Once upon a time, in a far-off galaxy, if a policy of insurance was procured by means of fraud or material misrepresentation or material nondisclosure, the policy was void--period, end of story. Not so today.

Perhaps the most significant modification to this principle is the concept, by now both long-standing and time-honored, that a mortgagee of real property stands in a special position. It is universally recognized today that a mortgagee has a separate contractual relationship with the insurer and that its right in the policy cannot be vitiated because of the mortgagor's acts or omissions in the procurement of the coverage. (This is not to say, of course, that the mortgagee's rights cannot be vitiated because of the mortgagee's own breach of a condition subsequent, such as failure to comply with a demand to appear for examination under oath.)

There has also been in recent decades a virtually irresistible trend on the part of most courts to afford similar protection to what has become known as "the innocent co-insured," e.g., the spouse or partner who had nothing to do with the arson or the fraud or whatever other evil has been perpetrated on (or sought to be perpetrated on) the insurer. In most jurisdictions today, the innocent co-insured is protected against the fallout of such misdeeds.

Loss Payee Denied Protection

There is, however, a significant distinction to be drawn between an innocent co-insured and an innocent loss payee. A prestigious New York court has recently reaffirmed that distinction, and refused to extend to a loss payee the kind of protection afforded to a co-insured.

The case was Sun Insurance Company of New York et al. v. Hercules Securities Unlimited, Inc., et al., 195 A.D.2d 24, 605 N.Y.S. 2d 767, decided in December of 1993 by the Appellate Division, Second Department, of New York's Supreme Court (which, just to confuse matters a little, is not the highest court of the State, which is the Court of Appeals, the four Appellate Divisions being just below the Court of Appeals in the hierarchical ladder).

Ingenious Theft Scheme Prompts Coverage Issue

The case was generated by a $3,700,000 theft from the vault of an armored car company. The planning that went into the crime was both extensive and ingenious; for our purposes, the most significant element was the fact that the thieves had actually acquired the armored car company itself as part of the plan. They then found ways to accumulate large quantities of cash at the target location and manipulated the means of access to the vault in an effort to make it look as if the previous owner was implicated.

In the meantime, of course, they put together quite a package of insurance coverage, including a $1,000,000 policy with the Sun Insurance Company and a Lloyd's cover note for an additional $3,000,000 in excess coverage. It was probably not a coincidence that the theft, when it was ultimately staged, involved property worth just a little less than the $4,000,000 of available coverage.

The insurance was "payable to the assured and/or its customers as their respective interest may appear." The "customers" who sustained losses as a result of the theft included, among many others, A&P, United Airlines, Sears Roebuck, Toys "R" Us, Macy's, Grand Union, and a large number of savings and loan associations.

Assured's Misrepresentation Voids Policies

The customers made two arguments that are of special interest here: that the policies were not void because there was no actual misrepresentation; and that even if there had been actual misrepresentation, the policies would be void only as respects the named insured, but the customers would nevertheless retain an independent right to recover. The Appellate Division rejected both arguments.

In dealing with the first of the contentions, the court furnished a convenient summary of New York law on the subject:

A policy of insurance will be voided where it is provided that in applying for the insurance coverage the insured fraudulently concealed a material fact (Sebring v. Fidelity-Phenix Fire Ins. Co., 255 N.Y. 382, 174 N.E. 761; see also, Mutual Life Ins. Co. v. Hilton-Green, 241 U.S. 613, 36 S. Ct. 676, 60 L.Ed. 1292). The mere nondisclosure of a fact, concerning which the insured has not been asked, will not necessarily void an insurance policy (see, Sebring v. Fidelity-Phenix Fire Ins. Co., supra; Valton v. National Fund Life Assur. Co., 20 N.Y. 32; Smith v. Countryman, 30 N.Y. 655, 671; Mallory v. Travelers' Ins. Co., 47 N.Y. 52; Browning v. Home Life Ins. Co., 71 N.Y. 508). However, if fraudulent intent is present, the opposite result will follow. In order to constitute fraud, there must be a willful intent to defraud and not a mere mistake or oversight (see, Sebring v. Fidelity-Phenix Fire Ins. Co., supra, 255 N.Y. at 386-387, 174 N.E. 761; see also, L. Smirlock Realty Corp. v. Title Guar. Co., 52 N.Y. 2d 179, 187, N.Y.S. 2d 57, 418 N.E. 2d; 650; Stecker v. American Home Fire Assur. Co., 299 N.Y. 1, 5-6, 84 N.E. 2d 797; Boyd v. Ostego Mut. Fire Ins. Co., 125 A.D. 2d 977, 519 N.Y.S. 2d 371; Lighton v. Madison-Onondaga Mut. Fire Ins. Co., 106 A.D. 2d 892, 483 N.Y.S. 2d 515; 45 C.J.S., Insurance, § 538).

The fact that was not disclosed to the insurers was, needless to say, that the insured company had been acquired and the insurance coverage had been procured with the specific objective in mind of staging a theft in order to acquire both the stolen property and the insurance proceeds. It would seem self-evident, to put it mildly, that this was a material fact. Nonetheless, the customers argued otherwise. The Appellate Division did not agree.

Hercules' customers also argue that there is an issue of fact whether the matters were concealed by Hercules, ... were material. We disagree. The materiality of the particular fact which was concealed in the case, i.e., the actual existence of a conspiracy to commit the theft, can be assumed as a matter of law (cf., Sebring v. Fidelity-Phenix Fire Ins. Co., 255 N.Y. 382, 174 N.E. 761, supra; Texaco, Inc. v. Synergy Group, 171 A.D. 2d 788, 567 N.Y.S. 2d 509 [materiality usually question for jury]). The evidence concerning materiality in the case is "clear and substantially uncontradicted [so] that the question is a matter of law for the court to decide" (Continental Ins. Co. v. RLI Ins. Co., 161 A.D.2d 385, 387, 555 N.Y.S.2d 325, citing Process Plants Corp. v. Beneficial National Life Ins. Co., 53 A.D. 2d 214, 385 N.Y.S.2d 308, affd 42 N.Y.2d 928, 397 N.Y.S.2d 1007, 366 N.E.2d 1361).

Loss Payees Not Co-insureds

The question of whether the customers should have an independent right to recover the insurance proceeds, untainted by the fraud of the named insured, is perhaps somewhat (if marginally) more controversial, but the Appellate Division had little difficulty with it:

In order to resist granting summary judgment against them on this ground, Hercules' customers argue, inter alia, that their right to recover under these policies is entirely independent of whatever right to recover might exist in favor of Hercules. Such an argument might be persuasive in the event that these innocent customers were co-insureds, that is, insureds named as such in the policies themselves (see, e.g., Reed v. Federal Ins. Co., 71 N.Y.2d 581, 528 N.Y.S.2d 355, 523 N.E.2d 480). However we agree with the plaintiffs that the provision of Sun's policy which permits any loss to be paid to Hercules' customers "as their respective interest may appear" confers upon those customers, at most, the status of traditional loss payees. As such, the customers' right to payment would be subject to the same defenses as those which the plaintiffs could assert against Hercules (see, e.g. Hessian Hills Country Club v. Home Ins. Co., 262 N.Y. 189, 186 N.E. 439; Waltman v. Cantor, 57 Misc.2d 276, 292 N.Y.S.2d 549; Golden Door Jewelry Creations v. Lloyd's Underwriters, 8 F.3d 760, revg. 758 F.Supp. 708 and 748 F.Supp. 1529; 10A Couch on Insurance 2d § 42:705 [rev ed.]; 5A Appleman, Insurance Law & Practice § 3401).

The court went on to deal with other issues including particularly that of "issue preclusion," i.e., whether the customers were precluded from relitigating the issue of fraud, since the perpetrators had already been convicted of, and were in prison for, that very fraud (the answer was yes, they were precluded). The decision of the Appellate Division granted summary judgment to the insurers and directed the "entry of appropriate judgment in their favor declaring that they have no obligation to the [customers] to cover any alleged losses."

Caveats and Limitations

The scope of this decision is, of course, limited to the "mere" loss payees, who are a very different species in the biology of property insurance from "innocent co-insureds." The effect of the decision is also somewhat limited by the unusual facts of the case, and indeed the Appellate Division was careful to make this clear in summarizing its determination:

We conclude that because the Sun's policy had been obtained by the conspirators after they already entered into the conspiracy to commit the theft from Hercules, the theft coverage contained in that policy, as well as the coverage contained in an excess policy, was void ab inito.

Even with all these caveats and limitations, however, the decision is noteworthy, if for no other reason than because it represents one more instance in which the New York courts have resisted the seemingly irresistible trend toward reaching into the pockets (presumably deep ones) of any available insurer in order to compensate any seemingly innocent party who has sustained a loss, regardless of whether or not there is really a contractual basis for finding coverage.
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Eugene Wollan is a partner in the New York law firm, Mound, Cotton and Wollan.

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