CHAPTER 5

• Jurisdiction: United States

CHAPTER 5

Rescission of Insurance Policies

A. An Equitable Remedy

When the English Common Law began, there were two separate court systems. The law courts dealt with disputes over money or property. The Equity courts, usually ruled by clerics, were limited to questions of fairness.

The early equity courts developed in England, and were called chancery courts, so named because they were administered by the King’s Lord Chancellor. Their authority derived from the King’s authority. They were the “keeper of the King’s conscience.” Courts of law and courts of chancery (equity) were separate courts, operating independently. Where a court of law delivered a result that was unfair or compounded an injustice, equity courts could and did act to mitigate or alter altogether harsh outcomes. For hundreds of years, the English equity courts wielded considerable power, and were largely unrestrained by black letter law or precedent.

Unlike courts of law, courts of equity historically were not governed by the black letter law, nor did they deliver monetary remedies. Instead, equity courts applied principles of justice and fairness that derived from natural law, which consists of laws and rights that emanate from the natural order of things, and are discoverable.¹

Gradually the courts of equity have merged with courts of law. Federal bankruptcy courts are the one example of courts which operate as courts of equity.²

Equitable powers in the realm of civil litigation are alive and well, albeit much changed from their chancery predecessors. Today, most American courts are combined courts of equity and courts of law. They are no longer separate courts. Additionally, modern equity courts do operate under some substantive and procedural constraints. They are not unbound from law and precedent as were earlier chancery courts. When exercised today, equitable powers generally take the form of non-monetary remedies, such as injunctions, writs and orders for specific performance, and are invoked where a monetary outcome alone would be considered inadequate.³

Equitable decisions are informed by the Maxims of Equity, including the following:

1. Equity sees that as done what ought to be done;

2. Equity will not suffer a wrong to be without a remedy;

3. Equity delights in equality;

4. One who seeks equity must do equity;

5. Equity aids the vigilant, not those who slumber on their rights;

6. Equity imputes an intent to fulfill an obligation;

7. Equity acts in personam or persons;

8. Equity abhors a forfeiture;

9. Equity does not require an idle gesture;

10. He who comes into equity must come with clean hands;

11. Equity delights to do justice and not by halves;

12. Equity will take jurisdiction to avoid a multiplicity of suits;

13. Equity follows the law;

14. Equity will not aid a volunteer;

15. Where equities are equal, the law will prevail;

16. Between equal equities the first in order of time shall prevail;

17. Equity will not complete an imperfect gift;

18. Equity will not allow a statute to be used as a cloak for fraud;

19. Equity will not allow a trust to fail for want of a trustee;

20. Equity regards the beneficiary as the true owner;

21. Where the equities are equal, the first in time shall prevail;

22. Delay defeats equities;

23. Equality is equity;

24. Equity looks to the intent rather than the form;

25. Equity looks on that as done which ought to be done; and

26. Equity imputes an intention to fulfil an obligation.⁴

Since insurance contracts are based upon total good faith and trust between the parties who enter into the contract of insurance disputes concerning the meaning and application of an insurance policy are dealt with courts acting as courts of equity.

If one of the parties breaches that trust, the law allows the parties to be returned to status quo ante⁵ and act as if no policy ever existed. The law that allows the return to status quo ante is called the equitable remedy of rescission.

Rescission is a remedy that allows the parties to obtain a fair resolution to a legal problem rather than money damages. If a contract is rescinded, it is, to the law, nonexistent and never existed at all. Because rescission destroys rights people believed they had under contracts, it requires that a preponderance of evidence convince the court that it would be unfair and unreasonable to allow anyone to enforce the terms of the contract.

Property and casualty insurers in the United States are the victims of more than $100 billion of insurance fraud annually. The rescission remedy, although fraught with danger if not elected carefully, can be an effective tool against a fraudulent claim. People who are intent on perpetrating the crime of insurance fraud know crime better than they know the law of insurance or equity. The fraud perpetrator will seldom be caught setting a fire or faking an invoice because they prepared their crime carefully. The fraud perpetrator, however, with little knowledge of the law of insurance and the equitable remedy of rescission, will often err when acquiring the policy.

A mutual mistake of material fact, a unilateral mistake of material fact, a breach of warranty, a material concealment, or a material misrepresentation can all be grounds for rescission.

It is unfair to make an insurer abide by a contract that was not obtained fairly. The ancient maxim that “no one may profit from his wrong” is applied when a court is faced with a request to confirm rescission.

As an equitable remedy the party seeking rescission must deal fairly with the other party. Insurers should use the remedy with care. If an insurer elects rescission without enough evidence, it can bring the wrath of the courts down on the insurer and may be the basis for allegations of extra-contractual torts.⁶

B. Statutory Requirements for Rescission

The California Insurance Code, a model applying the Marine rule, discussed infra,first explained by Lord Mansfield in Carter v. Boehm, defines terms and the basis for rescission in California, as follows:

Ÿ Neglect to communicate that which a party knows, and ought to communicate is concealment. California Insurance Code § 330.

Ÿ A representation is false when the facts fail to correspond with its assertions or stipulation. California Insurance Code § 358.

Ÿ The effect of concealment or false representation on a policy of insurance is that it entitles the other party to rescind. California Insurance Code §§ 331 and 359.

In Arizona, rescission is grounded in statute that provides:

Misrepresentations, omissions, concealment of facts and incorrect statements shall not prevent a recovery under the policy unless:

1. Fraudulent.

2. Material either to the acceptance of the risk, or the hazard assumed by the insurer.

3. The insurer in good faith would either not have issued the policy or would not have issued the policy in as large an amount or would not have provided coverage with respect to the hazard resulting in the loss, if the true facts had been made known to the insurer as required either by the application for the policy or otherwise.⁷

In Stipcich v. Metropolitan Life Ins. Co., 277 U.S. 311, 316 (1928), the Supreme Court observed that “[i]nsurance policies are traditionally contracts uberrimae fidei (utmost good faith) and a failure by the insured to disclose conditions affecting the risk, of which he is aware, makes the contract voidable at the insurer’s option.” Life insurance companies, for example, seek a wealth of health history information from applicants because that information is extremely important to the underwriting decision. Property insurers seek details about the property, the risk of loss of which the applicant seeks to insure. Liability insurers seek detail from the applicant about the applicant himself, herself or itself and the risks of loss faced by the applicant.

C. Innocent Third Parties Also Feel the Effects of Rescission

In New York Life Ins. Co. v. Johnson, 923 F.2d 279 (3d Cir. 1991), the Third Circuit explained why an innocent beneficiary could receive no insurance benefits if grounds for rescission exist:

While a court might sympathize with a beneficiary who does not receive the proceeds of a policy obtained by the insured’s fraud, there are strong reasons of public policy supporting the rule which we believe prevails in Pennsylvania. If the only consequence of a fraudulent misrepresentation in a life insurance application is to reduce the amount paid under the policy, there is every incentive for applicants to lie. If the lie is undetected during the two year contestability period, the insured will have obtained excessive coverage for which he has not paid. If the lie is detected during the two year period, the insured will still obtain what he could have had if he had told the truth. In essence, the applicant has everything to gain and nothing to lose by lying. The victims will be the honest applicants who tell the truth and whose premiums will rise over the long run to pay for the excessive insurance proceeds paid out as a result of undetected misrepresentations in fraudulent applications.

Because of a perceived need to protect the innocent claimant, rescission will not be allowed in some cases due to a statutory enactment similar to K.S.A. 1989 Supp. 40-3118(b). “Those courts have held that rescission has been abrogated and that the only remedy for an insurance company is cancellation in strict accordance with the terms of the statute.”⁸

D. Concealment or Misrepresentation

Although an insurer has the unquestioned right to rely upon the person who seeks insurance for the information it needs to make a wise decision about whether to insure or not insure, often that right is defeated by misrepresentation.

Recall AMI Stamping, LLC, v. Ace American Ins. Co., No. 16-2341 (6th Cir. Oct. 5, 2017), already discussed in Chapter 1: the Sixth Circuit found that an insurance company was correct in rescinding a policy issued based on a misrepresentation of the insured property’s value.

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