Second Circuit Upholds Trial Win for Insurer Rescinding Policy

In a win for Wiley Rein’s client, the Second Circuit has upheld a judgment declaring an accountants professional liability policy to be void ab initio based on material misrepresentations in the insured’s application for coverage.  Continental Cas. Co. v. Boughton, 2017 WL 2416902 (2d Cir. June 5, 2017).  The appellate court held that (1) the district court correctly granted summary judgment in favor of the insurer on the claimants’ ratification defense; and (2) the district court did not commit reversible error in instructing the jury during the trial on whether the insurer unreasonably delayed in pursuing rescission.

The insured, an accounting firm, submitted an application for professional liability coverage that contained several materially false answers, including a representation that none of the firm’s owners or partners were aware of any act, omission, or circumstance that might reasonably be expected to be the basis of a claim or suit.  In reality, two principals of the firm were involved in a complex Ponzi scheme in which they solicited firm clients to participate in a nonexistent investment opportunity.  After the SEC brought a civil enforcement proceeding against the two principals and after one of the principals was indicted on criminal charges, the insurer sought rescission of the policy due to the material misrepresentations in the application.  Two of the firm’s former clients intervened in the rescission lawsuit after entering into an assignment of rights agreement with one of the firm’s principals.

Before trial, the district court granted partial summary judgment in favor of the insurer, determining that it had not ratified the policy by taking various affirmative acts before seeking rescission.  The case proceeded to trial as to whether the insurer had unreasonably delayed in filing for rescission.  After a three-day trial, the jury found in favor of the insurer, answering, “NO!” to the question on the jury verdict form asking whether the claimants had proved that the insurer unreasonably delayed.  The jury deliberated for just 64 minutes.  The claimants appealed.

In its decision affirming the judgment, the Second Circuit rejected the claimants’ argument that the insurer had ratified the policy by taking various affirmative acts before seeking rescission, including by paying some of the insured’s defense costs and by offering an extended reporting period.  The appellate court reasoned that New York law required the insurer to continue performing its coverage obligations until a judicial determination that the insurer could rescind the policy.  Further, the court held that “[m]inisterial changes,” such as amending the insured’s name and address on the policy, could not serve as ratifying acts.  Finally, the court held that the claimants had waived any argument that the insurer ratified the policy by disclaiming coverage for certain of the Ponzi scheme-related claims in an earlier letter.

As to the jury verdict, the claimants argued on appeal that the district court had incorrectly instructed the jury as to when an insurer must seek rescission.  The appellate court noted that the difference between the claimants’ proposed instruction and the actual instruction delivered to the jury was “vanishingly small and insufficient to justify a new trial.”  The appellate court also rejected the claimants’ argument that the district court had incorrectly placed the burden of proof on the claimants to demonstrate that the insurer had not promptly rescinded.  The court held that, even if the jury instruction on the burden of proof was incorrect, the error was harmless when viewing the instructions as a whole and in light of the jury’s “speedy and emphatic verdict.”

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