Douglass v. Nationwide Mut. Ins. Co.

Lee DOUGLASS, In His Capacity as Commissioner
of the Arkansas Insurance Department, and
Arkansas Insurance Department v. NATIONWIDE
MUTUAL INSURANCE COMPANY and State Farm
General Insurance Company

95-233                                             ___ S.W.2d ___

                    Supreme Court of Arkansas
               Opinion delivered January 16, 1996


1.   Administrative law & procedure -- declaratory orders under
     Administrative Procedure Act have same status in adjudication
     as agency orders. -- Declaratory orders are contemplated under
     the Administrative Procedure Act and have the same status as
     agency orders in cases of adjudication.

2.   Administrative law & procedure -- no distinction seen between
     judicial review of agency rule and judicial review of
     declaratory order. -- The Administrative Procedure Act
     provides for petitions for declaratory judgment in circuit
     court concerning the validity of agency rules that threaten to
     injure the petitioner; where the instant case concerned review
     of a declaratory order by the agency rather than a rule, the
     supreme court saw, with respect to the issue of ripeness and
     the threat of injury, no legitimate distinction between
     judicial review of an agency rule and judicial review of a
     declaratory order by the agency.

3.   Administrative law & procedure -- issue fit subject for review
     and petition for declaratory relief where rule or declaratory
     order has direct effect on business operations of insurance
     company -- Commissioner's order ripe for determination and
     subject to review. -- Where a rule or declaratory order has a
     direct effect on the day-to-day business operations of an
     insurance company and places that company in a dilemma
     regarding the full range of its property and casualty
     insurance, the issue is a fit subject for judicial review and
     a petition for declaratory relief.

4.   Contracts -- rescission at law. -- In Arkansas, rescission of
     a contract at law is accomplished by the rescinding party's
     tendering the benefits received to the contracting party, and
     the courts have nothing to do with the repudiated transaction.

5.   Contracts -- rescission on grounds of fraud or deceit -- must
     be done as soon as rescinding party discovers truth. -- One
     who desires to rescind a contract on grounds of fraud or
     deceit must do so as soon as that person discovers the truth;
     the rescinding party must announce his purpose at once and act
     with reasonable diligence so that the parties may be restored
     to their original position as nearly as possible.

6.   Contracts -- rescission on grounds of fraud or deceit -- may
     be accomplished by prompt restoration of benefits to
     contracting party and by clear statement that rescission is
     intended. -- Rescission of a contract at law occasioned by
     fraud may be accomplished without court action but instead by
     a prompt restoration of benefits to the contracting party and
     by a clear statement that rescission of the agreement is what
     is intended; the contracting party then has the option of
     suing for breach of contract; the supreme court held that the
     circuit court was correct in applying these general contract
     principles to the matter at hand.

7.   Insurance -- rescission on grounds of fraud or deceit -- right
     of insurer to rescind coverages is unavailable where third-
     party claims are at issue. -- The right of an insurance
     company to rescind coverages based on fraud by the insured
     without consent of the insured or a declaratory judgment is
     unavailable when third-party claims are at issue.

8.   Insurance -- cancellation statutes -- sixty-day period for
     cancellation not applied under circumstances. -- Where neither
     Ark. Code Ann.  23-89-303(e)(2) (Supp. 1993) nor any other
     statute limited the right of an insurer to rescind to a
     particular time frame, the supreme court declined to apply the
     sixty-day period specified in the cancellation statutes as a
     limitations period for rescission based on fraud without
     clearer direction from the General Assembly.

9.   Appeal & error -- circuit court's policy justifications did
     not present grounds for reversal. -- Where the circuit court
     declared that it was "expeditious, cost-effective, and fair"
     to permit unilateral rescission, the supreme court held that
     the lower court's policy justifications for its decision did
     not present grounds for reversal.


     Appeal from Pulaski Circuit Court; John Plegge, Judge;
affirmed.
     Jeanette Denham, for appellants.
     Mitchell, Williams, Selig, Gates & Woodyard, P.L.L.C., by: 
Robert M. Eubanks III, Stuart P. Miller, and J. Lee Covington II,
for appellees.

     Robert L. Brown, Justice.Associate Justice Robert L. Brown
January 16, 1996






LEE DOUGLASS, IN HIS CAPACITY
AS COMMISSIONER OF THE ARKANSAS
INSURANCE DEPARTMENT, AND
ARKANSAS INSURANCE DEPARTMENT,
                   APPELLANTS,

V.

NATIONWIDE MUTUAL INSURANCE
COMPANY AND STATE FARM GENERAL
INSURANCE COMPANY,
                    APPELLEES,

95-233




APPEAL FROM THE PULASKI COUNTY
CIRCUIT COURT,
NO. 94-2593,
HON. JOHN PLEGGE, JUDGE,




AFFIRMED.






     This appeal by Lee Douglass, Commissioner of the Arkansas
Insurance Department, and the Arkansas Insurance Department itself
(collectively referred to as Department), focuses on whether an
insurance company may unilaterally rescind coverage based on fraud
or material misrepresentations by the insured after a loss has
occurred, when no third-party claims are involved.  According to a
Memorandum of Decision and Declaratory Order by the Department,
rescission by an insurance company may only transpire when the
company (1) seeks declaratory relief from a court of competent
jurisdiction, or (2) obtains consent from the insured and any
affected third parties.  The circuit court reversed the order of
the Department.  On appeal, we affirm the circuit court's order.
     The relevant facts are found in a complaint filed jointly by
appellees Nationwide Mutual Insurance Company and State Farm
General Insurance Company against appellant Department.  On April
26, 1993, State Farm issued a binder of coverage for renter's
insurance to Donna J. Carter and Michael Beirne based on
representations submitted in their application for insurance.  On
May 12, 1993, a claim for theft loss was presented for payment
under the policy.  During State Farm's investigation into the
claim, it discovered that Carter and Beirne had experienced a theft
loss three days prior to submitting their application for
insurance.  In the application, they had reported that no losses
had been experienced in the past three years.  State Farm alleged
that it would not have issued the policy, if the truth had been
known.  Apparently, State Farm rescinded the policy and returned
paid premiums to the insureds on or about July 20, 1993, but it is
not altogether clear precisely when this occurred.  Also on July
20, 1993, Donna Carter filed her complaint with the Arkansas
Insurance Department.
     On the same day that Carter filed her complaint, the Insurance
Commissioner issued the following Memorandum of Decision and
Declaratory Order:
     The Arkansas Insurance Department ("Department") has in
     the past several months received numerous consumer
     complaints regarding property and casualty insurance
     carriers unilaterally voiding insurance contracts ab
     initio for alleged material misrepresentation.  The
     Department has received a request for declaratory order
     to articulate its position on this matter.  As this
     raises an issue of great public importance, this order is
     being issued.
          In Ferrell v. Columbia Mutual Insurance Casualty
     Company, 306 Ark. 533, 816 S.W.2d 593 (1991), the
     Arkansas Supreme Court rendered an opinion relevant to
     this order.  The court opined that when an innocent third
     party has suffered damages as a result of an insured's
     negligence, the insurer cannot rescind coverage
     retroactively based on the grounds of fraud or
     misrepresentation under a compulsory automobile insurance
     or financial responsibility law.  Prospective
     cancellation was the only appropriate remedy the Ferrell
     court reasoned.  Additionally, it was held that where in
     an application for non-compulsory coverage there were
     misrepresentations of material facts the knowledge of
     which would have caused the insurer to decline to issue
     the policy, rescission was the proper remedy.
          The issue before the Department is, "Under what
     circumstances ... will such an insurer be permitted to
     rescind a policy?"  As recognized in Ferrell,
     cancellation is a prospective remedy and is based upon
     the insurer's contract rights or rights under statute,
     while rescission is an equitable, common law remedy which
     voids the contract ab initio.  An insurer may not purport
     to unilaterally rescind a policy ab initio, and such
     actions of an insurer violate Arkansas insurance laws and
     constitute an unfair trade practice under Ark. Code Ann.
      23-66-205,  23-66-206, and  23-89-301 et seq. 
     Rescission of a policy may only be properly accomplished
     with consent of the insured policy owner and any third
     parties in whom rights may have vested, or by seeking
     declaratory relief in a court of competent jurisdiction.
     In a letter dated July 29, 1993, the Department notified State
Farm of Carter's complaint and directed State Farm to respond. 
According to the letter, failure to respond could result in a
finding of an unfair trade practice and result in the imposition of
a fine up to $10,000.  On August 6, 1993, State Farm responded and
described the material misrepresentations by Carter and Beirne.  On
December 9, 1993, the Department informed State Farm that, pursuant
to its order, State Farm could not unilaterally rescind the policy.
     The second claim in the filed complaint involves Nationwide
Mutual Insurance Company.  On June 10, 1993, Nationwide bound
coverage on an automobile policy for Trischia Gostony and
Christopher M. Stefanik.  In the application, Gostony stated that
no one in the household had had any motor vehicle violations in the
last five years.  The insureds subsequently filed a claim with
Nationwide for an accident which occurred on July 4, 1993.  Motor
vehicle reports later revealed that Stefanik had received seven
violations within the last three years.  On July 9, 1993,
Nationwide rescinded its policy and returned the premiums to its
insureds.  On August 12, 1993, Gostony filed a complaint with the
Department and the Department later notified Nationwide of that
complaint.  The letter, dated August 20, 1993, directed Nationwide
to respond to the complaint or suffer potential penalties up to
$10,000.  Nationwide responded and asserted that it would not have
issued the policy but for the material misrepresentations.  Relying
on its order, the Department informed Nationwide that it had
improperly rescinded the policy.
     In a letter dated February 14, 1994, the Department advised
State Farm and Nationwide that their actions were not in accord
with Arkansas law.  On March 11, 1994, Nationwide and State Farm
filed their complaint for Declaratory Judgment and Request for Stay
of the Department's Order in circuit court.
     On September 9, 1994, the circuit court conducted a hearing
and heard arguments and subsequently filed its Memorandum Opinion
and Order.  After a detailed analysis, the court rendered the
following conclusions and order:
          Based on the foregoing, the court hereby declares
     that an insurer may exercise its common law right to
     rescind an automobile insurance policy or any other type
     of property and casualty insurance policy without
     obtaining the consent of the insured or a declaratory
     judgment.  This common law right of unilateral rescission
     may be exercised at any time before or after a claim is
     made by an insured when it is discovered that the insured
     procured the insurance policy through fraud or
     misrepresentation as long as the insurer notifies the
     insured of the decision promptly upon discovery of the
     fraud or misrepresentation and the insurer returns all
     premiums paid by the insured.  
          Accordingly, the Court FINDS, DECLARES, AND ORDERS
     that plaintiffs' complaint for declaratory judgment
     should be and is hereby granted, that the commissioner's
     order, A.I.D. No. 93-39, should be and is hereby
     reversed, and that an insurer may exercise its common law
     right of unilateral recision as set forth herein.

                           I. Ripeness
     For its first point on appeal, the Department contends that
the trial court erred in finding that it had jurisdiction to
determine whether an insurer could unilaterally rescind any type of
property and casualty insurance policy before or after a loss.  See
Ark. Code Ann.  23-62-104, 23-62-105 (Repl. 1994).  The
Department argues that the only issues ripe for determination were
whether Nationwide could unilaterally rescind the specific
automobile policy after a loss and whether State Farm could
unilaterally rescind the renter's policy after a loss.  All other
matters were contingent, remote, and speculative, according to the
Department.
     We initially observe that the Commissioner's order was
rendered in response to a request for a declaratory order
concerning the right of insurers to rescind their policies ab
initio and represents final agency action.  Declaratory orders are
contemplated under the Administrative Procedures Act and have the
same status as agency orders in cases of adjudication.  Ark. Code
Ann.  25-15-206 (Repl. 1992).  Judicial review of administrative
adjudications in circuit court is provided under Ark. Code Ann. 
25-15-212 (Repl. 1992).  We further observe that the Administrative
Procedure Act provides for petitions for declaratory judgment in
circuit court concerning the validity of agency rules that threaten
to injure the petitioner.  Ark. Code Ann.  25-15-207 (Repl. 1992);
McCuen Burial Ass'n v. Arkansas Burial Ass'n Bd., 298 Ark. 572, 769 S.W.2d 415 (1989); see also Travelers Indem. Co. v. Olive's
Sporting Goods, Inc., 297 Ark. 516, 764 S.W.2d 596 (1989).  The
instant case concerns review of a declaratory order by the agency
rather than a rule.  However, with respect to the issue of ripeness
and the threat of injury we see no legitimate distinction between
judicial review of an agency rule and judicial review of a
declaratory order by the agency.
     The Department advised State Farm and Nationwide in the wake
of their unilateral rescissions that failure to respond to the
complaints of the insureds would be considered an unfair trade
practice which could result in sanctions of up to $10,000 under the
Trade Practices Act.  See Ark. Code Ann.  23-66-201 to 408 (Repl.
1994).  In addition, the Commissioner's order alludes to the same
penalties for unilateral rescissions by insurance carriers
respecting any type of property and casualty insurance.  Thus, it
appears manifest that the threat of sanctions for failure to comply
with any aspect of the Commissioner's order was imminent.  It
stands to reason that when a rule (or declaratory order) has a
direct effect on the day-to-day business operations of an insurance
company and places that company in a dilemma regarding the full
range of property and casualty insurance, the issue is a fit
subject for judicial review and a petition for declaratory relief. 
See Abbott Laboratories v. Gardner, 387 U.S. 136 (1967).  The
Abbott conditions were satisfied in the case before us. 
Accordingly, the Commissioner's order, as it affected any type of
property and casualty insurance written by State Farm and
Nationwide, was ripe for determination and subject to review.

                    II. Unilateral Rescission
     The essential point in this appeal is whether State Farm and
Nationwide could unilaterally rescind their policies after a loss
when no third parties were affected and when the insureds
materially misrepresented the facts in their applications for
insurance.  The circuit court, initially, made it perfectly clear
at the hearing that no third-party claims were involved in this
matter:
          THE COURT: Number one, so that we all are playing on
     the same level field, we are only talking about first
     party claims here, we are not talking about third party
     claims.  Everybody agrees to that?
          MS. DENHAM (ATTORNEY FOR DEPARTMENT): Yes, sir.
The Department argues, however, that either consent of the insured
or judicial action is necessary before unilateral rescission for
fraud may occur.  We disagree, in the absence of innocent third
parties.
     In Ferrell v. Columbia Mutual Cas. Ins. Co., 306 Ark. 533, 816 S.W.2d 593 (1991), this court addressed whether the statute setting
out the method for prospectively cancelling an automobile insurance
policy had abrogated an insurance company's common law right to
rescind an automobile policy ab initio.  Ferrell, 306 Ark. at 534-
535, 816 S.W.2d  at 594.  In that case, Ferrell had made numerous
misrepresentations to his insurance agent when filling out the
application for his family's auto insurance policy, including the
failure to list his family's traffic violations and accidents. 
After coverage was bound, Ferrell's daughter ran a stop sign and
was hit by another car.  She immediately notified her insurance
agent.  A week later, the insurance company rejected the binder due
to the driving records of the Ferrell children.  On February 18,
1988, the insurance company, without knowledge of the wreck,
refunded the entire premium and notified Ferrell that it was
rescinding the policy ab initio.  This court observed in Ferrell
that all courts that have considered the question as it relates to
third-party claimants have held that insurers cannot unilaterally
rescind their contracts on grounds of fraud or misrepresentation. 
But we went on to say that because no third-party claimants were
involved in the case and the case involved only the insured's
property, there was no public policy reason to hold that an
insurer's common law right to rescind for fraud was abrogated.
     During the session of the General Assembly that followed the
Ferrell decision, the Ferrell reasoning was adopted in Act 457 of
1993, now codified at Ark. Code Ann.  23-89-303(e) (Supp. 1993),
which relates to automobile liability coverage:
          (e)(1) However, an insurer shall not be able to
     rescind bodily injury or property damage liability
     coverage under an insurance policy for fraud or
     misrepresentation with respect to any injury to a third
     party when suffered as a result of the insured's
     negligent operation of a motor vehicle.
          (2) Nothing in this subsection is intended to negate
     an insurer's right to rescind other coverages in the
     insurance policy purchased by the insured.
     The cases cited by the Department in support of its argument
that unilateral rescission may not transpire stand for the
proposition that a contract may be rescinded by mutual agreement. 
See Standard Abstract & Title Co. v. Rector-Phillips-Morse, Inc.,
282 Ark. 138, 666 S.W.2d 696 (1984); Wheatley v. Drennen, 209 Ark.
211, 189 S.W.2d 926 (1945); Duty v. Keith, 191 Ark. 575, 87 S.W.2d 15 (1935).  However, none of the cases adduced stands for the
proposition that mutual consent or court action is required for a
rescission at law based on fraud.
     In the insurance treatise, Couch on Insurance, the author
recognizes the right of the insurance carrier to rescind or
repudiate a contract based on the insured's fraud:
          There tends to be some confusion in the cases
     because of the use of the term "rescission" without
     distinguishing between a judicially sought rescission and
     a unilateral rescission or repudiation.  When the insurer
     asserts that it is not liable on the contract because it
     rescinds the contract because of insured's fraud, the
     insurer is repudiating the contract, and unless justified
     in so doing is guilty of breach of its contract.
17 Couch on Insurance 2d  67:314, p. 743 (1983).
     In Arkansas, rescission of a contract at law is accomplished
by the rescinding party's tendering the benefits received to the
contracting party, and the courts have nothing to do with the
repudiated transaction.  See Savers Federal Savings & Loan Ass'n v.
First Federal Savings & Loan Ass'n, 298 Ark. 472, 768 S.W.2d 536
(1989), quoting with approval Dan B. Dobbs, Pressing Problems for
the Plaintiff's Lawyer in Rescission: Election of Remedies and
Restoration of Consideration, 26 Ark. L. Rev. 322 (1972).  But one
who desires to rescind a contract on grounds of fraud or deceit
must do so as soon as that person discovers the truth.  See Herrick
v. Robinson, 267 Ark. 576, 595 S.W.2d 637 (1980), reh'g denied, 267
Ark. 592, 595 S.W.2d 647 (1980).  We stated in Herrick that the
rescinding party must announce his purpose at once and act with
reasonable diligence so that the parties may be restored to their
original position as nearly as possible.  Id.
     Hence, rescission of a contract at law occasioned by fraud may
be accomplished without court action but by a prompt restoration of
benefits to the contracting party and by a clear statement that
rescission of the agreement is what is intended.  Maumelle Co. v.
Eskola, 315 Ark. 25, 865 S.W.2d 272 (1993); Herrick v. Robinson,
supra.  The contracting party then has the option of suing for
breach of contract.  The circuit court applied these general
contract principles to the matter at hand, and we hold that it was
correct in doing so.  
     While we uphold the right of an insurance company to rescind
coverages based on fraud by the insured without consent of the
insured or a declaratory judgment, we underscore the point that
this right is unavailable when third-party claims are at issue. 
Other jurisdictions have likewise referred to these public policy
considerations.  See, e.g., Klopp v. Keystone Ins. Companies, 595 A.2d 1 (Pa. 1991) (concurring opinions); United Security Ins. Co.
v. Commissioner of Insurance, 348 N.W.2d 34 (Mich. App. 1984).  In
Klopp, a husband and wife, as insureds, sought to prevent an
insurance carrier from unilaterally rescinding an automobile policy
due to material misrepresentations in the application concerning
past accidents.  The trial court denied the carrier the right to
rescind, but the Pennsylvania Supreme Court reversed.  The Court
referred to a Pennsylvania statute which limited a carrier's
ability to cancel coverage 60 days after issuance of the policy but
concluded that the legislature did not intend to abrogate the
carrier's rescission rights within that same 60-day period.  Two
concurring opinions emphasized the necessity for protecting the
rights of innocent third parties and noted that third-party claims
were not at issue in that case.
     In United Security Ins. Co. v. Commissioner of Insurance,
supra, the Michigan Commissioner of Insurance prevented an
insurance carrier from rescinding an automobile policy based on
intentional misrepresentations in the application by the insured.
The trial court reversed the Commissioner's order, and the Court of
Appeals affirmed, holding that common law rescission for fraud was
still a right retained by insurers.  The Court took pains, however,
to assure that rescission was not appropriate when third-party
claims were involved:
          We emphasize that the person making the claim under
     the insurance policy here is the insured who made the
     intentional material misrepresentations; this is not a
     case in which the claimants are innocent third parties.
United, 348 N.W.2d  at 36.
     In the case before us, the circuit court made clear by its
questioning to counsel that third-party claims were not at issue. 
We, accordingly, read the circuit court's order of reversal as
being solely limited to matters where third-party rights are not
impacted.
     There is, next, the issue of whether unilateral rescission for
fraud may occur after the 60-day period from issuance of the
insurance policy set out in the cancellation statutes for
automobile insurance.  See Ark. Code Ann.  23-89-303, 23-89-304
(Repl. 1992 & Supp. 1993).  The Department is correct that Ferrell
v. Columbia Mut. Ins. Cas. Co., supra, concerned a rescission made
within 60 days and that these statutes apply only to automobile
liability insurance.  Nonetheless,  23-89-303(e)(2) does not limit
the right to rescind to a particular time frame; nor does any other
statute.  As a result, we decline to apply the 60-day period
specified in the cancellation statutes as a limitations period for
rescission based on fraud without clearer direction from the
General Assembly.
     The Department also disagrees with the circuit court's policy
rationale for reversing the Commissioner's order.  The language
used by the court was that it was "expeditious, cost-effective, and
fair" to permit unilateral rescission.  The court's policy
justifications for deciding as it did do not represent grounds for
reversal.
     Affirmed.
     Jesson, C.J., not participating.