In a recent and precedential Supreme Court judgment (Melamed v Leibovich, CA 7058/17, 10 March 2020), the court dealt with the application of the 'innocent insured doctrine' and determined that the doctrine applies in Israel. Hence, where an insurer is entitled to be discharged of liability towards an insured, in some cases, the exemption may not apply vis-à-vis other co-insureds. In this case (the Apolo case), the doctrine did not limit the discharge of the insurer.
Thirty-seven plaintiffs who invested their life savings using the services of investment consulting firm Apolo filed a claim for loss of most of their investments due to fraudulent acts committed by a felon, Ilan Morgan, who controlled the company from behind the scenes.
The claim was filed against:
- Apolo;
- Morgan;
- Apolo's director (who held Morgan's shares of Apolo in escrow);
- the investments consultant; and
- the professional liability insurer of Apolo, AIG Israel Insurance Company Ltd.
It transpired that Apolo was owned and managed by Morgan, who had been convicted for various capital market felonies when he resided in the United States. Morgan's involvement was concealed from Apolo's clients.
Morgan convinced Apolo's investment consultant to invest the plaintiffs' money in several fictitious funds that he owned. Thus, millions of the plaintiffs' shekels found their way into Morgan's pockets and were lost.
Morgan was convicted and sentenced to six years in prison.
AIG denied liability under the policy based on several arguments. The main argument was that the existence and involvement of Morgan was concealed from AIG when the proposal form was completed during the underwriting stage, prior to the issuance of the policy.
AIG claimed that Apolo's director had filed and signed a detailed questionnaire in which he had lied and withheld relevant information. AIG argued that no insurer would have agreed to insure an investment consulting firm owned and managed by a convicted felon.
According to Clauses 6 and 7 of the Insurance Contract Law, the insured must provide the insurer with all of the relevant information. Pursuant to the law, a breach of the insured's disclosure duty will exempt the insurer from liability in one of two circumstances – namely:
- where the insured acted with fraudulent intent; or
- where no reasonable insurer would have agreed to insure the insured knowing the true facts.
In this case, AIG claimed that both of the alternatives applied.
In addition, AIG argued that the policy explicitly exempts the insurer for any claim or loss "arising out of any dishonest, fraudulent, criminal or malicious act or omission of any director or partner of the insured".
In her judgment, Judge Keret-Meir thoroughly analysed the various insurance issues raised by the parties. She accepted AIG's position and dismissed the claim against it.
The court determined that a broad disclosure duty lies on the insured during a policy's underwriting phase. An insurance contract – like any other contract – is subject to duties of good faith and fairness.
The insurer can rely on the information provided to it by the insured and need not conduct additional independent investigations.
Regarding the validity of the above exclusion, the court declined the insureds' interpretation, according to which the exclusion does not apply to the liability of the other defendants as they had not committed fraud. The court preferred AIG's argument, according to which as long as the damage was caused due to fraud committed by a director or partner, the exclusion will apply.
The court determined that the reliance of third parties on the existence of the policy is irrelevant to the examination of insurance coverage.
The district court did not discuss the innocent insured doctrine, as it determined that none of the insureds were 'innocent' as they had all participated or at least contributed to the fraud in their own way and made it possible for the felon to conduct it.
The claim against Apolo and its employees (ie, the felon, the director and the investments consultant) was accepted and the district court ordered them to pay the plaintiffs approximately NIS2.5 million. The claim against AIG was dismissed.
All of the parties involved (ie, the plaintiffs, the director and the investments consultant) filed appeals to the Supreme Court. All of the appeals shared the same goal – to impose liability on the insurer using the innocent insured doctrine, with regard to the investments consultant. The appellants' main argument was that the investments consultant's innocence should have been examined in relation to the misleading disclosure during the underwriting phase (in which he had not been involved), and not regarding his involvement in the fraud.
The Supreme Court (the honourable Judges Grosskoff, Amit and Kara) saw this case as an opportunity to address the innocent insured doctrine in Israel and provide guidelines for its scope.
Innocent insured doctrine This doctrine was developed in the United States and relates to situations in which there are several insureds in a policy, and some of them are engaged in a wrongful conduct which entitles the insurer to be exempted from liability.
The basic question is: will the insurer also be released from liability towards the innocent insureds that did not take part in the wrongful act?
In the scope of tort law, this is a crucial observation, since the liability of the insureds towards a third party can be joint and several; therefore, if the insurer is liable for even one insured, the third party can collect the entire amount therefrom.
The Supreme Court stated that the innocent insured doctrine had already been adopted in Israel (in the Weissner case), and that the questions in this case were only in which circumstances it will apply and to what extent.
In order to answer these questions, the Supreme Court provided guidelines and described three categories that must be addressed in each case.
First, the question is whether the various insureds have a similar or common interest or whether they have different interests (eg, are they the owner or lessee of a property or the owners of different apartments in a building). In the latter circumstance, the right of every insured is separate and so is the insurer's obligation.
The second distinction is between an insurer's defence which relates to the pre-contractual stage and a defence which relates to breaches of policy terms at a later stage.
The third issue is whether the insurer's defence is dependent on the fault and culpability on part of the insured.
Where, for example, the insureds have separate interests but the insurer's defence does not require proof of fault or intent on part of the insured, the innocent insured cannot enjoy the doctrine and the insurer will be relieved from liability towards all insureds.
In the Apolo case, a false disclosure was given to the insurer in relation to Morgan's involvement in the firm and his criminal history. The mere fact that the answer was not truthful and related to a matter in respect of which the reasonable insurer would not have agreed to insure even for a higher premium, is sufficient to totally discharge the insurer from any liability under the policy (regardless the issue of the insured's intent to deceive).
This analysis was written by Grosskoff, and Amit and Kara agreed with the result of the judgment, discharging AIG of any liability. However, they left the door open for applying the doctrine in other circumstances on a case-by-case basis.
