By Michelle K. Aiena
Our firm has recently been involved in several cases regarding potential recession after discovering that an insured made material misrepresentations. In determining whether to rescind a policy, an insurer’s timing and actions are key considerations. As the recent New York appellate court decision discussed below demonstrates, courts do not afford insurers much leeway in their actions once there is sufficient knowledge of a material misrepresentation. Furthermore, an insurer’s reservation of the right to rescind is essentially meaningless once the insurer has sufficient knowledge of a material misrepresentation. The insurer must rescind immediately, or it risks waiving the right of rescission and ratifying the policy.
On February 14, 2012, in The United States Life Ins. Co. in the City of New York v. Blumenfeld, et al., 2012 NY Slip Op. 01103, the Appellate Division of the Supreme Court of New York, First Department, declared that a life insurance policy was valid, denying an insurer’s attempt to rescind the policy based on material misrepresentations by the insured.
Defendant Rebeka Blumenfeld (the “insured”) represented on her January 2006 life insurance application to the plaintiff insurer that she had a net worth of $35-$40 million, a household income of $400,000-$500,000, and that she was the beneficiary of two multi-million dollar life insurance policies.
On April 25, 2006, the insurer issued a life insurance policy with a $5,000,000 death benefit, which required a quarterly premium of $70,658.25. Defendant Rebeka Blumenfeld was the insured, and the beneficiary/policy owner was the defendant Blumenfeld Family Irrevocable Life Insurance Trust (the “Trust”). The policy included a two-year contestability clause pursuant to New York Insurance Law §3203(a)(3).
On April 22, 2008, the insurer notified the Trust of its intent to rescind the policy because of material misrepresentations concerning the insured’s financial status at the time she signed the life insurance application. The insurer also noted that there was an ongoing fraud investigation. In the letter, the insurer cited a March 2007 investigative report, which had revealed that the insured owned no real estate, that she rented an apartment in a neighborhood in Brooklyn, and that she had a median household income of $29,625. The letter further stated that the insurer would refund any applicable premiums and that it would file a declaratory judgment action to rescind the policy unless it received additional information from the insured or a signed copy of the rescission agreement, which the insurer enclosed with the letter.
It was undisputed that after the insurer received the March 2007 investigative report, the insurer retained the previous premium payments and continued to process premium payments in April and May 2007.
The insurer commenced a declaratory judgment action against the insured and the Trust on April 23, 2008, two days before the policy’s two-year contestability provision expired. The insurer sought to rescind the policy based upon alleged misrepresentations in the insured’s application. However, despite the material misrepresentations and ongoing litigation, the insurer notified the Trust on September 25, 2008, that the policy was in its grace period and would terminate without value unless the insurer received an additional premium in the amount of $81,262.73 prior to November 25, 2008. The Trust timely paid this premium.
In June 2010, the defendants moved for summary judgment dismissing the insurer’s complaint, asserting that the insurer had ratified the policy and waived its right to rescind by failing to promptly seek rescission upon learning, as early as March 2007, of the insured’s alleged misrepresentations. The defendants also argued that the insurer was estopped from rescinding the policy because it had retained premiums after learning of the insured’s alleged misrepresentations.
In response, the insurer asserted that it did not waive its right to rescind because its retention of premiums was inadvertent. The insurer stated that its computer system was not designed to reject premiums, and that rejecting premiums would have been potentially detrimental to the policyholder in the event the court rejected the insurer’s request for a declaration of recession. Lastly, the insurer argued that it could not have waived its right to rescind because the insurer stated in its April 22, 2008 letter to the Trust that it did not intend to waive its rights or remedies.
The trial court denied the defendants’ motion for summary judgment, and the defendants appealed. The appellate court reversed the trial court’s decision, noting that an insurer’s failure to rescind a policy promptly after obtaining sufficient knowledge of alleged misrepresentations by an insured constitutes ratification of the policy. Citing the Southern District of New York decision in S.E.C. v. Credit Bancorp, Ltd., 147 F. Supp.2d 238 (S.D.N.Y. 2001), the court rejected the insurer’s argument that it was not fully aware of the insured’s alleged fraud. As the court in S.E.C. noted, “knowledge which is sufficient to lead a prudent person to inquire about the matter, when it could have been ascertained conveniently, constitutes notice of whatever the inquiry could have disclosed, and will be regarded as knowledge of the facts.” Id. at 256.
In addition, the court explained that if an insurer accepts premiums after learning facts that it believes entitle it to rescind the policy, it waives the right to rescind:
An insurer’s attempt to reserve its rights while accepting premiums is unenforceable for lack of mutuality. This rule applies even where the insurer claims it accepted premiums after commencing a rescission action to ‘protect’ the insured pending the determination of the action.
(Internal citations omitted). In support, the court cited various case law, noting that inconsistencies in an insurer’s conduct is compelling, such as in the instant case, where the insurer sent a rescission letter specifically stating that it did not intend to waive any rights and then sent grace and lapse notices to the insured while maintaining the policy in active status.
Because the insurer knew as early as March 2007 that the insured had made material misrepresentations regarding her real estate holdings, net worth, and household income, the court held that the insurer had sufficient knowledge by March 2007 of potential material misrepresentations warranting rescission of the policy. However, despite this knowledge, the insurer retained the insured’s premiums and sought and continued to accept premiums after commencing a declaratory judgment action against the insured. The court thus concluded that the insurer’s conduct constituted a ratification of the policy and a waiver of its right to rescind.
The lesson to take from this case is that insurers must act immediately to rescind a policy and return premiums once they have sufficient, albeit minimal, knowledge that an insured made a material misrepresentation on the insurance application, even if the policy’s contestability period has not expired. Insurers cannot wait until a declaratory judgment action on the issue is decided, nor can they rely on a reservation of the right to rescind.
