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An Insurer’s Inaction May Result in a Waiver of its Right to Rescind a Policy after an Insured’s Misrepresentation

You may hear the practice of law described as putting out fires, and your job as that of a fireman. We are frequently called in after the blaze at the corporation is out of control. Much as a fireman asks over and over, ‘Why do people smoke in bed?’, we ask ourselves, ‘Why did our corporate clients take this action?’ Even if we are in-house corporate counsel instead of outside counsel, we will frequently be called only after the fire alarm has gonged and gonged. An example of a fire that could not be contained, on the premises and at the insurer, is found in the recent case of Landmark Am. Ins. Co. v. Green Lantern Roadhouse LLC, 2009 U.S. Dist. LEXIS 12211 (S.D. Ill. Feb. 18, 2009).
The Green Lantern Restaurant was built in 1938 on a section of U.S. 40, the National Road, just outside the eastern corporate limits of Effingham, Illinois. During World War II, local serviceman left their hats at the restaurant with plans to retrieve them after the war, and during the Korean War, veterans did the same with their ties. For many years it was regarded as a fine eating establishment, but in 2002 a new owner acquired the business and it enjoyed only limited success as a karaoke bar and roadhouse. In 2006 the new owner leased the property to Green Lantern Roadhouse LLC, and Green Lantern purchased a commercial insurance policy on the business and the property from Landmark American Insurance Company in December of that year. On June 5, 2007, a fire totally destroyed the building and its contents, with damages in excess of $ 500,000. The owner announced that she intended to rebuild as soon as she collected the insurance proceeds, but none were forthcoming because Landmark filed a declaratory judgment action that sought to rescind the policy.
Landmark sought to avoid payment of the claim on the basis that the application had required Green Lantern and the owner to maintain a central station burglar alarm and a central station fire alarm. Landmark alleged that Green Lantern made a false warranty in the application that there was a central station burglar alarm on the premises and that Green Lantern misrepresented in the application that a central station fire alarm was installed in the building. The owner and Green Lantern argued that Landmark had waived any misrepresentation because it failed to cancel the policy after it discovered in a property inspection in February, 2007 that there were no working alarms, and because the application had indicated that that there was no fire alarm and that Green Lantern was in the process of soliciting bids for a central station fire alarm.
The United States District Court for the Southern District if Illinois found that Landmark was liable for payment of the claim of Green Lantern and the owner. The court first held that the insurance contract was merely voidable and not void ab initio, because Illinois law did not mandate that an insurance policy was void as a result of a misrepresentation or false warranty by the insured.
One of the problems confronting the court was that there were two applications. The first application, dated December 14, 2006, was not signed by Green Lantern and the owner, but it was used to generate a price quote from Landmark. The court determined that the second application, dated December 27, 2006, the day before the policy was issued, was the relevant application. The second application did not state that there was a central burglar alarm in the building and stated that it was the intention of Green Lantern to have a central fire alarm installed. The court stated that it was a close jury question as to whether Green Lantern actually intended to have a fire alarm installed or if it made a misrepresentation because there were no plans for such an alarm.
But, this factual misrepresentation issue could be resolved on summary judgment by the court because Landmark waived its affirmative defense of misrepresentation and its right to rescission of the policy because it failed to take any action after it had an underwriting inspection of the policy conducted on the premises on February 1, 2007. The underwriting inspection specifically noted that there was no central station fire alarm, and although the inspection listed recommendations for the removal of some fire hazards on the property, it made no recommendation as to the fire alarm. Instead, Landmark only rescinded the policy on July 25, 2007, approximately seven weeks after the fire.
The court found that Landmark had waived its right to rescission of the policy because of its actions at the time that the policy was issued. “But Landmark did not immediately notify Green Lantern that it might rescind the contract when it first learned of the lack of a central station fire alarm. Landmark had knowledge that the premises were not protected by a central station fire alarm as of its receipt of the December 27th application. To be sure, the application stated that such an alarm would be activated at some point and Landmark may well have relied on this representation in assessing the value of the risk. But it did not require the installation of a central station fire alarm as a condition of the policy, nor did it ever provide Green Lantern a date certain by which any such system must be installed. In fact, Landmark never indicated by any means that the lack of a central station fire alarm was a problem.”
The court further stated that Landmark had additionally waived its rights after the property inspection. “Moreover, after the February 1, 2007 inspection, Landmark had knowledge that the premises still lacked a central station fire alarm…..Nonetheless, Landmark continued to accept premiums and made no indication that coverage depended on the presence of a central station fire alarm after the loss occurred, which was also halfway through the policy's duration…. It would be unjust and inequitable to permit Landmark to rescind the contract based on facts that it was aware of yet chose not to address.”
In the following paragraph, the court expressed a clear policy position that we should remind our clients of whenever we can. “Furthermore, to hold differently might signal to others in the insurance industry that rescission is available if one willing to bury his head in the sand. This Court declines to create a safe haven for insurers who wish to collect premiums despite a known risk in the hope that catastrophe will not occur, yet rescind the policy if it does. While the Court does not find that Landmark acted with any sinister intent here, the Court does not wish to sanction such behavior.”
If our clients act as ostriches, they may well find that we cannot put out their fires and save themselves from their actions. And you may find that your job more resembles the work on Denis Leary on Rescue Me on the FX Network instead of that of Sam Waterston on NBC’s Law & Order.