The Supreme Court of New Hampshire recently held that notwithstanding undisputed evidence that an insured had failed to disclosure material information, the existence of an “innocent insured” provision in a professional liability policy precluded rescission of that policy.  In Great American Insurance Co. v. Christy, No. 2011-228, 2012 N.H. LEXIS 126 (N.H. Sept. 28, 2012), the court, applying New Hampshire law, reversed the decision of the Superior Court that  had rescinded the policy, and remanded for a determination of whether the defendants’ conduct would preclude coverage under the policy.

The insured, a law firm partnership, had purchased successive professional liability policies from the insurer.  One of the partners had been embezzling hundreds of thousands of dollars from client funds in his control.  The other partner claimed to be unaware of the embezzlement.  Consequently, in applying for renewal of insurance for the 2007-2008 policy period, the “innocent” partner stated that, after inquiry, no lawyer was “aware of any claim, incident, act, error or omission in the last year that could result in a professional liability claim against any attorney of the Firm or a predecessor Firm.”  The “innocent partner” testified that he had asked the “guilty partner” whether the latter was aware of any information corresponding to this request.  In reliance on his assurance that there was none, the innocent partner executed the renewal application two months after his partner of 45 years had executed a settlement agreement with the victim of the embezzlement.  When the guilty partner was unable to pay the settlement in full, a claim ensued.

The insurer subsequently sought to rescind the policy on the grounds of a material misrepresentation, and the trial court agreed.  It held that the innocent partner’s ignorance was not a defense.  The question on the renewal application was not limited to the knowledge of the application preparer, but requested the knowledge of “any lawyer” at the firm.  Consequently, the guilty partner’s knowledge would be imputed to the other insureds.  Moreover, since the misstatements were material to the insurer’s decision to issue the policy, rescission was appropriate.

On appeal, the Supreme Court of New Hampshire reversed.  It rested its holding on policy language stating that the insurer would not punish innocent insureds who were unable to report claims under the policy because a fellow insured had concealed wrongful acts.  The court reasoned that it was possible the policy provision excluding imputed knowledge to innocent insureds also applied to the application.  As there was no provision “specifically imputing knowledge to innocent insureds of false statements” in the renewal application, the court determined this absence created an ambiguity.  In conformance with principles of New Hampshire insurance law, the ambiguity was resolved in favor of the insured, and the rescission was set aside.

This case, although unusual in its analysis, highlights the necessity of careful drafting of the verbiage in both the policy application and the policy itself.  Insurers may want to rely on language that distinguishes between failure to disclose material facts for claims reporting purposes, which the policy terms may excuse under certain circumstances, and concealment in a policy renewal application, which is rarely excused.