Failure to spot clerical error no bar to equitable reformation of policy
In 1998, a company bought a comprehensive commercial property insurance policy. Among other things, it provided $5 million in earthquake coverage for various buildings the insured owned. In 1999, the company, through its insurance broker, told the insurer that it wanted to renew the policy “under exactly the same terms” as the initial 1998 policy. However, the renewal policy, which the client accepted, contained only a $500,000 sublimit for earthquake coverage. The insurer subsequently acknowledged that the reduction in coverage resulted from a “clerical error in the preparation of that policy.”
In 2000, the insured asked the insurer to renew the policy once again on the same terms as the 1999 policy. Consequently, the mistaken $500,000 earthquake sublimit again carried through to the renewal policy. The carrier gave the insured (through the broker) a quotation confirmation including the $500,000 earthquake sublimit, and the insured “accepted the quote” and expressed its “wish … to have the agreement bound.” Also relevant to this discussion was the fact that the policy had a 5% per occurrence earthquake deductible, with a $50,000 minimum.
After the renewal took effect, the insured's corporate headquarters suffered significant damage from a large earthquake. Losses, according to the insured, exceeded $8 million. After the insured submitted a claim, the carrier discovered the $500,000 sublimit and traced it to the much earlier clerical error. It notified the insured of the limit and stated its intent to seek declaratory judgment that its liability would be $500,000, rather than $5 million. Moreover, the insurer said the claim would be subject to a deductible of $695,100, calculated as 5% of the total insured value of the damaged corporate headquarters building ($13,902,000).
A federal district court determined that the $500,000 sublimit was unambiguous and declined to consider extrinsic evidence to contradict that amount. The court also rejected the insured's claim of mutual mistake and refused to reform the contract. It said the insured's broker knew about the $500,000 sublimit, and that knowledge was imputed to the insured.
The insured moved for reconsideration and offered two declarations from the broker's employees, which it argued supported its mutual-mistake claim and directly contradicted the district court's finding that the broker knew of the mistake in the earthquake sublimit. The court refused to reconsider its earlier summary judgment. The insured appealed.
The appellate court ruled that the district court erred in holding the mutual-mistake doctrine inapplicable. Under Washington law, “a mutual mistake occurs when the parties, although sharing an identical intent when they formed a written document, did not express that intent in the document” (citation omitted). The insured claimed that a mutual mistake occurred when the contract for the 2000-01 term failed to express the parties' identical intent that the earthquake sublimit provide $5 million in coverage.
The court said that failing to observe that a writing does not express what has been assented to “is not a bar to reformation of a contract when the reformation claim is based upon mutual … mistake” (citation omitted). Here, the insured was negligent in failing to confirm that the terms of the 1999-2000 contract were the same as those in the 1998-99 contract, and were in turn correctly restated in the 2000-01 contract. The insurer was similarly negligent in failing to catch the mistake in the 1999-2000 contract, which the insured claimed the carrier unwittingly repeated in the 2000-01 policy.
The most reasonable inference, the court said, was that both the insurer and insured intended the terms of the original 1998-99 contract to carry over into the contracts governing policy years 1999-2000 and 2000-01. Because the insurer provided this inference and because the parties' mutual mistake in providing only $500,000 in coverage did “relate to a basic assumption on which both parties relied when making the contract” (citation omitted), the appellate court ruled that reformation was warranted.
The carrier argued that the insured had “constructive knowledge of the circumstances giving rise to the alleged mistake” (citation omitted) and was not entitled to reformation because its belief was actually in accord with the stated sublimit in the 2000-01 contract and thus not mistaken. However, the appellate court found no evidence that the insured actually knew that the sublimit had been reduced from the original 1998-99 amount–although had its broker compared the original policy with the 2000-01 renewal, the discrepancy would have surfaced. Moreover, although the broker acted as the insured's agent in securing insurance, its role in renewing the insurance contract with the insurer insofar as the earthquake sublimit was concerned was ministerial, and there was no evidence that the broker had the unilateral discretion to accept a change in the earthquake sublimit coverage. The broker was merely obeying the insured's instructions to renew on the terms the insurer had previously provided, which both the insured and its broker assumed were the same as those set forth in the original 1998 policy.
The court said it was important that the insurer admitted that both parties intended the original and first renewal insurance contracts to provide $5 million in earthquake coverage, and that the change to $500,000 was simply a clerical error. The parties' contractual intentions were identical, the court said, and even though the insured or its broker may bear some responsibility for not discovering the insurer's error, that did not preclude reformation for mutual mistake. The court said that “mere carelessness … is not necessarily a defense to an action for reformation,” and that “if negligence were a defense to a reformation claim, then reformation would almost never be available as a remedy because … negligence generally results from mistake.”
Because the district court erred in holding the mutual-mistake doctrine inapplicable on the basis of the broker's supposed knowledge of the stated $500,000 sublimit, the appellate court reversed the district court's summary judgment for the insurer. The court ruled that upon remand the district court should reform the 2000-01 contract to reflect the parties' intent that the earthquake sublimit provide $5 million in coverage.
Caliber One Indemnity Co. v. Wade Cook Financial Corp., No. 04-35181 (9th Cir. 06/22/2007) 2007.C09.0003197.
Barry Zalma, Esq., CFE, is a California attorney. His practice emphasizes the representation of insurers and others in the business of insurance. He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant. He provides expert witness testimony and consults with plaintiffs and defendants concerning insurance coverage, insurance claims handling and bad faith. He has qualified as an expert in state and federal courts in California, Mississippi, Texas and New Mexico, as well as in the Grand Caymans. He can be reached at [email protected]. His consulting practice's Web site is www.zic.bz.