Insurer May Not Rescind Renewal Policy Based on Misrepresentations in Prior Policy’s Application

An Illinois intermediate appellate court, applying Illinois law, has held that a renewal insurance policy may only be rescinded based on material misrepresentations made in the renewal application, and not based on misrepresentations made in applications for prior policies.  Ill. State Bar Ass’n Mut. Ins. Co. v. Rex Carr Law Firm, 2017 WL 2806126 (Ill. App. Ct. June 27, 2017).  The court also held that application of the policy’s prior knowledge provision depended on the insured law firm’s subjective expectation of whether the relevant circumstance might lead to a claim.

Several investors in a security company retained the insured law firm in connection with a dispute with another group of investors that was operating the company.  The investors represented by the insured firm filed a suit against the operating investors and a second suit against eight companies they alleged had conspired with the operating investors.  Both were transferred to the same court under a forum selection provision in a prior release among the investors.  The court granted summary judgment in favor of the defendants, holding that the prior release, which had been executed before the plaintiff investors retained the insured law firm, was valid and enforceable.  The release contained a fee-shifting provision, and the court awarded fees to the defendants.  It also held that the plaintiff investors’ attorneys were jointly and severally liable with their clients as to a portion of the fees.

The plaintiff investors sued the insured law firm, broadly alleging professional negligence and seeking damages in the amount of the fees awarded against them.  The insured law firm tendered the claim under its lawyers professional liability policy, and its insurer sought a declaratory judgment that it had no duty to defend and sought to rescind the policies it had issued to the insured firm.  After the trial court entered summary judgment in favor of the insured firm, the insurer appealed.

The intermediate court of appeals held that the insurer could not rescind coverage based on the insured’s omission of a prior malpractice claim from its application for its 2008 policy.  The insurer contended that, had the insured firm disclosed the earlier suit, it would not have issued the 2008 policy or the renewal policies, including the 2012 policy, under which the instant claim was tendered.  The court held, however, that each renewal policy is a new contract, and that under the Illinois Insurance Code, only material misrepresentations made with respect to the relevant policy may form the basis for rescission.

The insurer also contended that the claim against the insured firm did not seek Damages, because the policy excluded “legal fees, costs or expenses paid or incurred by the claimant” from the definition of Damages.  The court noted, however, that the allegation of damages from the insured firm’s professional negligence was open-ended and not limited solely to the legal fees.  Resolving any doubt in favor of the insured, the court held that the complaint stated facts that were potentially within the coverage of the policy.

Finally, the insurer contended that the policy’s prior knowledge provision precluded coverage, because the insured firm had knowledge that the court in the underlying action had granted summary judgment in favor of the defendants prior to the inception of the relevant policy.  The court held, however, that a subjective standard applied to both inquiries, regarding the insured’s actual knowledge of the circumstances and the expectation as to whether a claim may result.  The court found no evidence that the insured law firm had known that its clients might pursue a claim arising out of the entry of summary judgment against them.  The appellate court therefore affirmed the trial court’s entry of judgment in the insured firm’s favor.