Preponderance of Evidence is Sufficient to Prove Fraud or Concealment

An Arizona Divergence Requiring Clear & Convincing Evidence Reversed

One Arizona Court of Appeal has imposed on insurers faced with fraud a heavier burden of proof, that is, clear and convincing evidence, a burden greater than that called for by the US Supreme Court in Coy R. Grogan v. Frank J. Garner (01/15/91) 498 U.S. 279, 111 S. Ct. 654, 112 L. Ed. 2d 755, 59 U.S.L.W. 4072. The Arizona Court of Appeal decision in American Pepper Supply Company v. Federal Insurance Company, 93 P.3d 507 08 Ariz. 307 (Ariz., 2004) an earlier decision of the Arizona Supreme court, Godwin v. Farmers Ins. Co. of America, 129 Ariz. 416, 418-19, 631 P.2d 571, 573-74 (1981), that stated the majority rule in the country.

The Arizona Supreme Court followed SCOTUS and reversed the Arizona Court of Appeals’ decision in American Pepper v. Federal Insurance Company,[1] the Arizona Supreme Court, concluded that:

The proper burden of proof applicable to a policy defense of concealment or misrepresentation is proof by a preponderance of the evidence and the burden is on the insurer to establish whether to prove misrepresentation, concealment, fraud or intentional act. ”[2]

Justice Berch, writing for the Supreme Court, related that on August 27, 1996, American Pepper Supply Company reported to its insurer, Federal Insurance Company, a theft of equipment left outside its building during the preceding weekend. Within three weeks of American Pepper’s initial report of the loss, Federal’s investigation revealed facts and inconsistencies that rendered American Pepper’s claim suspicious:

1. the equipment, which American Pepper claimed had a replacement value of more than $87,000, was left in an unfenced and unguarded area;

2. the equipment stolen was no longer used in American Peppers business;

3. there were inconsistencies between American Pepper’s initial reports and later reports to both the insurance company and the police the reportedly stolen equipment;

4. American Pepper wanted to settle the claim quickly for two-thirds of the value of the equipment; and

5. American Pepper was not forthcoming regarding details of the acquisition of the equipment.

For example, American Pepper initially reported that 600 galvanized steel meat hooks were stolen but revised the number and quality to 3000 stainless steel meat hooks.

The investigation revealed that, contrary to American Pepper’s initial reports that the equipment had been left on the ground outside its building, employees had actually left the equipment in a scrap metal salvage bin, which was discovered empty on Monday, August 26.

When confronted with the discrepancy, American Pepper’ general manager claimed that the equipment had been stolen out of the bin, and that the bin was empty when National Metals, a metal recycler, picked up the bin on Tuesday, the day American Pepper reported the claim to Federal. But further investigation revealed that when National Metals picked up the bin on Tuesday, it contained more than four tons of material.

On November 19, 1997, Federal sent a letter formally denying American Pepper’s claim on the grounds that the investigation revealed that the equipment reported stolen was sold for scrap metal and that American Pepper concealed or misrepresented material facts in the claim presentment process. Federal concluded that the claim was not covered due to the misrepresentation/concealment provisions of the policy and under the law.

The Supreme Court, reviewing the law in other states found: “Although a few jurisdictions require that exclusions from coverage be proved by clear and convincing evidence, the burden of proving insurance policy exclusionary provisions is usually a preponderance of the evidence. Lee R. Russ & Thomas F. Segalla, 17 Couch on Insurance 254:14 (3d ed. 2003) [hereinafter Couch]; compare Rego v. Conn. Ins. Placement Facility, 593 A.2d 491, 494-95 (Conn. 1991) (following the majority of courts and commentators suggesting that insurers must prove policy defenses by a preponderance of the evidence), with Am. Family Mut. Ins. Co. v. Schley, 978 F. Supp. 870, 874-75 (E.D. Wis. 1997).”

In addition, the Supreme Court stated:

Although we agree that allegations of concealment or misrepresentation, like allegations of fraud, may harm an insureds reputation, several countervailing concerns persuade us that for insurance contract defenses, the preponderance of the evidence standard properly balances the parties and society’s interests. First is ease of application. Applying an identical preponderance burden of proof for both the insured in establishing coverage and the insurer in establishing a contract defense will reduce juror confusion.

This is especially true in a case like this one, in which the insurers defense is simply the flip-side of the plaintiffs claim. A jury will more easily comprehend that the plaintiff-insured must prove theft and the defendant-insurer must prove not theft by the same legal standard.[3]

In Rego v. Connecticut Ins. Placement Facility, 593 A.2d 491, 495 (Conn. 1991), the Supreme Court of Arizona concluded that applying the same burden of proof to all contract defenses an insurer raises simplifies the analyses for the jury. It recognized that an insurer will often pursue in the same case several related policy exclusions, such as arson, dishonesty, and concealment or misrepresentation.

The distinction between dishonesty and concealment or misrepresentation seems elusive at best and certainly is not one that supports the imposition of different burdens. The Supreme Court understood, and now requires that courts in Arizona never apply different burdens to establish one defense over another raised by insurers to a claim of an insured.