The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

In a May 16, 2013 decision (here), Eastern District of Missouri Magistrate Judge Terry Adelman, applying Missouri law, determined that the failure of an insured under a management liability insurance policy to provide timely notice of claim precluded coverage under the policy, even in the absence of a showing of prejudice to the insurer.

Background       

On December 28, 2007, Secure Energy’s Board of Directors received a demand from Michael McMurtrey regarding commissions he allegedly was owed. On May 16, 2008, McMurtrey filed a lawsuit against Kenny Securities and against John Kenny, a director and founder of Secure Energy. On April 13, 2009, McMurtrey added Secure Energy as a defendant to the lawsuit. McMurtrey sought to recover $1.8 million in commissions and $2 million in punitive damages. McMurtrey alleged breach of contract, unjust enrichment, fraud, negligent misrepresentation, and conspiracy against Secure Energy. McMurtrey voluntarily dismissed his suit on June 25, 2009 but refilled it against the same defendants on July 8, 2009.

Secure Energy’s management liability insurance policy provided that the insured must provide notice of claim to the insurer as soon as practicable after becoming aware of the claim but no later than 60 days after the expiration of the policy. However, Secure Energy did not notify the insurer of the claim until May 4, 2011. According to the Magistrate Judge’s opinion, the reason for Secure Energy’s delay in providing notice was it was unsure whether it had a claim. However, the Magistrate Judge also noted that in 2009, the company’s insurance broker had advised the company that while there may be little or no coverage under the policy for the claim, the only way to determine coverage is to submit a claim.

The insurer rejected coverage for Secure Energy’s claim on the grounds of late notice. Secure Energy then filed an action seeking a judicial declaration that there was coverage for the claim under the policy. The insurer filed a motion for summary judgment arguing that coverage was precluded because Secure Energy had failed to provide timely notice. Secure Energy argued that coverage was not precluded because the insurer had suffered no prejudice from the untimely notice.

The May 16, 2013 Decision

In a short May 16 opinion, Magistrate Judge Adelman granted the insurer’s motion for summary judgment. Secure Energy had tried to argue that under Missouri law, an insurer cannot deny coverage for a claim based on late notice unless the insurer can demonstrate that the insured’s failure to comply with the notice provisions prejudiced the insurer. The insurer argued that under Missouri case law, in order to deny coverage on the basis of late notice, an insurer under a “claims made” policy need not demonstrate prejudice.

After reviewing the case law, Magistrate Judge Adelman observed that “the Missouri Supreme Court distinctly held that an insurer is not required to show prejudice in a ‘claims made’ policy. Several Missouri state and federal courts have followed this reasoning.” Magistrate Judge Adelman concluded that the insurer “is not required to demonstrate that it was prejudiced by Secure Energy’s failure to provide notice under the claims made policies. Secure Energy’s failure to give the requisite notice precludes it from coverage.”

Discussion         

Delayed notice is a recurring problem for policyholders seeking to obtain insurance coverage for claims. The reasons that the notice is delayed are innumerable. All too often, it will emerge that the reason the notice was delayed is that the policyholder did not think there was coverage or, as apparently was the case here, the policyholder did not think there was yet a claim. In other cases, the insured simply concluded that the claim was no big deal – only to find out later that it is a bigger problem than first appeared. Because I have seen these patterns so many times over the years, I have developed a simple rule – always give notice. No good comes from withholding notice. If you are asking the question whether or not you should give notice, then you should give notice.

But if policyholders sometimes hurt themselves by withholding notice, it can sometimes appear that some carriers in some instances seek to use the notice requirements as a coverage dodge. (Please note that in making this observation here, I am in no way commenting on the carrier’s behavior in the Secure Energy case.). For that reason, I am concerned when late notice can serve as a basis to deny coverage even in the absence of prejudice to the insurer. In fairness, the notice here was years late. The tardiness of the notice here is hard to excuse, particularly when two years prior to actually providing notice, the company had been advised by its broker to go ahead and give notice. But even here, the carrier does not appear to have prejudiced by the delay – or, at a minimum, did not claim to have been prejudiced by the delay.

The best way for companies to avoid problems with the notice requirement is to have processes to ensure that notice to the insurer is quickly provided after a claim has arisen. However, long experience has taught me that in the real world, the insurer is not always notified right away. The simple fact is that company management, particularly at some smaller companies, is focused on operational issues and is not always sophisticated about insurance issues. Courts evolved the “notice prejudice” rule in recognition of this practical reality.

I know that there are a number of jurisdictions where the courts have held that the “notice prejudice” rule is not applicable in the claims made context. I would argue that the “notice prejudice” rule has a place, even in the world of “claims made” policies. As I discussed in a prior post (here), some courts have applied the notice prejudice rule even in the claims made context (although, it should be noted, in that prior post, I noted some concerns with the court’s application of the rule in that specific case).

My concern is that without the application of the “notice prejudice” rule, the notice requirements can become a trap for the unsophisticated or uninformed insured and result in an inadvertent loss of the insured’s rights under the policy. I recognize that insurers want to be able to be involved in claims and don’t want to get caught up in murky questions about what may constitute “prejudice,” and therefore prefer a bright-line notice test. I would argue that the “notice prejudice” provides an appropriate balancing of interests. Obviously, the later a policyholder’s notice of claim is, the harder it would be for a policyholder to obtain coverage under the policy.  

I know my friends on the carrier side may have differing views, and in particular may well contend that the notice provisions serve important purposes that should not lightly be set aside. I invite readers to add their views using this blog’s comment feature in the right hand column.

BlackRobe Litigation Funding Firm Shuts Down: In recent posts (most recently here), I have noted with alarm the apparently proliferation of firms in the U.S. formed to provide litigation financing. The firms are in the business of providing funding for litigation as a form of investment. Among the many developments in this area that captured my attention was the 2011 formation of BlackRobe Capital Partners. The firm’s principals included Sean Coffey, a former partner at the Bernstein Litowitz plaintiffs’ securities firm, joined a year later by retired Simpson Thacher partner Michael Chepiga. As I noted at the time, the involvement of highly respected attorneys like Coffey and Chepiga added an entirely new dimension to the emerging litigation funding phenomenon.

Now comes the news that BlackRobe is closing down. As reported in a May 14, 2013 Wall Street Journal article (here), the firm’s founders are “walking away from the litigation-finance firm, citing internal disagreements and a failure to attract enough outside capital from investors.” Though the firm has made over $30 million in investments, “the firm wasn't able to raise a large discretionary pool of capital.”

It is hard to know how much significance to attach to BlackRobe’s demise. On the one hand, a significant factor contributing to the firm’s closure were philosophical differences among the firm’s founders. On the other hand, the firm was also having trouble raising capital, which could suggest an overall lack of investor support for the litigation funding project. However, representatives of several more established litigation funding firm are quoted in the Journal article to the effect that their firms have had no difficulty raising money. So it is possible that BlackRobe’s quick end reflects nothing more than the difficulty that startups face in an evolving industry.

Susan Beck’s May 16, 2012 Am Law Litigation Daily article about the BlackRobe firm’s demise (here), includes comments from several of the firm’s principals that seem to corroborate the conclusion that firm’s end was in large measure the result of company-specific factors, including in particular differences among the firm’s principals about how to run the firm.

Although the demise of the BlackRobe firm unquestionably is noteworthy, it may or may not say anything about the emergence of the litigation funding phenomenon. Certainly the firm’s difficulties raising capital suggest that it may be a difficult field for startups. Overall, it seems that litigation funding will continue to be a factor, notwithstanding BlackRobe’s demise.

Libor Claimants Face High Hurdles: As readers of this blog know, the civil claimants attempted to recover damages against the Libor benchmark rate-setting banks have found the going difficult. For example, most recently the claimants in the Libor scandal-related securities suit filed against Barclays had their action dismissed (about which refer here). A May 16, 2012 Law 360 by Michael Gass, Stuart Glass and Kevin Quigley of the Choate Hall law firm entitled “Libor Litigation Must Overcome Significant Obstacles” (here, subscription required) reviews the various adverse litigation developments the Libor scandal claimants have had to face and concludes that the claimants’ “obstacles to recovery are inherent and, perhaps, insurmountable.”

Special thanks to a loyal reader for sending along a link to the Choate Hall memo.

• Print
• Comments
• Trackbacks
• Share Link

Disputes over notice of claim requirements usually involve questions about the timing or content of the notice. A recent notice dispute involving UnitedHealth Group raised neither questions of timing or content; rather, the dispute involved the question of “to whom” the notice must be sent. In an April 25, 2013 opinion (here), District of Minnesota Judge Patrick J. Schlitz, applying Minnesota law, held that in order to satisfy the notice of claim requirements in an excess  insurance policy, the notice had to be sent to the insurer's claims department as specified in the policy. Because the policyholder had failed to establish a genuine issue of fact whether the claims department had received the notice of claim, the Court granted summary judgment in favor of the excess insurer.

The dispute over the adequacy of notice arose in the context of a protracted and procedurally complicated action in which UnitedHealth is seeking insurance coverage from its insurers for a series of claims in which the company was involved between December 1998 and December 2000. The company’s primary insurance policy has been exhausted by payment of loss and the company has settled with five of its excess insurers. Four excess insurers remain as defendants.

In his April 25 order, Judge Schlitz considered a number of different motions in the continuing coverage litigation, including the motion for summary judgment of one of the remaining excess insurers, based on its assertion that it had not been provided notice of a claim known as the AMA claim. The AMA claim later settled for $350 million.

The notice provision in the excess insurer’s policy specified that:

It consideration of the premium charged, it is hereby understood and agreed that notice hereunder shall be given in writing to [the excess insurer], Financial Services Claims Department, 175 Water Street, New York, New York 10038 (herewritten the “Insurer”)

(a) The Company or the Insureds shall, as a condition precedent to the obligations of the Insurer under this policy give written notice to the Insurer as soon as practicable during the Policy Period, or during the Extended Reporting Period (if applicable), or [sic] any claim made against the Insureds.

According to the court’s opinion, the parties agreed that UnitedHealth had not provided written notice of claim sent to the specified address. UnitedHealth nevertheless argued that it had satisfied the notice requirements because it had “substantially complied” with the provisions. Judge Schlitz agreed with UnitedHealth that because Minnesota law “generally disfavors technical and narrow objections to the existence of coverage, especially when it comes to matters of notice,” substantial compliance is sufficient to satisfy a “to whom” notice requirement. But, he added, “substantial compliance requires notice that is substantial.”

Judge Schlitz disagreed with UnitedHealth that the “to whom” requirement is satisfied if the company “provides any kind of notice to any kind of agent” of the excess insurer.  He found that under the policy’s provisions, the notice requirement “has not been substantially complied with unless the Claims Department received notice of claim – somehow, from someone --- during the policy period.” He added that if an agent of the insurer becomes aware of a claim “but the agent does not work in the Claims Department and does not notify the Claims Department of the claim, then there has not been substantial compliance with the ‘to whom’ requirement.” Judge Schlitz reasoned in that regard that:

“Compiance” with a provision of an insurance policy should not be deemed “substantial” if doing so would defeat the very purpose of the provision. And the very purpose of a “to whom” requirement – its entire reason for existing – is to ensure that notice is provided not just to the insurance company, but to a particular part of the insurance company. A large insurance company has a legitimate reason to require that notice of claim be given to a particular person or department with the company, rather than to any of the company’s thousands of employees and agents scattered around the globe. Otherwise, there is a substantial danger that the “notice” will not be recognized as such and will not serve its function.

Judge Schlitz added that “The Court can conceive of no reason why an insurer … should not be able to protect itself by requiring that notice be given to a particular person or department. And enforcing such a requirement does not place an onerous burden on an insured – particularly an insured such as United, which is itself a huge and sophisticated insurance company, and which has no excuse for failing to send notice of the AMA claim to the Claims Department, as [the excess insurer’s] policy clearly required United to do.” He concluded that in order for UnitedHealth to show that it substantially complied with the notice requirement, it must show that notice of the AMA claim was received by the Claims Department during the policy period.

Judge Schlitz then reviewed the various ways in which UnitedHealth claimed that it had provided notice of the claim. UnitedHealth argued that the AMA claim had been noticed in a monthly loss run report that the company’s broker supplied to the excess insurer and that the loss run report also was attached to UnitedHealth’s renewal insurance application. However, while Judge Schlitz found that there is sufficient evidence from which a jury could find that someone at the excess insurer received the loss runs, there was no evidence that that the loss runs were provided to the claims department.

And while the AMA claim apparently was discussed at a meeting in connection with UnitedHealth’s  insurance renewal, there was no evidence that anyone from the excess insurer’s claims department had attended the meeting. Judge Schlitz specifically concluded that there was no evidence to suggest that the excess insurer’s claims department had received information about the AMA claims from the underwriting department.

Judge Schlitz also rejected UnitedHealth’s argument that because it had provided notice of claim to the primary insurer that is owned by the same insurance holding company as the excess insurer asserting the notice defense that the notice requirements had been satisfied.

Because UnitedHealth had “failed to show that there is a genuine issue of fact about whether the Claims Department received notice of the AMA claim during the policy period,” Judge Schlitz granted the excess insurer’s motion for summary judgment.

Discussion

Judge Schlitz’s conclusion that an insurance notice requirement is not satisfied unless it can be shown that notice has been given to the specific department identified in the notice provision is a cautionary tale for practitioners in this area. In the press of day to day business, it would be far too easy for a notice to be sent to the right company but to a person, location or address other than the one specified in the policy. The clear lesson is that everyone involved in the process of providing notice of claim to needs to help to ensure that notice is sent not just to the correct insurer but also to the correct location – and to the correct location for each of the insurers in an insurance program. The case also underscores the value of having processes to require and obtain acknowledgement of receipt of notice of claim as well.

UnitedHealth’s apparent failure to provide the requisite notice of claim here is a little bit of a mystery. The claim was obviously very serious (or, at a minimum, it became very serious). It is clear from the Court’s opinion that the primary insurer on UnitedHealth’s insurance program was provided with the notice of claim required under its policy. It isn’t explained in the opinion how it came about the notice of claim had been sent to the prmary insurer (and apparentlyto other excess insurers as well) but not to the excess insurer involved in this motion. The court’s reference to the monthly loss runs is a reminder that UnitedHealth is a big, complex company that apparently became involved in a number of claims. The suggestion is that in the hubbub the notice of the AMA claim to this excess insurer somehow slipped through the cracks. Reading between the lines, there may also have been a confusion of or breakdown in responsibilities among the varaious process participants.

There is one aspect of this opinion that I find interesting. There is nothing in Judge Schlitz’s opinion to suggest that the excess insurer was prejudiced in any way by the absence of compliance with the policy’s notice provisions. At least as presented in the court’s opinion, it does not appear that the excess insurer argued that its interests had been prejudiced. The court was concerned only with the question whether or not the policyholder had satisfied the procedural requirements stated in the policy. There is no sense in the opinion of a consideration of a “no harm, no foul” point of view. .

The arguably harsh outcome of this dispute might be more comfortable if the analysis had been accompanied by some suggestion that UnitedHealth’s failure to satisfy the procedural requirements had somehow caused a problem for the excess insurer with reference to the AMA claim. Here’s my concern. Some  insurers try to enforce their policies’ notice requirements as if the implementation of the provions were a game of “Mother May I?” On some occasions, some insurers brandish supposed notice issues as if, as a result of the supposed notice defect, they have won the game because the policyholder failed to say “Mother May !?” D&O insurers are of course fully entitled to expect compliance with policy requirements. However, reasonable business considerations should temper the enforcement of the requirements.

Judge Schlitz commented that it was fair to strictly enforce the requirements of the notice provision against a large sophisticated company like UnitedHealth. Whether or not that is true, my concern is that the same analysis as he is applying to a big sophisticated company like UnitedHealth could also be applied to a company that isn’t as big or sophisticated.

In all fairness, however, it should be noted that isn’t a case where a notice of claim as such was sent to the wrong address or the wrong department. Notwithstanding UnitedHealth’s arguments, it looks as if for whatever reason, there really was not a notice of claim as such sent to any address or department. Without that, UnitedHealth was left to argue that various fragments of informatoin about the claim could be shown to have filtered through a complex pattern of interaction between the company and the excess insurer. That was aloways going to present some difficulties for UnitedHealth. The company was not in the best position it could have been in on these issues. 

As I said at the outset, this case is a cautionary tale for all of us working in this business. The lesson for all of us is to try to make sure that the notice of claim both goes to the specific address stated in the policy and that it goes to all of the insurers.

Ninth Circuit Reverses District Court Holding That E&O Insurance Policy Exclusion Precluded Coverage: On April 26, 2012, in a terse, unpublished four-page decision, a three judge panel of the Ninth Circuit reversed the district court’s dismissal of an insurance coverage action that Ticketmaster had filed against its error and omissions insurer. A copy of the Ninth Circuit’s opinion can be found here.

The errors and omissions insurance policy provided liability coverage for Ticketmaster for claims arising from the performance or the failure to perform professional services. The policy contained an exclusion, Exclusion E, specifying that the policy does not apply to any claim “based on or arising out of … any dispute involving fees, expenses or costs paid to or charged by the Insured.”

Ticketmaster was sued in a putative class action brought by ticketholders alleging that the company had made false representations regarding UPS delivery fees and order-processing charges for ticket events. Ticketmaster sought to have its E&O insurer defend it in the ticketholder claims. The insurer declined based on Exclusion E. Ticketmaster sued the insurer for breach of contract and bad faith. The district court granted the insurer’s motion for judgment on the pleading. Ticketmaster appealed.

In its April 26 opinion, the Ninth Circuit panel reversed the district court, holding that Exclusion E is “reasonably susceptible of at least two meanings, particularly in light of the Policy’s other 27 exclusions, and is thus ambiguous.” The appellate court identified the two possible meanings: “(i) Exclusion E may refer narrowly to a dispute regarding the monetary amount paid to or charged by Ticketmaster for uncontested services, or (ii) more generally, Exclusion E may refer to any dispute regarding a fee or charge for professional services, including a dispute regarding the relationship between services and the fees charged.”

The appellate court said that the E&O insurer had failed to carry its burden of showing that the second interpretation is the only reasonable one. The court noted that there are at least some allegations in the ticketholders’ action that do not involve the amount charged for uncontested services, such as the allegation that Ticketmaster performed no services in exchange for its order-processing charge. This allegation, the court said, did not dispute the amount charged but rather the relationship between any fee at all and the services provided. This dispute would be precluded by interpretation (ii) of Exclusion E but not interpretation (i).

The Ninth Circuit reversed the district court and reinstated the complaint, including Ticketmaster’s bad faith allegations.

FDIC Files Another Failed Bank Lawsuit and Two More Bank Fail: On April 26, 2013, the FDIC filed yet another lawsuit in its against the directors and officers of a failed bank. In its complaint (here), the FDIC, in its capacity as receiver of the failed Frontier Bank of Everett, Washington, has asserted claims for negligence, gross negligence and breach of fiduciary duty against twelve former directors and officers of the bank. The bank failed on April 20, 2010, so the FDIC filed its action just before the three-year statute of limitations expired.

The FDIC alleges that the defendants breached their duties to the bank by “causing the Bank to violate its own policies and prudent, safe and sound banking practices” in connection with the approval of at least eleven loans between March 2007 and April 2008. The FDIC sees to recover damages “in excess of $46 million.”  An April 26, 2013 Puget Sound Business Journal article regarding the FDIC’s new Frontier Bank lawsuit can be found here.

Not only did the FDIC file the lawsuit against the former Frontier Bank directors and officers, but the agency also took over as receiver of two more failed banks on Friday. The two banks are the Douglas County Bank of Douglasville, Georgia and the Parkway Bank of Lenior, North Carolina. Between January 1, 2013 and April 20, 2013, there were only five bank failures total,  but just in the last two weeks there have now been five more, for a total of ten so far during 2013. As I recently noted, though it has seemed as if the bank failure wave had just about played itself out, it now appears that there may yet be more bank failures yet to come.

With the failing of the latest lawsuit, the FDIC has now filed a total of 57 lawsuits against the former directors and officers of failed banks, including 13 so far this year alone. As I discussed here, it seems likely there will be more to come, as well.

Speakers’ Corner: On Tuesday, April 30, 2013, I will be participating in Advisen’s Quarterly D&O Claims Trends Webinar. In this free webinar, which will take place at 11:00 am EDT, I will be participating on a panel with Paul Ferrillo of the Weil Gotshal law firm, David Murray of AIG, and Jim Blinn of Advisen. The panel will discuss claims trends and developments during the first quarter of 2013. Registration information for the webinar can be found here.

• Print
• Comments
• Trackbacks
• Share Link

On February 5, 2013, in a detailed opinion exploring the nuances of a D&O policy’s extended reporting period provisions, Western District of North Carolina Judge Henry Herlong Jr.  determined that the directors of the failed Bank of Ashville of Asheville, North Carolina timely provided their D&O insurer notice of the FDIC’s lawsuit against them as the failed bank’s receiver. Practitioners in the D&O arena will want to read this opinion, a copy of which can be found here, for its examination of the interactions between the policy’s “basic” 60-day extended reporting period and its 12-month “supplemental” extended reporting period.

Background

The Bank of Asheville failed on January 21, 2011. As discussed here, on December 29, 2011, the FDIC as the failed bank’s receiver filed a lawsuit in the Western District of North Carolina against seven former directors of the bank. On December 29, 2011, the directors provided the bank’s holding company’s D&O insurer with notice of the FDIC’s lawsuit.

The D&O policy provided coverage for the period November 3, 2007 through November 3, 2010. However, the policy contains a 60-day “basic” extended reporting period, allowing for the notice of claims 60 days beyond the policy’s expiration. The policy also provided for a 12-month “supplemental” extended reporting period that, by endorsement and upon payment of an extra premium charge, allows an additional 12 month reporting period. The “supplemental” extended reporting provision in the policy provided that “the supplemental Period starts when the Basic Extended Reporting Period …ends.” 

Through a process that the court’s opinion reviewed in detail, the bank purchased the 12-month supplemental extended reporting period prior to the expiration of the policy period. The endorsement the D&O insurer issued specified that the supplemental extended reporting period is “11-01-2010 – 11-01-2011.”

After the directors submitted notice of the FDIC lawsuit to the insurer, the insurer took the position that the notice was untimely. The directors filed an action seeking a declaratory judgment that the insurer is required to pay defense costs and any settlements or judgments in the FDIC’s lawsuit. The directors also alleged a claim for reformation of the policy. The parties filed cross-motions for summary judgment.

The February 5 Opinion

In his February 5 opinion, Judge Herlong granted the directors’ motion for summary judgment, holding that the directors had timely provided notice of the FDIC lawsuit to the insurer prior to the expiration of the extended reporting period.

The dispute that the court considered came down to the question whether the 12-month supplemental extended reporting period ran from the end of the policy period of the policy or from the end of the policy’s 60-day basic extended reporting period.

After a detailed review of the communications between the various parties involved in the acquisition of the supplemental extended reporting period, the court concluded that

Although the Policy provided a 60-day basic Extended Reporting Period automatically, [the D&O insurer] charged the Bank the maximum permitted under the Policy, a 200 percent premium, for the 12-months of Supplemental Extended Reporting Period coverage. However [the D&O insurer] erroneously used the dates November 3, 2010 to November 3, 2011. Thus under [the D&O insurer’s] argument, the Bank paid for 12 months and received only 10 months of additional extended reporting coverage. Based on the foregoing, the court finds that the starting and ending dates of the Endorsement conflict with the terms of the Policy and is ambiguous because it is subject to different interpretations regarding the 60-day Basic Extended Reporting Period and the 12-month Supplemental Extended Reporting Period.

The D&O insurer argued that all of the documents and communications, including in particular the endorsement showing a supplemental extended reporting period from November 3, 2010 to November 3, 2011, “support a finding that the intent of the parties was to eliminate the 60-day Basic Extended Reporting Period.”

Judge Herlong said that this “is an amazing argument, “ asking the question “Why would the Bank forfeit the 60-day Basic Extended Reporting Period when the Policy specifically provides that if the Bank purchases an extended reporting period of 12 months, the 12-month period begins when the 60-day Basic Extended Reporting Period ‘ends’?”

Judge Herlong concluded that “the evidence is clear that the Plaintiffs did not know or intend to forfeit the 60-day Basic Extended Reporting Period. To the contrary, the only inference that can be drawn from the evidence is that the Plaintiffs paid for 14-months of extended reporting coverage, which includes the 60-day Basic Extended Reporting Period and the 12-month Supplemental Extended Reporting Period.” Judge Herlong granted the directors request to reform the schedule of the endorsement to allow for notice during the period January 3, 2011 to January 3, 2012, as a result of which the directors’ notice to the insurer of the FDIC’s lawsuit was timely.

Discussion

Although this decision is fact intensive and is a reflection of the specific policy language involved, it nevertheless represents a cautionary tale that is worth heeding. D&O policies are complex contracts with a variety of parts that interact in myriad subtle ways. My review of the sequence of events here as well as a familiarity with the way that the transaction of the kind involved here are processed suggests to me that the parties really were not fully conscious of the possible complications arising from the interaction between the basic extended reporting period and the supplemental extended reporting period.

Once the dispute arose, the parties tried to argue over what had been intended, when in reality there had really been no intent, as the persons involved in the transaction may not have been conscious of the potential issue in the first place; the carrier provided a quote with and issued the supplemental extended reporting period endorsement with dates that did not take the 60-day basic extended reporting period into account. The bank and its representatives accepted the quote and placed the order for the supplemental extended reporting period without objecting that the specific period that the carrier proposed to provide did not take the 60-day basic extended reporting period into account. Accordingly, faced with a fundamentally ambiguous situation (but taking into account the policy’s provision that the supplemental extended reporting period starts when the basic extended reporting period ends), the court construed the situation in the directors’ favor.

I think anyone who has been involved in these kinds of situations can see how this happened. The policy allowed for a 12 month reporting period extension, the bank said it wanted a 12 month extension, and the carrier issued an endorsement that extended the reporting period 12 months. Because I can see how what happened here could happen, I am reluctant to try to draw conclusions too broadly, other than to say that this case does provide a lesson for us all on the need when modifying a policy to consider all of the ways that the proposed modification will affect the policy.  On a much simpler level, the case does provide an important illustration of the ways that the policy’s various extended reporting provisions interact. I want to make clear that in stating these conclusions here, I do not mean to suggest that I am finding fault with anyone’s actions. As I said, I can see how this situation came about.

• Print
• Comments (1)
• Trackbacks
• Share Link

Among the recurring sources of D&O insurance coverage disputes are issues relating to timely notice of claim. A 6-3 decision by the Texas Supreme Court on March 27, 2009 (here), written over a vigorous dissent (here), recapitulates many of the perennial notice issues and reaches a result that while unquestionably policyholder friendly also poses certain concerns.

Background

At the time of FlashNet Communications May 2000 merger with Prodigy Communications, FlashNet purchased a 3-year discovery period under its existing D&O insurance program, which extended coverage for claims first made during the period May 31, 2000 to May 31, 2003.

The notice provision in the policy had been amended. The original provision required as a "condition precedent to coverage" that the insured provide notice of claim "as soon as practicable…but in no event later than ninety (90) days after such claim is made." The amended provision required "as a condition precedent" to coverage that the insured provide "notice, in writing, as soon as practicable of any claim first made against [the insureds] during the Policy Period, or Discovery Period (if applicable) but in no event later than ninety (90) days after the expiration of the Policy Period, or Discovery Period."

On November 28, 2001, FlashNet was named as a defendant in a securities class action lawsuit that was one of the many IPO laddering cases. Prodigy was served with a copy of the complaint on June 20, 2002.

Prodigy first communicated with the insurer by letter dated June 6, 2003, in which Prodigy sought the insurer’s consent under the policy to settlement of the securities case. The insurer responded that the June 6 letter failed to comply with the policy’s notice requirements. In reply, Prodigy sent a formal notice of claim on June26, 2003, which Prodigy claimed was timely because it was sent within ninety days of the May 31, 2003 expiration of the 3-year discovery period. The carrier denied coverage and Prodigy initiated an action seeking a judicial declaration of coverage.

Proceedings Below

The trial court ruled that Prodigy had failed to comply with the condition precedent to coverage and that this failure "avoids coverage, with or without prejudice to [the insurer]." The court of appeals affirmed, holding among other things that notice given almost one year after the lawsuit was filed was not "as soon as practicable," and that the insurer was not required to proved that it was prejudiced.

The Majority’s Opinion

Chief Justice Wallace B. Jefferson’s opinion for the majority framed the question before the court as "whether, under a claims made policy, an insurer can deny coverage based on its insured’s alleged failure to comply with a policy provision requiring that notice of claim be given ‘as soon as practicable’ when (1) notice of claim was provided before the reporting deadline specified in the policy; and (2) the insurer was not prejudiced by the delay."

The majority did not consider it determinative that notice as "as soon as practicable" was identified in the policy as a "condition precedent" to coverage. Rather, the Chief Justice wrote, in order to determine whether or not a showing of prejudice is or is not also required in order for the insurer to assert late notice as a defense to coverage, the question is whether the "notice as soon as practicable" language was "an essential part of the bargained-for exchange in the claims made policy at issue."

After reviewing the role of the notice provisions within claims made policies generally, the Chief Justice concluded that the insured’s obligation to provide notice "as soon as practicable" was "not a material part of the bargained-for exchange," and further concluded that "in a claims-made policy, when an insured gives notice of a claim within the policy period or other specified reporting period, the insurer must show that the insured’s noncompliance with the policy’s ‘as soon as practicable’ notice provision prejudiced the insurer before it may deny coverage."

Therefore, because the insurer had admitted that it was not prejudiced by the delay in receiving notice, the majority held that the insurer could not deny coverage based on Prodigy’s failure to provide notice as soon as practicable.

The Dissenting Opinion

The dissenting opinion, written by Justice Phil Johnson and joined in by two other justices, asserted that "today the Court rewrites an unambiguous insurance contract and changes the agreement of the parties." Justice Johnson wrote that "the record does not show as a matter of law that the notice language was not essential to the parties’ agreement," adding that "the Court’s conclusion otherwise is in derogation of the parties’ intent as expressed by the policy language."

Justice Johnson added that "there is no basis in the record for concluding that Prodigy’s one-year delay in reporting the claim was any more or less important to [the insurer’s] insurance business than if Prodigy had delayed for a year reporting a claim made on the last day of the Discovery Period."

Discussion

If nothing else, the majority opinion in this case confirms the frequent observation that courts disfavor insurance coverage denials based on late notice defenses. The general reluctance of courts to recognize notice defenses is based on an apparent perception that a policy notice requirement can operate like a "gotcha" to cut insureds off from the policy coverage for which they paid and to which they would have been entitled if notice were timely – and if the carrier is not prejudiced by the late notice, well then, no harm, no foul, right?

But even allowing for these assumed biases, the majority’s opinion’s disregard of the policy’s explicit "condition precedent" language and its own determination that the "as soon as practicable" language was "not a material part of the bargained for exchange" are both discomfiting.

Some perspective seems in order here. Not only was Prodigy’s notice to the insurer delayed by nearly a year, but Prodigy’s first contact with the insurer was a request for settlement consent. At some level, these facts exemplify the very kinds of circumstances to which insurers will sometimes refer in attempting to explain why notice provisions are necessary.

It may well be objected that if the insurer was not prejudiced by the delay here, what difference did the one-year delay really make? The typical insurer answer to this question is that they don’t want to get caught up in sometimes complicated and potentially fraught debates about whether or not a delay prejudiced their interests. After all, what really constitutes prejudice? What has to shown to establish prejudice? Rather than having to debate these kinds of fact intensive and divisive issues, the insurers prefer certain bright line tests that specify the minimal requirements under certain circumstances.

On the other hand, the policy language itself may have preordained a policyholder friendly outcome here. The notice provision the court was interpreting had in fact been amended to make it more policyholder friendly, by substituting the more flexible "as soon as practicable language" for the policy’s base form requirement of notice within a specified number of days.

The question is whether the majority opinion’s ruling represents more of a policyholder friendly outcome than the insurers may have thought they were offering with the more flexible language – an outcome that may in the future constrain the insurers’ willingness to offer the flexible language and encourage them to insist on more rigid alternatives as reaction to this kind of outcome. A more rigid approach could in turn lead to more questions about the timeliness of notice and potentially to more coverage disputes.

All of that said, and knowing full well how devastating any coverage denial can be to policyholders, and how some clerical or administrative error potentially could produce notice problems that otherwise might leave policyholders in the lurch, there arguably is some fundamental fairness to the judicial system’s chronic suspicion of notice defenses. Viewed in that light, the outcome in the Prodigy case is at least understandable, even if the majority opinion itself could be unsettling in certain respects.

Special thanks to the several readers who provided me with copies of the Prodigy opinion.

• Print
• Comments
• Trackbacks
• Share Link