Key Points

  • The Fourth Appellate District, Division Three, affirmed summary judgment declaring two years of Scottsdale primary and excess policies issued to TL Veterans Construction rescinded for material misrepresentations on the insurance applications.
  • An insurer's failure to investigate a claim that hinted at one misrepresentation (work on a medical building) did not waive its right to rescind based on an independent misrepresentation (asbestos abatement) that the claim did not distinctly imply under Insurance Code section 336.
  • Rutherford v. Prudential's duty to investigate applies only where an application is riddled with known falsehoods; otherwise an insurer may waive one fact without waiving others.
  • The equitable Meyers v. Merillion rule denying rescission where third parties' rights have intervened does not apply to an insurer's statutory rescission for misrepresentation or concealment, because Insurance Code section 650 permits rescission at any time before an action on the contract and applies it to additional insureds.
  • The court said any change to that allocation of loss for large construction contracts is for the Legislature.

A California appeals court held that Scottsdale Insurance Co. could rescind, or void from the start, two years of liability coverage it sold to a construction contractor that misstated its work on its applications. The court reached that result even though the California Military Department relied on the coverage when it hired the contractor to renovate buildings at a military base, where a fire later destroyed one of them.

The Fourth Appellate District, Division Three, affirmed a summary judgment for Scottsdale in an opinion filed Oct. 14 and certified for publication. Justice Delaney wrote for the panel, joined by Acting Presiding Justice Moore and Judge Schwarm of the Orange County Superior Court, who sat by assignment. The decision leaves the department, which holds a $9,787,124 default judgment against the contractor, TL Veterans Construction Inc., unable to recover under the policies as an additional insured.

The panel held that an insurer that overlooks a hint of one false answer does not give up its right to rescind over a different one. It also held that an 1897 California Supreme Court rule barring rescission once third parties have relied on a contract does not limit an insurer’s rescission rights under the Insurance Code. "The Meyers rule, therefore, does not apply where an insurer rescinds a policy based on a material misrepresentation or concealment by the insured," Justice Delaney wrote.

TL Veterans applied to Scottsdale in January 2021 and reported gross receipts of $300,000, according to the opinion. It listed its largest project in five years as "county office remodeling $105,869" and answered "No" when asked whether it did work involving asbestos or "medical and/or industrial life." At the time, the company held a roughly $2.2 million state contract to replace roofs at skilled nursing facilities of the Department of State Hospitals in Norwalk. Scottsdale issued a $1 million primary policy and a $4 million excess policy.

Less than a month later, the Military Department posted its award to TL Veterans of a roughly $3 million contract to renovate two buildings at the Joint Forces Training Base in Los Alamitos. The work included asbestos abatement. TL Veterans gave the department a certificate of insurance reflecting the Scottsdale policies. When it renewed in January 2022, the company again reported $300,000 in receipts, named a $135,000 school remodel as its largest project and denied asbestos or medical work.

On May 27, 2022, TL Veterans notified Scottsdale that a fire had destroyed one of the Los Alamitos buildings. Crews had left a powered light fixture on flammable roofing materials, and TL Veterans accepted responsibility. Scottsdale investigated and in November 2022 demanded rescission, citing the contract sizes and the asbestos work. TL Veterans agreed in January 2023.

Scottsdale sued in July 2024 for a declaration that the rescission was effective. The department cross-claimed and separately won its default judgment against TL Veterans. Orange County Superior Court Judge William D. Claster granted Scottsdale summary judgment, declaring the policies void.

On appeal, the department did not dispute that TL Veterans’ misstatements were material. It argued instead that Scottsdale waived rescission by failing to investigate a September 2021 claim over water that leaked into a Norwalk nursing building and forced patients to evacuate. Insurance Code section 336 provides that the right to information may be waived by neglecting to inquire about facts "distinctly implied" in other information that is communicated.

The panel agreed that the Norwalk claim "clearly tipped Scottsdale off that TL Veterans was working on a medical building." But it accepted Judge Claster’s conclusion that the asbestos misstatement was an independent basis for rescission. "Nothing in the Norwalk claim distinctly implied that TL Veterans was conducting asbestos abatement," Justice Delaney wrote.

The department had relied on Rutherford v. Prudential Insurance Co., a 1965 life insurance decision. The panel read that case as limited to applications "riddled with known falsehoods." It held that the general rule lets an insurer waive one fact while preserving its rights as to others. A medical building and asbestos abatement "present starkly different risk profiles, and Scottsdale was entitled to treat them independently," the court wrote.

The department’s second argument drew on Meyers v. Merillion, an 1897 dispute between business partners. In that case the California Supreme Court wrote that "where the rights of others have intervened," and rescission would injure them, "rescission will be denied and the complaining party left to his action at law for damages for the fraud." Two later appellate decisions applied the rule in insurance-related disputes, the panel noted, but both arose from disputes other than a false statement on an insurance application.

"The fundamental problem with applying the Meyers doctrine in this case is that the rescission here was not a creature of equity or general contract principles, but instead a statutory right," Justice Delaney wrote. Section 650 of the Insurance Code allows an insurer to rescind "at any time previous to the commencement of an action on the contract," and provides that the rescission applies to "additional insureds" unless the policy says otherwise. "An additional insured is, essentially, what CMD is claiming to be," the opinion said, using its abbreviation for the department. The panel cited a 2006 California Supreme Court decision stating that an insurer that rescinds in conformity with the law generally may avoid liability to third parties injured by the insured.

"Cases like this—where a loss must be allocated between two innocent parties—are challenging," Justice Delaney wrote. The panel said Scottsdale could have investigated further, and the department could have sent the insurer a description of the Los Alamitos project. On whether the rule should change for large construction contracts, the court wrote that "it is particularly appropriate for the California Legislature to strike that balance, not the Judiciary."

The Military Department was represented by the office of Attorney General Rob Bonta. Scottsdale was represented by Sheryl W. Leichenger of Selman Leichenger Edson Hsu Newman & Moore.

The panel affirmed the judgment in Scottsdale’s favor and ordered that the insurer recover its costs on appeal.