What Happened

During the underlying litigation, but before Rosenbalm’s motion was granted, Loya “undisputedly” learned that Rosenbalm intended to file an extracontractual bad faith claim (the bad faith claim) based on the conduct that had been the impetus for the underlying action. Then, between the time the judge granted summary judgment to Rosenbalm and the time the order was entered, Loya submitted an application for professional liability coverage to Certain Underwriters at Lloyds (Lloyds) without disclosing the bad faith action they had heard Rosenbalm intended to file. Lloyds subsequently issued a professional liability policy to Loya that would cover any excess damages arising from an extracontractual claim like Rosenbalm’s.

Rosenbalm filed the anticipated bad faith action the following spring. Loya submitted a $1 million claim to Lloyds, who in turn posted a reservation of rights letter. The letter made it clear that Lloyds was only reserving its rights and not outright denying the claim. However, Lloyds pointed out that Loya had been made aware of Rosenbalm’s intentions nearly one year before submitting its coverage application, yet had answered “No” when the same application asked whether, at that time, Loya knew of any pending claims.

Lloyds formally denied the claim a month later. According to the denial letter, Loya’s failure to disclose Rosenbalm’s potential bad faith action on the application was a material misrepresentation. Therefore, Loya was not entitled to defense or indemnity from Lloyds.

Loya sued Lloyds for breach, arguing the policy covered exactly the sort of claim Rosenbalm had filed. Lloyds asserted an affirmative defense for material misrepresentation on the application and made a counterclaim for rescission of the policy. Loya filed a motion for partial summary judgment on the material misrepresentation issue. Loya also claimed an affirmative defense, that Lloyds could not claim the material misrepresentation defense because it had not properly notified Loya in compliance with Tex. Ins. Code §705.005. Since Loya was claiming the affirmative defense to material misrepresentation, it was Loya’s responsibility to prove Lloyds had not provided proper notice.

Waiver and Violation of Tex. Ins. Code §705.005

Under Tex. Ins. Code §705.005, an insurer may only void a policy based on misrepresentations made on an application if it notified the policyholder of its “refus[al] to be bound by the policy” within 90 days after discovering the material misrepresentation. Loya claimed Lloyds knew or should have known about the material misrepresentation on May 22, 2020 – the day Loya filed its claim for the bad faith suit. However, Lloyds did not inform Loya of its intent to deny the claim based on the material misrepresentation until September 10, 2020, 112 days later. Therefore, the insurer could not deny Loya’s claim based on material misrepresentation.

The court said Loya’s information would be sufficient to satisfy its burden of proof and make it Lloyds’s responsibility to prove the notice had been made. Lloyds acknowledged the notice requirement for an insurer that cancels for material misrepresentation, but also claimed that Tex. Ins. Code §705.005 only came into play when an insurer wanted to void or rescind a policy for material misrepresentation. By the time Loya made the argument against Lloyds’s denial of the claim, Lloyds had backtracked, stating that Loya had not made a material misrepresentation on its coverage application, and the company fully intended to be bound by the policy terms and conditions. The rescission claim and affirmative defense for material misrepresentation were both withdrawn.

The judge determined that this argument also operated as a waiver of the material misrepresentation affirmative defense. In avoiding the notice required by Tex. Ins. Code §705.005, Lloyds admitted it was not trying to rescind the policy based on material misrepresentation. The court granted Loya’s motion that Lloyds was prevented from asserting the material misrepresentation affirmative defense.

Unfortunately for Loya, the judge pointed out that Loya’s argument against Lloyds using material misrepresentation to deny coverage only made sense if Lloyds actually claimed material misrepresentation as an affirmative defense. Lloyds had definitively abandoned that affirmative defense when it withdrew both its claim for rescission and the material misrepresentation defense. Since Loya’s claim was based on a defense Lloyds had abandoned, it was Loya’s argument that fell flat, not Lloyd’s. The request for relief was denied because the thing Loya wanted relief from was no longer in play.

Conclusion

Loya’s motion for summary judgment was granted concerning Lloyds’s waiver of the material misrepresentation affirmative defense. Ultimately, however, since Lloyds abandoned that defense, Loya’s argument that Lloyds could not use it was ineffective, so the remainder of its motion for summary judgment was denied.

Editor’s Note: Lloyds also argued it shouldn’t have to pay Loya’s claim because Loya had known about the loss at the time it submitted its coverage application, a concept called the “known loss doctrine.” The whole purpose of insurance is preparing for a loss situation before it happens. Insurers will not pay for a loss the insured knew was coming or that happened before coverage kicked in.

Loya, however, argued that the loss occurrence–Rosenbalm’s bad faith claim–had not been filed until well after Loya applied for insurance with Lloyds. Though Loya had gotten wind of Rosenbalm’s intent to file a bad faith claim, the claim had not actually been filed.

The judge in this case determined factual issues remained concerning what Loya actually knew on the date it submitted its application to Lloyds. Issues of fact are for a jury to decide, not a judge, so it was too early to tell whether the known loss doctrine would apply to this situation.

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