Insurer Entitled to Rescind Policy for Insured’s Failure to Disclose Prior Losses

The United States Court of Appeals for the Third Circuit, applying New York law, has held that an insurer was entitled to rescind a policy based on an insured’s omission of prior loss data on an insurance application.  H.J. Heinz Co. v. Starr Surplus Lines Ins. Co., 2017 WL 108006 (3d Cir. Jan. 11, 2017).

The insured, a large food products company, purchased insurance coverage for losses arising from accidental contamination or government-imposed product recalls.  In its application, the insured submitted a spreadsheet showing a loss history disclosing only one loss greater than its requested $5 million retention over a ten-year period.  Two weeks after its policy incepted, authorities informed the insured that baby food it manufactured in China was contaminated with lead.  The insured food products company notified its insurer of the loss.  The insurer then hired two consultants to investigate.  During the investigation, the insurer learned that the insured had previously incurred a loss of more than $10 million after discovering excessive levels of nitrite in baby food manufactured in China but did not disclose that loss, as well as several others, with its application.  In ensuing coverage litigation, a trial court ruled that the insurer was entitled to rescind the policy.

On appeal, the court affirmed.  First, the court applied New York law to the rescission issue in light of the New York choice-of-law clause in the policy.  In so doing, the court determined that a service-of-suit amendatory endorsement, which stated that “all matters . . . shall be determined in accordance with the law and practice of such Court,” did not modify the choice-of-law provision but instead spoke only to forum and venue.  The court also rejected the insured’s argument that the insurer ratified the policy by seeking to enforce its choice-of-law provision, ruling instead that the choice-of-law provision by its terms also applied to matters regarding the “validity” of the policy.

The court also held that there were clearly misrepresentations (in the losses omitted from the loss history) and that they were material (which the court observed to be “self-evident”).  While the court determined that the trial court erred in not requiring the insurer to prove reliance, it affirmed the ruling as harmless error given that it was “highly probable” that the outcome would be the same given the overwhelming evidence that the insurer relied upon the misrepresentations in underwriting the policy.

Finally, the court rejected the insured’s argument that the insurer waived its right to rescission.  First, the court affirmed the district court’s finding that the fact that one of the insurer’s underwriters had reviewed internet stories about certain losses that were not disclosed did not prove waiver because, without more, it “would not trigger a reasonably prudent insurer to follow-up further.”  Second, the court ruled that the insurer did not fail to promptly assert rescission after a period of investigation.  On that point, the court observed that the knowledge gained by the consultants hired to investigate the loss could not be imputed to the insurer for purposes of rescission, but even if it could, the five-month delay between their knowledge of those facts and the insurer’s claim for rescission was not unreasonable.