Court of Appeal Refuses To Let Insured Get Away With An Objectively False Representation in a Policy Application
On October 1, 2008, the California Court of Appeal in Sigelman v. Lawyers’ Mutual Insurance Company (“LMIC”), Case No. D050783 (unpublished), agreed with Musick Peeler & Garrett and determined that LMIC is entitled to rescind a professional liability policy because the Insured made an objectively false representation in an application for insurance based on the facts known to him at the time he signed the application. The Court reversed the trial court judgment and remanded to determine the amount of reimbursement to LMIC.
The Insured, an attorney, was insured under an existing policy with LMIC. When he sought to renew the policy, he filled out an application that had the following question and answer:
Does the applicant law firm, or any lawyer named in Question No. A9, for whom coverage is sought by this application, have knowledge of any error or omission or any disagreement with the client which might reasonably give rise to a claim or suit against him or her or against the applicant law firm? __ Yes _X_ No.
Based on this application, LMIC renewed the policy for another year.
At the time he filled out the application, the Insured knew that two wrongful death cases had been dismissed because of his legal malpractice. A few months after the policy renewal, attorneys representing the plaintiffs in the wrongful death cases threatened legal action against the Insured.
Upon receipt of the potential claims, LMIC appointed counsel to defend the Insured and investigated the coverage issues. LMIC then advised the Insured that there was no coverage for either claim, citing, among other things, his material misrepresentation in the renewal policy application, i.e., he was aware of his errors or omissions in each of the wrongful death cases before he answered “no” to the question in the renewal application.
Thereafter, LMIC appointed independent counsel for the Insured. LMIC agreed to settle the two malpractice claims, subject to a full reservation of rights and the right to seek reimbursement from the Insured.
The Insured then sued LMIC, alleging that the claims were covered. LMIC filed its own cross-complaint for a declaration of no coverage and for reimbursement of the amounts it paid to settle and defend the claims. In addition to other grounds, LMIC asserted it was entitled to rescind the policy based upon material misrepresentation in the application.
The matter went to a bench trial on mostly stipulated facts. Most significantly, the Insured admitted that: (1) he knew LMIC would rely on the truth of the representations in the policy application; (2) he knew he had committed legal malpractice in both wrongful death cases before he signed the application; and (3) he knew the statute of limitations to sue him on both claims had not yet expired when he signed the application. Nevertheless, the Insured argued he had no intent to deceive or defraud LMIC when he signed the application. Amazingly, the trial court entered judgment in favor of the Insured.
The Court of Appeal reversed, noting that California law permits rescission even for unintentional misstatement or concealment of a material fact. The Court recognized the importance of the application to an insurer’s decision to issue or renew insurance coverage. The Court also agreed that specific questions, which go to insurability, risk and premium for a policy, are material as a matter of law if the information was requested and relied upon in issuing the policy.
The Court stated that more specific underwriting testimony of materiality was not essential. As the Court noted, the LMIC policy itself states: “By acceptance of this policy, the Insured agrees that the statements in the application are his representations, that they shall be deemed material, that this policy is issued in reliance upon the truth of such representations and that this policy embodies all agreements existing . . . relating to this insurance.” (Emphasis added.)
The Court concluded that the trial court had erred in applying a subjective standard and rejected the Insured’s argument that the trial judge’s credibility determination must be upheld if supported by substantial evidence. Instead, the Court applied an objective standard to evaluate whether the answer was false: how would a “reasonable attorney” in exercising his professional judgment have responded to the question?
The Court found that reasonable minds could not dispute the Insured failed to meet his standard of care in each case and he admitted he did not, so there was no dispute on the point. The Court reasoned that “[n]one of the factors relied on by Plaintiff to excuse the omissions in his application would justify his professed subjective belief as objectively reasonable, under all the circumstances.” The wrongful death cases involved potentially large compensatory damages, the Insured had previously assessed them as strong cases, and he knew the statute of limitations had not lapsed as to either potential malpractice claim. Plus, there was nothing in the record to show that he was led to believe by his former clients that they would not pursue a malpractice claim. Given his acknowledged malpractice in each case, the Court concluded he was “on notice that such errors and omissions might reasonably lead to a formal claim being made . . .”
Further, according to the Court, the application question was an issue of law because the question simply asked if the Insured had “knowledge” of “errors and omissions” that “might reasonably give rise to a claim or suit” against him. The Court concluded that “as a matter of law, regardless of any subjective intent or belief on Plaintiff’s part, the answers he gave are objectively false as to material information.”
This decision is an example of a court’s receptivity to an insurer’s rescission and reimbursement claim where a policyholder has made demonstrably false statements in its application or concealed information material to the underwriting process. LMIC was rewarded by doing the right thing - defending the insured under a reservation of rights, settling to cap the insured’s exposure and prevent excess personal liability to the insured, and then asserting its rights to rescind and seek reimbursement. The decision also shows that the language of the question on the application, the insured’s knowledge, and the totality of the circumstances will all determine the likelihood of success on a rescission claim.