One of the most challenging and controversial issues an insurer faces is whether an insurance applicant’s apparent misrepresentation in an application entitles the insurer to rescind the policy. In a recent decision, a California court of appeal found that an insurer was not entitled to rescind an insurance policy even though there was evidence that the insured had concealed material facts in his application. What doomed the insurer’s ability to rescind the policy was the ambiguity and lack of clarity of the application questions at issue.
In Victor Duarte v. Pacific Specialty Insurance Company (June 12, 2017) 13 Cal.App.5th 45, plaintiff Victor Duarte bought a tenant-occupied rental property in 2001. Sometime thereafter, the daughter of the tenant moved into the rental property with her father, and continued to reside there after his death in 2010. In February 2012, Duarte served the daughter with an eviction notice. The daughter did not leave the rental property and Duarte did not take any further action to remove her.
In April 2012, Duarte electronically submitted an application for a landlord insurance policy with defendant Pacific Specialty Insurance Company. Pacific issued a policy to Duarte covering the rental property the same day.
In June 2012, the tenant/daughter filed a lawsuit against Duarte for habitability defects at the rental property which allegedly existed since 2009. The lawsuit alleged that Duarte had been notified of these defects and, therefore, the tenant/daughter sought various damages arising from the defects. Duarte tendered the defense of the lawsuit to Pacific which denied coverage. Duarte then sued Pacific for breach of contract and other claims on the grounds that Pacific not only failed to defend the tenant lawsuit but also wrongfully cancelled his policy. In responding to the lawsuit, Pacific asserted a right to rescind the policy due to material misrepresentations on the application.
In cross-motions for summary judgment/adjudication, Pacific argued it was entitled to rescind the policy because Duarte made material misrepresentations when he answered “no” to two questions on the insurance application — i.e., (1) Was Duarte aware of any disputes concerning the property? and (2) Were any businesses conducted on the property? In support of its motion for summary judgment, Pacific demonstrated that its application set forth underwriting guidelines with a list of “unacceptable properties” that included “[d]wellings with unrepaired damaged (including earthquake damage) and /or open or pending claims, and/or known or potential (a) defects, (b) claim disputes, (c) property disputes, and/or (d) lawsuits.” The guidelines also contained a list of “unacceptable risks” that included “[r]isks where space is rented to others for commercial use or risks with any type of business (including childcare provided to unrelated individuals for compensation), trade or illegal activity on the premises.”
Pacific also submitted records regarding a March 2012 complaint filed by the tenant/daughter against Duarte with a public agency in which she complained about Duarte doubling her rent, not paying for water or garbage removal and ignoring her requests that Duarte repair roof leaks and address plumbing, mildew and pest issues. In a response to the 2012 complaint, Duarte indicated that the tenant/daughter had a welding shop in the house and was using oxygen tanks and hazardous materials which created a fire hazard. In addition, Pacific submitted a transcript of Duarte’s deposition in which he testified about his understanding regarding the complaint filed against him by the tenant/daughter concerning issues with the rental property. Based on this evidence, the trial court granted Pacific’s motion for summary judgment and denied Duarte’s motion for summary adjudication. Duarte appealed, and the court of appeal reversed.
The appellate court first found it was procedurally proper for Pacific to seek rescission of the policy in conjunction with its motion for summary judgment even though Pacific had not filed a pleading seeking affirmative declaratory relief. The court explained that Pacific’s rescission affirmative defense was all that was required. The court also rejected Duarte’s argument that Pacific’s motion was defective because it had not complied with California Civil Code section 1691 which states that notice and restoration of premium were procedural requirements for rescission. The court found the service of an answer pleading rescission as an affirmative defense satisfies the notice and offer requirement of Section 1691.
The court next addressed the substantive issue of rescission. The court cited the general law of rescission as applied to insurance contracts:
It is generally held that an insurer has a right to know all that the applicant for insurance knows regarding the state of his health and medical history. [Citations.] Material misrepresentation or concealment of such facts are grounds for rescission of the policy, and an actual intent to deceive need not be shown. [Citations.] …. Materiality is determined solely by the probable and reasonable effect which truthful answers would have had upon the insurer. [Citations.] The fact that the insurer has demanded answers to specific questions in an application for insurance is in itself usually sufficient to establish materiality as a matter of law. [Citations.] (Thompson v. Occidental Life Insurance Co. (1973) 9 Cal.3d 904, 915-16.)
The court then held that Pacific did not meet its initial burden of proving that Duarte made misrepresentations on the insurance application. The court cited the actual language of the first application question at issue — “Has damage remained unrepaired from previous claim and/or pending claims, and/or known or potential (a) defects, (b) claim disputes, (c) property disputes, and/or (d) lawsuit?” The court stated that this question had “garbled syntax” and was “utterly ambiguous.” The court found that the evidence submitted by Pacific showed that Duarte knew of claims and/or disputes concerning the property. However, the court rejected Pacific’s position that the question required the answer, “yes” if there was unrepaired damage, any open or pending claims, potential defect, property disputes or potential lawsuits. Instead, given the question’s construction, the court determined the question could be reasonably construed as asking whether damage has “remained unrepaired” from various past events, such as a “previous claim” or a property dispute or lawsuit. Given the question’s ambiguity, the court found that Duarte properly answered, “no” because he reasonably interpreted the question to ask whether the property had unrepaired damage associated in some way with previous or pending claims, defects, claims disputes, property disputes or potential lawsuits.
With regard to the second application question — “Is there any type of business conducted on the premises?” — the court noted that Pacific submitted evidence that showed that Duarte knew the tenant and tenant/daughter occasionally sold motorcycle parts from the rental property. Nonetheless, the court held that Duarte properly answered, “no,” because he reasonably interpreted the question as referring to “regular and ongoing business activity,” of which there was none to his knowledge.
The court of appeal concluded that the trial court erred in determining that Pacific’s rescission defense defeated Duarte’s claims. On this basis, the appellate court reversed the trial court’s order granting Pacific’s motion to summary judgment and denying Duarte’s motion for summary adjudication. It remanded the case to the trial court to rule on Duarte’s summary adjudication motion on the unaddressed grounds of whether there was a potential for coverage as to the duty to defend.
As demonstrated by the Duarte case, California courts will grant rescission to insurers if there is evidence the insured materially misrepresented information on the insurance application. However, insurers still carry the burden of proving a material misrepresentation and not that there is a difference of opinion as to the meaning of questions on the insurance application. Insurers cannot take for granted that the questions on their applications are clear and unambiguous simply because they mirror the substance of underwriting guidelines. Rather, insurers must review their application questions from the applicant’s perspective to determine whether the questions are understandable to a reasonable person and if they truly ask for the information the insurer wishes to obtain.