Economy Fire & Casualty v. Warren

A Material Misrepresentation Voids Malpractice Policy as to All Firm Attorneys

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By Shelby L. Drury, Of Counsel, Novack and Macey LLP

Shelby L. Drury
Shelby L. Drury

Do you know what your partners are up to?  What about your associates?  Do you know if they have done anything that might be grounds for a client to sue them for legal malpractice? In light of the Illinois Supreme Court’s recent decision in Ill. State Bar Association Mutual Insurance Company vs. Law Office of Tuzzolino and Terpinas et al., 2015 IL 117096 (February 20, 2015) (“Tuzzolino”), you would be wise to find out or risk losing your malpractice insurance coverage and that of each and every attorney in your law firm.

The Tuzzolino case

In Tuzzolino, the partner that filled out the insurance renewal application — Tuzzolino — was the “wrongdoer.”  At the time he filled out the application, he was well aware of a former client’s potential claims against him for legal malpractice.  In fact, he had offered the former client a substantial sum to settle the claim.  Id. ¶4.  Shortly after that, Tuzzolino completed the firm’s malpractice insurance renewal application.  In it, he stated that no member of the firm was aware of a past or present circumstance that might give rise to an as-yet-unreported malpractice claim.  He affirmed that the information in the application was true and complete and acknowledged that it would be the basis for the issuance of the insurance policy.  Id. ¶5.  ISBA Mutual issued the firm a malpractice policy based on the application.  Id.

About a month later, Tuzzolino’s partner (Terpinas) learned about Tuzzolino’s misconduct when he received a lien letter from an attorney representing the former client.  Terpinas immediately reported the claim to ISBA Mutual.  Id. ¶6.

ISBA Mutual sued Tuzzolino, Terpinas, the firm and the former client, seeking rescission and other relief on the ground that Tuzzolino’s material misrepresentation voided the policy.  Id. ¶7.  The circuit court entered judgment in favor of ISBA Mutual.  Id. ¶8-9.  Terpinas and the former client appealed.  (Tuzzolino consented to the judgment against him, and the firm did not appeal the judgment against it. Id. ¶9-10)

The appellate court reversed the circuit court and found that the policy should not be rescinded as to Terpinas because he was “an innocent insured” and should not be blamed for his partner’s misrepresentations.  Id. ¶10.  ISBA Mutual then appealed.

The Illinois Supreme Court reversed the appellate court and reinstated the judgment rescinding the insurance policy in its entirety.  The Court held that rescission is proper under Section 154 of the Illinois Insurance Code, 215 ILCS 5/154., when an insured makes a material misrepresentation on the insurance application.

The court applied the following two-prong test to determine if rescission was proper under Section 154:  (1) the statement must be false and (2) the statement “either must have been made with an actual intent to deceive or must ‘materially affect the acceptance of the risk or hazard assumed by the insurer.’” Id. at &17 (citing Golden Rule Ins. Co. v. Schwartz, 203 Ill.2d 456, 464 (2003) (emphasis added)). Importantly, Section 154’s “provisions are to be read in the disjunctive, so that either an actual intent to deceive or a material misrepresentation which affects either the acceptance of the risk or the hazard to be assumed can defeat or avoid the policy.’” Tuzzolino, supra (citing Nat’l Blvd Bank v. Georgetown Life Ins. Co., 129 Ill. App. 3d 73, 81 (1st Dist. 1984) (emphasis in original).  Accordingly, even an innocent misrepresentation may be a basis to void a policy.  That is because “[i]f the misrepresentation materially affects the insurer’s acceptance of the risk, it does not matter that one of the parties, or an insured, might not have been to blame for the misrepresentation.”  Id.

The Court distinguished this situation from one where the common law “innocent insured” doctrine (relied on by the appellate court) would apply.  That situation typically involves an innocent insured who seeks recovery under a policy that excludes coverage for intentional acts.  In such cases, the insured seeking coverage did not commit the excluded, intentional act and so retains coverage for itself.  For example, the court cited a case where a wife set fire to a home owned jointly with her husband. In that case, the innocent husband, who did not know of or participate in his wife’s arson, was entitled to retain his half of the insurance proceeds.  Id. ¶¶21-24.[1]

The Court noted that the “innocent insured doctrine makes sense in that context because the insured’s innocence is relevant to whether an intentional act invokes an exclusion to coverage.  But the innocent insured doctrine appears irrelevant to rescission, a recognized remedy for even innocent misrepresentations.”  Id. ¶24.

The crux of the distinction seems to be that the innocent insured doctrine comes into play in “situations where an insured’s wrongdoing triggers a policy exclusion, and the question is whether the insurer has a duty to defend [or otherwise cover] the innocent insured under a policy that is still in effect.” Id. ¶31; see also ¶23. On the other hand, a misrepresentation on a policy application goes to the formation of the insurance policy and affects the validity of the policy as a whole. That issue is governed by Section 154 and “is not concerned with whether an insured is innocent of a misrepresentation that prejudices the insurer.”  Id. ¶31.

Practice Points

In Tuzzolino, the ‘wrongdoer’ attorney who knew of the potential malpractice claim lied on the firm’s insurance renewal application and that justified rescission.  However, note that under the Supreme Court’s reasoning, rescission would have been proper even if an innocent person with no knowledge of the potential malpractice claim had filled out the firm’s insurance application and incorrectly stated there were no potential malpractice claims on the horizon.  This is so because the false statement still would have materially affected the insurer’s risk.

The Dissent aptly observes that the Court’s opinion is troubling due to the potential “scope of the consequences resulting from the majority’s holding on other law firms especially midsize and large firms. . . . as the size of the affected firm increases, so does the potential harm to the public [i.e., consumers of legal services who may not be able to recover for attorney malpractice].”  Id. ¶54.

Attorneys may want try to negotiate with their insurance carriers to include provisions in their policy that attempt to minimize or eliminate the harsh consequences of the Supreme Court’s decision.

[1] The appellate court relied principally on that case — Economy Fire & Casualty v. Warren, 71 Ill. App. 3d 625 (1st Dist. 1979).  The Supreme Court distinguished it because, among other things, the dispute in Warren arose after the settlement had been paid, thus the case was about the rescission of the settlement agreement, not the rescission of an insurance policy.  Accordingly, Section 154 of the Insurance Code did not apply.  Id. &23.