California Court: Misrep in Application Leaves Innocent Insureds with No Policy

A decision earlier this month by a California appeals court highlights the serious ramifications of misrepresenting or concealing information in an insurance application and the care that should be taken when completing one and when compiling other information to submit with the application.

Genesis Insurance Company issued a $10 million D&O policy to Homestore, Inc. TIG Insurance Company of Michigan issued a $5 million excess policy that followed the Genesis form.

The policy contained a representation section that said in part:

“In the event that the Application, including materials submitted therewith, contains misrepresentations… which materially affect either the acceptance of the risk or hazard assumed by the Insurer, no coverage shall be afforded… for any Director or Officer who did not sign the Application but who knew on the inception date of this Policy the facts that were so misrepresented, and this Policy in its entirety shall be void and of no effect whatsoever if such misrepresentations were known to be untrue on the inception date of the Policy by one or more of the individuals who signed the Application.”

The insured’s CFO signed the application and provided a Form 10-Q along with it, as required by the insurer.

The insured’s board of directors later began an inquiry into the company’s accounting methods. Ultimately the company issued a restatement that reduced its previously reported revenue from $105.5 million to $63.8 million. Net losses went from $67.1 million to $99.8 million. The CFO pleaded guilty to one federal charge of conspiracy to commit securities fraud.

Securities class actions and derivative liability lawsuits were filed against the insured and many of its directors and officers. TIG filed suit for a declaration that it was entitled to rescind the policy.

The representations section quoted above is a mouthful, but the latter part of it became the core of the dispute between insurer and insured.

The insureds argued that the language was ambiguous and susceptible to an interpretation that coverage could not be denied to insureds who neither signed the app nor knew about the misrepresentation. Neither the trial court, the appeals court nor a federal court that heard the same issues in a separate case filed by Genesis agreed with the insureds.

California law permits rescission of a policy for misrepresentation or concealment of material information, whether intentional or unintentional. The law says rescission “shall apply to all insureds, including additional insureds, unless the contract provides otherwise.”

The court found that the representations statement clearly said that the policy could be voided “if such misrepresentations were known to be untrue on the inception date of the Policy by one or more of the individuals who signed the Application.”

That language was not over-ridden by the other language that said if a director or officer knew of the facts misrepresented but didn’t themselves sign the application, coverage would not be available to them individually, which would permit so-called innocent insureds to still have the benefit of coverage. The court found the two provisions could exist side by side and were not ambiguous.

See our previous post for more information on rescission and application disclosure.