Rescission is an equitable remedy as ancient as the common law of Britain.
When the United States was conceived in 1776 the founders were concerned with protecting their rights under British common law. They adopted it as the law of the new United States of America modified only by the limitations placed on the central government by the U.S. Constitution.
The viability and ability to enforce contracts was recognized as essential to commerce. Courts of law were charged with enforcing legitimate contracts. Courts of equity were charged with protecting contracting parties from mistake, fraud, misrepresentation and concealment since enforcing a contract based on mistake, fraud, misrepresentation or concealment would not be fair.
The common law developed rules that courts could follow to refuse to enforce the terms of a contract that was entered into because of mutual mistake of material fact, a unilateral mistake of material fact, the breach of warranty (a presumptively material promise to do or not do something), a material concealment, or a material misrepresentation. The remedy – called rescission – created a method for voidance of a contract and allowed courts to refuse to enforce such a contract.
Insurance contracts, unlike common run-of-the-mill commercial contracts, are considered to be contracts of utmost good faith. Each party to the contract of insurance is expected to treat the other fairly in the acquisition and performance of the contract. For example, the prospective insured is required to answer all questions about the risk he, she or it are asking the insurer to take and about the person the insurer is asked to insure.
Rescission, since before the U. S. Constitution, became an important remedy for insurers. As a contract of utmost good faith insurers and the courts recognized that the parties to a contract of insurance were more vulnerable than other contracting parties to misrepresentation or concealment of material fact. The remedy is available to either party to the contract and when one determines it was deceived into entering into the contract it may declare the contract void from its inception, return the consideration and treat it as if it never existed.
When an insurer or the insured discovers the existence of a factual basis for rescission they have the opportunity, but not the duty, to exercise the remedy of rescission. In California the remedy is available to both parties to the contract of insurance whether the party deceived believes the deceit was the result of a fraud or an innocent misrepresentation of a material fact. To do otherwise would be to make a gift to the person who deceived the insurer of rights not available to the truthful.
Equitable remedies, like the remedy of rescission, are expected to be fair. California follows the ancient equitable remedies and has codified the right to rescission of insurance contracts because the legislature considered it unfair to make a contracting party abide by a contract that was not obtained fairly. The ancient maxim that “No one can take advantage of his own wrong” is applied when a court is faced with a request to confirm rescission.
Under California law, every party to an insurance contract must communicate to the other, in good faith, all facts within his knowledge which are material to the contract and which the other has not the means of ascertaining.
When a party to a contract of insurance decides the policy must be rescinded it need only advise the other party in writing and return the consideration: either the premium collected by the insurer or the policy delivered to the insured who wishes to rescind. It is not necessary for either party to file suit to confirm the rescission, it is effected once notice is given and return of consideration is offered. If a party does not agree to the rescission he, she or it can file suit for a declaration by the court that the rescission was improper. If the party rescinding desires he, she or it can also sue for a declaration that the rescission was proper. Acceptance of the return of consideration is usually sufficient to confirm a rescission and will avoid unnecessary litigation.
If the parties do not agree to a mutual rescission the decision that a contract of insurance is effectively rescinded is a decision made only by a California court or U.S. District Court applying California law, sitting as a court of equity. The court of equity must exercise its discretion and make a ruling that is fair to all parties. When the court grants rescission it always requires that the both parties be returned to the status quo ante with all consideration paid or delivered is returned.
Rescission is the equitable process that authorizes a court of equity to conclude that it would be unfair to the parties to allow a contract to continue or be enforced. It places the parties back in the position they were in before the contract date. Although most reasons for rescission are not discovered until there is a claim sometimes insurers learn of grounds for rescission by conducting an engineering survey, a visit by the agent, broker or underwriter to the insured’s premises or an inquiry from the insured.
For example an insurer learns after a policy was issued that a jeweler insured who applied for insurance against theft and reported that his premises were protected by a central station reporting burglar alarm system. The insurer’s loss protection engineer visited the premises and reported to the insurer that the alarm is only a local gong that does not report to a central station. The insurer is entitled to rescind for misrepresentation of a material fact since the security promised was not the same as that which actually existed. The insurer returns the premium to the insured with notice that the policy is rescinded from its inception. The insured is unconcerned since, before the rescission, he had not suffered a loss. The rescission of the jewelers policy would have been as effective if the insurer had learned of the misrepresentation after a loss.
Rescission Is A Remedy That Must Be Used With Care
Insurers must use the rescission remedy with care. Insurers should never assume that the promise to pay indemnity to the insured under a policy of insurance can, with impunity, be broken by advising the insured that the insurer has rescinded the policy.
Rescission without sufficient evidence is wrongful. Rescission without the advice of competent counsel is a tactic fraught with peril. Where no valid ground for rescission exists, the threat or attempt to seek such relief, may constitute a breach of the covenant of good faith and fair dealing which is implied in the policy and expose the insurer to tort damages for that breach, including punitive damages.
California courts have made clear that if an insurer elects rescission without sufficient evidence it will bring the wrath of the courts down on it and will be the basis for allegations, easily proved, of extra-contractual torts.
If sufficient evidence exists, the rescission remedy will deprive the insured or the insurer of all rights under the policy. The court will conclude that the contract never existed and neither party has any right under the contract.
The primary bases for rescission in California are misrepresentation, concealment, mistake of fact, mistake of law and fraud. In California these bases are codified.
This book will include the full text of the relevant statutes and the decisions of the California Supreme Court, California Courts of Appeal, and the Federal Ninth Circuit Court of Appeal when it is called upon to interpret California law. By including the full text of the statutes and court decisions the insurance professional will be in a better position to recognize factual grounds that may give rise to remedy of rescission so that the factual bases can be presented to a competent, experienced insurance coverage lawyer for advice and counsel.
Before a party considers rescission, whether insured or insurer, the following must be established:
- The facts represented in the acquisition of the policy.
- Evidence that establishes whether an fact was misrepresented.
- Evidence that establishes that a material fact was concealed.
- Evidence that establishes that the fact(s) misrepresented was material to the decision of the insurer to insure or not insure.
- Evidence that the person seeking rescission did not have better knowledge of the facts claimed misrepresented or concealed.
- A sworn declaration from the underwriter who made the decision to insure or not insure concerning the effect true facts would have had on the underwriting decision.
- A review of the policy, application process, investigation results and applicable law by a competent insurance coverage lawyer.
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