Misrepresentation & Breach of Warranty Grounds to Rescind

Surreal to Ask a Court to Believe a Lie on Application Is Not Material

Insurers are not able to conduct a thorough investigation into representations made by a prospective insured at the time an application is submitted. Rather, the insurer relies on the covenant of good faith and fair dealing that the insured will be truthful in submitting an application. It is only after a claim is submitted that an insurer might learn of a misrepresentation concerning the risk that would cause the insurer to void the coverage.

In Essex Ins. Co. v. Galilee Medical Center S.C., — F.3d —- United States Court of Appeals, Seventh Circuit, 2016 WL 851688 (March 4, 2016) was faced with a trial court decision rescinding a policy of insurance and the claim of the defendants that their misrepresentations were really honest answers.

FACTUAL BACKGROUND

Plaintiff Essex Insurance Company (“Essex”) sued Galilee Medical Center S.C., doing business as MRI Lincoln Imaging Center (“Galilee”), and Luis Angarita, M.D., a physician employed by Galilee, seeking rescission of an insurance policy issued to Galilee.

Galilee provides medical services in Chicago. Essex issued a professional liability insurance policy to Galilee (the “Essex Policy” or the “Policy”) under which Essex was obligated to pay for claims against Galilee, the “insured,” for personal injuries caused by “any act, error or omission” in Galilee’s professional services. The Policy also covered claims against Galilee physicians, including Angarita, “solely while acting on behalf of [Galilee] and within the scope of his/her duties as such.”

To obtain coverage, Essex required both Galilee and Angarita to fill out applications. The applications contained a notice that Essex would rely on the answers provided by the applicants when issuing the policy. Accordingly, the Essex Policy deemed all information and statements made in the applications “material to the acceptance of the risk or hazard assumed by” Essex. Coverage under the Essex Policy was conditioned on Galilee’s acceptance that the applications were part of the Policy, that Essex had relied on the truth of the representations made in the applications, and that Essex had deemed the representations material to the acceptance of the risk assumed by Essex.  Essentially, the defendants, warranted the truth of all of the statements made  in the application were absolutely true.

The applications submitted falsely represented that Galilee did not use drugs for weight reduction for patients. ? Galilee also answered “no” to the question of whether its employees or independent contractors performed any experimental procedures.  Likewise, Angarita answered “no” to similar questions and that he does not use experimental procedures, devices, drugs, or therapy in treatment or surgery?

Medical Negligence Action

In June 2011, Rosa Ravelo, one of Angarita’s former patients, sued Angarita and an affiliated Galilee corporation, Galilee Medical Center S.C., doing business as Affiliated Physicians (“Galilee Affiliated Physicians”), for medical negligence based on mesotherapy treatments recommended and administered by Angarita. Mesotherapy is a non-surgical medical treatment involving injections into subcutaneous layers of fat. According to Angarita, “mesotherapy is intended to dissolve deposits of subcutaneous fat to reduce the size of isolated portions of the body in order to provide a more desirable body shape and contour for patients. Common examples include flattening areas of cellulite and smoothing … [such as the] pouching of a woman’s stomach following birth.” Mesotherapy has not been approved by the U.S. Food and Drug Administration for any purpose. Angarita admitted to providing mesotherapy treatment to more than 5,000 patients, including Ravelo.

Ravelo’s first appointment with Angarita occurred on November 8, 2008, at Galilee Affiliated Physicians. From November 15, 2008 to July 30, 2009, Angarita treated her with mesotherapy at his home office in Riverside, Illinois.

DISCUSSION

Defendants1 argue that the district court erred in holding that they made material misrepresentations in their insurance policy applications.  The parties agreed that Illinois law governs this suit. Section 154 allows insurers to deny coverage and rescind a policy if (1) a statement in the policy application is false and (2) the false statement either was made with the intent to deceive the insurer or materially affects the acceptance of the risk assumed by the insurer.

Illinois courts construe terms in an insurance application in accordance with their plain meaning and from the standpoint of an ordinary, reasonable person. Gillen v. State Farm Mut. Auto. Ins. Co., 215 Ill.2d 381, 294 Ill.Dec. 163, 830 N.E.2d 575, 582 (Ill.2005).

Applying that standard, the Seventh Circuit agreed with the district court that the term “use” is not ambiguous, nor should it be interpreted narrowly to encompass only the act of administering mesotherapy. Essex wanted to know whether Galilee doctors were recommending and administering such procedures. Defendants did not disclose this information, and thus, Essex was not able to correctly price the insurance policy based on the risk it was undertaking. The Seventh Circuit refused to permit the defendants, who did not pay for coverage for suits arising out of weight loss procedures, to circumvent their duty to make truthful representations to their insurer by reading ambiguity into a clear insurance policy application.

Any reasonable person would have understood from the insurance policy application questions that Essex wanted to know whether Galilee doctors performed non-traditional weight loss procedures. Experimental procedures used to eliminate fat in certain parts of the body, such as mesotherapy, certainly fall within that category.

Finally, defendants’ misrepresentations were sufficiently material to warrant rescission. To determine materiality, Illinois courts use an objective test that asks whether a “reasonably careful and intelligent” underwriter “would regard the facts as stated to substantially increase the chances of the event insured against, so as to cause a rejection of the application.” Small v. Prudential Life Ins. Co., 246 Ill.App.3d 893, 186 Ill.Dec. 841, 617 N.E.2d 80, 83 (Ill.App.Ct.1993). Testimony from an insurer’s underwriter may be used to establish the materiality of omitted information.  Accordingly, Essex submitted an affidavit from the managing director of Essex’s underwriter stating that if Galilee and Angarita had answered “yes” to the disputed questions, Essex would not have issued the policy or would have issued it for a much higher premium. That conclusion is consistent with the insurance policy application, which asked several questions about non-traditional and experimental weight loss procedures, and with the Policy itself, which noted that all statements made in the application were material to the acceptance of the risk assumed by Essex.

Although defendants argue that summary judgment is warranted only if the insurer can show that truthful statements by the insured would have caused the insurer to reject the application entirely, defendants’ interpretation of the materiality inquiry is too limited. A  misrepresentation is material by statute, if it “affects either the acceptance of the risk or the hazard assumed” by the insurer.

Here, the misrepresentations involving the scope of Angarita’s medical practice significantly increased Galilee’s exposure, and thus, Essex’s risk. Because Angarita’s use of mesotherapy led directly to Essex’s exposure in the Ravelo suit, it borders on the surreal to think that the nondisclosure was immaterial.

ZALMA OPINION

The covenant of good faith and fair dealing requires that neither party do anything that will prevent the other from enjoying the benefits of the contract. By misrepresenting – lying – to the insurer about the use of experimental techniques and drugs in the weight loss practice, the defendants (Insureds) deprived the insurer of the right to properly evaluate and price the risk they were asked to take. As a result, equity required that the parties be put back in the position they were in before the policy was issued as if no policy was ever issued.

ZALMA-INS-CONSULT                      © 2016 – Barry Zalma

Barry Zalma, Esq., CFE, practiced law in California for more than 43 years as an insurance coverage and claims handling lawyer.  He 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 founded Zalma Insurance Consultants in 2001 and serves as its only consultant.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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