Michigan Supreme Court: ‘Innocent Third-Party Rule’ No Longer Exists

The innocent third-party rule was abolished in Titan Ins Co v Hyten, 491 Mich 547 (2012), according to a 5-2 Michigan Supreme Court in Bazzi v Sentinel Ins Co.

However, the Supreme Court majority also said the Court of Appeals in Bazzi erred in finding that the insurance company was automatically entitled to rescission of the no-fault policy based on fraud. As a result, the Court remanded the case to the trial court, for a determination whether rescission was an equitable remedy.

For decades, the innocent third-party rule has allowed Michigan auto accident victims and medical providers to collect personal injury protection (PIP) benefits, even if the policyholder engaged in fraud when obtaining the no-fault policy. In 2016, the Court of Appeals struck down the innocent third-party rule, finding it did not withstand Titan. That decision was appealed.

In a July 18, 2018, majority opinion written by Justice Kurtis T. Wilder, the Michigan Supreme Court said: “[W]e hold that Titan abrogated the innocent-third-party rule but that the Court of Appeals erred when it concluded that Sentinel was automatically entitled to rescission in this instance. Accordingly, we affirm in part, reverse in part, and remand to the trial court to consider whether, in its discretion, rescission is an available remedy.”

The Facts

Plaintiff Ali Bazzi was injured while driving a vehicle owned by his mother, Hala Bazzi. He sought PIP benefits for the injuries he suffered. But the no-fault insurer, Sentinel Insurance, claimed that Hala Bazzi fraudulently obtained the policy and rescinded the policy.

When Sentinel filed a motion to dismiss Bazzi’s PIP claim, the trial court denied the motion. According to the trial court, Bazzi still had a claim for no-fault coverage under the innocent third-party rule.

On appeal, the Court of Appeals ruled in Sentinel’s favor and abolished the innocent third-party rule. The appellate court said, “[I]f an insurer is able to establish that a no-fault policy was obtained through fraud, it is entitled to declare the policy void ab initio and rescind it, including denying the payment of PIP benefits to innocent-third-parties.”

No More Innocent Third-Party Rule

In its opinion, a majority of the Michigan Supreme Court officially declared that the innocent third-party rule did not survive Titan.

MCL 500.3112 states that PIP benefits “are payable to or for the benefit of an injured person or, in the case of his death, to or for the benefit of his dependents,” the Court explained. Therefore, there “is no question that PIP benefits are mandated by the statute and that the insurance policy must therefore be read together with the no-fault act; instead, the question is whether the statute prohibits an insurer from availing itself of the defense of fraud.”

Moreover, when the Legislature intends to limit the remedies available to an insurer for fraud, the intent is clearly reflected in the language of the statute, the Court said. “In this case, however, the plain language of the no-fault act does not preclude or otherwise limit an insurer’s ability to rescind a policy on the basis of fraud. Therefore, Sentinel may raise that defense and seek rescission of the no-fault insurance policy.”

Further, public policy did not compel the adoption of the innocent third-party rule, the Court stated. “We are not persuaded by the argument of plaintiff, intervening plaintiffs, and the Court of Appeals dissent that Titan only addressed the easily-ascertainable-fraud rule, and left undisturbed the innocent-third-party rule.”

According to the Court, although PIP benefits are mandated by statute, the No-Fault Act neither prohibits an insurer from invoking the defense of fraud nor limits or narrows the remedy of rescission.

“However, although an innocent third party might have a reasonable right to expect that other drivers carry the minimum insurance required under the no-fault act, that expectation does not, by operation of law, grant an innocent third party an absolute right to hold an insurer liable for the fraud of the insured,” the Court wrote. “In other words, an insurer has a reasonable right to expect honesty in the application for insurance, and there is nothing in the no-fault act that indicates that the reasonable expectations of an innocent third party surmount the reasonable expectations of the insurer.”

Rescission Not An ‘Absolute Right’

The Supreme Court continued by noting that rescission is not an absolute right, but rather is an equitable remedy.

Therefore, “we do not agree that Sentinel was categorically entitled to rescission,” the Court said, pointing out that courts are not required to grant rescission in all cases – for example, when it would be unjust or inequitable.

“In this instance, rescission does not function by automatic operation of the law,” the Court stated. “Just as the intervening interest of an innocent third party does not altogether bar rescission as an equitable remedy, neither does fraud in the application for insurance imbue an insurer with an absolute right to rescission of the policy with respect to third parties.”

Instead, equitable remedies are “adaptive to the circumstances of each case, and an absolute approach would unduly hamper and constrain the proper functioning of such remedies,” the Court said. “Therefore, we remand this matter to the trial court to exercise its discretion.”

Dissent: All Sides Lose

Justice Bridget M. McCormack, joined by Justice David F. Viviano, disagreed with the majority opinion.

“Because mandatory coverage was not at issue in Titan, we construed the policy as an ordinary contract,” she wrote. “This case is almost a perfect mirror-image of Titan – involving statutorily mandated personal protection insurance (PIP) benefits, in contrast to Titan’s optional contractual residual-liability insurance – yet the majority applies Titan’s optional-coverage standard.”

According to Justice McCormack, PIP benefits arise from the No-Fault Act and a policy must be construed together with the Act, as though the statute was part of the contract. “I would hold that MCL 500.3101 limits rescission of PIP benefits, just as MCL 500.3009(1) limits rescission of residual-liability coverage,” she said. “Rescission is available when consistent with the Act and not available when inconsistent with the Act.”

Moreover, innocent third parties “are always eligible claimants” and the majority’s decision, which requires “equitable balancing” in every case has “built a bridge to nowhere,” Justice McCormack stated. “Requiring costly litigation to determine in every case who will be the payor and who will be the reimbursor is an exercise in futility and is contrary to the Act’s purpose – to ensure prompt coverage and to reduce litigation. Instead, today’s decision will delay coverage and increase litigation – a coup for lawyers at their clients’ expense.”

Labeling the majority’s decision as “a victory only for lawyers,” Justice McCormack pointed out that innocent third parties must be covered somehow because the No-Fault Act requires it and that equitable balancing cannot impose a remedy contrary to law.

“Although innocent third parties surely will have to endure new delays with the new litigation (and new uncertainty over the availability of MACP coverage at all if litigation commences after the one-year notice period for the MACP),” Justice McCormack said. “Insurers lose too. Sentinel’s ‘win’ in today’s innocent-third-party rescission litigation will be another insurer’s loss when the MACP assigns it to pick up the tab. Lawyers, on the other hand, have lots of new litigation to pursue.”