A California appeals court found that an insurer was not entitled to rescind an insurance policy due to material misrepresentation and/or concealment of material facts as a matter of law. The court held that the insurer could not prove that the insured made misrepresentations when he applied for the policy because the application questions at issue were ambiguous and the insured’s interpretations of those questions were reasonable.

Victor Duarte bought a tenant-occupied rental property in 2001. Sometime thereafter, the daughter of the tenant moved into the rental property with her father, and continued to reside there after her father’s death in 2010. In February 2012, Duarte served the daughter with an eviction notice. The daughter did not leave the rental property and Duarte did not take any further action to remove her.

In April 2012, Duarte electronically submitted an application for a landlord insurance policy with defendant Pacific. Pacific issued a policy to Duarte covering the rental property the same day.

In June 2012, the tenant/daughter filed a lawsuit against Duarte for habitability defects at the rental property which allegedly existed since 2009. The lawsuit alleged that Duarte had been notified of these defects, and sought various damages arising from the defects. In August 2012, Duarte tendered the defense of the lawsuit to Pacific which denied coverage. Duarte then sued Pacific for breach of contract and other claims on the grounds that Pacific not only failed to defend the tenant lawsuit but also wrongfully cancelled his policy. In responding to the lawsuit, Pacific asserted a right to rescind the policy due to material misrepresentations on the application.

In cross-motions for summary judgment/adjudication, Pacific argued that it was entitled to rescind the policy because Duarte made material misrepresentations when he answered “no” to two questions on the application: (1) whether he knew of any disputes concerning the property; and (2) whether there were any businesses conducted on the property. In support of its position, Pacific submitted records regarding a March 2012 complaint filed by the tenant/daughter against Duarte with a public agency in which she complained about Duarte doubling her rent, not paying for water or garbage removal, and ignoring her requests for repairs for leaks with the roof and plumbing, mildew and pest issues. In a response to the 2012 complaint, Duarte indicated that the tenant/daughter had a welding shop in the house and was using oxygen tanks and hazardous materials which created a fire hazard. Pacific also submitted a transcript of Duarte’s deposition in which he testified about his understanding about the complaint filed against him by the tenant/daughter concerning issues with the rental property. The trial court granted Pacific’s motion and denied Duarte’s motion. Duarte appealed, and the appeals court reversed.

The appeals court first found that it was procedurally proper for Pacific to seek rescission of the policy in conjunction with its motion for summary judgment even though Pacific had not filed a pleading seeking affirmative declaratory relief. The court explained that Pacific’s rescission affirmative defense justified Pacific using this procedure to seek rescission. The court also rejected Duarte’s argument that Pacific’s motion was defective because it had not complied with Civil Code section 1691 which states that notice and restoration of premium were procedural requirements for rescission. The service of an answer which pleads rescission as an affirmative defense satisfies the procedural requirements of rescission.

The court then held that Pacific did not meet its initial burden of proving that Duarte made misrepresentations on the insurance application. The court noted that the first application question at issue – “Has damage remained unrepaired from previous claim and/or pending claims, and/or known or potential (a) defects, (b) claim disputes, (c) property disputes, and/or (d) lawsuit?” – had “garbled syntax” and was “utterly ambiguous.” The court found that the evidence submitted by Pacific showed that Duarte knew of claims and/or disputes concerning the property. However, the court rejected Pacific’s position that the question required the answer, “yes” if there was unrepaired damage, any open or pending claims, potential defect, property disputes, or potential lawsuits. Given the question’s ambiguity, the court found that Duarte properly answered, “no” because he reasonably interpreted the question to ask whether the property had unrepaired damage associated in some way with previous or pending claims, defects, claims disputes, property disputes or potential lawsuits.

With regard to the second application question – “Is there any type of business conducted on the premises?” – the court noted that Pacific submitted evidence that showed that Duarte knew the tenant and tenant/daughter occasionally sold motorcycle parts from the rental property. Nonetheless, the court held that Duarte properly answered, “no,” because he reasonably interpreted the question as referring to “regular and ongoing business activity,” of which there was none to his knowledge.

The appeals court remanded the case back to the trial court to rule on Duarte’s summary adjudication motion on the unaddressed grounds of whether there was a potential for coverage as to the duty to defend.

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