Massachusetts Appeals Court holds that de minimis departure from representation on bond application does not void coverage

In Hanover Ins. Co. v. Treasurer and Receiver Gen., 74 Mass. App. Ct. 725 (2009) Hanover issued employee dishonesty bonds from 1993 to 1999 to the Massachusetts Treasurer's Department. The bonds covered losses caused by the dishonesty of any department employee.

In February, 1999, the Attorney General's office began an investigation that determined that a Treasury department employee, Trischitta, had stolen $6.5 million from the department's unpaid check fund ("UCF"). The department recovered the full amount of the stolen funds, plus interest.

With Trischitta's cooperation the department discovered that he was not the only department employee stealing money from the UCF. The department gave notice to Hanover of the claim on March 19, 1999. Hanover refused to make payment on the bonds, and filed a declaratory judgment action.

Hanover first argued that the department made misrepresentations in its bond applications that (1) there was independent reconciliation of bank accounts; (2) it had an internal auditor; and (3) there was a voucher system in place to prevent the unauthorized issuance of checks.

The court noted that pursuant to Mass. Gen. Laws ch. 175 § 186, an insurer may not refuse to pay a claim on the grounds of misrepresentation in a policy application unless the misrepresentation "is made with actual intent to deceive, or unless the matter misrepresented or made a warranty increased the risk of loss."

The court held that Hanover had the burden of proof on those issues.

In determining whether a misrepresentation increased a risk of loss, "a fact must be regarded as material, the knowledge or ignorance of which would naturally influence the judgment of the underwriter in making the contract at all, or in estimating the degree and character of the risk or in fixing the rate of the premium."

The department had stated on its application that bank accounts were reconciled monthly by someone not authorized to deposit or withdraw funds. The trial judge had found that the department's contract with a bank to provide bank reconciliations services satisfied the department's representation on the applications. Hanover argued that the reconciliation service did not include checks issued by the UCF, demonstrating lack of substantial compliance.

The Appeals Court disagreed with Hanover, noting that no one in the department with appropriate authority was aware that the UCF was not included in the bank's reconciliation services, and that the number of checks not reconciled was de minimis (one tenth of one percent) compared to the total number of checks. The court held that the representation was therefore substantially true and the department was in substantial compliance with its representation.