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Most insurance fraud perpetrators know crime but have no knowledge of insurance. It is difficult to prove fraud in the presentation of a claim. It is relatively easy, on the other hand, to rescind a policy if the fraudster lies to get the insurance in the first place.
Rescission is an equitable remedy as ancient as the common law of Britain. (Carter v. Boehm, S.C. 1 Bl.593, 3 Burr 1906, British House of Lords, 11th May 1766)
When the United States was conceived in 1776 the founders were concerned with protecting their rights under British common law. They adopted it as the law of the new United States of America modified only by the limitations placed on the central government by the U.S. Constitution approved in 1789.
The viability and ability to enforce contracts was recognized as essential to commerce. Courts of law were charged with enforcing legitimate contracts. Courts of equity were charged with protecting contracting parties from mistake, fraud, misrepresentation and concealment since enforcing a contract based on mistake, fraud, misrepresentation or concealment would not be fair.
The common law developed rules that courts could follow to refuse to enforce the terms of a contract that was entered into because of mutual mistake of material fact, a unilateral mistake of material fact, the breach of warranty (a presumptively material promise to do or not do something), a material concealment, or a material misrepresentation. The remedy – called rescission – created a method to apply fairness to the insurance contract and allow an insurer to void a contract and allowed courts to refuse to enforce such a contract entered into by misrepresentation or concealment of material facts.
Insurance contracts, unlike common run-of-the-mill commercial contracts, are considered to be contracts of utmost good faith. Each party to the contract of insurance is expected to treat the other fairly in the acquisition and performance of the contract. For example, the prospective insured is required to answer all questions about the risk he, she or it are asking the insurer to take and about the person the insurer is asked to insure.
Rescission, since before the U. S. Constitution, became an important remedy for insurers. As a contract of utmost good faith insurers and the courts recognized that the parties to a contract of insurance were more vulnerable than other contracting parties to misrepresentation or concealment of material fact. The remedy is available to either party to the contract and when one determines it was deceived into entering into the contract it may declare the contract void from its inception, return the consideration and treat it as if it never existed.
When an insurer or the insured discovers the existence of a factual basis for rescission they have the opportunity, but not the duty, to exercise the remedy of rescission.
In most states the remedy is available to both parties to the contract of insurance whether the party deceived believes the deceit was the result of a fraud or simply an innocent misrepresentation or concealment of a material fact. To do otherwise would be to make a gift to the person who deceived the insurer of rights not available to the truthful.
Equitable remedies, like the remedy of rescission, are expected to be fair. Some states, like California, follow the ancient equitable remedies and have codified the right to rescission of insurance contracts. The legislative right to rescission arose because legislatures considered it unfair to make a contracting party abide by a contract that was not obtained fairly. The ancient maxim that “No one can take advantage of his own wrong” is applied when a court is faced with a request to confirm rescission. Other states have imposed limitations on insurers in their state and make the ability to rescind a contract of insurance more difficult than it was under the common law.
Insurers must use the rescission remedy with care. Insurers should never assume that the promise to pay indemnity to the insured under a policy of insurance can, with impunity, be broken by advising the insured that the insurer has rescinded the policy.
Rescission without sufficient evidence is wrongful. Rescission without the advice of competent counsel is a tactic fraught with peril. Rescission without a thorough investigation is dangerous. Where no valid ground for rescission exists, the threat or attempt to seek such relief, may constitute a breach of the covenant of good faith and fair dealing which is implied in the policy and expose the insurer to tort damages for that breach, including punitive damages.
One plaintiffs’ lawyer became wealthy when he learned that claims people were given a rubber stamp that said “RESCISSION” and had no idea what it was. He would take the claims person’s deposition and ask them to spell the word. When the claims person failed his bad faith case was established. When they spelled the word correctly, he would ask the adjuster to state the elements necessary to effect a rescission. Almost none could answer.
California, with a Draconian rescission law, still make it clear that if an insurer elects rescission without sufficient evidence it will bring the wrath of the courts down on it and will be the basis for allegations, easily proven, of extra-contractual torts. (Imperial Casualty & Indemnity Co. v. Sogomonian (1988) 198 Cal.App.3d 169, 184, 243 Cal. Rptr. 639.) [enhanced version available to lexis.com subscribers].
If sufficient evidence exists, the rescission remedy will deprive the insured or the insurer of all rights under the policy. The court will conclude that the contract never existed and neither party has any right under the contract.
The primary bases for rescission are:
Rescission is an important remedy available to both parties to an insurance contract. It should be used with care and the advice of competent counsel. This article was adopted from my e-book on rescission and is available at http://www.zalma.com/zalmabooks.htm.
By Barry Zalma, Attorney and Consultant
Reprinted with Permission from Zalma on Insurance, (c) 2015, Barry Zalma.
Barry Zalma, Esq., CFE, is a California attorney who limits his practice to consultation regarding insurance coverage, insurance claims handling, insurance bad faith and fraud and acting as a mediator or arbitrator on insurance disputes. Mr. Zalma serves as a consultant and expert almost equally for insurers and policyholders. He founded Zalma Insurance Consultants in 2001 and serves as its only consultant. He recently published the e-books, "Zalma on Rescission in California - 2013"; "Random Thoughts on Insurance" containing posts from this blog; "Zalma on Insurance;" "Murder and Insurance Don't Mix;" “Heads I Win, Tails You Lose — 2011,” “Zalma on Diminution in Value Damages,” “Arson for Profit” and “Zalma on California Claims Regulations,” and others that are available at Zalma Books.
Mr. Zalma can be contacted at or email@example.com, and you can access his free "Zalma on Insurance Fraud" newsletter at Zalma’s Insurance Fraud Letter.
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