Insurers Can Rescind Policy When its Agent Lies on Behalf of the Insured
Post 5042
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Some years ago, my solution to a mid-life crisis was to buy a custom made replica of the Studebaker Avanti, a fiberglass sports car powered by a 5 Liter V-8.
After I bought my dream car I found it was almost impossible to insure because the manufacturer only made 400 a year. My insurer cancelled me because it could not calculate an appropriate premium. I went to my neighborhood direct writer who had no problem insuring the car. The agent filled out a lengthy application form and handed it to me to sign.
Much to the agent’s surprise I actually read the application and found he had marked the form showing “no cancellations.” I had told him of the cancellation and asked why he had put a false statement in the application.
“It’s not important,” he responded, “you weren’t cancelled for cause.”
The application only asked if I was cancelled so I insisted he correct the application. The insurance was issued. Had I allowed the application to go through as filled out and had a claim I would have faced a situation where I might have had no coverage. Of course, if I could prove that the agent of the direct writer had the knowledge of the prior cancellation I could have defeated a claim of rescission, but with difficulty. If I did, the agent would have found himself liable to the insurer for any claim it paid to me.
In most states a mutual mistake of material fact, a unilateral mistake of material fact, the breach of a warranty, a material concealment, or a material misrepresentation can all be grounds for rescission. When an insurer is deceived, regardless of the intent of the deceiver, the remedy of rescission is available to the insurer. Rescission is an equitable remedy that was created by ancient ecclesiastical courts in England. When an insurance policy is rescinded it places the parties back in the position they were in before the contract date. The insured gets the premium back and the insurer gets back the policy as if there was never a contract.
Insurers usually use the remedy with care. As one court put it after agreeing that a rescission was proper: "Our conclusion here should not result in an assumption by insurers that policy liability can, with impunity, be avoided or delayed by assertion of a claim for rescission. That is a tactic which is fraught with peril. Where no valid ground for rescission exists, the threat or attempt to seek such relief may itself constitute a breach of the covenant of good faith and fair dealing which is implied in the policy." (Emphasis Added) [Imperial Casualty & Indemnity Company v. Levon Sogomonian, 198 Cal. App. 3d 169 (1988)]
In a decision of the California Court of Appeal a man named Mitchell was the named insured of an insurance policy issued by United National Insurance Company whose commercial building was destroyed by an arson fire. United National discovered several misrepresentations in Mitchell’s application for insurance, obtained the advice of counsel and rescinded the policy. Mitchell sued. The trial court granted summary judgment to the insurer because the application made material representations upon which United National’s underwriter relied in deciding to insure Mitchell which included matters that should have been learned by his agent and avoided. For example, Mitchell misrepresented:
1. The property was not owned by Mr. Mitchell but by a family trust.
2. The property was vacant.
3. The property had been previously insured by the FAIR Plan, an insurer of last resort, who had cancelled.
4. The property had been condemned by the city. [James E. Mitchell, Individually and as Trustee of the Mitchell Family Trust v. United National Insurance Company, 127 Cal.App.4th 457, 25 Cal.Rptr.3d 627 (2005)]
The trial court granted summary judgment in United National’s favor and the Court of Appeal affirmed finding “as a matter of law on the undisputed facts that the information sought by United’s underwriter and denied to it by plaintiff’s false answers and omissions was material to United’s decision to provide insurance coverage.”
Insurance Agent Knowingly Presents a False Application
The investigation of the broker, and the broker’s actions can provide an insurer with an opportunity to recover losses due to fraud from a person with assets rather than a fraud perpetrator whose only source of income may have been the fraudulent claim. The Fourth District California Court of Appeal, in Century Sur. Co. v. Crosby Ins., Inc., 124 Cal. App. 4th 116 (2004), allowed an insurer to seek damages from the insurance broker who submitted to it a fraudulent and false application for insurance.
The case established that Crosby Insurance Inc. submitted to Century Surety Co. an insurance application for Baroco West Inc. The application classified Baroco as a “drywall” contractor. Century issued a policy in reliance upon the facts represented in the application. A construction defect action was filed against Baroco as the “general” contractor. Century undertook the defense but later withdrew after discovering Baroco’s insurance application contained false information. Century sued Crosby for losses caused by Crosby’s alleged fraud, negligence and negligent misrepresentation. The application incorrectly classified Baroco and was supported by a forged letter from Crosby’s office stating that Baroco had no losses for two years.
Crosby argued that Century’s exclusive remedy was against the insured, Baroco. The trial court agreed and sustained the demurrers without leave to amend. The Court of Appeal reversed the trial court decision. The Court of Appeal concluded that liability may be imposed on a broker in an insurer’s action to recover losses caused by a broker’s fraud in the application process. It also found that public policy supports imposing a duty on brokers to prepare applications with reasonable care. Failure to use reasonable care can result in the broker paying for the insurer’s loss.
To avoid litigation from the client of an insurance agent or broker when the clients’ policy is rescinded, the insurance agent or broker must, when obtaining an application for insurance, explain to the proposed insured the importance of truthful and accurate responses to the questions. The agent or broker should never make subjective decisions on the importance of facts to a particular insurer.
The prudent agent or broker should ask the proposed insured each and every question on the application for insurance. None should be skipped even if they seem to have no relevance to the particular insured. The agent or broker should also insist that the insured read the application and affirm that all of the answers are correct before it is signed. If the insured refuses, or cannot read English, the agent or broker should read the application to the insured or have it translated into a language the applicant understands. The application process should be noted in the agent or brokers log and the insured should be asked to sign the application.
The insurance adjuster, needing to complete a thorough investigation as required by fair claims practices statutes and Regulations, work as a regular practice, asking each insured every question on the application for insurance.
If there is a discrepancy between the statements made by the insured at the time of the investigation and those made by the application the adjuster must not assume the investigation is complete. The adjuster must go to the offices of the agent or broker and obtain a complete copy of the file and ask the agent or broker if he knew of the true facts as related by the insured. The adjuster must collect the contract between the agent or broker and the insurer to clarify their relationship.
Finally, the adjuster should submit the findings of the investigation to competent coverage counsel for advice on whether the remedy of rescission or voidance is available to the insurer.
(c) 2025 Barry Zalma & ClaimSchool, Inc.
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Post 4860
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Post 4856
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