Claims, arguments and tactics that are familiar from coverage disputes with consumers are increasingly being used against carriers by large corporate insureds—often with the assistance of well-known plaintiffs’ firms. Once in a while, though, it’s the big policyholder that comes out looking small. This month, in H.J. Heinz Co. v. Starr Surplus Lines Ins. Co., No. 15cv0631 (W.D. Pa. Feb. 1, 2015), a federal court in Pennsylvania rescinded a food manufacturer’s Contaminated Products Insurance (CPI) policy, and dismissed that company’s coverage claim, on the ground that the insured had intentionally omitted material information from its initial application.
In August 2014, Heinz announced a recall of its AD Calcium Hi-Protein Cereal, a product it sold in China, after officials in Zhejiang found that the cereal contained excessive levels of lead. The manufacturer then sought to recover its losses from the recall under a $25 million CPI policy that Starr Surplus Lines had issued less than two months earlier. In May 2015, the claim had not yet been paid. The manufacturer filed a lawsuit for breach of contract and bad faith, and the insurer responded with a counterclaim for rescission.
The case proceeded to trial in December 2015. The court decided to try the rescission counterclaim first, reasoning that a result in favor of the insurer would render the policy void ab initio—and, therefore, would moot the underlying claims.
I Forgot to Mention …
The insurer alleged that the manufacturer had applied for the policy in late May 2014, completing an application that called for answers to the following questions (among others):
“In the last 10 years has the Applicant experienced a withdrawal, recall or stock recovery of any products …, whether or not insured or insurable under an accidental and malicious contamination policy?
“[H]ave any fines or penalties been assessed against the Applicant by any food or similar regulatory body over the last 3 years?
In its response, the manufacturer failed to disclose a $12 million loss suffered in early 2014 from a “silent recall” of 245,000 pounds of baby cereal contaminated with nitrite, as well as three smaller 2014 losses in New Zealand and Canada. It failed to disclose a fine imposed by a Chinese food safety agency in 2013. And it reported the total loss for a 2008 contamination incident at a facility in San Diego as “-” or “null,” when the actual loss was $12.7 million.
The insured maintained that its application had provided the best information regarding losses that was available at the time, and it offered various reasons for certain specific omissions. It also contended that its nondisclosures had not been material, and, in any event, that the insurer should have discovered them.
It asserted, for example, that it failed to disclose the 2014 recalls and the 2008 facility issue, because those losses would not have been covered by a CPI policy. Citing the fact that it had submitted a 15-year loss history that was “dated ‘as of’ May 1, 2013,” and had stated that this history was being provided “in lieu of” a response to the application’s question about recalls over the last 10 years, it argued that it had been unreasonable for the insurer to assume that this response made any representation about events in 2014.
The manufacturer also contended that the undisclosed losses had been reported in the press, and that a newspaper article discussing some of them had even made its way into the underwriting files.
Trial By Jury (Almost)
The policy at issue in Heinz was governed by New York law. In New York, when an equitable counterclaim (e.g., rescission) is asserted in response to a legal claim (e.g., breach of contract), a jury may decide all disputed factual issues relating to the underlying claim, but all legal and factual issues relating to the counterclaim are to be decided by the court. Nevertheless, after consultation with counsel, the court decided to submit aspects of the counterclaim to the jury. The jury’s verdict, however, was “merely advisory,” and the court was not bound by it.
Under New York law, a misrepresentation will support a claim for rescission only if it is “material.” N.Y. Ins. Law § 3105. The jury found the insurer had proved, by a preponderance of the evidence, that Heinz had made misrepresentations in its application, and those misrepresentations had been “material.”
A material misrepresentation may void an insurance contract, even if it was made unintentionally. However, rescissionmay not be based on the nondisclosure of information that the insurer has not requested, unless the insurer demonstrates—by clear and convincing evidence—that the policyholder withheld the information with intent to defraud. In Heinz, the jury found that the insurer had failed to satisfy the standard for proving fraudulent intent, and, therefore, that the rescission claim could be supported only by the misrepresentations in the application.
Finally, an insurer can waive its right to rescind a policy, if it fails to act on information that “would [lead] a reasonably prudent insurer to inquire about the matter.” Heinz asserted that Starr had possessed such information, and the court asked the jury to weigh in on whether the insured had waived its rights—either because it possessed sufficient information about the relevant losses when it issued the policy, or because it failed to seek rescission promptly after learning about those losses. The jury found that the policyholder had established the prior knowledge of the insurer by a preponderance of the evidence.
Don’t Take My Advice
The court agreed with the advisory jury that the insurer had “adequately demonstrated that Heinz made material misrepresentations … that … were intentional.” Of particular note on the issue of materiality was the fact that the Heinz executive who prepared the company’s application had previously given a presentation to the company’s senior management, in which he recommended that it obtain greater coverage than it had previously purchased. The presentation included the losses were omitted from the application to Starr, and the court reasoned:
“[I]f this information was sufficiently important for [the Heinz executive] to include in a presentation memorandum to the Heinz senior management, it was sufficiently important to include on the Application … .
The court also agreed with the jury’s finding that the insurer had failed to meet the “clear and convincing evidence” standard with respect to intent to defraud.
“[A]lthough the Court finds that Heinz intentionally omitted certain information under the preponderance of evidence standard, under the ‘clear and convincing’ burden, which requires a higher standard of proof, the Court will not disturb the findings of the advisory jury.
But the court parted ways with the jury on the issue of waiver. Noting that “[m]ere negligence by the insurer is not sufficient” to effect a waiver, the court concluded:
“While Starr was not ‘perfect’ in its assessment and underwriting practices, perfection is not the standard. …
“Starr did not have … ‘sufficient knowledge,” as Heinz argued, because of certain information in a prior application for a different type of insurance policy, or because a newspaper article discussing the undisclosed incidents was contained in Starr’s underwriting files … . These items, without more, would not trigger a reasonably prudent insurer to follow-up further.
The court then proceeded to the question the jury had not had to answer: whether the insurer had failed to seek rescission with sufficient promptitude. The court found that the insurer had first become aware of the 2014 nitrite contamination on April 20, 2015; that it asked why the contamination had not previously been reported in a letter dated May 11; that it asked why the nitrite contamination had not been disclosed on May 14; and that Heinz had sued for breach of contract that same day. On these facts, the court ruled that “there was no credible evidence to support a finding that Starr failed to act promptly.”
As a result of these findings, the Court declared that it would “exercise its equitable discretion to void the policyab initio.”
The moral: a modern corporate risk management department might be no more reliable than any other insured. As corporate policyholders become more obstreperous, they can become subject to unexpected defenses.