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BIRD v. PENN CENT. CO.

November 15, 1971

BIRD ET AL., Plaintiffs,
v.
PENN CENTRAL CO. ET AL., Defendants


Lord, D. J.


The opinion of the court was delivered by: LORD

Plaintiffs in this action are certain named underwriters trading under the name of Lloyds of London. They seek rescission of an insurance policy providing coverage for defendants which was issued on July 2, 1968, effective as of July 3, 1968. Defendants are the Penn Central Company and numerous individuals, all of whom are present or past directors and/or officers of Penn Central.

 On July 2, 1968, defendant David C. Bevan, Chairman of the Finance Committee of the defendant corporation, executed an application *fn1" for directors and officers liability insurance and company reimbursement insurance. A policy was issued that day, effective the following day, which specifically incorporated this application as a part of the policy.

 Item 10 of the application reads:

 
"No person proposed for this insurance is cognizant of any act, error, or omission which he has reason to suppose might afford valid grounds for any future claim such as would fall within the scope of the proposed insurance except as follows:"

 Mr. Bevan's reply on the application to Item 10 was "None Known". Plaintiffs contend that this response was false, and that it was known to be so at the time of the application by Mr. Bevan, as well as other unspecified directors and officers proposed for coverage under the policy. It is claimed that they were aware of at least three situations at the time of application which should have been indicated in response to Item 10: (1) the alleged investment by Penn Central in Executive Jet Aviation; (2) the alleged conflict of interest of certain directors who were involved in a private venture known as Penphil Corporation, and (3) the alleged illegal activities of Howard Butcher, III, a director of the railroad and a senior officer of the stock brokerage firm of Butcher & Sherrerd, which is also alleged to have been involved in such activities.

 Plaintiffs allege that the answer given to Item 10 was made in bad faith, was material to the risk, and was justifiably relied on so as to entitle them to rescind the policy because of fraud.

 Three of the named defendants, Kattau, Kirk and Annenberg, have now moved for summary judgment under Rule 56, Federal Rules of Civil Procedure, advancing many arguments. Movants' principal argument is that as a matter of law plaintiffs are not entitled to rescission because in their view the policy provides that the sole and exclusive remedy for the failure to advise the insurer of facts in Item 10 is the denial of coverage for any claims subsequently arising from these facts.

 In support of this construction of the policy, movants first compare it with other policies of Lloyds, noting that it does not contain any specific language reserving the right to rescind for fraudulent misstatement, unlike, for example, a "Lloyds Accident Policy" form, which is offered as an exhibit. However, as movants recognize, rescission is an equitable remedy available to a defrauded insurer without the necessity of any provision in the policy itself providing for rescission. Fraud renders a contract voidable by the innocent party e.g., Bremmer v. Protected Home Mutual Life Insurance Co., 436 Pa. 494, 260 A.2d 785 (1970); Schleifer v. Nationwide Life Insurance Co., 421 Pa. 359, 219 A.2d 692 (1966); Allstate Insurance Co. v. Stinger, 400 Pa. 533, 163 A.2d 74 (1960). The fact that another type of Lloyds policy expressly provides for rescission is not persuasive that the absence of such a provision expresses an intent to waive the equitable remedy of rescission which is normally available in cases of fraud.

 Movants rely heavily on a provision of the application which they assert conclusively proves that plaintiffs intended that any fraudulent response given to Item 10 would not be grounds for cancelling the policy, but rather for a limitation of coverage.

 Item 12 of the application reads as follows:

 
"No fact, circumstance or situation indicating the probability of a claim or action against which indemnification is or would be afforded by the proposed insurance is now known to any Director or Officer of this Company; and it is agreed by all concerned that if there be such knowledge of any such fact, circumstance, or situation, any claim or action subsequently emanating therefrom shall be excluded from coverage under the proposed insurance."

 What is immediately apparent is that this provision does not mention rescission at all, and in fact contains no language concerning damages or any other remedy whatsoever. There is likewise no reference to fraudulent non-disclosure. It is simply an exclusion from coverage provision for claims arising from any known situations at the time the policy was issued that indicated the probability of a claim. As such it was a vital provision for plaintiffs, in that it excluded from coverage known situations disclosed in reply to Item 10, as well as innocently misrepresented situations either disclosed or non-disclosed. Since Item 12 was directed not only to fraudulent misrepresentation in response to Item 10, it does not become mere surplusage as movants contend, if we construe the policy to permit rescission for fraudulent misrepresentations. Since a fraudulently induced contract is voidable at the option of the innocent party, Item 12 also serves to protect plaintiffs from claims arising from fraudulent misrepresentations if they should decide to affirm such a fraudulently induced policy, rather than seek to avoid it.

 If we were to accept movants' construction of the policy, Item 10, rather than Item 12, would come close to being mere surplusage. Since Item 12 provided for exclusion from coverage, and this is all that plaintiffs were concerned with in the view of movants, there would be little value in plaintiffs' attempting to apprise themselves of any existing situations before issuing the policy, as they did in Item 10. This is especially true since the insureds would have every incentive to answer Item 10 dishonestly, since there would be no adverse consequences for so doing, while coverage might be gained for Item 10 situations then known by the insureds if the insurer never learned that they were known at the time. We read Item 10 as serving a more important function. We construe it as being directed at gaining information regarding the nature and scope of the insured risk. Lending force to this interpretation are the questions on either side of Item 10 on the application, Items 9a, 9b, and 11, which are all quite plainly directed at obtaining background information concerning the risk to be involved for plaintiffs, if they were to issue a policy to defendants. *fn2" We cannot say that plaintiffs would not have acted differently before issuing a policy, if given the knowledge of situations undisclosed by potential insureds in response to Item ...


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