The Supreme Court of Montana has held that a Montana statute allowing insurers to “prevent a recovery” under an insurance policy in certain circumstances, including when the insured made misrepresentations or omissions in its application, does not provide a right to rescind the policy ab initioALPS Prop. & Cas. Ins. Co. v. McLean & McLean, PLLP, 2018 WL 3737950 (Mont. Aug. 7, 2018).  The court also held that an innocent insured attorney had a reasonable expectation of retaining attorney malpractice insurance by purchasing an extended reporting period endorsement.

A father and son practiced law together in a firm, which was insured under successive claims-made insurance policies.  Each year, the firm submitted a policy renewal application, which asked whether any insured was aware of circumstances that could reasonably be expected to be the basis of a claim.  Each year, the father answered “no” on behalf of himself individually and the firm, and the son answered “no” on behalf of himself individually.  Unbeknownst to the son, the father regularly withdrew funds from client trust accounts for his own personal use.  Once the son was alerted to his father’s thefts, he reported the matter to the Office of Disciplinary Counsel and to the firm’s insurer.  Shortly thereafter, clients began making claims against the firm and the attorneys arising out of the father’s thefts.  The insurer sent the firm and the attorneys a notice that it was cancelling the policy for nonpayment of premium.  In response, the son did not dispute that the policy had been properly cancelled but asserted that he appeared to meet the policy’s definition of an “innocent insured” and requested extended coverage after cancellation for himself alone under an extended reporting period endorsement.  Ultimately, the insurer advised that it was rescinding the policy from the date of inception on the ground that the insureds had made material misrepresentations in the applications.

The insurer then filed this lawsuit, seeking a declaration that the policy was properly rescinded or, in the alternative, that the policy did not provide coverage for the claims that had been made against the insureds.  The trial court granted summary judgment to the insurer, holding that it properly rescinded the policy from inception.  The insureds appealed.

On appeal, the court held that the relevant statute—Section 33-15-403 MCA—does not provide insurers the right to rescind a policy from inception based on material misstatements in an application, overruling prior Montana case law characterizing the statute as providing such a right.  However, the court also held that, even absent rescission, the statute does allow the insurer to deny coverage for the father and the firm based on the misstatements made by the father, on his own behalf and on behalf of the firm, in the application for insurance.

Further, the court determined that, because the policy was not rescinded, the son had a reasonable expectation of retaining attorney malpractice insurance and purchasing an extended reporting period endorsement based on the Policy’s “innocent insured” provision, which provided that the policy’s fraud exclusion did not apply to innocent insureds.