Why it matters: The “innocent insured doctrine” protected one law partner where another made a material misrepresentation during the formation of the policy, according to the Illinois Appellate Court. Facing the possible rescission of his malpractice insurance, a law partner argued that his partner’s bad act – failing to disclose during policy renewal a possible malpractice claim – should not be held against the partner that had no knowledge of the potential claim. The court found that the “innocent insured” provision of the policy – which addresses failure to give timely notice – was not implicated, but that the policy could not be rescinded as to the innocent partner under the common law “innocent insured” doctrine.

Detailed Discussion

Sam Tuzzolino and Will Terpinas were partners in the Law Office of Tuzzolino and Terpinas. Tuzzolino represented a client named Antonio Colletta for a number of years until Colletta, believing that the lawyer had mishandled litigation relating to a business venture, filed a malpractice suit against him.

Tuzzolino convinced Colletta to drop the suit and to sue another person instead. But Tuzzolino failed to file the complaint within the statute of limitations and then lied to Colletta for more than a year about the status of the litigation. When Colletta learned the truth, Tuzzolino offered him $670,000 to settle any claims against him.

Not long after, Tuzzolino received the firm’s malpractice insurance renewal quote and paperwork from the Illinois State Bar Association Mutual Insurance Company. Certifying that he was not aware of any circumstances “which may give rise to a claim that has not been reported,” Tuzzolino returned the form.

Weeks later, Terpinas learned of the Colletta situation. He notified the firm’s insurer, which responded with a lawsuit seeking rescission of the entire insurance policy.

Terpinas filed a counterclaim, seeking a declaratory judgment that the policy covered him with respect to Colletta’s malpractice suit. He argued that the “innocent insured” provision in the policy meant he was owed coverage and that a separate severability clause allowed the court to rescind the policy as to Tuzzolino while leaving it in force for Terpinas. A trial court judge disagreed.

The “innocent insured” provision stated that “whenever coverage under this policy will be excluded or lost because of the insured’s failure to provide timely notice, the company agrees that such insurance as would otherwise be afforded under this policy, should be applicable with respect to any insured who do not personally fail to give timely notice after having knowledge of the conduct that forms the basis of the claim.”

Because the provision addresses notice, the court held that it did not apply to the insurer’s rescission claim. Terpinas’ “argument ignores the distinction between the nondisclosure of a malpractice claim under an existing insurance policy and the nondisclosure of a malpractice claim on the renewal application for a new policy,” the court wrote. “If this case merely involved the former, Terpinas would remain covered; the record indicates Terpinas provided notice as soon as he became cognizant of his partner’s malfeasance and plaintiff does not assert that Terpinas is not covered under the language of the agreement. This case, however, involves the latter.”

Nevertheless, rescission was improper as to Terpinas under the common law “innocent insured” doctrine, the court held, reversing the trial court’s decision.

“The common law innocent insured doctrine applies in a situation where two or more insureds have an insurance policy and one of the insureds commits an act that would normally void the insurer’s contractual obligations,” the court explained. In Illinois, case law on the doctrine was typically found “in the situation where one property owner sets fire to mutually owned property without the co-owner’s knowledge,” and courts have allowed the innocent property owner to collect his or her portion of the insurance proceeds.

The insurer objected that the common law doctrine should not protect Terpinas, because the insurer was the truly innocent party; because of Tuzzolino’s misrepresentation during the formation of the policy, the policy was void ab initio. Therefore, it never existed and Terpinas could not rely upon it.

But the appellate court disagreed. The court noted that “while insurers and insureds may argue over who is the truly ‘innocent’ party for the purposes of equities, such a focus misses the impact on the underlying malpractice litigation.”

The real focus – and truly innocent party – is the victim of malpractice, the court said. Illinois policy therefore favors coverage whenever the facts justify it, and the state’s highest court has generally interpreted the Insurance Code to favor innocent insureds, in part due to public policy in the context of legal malpractice insurance.

Voiding the policy with respect to Terpinas would leave him without coverage for any actions in unrelated matters, including simple malpractice, and would be contrary to the public interest, the panel said. “[A] denial of coverage does not only negatively affect the potential insured. Without coverage, many defendants become unable to pay out the settlements or judgment awards, in effect harming the initially wronged party (in this case, Colletta).”

“[G]iven the existing case law regarding the innocent insured doctrine, Illinois courts’ overall inclination to protect the insured, and the persuasive authority from other jurisdictions, we find that the innocent insured doctrine preserves coverage for Terpinas under these facts,” the panel concluded. The court also ruled that the severability provision could operate to partially rescind the policy as to Tuzzolino.

To read the decision in Illinois State Bar Association Mutual Insurance Co. v. Law Office of Tuzzolino and Terpinas, click here.