Most companies have become pretty adept at providing timely notice, engaging a crisis management or PR firm approved under their policy, identifying coverage counsel, retaining affected product samples and test results, properly documenting the companies losses associated with the incident, and preparing a timely proof of loss.
What companies are not always so assiduous about, however, is fully and accurately completing the insurance application in the first place, and failure to do so can potentially scupper their chances of securing a payout under the policy should they need to make a claim.
That is because insurers have increasingly come to rely upon the rescission defense, i.e., seeking to have the policy declared void due to a material misrepresentation and/or omission in the policy application, to avoid coverage for otherwise covered claims.
Recently, in H.J. Heinz Company v. Starr Surplus Lines Insurance Company, Case No. 16-1447, 2017 WL 108006 (3d Cir. Jan. 11, 2017) over lead-tainted babyfood in China, the Third Circuit affirmed a District Court holding from the Western District of Pennsylvania (H.J. Heinz Company v. Starr Surplus Lines Insurance Company, Case No. 15-cv-0631, 2016 WL 374307 (W.D. Pa. February 1, 2016)) that the insurer, Starr, was entitled to rescind an accidental contamination policy due to misrepresentations and omissions by Heinz in the initial application for the policy at issue.
Heinz had sought a declaratory judgment that Starr owed it coverage for losses in connection with the Chinese authorities’ 2014 discovery of lead in Heinz’s baby cereal.
In response to Heinz’s complaint, Starr filed a counterclaim for rescission alleging that Heinz failed to disclose in its initial policy application prior incidents involving findings by Chinese authorities of nitrate and mercury in Heinz’s baby cereal products, and to identify the actual amount of a loss associated with a prior incident involving listeria contamination at Heinz’s San Diego facility.
Heinz’s omissions entitled Starr to rescind the policy
Although none of these prior incidents implicated insurance at the time, the Court found that Heinz’s failure to include the two prior findings by the Chinese authorities and list the full amount of the loss associated with the listeria incident constituted material misrepresentations and/or omissions entitling Starr to rescind the policy.
More specifically, the Court found that the policy application had specifically inquired into whether Heinz had been the subject of any governmental agency complaints within the last three years and whether Heinz had experienced a product recall or withdrawal within the last ten years (and the amount of the loss).
Since the application had specifically asked these questions, the court found the requested information material and held that Heinz, by not listing the prior incidents with the Chinese authorities and writing in a “–” instead of the actual dollar amount of the listeria loss, had deliberately misrepresented and omitted material information in the policy application.
When does the insurer have the right to rescind the policy?
The inquiry then turned to whether Starr had waived its right to seek rescission. There are varied grounds upon which an insurer can waive a rescission defense, including (1) selling the policy despite sufficient knowledge of the misrepresentation or omission, (2) accepting premiums despite sufficient knowledge of the misrepresentation or omission, (3) failing to promptly assert rescission after gaining sufficient knowledge of the grounds to do so, and (4) acting in a manner inconsistent with rescission after gaining sufficient knowledge of the grounds for rescission.
Only the first and third grounds were at issue in Heinz. Specifically, Heinz argued that Starr had sufficient knowledge of the prior incidents through information disclosed in connection with a prior application for a different policy and through an article contained in Starr’s underwriting file for the policy at issue.
Although an advisory jury issued a verdict in favor of Heinz, finding that Starr had waived its rescission defense, the judge rejected the advisory verdict, holding that information contained in a separate policy application and the mere presence of the article in the policy’s underwriting file were insufficient to trigger a reasonably prudent insurer to follow-up further, and that Starr’s underwriters had acted professionally and prudently given the information provided by Heinz in the policy application itself.
The Court also rejected Heinz’s argument that Starr had failed to act promptly in asserting its rescission defense.
The grounds for rescission can vary from state to state
Although the Heinz decision is discouraging, choice of law issues are important in the rescission context as the grounds for rescission are typically governed by statutes which tend to vary from state to state. Accordingly, Heinz sought the application of Pennsylvania law. It was unsuccessful in its argument, however, and the rescission law of New York, more favorable to the insurer, was applied. Had Pennsylvania law applied from the outset the outcome may have been different.
Along with the statutes applicable to rescission, the case law on waiver also varies from state to state. For example, Illinois’ rescission statute places a more onerous burden on insurers and Illinois case law has found waiver under circumstances not all that different from those present in Heinz.
In Certain Underwriters at Lloyd’s, London v. Abbott Laboratories, 16 N.E. 3d 747 (1st Dist. 2014), the Illinois Appellate Court found that Abbott’s transmission to its insurers of a Wall Street Journal article discussing potential problems with a drug to be acquired by Abbott, simultaneous with the application for an extension of a product contamination/recall policy wherein Abbott answered “No” in response to whether it was aware of any facts or situation that may lead to a claim, demonstrated that Abbott did not intend to deceive the insurers and the article was sufficient to put the insurers on notice to investigate further before accepting additional premium on the policy.
Moreover, the Court found that the insurers’ acceptance of premium and failure to raise rescission until a subsequent claim was made under the policy nearly a year later were sufficient to constitute waiver.
Which state laws apply?
Accordingly, when faced with a potential rescission defense, it is important to assess the applicable law on rescission and waiver. If the law of more than one state may apply to the claim, then the law of both states should be assessed and immediate steps should be taken to strengthen any argument for application of the law of the preferred state.
Coverage counsel can be invaluable in assessing these issues once a coverage dispute arises, and placing a policyholder in the best position to defeat a rescission argument.
The takeaway from Heinz v Starr
The decision in Heinz, however, should act as a reminder to all policyholders of the importance of the policy application in securing coverage for future claims.
That is not to say that a company needs to disclose everything under the sun in the policy application, but it should take care to review the specific questions asked in the application and answer them as completely and accurately as possible.
If there is any question about the need to disclose certain information or how best to disclose it, consulting coverage counsel is always a good idea.
As the Heinz case reminds us, it is never too early to be thinking about insurance and making sure that you have placed your company in the best position to be able to access insurance coverage in a time of crisis.
Michael McGaughey is an insurance recovery partner at law firm Lowenstein Sandler, and represents companies in recovery efforts and litigation against their insurers. He has extensive experience in representing policyholders in the food and beverage industry, with particular expertise in securing coverage for product recalls and false labeling claims.