California Court: Commercial Crime Policy Rescinded Due To Insured’s Material Misrepresentation Concerning Handling of FundsApril 18th, 2014
Kurtz v. Liberty Mutual Insurance Co., et al., Case No. 2:11-cv-7010 (C.D.Cal. April 14, 2014), was an insurance coverage dispute arising out of the downfall of Los Angeles businessman Ezri Namvar who has also been referred to as the “Bernie Madoff of Beverly Hills.” The Chapter 7 Bankruptcy Trustee for one of Namvar’s companies, Namco Financial Exchange Corp. (NFE), sued its primary and excess insurers seeking to recover over $35 million in client funds misappropriated from NFE.
The Commercial Crime Policy’s application asked, “Are proceeds from 1031 transactions held in bank accounts segregated from those of your operating funds?” NFE answered “Yes,” to this question, representing that it did in fact segregate its client funds from operating funds. In their motion for summary judgment, the insurers asserted that they were entitled to rescind their respective policies on the ground that NFE’s response to the segregation question constituted a material misrepresentation that the insurers relied upon in issuing the policies.
The insurers’ joint motion cited testimony from NFE’s own employees, as well as NFE’s broker and the underwriters, concerning the segregation requirement. The evidence demonstrated that, instead of segregating client funds, NFE maintained both client funds and operating funds in one comingled bank account. NFE argued that, because it accounted for each client’s funds separately in its internal ledgers, it answered the segregation question honestly. The court disagreed. It rejected the insured’s argument that differences between the policy provisions and the application questions created an ambiguity, and held that the question on the application was unambiguous and subject to only one reasonable construction – i.e. whether NFE maintained client funds and operating funds in segregated bank accounts. Because NFE misrepresented that it segregated operating funds from client funds on the application, and the evidence also established that this misrepresentation was material, the court held that rescission was proper.
The court rejected two additional arguments from the NFE Trustee. First, the court rejected the Trustee’s argument that the insurers were estopped from denying coverage for failure to comply with insurance regulations concerning timely responses to claims. The court held that even if the insurers did violate the regulations (which the insurers denied), estoppel did not apply because the Trustee had failed to present evidence of any reliance on the insurers’ conduct, and the Trustee could not demonstrate any harm as the policy was void ab initio due to the material misrepresentation on the application. Second, the court rejected the Trustee’s claim that the insurers could not raise rescission as a defense for failure to allege it as an affirmative defense or first tender the premiums earlier. The court held that the insurers had properly raised rescission as a defense in their answers, and that under California law an insurer may properly allege rescission as a defense to a suit filed by the insured without first tendering the premiums.