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the rule has long been that an insurer is still liable to innocent third parties even if the policy at issue is rescinded based on the insured’s misrepresentations. As discussed in a prior blog post, that rule was reaffirmed by the New Jersey Supreme Court just a few months ago in Citizens United Reciprocal Exchange v. Perez, 223 N.J. 143 (2015). Allowing an innocent third party to recover under an insurance policy that has been rescinded is based, in part, on the fiction that the third party relied on the fact that the other driver had insurance.
The New Jersey Supreme Court recently addressed a somewhat similar issue in DeMarco v. Stoddard, 2015 WL 7722997 (Dec. 1, 2015). There, the Court held that an insurer owed no duties to a doctor who lied on his insurance application, leaving an innocent third party injured by the doctor’s actions without a remedy.
DeMarco involved a medical malpractice claim asserted against a podiatrist. The podiatrist’s insurer, the Rhode Island Medical Malpractice Joint Underwriting Association (“RIJUA”), denied coverage on the basis that the podiatrist misrepresented certain information on his insurance application. Specifically, in applying for insurance, the doctor represented that at least 51% of his practice was based in Rhode Island. He repeated that representation in several renewal applications. That representation turned out to be false.
RIJUA provides coverage only to those physicians who maintain at least 51% of their practice in Rhode Island. Thus, the policy never would have been issued had the doctor been truthful on his application. Consequently, when it learned of the misrepresentation, RIJUA rescinded the policy. The rescission did not take place, however, until after the doctor was sued for malpractice by one of his former patients.
The patient and his spouse commenced a malpractice action against the doctor. They later amended their complaint to assert a claim against RIJUA. The doctor/insured claimed he had no assets and had “a significant amount of debt.” Thus, it appeared that the insurance policy was the plaintiffs’ only recourse.
Both the plaintiffs and RIJUA moved for summary judgment seeking a ruling as to whether RIJUA had a duty to defend and indemnify the doctor. The trial judge held that despite the fact that the policy was rescinded, RIJUA had an obligation to defend and indemnify the doctor, up to the statutorily required $1 million in coverage, in connection with any claims that arose prior to recission of the policy. Under New Jersey law, podiatrists are required to maintain a minimum of $1 million in professional liability insurance.
RIJUA appealed, and the Appellate Division affirmed. The Appellate Division “compared medical malpractice liability insurance to the protection afforded to innocent third parties when a motor vehicle liability insurance policy has been rescinded.” Id. at *3. Thus, it held that while RIJUA was entitled to rescind the policy, RIJUA was required to provide coverage to “an innocent third party, such as a patient whose claim arose prior to rescission, up to the minimum amount of required coverage.” Id.
On further appeal, the New Jersey Supreme Court reversed. As succinctly stated by the Court, “[t]he critical inquiry . . . is whether a rescinded policy of medical malpractice liability insurance provides any coverage to the insured for claims that arose prior to rescission.” Id. at *1. The Court concluded that it did not. According to the Court, “the RIJUA owed neither a duty to defend nor a duty to indemnify its insured, who had misrepresented the proportion of his practice generated in Rhode Island, which was a fact that formed the basis for his eligibility for insurance through the RIJUA.” Id.
The Court noted “that the Appellate Division erred when it referred to the compulsory automobile liability model as the guidepost for fashioning a remedy for third-party claimants whose claims arose prior to rescission.” Id. at *1. The Court also stated that the Appellate Division “further erred by reforming the rescinded policy to require the insurer to defend and indemnify its insured up to the mandatory minimum amount of coverage required in this State.” Id.
The New Jersey Supreme Court concluded that the situation before it was more analogous to the rescission of a legal malpractice policy based on material misrepresentations made by the insured during the application process. Despite the fact that legal malpractice insurance is mandated in certain instances, the New Jersey Supreme Court has held that an insurer may rescind a policy ab initio based on the insured’s misrepresentations. The Court observed:
[I]t is well established in this State that an attorney will not have access to insurance coverage to respond to claims from injured third parties, clients, or title companies, if the professional liability insurance policy has been rescinded due to the attorney’s misrepresentations of material fact in the policy application. We discern no basis to treat other professionals required to obtain and maintain professional liability insurance, including physicians and podiatrists, in a different manner.
Id. at *7. According to the Court, “[p]ermitting reformation of a medical malpractice liability policy to conform to statutorily mandated minimum amounts also suggests that fraudulent conduct is condoned.” Id.
The Court took great pains to distinguish compulsory automobile insurance from professional liability insurance. The Court noted that the New Jersey’s “long-established and comprehensive no-fault automobile insurance system . . . centers on compulsory automobile liability insurance.” To that end, pursuant to statute coverage must be provided once an insured becomes liable for the loss or damage even if the policy is later rescinded. The Court went on to note:
The web of interrelated provisions attending the no-fault automobile liability model, including the compulsory automobile liability provisions, may minimize the number and amount of the claims of injured third parties. Moreover, the compulsory automobile liability insurance model has created an expectation among those operating motor vehicles that every individual who may be in an accident will be insured. By contrast, the Legislature has not constructed a similar matrix of alternate remedies for any other type of liability insurance, including compulsory professional liability insurance, or created an expectation that insurance coverage will be available to redress an injury even in the face of a fraudulently obtained policy.
Id. at *8. Consequently, the Court concluded that “the Appellate Division’s reference to and reliance on the compulsory automobile liability insurance model was misplaced.” Id. at *9. The Court further noted that the Appellate Division’s “reliance on that model also ignored this State’s longstanding rule that an insured professional cannot expect insurance coverage to respond to third-party claims when the professional liability insurance has been rescinded due to misrepresentations of material fact in the application.” Id.
In DeMarco, the Court made it clear that “a professional who has made a misrepresentation of material fact in an application for professional liability insurance can expect that the policy may be rescinded on application of the insurer.” Id. at *10. In that event, any claims that arose prior to rescission will be excluded from coverage. While one could argue that this has been the law for some time, the trial court and the Appellate Division both got it wrong. It appears both courts misapplied the Court’s holding in Citizens United, which involved compulsory auto insurance, and misinterpreted the legal malpractice insurance cases. Although DeMarco involved a professional liability policy, based on the Court’s broad pronouncements, the Court’s holding arguably applies to all types of liability policies other than auto policies. It remains to be seen whether the trial courts and the Appellate Division will agree.
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