The United States District Court for the Eastern District of Virginia, applying Virginia law, has held that an insurer was entitled to rescind a crime policy based on the insured company’s knowingly false statement on the policy application. Koger Mgmt. Group v. Cont’l Cas. Co., No. 08-301 (E.D. Va. Mar. 3, 2009).

The insurer issued a crime insurance policy for the period of 2003 to 2007 to a company that managed homeowners’ associations. The company performed financial transactions on behalf of its clients and maintained bank accounts for each client. In 2006, the company discovered that the chief financial officer (CFO) had embezzled over $2 million by electronically transferring funds from client accounts to his personal accounts. In 2007, the company submitted a claim under the crime policy for the losses arising from the embezzlement.

The insurer responded by seeking to rescind the policy based on alleged misrepresentations in the policy application signed by the company president in 2003. In response to a question regarding whether “bank accounts [were] reconciled by someone not authorized to deposit or withdraw therefrom,” the president responded affirmatively. The insurer contended that this response was false because, in reality, the CFO reconciled the accounts and had authority to deposit or withdraw funds. The insurer also contended that this false response was material to its decision to issue the policy.

After a bench trial, the court issued a memorandum opinion that first noted the rescission standard under Virginia law. According to the court, to rescind the policy, the insurer had to prove that a statement on the application was both false and material to the risk. In addition, because the application asked the applicant to “attest to the truth of the statement to the best of his knowledge,” the insurer had to prove that the answer was “knowingly false.” The court then concluded that the insurer had met its burden with respect to this standard.

First, the court concluded that a statement is considered material under Virginia law if it reasonably influenced the insurer’s decision to issue the policy. The court determined that the statement was material to the risk because underwriters testified that the insurer would not have issued the crime policy if the question regarding reconciliation of bank accounts had been answered “No.” In addition, an underwriter testified that the insurer relied on this answer in deciding to renew the crime policy.

Second, the court found that the statement was false because the CFO had reconciled or supervised the reconciliation of the transfer account and client accounts from which he had the authority to withdraw funds. The court then addressed the company’s argument that the answer was not “knowingly false” because the president misunderstood the question. According to the court, under Virginia law, if the president had answered the question truthfully based on his understanding of the question, it would not be a knowingly false answer. The president testified that he believed that the question referred only to client accounts and not the transfer account. After reviewing the context and drafting of the question as well as evidence that other applicants had similarly misunderstood the question, the court concluded that the president’s misinterpretation was reasonable. However, the court found that the answer was knowingly false despite the president’s understanding that the question referred only to client accounts because the president was aware that the CFO supervised the reconciliation of client accounts and knew that the CFO had the authority to withdraw from client accounts. The court therefore found the response to be knowingly false despite the president’s misinterpretation. Accordingly, having found that the response on the application was material, false, and knowingly false when made, the court entered judgment in favor of the insurer.