SDNY Reforms Away Policy Exclusion on Mutual Mistake and Illusory Grounds

In GuideOne National Insurance Co. v. Systems 2000 Plumbing Service Inc., a New York federal judge found, following a bench trial, that reformation of an excess contract was warranted for two independent reasons to strike an exclusion found in the primary policy to which it followed form. The court found clear and convincing evidence of mutual mistake between the excess insurer and the plumber-insured, which caused the inclusion of the residential work exclusion at issue, and otherwise found that maintaining the exclusion would render coverage illusory.

The loss in question stemmed from a fire in an apartment building where the plumber-insured, Systems 2000, was performing work and faced millions of dollars in claims. The primary policy contained a “residential work exclusion” that excluded coverage for “work ... on or for any project that ... is ... any residential condominium [or] any residential apartment.” However, Systems 2000 never received a copy of this exclusion until after the fire. Its full text was not included in the policy proposal signed by Systems 2000, which instead contained — according to the court — a “confusingly worded reference” to the exclusion in the coverage and amendments list. After an initial denial based on the exclusion, the primary carrier decided to cover Systems 2000 for the claims, “reforming” the policy to remove the exclusion. Despite the primary carrier’s decision, the follow-form excess carrier maintained its denial, pointing to a clause in its policy specifying its right to decline to follow changes made to the scheduled underlying insurance after the inception date.

The court made a number of factual findings to establish that a mutual mistake had occurred between Systems 2000 and the excess carrier. Systems 2000’s application materials were filled with references to its work on apartment buildings, including descriptions of the business, a location schedule listing apartment buildings, answers to questionnaire questions, as well as documentation by the excess carrier underwriters. Deposition testimony further revealed that the excess underwriters, including the individual who approved coverage, understood Systems 2000 to perform plumbing work for commercial apartment buildings and considered the risk acceptable. Nowhere did the excess underwriters discuss a residential exclusion, nor did they even communicate with the primary carrier or rely on any primary underwriting materials. As such, the court found clear and convincing evidence that the excess carrier knew about Systems 2000’s residential work and intended to provide coverage for such work at the time it executed the excess policy. Likewise, Systems 2000 clearly intended to obtain coverage for this work, as it was the entirety of its workload. Neither party had seen the exclusionary language at the time of the binding agreement. Because both Systems 2000 and its excess carrier had understood, intended, and agreed to coverage for Systems 2000 residential work, the presence of the exclusion was a mutual mistake that required reformation.

The court separately concluded that giving effect to the residential exclusion would render coverage illusory. Because the excess policy would provide Systems 2000 with no effective protection due to its line of work in residential apartment buildings, and because the excess carrier was actually aware that such an exclusion would have rendered coverage illusory when it issued the policy, the court found reformation was additionally warranted on this ground.