In Minnesota Lawyers Mutual Insurance Company v. Michael D. Hancock, et al., Civil Action No. 3:08-CV-409-HEH (E.D. Va. Feb. 23, 2009), the United States District Court for the Eastern District of Virginia found in favor of rescinding a law firm’s malpractice insurance policy due to misrepresentations by the firm and its authorized agent in the firm’s application for insurance.  

Background  

In January 2006, Michael Hancock and Stephen Dalton merged their law practices and created Dalton Hancock PLLC. At the time of the merger, Dalton had a claims-made legal malpractice policy issued by Minnesota Lawyers Mutual Insurance Company. To obtain coverage under Dalton’s policy, Hancock executed an “Adding an Attorney” form on which he represented that he was “unaware of any incident which could reasonably result in a claim being made against him.” Hancock was added to the policy.  

In March 2007, when the policy was up for renewal, Dalton submitted an application in which he certified on behalf of the firm that the information previously supplied to Minnesota Lawyers — including the Adding an Attorney form executed by Hancock in 2006 — was still accurate, and no firm member was aware of any incident that could reasonably result in a claim being made against the firm or any of its members. In June 2007, Dalton executed a “Request to Issue” form, representing there had been no significant changes in information contained in the firm’s previously submitted applications, and he was unaware of any claims or circumstances that could result in claims or disciplinary actions that had not been reported to Minnesota Lawyers. Minnesota Lawyers renewed the policy.  

On October 24, 2007, Hancock voluntarily reported to the Virginia State Bar that he had been embezzling from his clients since February 2005. He surrendered his law license and was subsequently indicted for, and pled guilty to, charges of embezzlement. Dalton was unaware that his partner had engaged in the misconduct, and it was not until he read the pleadings filed against Hancock by the Virginia State Bar that he learned of the misconduct. Hancock’s former clients brought lawsuits against him and the firm in state court in October 2007 and 2008 for damages arising out of his admitted embezzlement. In June 2008, Minnesota Lawyers instituted a declaratory judgment action against Hancock, the firm and the underlying plaintiffs. Minnesota Lawyers sought declarations that the terms of the policy excluded coverage for Hancock and the firm and/or that the policy should be rescinded and void ab initio because of the material misrepresentations and omissions made by Hancock, Dalton and the firm in obtaining the policy. Minnesota Lawyers moved for summary judgment in January 2009, which was granted on the rescission count.

The Decision  

In awarding summary judgment to the insurer, the court held that, under Virginia law, rescission based on an insured’s misrepresentation is appropriate where (1) a statement on the insurance application was untrue; and (2) the insurance company’s reliance on the false statement was material to the company’s decision to issue the policy. However, where an insured certifies that its representations in an application are correct to the best of its knowledge, the insurer must demonstrate clear proof that the insured’s statements were knowingly false.  

The court determined here that Hancock and Dalton made unqualified statements on the applications in question concerning incidents that might give rise to liability against the firm. The court, therefore, applied the more stringent standard.

In doing so, the court concluded that Minnesota Lawyers sufficiently demonstrated by clear proof that the statements made by Hancock and Dalton in the insurance application were false. Specifically, the court found that Hancock admitted that the certified representation he provided in 2006 concerning incidents that could reasonably result in a claim against him was false. The court further found that Dalton adopted this false representation in 2007, when he, acting on behalf of the firm, certified that the information previously supplied to Minnesota Lawyers was still correct, and that no member of the firm was aware of any incident that could result in a claim. Dalton’s representations on behalf of the firm were, unbeknownst to him, false in light of Hancock’s admission of embezzlement.  

Turning to the policy, the court found that the policy language specifically stated that statements in the application were deemed representations of all insureds, thereby imputing Hancock’s misrepresentations to Dalton and the firm. Since under the applicable standard for rescission Minnesota Lawyers did not need to show Dalton or the firm knowingly made false representations, but only show by clear proof that the statements in the application were false, the court found that it was immaterial that Dalton did not know the application information was false.  

The court next concluded that the false statements in the “Adding an Attorney” form were material to Minnesota Lawyers’ decision to undertake the risk of insuring the firm. The court noted that the policy contained standard form language warning that the representations made in the application were material. Nevertheless, the court noted that the policy language was not itself determinative. Rather, the court explained, Virginia law requires a greater showing of materiality to rescind a policy than boilerplate language. Here, in addition to the policy language, the court relied on Minnesota Lawyers’ affidavits indicating that the company relied on the misrepresentations; and the misrepresentations were material to the insurer’s decision to issue the policy to the firm. As such, the court determined that the insurer sufficiently demonstrated that had Minnesota Lawyers known of Hancock’s embezzlement, it would have rejected the risk or charged a higher premium rate.  

Having found Minnesota Lawyers satisfied the two prongs of Virginia’s standard for rescission, the court held that Minnesota Lawyers was entitled to judgment as a matter of law even though the policy contained an innocent insured provision. According to the language of the policy, coverage was excluded for claims arising out of dishonest, criminal, malicious or deliberately fraudulent acts, errors or omissions of the insured. The policy contained an exception, however, for innocent insureds — persons who qualified as insured under the policy who did not personally participate in or acquiesce to the acts, errors or omissions of another insured and who had no knowledge of or reason to believe any such act, error or omission was being committed. The court concluded that this provision did not prevent rescission of the policy, however, because the provision did not reference or preclude the remedy of rescission for material misrepresentation. The court further found there to be a critical difference between affording coverage to an innocent insured and rescinding the policy altogether. Dalton’s lack of personal knowledge of Hancock’s embezzlement and false representations, therefore, could not save the policy, which the court rescinded in its entirety.  

Implications  

Hancock demonstrates the significant ramifications of making a material misrepresentation in an insurance application where that misrepresentation is relied upon in the issuance of the policy. The decision also demonstrates the significant implications to innocent partners, where one partner is charged with the responsibility of providing the information that will be used in the application process. By permitting rescission notwithstanding the innocent insured provision, the court in effect found that innocent insureds could be left without coverage due to dishonest acts of others. Insureds should therefore be cautious about taking proper steps to ensure that the information provided in the application process is as accurate as possible.