Policy Void From Its Inception if Obtained by a Lie
Every policy of insurance includes an unwritten covenant – promise – to deal fairly and in good faith with the parties to the contract. The promise to deal fairly devolves equally upon the insured and the insurer. When a person obtains insurance because of a misrepresentation or concealment of a material fact, the party deceived – insured or insurer – has the right to seek a court order rescinding the policy from its inception.
In H.J. Heinz Company v. Starr Surplus…, United States Court Of Appeals, Third Circuit, — Fed.Appx. —-, 2017 WL 108006 (January 11, 2017) H.J. Heinz Company appeals the District Court’s order rescinding a product contamination insurance policy it purchased from Starr Surplus Lines Insurance Company. See our discussion of the trial court decision at http://zalma.com/blog/innocent-or-intentional-misrepresentation-requires-rescission/.
Heinz makes and sells food products worldwide. Starr is a global insurance company that sells contaminated product insurance that protects food product companies against losses arising from accidental contamination or government-imposed recall of their products. Beginning in May 2014, Heinz sought proposals for contaminated product insurance, including accidental contamination insurance, for the period covering July 1, 2014 to July 1, 2015. Heinz’s new global insurance director, Ian Ascher, was responsible for preparing and certifying the accuracy of Heinz’s insurance application (the “Application”).
Question 6e of the Application asked: “Has the Applicant, its premises, products or processes been the subject of recommendations or complaints made by any regulatory body, internal or third party audit over the past 12 months or have any fines or penalties been assessed against the Applicant by any food or similar regulatory body over the last 3 years?” Heinz responded “NO” without further explanation or qualification.
Question 11a asked: “In the last 10 years has the Applicant experienced a withdrawal, recall or stock recovery of any products or has the Applicant been responsible for the costs incurred by a third party in recalling or withdrawing any products, whether or not insured or insurable under an accidental and malicious contamination policy?” Heinz did not fill in either the “YES” or “NO” box, but instead attached a spreadsheet detailing the company’s loss history from 1998 to 2013. The loss history disclosed only one loss over ten years greater than Heinz’s requested $5 million SIR. In addition to the Application, Aon provided Starr with a loss ratio analysis dated June 5, 2014.
Two weeks later, Chinese authorities informed Heinz that baby food it manufactured in China was contaminated with lead (the “2014 China Lead Loss”). Heinz recalled the product. On August 5, Heinz notified Starr of the loss and sought coverage under the new Policy. During the investigation, the Starr employee responsible for the 2014 China Lead Loss claim found out that, prior to Policy inception, Heinz incurred a loss in excess of $10 million after discovery of excessive levels of nitrite in baby food manufactured in China (the “2014 China Nitrite Loss”). Heinz did not disclose this loss in its Application.
The parties agreed to litigate Starr’s counterclaim first. On February 1, 2016, the District Court issued an opinion agreeing with the jury on misrepresentation, but disagreeing on waiver. The District Court declared the Policy void ab initio and entered judgment for Starr.
First, Heinz contends the District Court erred in concluding that New York law, rather than Pennsylvania law, governs Starr’s rescission counterclaim. As a corollary to that point, Heinz argues that Starr’s invocation of the Policy’s choice-of-law provision amounted to ratification of the Policy.
Second, Heinz asserts that the District Court misapplied New York rescission law by holding Starr to the incorrect burden of proof and relieving Starr of its obligation to prove every element of its prima facie case.
Finally, Heinz submits that Starr waived its right to assert rescission.
Choice of Law
Having found that the parties contracted for New York law to apply, the District Court properly employed the two-part test of section 187 of the Restatement (Second) of Conflict of Laws, as adopted by Pennsylvania courts, to confirm that the parties’ contractual choice should not be displaced. The Third Circuit, therefore, held that the District Court was correct that New York law governs Starr’s rescission counterclaim.
But can Starr claim that the Policy should be rescinded as if it never existed, while at the same time seek to have its choice-of-law provision apply to the dispute? Heinz says no—by taking both actions at once, Starr ratified the Policy. The Third Circuit found that the plain text of the Policy’s choice-of-law provision — which states that the “validity … of this Policy will be governed” by New York law, — refutes this argument and the court refused to adopt Heinz’ theory.
New York law entitles an insurer to rescind an insurance policy—thereby deeming the policy void ab initio— if it was issued in reliance on material misrepresentations. A misrepresentation in an insurance application is a false statement as to past or present fact, made to the insurer by, or by the authority of, the applicant for insurance or the prospective insured, at or before the making of the insurance contract as an inducement to the making thereof.
Burden of Proof
Heinz contends that the District Court held Starr to the incorrect burden of proof and relieved Starr of its obligation to prove every element of its prima facie case. The District Court was correct to hold that Starr’s evidence met the clear and convincing evidence standard in reaching its decision to rescind.
The District Court found that Heinz intentionally made four material misrepresentations of fact about its loss history in its answers to Questions 6e and 11a of the Application. Failure to disclose is as much a misrepresentation as a false affirmative statement. A misrepresentation is material if the insurer would not have issued the policy had it known the facts misrepresented.
Starr did what was required and the District Court credited all this evidence in concluding that Starr would not have offered Heinz the Policy at a $5 million SIR if it knew about the misrepresentations. The Third Circuit concluded that the materiality of Heinz’s misrepresentation was self-evident. Heinz’s misrepresentations were of such magnitude that they deprived Starr of its freedom of choice in determining whether to accept or reject the risk upon full disclosure of all the facts which might reasonably affect that choice.
The District Court then held that “Starr properly relied upon the representations of Heinz in the application process coupled with the Certification.” Heinz says that the District Court relieved Starr of its burden of proving reliance.The Third Circuit concluded that District Court erred in not holding Starr to its burden of proving reliance. However it concluded that the District Court’s error was harmless and does not require reversal.
Starr underwriters testified that they looked to Heinz’s loss history in calculating the appropriate risk and conducting their loss ratio analysis. The Policy’s certification, signed by Heinz’ Ascher, stated that he would inform Starr of any material changes to Heinz’s risk. Ascher knew about the 2014 China Nitrite Loss during June, but did not inform Starr.
It was highly probable that, had the District Court properly held Starr to its burden of proving reliance, the outcome would be the same.
Courts applying New York rescission law have found investigation periods from six to twelve months to be reasonable. The five-month period between January 2015 and the filing of Starr’s rescission counterclaim on June 16, 2015, was wholly unobjectionable.
Heinz did not convince The Third Circuit that the District Court erred in concluding that Starr agreed to sell the Policy despite sufficient knowledge of Heinz’s misrepresentations. Heinz failed to prove that Starr waived its right to assert rescission.
As I said in February 2016, rescission is an equitable remedy that when one party to a contract of insurance is deceived by the other into entering into the contract by misrepresentation or concealment of material fact, the parties must be returned to the status quo that existed before the contract was made. Heinz intentionally deceived Starr to obtain a reduced premium and a smaller SIR. Since equity requires that Heinz should not be allowed to profit from its deception rescission was the only proper remedy because it would not be fair to compel Starr to insure a risk it would not have taken but for the deception.
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 49 years in the insurance business.
Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.
Look to National Underwriter Company for the new Zalma Insurance Claims Library, at www.nationalunderwriter.com/ZalmaLibrary The new books are Insurance Law, Mold Claims Coverage Guide, Construction Defects Coverage Guide and Insurance Claims: A Comprehensive Guide
The American Bar Association, Tort & Insurance Practice Section has published Mr. Zalma’s book “The Insurance Fraud Deskbook” available at http://shop.americanbar.org/eBus/Store/ProductDetails.aspx?productId=214624, or 800-285-2221 which is presently available and “Diminution of Value Damages” available at http://shop.americanbar.org/eBus/Store/ProductDetails.aspx?productId=203226972
The author and publisher disclaim any liability, loss, or risk incurred as a consequence, directly or indirectly, of the use and application of any of the contents of this blog. The information provided is not a substitute for the advice of a competent insurance, legal, or other professional. The Information provided at this site should not be relied on as legal advice. Legal advice cannot be given without full consideration of all relevant information relating to an individual situation.