Fourth Circuit: Twenty-Seven Days of Inaction Enough to Waive Right to Rescind for Violations of Protective Safeguards Clause

The marriage liturgy in the Anglican Book of Common Prayer contains the well-known line “speak now or forever hold your peace,” and the take-away from a recent Fourth Circuit decision out of North Carolina is clearly “act now or forever lose your rights.”  In Colony Ins. Co. v. Peterson, — Fed.Appx. —, 2014 WL 4179962, 2014 U.S. App. LEXIS 16320 (4th Cir., Aug. 25, 2014), a divided panel of the Court of Appeals held that an insurer had to pay a $2.5 million fire loss even though the policyholders had made material misrepresentations in their application and violated a protective safeguards endorsement.  The carrier was deemed to have waived its right to rescind and to be estopped from denying coverage because it had not acted on an inspection report revealing the violations that was received only twenty-seven days before the blaze.

shutterstock_148029368Effective March 16, 2010, Colony Insurance Company issued a commercial property policy providing $4.5 million in coverage for a vacant, 95,000 sq. ft. building in Montezuma, Georgia.  In light of the vacancy, the insurer insisted that the policy include a protective safeguards endorsement requiring that the policyholders maintain an automatic sprinkler system, fire extinguishers, and functioning utilities and reciting that Colony would “not pay for loss or damage caused or resulting from fire if, prior to the fire, [the insureds] [f]ailed to maintain any protective safeguard . . . in complete working order.”  The policyholders’ application for coverage also recited that the utilities in the building were on.  When the insurer had the structure inspected in early April, however, the utilities were all found to be shut off.

Colony received the inspection report on April 21st, but its underwriter did not review it until June 18th.  In the interim, the insurer issued both a mortgagee endorsement (April 22nd) and a loss payee endorsement (May 6th).  The building was then severely damaged by fire on May 18th.  After the blaze, firefighters discovered that the valves controlling the sprinkler system had been turned off and “tampered with and vandalized.”

Colony denied liability and filed a declaratory judgment action in federal court in North Carolina, arguing that material misrepresentations in the application rendered the policy void and that breach of the protective safeguards endorsement precluded coverage.  The insureds counterclaimed for breach of contract.  The trial court permitted the case to go to the jury, and the panel awarded the policyholders $2,369,000, finding that although material misrepresentations had indeed been made and the protective safeguards endorsement had been breached, Colony had nonetheless waived its right to rescind the policy and was estopped from denying coverage.

On appeal, a divided Fourth Circuit panel affirmed.  The majority opinion by Judge James A. Wynn, Jr. held that the protective safeguards endorsement was subject to waiver.  Under North Carolina law, waiver requires both “knowledge [by] the insurer of the pertinent facts” and “conduct thereafter inconsistent with an intention to enforce the condition” at issue.  The Court of Appeals found that both requisites were met.  As Judge Wynn explained:

we must agree with the district court that we “cannot say that the 27 days between the time Colony received the inspection report and the fire was insufficient, as a matter of law, for Colony to take action on the inspection as provided[.]”

As a result, the majority held that the waiver and estoppel issues were properly submitted to the jury.

In a lengthy and well-reasoned opinion, Judge Henry F. Floyd dissented.  Judge Floyd noted that North Carolina law requires that the insurer be given a reasonable time to notify its insured of a decision to cancel the policy, and he looked at prior Fourth Circuit case law and found what he called “a much-needed yardstick for assessing reasonableness in a factual scenario identical to the one at play.”  In United Capital Ins. Co. v. Kapiloff, 155 F.3d 488 (4th Cir. 1988), the Court of Appeals had held – albeit under Maryland law – that an insurer had not waived a building occupancy requirement even though it learned of the vacancy in January, 30-60 days prior to fire losses in February and March.  As the Kapiloff decision stated:

an insurance company must be entitled to a sufficient time to collect the facts, evaluate them, and make legal determinations with respect to those facts.  These activities require not only field work but also an internal evaluation with a review by appropriate personnel.  The one or two months urged by [the insured] as supporting the finding of waiver or estoppel would hardly provide an insurance company with adequate time to make this kind of decision, particularly when its liability for a wrongful decision could expose it to the risk of bad faith.

As a result, Judge Floyd concluded that Colony could not be said to have waived the protective safeguards endorsement “on account of its inaction during the twenty-seven days between its receipt of the inspection report on April 21, 2010, and the burning of the . . . building on May 18, 2010” and that the district court had erred in submitting the issue of waiver and estoppel to the jury.

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Posted in Arson, Arson and Fraud, Fire, Inspection, Protective Safeguards, Rescission, Waiver
About The Property Insurance Law Observer
For more than four decades, Cozen O’Connor has represented all types of property insurers in jurisdictions throughout the United States, and it is dedicated to keeping its clients abreast of developments that impact the insurance industry. The Property Insurance Law Observer will survey court decisions, enacted or proposed legislation, and regulatory activities from all 50 states. We will also include commentary on current issues and developing trends of interest to first-party insurers.
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