Why it matters: What happens when innocent co-insureds seek coverage for a lawsuit based on fraudulent misrepresentations made by another co-insured? In the Fourth Circuit Court of Appeals, the federal appellate panel found that innocent doctors at Agape Senior Primary Care remained entitled to coverage under a medical malpractice policy where an individual lied about his medical credentials and held himself out as a doctor. Before learning about the fraud, the company and its physicians—including the imposter—submitted renewal applications to the insurer. After the fraud was revealed, multiple lawsuits were filed against Agape, some naming the other doctors, and they turned to Evanston Insurance Company under a professional liability policy. The insurer denied the tender and filed a declaratory judgment action to rescind the entire policy. But the panel affirmed a district court's decision to invalidate coverage for the fake doctor only and leave it in place for the other insureds. The co-insureds were innocent and had no knowledge of the fraud, the court said, and public policy would not be served by rescission as applied to them. And as the drafter of the policy, the insurer could have added language for instances of fraudulent misrepresentations by one applicant—but failed to do so, the panel added.

Detailed discussion: A case of identity theft resulted in an insurance dispute involving a medical practice in South Carolina. In early 2012, Agape Senior Primary Care hired a man holding himself out to be Dr. Arthur Kennedy, a physician certified by the state board. The company employs physicians and other medical professionals who are sent to nursing homes and assisted living facilities branded with the Agape name.

Neither Agape nor any of its employees knew that Kennedy was actually a man named Ernest Osei Addo, a former friend of Dr. Kennedy who had stolen his identity and obtained a South Carolina driver's license with his own photo. The real Dr. Kennedy was out of the country at the time.

About six months after the fraud began, the truth was revealed when the police arrested Addo and notified the company of his true identity. Following his conviction for aggravated identity theft, Addo was sentenced to two years of imprisonment by a federal court judge.

Prior to Addo's conviction, Evanston Insurance Company issued a professional liability policy to physicians and other medical professionals at Agape, which also provided coverage for Agape. During Addo's time at Agape, the insurer sent renewal forms with individual applications for each physician. Addo filled out an application representing himself as Dr. Kennedy, board-certified in family medicine. The insurer renewed the policy and added Kennedy with an endorsement, charging an additional $4,000 premium for his coverage.

Three lawsuits were filed against Agape relating to Addo's fraud, and other entities gave notice of their intent to file suit. Although Evanston provided a defense for the lawsuits, the insurer filed a separate declaratory action against Agape seeking to rescind the policy.

A federal district court agreed that the policy was void as to Addo because of his fraudulent misrepresentations, but reached the opposite conclusion for the other insureds. In an unpublished opinion, a panel of the Fourth Circuit Court of Appeals affirmed, relying upon both state law and principles of equity.

"South Carolina law disfavors rescission against the insured," the court said. "In particular, under South Carolina law, three factors tip the equity scales in favor of Agape: (1) as the insurer and drafter, Evanston could have included forfeiture language in the policy; (2) neither Agape nor any of its employees had any knowledge of Addo's fraud, rendering them 'innocent' under South Carolina law; and (3) the public interest would not be served through rescission."

As the drafter of the policy, Evanston had the option to include express language supporting rescission for the intentional misrepresentation of any applicant and decided not to do so, the panel wrote. Case law emphasizes that "the existence of such provisions, when they are present, [operate] to limit coverage," the court said, and Evanston "could easily have included" such a provision.

Secondly, the extension of the innocent co-insured doctrine under South Carolina law made sense in this case because state law examines the liabilities of the parties for the fraudulent act, not their obligations. As the Fourth Circuit explained, "[T]he insured usually must exhibit some fault in order to support vitiation of an insurance policy."

Public policy considerations only served to reinforce the other two points, the court said.

"Equity cannot demand that the actions of one corrupt applicant, who conned Agape and Evanston alike, deprive the innocent insureds of the benefit of their contract," the panel wrote. "Agape and its employees separately applied for medical malpractice insurance in good faith, and they would be left without such insurance through no fault of their own. Evanston accepted individual premiums as to each insured and seemingly spread the risk accordingly. Further, and perhaps most important in an equitable determination, rescission would leave the public essentially unprotected on matters of medical malpractice brought against every other Agape employee."

To read the per curiam opinion in Evanston Insurance Co. v. Agape Senior Primary Care, click here.