B. David Van Dam's Knowledge
David Van Dam was aware of acts that could lead to a claim against the firm in November of 1989 when he submitted the insurance application. David Van Dam also became aware of other circumstances that could lead to claims against the firm prior to the effective date of the new policy.
1. Pre-Application Acts
At the time he signed the insurance application, David Van Dam was aware of at least two circumstances that could expose the firm to liability. First, David Van Dam knew that he had made a misrepresentation to Polifly Savings & Loan ("PS&L") regarding his partner Robert Hartmann's interest in one of the entities to which PS&L loaned money.
Hartmann Brooks acted as associate counsel to PS&L from July 1984 until March 6, 1990. Robert Hartmann served as a director of Polifly Savings and Loan ("PS&L") from 1973 until March 6, 1990. Because Hartmann was a director of PS&L, PS&L was barred by federal banking regulations from loaning more than $ 100,000 to any entity in which Hartmann or a member of Hartmann's family had an interest. David Van Dam was aware of this prohibition.
Nevertheless, Hartmann possessed an interest in Changebridge East, Inc., a company that PS&L loaned $ 26,000,000. Changebridge East was a New Jersey corporation that owned real estate in Montville, New Jersey which it intended to develop into townhouses and single family homes.
In October, 1986 PS&L asked Changebridge for a list of its shareholders. At the time, David Van Dam represented Changebridge. He responded to PS&L's request in an October 30, 1986 letter in which he falsely indicated that the only shareholders in Changebridge were himself and two other individuals. David Van Dam intentionally did not list Hartmann or Hartmann's wife as shareholders, even though Hartmann owned 24 shares that he had placed in his wife's maiden name. On May 23, 1993, David Van Dam pled guilty to making a false statement to a federally insured financial institution and obstruction of justice based on this misrepresentation.
At the time David Van Dam signed the insurance application, he was aware of this misrepresentation. He knew that he had a legal and ethical obligation to disclose Hartmann's interest and was aware that if PS&L knew about Hartmann's interest it could not make the loan to Changebridge. 4-3-96 Tr. at 154-55. David Van Dam also knew that Changebridge was a problem loan, and knew that he could be subject to liability for his misrepresentation.
In addition to misrepresenting Hartmann's interest in Changebridge, David Van Dam was also aware that he had engaged in a "questionable" transaction regarding David Esoldi's purchase of a unit located at the Northgate condominium complex ("Unit 39"). The Northgate complex was owned by Northgate Associates, a limited partnership in which the limited partner was Chalder Investment Corp., a wholly owned subsidiary of PS&L, and the general partner was North Hedge Builders, Inc., a corporation in which Chuck Esoldi was a shareholder, director and the corporate secretary.
Chuck Esoldi told David Van Dam that he refused to sign a deed from Northgate Associates to David Esoldi for Northgate Unit 39 before there was an accounting. David Van Dam had his legal secretary sign the deed in April, 1989, as assistant secretary of North Hedge Builders. After the secretary executed the deed David Van Dam delayed recording the deed in order to satisfy Chuck Esoldi's desire to have an accounting before the deed was executed. 4-3-96 Tr. at 75.
David Esoldi secured a loan from PS&L for the purchase of Unit 39 prior to the execution of the deed by David Van Dam's secretary. David Van Dam gave PS&L a mortgage signed by David Esoldi, certified that PS&L had a first lien on the property, and recorded the mortgage before his secretary signed the deed. At the time, he knew that recording the mortgage before recording the deed was "questionable." 4-3-96 Tr. at 161.
David Van Dam ultimately recorded the deed sometime after Chuck Esoldi filed this action. David Van Dam was aware of the lawsuit but did not consult with Chuck Esoldi before recording the deed. Although David Van Dam credibly testified that he did not think of this transaction as the basis for a lawsuit, he knew that it was "questionable." Id. at 76. He admits that if he didn't know that a claim could be made against him based on the Unit 39 transaction, he should have known. Id. at 162.
David Van Dam admits that "in retrospect, there's no question" that he was aware of circumstances that could result in a claim being made against him or the firm when he signed the insurance application. 4-3-96 Tr. at 165.
2. David Van Dam's Knowledge Before the Effective Date of the Policy
David Van Dam also became aware of additional information that could lead to a claim against Hartmann Brooks or himself between executing the insurance application in November 1989 and the effective date of the policy, March 28, 1990.
On March 6, 1990, PS&L terminated Hartmann Brooks as counsel pursuant to a consent agreement with the Office of Thrift Supervision.
On March 22, 1990 plaintiffs' counsel took David Van Dam's deposition. David Van Dam's attorney requested that his deposition be continued on another date because David Van Dam believed that the line of questioning was "an area that could potentially expose him to personal liability." 4-3-96 Tr. at 69.
Despite these events, David Van Dam did not notify National Union before the effective date of the policy of any potential claims.
3. National Union's Actions
In March of 1991 National Union declined to renew the Hartmann Brooks policy. Pursuant to discussions between Hartmann Brooks and National Union, National Union extended the policy to April 1991 and Hartmann Brooks purchased a six-year extended reporting privilege.
On June 25, 1991 PS&L filed suit in this court against Hartmann Brooks and its partners, including David Van Dam. The complaint alleged that Hartmann Brooks and David Van Dam had engaged in improper activities as counsel for PS&L. On August 23, 1991 PS&L filed a separate suit in the Superior Court of New Jersey against its former general counsel and its accountants. PS&L subsequently dismissed its federal action and joined Hartmann Brooks and David Van Dam as defendants in the state court action.
In response to the PS&L suit, National Union filed a declaratory judgment action against Hartmann Brooks in the Superior Court of New Jersey on August 14, 1992. National Union sought to rescind or reform Hartmann Brooks insurance policy because Hartmann Brooks allegedly procured the renewal of the policy and increase in the limits through fraud. National Union also sought a declaration that Hartmann Brooks' conduct identified by PS&L was excluded from coverage under the policy. PS&L made a motion to intervene which was granted in September, 1992.
In November, 1992, the parties reached a settlement agreement resolving both the declaratory judgment action and PS&L's suit. Pursuant to the settlement, the Hartmann Brooks policy was reformed to its prior limits of $ 2 million per claim and $ 3 million aggregate and National Union paid PS&L $ 2 million in satisfaction of its claims. The Esoldi plaintiffs did not intervene in the law suit and did not participate in the settlement, thus, the reformation is not effective as to their claims. National Union did, however, expressly reserve the right to contest any future claim on the policy, including the claim of the Esoldi plaintiffs. In October, 1993 National Union filed its counterclaim for reformation in the Esoldi action.
III. CONCLUSIONS OF LAW
The court concludes that National Union has established by clear and convincing evidence that it is entitled to reformation of the insurance policy from limits of $ 5 million per claim and $ 5 million aggregate to the prior policy limits of $ 2 million per claim and $ 3 million aggregate.
"Equity will grant reformation of an insurance policy where there is mutual mistake or where a mistake on the part of one party is accompanied by fraud or other unconscionable conduct of the other party." Stamen v. Metropolitan Life Insurance Co., 41 N.J. Super. 135, 140, 124 A.2d 328 (App. Div. 1956). "The fact that the mistake was induced or contributed to in some way by the other party is generally sufficient to justify reformation." Couch on Insurance 3d at sec. 27:10. The standard of proof is clear and convincing evidence. St. Pius X Home of Retreats v. Camden Diocese, 88 N.J. 571, 580-81, 443 A.2d 1052 (1982).
Fraud in the equitable sense differs from fraud in the legal sense because it does not require proof of scienter. As the New Jersey Supreme Court recently explained:
A misrepresentation amounting to legal fraud consists of a material representation of a presently existing or past fact, made with knowledge of its falsity and with the intention that the other party rely thereon, resulting in reliance by that party to his detriment. The elements of scienter, that is, knowledge of the falsity and an intention to obtain an undue advantage therefrom, are not essential if plaintiff seeks to prove that a misrepresentation constituted only equitable fraud. Thus 'whatever would be fraudulent at law will be so in equity; but the equitable doctrine goes farther and includes instances of fraudulent misrepresentations which do not exist in the law.'
Bonnco Petrol, Inc. v. Epstein, 115 N.J. 599, 609, 560 A.2d 655 (1989). "Both [rescission and reformation] are available remedies in an action for equitable fraud." Id. at 611. Thus, it is not necessary for National Union to establish that David Van Dam had an intent to defraud.
The court concludes that David Van Dam's answer to question 14 on the insurance application constituted equitable fraud. David Van Dam credibly testified that he did not intend to defraud National Union, however, David Van Dam was objectively aware of several circumstances that could produce claims at the time he signed the application. He admits that with hindsight, "there's no question" that he was aware of circumstances that could result in a claim being made against him or the firm. 4-3-96 Tr. at 165.
National Union has demonstrated by clear and convincing evidence that David Van Dam's answer to question 14 was material to its decision to increase the policy limits. Herbert L. Jamison & Co., LLC ("Jamison") is the administrator of National Union's Lawyers Professional Liability Insurance Program in New Jersey. Joseph Bieniowski, a vice-president of the professional services division of Jamison credibly testified that if a "clean" application comes in, Jamison has the authority to increase the policy limits to a specified level without consulting with National Union. A clean application is one that indicates there are no circumstances that could give rise to a claim.
In contrast, if an application identifies potential claims, Jamison is required to transfer the application to a National Union underwriter for approval. Thus, if David Van Dam had answered yes to question 14, Jamison would have transferred the application to National Union for approval. Patricia Stack, one of National Union's senior underwriters, credibly testified that if David Van Dam had responded to question 14 by identifying the circumstances regarding Changebridge and the Unit 39 transaction, she would not have authorized the increase. 4-4-96 Tr. at 8-9.
National Union has established by clear and convincing evidence that it committed a mistake regarding the risk of its insured and that its mistake was induced by the material misrepresentation of David Van Dam. Consequently, National Union is entitled to reformation of the insurance policy from limits of $ 5 million per claim and $ 5 million aggregate to $ 2 million per claim and $ 3 million aggregate.
A. Misrepresentation or Misunderstanding?
Plaintiffs argue that David Van Dam's answer was not a misrepresentation because the question related to his awareness of the actions of third parties' preparing to file a claim. Plaintiffs rely on St. Paul Fire and Marine Ins. Co. v. Jacobson, 826 F. Supp. 155, 158 (E.D. Va. 1993) aff'd 48 F.3d 778 (4th Cir. 1995), in which the court determined that the defendant doctor had not made a material misrepresentation on an insurance application even though he did not disclose his illegal activities in response to a question about potential liability. The question at issue in St. Paul was: "Do you have knowledge of any pending claims or activities (including requests for medical records) that might give rise to a claim in the future? " The court held that a reasonable person would interpret the question to refer to pending claims and third party activities prior to filing a claim.
The question in St. Paul is markedly different than the question in the National Union application. Question 14 was: "Is the firm aware of any circumstances, or any allegations or contentions as to any incident which may result in any claim being made against the firm or any of its past or present Owners, Partners, Shareholders, Corporate Officers or Employees or its predecessors in business?" This court concludes that "the meaning of the provision is clear to the reasonable reader, regardless of hidden 'ambiguities' that can be unearthed by grammatical digging." Longobardi v. Chubb Ins. Co. of New Jersey, 121 N.J. 530, 543, 582 A.2d 1257 (N.J. 1990). Question 14 clearly refers to events that could give rise to a claim, not strictly third parties' manifested intentions to pursue a claim.
B. Availability of the Reformation Remedy
Plaintiffs argue that reformation is only available where the misrepresentation concerns the contents or effect of an instrument, and does not apply where the misrepresentation induces a party to enter the contract. Plaintiffs are correct that the Esoldi situation is not the classic reformation case in which the parties' written agreement fails to reflect the understanding of the parties at the time of contracting. See e.g., Parrette v. Citizens' Casualty Co., 128 N.J. Eq. 206, 15 A.2d 802 (E & A 1940). Here, both parties understood that the contract increased the policy limits to $ 5 million per claim and $ 5 million aggregate.
Although the traditional reformation case involves an agreement that is different than what the parties intended, recent cases reflect an expansion of the doctrine to allow reformation in situations where one party enters into an agreement on certain terms based on a mistake of fact induced by the other party's misrepresentation. In Weinisch v. Sawyer, 123 N.J. 333, 587 A.2d 615 (1991) for example, the court held that "when an insured sues the insurer and its agent for the agent's failure to inform the insured of available coverage, the proper remedy is reformation." Id. at 336. Weinisch contended that Allstate and its agent did not inform plaintiff of the option to purchase higher limits of uninsured/underinsured ("UM/UIM") motorist coverage. The UM/UIM coverage on his policy was the statutory minimum. He sought to "recover the amount he would be due if the policy had contained higher UM/UIM limits." Id. at 341-342. The court concluded that the relief requested was reformation, and calling it by any other name was "merely wordplay." Id. at 342. If reformation is available in New Jersey to increase the limits of a policy, the court does not see why it is not available to decrease limits where there is equitable fraud.
Other jurisdictions have allowed reformation based on a mistake regarding an external fact. Kansas courts, for example "have entertained the use of reformation where a party mistakenly enters into a written contract on certain terms because of the other party's misrepresentations of material fact." Inter-Americas Ins. Corp., Inc. v. Xycor Systems, Inc., 757 F. Supp. 1213, 1221 (D. Kan. 1991). In Inter-Americas, the court denied a motion to dismiss plaintiff's reformation claim where plaintiff asserted that it would not have agreed to limitation of remedy or disclaimer clauses if it had known that the defendant had misrepresented the accuracy and reliability of its product.
Similarly, in Monarch Ins. Co. of Ohio v. Lankard, 715 F. Supp. 304 (D. Kan. 1989), the court granted reformation of an insurance contract to include the insured's wife as a co-insured. The plaintiff issued an insurance policy on an aircraft based on the insured's representation that he was the sole owner of the plane. The insured subsequently crashed the plane, killing himself and his wife. The policy required the plaintiff to defend claims, except claims by co-insureds. The court granted reformation of the policy to name the wife as a co-insured in order to relieve the insurance company of its obligation to defend the husband's estate against the wife's estate's claim.
The Second Circuit Court of Appeals has also applied the doctrine to mistakes that would have changed the parties' bargain. In National Am. Corp. v. Federal Republic Bank of Nigeria, 597 F.2d 314 (2d Cir. 1979), the court upheld reformation of a settlement agreement. The parties had agreed to pay demurrages for twelve ships in a Nigerian harbor but only six ships were actually in the harbor. The court reduced the amount of the demurrages in the agreement to reflect that only six ships were actually in the harbor. The court reasoned that the parties intended the ships in the harbor to be covered and either were mutually mistaken or fraudulently induced to believe that twelve ships were present. Although the court did not expressly expand the doctrine, Judge Van Graafeiland noted in dissent that because the parties intended to cover all twelve ships, the settlement accurately reflected their agreement and traditional reformation was not available. Id. at 326.
In light of the New Jersey Supreme Court's discussion in Weinisch and the expansive cases from other jurisdictions, the court concludes that reformation is available to National Union. Adopting the plaintiffs' argument that an insurer's only remedy in fraudulent inducement cases is rescission would punish National Union for seeking a less drastic remedy. It defies common sense and offends equitable principles to deny an insurer who could seek rescission the right to instead perform the contract and simply seek reformation of the policy limits.
There is no New Jersey law that prevents this court from exercising its equitable discretion to use reformation as the appropriate remedy. "The court of equity has the power of devising its remedy and shaping it to fit the changing circumstances of every case and the complex relations of all the parties. A lack of precedent, or mere novelty in incident is no obstacle to the award of equitable relief . . ." Roach v. Margulies, 42 N.J. Super. 243, 246, 126 A.2d 45 (App. Div. 1956), quoting Sears, Roebuck & Co. v. Camp, 124 N.J. Eq. 403, 411, 1 A.2d 425 (E & A 1938) (internal citations omitted).
C. Delay in Asserting the Remedy
Plaintiffs argue that even if the remedy of reformation is available to National Union, National Union waived its right to reform. Plaintiffs contend that National Union was aware of facts that alerted it to the misrepresentation on September 9, 1990 when Hartmann Brooks notified National Union of the Esoldi claim but did not assert its counterclaim for reformation until October 1993. Plaintiffs argue that National Union was under a duty to diligently investigate whether it had a basis for reformation and to reform the contract within a reasonable time.
Plaintiffs have not produced any evidence that the Esoldi complaint was sufficient to notify National Union of David Van Dam's material misrepresentation on the insurance application. Furthermore, National Union expressly reserved its rights under the policy when it agreed to defend Hartmann Brooks in the Esoldi and PS&L actions. The reservation of rights letters issued by National Union preserve National Union's option to reform the contract despite the fact that it assumed Hartmann Brooks' defense. See Merchants Indem. Corp. v. Eggleston, 37 N.J. 114, 179 A.2d 505 (1962).
Even if National Union's delay was unreasonable, plaintiffs are barred from raising waiver or estoppel. The rights of a third party claimant derive from the rights of the insured. See Tal v. Franklin Mut. Ins. Co., 172 N.J. Super. 112, 117, 410 A.2d 1194 (App. Div.) cert. denied 85 N.J. 103, 425 A.2d 267 (1980). "Waiver and estoppel apply when the insured is deceived or misled to his detriment, not when an insured invokes waiver and estoppel in order to make his fraud effective." Schrader v. Prudential Ins. Co., 280 F.2d 355, 364 (5th Cir. 1960). Hartmann Brooks can not assert waiver or estoppel in order to make David Van Dam's misrepresentation effective; consequently, plaintiffs are also barred from raising these arguments.
D. The Effect of the Reformation on Innocent Insureds
Plaintiffs argue that under the terms of the policy, the reformation does not apply to the innocent partners who were unaware of David Van Dam's fraudulent misrepresentation. Section V of the policy provides:
V. Innocent Insured
Whenever coverage under this policy would be excluded, suspended, or lost
(a) because of any exclusion relating to criminal, dishonest, fraudulent or malicious acts, errors or omissions by any insured, and with respect to which any other insured did not personally participate or personally acquiesce or remain passive after having personal knowledge thereof, and