Material misrepresentations deprived insurer of freedom of choice in underwriting risk.

The United States Court of Appeals for the Third Circuit, applying New York law, upheld the district court and held that H.J. Heinz Company (“Heinz”) made material misrepresentations in its application for insurance to Starr Surplus Lines Insurance Company (“Starr”).  The court rejected Heinz’s argument that Starr waived the right to assert rescission and declared the policy void.

Prior to 2013, Heinz purchased insurance for product contamination from insurers other than Starr and this coverage was subject to a $20 million self-insured retention (“SIR”).  Beginning in May 2014, Heinz submitted insurance applications for contaminated product insurance for the period of July 1, 2014 – July 1, 2015.  As a part of its application with Starr, Heinz attached a spreadsheet detailing the company’s loss history and a loss ratio analysis from 1998 to 2013. The loss documents disclosed only one loss over ten years greater than Heinz’s requested $5 million SIR.   Two Starr underwriters conducted independent analyses of the materials submitted and determined that the requested $5 million SIR was appropriate and thus submitted a proposal to Heinz.  Heinz accepted the proposal and the policy became effective on July 1, 2014.

Soon thereafter, Chinese authorities informed Heinz that baby food it manufactured was contaminated with lead.  Heinz recalled the product, notified Starr of the loss, and sought coverage.  Starr conducted an investigation into the loss and found that prior to the policy, Heinz incurred a loss in excess of $10 million after discovery of excessive levels of nitrite in baby food also manufactured in China.  This loss was not disclosed on Heinz’s application for insurance.  Starr informed Heinz that it was reserving its right to limit or withhold coverage under the Policy.  Heinz filed suit seeking damages for breach of contract and bad faith, as well as a declaration that Starr must indemnify Heinz for the loss.  In its answer, Starr asserted a counterclaim for rescission based on misrepresentation in Heinz’s application for insurance.   An advisory jury found that Heinz made material misrepresentations of fact in its insurance application, but that Starr waived its right to assert rescission.  The district court issued an opinion agreeing with the jury on misrepresentation, but disagreeing on waiver.  The district court declared the policy void.  Heinz appealed.

The Third Circuit upheld the application of New York law.  Heinz argued that Pennsylvania law should be applied based on the policy’s service-of-suit endorsement.   However, the court found that the policy’s service-of-suit endorsement governed jurisdiction and did not supersede the unambiguous choice-of-law provision.  Heinz argued that Starr ratified the policy by arguing that the policy’s choice-of-law provision applied at the same time as it argued that the policy should be rescinded.  The circuit court disagreed.  It found the plain language of the choice-of-law provision refuted that argument because the choice-of-law provision provided that the “validity” of the policy would be governed by New York law.

Next, the court held that it did not need to determine if New York law required rescission to be proved by a preponderance of the evidence, rather than the more demanding clear and convincing evidence standard, because the court found that Starr’s evidence met the clear and convincing evidence standard.  Starr presented evidence that included documentation regarding its underwriting practices which showed that it would not have issued the same policy if the correct information had been disclosed on the application.  The circuit court stated, “Heinz’s misrepresentations were of such magnitude that they deprived Starr of ‘its freedom of choice in determining whether to accept or reject the risk upon full disclosure of all the facts which might reasonably affect that choice.’”

Lastly, the circuit court upheld the district court’s decision that Starr did not waive its right to assert rescission.  Heinz argued that Starr issued the policy despite sufficient knowledge of the misrepresentations.  As evidence, Heinz referred to emails that indicated that one of Starr’s underwriters had read an article about one Heinz loss and also was aware of another loss because it was disclosed in a prior application for a different kind of insurance policy. The district court found, “based on the credibility of the witnesses,” that “[t]hese items, without more, would not trigger a reasonably prudent insurer to follow-up further.”  The circuit court held that that the district court made no error, legal or factual.  The circuit court also rejected Heinz’s argument that Starr failed to promptly assert rescission after a reasonable period of investigation.  The five month gap between when investigators knew of the previous losses to when Starr asserted rescission was “wholly unobjectionable.”  H. J.  Heinz Co. v. Starr Surplus Lines Ins. Co., No. 2-15-cv-00631 (W.D. Pa. Jan. 11, 2017).