Failure to spot clerical error no bar to equitablereformation of policy
In 1998, a company bought a comprehensive commercial propertyinsurance policy. Among other things, it provided $5 million inearthquake coverage for various buildings the insured owned. In1999, the company, through its insurance broker, told the insurerthat it wanted to renew the policy “under exactly the same terms”as the initial 1998 policy. However, the renewal policy, which theclient accepted, contained only a $500,000 sublimit for earthquakecoverage. The insurer subsequently acknowledged that the reductionin coverage resulted from a “clerical error in the preparation ofthat policy.”
In 2000, the insured asked the insurer to renew the policy onceagain on the same terms as the 1999 policy. Consequently, themistaken $500,000 earthquake sublimit again carried through to therenewal policy. The carrier gave the insured (through the broker) aquotation confirmation including the $500,000 earthquake sublimit,and the insured “accepted the quote” and expressed its “wish … tohave the agreement bound.” Also relevant to this discussion was thefact that the policy had a 5% per occurrence earthquake deductible,with a $50,000 minimum.
After the renewal took effect, the insured's corporate headquarterssuffered significant damage from a large earthquake. Losses,according to the insured, exceeded $8 million. After the insuredsubmitted a claim, the carrier discovered the $500,000 sublimit andtraced it to the much earlier clerical error. It notified theinsured of the limit and stated its intent to seek declaratoryjudgment that its liability would be $500,000, rather than $5million. Moreover, the insurer said the claim would be subject to adeductible of $695,100, calculated as 5% of the total insured valueof the damaged corporate headquarters building ($13,902,000).
A federal district court determined that the $500,000 sublimit wasunambiguous and declined to consider extrinsic evidence tocontradict that amount. The court also rejected the insured's claimof mutual mistake and refused to reform the contract. It said theinsured's broker knew about the $500,000 sublimit, and thatknowledge was imputed to the insured.
The insured moved for reconsideration and offered two declarationsfrom the broker's employees, which it argued supported itsmutual-mistake claim and directly contradicted the district court'sfinding that the broker knew of the mistake in the earthquakesublimit. The court refused to reconsider its earlier summaryjudgment. The insured appealed.
The appellate court ruled that the district court erred in holdingthe mutual-mistake doctrine inapplicable. Under Washington law, “amutual mistake occurs when the parties, although sharing anidentical intent when they formed a written document, did notexpress that intent in the document” (citation omitted). Theinsured claimed that a mutual mistake occurred when the contractfor the 2000-01 term failed to express the parties' identicalintent that the earthquake sublimit provide $5 million incoverage.
The court said that failing to observe that a writing does notexpress what has been assented to “is not a bar to reformation of acontract when the reformation claim is based upon mutual … mistake”(citation omitted). Here, the insured was negligent in failing toconfirm that the terms of the 1999-2000 contract were the same asthose in the 1998-99 contract, and were in turn correctly restatedin the 2000-01 contract. The insurer was similarly negligent infailing to catch the mistake in the 1999-2000 contract, which theinsured claimed the carrier unwittingly repeated in the 2000-01policy.
The most reasonable inference, the court said, was that both theinsurer and insured intended the terms of the original 1998-99contract to carry over into the contracts governing policy years1999-2000 and 2000-01. Because the insurer provided this inferenceand because the parties' mutual mistake in providing only $500,000in coverage did “relate to a basic assumption on which both partiesrelied when making the contract” (citation omitted), the appellatecourt ruled that reformation was warranted.
The carrier argued that the insured had “constructive knowledge ofthe circumstances giving rise to the alleged mistake” (citationomitted) and was not entitled to reformation because its belief wasactually in accord with the stated sublimit in the 2000-01 contractand thus not mistaken. However, the appellate court found noevidence that the insured actually knew that the sublimit had beenreduced from the original 1998-99 amount–although had its brokercompared the original policy with the 2000-01 renewal, thediscrepancy would have surfaced. Moreover, although the brokeracted as the insured's agent in securing insurance, its role inrenewing the insurance contract with the insurer insofar as theearthquake sublimit was concerned was ministerial, and there was noevidence that the broker had the unilateral discretion to accept achange in the earthquake sublimit coverage. The broker was merelyobeying the insured's instructions to renew on the terms theinsurer had previously provided, which both the insured and itsbroker assumed were the same as those set forth in the original1998 policy.
The court said it was important that the insurer admitted that bothparties intended the original and first renewal insurance contractsto provide $5 million in earthquake coverage, and that the changeto $500,000 was simply a clerical error. The parties' contractualintentions were identical, the court said, and even though theinsured or its broker may bear some responsibility for notdiscovering the insurer's error, that did not preclude reformationfor mutual mistake. The court said that “mere carelessness … is notnecessarily a defense to an action for reformation,” and that “ifnegligence were a defense to a reformation claim, then reformationwould almost never be available as a remedy because … negligencegenerally results from mistake.”
Because the district court erred in holding the mutual-mistakedoctrine inapplicable on the basis of the broker's supposedknowledge of the stated $500,000 sublimit, the appellate courtreversed the district court's summary judgment for the insurer. Thecourt ruled that upon remand the district court should reform the2000-01 contract to reflect the parties' intent that the earthquakesublimit 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 practiceemphasizes the representation of insurers and others in thebusiness of insurance. He founded Zalma Insurance Consultants in2001 and serves as its senior consultant. He provides expertwitness testimony and consults with plaintiffs and defendantsconcerning insurance coverage, insurance claims handling and badfaith. He has qualified as an expert in state and federal courts inCalifornia, Mississippi, Texas and New Mexico, as well as in theGrand Caymans. He can be reached at [email protected]. Hisconsulting practice's Web site is www.zic.bz.