Avoiding Pitfalls

While not an everyday occurrence, it is an unfortunate reality that some insureds are not truthful when applying for insurance. Material non-disclosure may come to light during the investigation of a claim or upon renewal of the policy.

However that information is obtained, once it is available to the insurer or its agent, the insurer must make an election as to how to proceed. The following three possibilities exist:

(a) retain the premium and treat the contract as valid and subsisting;

(b) avoid the contract and return the premium; or,

(c) give notice of cancellation of the policy.

Once the choice is made, an insurer is most often “stuck” with that decision and cannot later change course, as the courts have determined in a number of cases over the years that these options present distinct legal positions. By choosing one option, the insurer is “waived” or “estopped” from later changing its mind and attempting to invoke a separate path.

Waiver occurs when the insurer has full knowledge of its right to void the policy and makes an unequivocal and conscious choice to abandon that right. Estoppel applies when there is knowledge of facts that indicate a lack of coverage, and a course of conduct is taken by the insurer upon which the insured relies to its detriment.

By way of example, while investigating a claim, an insurer learns of facts evidencing a material misrepresentation. The claim is small and, perhaps for customer service reasons, the insurer chooses not to raise the material misrepresentation.

While it may never specifically address the misrepresentation, the insurer is, in essence, electing to treat the insurance contract as valid and is waiving its right to rely on the misrepresentation as a basis to void the policy – now and in the future, as noted by the Supreme Court of Nova Scotia in Snair v. Halifax Insurance Nationale-Nederlanden North America Corporation.

The result is that if the insured presents a much larger claim at a later date, the insurer is unable to void the policy given the earlier election made with full knowledge of the material misrepresentation.

This situation was considered in Gill v. Zurich Insurance Co., released in 1999 by the Court of Appeal for Ontario, where the insurer learned of misrepresentations made by the insured and, in spite of those misrepresentations, the insurer continued to accept the premium payment from the insured.

The court found that by continuing to accept the premiums, the insurer had elected to treat the contract as valid and subsisting and could not take the position that the policy was void upon occurrence of the loss.

VOIDING OR CANCELLING

Another potential pitfall can arise from the choice between voiding or cancelling the policy. In the former case, the position normally taken is that the contract is void from inception given the material misrepresentation.

If the insurer voids the policy, claims are not payable since the policy is treated as if it never existed. This is because the misrepresentation was “material,” in that the insurer would not have written the risk, or would have charged a higher premium, had it known the true nature of the risk.

Conversely, when cancelling a policy, a contract is acknowledged, but a power of cancellation is exercised. A claim presented before cancellation is still payable and, in fact, some claims presented after cancellation may still be covered depending on the policy at issue.

By exercising the power to cancel the contract, the insurer has thereby waived its right to void the policy, as it has, in essence, affirmed that the policy exists. While the distinction appears minimal, the effect is considerable.

COMMUNICATION BREAKDOWN

Mishaps can occur when there is a breakdown in communication between the claims handler and those underwriting the risk. While the claims handler may still be investigating a loss and, in particular, whether there was a material misrepresentation, the underwriters may be unaware of the investigation and may cancel the policy based on other considerations.

Unfortunately, once that cancellation is made, it can affect the insurer’s ability to void the policy, depending on how much information about the material misrepresentation was known at the time of cancellation.

Accordingly, before a decision is made to cancel a policy upon the happening of a loss, underwriters should first determine whether or not the claim might be denied based on misrepresentation or non-disclosure.

Once the insurer has made the difficult decision to void the policy for a material misrepresentation, the next consideration – and one that can be easily overlooked – is what becomes of the premium paid previously by the insured.

Typically, the insurance premium is returned upon voiding the policy and, in many cases, this is the appropriate response. However, two decisions stand for the proposition that in some instances the premium need not be returned at all, or only a portion of the premium need be returned.

In Moscarelli v. Aetna Life Insurance Co. of Canada, issued by the then Ontario Supreme Court in 1995, an insurer voided a policy on the basis of fraudulent misrepresentation. The court looked only at the issue of whether, when properly voiding a policy of accident and sickness insurance for fraudulent misrepresentation, the insurer can retain the premiums paid by the insured versus returning the premiums.

The insured argued that where one party is induced by fraud to enter into a contract with another, and then discovers the fraud, the party must, within a reasonable time after discovering the fraud, notify the other party of the contract’s rescission and restore whatever consideration has been received under the contract. The insurer argued that when a policy of insurance is voided for fraudulent misrepresentation, there can be no claim by an insured for a return of the premiums.

The court noted that there did not appear to be a single case decided in Canada where an insured, having made a fraudulent misrepresentation, had been able to successfully sue for the return of premiums. Past cases had pointed to the “clean hands doctrine,” and found that based on public policy, a contracting party could not plead restitution grounded on its own fraud.

Ultimately, the court concluded the authorities supported the position of the insurer, that there is no return of premiums in the case of fraud, stating that this was the “more principled and rational position.”

FULL, PARTIAL RETURN OF PREMIUM

Shortly after this decision, the Ontario court considered a similar issue in the 1996 decision, Lloyd’s London, Non-Marine Underwriters v. National Armoured Ltd. In that case, National Armoured Ltd. was insured with Lloyd’s under three policies of insurance, which were put in place in September 1991, and renewed in September 1992.

Lloyd’s voided the policies ab initio on the basis of misrepresentation and non-disclosure of material facts. However, upon voiding the policies, Lloyd’s only returned the premium from the current policy period. It did not return the premium from the previous policy year, even though the same misrepresentations were operative during that period.

The insured argued that Lloyd’s lost the right to void the policies on the ground that it was required to void the earlier policy, as the same misrepresentations were operative during the previous policy period. While the case is not entirely clear on this point, the insured appeared to be saying that by failing to void all policies and return all premiums, the insurer was estopped or waived from voiding the single policy period at issue.

The court found that there was no reason why the insurer should forfeit its right to void the policies, “on the ground that it could have taken a more drastic action.
“

While not specifically stating there was a fraudulent misrepresentation, the court then pointed to the decision in Moscarelli for the proposition that where an insurer voids the policy because of fraudulent misrepresentation, it is not obliged to refund the premium.

It is unclear whether this case stands for the proposition that only the current policy has to be voided (and only the current premium returned) in the case of an innocent material misrepresentation present from inception of the policy. It seems more logical that if the material misrepresentation made at the time of application renders the policy void from the inception of coverage, then all policies and renewals are affected equally and premiums from all years should be returned.

Certainly, it is the safer practice to return the entire premium in the case of an innocent material misrepresentation, so as to avoid the type of argument advanced in National Armoured Ltd.

Based on the foregoing, when an insurer learns of facts that could give rise to a material misrepresentation, consideration must be given to voiding, cancelling or confirming the policy.

For the reasons set out above, the choice made at that time should be very carefully thought-out. If the decision is made to void the policy, the specific circumstances surrounding the material misrepresentation should then be reviewed to determine the appropriate manner of dealing with the premium.

Alexander Holburn Beaudin + Lang LLP is a member of The ARC Group of Canada, a network of independent insurance law firms across Canada.