Applying Georgia law, a federal district court has held that rescission of an insurance policy based on a material misrepresentation in the application voids all provisions of the policy, including the “innocent insured” provision, such that the insureds who had no knowledge of the fraud cannot rely on that provision to preserve coverage for themselves. ProAssurance Cas. Co. v. Smith, 2016 WL 4223666 (S.D. Ga. Aug. 9, 2016).
In June 2014, one of the two named partners of a law firm completed a renewal application for professional liability coverage. As part of that application, the partner represented on behalf of the firm that there were “no circumstances, acts, errors or omissions of which [he] was aware that have been or could result in a professional liability claim.” As it turns out, however, several months earlier, that partner had forged the signatures of two clients, settled their claims without their knowledge and deposited the resulting $500,000 in settlement funds into his personal account. In light of these undisputed facts, the court found that his representation on the application regarding acts that could result in a malpractice claim was both objectively false and material, entitling the insurer to rescind the “entire policy” that had been issued to the firm.
The law firm and the other named partner argued that because they had no knowledge of the theft or of the falsity of the representation on the application, the policy was not rescinded as to them. In support of this position, they pointed to the policy’s “innocent insured” provision, which stated that “if a claim is made involving the dishonest, criminal … or fraudulent act, error or omission of an Insured, this policy will apply to any Insured who did not participate [or] acquiesce in … such acts, errors or omissions.” The court rejected the insureds’ argument, holding that because the policy is void on account of a material misrepresentation in the application, “the innocent insured provision is inapplicable [as] there … never was a contract for insurance.” In reaching this conclusion, however, the court did note that an insurer may agree to limit its right to rescind to an insured who knew of a falsity in the application for coverage with express language to that effect, but no such language existed in the policy at issue.