A powerful weapon in any policyholder’s arsenal is the potential to argue that an insurer waived its right to rescind a policy or deny coverage.  Successfully arguing waiver may allow a policyholder to obtain coverage even where it is alleged to have made material misrepresentations in the policy application or failed to meet a condition precedent.  Such was the case in Colony Insurance Co. v. Peterson, No. 13-1033 (4th Cir. Aug. 25, 2014), a recent decision by the United States Court of Appeals for the Fourth Circuit that upheld a nearly $2.4 million jury verdict against Colony Insurance Company (“Colony”).  The court found that Colony was obligated to pay for fire losses under a commercial property policy, even though the insured materially misrepresented the status of its fire safeguards in the application, because Colony waived its right to rescind the policy.

In early 2010, Colony issued a commercial property policy insuring a vacant building against the risk of loss caused by fire.  About a month after the policy became effective, Colony received a report from an inspector it had hired which noted that the utilities and heat for the building were off.  This contradicted information provided to Colony by the insureds during the policy application process, which indicated that the power and heat would remain on at the building during vacancy.  Colony nevertheless continued with business as usual, issuing two endorsements to the property policy, a mortgagee endorsement and loss payee endorsement, after receiving the inspector’s report.  Two weeks after issuance of the second endorsement, a fire damaged the building and its contents.  Firefighters discovered that two valves controlling the sprinkler system had been turned off, apparently by vandals.  It wasn’t until a month after the fire that Colony’s underwriter finally reviewed the inspector’s report.

Colony denied coverage for the loss, arguing that material misrepresentations on the insurance application about maintenance of the utilities in the vacant building rendered the policy void.  Colony also argued that it was not required to pay for the fire damage under a “fire protective safeguards” endorsement that excluded coverage for fire damage if, prior to the loss, the named insured “[f]ailed to maintain any protective safeguard … in complete working order” or [k]new of any suspension, malfunction or impairment in any protective safeguard” and failed to notify Colony.

Colony sued its insureds, seeking a judgment that it was not obligated to indemnify the loss caused by the fire, but lost at trial.  On appeal, the Fourth Circuit affirmed the verdict, concluding that Colony had knowledge that the utilities were off at the building approximately four weeks before the fire, and thereafter acted in a way that was inconsistent with any intention to enforce the endorsement it was now trying to invoke to escape liability.  The Fourth Circuit noted that in the 27 days between Colony’s receipt of the inspection report and the fire, Colony “neither informed defendants of the violation nor took steps to cancel the policy.”  Instead, Colony confirmed coverage by issuing the mortgagee and loss payee endorsements.  These facts, along with evidence that Colony’s underwriter would have “immediately” taken steps to cancel the policy had she reviewed the inspection report before the fire, supported the trial verdict concluding that Colony waived its right to rescind the policy.

The Colony decision is an important reminder that an insurer’s defenses to coverage based on alleged misrepresentations in an insurance policy application or a failure of a condition precedent must be closely scrutinized against the insurer’s conduct after issuing the policy.  An insurer may be obligated to provide coverage if it fails to promptly take the necessary steps that would inform the policyholder that the benefits it thought it had bargained for may not be available.