A Tale of Two Remedies—
Rescission vs. Cancellation
Rick L. Hammond
Johnson & Bell
33 W Monroe St Ste 2700
Chicago, IL 60603
(312) 984-3425
[email protected]
Rick L. Hammond is a shareholder with the law firm of Johnson & Bell Ltd. in Chicago and co-chairs the firm’s insurance coverage group. Mr. Hammond concentrates
his practice on property insurance coverage, arson and fraud and bad faith litigation.
He is the past president of the Illinois Association of Defense Trial Counsel, Illinois
State Representative for DRI, and a member of the Federation of Defense & Corporate Counsel. Mr. Hammond was recently selected by the Lexis Nexis Insurance Law
Center to receive its honorable mention Insurance Lawyer of the Year Award. The
author wishes to thank and acknowledge the research of and contribution by Johnson and Bell, Ltd. associate attorney Gabriel Judd, whose efforts were instrumental
in the development of this paper.
A Tale of Two Remedies—Rescission vs. Cancellation
Table of Contents
I.Background...................................................................................................................................................83
II.Rescission......................................................................................................................................................83
A. Common Law Approach.......................................................................................................................83
B. Statutory Requirements........................................................................................................................84
C. Statutes of Limitations..........................................................................................................................84
D. Intent to Deceive....................................................................................................................................85
E.Misrepresentation..................................................................................................................................85
F. Insurer’s Duty to Investigate.................................................................................................................85
G.Materiality..............................................................................................................................................86
H.Concealment..........................................................................................................................................86
I. Restoration of Status Quo.....................................................................................................................86
J. Rescission of a Mortgagee’s Right of Recovery....................................................................................87
K. Rescission Regarding the Rights of an Innocent Insured...................................................................88
L. Duty to Initiate Litigation Prior to Rescission.....................................................................................88
M. Misrepresentations in Online Applications.........................................................................................89
N. Waiver and Estoppel..............................................................................................................................90
III.Cancellation...................................................................................................................................................90
A.Background............................................................................................................................................90
B. Acceptance of Late Payments—Charles Keys v. Safeway Insurance Company, 2011
U.S. Dist. LEXIS 13197 (S.D. Miss., Feb. 9, 2011)................................................................................91
C. Acceptance of Partial Payments—Theresa Kelly v. Allstate Insurance Company, 138
F. Supp. 2d 657 (E.D. Pa. 2001).............................................................................................................92
D. Drug Activity = Increase in Hazard?—Erie Insurance Exchange v. Commonwealth
Pennsylvania, 564 A.2d 1312 (Pa. Commw. Ct. 1989)........................................................................93
E. Cancellation of Force Placed Insurance/Proof of Mailing and Proper Notice—
Telma L. Hardison v. Balboa Insurance Company, 4 Fed. Appx. 663 (10th Cir. 2001)......................94
F. Rule of Divisibility—First Savings and Loan Association of Jersey City v. American
Home Assurance Company, 35 A.D.2d 344 (N.Y. App. Div. 1970)......................................................95
G. Duty to Defend—James Johnson v. State Farm Fire & Casualty Company, 2011 IL
App (2d) 100586-U (Ill. App. Ct. 2011) (unpublished).......................................................................95
H. Cancellation Notice Effective Even When Less than Statutory Requirement—Daniel Adams v.
Universal Underwriters Insurance Co., 2011 U.S. Dist. LEXIS 106864 (D. Me., May 19, 2011)........95
IV.Conclusion.....................................................................................................................................................96
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A Tale of Two Remedies—Rescission vs. Cancellation
I.Background
The difference between an insurer’s cancellation of a policy or its rescission is stark, i.e., cancellation eliminates any future obligations under a contract. Whereas, rescission rolls everything back to the point
before the contract ever existed. This paper will examine issues regarding when an insurer may properly
rescind or cancel an insurance policy; how a policy should be rescinded or cancelled; and the election of remedies between cancellation and rescission.
II.Rescission
With respect to rescission, most property policies provide the insurer with the right to rescind a
policy and deny a claim to an insured who intentionally conceals or misrepresents material facts in the application for insurance, versus a misrepresentation made afterwards, i.e., in the presentment of a claim. For
example, a typical policy provision governing the related rights of an insurer states as follows:
Concealment or Fraud - This policy will be void if an insured has, before or after a loss: intentionally concealed or misrepresented any material fact or circumstance; or made false statements
or engaged in fraudulent conduct relating to this insurance; with the intent to deceive.
A. Common Law Approach
Under common law in most states, an insurance policy may be revoked for the same reason as any
other written contract, i.e., when clear and convincing evidence compels a conclusion that an instrument, as
it stands, does not properly reflect the true intention of the parties, and when there has been either a mutual
mistake or mistake by one party and fraud by the other. Board of Trustees of University of Illinois v. Insurance
Corporation of Ireland, 969 F.2d 329 (7th Cir. 1992).
Thus, under common law, an equitable claim for rescission on the basis of fraud voids the policy ab
initio, i.e., at its inception, and may be asserted by establishing:
1) a representation in the form of a statement of material fact, made for the purpose of inducing the
other party to act;
2) that the statement is false and known by the party making it to be false, or not actually believed
by him to be true; and
3) the party to whom it is made is ignorant of its falsity, must reasonably believe it to be true, must
act thereon to his damage, and in so acting must rely upon the truth of the statements.
Chapman v. Hosek, 475 N.E.2d 593 (Ill. App. Ct. 1985); Allstate Insurance Co. v. National Tea Co., 323 N.E.2d
521 (Ill. App. Ct. 1975).
In Stone v. Those Certain Underwriters at Lloyds, etc., 401 N.E.2d 622 (Ill. App. Ct. 1980), the court
adopted the Restatement of Contracts, §472 (1) (b), which requires the insured to disclose information not
known to the insurer, and is so vital to the contract that if the mistake were mutual the contract would be
voidable. If the non-disclosing party knows that the other party doesn’t know the facts, non-disclosure is not
privileged and is fraudulent. Stone, 81 Ill. App. 3d at 336.
It is important to note, however, that one seeking to rescind a transaction on the ground of fraud or
misrepresentation must elect to do so promptly after learning of the fraud or misrepresentation, and must
A Tale of Two Remedies—Rescission vs. Cancellation ❖ Hammond ❖ 83
announce his purpose and adhere to it. Mollihan v. Stephany, 340 N.E.2d 627 (Ill. App. Ct. 1975); see also Vincent
v. Vits, 566 N.E.2d 818 (Ill. App. Ct. 1991) (stating that the “right of rescission must be exercised promptly”). An
unreasonable delay in taking the necessary steps to set aside a fraudulent contract will have the effect of affirming it. See White Brass Castings Co. v. Union Metal Manufacturing Co., 135 Ill. App. 32 (1st Dist. 1907).
B. Statutory Requirements
The courts of many states have promulgated statutes regarding the insurer’s right of rescission. For
example, the Illinois Insurance Code (§215 ILCS 5/154 (2012)) provides:
Misrepresentations and False Warranties. No misrepresentation or false warranty made by
the insured or in his behalf in the negotiation for a policy of insurance, or breach of a condition
of such policy shall defeat or avoid the policy or prevent its attaching unless such misrepresentation, false warranty or condition shall have been stated in the policy or endorsement or rider
attached thereto, or in the written application therefor. No such misrepresentation or false warranty shall defeat or avoid the policy unless it shall have been made with actual intent to deceive
or materially affects either the acceptance of the risk or the hazard assumed by the company.
With respect to a policy of insurance as defined in subsection (a), (b), or (c) of Section 143.13
[215 ILCS 5/143.13], except life, accident and health, fidelity and surety, and ocean marine policies, a policy or policy renewal shall not be rescinded after the policy has been in effect for one
year or one policy term, whichever is less. This Section shall not apply to policies of marine or
transportation insurance.
Thus, in Illinois an insurer satisfies the basic requirements of the statute if the insurer is able to
establish either the intent to deceive, or a material misrepresentation. The elements of “intent to deceive”
and “material misrepresentation” should be read in the disjunctive, i.e., if a misrepresentation is deemed
to be material, it need not have been made with the intent to deceive. Campbell v. Prudential Insurance Co.,
155 N.E.2d 9 (Ill. 1958); Roberts v. National Liberty Group of Companies, 512 N.E.2d 792 (Ill. App. Ct. 1987);
Logan v. Allstate Life Insurance Co., 312 N.E.2d 416, 420 (Ill. App. Ct. 1974).
C. Statutes of Limitations
As noted above, Illinois has promulgated a one year statute limiting the time period during which
an insurer may seek to rescind a policy of insurance. Similarly, California enacted California Insurance Code
§650 (2012), which seemingly seeks to do likewise. However, Section 650 has apparently caused a level of consternation and confusion for policyholders as courts have not always construed this statute in a manner to
limit an insurer’s right of rescission. Section 650 provides:
Whenever a right to rescind a contract of insurance is given to the insurer by any provision of
this part such right may be exercised at any time previous to the commencement of an action on
the contract. The rescission shall apply to all insureds under the contract, including additional
insureds, unless the contract provides otherwise.
Although Section 650 arguably affords an insurer with the right of rescission only until “the commencement of an action on the contract,” California courts have consistently recognized the right of insurers to rescind contracts upon the provision of proper notice. See Meyer v. Johnson, 46 P.2d 822 (Cal. Ct. App.
1935); Ashley v. American Mutual Liability Ins. Co., 167 F. Supp. 125, 128 (N.D. Cal. 1958).
In either case, insurers should be mindful of determining the timelines for seeking rescission in their
respective states when such action is being contemplated.
84 ❖ Insurance Coverage and Claims Institute ❖ March 2012
D. Intent to Deceive
Courts define “intent to deceive” as the intent of the insured to induce his acceptance as an insurance risk by false statements. Courts will typically examine a wide range of circumstantial evidence in order to
determine whether there was fraudulent intent. Roberts v. National Liberty Group of Cos., 512 N.E.2d 792 (Ill.
App. Ct. 1987); Fireman’s Fund Insurance Co. v. Knutsen, 324 A.2d 223 (Vt. 1974).
In the Fireman’s Fund case, the Court held that similar fraudulent acts, if committed sufficiently near
in time so that the same motive may reasonably be inferred to exist, are admissible to establish intent on the
sound logical principle that such similar acts diminish the possibility that an innocent mistake was made in
an untrue and misleading statement. Knutsen, 324 A.2d at 227.
E.Misrepresentation
Most Courts have interpreted “material misrepresentation,” as it pertains to insurance contracts, as
an untrue fact which affects the risk undertaken by the insurer. Thus, the insured’s misrepresentation must be
shown to have caused a substantial increase in the risk insured against, and would have, if the misrepresentations were known by the insurer, caused a rejection of the application. American Country Insurance Co. v.
Mahoney, 560 N.E.2d 1035 (Ill. App. Ct. 1990).
The Mahoney court concluded that an insurance applicant has a duty to act in good faith, and that an
insurer is entitled to truthful responses so that it may determine whether the applicant meets its underwriting criteria. Nevertheless, in some states a good faith mistake does not excuse a material misrepresentation
on an insurance application and does not preclude an insurer from rescinding a policy of insurance. Bageanis
v. American Bankers Life Assurance Co., 783 F. Supp. 1141 (N.D. Ill. 1992); White v. Continental General Insurance Co., 831 F. Supp. 1545 (D. Wyo. 1993).
F. Insurer’s Duty to Investigate
It’s interesting to note that an insurer is not always required to attempt an independent verification of
the information provided by the insured. Allstate Insurance Co. v. National Tea Co., 323 N.E.2d 521 (Ill. App.
Ct. 1975). For example, in Bade v. Badger Mutual Ins. Co., 31 Wis. 2d 38, 142 N.W.2d 218 (Wis. 1966), the
court allowed the insurer to rescind the policy even though the misrepresentations were discovered four years
- and several renewals - after they were made.
Accordingly, courts have recognized that “an insurance company has the right to rely on the truthfulness of the answers given by an insurance applicant, and the insured has the corresponding duty to supply
complete and accurate information to the insurer.” Commercial Life Ins. v. Lone Star Life Ins., 727 F. Supp. 467,
471 (N.D. Ill. 1989). However, an insurer is estopped from voiding a policy for untrue representations in the
application if “the insured discloses facts to the agent and the agent, in [completing ] the application, does not
state the facts as disclosed to him, but instead inserts conclusions of his own or answers inconsistent with the
facts.” Boyles v. Freeman, 315 N.E.2d 899 (Ill. App. Ct. 1974).
Also, an insurer cannot rely on incorrectly recorded answers, “even when the insured knows that the
agent has entered answers different from the ones he or she [provided, if] the incorrect answers are entered
under the agent’s advice, suggestion, or interpretation.” Logan v. Allstate Life Insurance Co., 312 N.E.2d 416
(Ill. App. Ct. 1974). Thus, courts impute the agent’s knowledge of the truthfulness of the . . . statements” to the
insurer. Logan, 312 N.E.2d at 421. “Only [when an] applicant has acted in bad faith, either on his or her own
or in collusion with the insurer’s agent, will a court refuse to impute the agent’s knowledge to the insurance
company.” Id.
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G.Materiality
Materiality is a question of fact and is generally judged by an objective standard. Accordingly, the
insured must disclose any facts requested on the application that, objectively considered, might give rise to a
claim, regardless of the insured’s subjective belief. However, materiality may also be proven by the testimony
of an insurer’s underwriter or employee regarding the significance of the information sought, or based upon
the underwriter’s experience or the practices of the insurance industry.
It is important to note, however, that if the insurer fails to request certain information in an application, such information may be deemed immaterial. Garde v. County Life Insurance Co., 498 N.E. 2d 302 (Ill.
App. Ct. 1986); Ratcliffe v. International Surplus Lines Insurance Co., 550 N.E.2d 1052 (Ill. App. Ct. 1990); International Insurance Co. v. Peabody International Corp., 747 F. Supp. 477, 480 (N.D. Ill. 1990); and Bowman v.
Zenith Life Insurance Co., 384 N.E.2d 949 (Ill. App. Ct. 1978).
H.Concealment
Courts have held that an insurance applicant’s failure to disclose information to an insurer may rise
to the level of a material misrepresentation. Stone, 401 N.E.2d at 626. Thus, representations in an application
for insurance should not only be true but full; i.e., the insurer has a right to know the whole truth in order to
make its own inquiries, and in order to determine whether or not the risk should be assumed. Government
Employees Insurance Co. v. Chavis, 176 S.E.2d 131 (1970). For example, in Garde v. Country Life Insurance Co.,
498 N.E.2d 302 (Ill. App. Ct. 1986), the court allowed an insurer to rescind its policy based upon the insured’s
nondisclosure of twenty-two policies of insurance already in force.
The fact that an insurer conducts an independent investigation does not absolve an insured from
speaking the truth. Nor, does it lessen the right of the insurer to rely upon the insured’s representations,
unless, the investigation disclosed facts sufficient to expose the falsity of the representation made, or, the misrepresentation was of such a nature as to place the insurer on notice of the duty to make further inquiry. Allstate Insurance Co. v. Meloni, 236 A.2d 402 (N.J. Super. Ct. App. Div. 1967).
It is important to note an exception to the general rule regarding an insured’s duty to disclose. In
Boyles, the court held that where a prospective insured, in good faith, admitted that his driver’s license had
been suspended or revoked, but qualified his statement by saying that he couldn’t remember whether it
occurred in the preceding five years, and where the insurer had an election of ignoring the qualification or
refusing the risk, but elected to ignore the qualification and issue the policy, it could not later seek to rescind
the policy because the statement without the qualification was false. 315 N.E.2d at 902.
I. Restoration of Status Quo
It is a general principle of the doctrine of rescission that a person demanding rescission must restore
the other party to the status quo existing at the time the contract was made. Puskar v. Hughes, 533 N.E.2d 962
(Ill. App. Ct. 1989); Luciani v. Bestor, 436 N.E.2d 251 (Ill. App. Ct. 1982). Accordingly, if an insurer fails to give
prompt notice of its election to rescind and fails to restore the insured to the status quo existing at the time the
contract was made, it may lose its rights in that regard. International Insurance Co. v. Sargent & Lundy, 609
N.E.2d 842 (Ill. App. Ct. 1993).
It is important to note, however, that the granting of rescission is not necessarily precluded when it
is impossible to restore the other party to the status quo. Thus, restoration to status quo will not be required
when the restoration has been rendered impossible by circumstances not the fault of the party seeking rescission, i.e., where the insured obtained a benefit from the contract and where, by the nature of the insured’s
86 ❖ Insurance Coverage and Claims Institute ❖ March 2012
fraud or other act, it is impossible to restore the status quo. John Burns Construction Co. v. Interlake, Inc., 433
N.E.2d 1126 (Ill. App. Ct. 1982). Conversely, rescission will usually not be granted where the actions of the
party seeking rescission have created an impediment to the court’s ability to restore the status quo. Klucznik v.
Nikitopoulos, 503 N.E.2d 1147 (Ill. App. Ct. 1987).
J. Rescission of a Mortgagee’s Right of Recovery
The issue of whether a mortgagee is protected where an insurance policy is deemed void at its inception due to the acts or neglect of the mortgagor in procuring the policy has not been unanimously resolved by
many states. However, most courts have held that fraudulent misrepresentations in the application for insurance do not void coverage for the mortgagee.
For example, in Fayetteville Building & Loan Ass’n v. Mutual Fire Insurance Co., 141 S.E. 634 (W. Va.
1928), the court refused to bar the mortgagee’s insurance claim even though the mortgagor’s application for
insurance contained a fraudulent representations. The court cited the reasoning in Germania Fire Insurance
Co. v. Bally, 173 P. 1052 (Ariz. 1918), as support for its conclusion.
As is well known, many insurance policies are issued, primarily, to protect mortgagees. In fact,
it is made a condition of the mortgage, as in this case, that the insurance shall be carried by
the owner of the property to protect the interests of the mortgagee. This exaction by the mortgagee is well known to the insurance companies, and they are only too glad to take the risk. The
insurer issues the policy to the mortgagor. It is a contract between the mortgagor and the insurance company. The mortgagee is not interested in the contract in its inception, and only becomes
interested after its execution, when the mortgage clause is attached to the policy for his protection.
*****
We think the mortgagee, when a policy is presented to him with a standard mortgage clause
attached thereto in his favor, is justified in assuming that the insurance company has satisfied
itself that the policy is valid and free from impeachment for any conduct or act of the assured at
its inception or prior to the attachment of the mortgage clause. The authorities are not agreed
on this proposition, but we think the better reason is with those that hold the rights of the mortgagee are unaffected by any act or neglect of the insured as well before the attachment of the
mortgage clause as afterward.
Fayetteville Building & Loan Ass’n, 141 S.E. at 636.
Conversely, the case of Young Men’s Lyceum v. National Ben Franklin Fire Insurance Co., 177 A.D. 351
(N.Y. App. Div. 1917), provides a stark contrast to the conclusions reached in Fayetteville Building & Loan
Ass’n. In Young Men’s Lyceum, the court reasoned that if the insured makes a false representation regarding
a fact that affects a material risk that would affect the insurer’s decision to issue the policy or the premium it
charges, that false statement could be the basis for rescinding the policy as to both the insured and the mortgagee. Id. at 356-57. (See also Genesee Falls Permanent Savings, v. U.S. Fire Insurance Co., 15 A.D. 587 (N.Y.
App. Div. 1897) (recognizing that if the mortgagor misrepresented in the policy application that he was the
sole owner of the insured property, the false statement could void the policy at the outset and negate the separate contract that the mortgage clause creates for the mortgagee), and Hanover Fire Insurance Co. v. National
Exchange Bank, 34 S.W. 333 (Tex. 1896) (voiding policy as to the mortgagee because there was a lien on the
property that the mortgagor did not disclose when applying for the policy)).
A Tale of Two Remedies—Rescission vs. Cancellation ❖ Hammond ❖ 87
K. Rescission Regarding the Rights of an Innocent Insured
Some courts have held that an insurer’s right to rescind a policy of insurance only applies to the
claims of the insured, not to the claims of an innocent third party who is injured by the insured’s tortuous act
(See Fogel v. Enterprise Leasing Co., 817 N.E.2d 1135, 1142 (Ill. App. Ct. 2004)). This argument tends to arise in
the context of personal injury cases where an insured, who fraudulently obtained coverage, tortuously injures
a third party. While courts may deny relief to the contracted insured, they tend to grant relief to innocent
third parties injured by the insured. Thus, as one court aptly stated:
[I]t may appear harsh to force the insurance company to abide by a contract procured by fraud,
but it would be beyond harsh to preclude third-party [claimants] who are innocent of trickery,
and injured through no fault of their own, from receiving protection under the policy.
Erie Insurance Exchange v. Lake, 671 A.2d 681 (Pa. 1996).
On the other hand, at least one court has granted an insurer’s right of rescission in the context of an
innocent first-party insured. For example, in Columbia Mutual Insurance Co. v. Martin, 912 S.W.2d 640 (Mo.
Ct. App. 1995), Dean and Lois Martin allegedly submitted an application for insurance to Columbia Mutual
Insurance Company and allegedly failed to inform the carrier of prior criminal violations and several previous
fire losses. The Martins’ home was destroyed by fire several months after the policy’s inception date, and coverage was denied to both insureds after Columbia learned of the material misrepresentations in the application for insurance.
Dean Martin allegedly pleaded guilty to the charge of arson and his former wife, Lois Martin, filed
a declaratory judgment action against the insurer. The trial court entered summary judgment in favor of the
insurer and Ms. Martin appealed. The Court of Appeals, in an apparent effort to distinguish between the obligations of an insurer to an innocent insured when fraud is committed before, versus after a loss, held that the
actions of Dean Martin voided the policy from its inception and that, as there was no valid policy, there should
be no coverage for either insured. The court went on to state that there is no dispute that the policy would not
have been issued had the true facts been known to the insurer at the time of application.
L. Duty to Initiate Litigation Prior to Rescission
There are differing views on whether an insurer is required to initiate litigation, i.e., in the form of a
declaratory judgment, prior to rescinding a policy of insurance. Versus, whether it’s permissible for an insurer
to unilaterally rescind a policy by mere notice to the insured. For example, in Ghose v. CNA Reinsurance Co.,
Ltd., 43 A.D.3d 656 (N.Y. App. Div. 2007), the New York Appellate Division dismissed a coverage action for
forum non conveniens and, in dicta, reaffirmed the proposition that unilateral rescission is not permissible
under New York law.
Conversely, in JP Morgan Chase Bank N.A. v. Republic Mortgage Insurance Co., 2011 U.S. Dist. LEXIS
47918 (D.N.J. May 4, 2011) (unpublished), Chase sued the Republic Mortgage Insurance Company asserting
that Re­public breached the terms of the policies by unilaterally re­scinding coverage since, according to Chase,
RMIC was required by law to seek rescission from a court or arbitrator. Both parties moved for summary
judgment. The court rejected Chase’s contention that Repub­lic was required to commence litigation or arbitration prior to rescinding the policy. Similarly, a San Francisco federal district court held that insurers may
rescind their insureds’ policies without a prior judicial order, and may thereafter extinguish any defense obligations they might have for a pending claim. Atmel Corporation v. St. Paul Fire & Marine, 426 F. Supp. 2d 1039
(N.D. Cal. 2005).
88 ❖ Insurance Coverage and Claims Institute ❖ March 2012
Needless to say, the conservative viewpoint is that an insurer should seek a court’s declaration of its
right of rescission prior to denying coverage. Thus, as one court aptly stated: “Insurance carriers do not function as courts of law. If a carrier wants the unilateral right to refuse a payment called for in the policy, the
policy should clearly state that right.” Associated Elec. & Gas Ins. Servs. v. Rigas, 382 F. Supp. 2d 685 (E.D. Pa.
2004) (the “Adelphia” case).
M. Misrepresentations in Online Applications
Rescissions based upon misrepresentations made in an application for insurance submitted via the
internet raise unique evidentiary issues. A recent decision issued by the Michigan Court of Appeals is one of
few cases that have touched on this issue.
In Springborn v. Allstate Insurance Co., 2010 Mich. App. LEXIS 1893 (Mich. Ct. App. Oct. 7, 2010)
(unpublished), Laura Springborn submitted an application for auto insurance via the internet with Allstate
Insurance Company. Allstate alleged that she represented herself as divorced in the application by checking an
interactive box on the computer screen. Laura stated that she believed she checked the box indicat­ing that she
was married and that she didn’t remember checking the “divorced” box. Allstate issued the policy based upon
the representations made in the online application for insurance.
Laura and her husband, Eric, were subsequently involved in an accident while Eric was driving the
car. Laura began experiencing pain over the next few days and eventually stopped working. Allstate voided the
policy ab in­itio on the alleged basis that Laura materially misrepre­sented her marital status on the application
for insurance. Thus, apparently Eric had too many violations on his driving record, and it was Allstate’s policy
that spouses could not be excluded.
Laura sued alleging that Allstate breached the policy of insurance. Allstate asserted that Laura made
a material misrepre­sentation on the insurance application and, therefore, it was within its rights to rescind the
policy. The trial court granted a motion for summary judgment filed by Allstate and Laura appealed.
The appellate court reversed the trial court’s ruling and re­manded the case back to the trial court on
the basis that Allstate failed to show the printout was actually what it purported to be—an accurate re­flection
of Laura’s representations in applying for insurance online. The appellate court held that this error affected
Laura’s substantial rights because it affected the outcome of the case. “If, on remand, Allstate can establish
the printout accurately reflects Laura’s data input, it will be entitled to summary disposition because it issued
the policy as a result of the misrepresentation when it otherwise would not have done so due to Eric’s driving
record.”
Thus, computer-stored or computer-generated information often has special evidentiary concerns. In
general, an insurer should be prepared to offer testimony from an employee in the IT department in addition
to claims personnel. Moreover, an affidavit or deposition testimony to support their evidentiary assertions
should be submitted stating:
• How the online application page works in general. How is user-entered information stored and
how is it retrieved and used by the company;
• A description of how employees use the information entered online to process the application
and how they have been trained in its use; and
• Identification of any procedures that the software uses to catch errors and to bring them to the
attention of the user.
A user who can be shown to have entered information on an online form, reviewed the information in a browser display, and then received an e-mail confirmation which recites the information they have
A Tale of Two Remedies—Rescission vs. Cancellation ❖ Hammond ❖ 89
entered would seemingly have a difficult time persuading a judge that they made an innocent error in completing the form.
N. Waiver and Estoppel
An insurer’s right to rescind a policy of insurance is a privilege which may inadvertently be lost by
waiver or estoppel where the conduct of an insurer induces the insured to believe that he/she need not comply
with certain policy provisions, or that such provisions will not be enforced. Downing v. Wolverine Insurance
Co., 210 N.E.2d 603 (Ill. App. Ct. 1965). Thus, in order for an insured claiming waiver, they must establish that
the insurer had knowledge, actual or constructive, of the existence of their rights or facts upon which they
depended at all relevant times. In other words, waiver cannot be established by consent given under a mistake
of fact. Government Employees Insurance Co. v. Chavis, 176 S.E.2d 131 (S.C. 1970).
It is important to note, however, that lack of good faith on the part of an insured does not prevent
consideration of whether an insurer waived a coverage defense based on misrepresentations in an application for insurance. Thus, a “lack of good faith” defense is applicable only to the doctrine of estoppel and not to
waiver, which involves acts or conduct by one of the parties to the contract. Knutsen, 324 A.2d 223 (1974).
III.Cancellation
A.Background
Most policies of insurance provide the insurer with the right to cancel a policy under certain terms
and conditions. A sample provision of this type states as follows:
Cancellation
a. We may cancel this policy as provided in this condition. The cancellation notice, together with
our reason for cancellation, will be mailed to you at your last mailing address known by us, and
we will obtain a certificate of mailing. A copy of the notice will also be sent to the agent or broker
and the last known mortgagee or lien holder at the last mailing address known by us.
(1) When this policy has been in effect for less than 60 days and is not a renewal with us, we
may cancel for any reason.
(2) When this policy has been in effect for 60 days or more, or if it is a renewal with us, we may
cancel:
(a) for non-payment of premium;
(b) if this policy was obtained by misrepresentation or fraud; or
(c) for any act which measurably increases the risk originally accepted.
b. If we cancel for non-payment of premium we will let you know of our action at least 20 days
before cancellation takes effect. If we cancel for a reason other than non-payment of premium,
we will let you know of our intention at least 31 days before cancellation takes effect.
Accordingly, insurance cancellations can generally occur at a specified time prior to the expiration
date of the policy or its renewal date. As noted, if the policy is canceled by the insurer, any unearned premium on the account must be returned to the policyholder. An unearned premium is a prorated amount that
has already been paid towards the policy. There are a number of reasons why an insurer may elect to cancel
a policy, but typically cancellations occur when there has been an undisclosed risk of loss, insurance fraud, a
recently increased risk, or a failure to pay premiums on time.
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This section of the article will examine some of the issues that might arise to impact the rights or
obligations of the insurer and insured when an insurer elects to cancel a policy of insurance. Although several
of the following cases are not authoritative, they all provide an illustration of the mindset of many courts concerning an insurer’s right of cancellation.
B. Acceptance of Late Payments—Charles Keys v. Safeway Insurance Company,
2011 U.S. Dist. LEXIS 13197 (S.D. Miss., Feb. 9, 2011)
If an insured routinely accepts late payment without cancellation of the insured’s policy, an issue
arises on whether their prior conduct causes the insured to rely to their detriment that no future cancellations
will occur when premiums are submitted late. In Charles Keys v. Safeway Insurance Co., 556 F. Supp. 2d 586
(S.D. Miss. 2008), the U.S. District Court for the Southern District of Mississippi examined this issue.
On December 7, 2006, Safeway Insurance Company sent a bill to Charles Keys stating that his
$106.40 premium was due on December 22, 2006. On December 11, 2006, having not yet received payment,
Safeway sent a notice of cancellation to Keys. The notice stated that the cancellation date was December 22,
2006, and that the amount due was $106.40. Keys failed to pay the premium by December 22, 2006, and a
week later he was involved in an automobile accident. Shortly following the accident, he paid the outstanding
premium and filed a claim for the loss.
Safeway rejected the premium payment and denied the claim in a letter stating that the policy had
been “cancelled for non-payment of premium on 12-22-06 at 12:01 am.” After Keys retained counsel, Safeway
reversed its position and chose to pay the claim. Keys subsequently filed suit alleging that Safeway acted with
gross negligence, malice and reckless disregard for his rights when it cancelled the policy. He further prayed
for punitive damages, exemplary damages, and damages for emotional distress, mental anguish, and loss of
enjoyment of life.
Safeway filed a Motion for Summary Judgment arguing that even if it had violated the Mississippi
Insurance Code, its actions didn’t rise to the level of bad faith. In response, Keys argued that he’d been late on
prior premium payments and on those occasions Safeway didn’t cancel his policy. Therefore, he argued that
the only possible reason that his policy was canceled on this occasion was that he filed a claim.
The court held, however, that even if Safeway accepted late payments in the past, it was unreasonable for Keys to assume that Safeway would do so in this case, particularly in light of the clear demand made
for the payment of premiums by a date certain. In response to Key’s argument that Safeway agreed to pay his
claim only because he retained an attorney as evidence of the insurer’s bad faith, the court stated:
Nor is it necessarily true, that because an insurance company pays a claim prior to being sued,
it admits it owed it, and was therefore unjustified in not paying the claim to begin with. . . . If we
ever announce, as a rule of law, that in paying a claim which has been questioned the insurance
company admits to some questionable conduct in handling the claim, then we will guarantee
that no insurance claim will ever be given the benefit of the doubt. If the company pays prior to
litigation, it may subject itself to a bad faith claim. Who wants this?
*****
The Mississippi Supreme Court recognized that such a rule would create a disincentive for insurers to settle disputed claims. Accordingly, the Court finds that Defendant’s payment of the claim
after Plaintiff retained counsel -- standing alone -- is not sufficient evidence of bad faith to survive summary judgment.
Keys, 2011 U.S. Dist. LEXIS at *21.
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C. Acceptance of Partial Payments—Theresa Kelly v. Allstate Insurance Company,
138 F. Supp. 2d 657 (E.D. Pa. 2001)
In some cases, a question arises on whether an insurer’s acceptance of a partial payment for premiums operates as a waiver of the insurance company’s right of forfeiture for lapse of premiums. In Theresa Kelly
v. Allstate Insurance Company, 138 F. Supp. 2d 657 (E.D. Pa. 2001), the U.S. District Court for the Eastern District of Pennsylvania examined this issue.
In this case, plaintiff, Theresa Kelly, purchased an auto policy from Allstate Insurance Company
insuring two vehicles, a 1991 Cadillac and a 1995 GMC Jimmy. On April 10, 2000, Allstate sent Kelly a bill
for the premium period of February 28 - August 29, 2000, and offered her the option of paying the full bill of
$896.72, or paying four monthly installments of $227.68. The bill indicated that payment was due by April
29, 2000. Because Kelly failed to make any payment by the proscribed due date, Allstate issued a cancellation
notice on May 9, 2000 stating that if a payment of $451.88 was not received before May 29, 2000, her policy
would be cancelled by 12:01 a.m. on that date.
On May 11, 2000, Kelly mailed a check to Allstate in the amount of $227.68 which they received on
May 16, 2000. That same date, Allstate mailed a special notice to Kelly advising her that while it had credited
the partial payment toward her policy, unless an additional payment of $227.68 was received before 12:01
a.m. on May 29, 2000, the policy would terminate according to the cancellation notice sent previously. Allstate didn’t receive another $227.68 payment from Kelly until June 11, 2000, so it advised her by reinstatement
notice dated June 13, 2000 that her policy had been cancelled at 12:01 a.m. on May 29, and that it had been
reinstated at 12:01 a.m. on June 11, 2000.
Two days earlier, on June 9, 2000, Kelly was involved in an automobile accident in which she sustained personal injuries, so she filed a claim for her medical expenses under the medical payments provision of her policy. Allstate denied the claim on the basis that her losses were not covered because the accident
occurred during the period that the policy had lapsed. Kelly then filed suit seeking damages for breach of contract and bad faith, and both parties filed cross-motions for summary judgment.
Kelly argued in her motion that her policy could only be cancelled for nonpayment of premium if a
cancellation notice is sent after the premium becomes past due, and if the notice is sent at least fifteen days
before the effective cancellation date. She admitted that her $227.68 installment payment was due on April
29, 2000 and that it wasn’t paid until May 11, 2000. Notwithstanding, she contends that her policy couldn’t
be cancelled for non-payment of premium until after she failed to pay the next installment which was due on
May 29, 2000. The court disagreed stating that:
[T]he payment of premiums is said to be the very essence of an insurance contract; premium
payments are a condition precedent to or at least concurrent with the assuming of any liability
by an insurance company, In re Moran, 249 B.R. 90, 96 (Bkrcy. E.D. Pa. 2000). Acceptance of a
partial payment for premiums due does not operate as a waiver of the insurance company’s right
of forfeiture for lapse of premiums and an insurer cannot be compelled to apply a dividend less
than a full premium so as to extend the term of the policy proportionately.
*****
Here, when Plaintiff failed to make an installment payment of $227.68 by 12:01 a.m. on May 29,
2000, Defendant could have and did properly cancel the auto insurance policy which she had on
her two vehicles. Given that Ms. Kelly did not make her $227.68 May installment payment until
June 11, 2000, Allstate did not reinstate her policy until that date. We therefore find that when
Ms. Kelly was involved in the automobile accident on June 9, 2000, the Allstate policy was not in
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effect and Allstate therefore does not owe her any benefits under [the policy] as a result of that
accident … In addition we find that defendant is also entitled to judgment in its favor as a matter
of law on the plaintiff ’s claim for bad faith.
Kelly, 138 F. Supp. 2d at 662.
D. Drug Activity = Increase in Hazard?—Erie Insurance Exchange v. Commonwealth
Pennsylvania, 564 A.2d 1312 (Pa. Commw. Ct. 1989)
In this case, Erie Insurance Exchange appealed an order of the Insurance Commissioner of the Commonwealth of Pennsylvania who determined that Erie’s cancellation of their insured’s, Frank S. Piehl, Jr.’s,
homeowners’ policy violated the Unfair Insurance Practices Act.
On June 21, 1988, Erie cancelled the insured’s policy, which had twice been renewed annually,
because Erie concluded that there was a “substantial increase in hazard -- moral hazard” based on the
insured’s guilty plea to a charge of possession with intent to distribute marijuana. The insured petitioned
the Pennsylvania Insurance Commissioner to review the legality of the cancellation and on July 7, 1988 the
Department issued an “Investigative Report/Order,” finding that the cancellation violated the Act because the
incident concerning the basis for the cancellation happened before the policy’s inception date. The Department then ordered Erie to reinstate Piehl’s policy.
Erie filed an appeal to the Commonwealth Court of Pennsylvania contending that it should be
allowed to cancel the insured’s policy because his alleged guilty plea to drug trafficking charges constituted a
substantial increase in the moral hazard assumed by the insurer. The court acknowledged that although this
was an issue of first impression, in earlier cases it had interpreted the phrase “substantial increase or change
in hazard” to mean “’a substantial and material increase, such as the insurer, in view of the terms of the policy,
could not reasonably be presumed to have contracted to assume.’” Lititz Mutual Insurance Co. v. Sheppard,
401 A.2d 606, 608 (Pa. Commw. Ct. 1979) (citing 8 Couch on Insurance, 304 (2d ed. 1961)). The court further
acknowledged that “moral hazard” is construed to be “the risk, danger, or probability that the insured will
destroy, or permit to be destroyed, the insured property for the purpose of collecting the insurance.” 8 Couch
on Insurance 2d (Rev. ed.) §37A:292.
In support of their argument that the insured’s conduct amounted to an increase in risk, Erie’s counsel proffered a New York State Journal of Medicine article titled “The relationship of smoking to motor vehicle
accidents and traffic violations,” which indicated that smokers and drinkers are greater insurance risks. Notwithstanding, the court held that Erie presented no evidence to support their contention that the insured’s
conviction, alone, would result in a substantial increase of risk to the insurance company, and further held
that Erie presented no evidence to support an argument that the insured would tend to be a party to the
destruction of his property for the purpose of collecting insurance proceeds. Accordingly, in finding for the
insured the court stated:
Insurance companies routinely consider the risks involved when setting premium rates for
respective policyholders. By no means do we condone the illegal act of drug possession; however, the relationship of Piehl’s conduct to the insured risk is not so substantial or material that
Erie could not reasonably contract to assume it. Therefore, we hold that the commissioner properly concluded that Piehl’s action did not represent an increase in hazard which warrants cancellation of his insurance policy.
Erie Insurance Exchange, 564 A.2d at 1314.
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E. Cancellation of Force Placed Insurance/Proof of Mailing and Proper Notice—
Telma L. Hardison v. Balboa Insurance Company, 4 Fed. Appx. 663 (10th Cir. 2001)
In light of the country’s current economic crisis, along with the increase in foreclosures, it stands to
reason that force placed insurance coverage is on the rise. In that regard, unique issues can arise when a force
placed policy is cancelled to the detriment of the mortgagor/homeowner.
For example, in this case Telma Hardison purchased a home in Oklahoma City, Oklahoma with a
mortgage provided by United Companies Lending Corporation. Allegedly, she defaulted on the loan and failed
to maintain insurance as required by the terms of the mortgage. The United Companies instituted a foreclosure action and Hardison filed for bankruptcy. In November 1996, the United Companies exercised their contractual right to “force place” a fire insurance policy on the home to protect their interest in the property. The
policy was issued by Balboa Insurance Company and United Companies was reflected as the named insured.
The policy was cancelled in November 1997 by the United Companies without explanation and in
June 1998 a tornado damaged the property. Hardison attempted to file a claim; however, Balboa denied the
claim stating that the policy had been cancelled prior to the date of loss. Hardison insisted that the policy’s
cancellation was ineffective because she never received notice and, therefore, she filed suit against Balboa
alleging bad faith breach of the insurance contract.
Although it’s undisputed that the United Companies, as the named insured, cancelled the force
placed policy, the district court held that Balboa had no legal duty to notify Hardison of that cancellation.
Alternatively, the district court held that even if there was such an obligation, the evidence demonstrated that
Balboa, in fact, mailed notice to Hardison. Therefore, the court granted Balboa’s motion for summary judgment on the bad faith claim.
On appeal, Hardison argued that Balboa’s cancellation was legally ineffective without proper notice,
and that their purported evidence of notice was inadmissible and, even if the evidence was admissible, Balboa did not demonstrate that they actually mailed the notice of cancellation. Hardison also argued that Balboa never evidenced that its employees followed customary procedures in mailing their cancellation notices,
that Balboa didn’t have a duplicate of the actual letter purportedly mailed to her, and there wasn’t a notation in
either written or computer form to verify the actual mailing of the cancellation notice prior to the loss.
However, Balboa offered evidence reflecting that it mailed a cancellation notice including computergenerated reproductions of two separate original cancellation notices to Hardison, a template used to generate
one of those notices, computer printouts which allegedly reflected the mailing of a cancellation notice, and an
affidavit by Balboa’s Vice-President of Tracking Operations explaining how the computerized records regarding the force placed policy covering Hardison’s home were processed and maintained. In addition, Balboa’s
answers to Hardison’s interrogatories provided extensive information concerning Balboa’s computer record
keeping system that was verified by two Balboa employees.
In reaching its decision, the appellate court noted that it’s not necessary for Balboa to prove that
Hardison actually received notice of the cancellation. Rather, Balboa need only present undisputed evidence
which demonstrates that it mailed a cancellation notice to Hardison. (See Richardson v. Brown, 443 F.2d 926,
927-28 (10th Cir. 1971) where an insurance company strictly complies with policy terms relating to cancellation, including mailing insured a cancellation notice at address shown on policy, risk of non-receipt falls on
the insured) (citing Midwestern Ins. Co. v. Cathey, 262 P.2d 434, 436 (Okla. 1953)). Therefore, the court held
that Hardison had failed to show a factual dispute on the issue of whether Balboa mailed her notice of the
United Companies’ cancellation of the force placed policy, and held that summary judgment on behalf of Balboa was proper.
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F. Rule of Divisibility—First Savings and Loan Association of Jersey City v. American
Home Assurance Company, 35 A.D.2d 344 (N.Y. App. Div. 1970)
An interesting question is raised when an insurer attempts to cancel coverage under an entire policy
for non-payment of premiums when the premium for the original policy has been paid, but when there is an
additional premium due because of a subsequent increase in the amount of coverage.
In this case, an insured increased the limits of liability on a fire policy by an endorsement. The
endorsement didn’t add any new coverage nor did it add any new risks to the existing policy. Subsequently,
however, the insured failed to pay the additional premium for the increased limits of liability. The insurer
sought to cancel the entire policy based upon the non-payment. The Court ruled that the insurer could, in
fact, cancel the entire policy, reasoning that because the endorsement increased the amount of coverage for
the same property and risk, the endorsement merged into the underlying insurance policy, and that the policy
and the endorsement were not divisible.
Conversely, in Nationwide Mutual Insurance Company v. Mason, 37 A.D.2d 15 (N.Y. App. Div. 1971),
the court held that if an insured failed to pay the premium due on an endorsement which added an additional
vehicle, the insurer could only cancel the coverage for that additional vehicle. Accordingly, if a subsequent
endorsement either adds coverage for an existing risk or covers a new risk, like adding collision coverage to a
liability-only auto policy or adding an additional automobile, the endorsement will generally be treated as being
divisible from the policy, provided that such coverage is separately stated and the premium is separately fixed.
G. Duty to Defend—James Johnson v. State Farm Fire & Casualty Company, 2011 IL
App (2d) 100586-U (Ill. App. Ct. 2011) (unpublished)
In some states it is well settled that an insurer preserves its coverage defense by timely filing a complaint for declaratory judgment or by defending the insured under a reservation of rights (See State Farm Fire
& Cas. Co. v. Martin, 710 N.E.2d 1228 (Ill. 1999)). The question becomes whether a court should treat a cancellation as it would any other coverage defense. In other words, whether an insurer should be required to
defend an underlying action under a reservation of rights, or be required to file a declaratory judgment action
prior to the entry of a default judgment against the insured in the underlying action when cancellation is
being asserted.
In Johnson, the Illinois Appellate Court, Second Judicial District, held that State Farm was estopped
to rely on cancellation of a manufactured home policy for nonpayment of the monthly premium where there
was a dispute over the effectiveness of the cancellation. Instead, the court treated the cancellation as it would
any other coverage defense, which required State Farm to defend the underlying action under a reservation of
rights, or to file a declaratory judgment action prior to the entry of the $300,000 default judgment against the
insured in the underlying action.
Before the appellate decision in this case, one other appellate panel in American Standard Insurance
Co. v. Gnojewski, 747 N.E.2d 367 (Ill. App. Ct. 2001), likewise held that an insurer was estopped from relying
on cancellation of the policy as a defense.
H. Cancellation Notice Effective Even When Less than Statutory Requirement—
Daniel Adams v. Universal Underwriters Insurance Co., 2011 U.S. Dist. LEXIS
106864 (D. Me., May 19, 2011)
If an insurer issues a notice of cancellation but provides the insured with less time than required by
statute, is the cancellation ineffective? Yes, according to the U.S. District Court for the District of Maine who
A Tale of Two Remedies—Rescission vs. Cancellation ❖ Hammond ❖ 95
ruled that an insurer’s notice of cancellation because of nonpayment of premiums was effective notwithstanding that the insurer’s notice was mistakenly issued with less time than required by statute.
In that case, following a default judgment in a personal injury suit between Daniel Adams and KDT
Towing & Repair Inc., Adams sought proceeds from KDT’s insurer, Universal Underwriters Insurance Co. The
parties cross-moved for summary judgment, primarily contesting whether Universal’s notice of cancellation
to KDT for nonpayment of premiums effectively canceled its insurance policy before Adams’ accident. Finding
the cancellation was effective, the district court granted Universal’s motion and denied Adams’ motion.
In so ruling, the court rejected Adams’ assertion that when an insurance company provides an
insured with a shorter notice of cancellation than required by statute, the notice is rendered ineffective and
the policy remains in effect. Accordingly, the district court held that a notice of cancellation that mistakenly
provides a shorter notice period than the statutory minimum but otherwise meets the statutory requirements,
delays the effective date of cancellation until the statutory period has run. But, the error does not void the cancellation.
IV.Conclusion
In some ways, rescission and cancellation complement each other. Thus, from the perspective of an
insurer each method is a vehicle to “right a wrong.” However, from the standpoint of many policyholders,
rescission and cancellation are tactics to “post-claim” underwrite a policy, and tactics to avoid the payment of
otherwise valid claims.
As long as these diametrically opposed viewpoints exist, there will likely be ongoing litigation
between insureds and insurers, and there will likely be continued judicial scrutiny of the manner in which an
insurer elects to rescind or cancel a policy of insurance.
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