US Federal Court Orders Reformation of CGL Policy to Restore Exclusion Mistakenly Omitted on Renewal: Implications for the Rectification of Insurance Policies

In General Casualty Co. of Wisconsin v. Reed Hein & Associates, LLC, the United States District Court for the Western District of Washington held that a commercial general liability (“CGL”) policy was subject to reformation – the equivalent of rectification under South African law – to restore a personal and advertising injury exclusion that had been inadvertently omitted from the policy upon renewal. The court was satisfied, on the basis of clear, cogent, and convincing evidence, that the insured knew before purchasing the original policy that the exclusion would form part of the cover, and that the exclusion’s absence from the renewal policy was the result of a processing error by a third-party vendor, not a change in what the parties had agreed.

Background

The insured was a company providing “timeshare exit” services. It had a substantial claims history, including proceedings brought by a state government authority alleging unfair and deceptive practices in its advertising and its handling of its timeshare exit services. Owing to this loss record – and after at least 27 other insurers had already declined to offer general liability, umbrella, or excess cover to the insured – the insurer agreed to issue CGL cover only on condition that the policy exclude coverage for personal injury and advertising liability. The original policy duly contained that exclusion, and when the insured’s broker later approached the insurer’s underwriting agent about renewal, the broker understood the renewal to be an automatic continuation of the previous policy’s terms.

However, while generating the renewal policies, an employee of the underwriting agent’s third-party processing vendor deleted the personal and advertising injury exclusion from the new primary policy. The umbrella policy issued for the same renewal period continued to include the exclusion the parties had negotiated. During the renewed policy period, customers filed a class action against the insured alleging that it had engaged in deceptive advertising that induced them to pay for timeshare exit services the insured could not provide, and that it had misappropriated client funds by treating pre-service payments as earned income rather than placing them in trust or escrow.

The insured tendered the class action for coverage under its CGL policy. The class action later settled, with the insured assigning its rights against its insurers to the plaintiff. The insurer then brought proceedings seeking reformation of the renewal policy to restore the personal and advertising injury exclusion, together with declaratory relief that it had no duty to defend the insured in the underlying action.

The Court’s Analysis

The court granted reformation, applying the established principle that reformation is an equitable remedy used to bring a writing that is materially at variance with the parties’ actual agreement into conformity with that agreement – the goal being not to alter the parties’ bargain, but to ensure the written contract reflects their mutual understanding at the time it was made. Reformation requires a showing of fraud or mutual mistake, and where mutual mistake is relied upon, it must be established by clear, cogent, and convincing evidence; a mistake made by only one party is not sufficient. On the facts, the court found this standard amply satisfied. The record established that the exclusion had been specifically negotiated as a condition of coverage; that the insured was aware it could not obtain CGL insurance without accepting the exclusion; and that the renewal was intended to be an automatic continuation of the original policy’s terms. The court held that the fact the omission arose from a processing error by a third-party vendor did not make it a unilateral mistake on the insurer’s part – rather, the mutual mistake lay in the parties proceeding with a written renewal that did not reflect what they had actually agreed. The continued presence of the exclusion in the umbrella policy for the same period further reinforced the conclusion that neither party had intended to alter the scope of cover upon renewal.

The insured’s representatives (assignees of its rights following the settlement) argued that reformation should be refused because the insurer had acted in bad faith in handling the claim, and pointed to an email exchange shortly before renewal in which an employee of the insured questioned whether certain matters were covered or excluded. The court rejected both points. It found nothing in the email exchange to suggest the parties were even discussing the personal and advertising injury exclusion, let alone that cover had changed. More fundamentally, the court reasoned that evidence of bad faith in the claims-handling process does not bear on the parties’ intention at the time the contract was formed, which is the focus of the reformation enquiry. The relevant question is what the parties agreed when the renewal was concluded, not how the insurer later responded to a claim made under it.

Having reformed the policy to include the exclusion, the court held that the insurer had no duty to defend the insured in the underlying class action, since none of the theories of liability advanced fell within the scope of cover as reformed. Notably, the court also rejected an argument that the insured’s alleged mishandling of customer funds triggered the policy’s property damage coverage, reasoning that financial assets lacking physical form do not constitute “tangible property” for that purpose – a separate and independent basis, apart from the reformed exclusion, for finding no duty to defend on that theory.

Takeaway

This decision confirms that a policy document can be corrected after the fact where clear evidence establishes that it does not reflect what the parties actually agreed. From the insurer’s perspective, the case is a useful illustration that an administrative or documentation error- including one made by a third-party vendor during the renewal process – need not lock the insurer into unintended coverage, provided the true agreement can be clearly demonstrated. Particularly significant is the court’s reliance on consistent terms in a related policy (the umbrella policy for the same period) as evidence reinforcing the parties’ shared intention, and the court’s emphasis that the focus of the enquiry is on what the parties intended at the time the contract was concluded rather than on the insurer’s subsequent claims-handling conduct.