Judge finds Advisory Jury was Ill-Advised, rules Heinz’s Insurer can Rescind $25M Policy.

In a dispute between H.J. Heinz Company and its insurer, Starr Surplus Lines Insurance, over coverage for an estimated $30M in business interruption costs, a Pennsylvania judge rejected a crucial finding by an advisory jury that the insurer waived its right to rescind the $25M policy. The ruling cleared the way for Starr to rescind the policy based on Heinz’s failure to disclose prior contamination incidents in the policy application, which both the advisory jury and judge agreed were material misrepresentations.

The dispute stemmed from an Accidental Contamination and Government Recall (ACI) insurance policy that Starr issued to Heinz in July 2014. The policy provided $25M in coverage after a $5M Self Insured Retention (SIR). One month after the policy was issued, Heinz made a claim for business interruption costs following the discovery of lead in the company’s baby cereal by Chinese authorities. Starr’s investigation uncovered several prior contamination incidents that were not disclosed on the application. After Starr pressed Heinz to answer why it had not disclosed the prior incidents, the company filed a declaratory judgment action. Starr responded with a counterclaim for rescission. Heinz asserted waiver as an affirmative defense, contending that Starr knew about the prior incidents, but sold the policy anyway. In the first phase of the lawsuit, Starr’s counterclaim was submitted to an advisory jury in December. The jury agreed with Starr that Heinz made material misrepresentations in the application, but sided with Heinz on the issue of waiver.

On February 1, U.S. District Court Judge Arthur J. Schwab issued an opinion accepting the jury’s finding that Heinz’s application contained material misrepresentations, but rejecting its finding that Starr waived its right to rescind the policy. Heinz’s primary waiver argument was that Starr should have been aware of its misrepresentations at the time the policy was issued based on information outside of the policy application, including information from a prior application for a different insurance policy and a newspaper article in the underwriting file that discussed the undisclosed incidents. Judge Schwab found that these outside materials, “without more, would not trigger a reasonably prudent insurer to follow-up further.” Starr’s underwriters, the judge wrote, “acted professionally and prudently, and they should not have been expected to look at an application for a different type of insurance submitted at some other time, or to independently verify the entries on Heinz’s loss history, or to determine whether, at some point in history, Heinz disclosed something about one of the listed losses that might have prompted further inquiry, in order to properly assess the risk.”

Although the action was commenced in Pennsylvania federal court, Judge Schwab previously ruled that the claims were governed by New York substantive law. The ruling is a win for insurers facing challenges to underwriting practices based on materials outside of the application. For policyholders, the case is a reminder that all relevant information should be disclosed in a policy application.

The case is captioned H.J. Heinz Co. v. Starr Surplus Lines Insurance Co., Case No 2:15-cv-00631-AJS, in the U.S. District Court for the Western District of Pennsylvania. Please contact us if you would like a copy of the case or have any questions.

Recent South Carolina Case Addressing False Answers on Life Insurance Policy Application

The South Carolina Court of Appeals recently overturned a directed verdict finding no coverage under a life insurance policy where false answers were provided in Shenandoah Life Insurance Company v. Lakeisha Smallwood.  Ms. Smallwood purchased the policy to cover her deceased husband who had twice admitted to medical professionals that he had used alcohol and drugs, particularly cocaine, and believed he suffered from post-traumatic stress disorder (“PTSD”)  following his military service.  Despite these facts, on his life insurance application, Mr. Smallwood denied use of cocaine with the last five years and any diagnosis or treatment for a “mental or nervous disorder, alcohol or drug dependency” within the last ten years.

The trial court granted Shenandoah’s motion for directed verdict at the close of evidence finding that Shenandoah clearly and convincingly proved that Mr. Smallwood intended to defraud Shenandoah with his false denials.  The Court of Appeals reversed finding that Shenandoah failed to prove that Mr. Smallwood intended to defraud Shenandoah, because a reasonable jury could find several plausible explanations for the false answers existed, such as the possibility that Mr. Smallwood desired to keep his drug use and PTSD secret from his family.

The Court of Appeals distinguished Smallwood from several very similar cases on the bases of differences in the facts concealed relative to the risk insured.  The Court held that the instant matter did not present “one of those rare cases where the only reasonable conclusion from the uncontradicted facts is that [Mr. Smallwood] intended to deceive and defraud” Shenandoah.  Unlike similar cases finding an intention to defraud the insurance company based on concealed facts that related directly to a significantly increased risk of death, the Court of Appeals found that Mr. Smallwood did not associate his drug use with any increased medical risk.  In so doing, the court appeared to rely heavily on the lack of a formal diagnosis of PTSD or drug abuse and the lack of testimony in the record by Mr. Smallwood’s treating physicians that Mr. Smallwood was made aware of the risks associated with PTSD and drug use.

David Harmon, Partner
Carlock Copeland & Stair
40 Calhoun Street
Suite 400
Charleston, South Carolina 29401