by Christopher Graham and Joseph Kelly

May an insurer rescind a legal malpractice policy for misrepresentations by one attorney, leaving that attorney’s innocent partner with no coverage? Not when there’s a severability clause; and because of the “innocent insured doctrine,” even if there is no such clause. So says the Court in Illinois State Bar Association Mutual Ins. Co. v. Law Office of Tuzzolino and Terpinas, 2013 IL App (1st) 122660 (Nov. 22, 2013).

Tuzzolino, for his firm, answered “no” to the renewal form question: Has any member of the firm become aware of a past or present circumstance(s) which may give rise to a claim that has not been reported? But he knew he should have answered “yes” because his client had threatened to sue. Terpinas, Tuzzolino’s partner, had no knowledge of the threatened claim then. He learned of the claim upon receiving a lien letter from the client’s attorney and then reported it to ISBA Mutual promptly. Client thereafter sued Tuzzolino, Terpinas, and their firm. ISBA Mutual sued to rescind the policy. The appeals court reversed a summary judgment for ISBA Mutual against Terpinas.

The following severability clause saved Terpinas from Tuzzolino’s false application answer:

The APPLICATION, and any addendum or supplements and the Declarations, are the basis of the Policy. They are to be considered as incorporated in and constituting part of this Policy. The particulars and statements contained in the APPLICATION will be construed as a separate agreement with and binding on each INSURED. Nothing in this APPLICATION will be construed to increase the COMPANY’S Limit of Liability.

Each insured thus had its own policy; so ISBA Mutual could only “partially” rescind — with no rescission for the innocent insured’s, Terpinas’s separate policy.

And based on the common-law innocent insured doctrine, Terpinas had coverage even absent severability: When multiple insureds share a policy and one insured’s actions would void the policy, coverage for the innocent insured remains.

Economy Fire & Casualty Co. v. Warren, 71 Ill. App. 3d 625 (1979) controlled. It addressed a fire insurance policy under which, a husband and wife, settled a claim with their insurer for loss of their home to fire. But the settlement was based on a fraud by the wife, who unbeknownst to the husband, had burned down the house. The insurer tried to rescind the settlement agreement, but the court held that the husband — unaware of the wife’s fraud — could keep half the settlement monies.

The Court in ruling for Terpinas refused to follow Home Insurance Co. v. Dunn, 963 F. 2d 1023 (7th Cir. 1992), where the Seventh Circuit supposedly applying Illinois law allowed a legal malpractice insurer to rescind, even when some insureds weren’t aware of a misrepresentation in the application.

Lesson for insurers: With a severability clause like the above, you won’t be able to rescind as to innocent insureds; and you may not be able to do so even without it, though there’s considerable uncertainty about application of the common-law innocent insured doctrine.

Tags: Illinois, legal malpractice, professional liability, rescission, innocent insured, severability