A federal district court has held that an insurer waived its right to rescind a policy based on material misrepresentations because at the time of the application for coverage, the insurer’s agents knew of facts that “distinctly implied” that the information provided by the insured was false or inaccurate. Star Ins. Co. v. Sunwest Metals, Inc., 2015 WL 3741305 (C.D. Cal. June 15, 2015).
The operator of a recycling collection center procured coverage under the insurer’s scrap dealer program designed to insure metal recyclers. Paper and plastic recyclers were only eligible for the program where those activities were incidental exposures. On the insured’s application, the insured’s broker indicated that the amount of paper and plastic recycling it conducted was minimal. After a fire at the insured’s facility damaged much of the property, the insured sought coverage under the policy. The insurer subsequently discovered that the paper and plastic recycling exceeded the amounts represented in the application, and therefore it sought a declaration that it was entitled to rescind two consecutive yearlong policies based on material misrepresentations about the nature of the insured’s business. The insured filed counterclaims for breach of contract and bad faith for failing to diligently conduct a fair investigation of the claim.
The court held that, under California law, an insurer may waive its right to information about material facts by neglecting to make inquiries where those material facts are “distinctly implied” in other facts communicated to the insurer. The court found that the facts at trial established that the insurer and its agents were aware of information that brought the applicant’s representations regarding the amount of paper and plastic recycling under suspicion and that would induce a prudent person to make inquiry. For example, during the application process, the insurer’s agents noticed that the insured’s web site indicated that paper and plastic were recycled on site, and the insured’s broker answered inquiries about the paper and plastic recycling with vague and imprecise responses. The insurer also received a loss control report describing the operations of the insured as purchase and sale of aluminum, glass and paper—not specifying the quantities of each. The court held that these “numerous red flags” imposed upon the insurer a duty to investigate further, and that its failure to do so amounted to waiver of its right to rescind the policies.
The court further held that, although the insurer breached the contract, it did not act in bad faith because there was a genuine dispute as to the insured’s entitlement to benefits under the policies. According to the court, the insurer had a right to investigate whether it had a basis to rescind the policies, and investigating its right to rescind while also investigating the claims did not amount to bad faith.