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Telling an outright lie is something that most would consider “wrong” but what happens when you lie by omission? What happens when that omission occurs during the course of conducting business…or conducting business as an officer of a corporation? In a recent court case the 9th Circuit of the United States Court of Appeals determined just that when considering a case between an insurance company and a California Homeowners Association.

In Atain Specialty Insurance Company vLake Lindero Homeowners Association, the Court of Appeals affirmed a decision allowing Atain Specialty Insurance Company (“Atain”) to rescind an insurance policy with Lake Lindero Homeowners Association (“LLHOA”), as a result of an omission on the Association’s insurance application, leaving the Association without insurance coverage or defense for a claim filed against it by the prior management company. (No. 21-55319 (9th Cir. Feb. 7, 2022)).

How did this happen?

Prior to the insurance application in question, LLHOA held an annual election. Tensions ran high, and the eventually elected board president ran as a candidate in the election, on the platform of terminating the management company serving LLHOA. In addition, the current board sent no less than eight (8) emails to management alleging breach of contract, and threatening termination during this same time period. As word spread, LLHOA would also receive a written warning from one of its resident members that he would “personally take legal action” if the board proceeded with terminating the management company.

The election concluded, the candidate in question was elected to the board and voted in as president. As part of his LLHOA duties, the board president completed an insurance application with Atain on behalf of the association. Question 19 on the application asked for disclosure of “any fact, circumstance or situation which may result in a claim against the Organization or any of its Directors . . . [or] Officers.” LLHOA disclosed nothing and selected “No.” Atain and LLHOA entered into a policy agreement. Subsequently, the board terminated its contract with the management company and the management company promptly filed suit for breach of contract.

During the defense investigation, Atain learned of the previous correspondence regarding breach of contract and threat of legal action by a homeowner, and subsequently rescinded the insurance policy. In California, a “material misrepresentation or concealment” on an application entitles an insurance carrier to do so. W. Coast Life Ins. Co. v. Ward132 Cal.App.4th 181, 186-87 (2005); Cal. Ins. Code § 331.

The court found that LLHOA and the Board were aware of the threat of litigation against the directors or the association and concealed this fact in their application. The court determined this concealment was material to Atain’s decision to underwrite the policy, and that the intention of the application is for Atain to assess the risk they are insuring. Courts have previously held that an insurer requiring answers to certain questions in an application is “in itself usually sufficient to establish materiality as a matter of law.” LA Sound USA, Inc. v. St. Paul Fire & Marine Ins. Co.156 Cal.App.4th 1259, 1268 (2007). 

What does this mean for the association?

LLHOA argued that because no litigation had yet become known, they did not conceal a material fact. Atain, and the court, disagreed and allowed Atain to rescind the policy. Ultimately, this leaves LLHOA without insurance for the entire period of the policy, and without insurance coverage for defense of the lawsuit filed by prior management for breach of contract. It is ironic that in an attempt to protect the HOA by obtaining insurance coverage, the association subjected themselves to additional litigation and expenses.

LLHOA will, if it hasn’t already, obtain another insurance policy, likely at a significantly increased cost. In addition, any new policy is unlikely to cover claims prior to their policy period, and therefore the costs for both the case between LLHOA and prior management, and the cases between LLHOA and Atain will be out of pocket costs for the association. Litigation costs can escalate into the hundreds of thousands of dollars quickly, which means a significant financial impact for LLHOA. Coupled with the insurance premium increase, LLHOA is likely looking at significant special assessments to their owners. 

How can you protect yourselves?

The key here is disclosure. Boards must make a reasonable effort to answer questionnaires or applications like this honestly. If there are any questions, the association should discuss those with legal counsel and/or their insurance brokerage company for advice. In addition to being transparent up front, most policies have a clause requiring they be notified of potential litigation or claims. If the association receives a credible threat of legal action, the association should advise their insurance company immediately to determine at what stage they need to tender a claim. This case clearly exhibits the cost of dishonesty, and shows associations that honesty, truly is, the best policy.