Misrepresentation, Rescission Rights And An Innoncent Insured

The Illinois Supreme Court recently held that a material misrepresentation on a renewal application for a legal malpractice insurance policy gave rise to the insurer’s right to rescind the policy, even as to an innocent insured who was unaware of the misrepresentation.

The insurer in Illinois State Bar Association Mutual Insurance Co. v. Law Office of Tuzzolino and Terpinas, 2015 IL 117096, 2015 WL 728111 (Feb. 20, 2015) was represented by Pretzel & Stouffer Chtd. Roach Johnston & Thut of Libertyville represented William Terpinas Jr., a partner of the insured, Law Office of Tuzzolino & Terpinas, and the underlying claimant.

In 2008, one of T&T’s partners, Sam Tuzzolino, submitted a renewal form for malpractice coverage to ISBA Mutual, on behalf of himself, Terpinas and the firm. In it he affirmatively represented that he was not aware of any circumstances that could give rise to an unreported claim. In fact, a malpractice claim already had been asserted against Tuzzolino that was not reported.

Terpinas did not sign the form. He first became aware of the claim against Tuzzolino about a month later and reported it to ISBA. ISBA filed this suit for rescission in March 2009. After briefing, the parties filed cross-motions for summary judgment, and the trial court granted ISBA’s motion. It found that ISBA was entitled to rescission of the policy in its entirety, and that it had no duty to defend Terpinas or the firm.

Terpinas and the claimant appealed, and the appellate court reversed. That court held that the innocent-insured doctrine preserved Terpinas’ coverage even though Tuzzolino’s coverage was properly rescinded. ISBA then appealed to the Illinois Supreme Court.

Innocent-insured Doctrine

In an opinion by Justice Charles E. Freeman, the Supreme Court reversed the appellate ruling. Freeman initially quoted Section 154 of the Insurance Code, 215 ILCS 5/154, which provides the circumstances under which an insurer may seek rescission. The circumstances include a statement made on an application that is false and that materially affects the acceptance of the risk assumed by the insurer.

Freeman pointed out that under Section 154, a misrepresentation, even if innocently made, can serve to void a policy and that intent to deceive is not necessary. Here, moreover, the defendants did not dispute that the misrepresentation on the application materially affected acceptance of the risk.

The defendants nonetheless contended that the use of Section 154 in these circumstances is contrary to Illinois public policy, and that Section 154 should not be used as a sword to vitiate insurance coverage. They thus believed that the appellate court properly relied on the innocent-insured doctrine to protect the interests of Terpinas.

In Freeman’s view, however, the public policy of the state is properly expressed through legislation, such as Section 154.

He further observed that the case law authority on which the appellate court relied for the innocent-insured doctrine, Economy Fire & Casualty Co. v. Warren, 71 Ill.App.3d 625 (1979), did not involve rescission of a policy under Section 154. Rather, it involved the rescission of a settlement agreement between insureds and an insurer, in which one of the insureds misrepresented facts leading to the settlement.

Freeman further noted, moreover, that the innocent-insured doctrine may have relevance where one insured’s conduct triggers a policy exclusion, and a dispute arises whether the insurer has an obligation to an innocent insured.

On the other hand, the doctrine has no relevance on the issue of whether a policy should be enforced in the first place, which is a matter governed by statute. The appellate court therefore erred in applying the doctrine here.

Severability, Status Quo

Freeman said that the appellate court further erred in partially severing the policy to facilitate application of the innocent-insured doctrine, pursuant to the ISBA policy’s severability clause.

That clause effectively created a separate insurance agreement with each insured, through language stating, among other things, that the “particulars and statements contained in the application will be construed” separately as to each insured.

Even if the policy were treated separately as to each insured, according to Freeman, there was nothing to permit the application, or the misrepresentation it contained, to be split off from any individual contract.

The defendants further argued that it was impossible to return Terpinas to his status quo existing at the time the contract for insurance was made.

Freeman acknowledged that rescission law requires a restoration of the status quo ante, but that is typically accomplished by the insurer refunding the premium it received, which the ISBA did here. He quoted authority holding that, where restoration of the status quo ante is impossible but not due to the party seeking rescission, such restoration may not be required.

Finally, the defendants argued that the renewal form on which the misrepresentation was made was not really an “application” under Section 154. But Freeman pointed out that the form referred to itself as an “application” and required an attestation to the validity of the answers.

The court therefore reversed the appellate judgment and affirmed the trial court’s rescission in favor of the ISBA.

Justice Thomas L. Kilbride dissented, arguing that the innocent-insured doctrine should be applied because Terpinas had a reasonable expectation of continuing coverage.

Key Points

• Section 154 of the Illinois Insurance Code does not require an intent to deceive and may give rise to an insurer’s right to rescind based on an innocent, but material misrepresentation, in an application.
• The innocent-insured doctrine does not apply to an insurer’s right to rescind a policy pursuant to Section 154.
• Illinois public policy with respect to insurance policies may be found in statutes passed by the legislature.