Insurer May Rescind Policy From Inception if Issued Based On False Answers to Insurance Application Questions

On July 6, 2015 the U.S. District Court for the Central District of California, based on California law, applied in the EPLI (employment practices liability insurance) setting the large body of statutory and case law holding that an insurer may rescind an insurance policy issued based on application questions the insurer later discovers were answered by the insured with misrepresentations or concealment of material information. Information is material, the court held, if it would have made a difference to the insurer in deciding whether or not to issue the policy. (Oregon Mutual Ins. Co. v. Victorville Speed Wash, Inc., 2015 U.S. Dist. LEXIS 88109.)

The operative facts were that the defendant insured operated a car wash and hired one Miguel Iglesias, first as an assistant manager, promoted him to manager and then to general manager in 2010. A female co-employee sued the car wash and Iglesias for sexual harassment. After a bench trial the court found that Iglesias had engaged in unwanted and pervasive verbal and physical conduct in the workplace that it reasonably would be considered hostile or abusive. The court entered judgment for Iglesias and the car wash, however, because the co-employee’s medical records showed she began suffering from the mental distress she claimed in the lawsuit before she started working at the car wash.
Iglesias continued to work for the car wash until October 2013, when he quit by sending the car wash an email claiming he had been mistreated. After resigning, Iglesias began filing complaints with multiple California government agencies, claiming mistreatment by the car wash.

The car wash applied to Oregon Mutual for an EPLI policy with an application form asking the car wash if it had received any employment related lawsuits, negotiated settlements, grievances, EEOC or other administrative proceedings from any regulatory authorities or any other government entities. It also asked whether the car wash was aware of any facts or circumstances which it reasonably believed may result in employment-related claims being made against the car wash. The car wash responded to both questions by writing “none.”

The insurer issued the EPLI Policy, apparently on November 5, 2013, in reliance on the veracity and completeness of the application. (The court’s opinion mistakenly states that the policy was issued November 5, 2015.) On April 8, 2014, several months after the policy was issued, the car wash tendered the defense to Oregon Mutual of a claim and potential lawsuit involving Iglesias. In the course of investigating coverage, Oregon Mutual learned for the first time of the sexual harassment litigation, Iglesias’s complaints upon resignation that he was under paid in his wages, and notices from the California Labor Commissioner and Employment Development Department regarding wage and hour allegations and unemployment insurance and from Cal/OSHA a complaint of hazardous conditions at the car wash workplace.

Oregon Mutual then sued the car wash to establish that the policy could be rescinded from its inception due to the misrepresentations and concealments in the application.

The court granted summary judgment in favor of the insurer upholding rescission of the policy from its inception. In the course of its written decision, the court relied upon California Insurance Code section 332 which imposes a duty on one applying for insurance to disclose all facts within his knowledge which are or which he believes to be material to the contract and which the other party has no means of ascertaining.

The court pointed out that if the information misrepresented or concealed is material, the insurer may rescind the policy even if the insured’s misstatements or concealments were the result of negligence, or even the product of innocence.

Whether a fact is material is by statute determined solely by the probable and reasonable influence of the facts upon the insurer in forming its estimate of the disadvantages of the proposed contract. (California Insurance Code section 334.) In other words, the test for materiality is a subjective test. The critical question is the effect that truthful answers on the application would have had on the insurer issuing the subject policy, not on some average, reasonable insurer. The fact that the insurer has demanded answers to specific questions in an application for insurance is in itself usually sufficient to establish materiality with finality.

The car wash did not dispute that it knew but failed to disclose that it continued to employ Iglesias after a court had found that he had engaged in unwanted and pervasive conduct in the workplace that a reasonable woman would have considered hostile or abusive. Nor did it contest that Iglesias’s comments in his resignation email alleged that the car wash had underpaid him and threatened civil penalties against the car wash, nor that there had been claims against the car wash by the Labor Commissioner, the EDD and OSHA. Nor did the car wash offer any evidence that the insurer would have issued the policy if it had known the true facts.

The car wash rested its opposition entirely on the contention that, as a matter of contract interpretation, the car wash reasonably believed that the application did not require it to disclose these facts in the insurance application. The court rejected the car wash’s argument that the application’s use of the term “LOSS HISTORY” indicating that the insurance company was interested only in whether the car wash had previously lost or settled an employment-related claim at a formal tribunal. Instead, the court held, the question unambiguously asked if the car wash had received notice of any employment-related proceeding, including informal grievances, or state administrative proceedings. Since the undisputed evidence showed that, in the one month preceding the application, defendant had received notice of three employment-related proceedings with various State agencies and one informal employee grievance, all of which the car wash had failed to disclose when it answered the question in the application with the word “none,” there was no basis to deny the motion for summary judgment.

The second “LOSS HISTORY” question in the application, the court held, was even less equivocal than the first, since it asked the car wash whether it was aware of any facts or circumstances that it might reasonably believe could result in employment-related practice claims being made against the car wash. In short, both “LOSS HISTORY” questions called for the very information the car wash admitted it had withheld. This information, combined with the materiality established by the underwriting evidence entitled the insurer to rescission under the policy such there is no coverage for this claim.

Richard B. Wolf is a partner in the Los Angeles office of the nationwide law firm of Lewis Brisbois Bisgaard & Smith LLP. Since 1970, Wolf has specialized in insurance coverage advice and litigation.