policy, the "easily ascertainable" rule relieves the insured of what would otherwise be the insured's personal obligation in the face of his or her own misconduct. As between the fraudulent insured and the insurer, there can be no question that the former should bear the burden of his or her fraud.

Overruling earlier precedent, the Michigan Supreme Court, holding that there is nothing in the law to warrant the establishment or imposition of an "easily ascertainable" rule, placed the burden of the fraud, if it is proved at trial, on the person who bought the policy fraudulently and relieved the insurer of any obligation.

Conclusion

The California Supreme Court, the Michigan Supreme Court, and I feel sorry for the people injured by a person who obtained a policy of insurance by fraud. That empathy, however, does not change the rights of parties to a contract. Because of her fraud, if proved at trial, Ms. Hyten was uninsured because she had not been truthful in the application for insurance. Had she been truthful, she would never have been insured.

In Michigan, the victim of a fraud should not be required to conduct an investigation to determine whether an insured lied on the application. Since insurance is a business of utmost good faith, an insured can be expected to be truthful in an application for insurance, and the insurer should, in good faith, make its decision to insure based on an assumption that the facts in the application are true.


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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