Prior Policy Applications Found Relevant to Claim for Rescission

By Don R. Sampen, published, Chicago Daily Law Bulletin, March 21, 2023

The U.S. District Court for the Northern District of Illinois, construing Illinois law, recently evaluated the pleading requirements for an insurer seeking to rescind an insurance policy.

In doing so, it held that an insured’s prior applications for coverage could be relevant to whether a misrepresentation was made in the application for the policy sought to be rescinded.

The case is Call One Inc. v. Berkley Insurance Co., 2023 U.S. Dist. Lexis 21757 (Feb. 9). The insured, Call One, was represented by the Goodman Law Group of Chicago. Duane Morris LLP represented the insurer, Berkley.

Call One provides telecommunications services and equipment for its customers. In 2019, the Illinois Attorney General’s Office served the company with a subpoena pursuant to the Illinois False Claims Act. The subpoena sought documents relating to the company’s failure to collect and pay excise taxes and certain fees owed by customers, as required of telecommunications retailers under Illinois law.

Berkeley issued professional liability insurance to Call One for the time period covering the subpoena and for the prior seven years. It confirmed coverage for the costs in connection with the subpoena. Subsequently, however, it learned of a pending lawsuit against Call One for alleged IFCA violations relating to the subpoena, and denied coverage for the lawsuit.

Call One eventually settled the separate lawsuit and requested Berkley to pay defense costs and fund the settlement. When it declined, Call One brought the instant action for breach of contract and bad faith.

Berkley filed a counterclaim seeking rescission of the policy based on alleged misrepresentations in Call One’s 2018 policy application. Berkley claimed Call One had been aware of accounting deficiencies in its financial records since 2015 and became aware that it had failed to collect and remit taxes from its customers by 2017. Berkley sought rescission based on the company’s failure to report these deficiencies on its 2018 application for coverage.

Call One moved to dismiss the counterclaim.

Analysis

In an opinion by Judge Andrea R. Wood, the court denied the motion. She initially addressed the standards for rescission under Illinois law. Citing to 215 ILCS 5/154, she pointed out the two-prong test for rescission, namely, that (1) the insured’s representation in an application must be false, and (2) the representation must (i) have been made with intent to deceive or (ii) be material to the insurer’s decision to issue coverage.

Wood further observed that, under federal pleading standards, rescission claims based on an intent-to-deceive theory are subject to the heightened pleading standard under Federal Rule of Civil Procedure 9(b), applicable to fraud claims.

In this case, Wood said Berkley met both the intent-to-deceive and materiality options for rescission. It did so by identifying the 2018 application’s failure to disclose that Call One was aware of actual or potential claims against Call One, and by alleging that Berkley would not have issued the policy had it known of Call One’s misrepresentations.

Call One nonetheless argued that Berkley’s claim relied on misrepresentations in Call One’s 2015 and 2017 applications, but failed to identify an actual misrepresentation in the 2018 application. As an initial matter, Wood agreed that the 2018 Berkley policy could not be rescinded based on misrepresentations in prior applications.

That does not mean, however, wrote Wood, that the earlier applications could not be considered as evidence regarding misrepresentations in the 2018 application. She also noted that an incomplete answer or failure to disclose on an insurance application could constitute a misrepresentation when the omission prevents the insurer from assessing the risk involved.

In this case, Wood found that Call One answered “no” to being aware of information that could lead to a claim in its 2011 application. In 2015 and 2017 it answered “no” to being aware of any change in status of claims or circumstances previously reported, even though it had information to the contrary. And in 2018 it failed to provide an answer to the same question.

Wood concluded that the incomplete answer and failure to disclose the ongoing violations in 2018 provided a sufficient basis for Berkley’s rescission claim based on a knowing misrepresentation. The insurer plausibly alleged a claim for rescission based on a material misrepresentation theory as well.

The court therefore denied the motion to dismiss.

Key Points

• An incomplete answer or failure to disclose on an insurance application may suffice as a misrepresentation justifying rescission when it prevents the insurer from adequately evaluating the risk.
• Information provided by the insured on prior applications may be considered when a court assesses the adequacy of an application for coverage sought to be rescinded.