Archive for the ‘Uncategorized’ Category

New York’s Highest Court Affirms Zoning Ordinances Banning Hydrofracking

Wednesday, July 2nd, 2014

By Martin L. Eide, Sedgwick New York

The Insurance Law Blog has been following decisions related to hydraulic fracturing for potential impacts on insurance coverage issues. As we previously reported in May 2013, the New York Supreme Court, Appellate Division, upheld two zoning ordinances passed in 2011 by the Towns of Dryden and Middlefield, New York, which prohibited the exploration and production of natural gas and petroleum – including hydraulic fracturing, or hydrofracking. On June 30, 2014, the New York Court of Appeals affirmed the Appellate Division’s ruling finding that the New York Oil, Gas and Solution Mining Law’s (“OGSML”) supersession clause does not preempt “home rule” authority vested in the Towns to regulate land use. 

In Matter of Mark Wallach, as Chapter 7 Trustee for Norse Energy Corp. USA, v. Town of Dryden, et al., and Cooperstown Holstein Corp., v. Town of Middlefield, – N.Y.3d –, (June 30, 2014), the New York Court of Appeals affirmed the Appellate Divisions’ May 2013 decision upholding summary judgment in favor of Dryden and Middlefield which passed zoning ordinances banning natural gas and petroleum production operations.  The ordinances were established in 2011, and subsequently challenged by natural gas exploration companies alleging that the ordinances were preempted by the OGSML which, among other things, regulates the production and storage of oil and natural gas.  The trial courts disagreed with the production companies’ preemption arguments, and granted cross-motions for summary judgment in favor of the Towns because the zoning ordinances in question only limit the use of land and do not attempt to regulate the manner in which oil and gas is extracted under the OGSML.  The Third Department affirmed in May 2013, finding that the OGSML does not expressly preempt the local zoning regulations which did not limit the methods and means of mining proscribed by the OGSML, but merely limited where mining could occur.  Thus, the local zoning ordinances at issue were reasonable uses of the Towns’ home rule powers established pursuant to Article 9 of the New York Constitution.

In its opinion, the Court of Appeals affirmed finding that the OGSML’s supersession clause does not preempt the Town’s home rule power to regulate industrial land use, preserve a communities’ characteristics, and protect the health, safety and welfare of the community as a whole.  In particular, the Court of Appeals rejected the appellants’ arguments based on a three-pronged test previously discussed in Matter of Frew Run Gravel Prods. v. Town of Carroll, 71 N.Y. 2d 126 (1987).  In Frew Run, the Court of Appeals found that the Town of Carroll’s ordinance which restricted mining operations from a certain portion of the Town did not conflict with the Mined Land Reclamation Law (MLRL).  The Court of Appeals analyzed the plain language of the MLRL’s supersession clause, the statutory scheme of the MLRL as whole, and the MLRL’s legislative history to determine if the ordinance interfered with the MLRL.  The Court of Appeals found that the MLRL did not preempt a town’s ability to regulate land use because the New York Legislature passed the MLRL to regulate only the means and methods of extractive mining operations, and not where those operations could occur.

Here, the Court of Appeals applied the test in Frew Run and found that the plain language of the OGSML’s supersession clause, the statutory scheme as a whole, and the legislative history only focus on regulating the means and methods of gas, oil, and mining operations and not the location of where such operations could occur.  Therefore, the OGSML does not preempt the Towns’ home rule power to regulate land use and exclude gas and oil production operations.

The Court of Appeals also rejected the appellants’ secondary argument.  In this regard, the appellants argued that land use ordinances may only limit hydrofracking operations from certain portions of the Towns (i.e., residential areas) because a complete ban would run afoul of the OGSML and essentially, regulate the oil and gas industry.  The Court of Appeals disagreed, relying on Matter of Gernatt Asphalt Prods. v. Town of Sardinia, 87 N.Y.2d 668 (2006), a decision that follows Frew Run.  In Gernatt Asphalt, the Town of Sardinia amended its zoning ordinance to prohibit all mining operations following the New York State Legislature’s revision of the MLRL in accordance with Frew Run.  As a result of the Town’s amendment, a mining operator challenged the prohibition based on the MLRL’s supersession clause.  The Court of Appeals rejected the mining company’s challenge, finding that nothing in Frew Run or the MLRL obligates a town to permit mining just because minerals are available to be mined as a natural resource.

The Court of Appeals found that the restrictions at issue here are no different in substance to the ordinances passed by the Town of Sardinia and upheld in Gernatt Asphalt.  In addition, Dryden and Middlefield acted reasonably because they each studied the potential negative effects that hydrofracking may have on the character of their respective communities prior to enacting the ordinances.

Sedgwick tracks local and national developments in hydraulic fracturing in its newsletter, Hydraulic Fracturing Digest. Prior issues can be found here.

 

 

New York Court of Appeals Upholds Ban on Hydraulic Fracturing

Monday, June 30th, 2014

For readers following the developments in hydraulic fracturing and the potential insurance coverage implications, we have been tracking litigation in New York involving zoning ordinances passed by the Town of Dryden and the Town of Middlefield, and most recently reported on the litigation in our Hydraulic Fracturing Digest in January 2014.  Readers may recall that an appellate court decision issued on May 3, 2013, had upheld the zoning ordinances prohibiting the exploration and production of natural gas and petroleum.  Today, the New York Court of Appeals, the state’s highest court, affirmed the decisions.  We are reviewing the court’s decision and will provide further analysis in the Hydraulic Fracturing Digest.

New York High Court Finds that New York Insurance Law §3420(d)(2)’s Prompt Notice Requirement Does Not Extend to Claims Limited to Environmental Damage

Wednesday, June 11th, 2014

By Martin L. Eide, Sedgwick New York

In KeySpan Gas East Corp. v. Munich Reinsurance America, Inc., et al., — N.Y.3d –, (N.Y. June 10, 2014), a case involving two environmental damage claims, the New York Court of Appeals reversed an appellate decision which found that three excess insurance carriers had waived their right to disclaim insurance coverage for failure to timely raise late notice as an affirmative defense, citing N.Y. Insurance Law § 3420(d)(2).

KeySpan arises out of the clean-up and remediation of two former manufactured gas plants (“MGP”) located in Bay Shore and Hempstead, New York which were operated by the Long Island Lighting Company (“LILCO”).  LILCO initially notified its excess insurance carriers of potential environmental liabilities in connection with the two MGPs and sought indemnification for environmental damages.  In response, the carriers issued broadly worded reservation of rights letters to LILCO, including the right to disclaim coverage based on late notice, and requested additional information regarding the MGP sites.  LILCO provided additional information to the carriers in compliance with their request for information, but the carriers did not issue supplemental coverage position letters. 

Later, LILCO filed a declaratory judgment action in New York state court seeking indemnity for damages arising out of the cleanup and remediation of the MGPs.  Each carrier answered the complaint and asserted late notice as an affirmative defense – this defense had not previously been asserted as basis for a coverage disclaimer.  On cross motions for summary judgment, the trial court found that the carriers had no duty to indemnify LILCO for the Bay Shore site because of LILCO’s late notice of an occurrence.  But, as to the Hempstead site, the court denied the carriers’ motion because the reasonableness of LILCO’s notice was a disputed issue of fact.  Further, the trial court rejected LILCO’s claim that the carriers’ late notice defense, as asserted for the first time in the answers to the complaint, was untimely.  Following this decision, KeySpan received an assignment from LILCO to pursue the MGP claims and was added as a party to the litigation.

On appeal, the Appellate Division, Second Department, modified the trial court’s order by vacating the declaration in favor of no coverage for the Bay Shore site, but otherwise affirmed the order.  In this regard, the Appellate Division noted that issues of fact existed regarding the carriers’ coverage investigation, including whether coverage disclaimers should have been issued to LILCO as soon as reasonably possible after LILCO provided additional information to the carriers as requested in their reservation of rights letters.         

The carriers appealed to the New York Court of Appeals regarding whether the Appellate Division incorrectly applied the timeliness standard under section 3420(d)(2) when considering whether defendants had waived their rights to disclaim based on LILCO’s late notice of the MGP claims. 

The Court of Appeals analyzed the plain language of section 3420(d)(2), its legislative history, and controlling New York case law interpreting the law, and held that the statute does not extend to environmental damage claims.  The court noted that “[t]he environmental contamination claims at issue in this case do not fall within the scope of Insurance Law § 3420 (d)(2), which the Legislature chose to limit to accidental death and bodily injury claims, and it is not for the courts to extend the statute’s prompt disclaimer requirement beyond its intended bounds.”  The court also mentioned, in a footnote, that certain cases that may have extended section 3420(d)(2) to apply to claims that were not based on death or bodily injury “were wrongly decided and should not be followed.”  See Estee Lauder Inc. v. OneBeacon Insurance Group, LLC, 62 A.D.3d 33 (1st Dep’t 2009); Hotel des Artistes, Inc. v Gen. Accident Ins. Co. of Am., 9 AD3d 181, 193 (1st Dep’t 2004), leave dismissed 4 N.Y.3d 739 (2004); Malca Amit N.Y. v Excess Ins. Co., 258 A.D.2d 282,282 (1st Dep’t 1999).

 

So A Man Walks Out of a Bar . . . Applying the Liquor Liability Exclusion to a Drunken Pedestrian

Wednesday, April 30th, 2014

By Jason Chorley, Sedgwick San Francisco

In State Automobile Mutual Ins. Co. v. Lucchesi, ___ Fed. Appx. ___, 2014 WL 1395690 (3d Cir. Apr. 11, 2014), the U.S. Court of Appeals for the Third Circuit upheld summary judgment for State Auto and concluded that a liquor liability exclusion in a general liability policy precluded coverage for bodily injuries sustained by a bar patron hit by a taxi after leaving the bar.

State Auto issued a commercial general liability policy to the owners of Champs Sports Bar & Grill, located in State College, Pennsylvania.  The policy contained a liquor liability exclusion precluding coverage for “damages” an insured became obligated to pay because of “bodily injury” for which the insured was held liable because of “causing or contributing to the intoxication of any person,” “furnishing of alcoholic beverages to a person … under the influence of alcohol,” or violating a “statute … relating to the sale, gift, distribution, or use of alcoholic beverages.”

One night, Clinton Bonson was drinking at Champs and left the bar on foot.  While crossing a major thoroughfare, he was hit by a speeding taxi and seriously injured.  Bonson sued Champs, its owner, and two former bartenders, alleging that Champs was liable for his injuries because it:  (1) failed to cut Bonson off, which enhanced his degree of intoxication; and (2) allowed Bonson to leave the bar intoxicated.  Although State Auto initially provided a defense subject to a reservation of rights, it filed a declaratory relief action in Pennsylvania federal court and sought summary judgment based on the liquor liability exclusion.  Champs conceded that the liquor liability exclusion applied to the bar’s furnishing of alcohol to Bonson in excess, but argued that it did not apply to Bonson’s claim that Champs let Bonson leave the bar while intoxicated.  The district court granted summary judgment in favor of State Auto, noting that the claims were inextricably intertwined, and that the sole basis for the claims was the service of alcohol.

On appeal, the Third Circuit noted that every claim in Bonson’s complaint sought damages for the bodily injury he suffered when he was hit by the taxi.  Rejecting the same argument Champs made before the district court (i.e., that the exclusion did not apply to Bonson’s claim that he was allowed to leave the bar while intoxicated), the court stated that “if coverage of the former claim is excluded, so is coverage of the latter, as both claims see ‘damages because of’ the exact same ‘bodily injury.’”

California Court: Commercial Crime Policy Rescinded Due To Insured’s Material Misrepresentation Concerning Handling of Funds

Friday, April 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.

Accordingly the court granted judgment for the insurers. Sedgwick’s Michael R. Davisson, Susan Koehler Sullivan and Ira Steinberg represented one of the defendant insurers.

Florida High Court Liberally Construes Self-Insured Retention Endorsement

Thursday, April 10th, 2014

By Robert C. Weill, Sedgwick Fort Lauderdale

The Florida Supreme Court has taken a liberal view of self-insured retentions (SIRs), recently holding that an insured can apply indemnification payments from a third party to satisfy its SIR under a general liability policy. See Intervest Constr. of Jax, Inc. v. Gen. Fid. Ins. Co., 39 Fla. L. Weekly S75, 2014 WL 463309 (Fla. Feb. 6, 2014) (to read the slip opinion click here). The Court decided the case on two certified questions from the Eleventh Circuit Court of Appeals.

General Fidelity issued a general liability insurance policy to a homebuilder with a SIR of $1 million. The SIR endorsement indicated that General Fidelity would provide coverage only after the insured had exhausted the $1 million SIR. The homebuilder contracted with a third-party to, among other things, install attic stairs in a house under construction. The contract between the homebuilder and the subcontractor contained an indemnification provision requiring the subcontractor to indemnify the homebuilder for any damages resulting from the subcontractor’s negligence.

After the house was built, the homeowner fell while using the attic stairs and sued only the homebuilder for her injuries. The homebuilder sought indemnification from the subcontractor. Following mediation the parties and their insurers agreed to settle the homeowner’s claim for $1.6 million with the subcontractor’s insurer paying the homebuilder $1 million to settle the homebuilder’s indemnification claim against the subcontractor; the homebuilder would then pay the $1 million to the homeowner. A dispute then arose as to whether the homebuilder or its insurer was responsible for paying the $600,000 settlement balance.

The homebuilder argued that the $1 million contribution from the subcontractor’s insurer satisfied its SIR obligation, and General Fidelity was required to pay the remaining $600,000. General Fidelity, on the other hand, argued that the $1 million payment to settle the indemnity claim did not reduce the SIR because the payment originated from the subcontractor, not its insured. Thus, General Fidelity maintained that the terms of the policy required its insured—the homebuilder—to pay the additional $600,000 to settle the homeowner’s claim.

The Court adopted the position advanced by General Fidelity. Although the SIR endorsement required the payment to be “made by the insured,” the court looked to other policies’ SIR provisions that contained more restrictive language. These other policies specify that the SIR must be paid from the insured’s “own account” or make clear that payments from additional insureds or insurers could not satisfy the SIR. Because the General Fidelity policy did not employ this more restrictive language, the court took a more expansive view of General Fidelity’s SIR endorsement.

The second prong of the dispute centered around whether the transfer of rights provision in the General Fidelity policy gave General Fidelity priority over its insured to the $1 million that the subcontractor’s insurer paid. If it did, then the homebuilder could not claim the $1 million as satisfying the SIR. The majority found that the provision did not give General Fidelity priority over its insured. The majority rested it conclusion on the fact that the provision “does not address the priority of reimbursement nor does the clause provide that it abrogates the ‘made whole doctrine.’”

Justices Polston and Canady dissented. They believed the majority had “rewritten” the SIR provision “to allow satisfaction of the self-insured retention limit in a manner other than the manner specifically provided for in the policy.” They also characterized the majority’s reasoning as creating a “legal fiction” that “effectively reads the phrase ‘by you’ out of [the SIR endorsement].”

 

Washington Insurance Law: 2013 Year in Review

Tuesday, January 21st, 2014

2013 was a particularly eventful year in Washington insurance law. This paper, authored by Sedgwick Seattle’s Robert Meyers, summarizes the holdings of several notable Washington insurance decisions that were filed in 2013.  Download a copy of the paper here. 

In June 2013, Bob gave a webinar on The State of Bad Faith in Washington.   The WA program, and the others in our bad faith series, are are available for on demand viewing.  Please click here to request a link.

Straight Talking in Texas: The Contractual Liability Exclusion Means What It Says and Says What It Means

Friday, January 17th, 2014

By Kim Steele and Neil Rambin, Sedgwick Dallas

According to prominent insurance commentator, Randy Maniloff, Ewing Construction Co., Inc. v. Amerisure Insurance Co. was “probably the most closely watched coverage case in the country” in 2013.  This is no longer, as the Texas Supreme Court issued its opinion today, reversing the Southern District of Texas’ 2011 decision and holding that the contractual liability exclusion found within the standard CGL policy does not apply to a general contractor’s contractual promise to perform its work in a good and workmanlike manner. Ewing Const. Co., Inc. v. Amerisure Ins. Co., — S.W.3d —- (Tex. Jan 17, 2014) (NO. 12-0661).

Ewing was the general contractor hired by the Tuloso-Midway Independent School District to renovate and build additions to a school in Corpus Christi, Texas, including the construction of tennis courts at the school.  Shortly after Ewing’s completion of the tennis courts, the District complained that the courts were flaking crumbling and cracking.  It eventually sued Ewing for faulty construction, asserting claims for breach of contract and negligence, among others. Ewing tendered the lawsuit to its CGL carrier, Amerisure, seeking a defense and indemnity. Amerisure denied any duty to defend arguing, in part, that coverage was precluded by the “contractual liability” exclusion in its policy because Ewing had agreed in its contract with the District to build the tennis courts in a good and workmanlike manner, and failed to do so.  As a result, Ewing filed suit against Amerisure seeking a declaration that it had an obligation to defend Ewing, and in failing to do so Amerisure breached its duty to defend and violated Texas’ Prompt Payment of Claims Act. Amerisure counterclaimed, seeking a declaration that it had no duty to defend or indemnify Ewing.

Judge Janis Graham Jack of the Southern District of Texas broadly construed the Texas Supreme Court’s decision in Gilbert Texas Construction, L.P. v. Underwriters at Lloyd’s London, 327 S.W.3d 118 (Tex. 2010), and held that the contractual liability exclusion applied to preclude coverage for the claims against Ewing because “Ewing assumed liability with respect to its own work on the subject matter of the contract, the tennis courts, such that it would be liable for failure to perform under the contract if that work was deficient.” Ewing appealed that decision to the Fifth Circuit Court of Appeals which initially affirmed, but then on rehearing changed course, and withdrew its opinion and certified two questions to the Supreme Court of Texas:

1. Does a general contractor that enters into a contract in which it agrees to perform its construction work in a good and workmanlike manner, without more specific provisions enlarging this obligation, “assume liability” for damages arising out of the contractor’s defective work so as to trigger the Contractual Liability Exclusion.

2. If the answer to question one is “Yes” and the contractual liability exclusion is triggered, do the allegations in the underlying lawsuit alleging that the contractor violated its common law duty to perform the contract in a careful, workmanlike, and non-negligent manner fall within the exception to the contractual liability exclusion for “liability that would exist in the absence of contract.”

The Supreme Court answered “no” to the first question, thereby mooting the second.

The contractual liability exclusion in the Amerisure policy excluded claims for damage premised upon an insured’s contractual assumption of liability except when: (1) the insured’s liability would exist absent the contract, and (2) the contract is an “insured contract.”  Ewing maintained that its agreement to construct the tennis courts in a good and workmanlike manner did not add anything to its general obligation to comply with the contract’s terms and exercise ordinary care in doing so.  As a result, it argued that its express agreement to perform the construction in a good and workmanlike manner was not an “assumption of liability” within the meaning of the policy’s contractual liability exclusion.  The Supreme Court agreed, concluding that the allegations that Ewing failed to perform in a good and workmanlike manner were substantively the same as its claims that it negligently performed under the contract. The court ultimately held that “[a] general contractor who agrees to perform its construction work in a good and workmanlike manner, without more, does not enlarge its duty to exercise ordinary care in fulfilling its contract, thus it does not ‘assume liability’ for damages arising out of its defective work so as to trigger the contractual liability exclusion.”

The Supreme Court’s message in the Ewing decision is clear: the contractual liability exclusion will not apply to exclude coverage for a contractor’s violation of duties generally owed to its clients, irrespective of its contract.  Rather, it will only apply in cases where the contractor assumed atypical liabilities more akin to the contractual duties at issue in Gilbert.

West Virginia Reverses Course, Concludes that Faulty Workmanship is Covered Under a CGL Policy

Thursday, June 27th, 2013

By Aaron F. Mandel, Sedgwick New York

Last week, the Supreme Court of Appeals of West Virginia issued an opinion holding that faulty construction work qualifies as an “occurrence” under a CGL policy if it causes “bodily injury” or “property damage.” Cherrington v. Erie Insurance Property & Casualty Co., — S.E.2d —, 2013 WL 3156003 (W. Va. June 18, 2013). Cherrington reverses approximately 14-years’ worth of precedent concluding that CGL policies did not cover faulty workmanship.

For a full analysis of Cherrington and other recent case law addressing the “occurrence” issue in the context of faulty construction work, be sure to check out Sedgwick’s Construction Defect Coverage Quarterly when it drops next month.

Prior issues of the Construction Defect Coverage Quarterly can be found here.

  

First Circuit Permits Insurer to Retain Policy Premiums Despite Rescission

Wednesday, May 15th, 2013

By Aaron F. Mandel, Sedgwick New York

Courts often require insurers to return premiums (or at least offer to return them) when rescinding an insurance policy.  Some states may even require it under statute.  The reason is that rescission is an equitable remedy intended to place the parties in the same position they were before the policy was issued, and the insurer obviously does not receive any premiums until the policy is issued.  On Monday, the U.S. Court of Appeals for the First Circuit rejected this general rule and determined that an insurer was entitled to retain premiums as special damages when it seeks to rescind an insurance policy based on rampant fraud.

In PHL Variable Insurance Co. v. P. Bowie 2008 Irrevocable Trust, No. 12-2243, 2013 WL 1943820 (1st Cir. May 13, 2013), an insurance broker (“Rainone”) and an attorney acting on behalf of a trust (“Baldi”) submitted an application on behalf of Peter Bowie seeking a $5 million life insurance policy naming the trust as the beneficiary.  The application stated that Bowie had an annual salary of $250,000, and a personal net worth of approximately $7.5 million.  Rainone and Baldi represented that the policy premiums would not be paid by any third-party, the policy was not being purchased as part of any program to transfer the policy to a third-party within the first five years, and neither Bowie nor the trust had any agreement for any other party to take legal or equitable title to the policy.  Bowie confirmed this information to a third-party inspector working for PHL, and PHL issued the policy. 

The representations made by Rainone, Baldi, and Bowie were false.  Bowie turned out to be a retired city worker, used car salesman, and blackjack dealer who did not have a personal net worth anywhere near the $7.5 million he, Rainone, and Baldi claimed.  Bowie also could not personally afford the policy’s premium.  The premium was actually being paid by a company (“Imperial”) “whose business model consists of lending money to pay for life insurance policy premiums and, when borrowers default on those loans, taking possession of the policies as collateral”; indeed, Imperial’s loan terms made its loans virtually impossible to pay back.  A subsequent amendment to the trust documents provided that the policy would be assigned to Imperial if its loan was defaulted on and, if PHL rescinded the policy, any premiums refunded to the trust would be delivered to Imperial.

PHL eventually discovered the scheme and filed an action against the trust in the U.S. District Court for the District of Rhode Island seeking to rescind the policy.  PHL also sought to obtain the premiums paid in order to offset the damages it suffered in connection with issuing the policy.  These included costs to underwrite and issue the policy, payment of commissions and fees in connection with issuing and servicing the policy, costs incurred to investigate the scheme, and costs to initiate its rescission action.  Alternatively, PHL advised that it was ready, willing, and able to refund the premiums if the court required it to do so, and tendered the premium into the court’s registry.

Resolving cross-motions for summary judgment filed by PHL and the trust, the court determined that the sole issue was whether PHL was required by law to return the premiums, or if the court’s equity powers enabled it to permit PHL to retain the premiums as special damages.  The court determined that it could permit PHL to retain the premiums, and the trust appealed.  The First Circuit affirmed. 

Initially, the court rejected the trust’s argument that Rhode Island case law required an insurer to return premiums when seeking to rescind an insurance policy.  The court instead determined that the case law “do[es] not stand for such a broad and inflexible proposition,” and focused on equity principles that Rhode Island law permits courts to consider in attempting to make whole a party defrauded into entering a contract.  Those principles include: (1) rescission seeks to create a situation the same as if no contract ever existed; (2) parties should gain no advantage from their own fraud; and (3) a court in equity can grant all relief necessary to make the aggrieved party whole so long as it is permitted by the pleadings.  Because it concluded that PHL was deceived into issuing the policy as the result of a conspiracy, the First Circuit determined that:

these equitable principles provide ample support for the district court’s decision to make PHL whole by allowing it to retain the premium.  PHL paid a commission to Rainone of $172,365 that it would not have paid but for the misrepresentations that led it to issue the Policy.  Mere rescission of the contract would not have compensated PHL for this expense.  While PHL apparently did not provide a precise accounting of the other costs in incurred with respect to the Policy, it was reasonable for the district court to conclude that the costs alleged in PHL’s complaint — including underwriting, administration, and servicing of the Policy, as well as investigation into the misrepresentations in the application — justified awarding PHL the remaining $19,635 from the premium, particularly in light of the Trust’s fraud.

Although insurers generally are permitted to rescind policies only when there is no other adequate remedy at law, PHL Variable acknowledges that even permitting an insurer to rescind may not make it whole.  Rescission by itself does not compensate the insurer for all of the costs necessary to issue a policy, and even qualifying those costs as “overhead” does not acknowledge the insurer’s lost opportunity costs.  Accordingly, unless a statute or case law absolutely requires an insurer to return premiums in order to rescind its policy, insurers should consider their right to retain premiums as special damages.

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