It is well established that if an insurer discovers that its insured lied on the application for coverage, the insurer may rescind the policy. But New Jersey courts recently reaffirmed  that in auto cases, such a rescission cannot be used to deny benefits to an injured party not involved in the fraud.

Citizens United Reciprocal Exchange v. Sabrina A. Perez, et al. Perez had applied for and received the “basic” auto policy from CURE which provided state minimum coverage up to $15,000 per person and $30,000 per accident. Perez also elected to purchase optional personal injury coverage up to $10,000. In completing her application for insurance, she omitted a household member of driving age who had a poor driving record. Eventually, the undisclosed driver caused an accident while driving the Perez vehicle, injuring another driver.

CURE quickly discovered that Perez had lied on her insurance application, rescinded the policy, denied coverage to the injured driver, and filed a declaratory judgment action seeking a ruling that it did not owe coverage to the injured party. The trial court disagreed and found the innocent injured third party was entitled to coverage on the otherwise rightfully rescinded policy.

CURE made the same arguments on appeal. In a split decision, the majority held that an insurer is within its rights to rescind coverage based on fraud, but an innocent third party is still entitled to the compulsory State minimum of $15,000. The dissent agreed with rescission of the policy and that the injured driver was an innocent third party entitled to some form of coverage. However, it held that the injured driver should only be entitled to the optional coverage originally secured by Perez, or up to $10,000.

On appeal to the Supreme Court, CURE fared only slightly better. The Court held that while a policy can be rescinded based on fraud by the insured, an injured innocent third party is entitled to coverage up to the amount of any optional personal injury coverage originally secured by the insured.

It is worth noting that many states limit recovery by an innocent injured party to only those fraud cases that involve auto accidents due to the compulsory nature of auto insurance.   It will be interesting to see if this holding remains limited to such cases in New Jersey as well.

Thanks to Emily Kidder for her contribution to this post and please write to Mike Bono for more information.