New Case Authority Helps Guide The Insurer When It Discovers Material Misrepresentations In The Coverage Application

By:  Robert A. Crook, Esq.

The scenario is familiar. An insurance carrier receives an application to insure a single family home. No leaks. No pets. No business. No hazardous conditions. Only after the policy is in place – and a plaintiff sues the homeowner for injuries – does the insurer learn that the home is a rundown shack with a leaky roof, four pit bulls and a toxic chemical spill oozing over what’s left of a backyard lawn.

When an insurer is called upon to defend the insured, it must do so, or risk an insurance bad faith claim. However, in egregious situations, the insurer may refuse to defend and indemnify on the grounds that the insured made material misrepresentations in filling out the insurance application. The issue then becomes what a carrier must do to protect itself when it believes that misrepresentations have been made, particularly where those misrepresentations relate to the claim which the landowner is seeking indemnity and defense.

Duarte v Pacific Specialty Insurance Co. (2017) 13 Cal.App.5 th 45 recently provided guidance as to California insurers’ duties to protect themselves and their insureds. In reversing a trial court’s granting of the defendant’s Motion for Summary Judgment that voided the relevant insurance policy on rescission grounds – and thus ended Plaintiff’s bad faith claim — the Court of Appeal made two important rulings.

First, the court rejected the landowner’s argument that notice of rescission can only be provided by a Cross-Complaint filed by the insurance carrier. Notice requirements are adequately satisfied when the insurer pleads rescission and misrepresentation as an affirmative defense in its Answer. Thus, the filing of a Cross-Complaint by the insurer is unnecessary, making it easier for the insurer to raise the issue and avoid a Demurrer.

Second, the court affirmed that the insured’s responses to the application, and the language of the policy, must be construed in the insured’s favor. Application questions seeking whether there was any “prior unrepaired damage” and “business being conducted” out of the property were found to be ambiguous. Policy language relating to unrepaired damage and business operating off of the property were similarly found to be unenforceable (even where the occupier of the property was occasionally selling motorcycle parts out of the basement; the court found such business activity as being occasional and not ongoing.)

Note that the Duarte court specifically found that (1) the insurer is not required to show a causal relationship between the material misrepresentation or concealment of material fact and the nature of the claim; (2) the misrepresentation need not be intentional for an insurer to be entitled to rescind a policy “based on an insured’s negligent or unintentional concealment or misrepresentation of a material fact;” (3) the focus of the inquiry is not on the state of mind of the insured or applicant, but on “the probable and reasonable effect which truthful answers would have had upon the insurer.” The seemingly contradictory language of the decision underscores an important truth – insurers must second-guess themselves as to the language of their policies, giving any benefit of a doubt to their insureds before denying coverage. Any ambiguities in either the application or the policy itself risk a finding that the provisions are void.