Law and Insurance

Policyholder Dodges a Bullet On Late-Notice Quandary

SNL Financial, LC v. Philadelphia Indemnity Co., No. 3:09-cv-00010 (W.D. Va. September 30, 2009), see SNL Decision

This time the policyholder escaped the steel jaws of the late-notice trap.   But why do they linger like moths before the flame when prompt notice of what may or may not be a "claim" will avert any danger of losing coverage?

Claims-made policies are rampant now-a-days, particularly with errors & omissions, directors & officers, and professional liability policies.  Coverage under these policies is triggered not by the occurrence of the covered risk during the policy period, the alleged wrongful act itself, but by the claimant's assertion of the claim arising form the conduct.  The concept is simple:  should you, the insured, open your mail one day and find a "claim" being made against you, alarms should sound, and you immediately forward said claim to your insurer, who responds within 15 business days (in Texas) that receipt of claim is acknowledged within the policy period then in effect. 

The SNL case from Virginia illustrates that it is not always easy to recognize that the communication you received is a "claim." 

The policy at issue covered employment-related wrongful acts, such as discrimination, harassment, wrongful termination and the like.  The policy period was August 1, 2008 through August 1, 2009.  Philadelphia had issued employment-practice liability policies to SNL before and after the policy period in question.  But, the steely trap is that a claim made against SNL in one year that is submitted to Philadelphia the next year is not covered.

SNL received a letter on January 18, 2008 from an attorney stating a desire to meet with SNL's president to discuss "certain discriminatory conduct" against the attorney's client, a former SNL employee.  Numerous communications followed between the attorney and counsel for SNL, including a February 1, 2008 email, titled "Litigation Hold," instructing SNL to preserve all evidence that might be relevant to the former employee's potential claims.  In May 2008 SNL was permitted to review a draft complaint against SNL.  In July 2008, SNL's counsel asked the attorney if he wanted to make any demand for money to SNL, but the attorney declined.

Also in July, SNL submitted a renewal application to Philadelphia and marked the "no" box next to the question whether SNL "had been the subject or involved in any litigation in the past 12 months."

Suit was filed in October 2008, whereupon SNL submitted the matter to Philadelphia, who denied the claim due to late notice (as well as failing to truthfully disclose the claim in the application).  Coverage litigation ensured.  The court correctly identified the $64,000 question in the case.  "Had SNL received a "claim" before August 1, 2008?"

The policy defined "Claim" in several ways (mostly this or that type of formal proceeding or lawsuit), including, "a written demand for monetary or non-monetary relief."

The coverage quandary here for the policyholder reminds me of the Dirty Harry challenge.  I don't know how many of you are fond enough of Clint Eastwood to remember the climactic question in "Dirty Harry," during the gun-to-gun showdown when the bad guy is trying remember if Harry had shot all 6 rounds from his 357 Magnum, or just 5.  But, says Harry, since this is "the most powerful handgun in the world and would blow your head clean off, you've got to ask yourself one question: Do I feel lucky?  Well, do ya, punk?"

Is a "litigation hold" letter instructing SNL to preserve documents relevant to potential claims a demand for non-monetary relief?  You got to ask yourself.

Here the judge found that no claim had been submitted.  The monetary or non-monetary relief was either not presented in a written request or was not unequivocally demanded.  Luck goes to the policyholder.  I have appeared before plenty of judges who would have poured out the policyholder for being so dumb as to sit on letters like these instead of turn them over immediately.

The kicker is that most policies of this sort, including this one, have a mercy provision that allows the insured to send in communications that may or may not be "claims" but clearly point to potential claims, and nail down coverage later down the road, in a year or two, when the lawsuit is actually filed.  The policy in effect when notice of the potential claim is sent will cover the lawsuit.

So what excuse does the policyholder have for not promptly sending in hostile letters from attorneys or ex-employees? 

Insured Barely Avoids Late Notice Trap Under "Claims-made" Policy

Matkin-Hoover Engineering, Inc. v. Everest Nat'l Ins. Co., No. 08-cv-0451 (W.D. Tex. May 23, 2009)

This case illustrates one of the deadliest coverage traps for policyholders in the coverage world: late notice under a claims-made liability policy.  Matkin-Hoover (MH) designed a shopping center and parking lot.  Drainage problems appeared soon after construction, and the owner sent a series of e-mails and letters to MH, the general contractor, and the paving subcontractor raising the problem and seeking a solution.  Eventually, litigation ensued.  MH promptly submitted the suit papers to Everest, MH's professional services liability insurer, but Everest refused to defend the suit, alleging untimely notice of the claim.

Like many errors & omissions type policies, MH purchased a "claims-made" (as opposed to "occurrence") policy.  The distinction between an "occurrence" and a "claims-made" type policy is crucial.  "Occurrence" policies cover the insured's liability for claims asserting that the covered event or conduct (the "occurrence") occurred within the policy period, without regard to when the claim was actually asserted or the lawsuit filed.  By contrast, "claims-made" policies respond to claims asserted against the insured within the policy period, without regard to when the event or conduct occurred giving rise to the claim (although most claims-made policies impose a retroactive date limiting how far into the past the coverage will extend).

Last year, the Texas Supreme Court simplified late-notice disputes under occurrence policies by requiring the insurer to defend despite late notice of the claim unless the insurer can prove prejudice, which is almost impossible as long as notice was sent before trial.  See my discussion at PAJ Decision.  By contrast, failure to submit timely notice of a claim under a claims-made policy is usually fatal.  The insurer may avoid coverage simply by proving late notice.

Here, MH sent notice in May 2006, as soon as the lawsuit was filed.  The annual policy period began April 15, 2006.  Notice in May would be timely unless the owner first made a claim before April 15, which is the crux of the dispute in this case.  What constitutes a "claim"?  As defined in the policy:

"Claim" means a demand for money or professional services received by the insured for damages, including but not limited to, the service of a lawsuit or the institution of arbitration proceedings or other alternative dispute resolution proceedings, . . .

Everest argued that MH received a "claim" at least as early as January 29, 2006, when the owner sent an email to MH and the contractors stating that the parking lot, "does not drain properly and has gotten worse since the last repairs . . . I regret that I have to keep inviting you back to deal with the problem. . .   Please get [MH] to evaluate the situation to determine what really is the problem and how best to solve it."

MH responded by blaming the paving contractor for failing to follow the engineering plans.   The owner sent MH a letter in March 2006 asserting that the design slope was too flat and concluding:

You need to to develop a plan to correct the drainage problem.  Your plan has to include an engineering design and a provision for adequate funds to finance the construction.   Please provide such a plan to us by close of business on April 10, 2006.

The court rejected Everest's assertion that this constituted a sufficiently clear demand for money or professional services as damages.  The court was influenced by the fact that the owner sued the contractors as well as MH.  However, the primary basis for the decision was the court's determination that asking for a plan fell short actually demanding relief.

Nevertheless, I can tell you that other judges could come down on the insurer's side.  This is a very close call.  The court rightly gave the insured the benefit of any doubts, but this decision could be appealed, and the appellate court court reverse (the appellate court owes no deference to the lower court's interpretation of the language; it would make its own judgment).  However weak the "demand" might seem, a reasonable person arguably could interpret the letter as a demand.

The practical problem with this scenario is that most risk managers are reluctant to submit correspondence about a problem early in process, perhaps because most disputes get worked out short of litigation.  Also, insureds may fear that premature submission of "noise" letters might result in higher premiums or even non-renewal of coverage.  However, in my experience, that doesn't happen. 

I advise clients to err on the side of submitting this kind of correspondence early.  Most claims-made policies allow the insured to send notice of circumstances that might result in a "claim" (even before receiving any communication that might be a "claim"), any any later claim, even if made after the policy has expired, will be deemed to have been made (and notice given) at the time of the notice of circumstances.

Early notice has little or no downside for the insured and avoids the risk of denial for untimely notice.  If anyone has experienced a punitive bump in premium or cancellation because of early notice of a possible claim, please let me know. 

Texas Supreme Court Resolves Late Notice Conundrum Under Claims-Made Policies

Prodigy Communications Corp. v. Agricultural Excess & Surplus Ins. Co., # 06-0598 (Tex. March 27, 2009) see Prodigy Decision.

A little over a year ago, the Fifth Circuit Court of Appeals certified a question to the Texas Supreme Court (see my discussion at 5th Circuit Asks Texas Supreme Court to Clarify Prejudice Requirement for Late Notice Under Claims-Made Policies) , which it answered last week in the Prodigy case.  The question was:

Must an insurer show prejudice to deny payment of a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is nevertheless given within the policy's coverage period?"

The High Court, over three dissenting Justices, held that the insurer must prove prejudice under these circumstances, even though the policy is claims-made.  The distinction between an "occurrence" type and a "claims-made" type policy is crucial.  "Occurrence" policies cover the insured's liability for claims asserting that the covered accident, event or conduct (the "occurrence") occurred within the policy period, without regard to when the claim was actually asserted or the lawsuit filed against the insured.  By contrast, "claims-made" policies respond to claims asserted against the insured within the policy period, without regard to when the event or conduct occurred giving rise to the claim (although most claims-made policies impose a retroactive date limiting how far into the past the coverage will extend).

The Texas Supreme Court had earlier put to rest any dispute over the insurer's obligation to demonstrate that late notice caused prejudice under an occurrence type policy in the PAJ case (see discussion CGL Insurers Must Prove Prejudice to Avoid Coverage for Late Notice of Claims).   By holding that the insurer must show prejudice for late notice, as long as notice is still within the policy period or any extended reporting period, the Prodigy decision seems to resolve the issue fairly.

On the one hand, the claims-made insurer retains the benefit of its bargain by being able to curtail further claims at the end of the reporting period.  On the other hand, requiring the insurer to show that the delay actually prejudiced its interests prevents a harsh forfeiture of coverage yet still protects the insurer's interests.

The dissenters argued that requiring a demonstration of prejudice in effect rewrites the policy.  But that argument was aired and discarded in the PAJ case. 

The effect of Prodigy is that notice of a claim must now be given within the time allowed for reporting claims under the policy even if the policy requires notice as soon as practicable.  Failure to provide prompt notice shifts the burden to the insurer to show that the delay actually caused prejudice.

Insurer Failed To Say What It Meant in Pollution Buyback Endorsement

Solvent Underwriters v. Furmanite America, Inc., No. 14-07-00889-CV (Tex. App.-- Houston [14th Dist.] February 5, 2009) see Furmanite Opinion

Insurance companies are usually the ones that write the insurance policies, and this case gives a striking illustration of just how treacherous that activity can be -- I meaning using words.  The case has many twists.  The part that interests us is a Pollution Buyback Endorsement that partially reinstates coverage for certain pollution liability risks otherwise excluded by the pollution exclusion.  The Endorsement provides:

Nothwithstanding the [Pollution Exclusion] . . . coverage . . . will apply to . . . personal property or bodily injury or loss of, damage to or loss to use of property . . . caused by seepage and pollution ... or contamination of air . . .

Provided that . . . the following conditions are met:

(a)    . . . the loss is accidental . . .

(b)    the loss became known to the Assured within 7 days after its commencement . . .

(c)    the loss was reported in writing to these Underwriters within 14 days after having become known to the Assured.

Furmanite contracts with refineries and chemical plants to fix leaks and prevent the escape of hazardous liquids or gas from plant pipes or equipment while (and this is the tricky part) the plant remains on-line and operating.  Nobody is perfect, and in 2003, Furmanite was sued along with the refinery by a former engineer with the plant who alleged continual exposure to toxic airborne chemicals between 1992 and 1999.  Furmanite sought coverage, and Solvent Underwriters denied the claim, in part based on the conditions of the Buyback Endorsement.

Furmanite admitted that the alleged injury was not discovered within 7 days or reported within 14 days of discovery.  The Endorsement should apply anyway, argued Furmanite, and the trial and the appellate courts agreed.  On what basis, you ask.

Furmanite asserted that the conditions following "provided that" apply only to instances of property damage, not personal or bodily injury.  The Endorsement uses the word "loss" only in reference to property, and, in general, "loss" is typically linked to property damage, not bodily injury.  Although recognizing that "loss" is not always used exclusively to mean property damage, the Court held that the parties' intent as expressed in the language of the policy [Court's emphasis], was to limit the conditions only to property damage.

The Court attempted to explain why such a limitation would make sense by reasoning that damage to property is immediately apparent, and an insurer would need to quickly inspect the property.  "Bodily injury, however, is frequently not as apparent as property damage, and . . . often manifests itself much later."  Not.  There are about as many latent property damage cases as bodily injury cases.  Let's be honest.  Solvent Underwriters did not intend to leave itself wide open for long-tail bodily injury risks.  They just screwed up in drafting the Endorsement.

They as much as said so by arguing that the Court should read "loss" to mean"occurrence," which typically refers to both bodily injury and property damage in general liability polices.  The obvious rejoinder to this is the old saw that insurance companies hate, "Well, if you meant to write 'occurrence' why didn't you do so?"  There it is.  Even though the exposure to the toxic stuff occurred a decade before the claim came to light, the Court held that the insurer had to prove that the delay in reporting the claim prejudiced the insurer's rights, which an insurer can almost never do early in the lawsuit.  Case closed.

Words.

 

 

Crocker Rule Imposed On Additional Insureds: No Excuse for Late Notice

Maryland Cas. Co. v. American Home Assur. Co. et al., #01-07-00711-CV (Tex. App.-Houston[1st Dist.], see Maryland Cas. Opinion

No mercy shown to additional insured (or rather, to its own insurers) for failing to learn of its additional-insured status under the other fellow's insurance before settling the case.  This result is unsurprising in light of the Texas Supreme Court's decision earlier this year in Nat'l Union Fire Ins. Co. v. Crocker, 246 S.W.3d 603 (Tex. 2008) (see my discussion at Liability Insurer Has No Duty To Inform Additional Insured That Coverage Exists).  But this is an oft-told tale that additional insureds' risk management could and should avoid.

The additional insured in this case, National Equipment Services, Inc. (NES), leased a "trench box" to Laser Construction, three of whose workers were killed when a trench they were digging collapsed despite use of the trench box.  The deceased workers' families sued NES but not Laser (presumably due to the workers' compensation bar against suits against the employer).  The lease agreement required Laser to add NES as an additional insured to Laser's liability insurance, and, in fact, Laser's policy, issued by Maryland, effectively covered NES as an additional insured.

Here's where NES, or its defense counsel, or its insurers (or all three) dropped the ball.  Instead of notifying Laser and Maryland of the lawsuit and asking for defense and indemnity as an additional insured, NES submitted the claim to its own insurers, including American Home.  American Home defended NES and settled the lawsuit before trial.  Only after settlement did American Home learn of NES's additional-insured status under Maryland's policy and demand from Maryland reimbursement of defense costs and settlement for over $2.25 million.  Maryland rejected the demand and cried Foul! Breach of Duty to Cooperate! Prejudice! 

At first, American Home made some headway by persuading the lower court that Laser's failure to turn over a copy of its policy showing NES's additional-insured status until after the settlement excused NES's (and American Homes's) late notice.  But on appeal, the court noted that the Crocker decision scotched that argument.  Ignorance of one's additional-insured status, even if innocent or justified, is no excuse under the law.  An additional-insured must still comply with the named-insured's policy requirements to send to the insurer as soon as practicable notice of the circumstances of the claim as well as the lawsuit papers.  Moreover, settling the case before sending such notice constitutes prejudice as a matter of law (no quibbling over whether Maryland was actually prejudiced or whether Maryland really knew about the lawsuit as well as NES's additional-insured status).  And NES's insurers get no breaks either.  They are stuck with their insured's obligations.  Reversed and rendered!

Risks managers and defense counsel everywhere:  Avoid increases in your (or your client's) insurance premiums by making sure additional-insured notices are sent to the named insured's insurers early in litigation.  Risk managers should have certificates of insurance in their files identifying the insurance companies covering the additional insureds.  If not, that information is discoverable in Texas.  After Crocker, everyone is on notice that courts will not excuse failure to notify named-insured's carriers.

Insurer's Failiure to Reserve Rights Will not Expand Coverage Unless Insured Proves Prejudice

Ulico Casualty Co. v. Allied Pilots Association, No. 06-0247 (Tex. August 29, 2008) See Ulico Decision.

In the third, and last, of three important Texas Supreme Court decisions handed down just before Labor Day, the Texas Supreme Court overturns, some would say modifies, a 25 year-old rule that an insurer that assumes the insured’s defense of a claim without obtaining a reservation of rights or a non-waiver agreement, and with knowledge of the facts indicating that the claim is not covered, may be barred by principles of waiver and estoppel from later asserting policy defenses, including noncoverage.  (The rule established in Farmers Texas County Mut. Ins, Co. v Wilkinson, 601 S.W.2d 520 (Tex. Civ. App.-Austin 1980, writ ref’s n.r.e.)). 

In other words, the insurer can’t say, “We will defend you in this lawsuit that alleges that you owe damages because you broke the plaintiff’s priceless Ming vase” and then go forward and control the defense without mentioning, “Oh, by the way, you should know that the policy doesn’t cover intentional conduct, and the plaintiff alleges you might have broken the vase on purpose, so we won’t cover a judgment that you acted intentionally,” and then refuse to cover such a judgment.  The rule in Wilkinson is that this insurer “waived” or “is estopped from asserting” the intentional-act exclusion because the insured relied on the insurer’s agreement to defend without reservation.

The Ulico Court stated that the Wilkinson rule, at least in the unvarnished form stated above, offends a far more established and venerable rule that a policyholder can’t use the principles of waiver and estoppel to re-write the insurance contract and expand coverage beyond the coverage the parties agreed to.  (See Washington Nat’l Ins. Co. v. Craddock, 109 S.W.2d 165 (Tex.1937).  In other words, when the policyholder agreed to accept a policy that did not cover intentional acts, then the insurer’s failure to raise non-coverage at the outset should not bar, or estop, the insurer later denying coverage for intentional conduct.

As an aside, don’t get thrown by these terms “waiver and estoppel:” 

• Waiver is the intentional relinquishing of a known right (“Dear insured, we know we have the right to deny coverage for intentional acts, but we knowingly relinquish that right because we want to control the defense without any interference from you.”) 
• Estoppel prevents the insurer from misleading its insured in a way that hurts the insured.  Specifically, when the insurer misrepresents something material and intends that the insured will rely on the misrepresentation, and the insured, without means of knowing that it is a misrepresentation, in fact relies to her detriment, then the insurer is estopped (think of estoppel as a gag – the judge gags the insurer in the courtroom so it cannot assert the coverage defense it otherwise would have a right to assert based on the insurer’s misleading conduct.)

The Ulico Court said that the unvarnished Wilkinson rule must be modified to require the insured to prove that she was prejudiced by the insurer’s failure to reserve rights at the beginning of a claim.  The facts of the case are instructive at this point: 

Ulico issued a claims-made liability policy, which requires the insured to send notice of a lawsuit within a precisely defined time.  The Allied Pilots Association sent the notice about a month late (actually, the Association timely sent the lawsuit to its agent, but the agent sat on it for a month – no mention of the lawsuit against the agent).  Late notice under a claims-made policy is fatal.  Courts give no quarter nor require the insurer to show that it was prejudiced by the late notice.  In this case, however, the insurer agreed to defend without reserving its right to deny coverage for any reason, including late notice.  Even so, the Association kept its own defense attorneys, who defended the case without any involvement, or approval, of the insurer.  After filing a motion for summary judgment, the attorneys sent a $635,000 bill to Ulico.  Ulico choked and denied coverage based on late notice for the first time.  At the coverage trial, the Association offered no evidence that it was of prejudiced, and the jury was not asked if the damages (the defense costs incurred) were caused by the insured’s reliance on Ulico’s offer to defend. 

The Texas Supreme Court held that the Association’s claim against Ulico should be dismissed in the absence of evidence that Ulico’s offer to defend without reservation prejudiced the Association.  Requiring Ulico to defend a claim submitted after the claims-made policy period would effectively re-write the policy.

I referred earlier to the “unvarnished” Wilkinson rule.  In fact, as the Ulico concurring opinion points out (see Ulico Concurrence), the prejudice requirement has long been required under Texas law.  (See State Farm Lloyds v. Williams, 960 S.W.2d 781 (Tex. App.―Dallas, 1997, pet. dism’d)).  So the Court only adds polish to existing law. However, the prejudice requirement is now clearly the focus of all future fights over the insurer’s unqualified defense.  No doubt insurers will want to continue to scrupulously reserve rights to avoid that fight.  So, after all, not much has changed.

Bear Stearns Bungled Insurance Coverage Before Collapse

Vigilant Ins. Co. v. The Bear Stearns Cos., 2008 N.Y. LEXIS 542 (N.Y. March 13, 2008).

No question, Bear Sterns blew it.  Sadly, however, Bear Stearns is not alone in failing to heed insurance policy obligations to get the insurer's consent before agreeing to a settlement. 

Bear Stearns purchased a professional liability policy from Vigilant that arguably would have covered some of an $80 million settlement with various government agencies over alleged improper conflicts of interest in its financial services business.  After extensive negotiations with the regulators, Bear Stearns signed a consent agreement acceding to entry of a judgment for injunctive and monetary relief, approximately $45 million of which was arguably covered under the liability policy.

Unfortunately, Bear Stearns did not notify Vigilant of the proposed settlement until after execution of the consent agreement.  Vigilant raised several defenses to coverage, including violation of a common policy consent provision:

The insured agrees not to settle any Claim, Incur any Defense Costs or otherwise assume any contractual obligation or admit any liability with respect to any Claim . . .

In the coverage lawsuit following Vigilant's denial, Bear Stearns argued that the settlement was in fact not final because it was subject to court approval.  The high court of New York rejected this argument.  The consent agreement was final as far as Bear Stearns was concerned.  It acknowledged that the SEC could present a final judgment to the federal court for signature and entry without further notice.  "In short," observed the Court, "Bear Stearns did everything within its ability to settle the matter and no further action was required on its part."

Bear Stearns was managing its own defense within a substantial retention.  This is very common.  But it is vitally important to keep the insurer informed both when lawsuits are filed and when settlement negotiations are under way.  Somebody, Bear Stearns' risk management or outside litigation counsel, dropped the ball on this one.

Liability Insurer Has No Duty To Inform Additional Insured That Coverage Exists

National Union Fire Ins. Co. v. Crocker, #06-0868 (Tex. Feb. 15, 2008) see Crocker Opinion.

The old adage, "Hard facts make bad law" applies in this case.  A nursing home resident sued the facility and an employee after being injured when the employee allegedly swung open a door and hit the resident.  The employee never answered the lawsuit, and apparently never knew he was covered under the employer's policy.  A jury found that the nursing home, acting "by and through its agents acting within the course and scope of their employment," was not negligent.  The plaintiff's attorney moved to sever the defaulting employee before verdict.  After the take-nothing judgment in favor of the nursing home, the plaintiff obtained a $1 million default judgment against the employee and sought to collect against the nursing home's insurance company.

You see, the insurer knew all along that the employee was an "omnibus" or additional insured under the policy.  The insurer had tried to contact the employee by phone and certified mail regarding his status as an insured and right to a defense under the policy.  Apparently, the attorney hired by the insurer to defend the nursing home tried to speak to the employee at a deposition, but the employee refused to speak to him.  So no wonder that the insurer denied responsibility for the default judgment based on the employee's failure to notify the insurer or send a copy of the lawsuit as the policy required.

When the insurance coverage suit reached the 5th Circuit, the court certified the question to the Texas Supreme Court as follows:

Where an additional insured does not and cannot be presumed to know of coverage under an insurer's liability policy, does an insurer that has knowledge that a suit implicating policy coverage has been filed against its additional insured have a duty to inform the additional insured of the available coverage?

The 5th Circuit also asked if the insurer's actual knowledge of these circumstances establishes lack of prejudice as a matter of law. 

The Texas Supreme Court answered No to both questions.  "[A]n insurer that has not been notified that a defense is expected bears no extra-contractual duty to provide notice that a defense is available to an additional insured who has not requested one."  On the question of whether or not the insurer was prejudiced, the Court distinguished this case from PAJ, Inc. v. Hanover (see my discussion at CGL Insurers Must Prove Prejudice), in which the insured sent late notice to the insurer.  In this case, the Court stated, "[N]otice was not merely late; it was wholly lacking."

Bottom line: "Insurers owe no duty to provide an unsought, uninvited, unrequested, unsolicited defense."

But the facts in Crocker are extreme.  National Union bent over backward to contact the employee.  A jury determined that neither the facility nor its agents (including employees) were negligent before the plaintiff obtained a $1 million default judgment.  By contrast, in most additional-insured late-notice cases, the equities are more balanced or favor the additional-insured.  For example, should the insurer avoid coverage when an additional insured requests coverage during the investigation phase before a lawsuit is actually filed but after the plaintiff has demanded relief?  There may even be extensive pre-suit communications between the additional insured and the insurer in which the former's intent to seek coverage is clear.  As the Crocker Court observed, the insurer's duty to defend is not actually triggered until the lawsuit is filed and conveyed to the insurer.  Yet, if the additional insured fails to forward the lawsuit but continues to correspond about the claim, would the Crocker Court excuse the insurer or call it an unsought, uninvited, unrequested, unsolicited defense?

It appears likely that the PAJ decision will require the insurer to show prejudice before avoiding this type of coverage, which means that, as long as the additional insured sends a complaint (or amended complaint) to the insurer and requests a defense within a reasonable time before trial (some decisions have held that a month or two is reasonable), the duty to defend will be triggered. 

But it is clear that ignorance of one's additional-insured status is no excuse.  That is bad news for so-called "omnibus" insureds, like employees of a named insured company, who do not contract for their additional-insured status and so probably have no idea of their rights to coverage.  For those who become additional insureds by contract with the named insured, simply because the named insured is being defended in a lawsuit, does not mean that the insurer has any obligation to cover additional insureds until they send a copy of the complaint and demand defense and indemnity in their own right.

"Tension in the Duty To Defend" By Scott Stolley

In a recent article, referenced above, published in Headnotes, a publication of the Dallas Bar Association, (see Tension), Thompson & Knight Partner Scott Stolley identifies four unsettled areas in Texas law governing an insurer's duty to defend.  These include:

• Extrinsic Evidence
• Selection of counsel
• Recoupment of Costs
• Prompt Payment

The Texas Supreme Court recently addressed two of the areas of concern (See Frank's Casing and PAJ Inc.).  Nonetheless, many of the details, raised in Stolley's article, remain to be worked out in subsequent cases.  Worth the read. 

CGL Insurers Must Prove Prejudice To Avoid Coverage For Late Notice of Claims

PAJ, Inc. v. Hanover Ins. Co., No. 05-0849, (Tex. January 11, 2008)

This decision puts Texas squarely in the national majority position on what happens when the insured fails to give its liability insurer timely notice of a claim or suit.  It is now clear that in all types of claims, the insurer may not refuse to defend or indemnify the insured unless the delay prejudiced the insurer's rights under the policy.  However, this decision probably does not require the insurer to prove prejudice for late notice under a claims-made type policy.  (For more information on claims-made policies, see Late Notice Under Claims-Made Policy).

Standard Commercial General Liability (CGL) occurrence-type policies require the insured to send notice of a claim or suit "as soon as practicable"  (how soon varies with the facts of each case, but most courts require notice within a couple of months).  Before 1973, under Texas law, failure to do so resulted in forfeiture of coverage for that claim, without regard to any evidence of actual prejudice to the insurer.  The State Board of Insurance issued a 1973 order requiring CGL policies to preclude forfeiture of the claim unless the insurer is prejudiced by the late notice but only for bodily injury or property damage (which in 1973 is all that a standard CGL policy covered.  Later, CGL policies began covering what is now called "personal and advertising injury," at issue in the PAJ case).  Between 1973 and the present, Texas courts have split between holding that the insurer must prove prejudice in all cases or just in bodily injury/property damage cases. 

PAJ, Inc. is a jewelry manufacturer that was sued for copyright infringement, that qualified for coverage as an "advertising injury" under its CGL policy.  Apparently not realizing that the lawsuit might be covered by insurance, PAJ failed for four months to send Hanover notice of the lawsuit (PAJ stipulated that notice was not "as soon as practicable").  Hanover denied coverage but stipulated in court that the delayed notice did not cause prejudice.  The lower courts held that Hanover had the right to deny coverage without having to prove prejudice because the notice clause constituted a "condition precedent," not a "covenant."  And this is the legal distinction that the Texas Supreme Court had to parse.

A "condition precedent" in a contract is a condition that must be met before performance is due.  The "condition precedent" is viewed legally as an essential basis for the contract, at the heart of the bargain.  For example, suppose I want to donate land to a city to be used as a park.  If I grant the land to the city but only for so long as it is used as a recreational park, this is a condition precedent to my gift.  The grant is rescinded if the city tries to develop condos on the land.  If the condition precedent fails, the contract (or land grant in this case) fails.

A "covenant," by contrast, is simply a promise or obligation.  A contract usually contains a number of covenants.  In an insurance contract, the insurer promises to pay money or take certain action upon the occurrence of covered risks; the insured agrees in return to pay a premium.  The policy contains other terms and provisions that further define the parties' obligations, in light of anticipated circumstances that affect the contract.  The key distinction about covenants is that a party's performance may in some respect fall short of what was promised, but unless it materially affects the fundamental purpose of the contract, the deficiency will not result in a complete forfeiture of the bargained-for exchange.  Breach of a covenant may be material or immaterial.  If the breach is material, the breaching party may lose the benefit of the bargain.  If immaterial, then the breach may be overlooked or require only a reasonable modification.

Is the notice obligation a condition precedent or a covenant?  Often it looks like a condition precedent when it uses conditional language, such as [insurer will cover the claim] "unless" or "unless, as a condition precedent thereto," [notice is not given as soon as practicable].  In PAJ, the Supreme Court appeared to cut the Gordian Knot of arcane legalese and hold that it would treat these notice provisions as covenants regardless of the phraseology used.  In doing so, the Court recognized it was following the modern trend in favor of requiring proof of prejudice.

PAJ drew a spirited dissent joined by three other justices condemning what was perceived as a departure from established law on the interpretation of conditions precedent.  The dissent pointed out that the insurance industry recently changed the standard CGL policy by including an endorsement requiring prejudice for personal and advertising injury claims as well as bodily injury/property damage claims.  It if for legislative bodies or the contracting parties, not the courts, to alter the policies, says the dissent.

The PAJ decision brings a measure of certainty to the claim analysis when notice is delayed.  Policyholders in fact have an incentive to provide timely notice to their insurers, who have no obligation pay defense costs incurred before they receive notice.  So, I do not think this decision will result in tardier habits among risk managers.  Also, as mentioned before, courts will not require insurers under claims-made policies to show prejudice, at least as long as notice is sent within the policy period.