There is an old saying that “tough cases make bad law.” In the insurance litgation context, this truism is reflected in the reluctance of courts to deny liability coverage where they believe it would be unfair or inequitable.

In Barkan v. New York School Ins. Reciprocal, the Appellate Division, Second Department, denied the insurer’s cross motion for summary judgment seeking to void its two policies ab initio based on an alleged misrepresentation in an earlier renewal application. The action underlying Barkan was notorious on Long Island because it involved the alleged misappropriation of $11,000,000 from a wealthy school district by several of its employees. In response, the school district sued several former board members for negligence and breach of their fiduciary duties. The district’s insurer denied coverage to the former board members based on, among other reasons, the failure of the district to disclose in an earlier renewal application the misappropriations by a former employee in the district’s business office.

Several board members sued the insurer for coverage. The insurer responded by counterclaiming for rescission based on the district’s failure to disclose the earlier theft and commenced a third party action against other board members seeking a declaration that it had no duty to defend or indemnify them either. Motions for summary judgment were filed by the parties and the lower court found in favor of the board members. The Appellate Division affirmed, holding that the insurer failed to meet its evidentiary burden on the issue of rescission.

In order to rescind a liability policy, the insurer must demonstrate that the insured made a “material” misrepresentation. If proven, the policy is considered void ab initio. To meet its burden the insurer must present documentary evidence concerning its underwriting practices such as manuals, bulletins and rules relating to similar risks, which show that the policy would not have been underwritten in the same manner if the true facts were known. In this case, the insurer apparently relied exclusively on the affidavit from one of its underwriters without any documentary support whatsoever. The court rejected this proof and upheld the ruling that the insurer had, at a minimum, a duty to defend the board members against the claims made by the school district itself.

In our experience, courts are very reluctant to rescind a policy based on an alleged misrepresentation. In evaluating the strength of such a policy defense, an insurer and its counsel must support their claims with compelling documentary proof. The naked affidavit of an underwriter will generally not win this battle, particularly where the individuals seeking coverage may not have been directly involved in submitting the allegedly false information.

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http://www.courts.state.ny.us/reporter/3dseries/2009/2009_06494.htm