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.