Under New Jersey law, an insurer may rescind an insurance policy if the insured makes a material misrepresentation in connection with obtaining the policy. An insured’s misrepresentation is material if when made a reasonable insurer would have considered the misrepresented fact relevant to its concerns and important in determining its course of action. When a policy is rescinded, it is considered void ab initio. In other words, it is treated as if it never existed.
Courts have held that the omission of an insured’s name from an insurance application constitutes a material misrepresentation. For instance, an application for automobile insurance often requires a prospective insured to list all licensed and unlicensed drivers residing with the insured. Failure to identify an individual residing with the insured may entitle the insurer to rescind the policy.
When the rescission involves a liability policy, an issue that frequently arises is what happens if an innocent third-party is injured by the insured prior to rescission of the policy. At the time the incident occurs the policy is in effect. Once it is rescinded, however, it is as if it never existed.
With respect to auto liability policies, the rule has long been that an insurer is still liable to innocent third parties even if the policy at issue is subject to rescission based on the insured’s misrepresentations. That rule was once again revisited by the New Jersey Supreme Court in Citizens United Reciprocal Exchange v. Perez, which was decided on August 13, 2015.
The insured in that case, Sabrina A. Perez, applied for a “basic” automobile liability policy from Citizens United Reciprocal Exchange (“CURE”). Prior to 1998, all New Jersey drivers were required to obtain auto insurance providing mandatory bodily injury liability coverage of at least $15,000 per person and $30,000 per accident. Such a policy was known as a “standard” auto policy. In 1998, however, the law was changed to allow drivers to obtain a “basic” policy of auto insurance. The “basic” policy does not mandate bodily injury liability coverage, although applicants have the option of purchasing $10,000 in such coverage. Ms. Perez purchased a “basic” policy with the optional $10,000 in bodily injury liability coverage.
Although the application for insurance asked Ms. Perez to list all household residents who were old enough to drive, she failed to disclose that she lived with her boyfriend and father of her two children, Luis Machuca. Had she disclosed that he lived with her, CURE would not have issued the policy given his poor driving record.
While driving Ms. Perez’s car, Mr. Machuca was involved in an accident with Dexter Green. Both Messrs. Green and Machuca sued Ms. Perez for the injuries they sustained in the accident. CURE denied coverage for the claims and advised Ms. Perez that it was rescinding the policy. CURE subsequently filed a declaratory judgment action, seeking a determination that it had no obligation to provide coverage under the policy.
Ms. Perez and Mr. Machuca failed to enter an appearance in the action and a default judgment was entered against them. The trial court awarded CURE attorney’s fees and costs, finding that Ms. Perez violated the New Jersey Insurance Fraud Prevention Action by failing to identify Mr. Machuca as a resident of her household. The court also concluded that Mr. Machuca was responsible for the misrepresentation and, therefore, held that he was not entitled to coverage.
Mr. Green’s auto insurance company, Progressive Garden State Insurance Company (“Progressive”), agreed to defend him and entered an appearance on his behalf. The parties agreed to try the case on stipulated facts. The trial court held that CURE was entitled to rescind the policy, but that it was nonetheless liable to Mr. Green. Despite the fact that the policy limited liability to third parties to $10,000, the court held that CURE was liable to provide $15,000 in coverage.
The court determined that $15,000 was the minimum coverage mandated by law, despite the fact that Ms. Perez had purchased a “basic” and not a “standard” policy. Surprisingly, the Appellate Division affirmed. One judge dissented, however, correctly noting that the policy at issue was a “basic” policy that limited liability coverage to $10,000.
On further appeal, the New Jersey Supreme Court reversed. The court framed the issue before it as “whether the issuer of a basic automobile insurance policy, voided due to a fraudulent application, must pay the liability claim of innocent third parties.” The court held that although CURE was entitled to rescission, it was still obligated to provide coverage to Mr. Green.
However, the court held that the Appellate Division incorrectly ruled that CURE was liable in the amount of $15,000. The court noted that “[a]n insured’s fraud should not enhance recovery by a third party.” Rather, the court held that the insurer’s liability should be determined as it would have been had the policy not been rescinded. Thus, liability should have been limited to $10,000.
Allowing an innocent third party to recover under an insurance policy that has been rescinded is based on the fiction that the third party relied on the fact that the other driver had insurance. As noted, prior to 1998 every driver was required to maintain insurance providing bodily injury liability coverage of at least $15,000 per person and $30,000 per accident. Thus, there was some basis for that “fiction.” Things changed, however, in 1998. Drivers are no longer required to obtain bodily injury liability coverage. Thus, it can no longer be argued that third parties “rely” on the fact that all drivers have such coverage.
Nonetheless, the New Jersey Supreme Court refused to modify the law to reflect that fact. Rather, it simply held that the insurer’s liability was limited to the amount of coverage actually purchased by the insured. Because such coverage is no longer mandated, an injured party will not be entitled to recover if an insured, unlike Ms. Perez, chooses not to purchase such coverage.
As a side note, this case essentially involved a dispute between two insurance companies, CURE and Progressive. It is somewhat surprising that the parties appealed what was at most a $15,000 case all the way to the New Jersey Supreme Court. Legal fees alone must have far exceeded that sum. This is a case that should have been settled early on.
© William D. Wilson and NJInsuranceBlog.com, 2015. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to William D. Wilson or NJInsuranceBlog.com with appropriate and specific direction to the original content.