Insurer Entitled to Rescind Policy Due to Insured’s Failure to Disclose Contract Dispute and Potential Claim on Application

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A California federal district court has ruled that an insurer could rescind a professional liability policy because its insured failed to disclose a customer dispute and potential claim in its application for coverage. Scottsdale Indem. Co. v. Sun Coast Gen. Ins. Agency, 2020 WL 8569410 (C.D. Cal. Dec. 21, 2020).

In 2012, an automobile insurer entered into an agreement with another company that appointed the insurer as agent for producing and handling non-standard insurance policies in certain states. In the years that followed, the insurer and its client had a number of disagreements, culminating in the client’s termination of the agency contract. During that period, the client wrote letters to the automobile insurer alleging breaches of the contract and instructing the insurer to “notif[y] its errors and omissions insurance carrier of potential forthcoming claims arising from [the insured’s] breach of [the agreement].” Ultimately, in 2018, the company sued the automobile insurer, which in turn sought coverage under its professional liability policy. That insurer denied coverage, however, and sought to rescind the policy because the automobile insurer had not disclosed the dispute in its applications for professional liability coverage over the prior three years.

In the ensuing coverage litigation, the court ruled that the professional liability insurer was entitled to rescind the policy. First, the automobile insurer made misrepresentations when it failed to disclose the cancellation of the contract and the potential claim. The applications had asked the automobile insurer whether it was “aware of any claims or potential claim that has not been reported to [the professional liability insurer],” to which the automobile insurer responded “no” in each instance. The court reasoned that, by the time the automobile insurer submitted its applications, it was on notice because it had received several communications about the company’s potential claim, including the letter advising the automobile insurer to inform its professional liability insurer of potential claims arising from its alleged breach of contract.

Second, the court found the misrepresentation to be material because of the nature of the information withheld and the likely effect of the non-disclosure on the issuance of the policy. The court determined that the cancellation of the contract was relevant to the insurer’s assessment of the risk and that, if the cancellation or potential claim had been disclosed, the insurer may have increased premiums or not issued the policy.

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