In a twist on the old adage, “bad facts make bad law”, the Second Circuit’s recent decision in Fireman’s Fund Insurance Company v. Great American Insurance Company of New York, Civil Action No. 14-1346-cv, 2016 WL 2943139 (2d Cir., May 20, 2016), clearly demonstrates that bad facts withheld by an insured from its insurers can make for a very bad result for insureds.
This recent May 20, 2016, Second Circuit decision arose from a contribution action filed by Fireman’s Fund and the insured, Signal International, LLC, against the insured’s pollution carrier and excess property insurer, due to losses and environmental cleanup costs that resulted when the insured’s dry dock sank. Post-loss, and based on the $13.6 million value of the dry dock as represented by the insureds in the Statement of Values, the primary property insurer paid its total coverage amount of $10 million; and the excess property insurer paid $3.6 million. When the excess property and pollution insurers argued that their respective policies did not cover the costs of the dry dock removal and environmental cleanup, Fireman’s Fund, the marine general liability insurer, agreed to fund the removal and cleanup efforts, reserving its rights to seek reimbursement from the excess property and pollution carriers.
In response to the contribution action filed by Fireman’s Fund and the insured, both the excess property insurer and the pollution insurer sought the district court’s declaration that their policies were void due to the misrepresentations and nondisclosures of the dry dock’s deteriorated condition during the underwriting process. The lower district court agreed that each of the policies were void and Fireman’s Fund appealed to the Second Circuit.
In affirming the lower district court, the Second Circuit clarified the test to determine whether a policy is, in fact, a marine policy, and the importance of that determination upon the remaining rescission analysis, particularly when the policy is determined a marine policy and subject to the doctrine of uberrimae fidei (i.e., parties to a marine insurance policy must accord each other the highest degree of good faith). The Second Circuit’s analysis further demonstrates that, even with non-marine policies where the doctrine of uberrimae fidei does not apply, an insured must still provide information to an insurer in a way that is not misleading and half-truths by an insured will not always protect an insured from policy rescission.
The Maritime Nature of the Pollution Policy. Prior to 2004, the Second Circuit limited admiralty jurisdiction to contracts that are purely maritime, and, thus, generally excluded mixed contracts like at issue here from admiralty jurisdiction. In 2004, however, the United States Supreme Court decision, Norfolk S. Ry. Co. v. Kirby, 543 U.S. 14, 125 S.Ct. 385 (2004), established a conceptually based analysis that required an examination of an insurance contract’s nature and character, expanding admiralty jurisdiction to mixed contracts of both admiralty and non-admiralty obligations where the mixed contract’s principal objective remained maritime commerce. Following the Kirby decision, the Second Circuit later amended its jurisprudence on maritime contracts and determined that admiralty jurisdiction would exist over an insurance contract where the contract’s primary objective is the establishment of marine insurance policies; and whether an insurance policy is marine insurance is dependent on whether the policy assumes marine risks. See Fireman’s Fund Ins., at *9-10 (citing Williamson v. Recovery Ltd. P’ship, 542 F.3d 43, 49 (2d Cir. 2008); Folksamerica Reinsurance Co. v. Clean Water of N.Y., Inc., 413 F.3d 307 (2d Cir. 2005) (quoting Kirby, 543 U.S. at 25)) (other internal citations omitted).
In applying this primary objective standard, given that the pollution policy was to insure against risk of liability for pollutants to the water from repair and maintenance operations, the Second Circuit had little difficulty in subjecting the policy to admiralty jurisdiction and federal maritime law. The court focused on the fact that the dry dock coverage insures: against liability for accidental discharge from the dry dock “into the navigable waters of the United States”; liability arising from various statutes that hold parties responsible for the release of pollutants into navigable waters; and against liability for emissions from “all Vessels while under repair” within “a 100 nautical mile radius” of the dockyard. The court, therefore, concluded that the policy provided coverage for vessels located at the dry dock in connection with the insured’s repair business – the type of business long recognized as maritime. Fireman’s Fund Ins., at *10 (quoting Folksamerica, 413 F.3d at 313).
The Importance of Determining Whether the Policy is a Marine Policy. The inquiry of whether a policy is a maritime policy has significant relevance far beyond conferring federal jurisdiction. A contract deemed a maritime one will also be controlled by federal law, under which a marine insurance contract is subject to the federal maritime doctrine of uberrtimae fide, or the “utmost good faith” requirement for the parties. Essentially, the parties to a marine insurance policy must act in the highest degree of good faith. Thus, the insured is bound, even if no inquiry is made by the insurer, to disclose every fact within his knowledge that is material to the risk being insured.
Violation of Uberrtimae Fidei Doctrine. In the Second Circuit, the doctrine only requires voiding the policy where the undisclosed facts are both material and relied upon by the insurer. The standard for a disclosure is objective – i.e., whether a reasonable person in the insured’s position would know that a particular fact is material. The facts in the Fireman’s Fund were especially egregious. The insured had been advised as far back as 2002 that the insured dry dock was in a severely deteriorated condition having received no less than four formal risk assessments not including one internal assessment all of which reported that the dry dock was in danger of imminent failure of collapse. Moreover, one evaluation reported that the value of dry dock had a zero value and another reported indicated that it would cost approximately $22 million to extend the life of the dry dock for another 10-15 years. The insured’s internal report stated that the dry dock’s use in 2003 was only “3 to 5 years.” During the next seven (7) year period, the insured made numerous short term repairs. It was during one of the implementations of a “fix” that the entire dry dock sank into the Sabine-Neches Waterway near the Gulf of Mexico. Despite the volume of negative information about the condition of the dry dock, neither the insured nor its agent ever disclosed this information to any of the implicated insurers (of which there were at least five – three of which were property insurers and two of the policies were pollution policies). The property insurers paid the loss but then sought contribution from the pollution insurers. The court, therefore, found that the undisclosed information was clearly material, as it would have influenced the judgment of a reasonable and prudent underwriter.
The court then turned to whether the undisclosed information was relied upon by the insurer. The underwriter who evaluated the insured’s pollution policy applications from 2005 – 2010 testified at her deposition that, had she known the contents in the undisclosed surveys, she would have been concerned. “More than likely,” the underwriter would have not covered that part of the property until the insured completed the surveys’ recommended repairs. The underwriter’s testimony also established that, “in agreeing to underwrite the policy, she was acting on the understanding that [the insured] was complying with its duty of utmost good faith.” As a result, the Court concluded that the insured breached its duty of utmost good faith by its failure to disclose information about the dry dock’s condition to its pollution carrier. Since this information was both material and relied upon by the pollution carrier, the carrier is entitled to void the pollution policy.
Rescission of Excess Property Policy under Mississippi Law. The court then addressed the rescission of the non-marine excess property policy, but under Mississippi law (rather than federal law), based on the choice of law analysis of the forum state, New York, rendering Mississippi law as the governing law.
Fireman’s Fund argued that, as the excess property policy was not a marine policy, the insured was not bound by the maritime doctrine of uberrimae fidei. Moreover, the excess property insurer’s application only inquired into a Statement of Values and nothing else, precluding the insurer from rescinding the policy because no false answers were given to the limited question provided. At a minimum, according to Fireman’s Fund, a fact issue existed on whether a misrepresentation had been made under Mississippi law, as the excess property insurer must prove that the insured intended to deceive its insurer under Mississippi law before the policy could be rescinded. The Second Circuit ultimately found those arguments unpersuasive.
Although the information provided by the insured on its face was not false, the Second Circuit focused on the information in the insured’s possession that undisputedly reflected that the information the insured provided to its excess property insurer was, at best, half-truths and, at worst, was known to be misleading under all of the facts in the insured’s possession. The Second Circuit found that, when an insured provides information to an insurer, it is required “…to do so in a way that as not misleading.” Simply put, the Second Circuit held that an insured cannot put a positive spin on the information it provides to an insurer knowing that such information paints a false picture of the condition of the property. While it can be argued that the Second Circuit stretched slightly in its reasoning, it cannot be said that it reached the wrong result.
Conclusion and Takeaways. If an insurer finds a nondisclosure or misrepresentation by the insured related to a marine policy, or in a mixed policy that may be determined a marine policy under the objective purpose test above, the insurer should consider the more expansive rescission analysis under federal admiralty law based on the marine insured’s much broader duty of disclosure under the doctrine of Uberrtimae Fidei. Furthermore, even with non-marine policies where the rescission analysis is more limited and requires insurers to carry an overall heightened burden of proof for policy rescission, there are U.S. jurisdictions willing to tackle rescission at the summary judgment stage, applying black letter rescission law and legally sound reasoning to undisputed facts to protect a truly innocent insurer from an insured’s significant and material misrepresentations and non-disclosures.