A California court held that an aircraft insurer was entitled to rescind its policy after the carrier learned that the aircraft had been purchased with embezzled funds. Although the underwriting application did not ask about the source of the purchase funds, the court emphasized that a carrier may rescind a policy when an applicant fails to disclose material facts. The former manager’s knowledge was imputed to the insured despite another member’s lack of knowledge. 

The carrier covered an aircraft owned by a limited liability company (the “insured”). Its two members were a former attorney and a company controlled by another individual. The attorney initially served as the Insured’s manager and used embezzled client funds to buy the aircraft. The other individual neither knew of nor participated in the crime. 

The other individual later assumed management responsibilities and signed the application for a third one-year policy term. During the policy period, the federal government seized the aircraft as part of a criminal prosecution against the former attorney. The policy included an endorsement covering physical loss caused by government seizure. The carrier later denied coverage, asserting that the aircraft’s purchase with stolen funds was a material fact concealed during underwriting.

The application focused on the insured’s ability to operate the aircraft safely, the risks associated with the aircraft, where it would be operated, and how it would be used. It did not ask whether the aircraft had been purchased with illegally obtained or stolen funds—a question the court noted was not standard in the industry.

The trial court had ruled for the insured, reasoning that the carrier assumed the risk by failing to ask about the source of the funds. This court disagreed and explained that whether a concealed fact was material did not depend on whether the insurer asked about it or conducted a reasonable investigation. An insurance applicant had an affirmative duty to disclose facts within the applicant’s knowledge that were, or that the applicant believes were, material to the contract. Materiality turned on the probable and reasonable effect disclosure would have had on the underwriting decision. The court explained that a carrier could lose its right to rescind a policy for nondisclosure if it ignored warning signs that the applicant had withheld material information. However, the court found no such warning signs. 

The carrier’s underwriters testified that it would not have issued the policy had it known the aircraft was purchased with illegal funds. The court independently concluded that the embezzlement was material as a matter of law because it substantially increased the risk of government seizure. A reasonable carrier would have declined the risk or charged a higher premium. 

The court also held that the former attorney’s knowledge was imputed to the insured because he acted as its manager when he applied the embezzled funds to the purchase and when the insured obtained the original policy. The exception of an agent acting adversely to the insured did not apply because the conduct initially benefited the insured by enabling it to complete the purchase. Thus, the court reversed the lower court’s decision and held that the carrier was entitled to rescind the policy.