Michigan Law Does Not Permit Insurance Companies to Rescind Insurance Policies as a Matter of Right.

An insurance policy is a contract and falls under the same legal principles that govern contracts in general. According to Michigan law, a contract can be rescinded under certain conditions, and recently, insurance companies have increasingly sought rescission of insurance policies as a remedy. However, the requirements for an insurance company to achieve rescission are stringent and involve multiple conditions. Typically, an insurance company seeks to rescind a policy when it discovers inaccuracies in the application submitted by the policyholder before the policy was issued.

Michigan law states that rescission voids a contract and returns the parties to their original positions as if the contract had never existed. This is a significant remedy that requires a court to apply its "equity" powers, which essentially means ensuring "fairness."

Therefore, it is insufficient for an insurance company to merely point out inaccuracies in an application. Instead, the inaccuracies must be "material" to the policy's issuance. In other words, the insurer generally needs to demonstrate that it would not have issued the policy or would have charged a higher premium if the information had been correct.

Insurance companies often argue that inaccurate material information on an insurance application alone justifies rescinding the policyholder's coverage. However, Michigan courts have ruled otherwise, stating that "rescission is not strictly a matter of right" and is only granted at the court's discretion. When exercising this discretion, a court will not grant rescission if it leads to an unjust or inequitable outcome.

Importantly, this rule of equity applies when information on an application is inaccurate, material, and the insurer substantiates all other elements of the legal theory underlying its efforts to rescind coverage. Even then, the court will only rescind an insurance policy if it results in a fair outcome.

Fairness is assessed in consideration of all innocent parties affected by the loss of coverage. This is known as the innocent third party doctrine, which requires the court to decide which blameless party should bear the loss by balancing the equities to determine if the insurance company is entitled to rescission.

The Michigan Court of Appeals adopted five nonexclusive factors identified by Justice Markman of the Michigan Supreme Court, which include:

(1) the extent to which the insurer could have discovered the fraud before the innocent third party was harmed; (2) the relationship between the fraudulent insured and the innocent third party to assess if the third party had any knowledge of the fraud; (3) the nature of the innocent third party’s conduct, whether reckless or negligent, in the event causing injury; (4) the availability of an alternative recovery method if the insurance policy is not upheld; and (5) whether enforcing the policy merely relieves the fraudulent insured of personal liability to the innocent third party.

A court will not grant rescission without considering these "Markman Factors" and other relevant information regarding the impact on parties innocent of wrongdoing.