One of the frequently recurring D&O insurance coverage issues is the question of whether or not the policyholder provided its insurer with timely notice of claim as required under the policy. This past week several readers sent me a copy of a recent decision in which a federal court denied coverage under a homeowners’ association’s D&O insurance policy because of the association’s untimely notice of claim. In light of the policy language involved, the facts at issue, and the court’s analysis, the court’s decision arguably is unremarkable. However, I found that after I read the decision, I couldn’t stop thinking about what the coverage denial meant for the homeowners’ association and its members. This in turn caused me to reflect upon the problems with late notice coverage disputes in general. After a brief discussion of the recent decision, I have set out below my thoughts about notice defenses.
The decision that triggered these thoughts was Central District of California Judge Jesus G. Bernal’s January 7, 2016 ruling in the coverage action brought by The Citrus Course Homeowners Association (HOA) against its D&O insurer. A copy of Judge Bernal’s decision can be found here.
Background
The HOA was sued on April 13, 2011 in an action in Riverside County Superior Court by Citrus El Dorado LLC (the “El Dorado Action”). El Dorado had been developing homes on property that HOA had annexed. El Dorado ran into financing difficulties and stopped paying its assessments to the HOA. The HOA commenced a foreclosure action against El Dorado. El Dorado initiated its Superior Court action to enjoin the foreclosure action and seeking declaratory relief against the initiation of foreclosure sales. The HOA appeared in the El Dorado action on April 21, 2011 to oppose El Dorado’s application for a TRO. On May 19, 2011, El Dorado filed an amended complaint, which added causes of action against the HOA for breach of contract, unjust enrichment, and conversion.
The HOA had D&O insurance three annual policy periods between 2009 and 2011. The 2010-2011 policy ran from May 19, 2010 to May 19, 2011. The 2011-2012 policy ran from May 19, 2011 to May 19, 2012. On March 8, 2012, during the third of three policy periods, the HOA tendered the El Dorado Action to the D&O insurer.
The D&O insurer rejected the tender, contending that the underlying claim had first been made during the period of the 2010-2011 policy, but that the policyholder had not provided notice of the claim within ninety days of the 2010-2011 policy’s expiration, as required in the policy. The HOA initiated an action against the insurer seeking coverage under the policy.
The underlying El Dorado Action remains pending. As of the date of Judge Bernal’s order, the HOA had incurred legal fees of approximately $414,000 in defending the action. Further future costs are expected.
Among other things, the D&O insurance policy at issue provides that:
The Insureds shall, as a condition precedent of their rights under the Policy, give the Insurer notice in writing of any claim made, as soon as practicable from the date the Chairman, President, Executive Director, Chief Financial Officers, General Counsel or equivalent has knowledge of the Claim, and in no event later than ninety (90) days after the end of the Policy.
The policy also provides that
More than one Claim involving the same Wrongful Act or Related Wrongful Acts of one or more Insureds shall be considered a single claim, and only on Retention shall be applicable to such a single Claim. All such Claims, constituting a single Claim, shall be deemed to have been made on the earlier of the following dates: (1) the earliest date on which any such Claim was made; or (2) the earliest date on which any such Wrongful Act or Related Wrongful Act was reported under this Policy or and other policy providing similar coverage.
.
Finally, the Policy also provided that
This policy does not apply to any claim made against any Insured:
…
For any actual or alleged liability of any Insured under any contract or agreement, express or implied, written or oral; provided however this exclusion shall not apply to : (1) Costs of Defense…
.
The January 7 Opinion
In his January 7 opinion, Judge Bernal found that the HOA was aware of the El Dorado action at least as of April 29, 2011, when the HOA appeared in the El Dorado Action. This date, Judge Bernal noted, was within the policy period of the 2010-2011 policy. Though the amended complaint was not filed until May 19, 2011, the first day of the 2011-2012 policy, Judge Bernal found that the amended complaint related to essentially the same set of facts – the same property, the same parties, and the same alleged misconduct – as the initial complaint. Judge Bernal also noted that though the initial complaint was considerably shorter, both complaints allege that the HOA breached the property annexation agreement with El Dorado, which allegedly caused El Dorado damages. Accordingly, Judge Bernal concluded that the Amended Complaint is deemed first made at the date the HOA became aware of the initial complaint, April 29, 2011, during the policy period of the 2010-2011 policy.
The policy’s notice provision requires that notice must be provided within 90 days of the policy’s expiration. The policy period of the 2010-2011 policy expired May 19, 2011, meaning that notice under the policy was due by August 17, 2011. However, Judge Bernal found, the HOA did not tender notice to the insurer until March 8, 2012, almost seven months later. Accordingly, Judge Bernal concluded that the HOA did not provide timely notice of claim as required under the policy, and therefore that the El Dorado action is not covered under the 2010-2011 policy.
Judge Bernal rejected the HOA’s argument that the El Dorado action was not first made under the 2010-2011 policy because it was not a covered claim under the 2010-2011 policy. In making this argument, the HOA contended that the initial complaint was basically a contract action, which was precluded from coverage under the policy’s contractual liability exclusion. Judge Bernal noted that even if this were true, the policy’s contractual liability exclusion does not apply to defense expenses, which is in fact the sole type of damages that the plaintiff sought to recover in the coverage action.
Finally, Judge Bernal also rejected the HOA’s argument that the court should “utilize equity to prevent a forfeiture.” Judge Bernal rejected the case authority on which the HOA sought to rely in making this argument, noting that though the policy gave the insureds 90 days after the expiration of the policy period to provide notice, the HOA did not even report the claim until almost seven months after this “grace period.” The Court, Judge Bernal said, “finds this delay of over eight months inexcusable and as such declines to equitably excuse the conditions precedent to coverage.”
Discussion
I want to emphasize at the outset that I am not finding fault with the insurer’s position here. In light of the facts and the policy language, I would have expected the insurer to take the position it took here. If I had been counsel for the insurer, I would have advised the insurer to take the position it took. If I had been the insurer, I would have taken the same position the insurer took here.
And yet I found that after I read this decision, I couldn’t stop thinking about it. For starters, there is the fact that the policyholder, an association of homeowners, is now on the hook for the over $410,000 the association has already incurred in defending the El Dorado action, with more fees yet to come. I presume the only way the association will be able to pay these fees is through an assessment of its members. Regardless of how you feel about Judge Bernal’s decision on the merits, it has to be said that the denial of coverage works a hardship on these homeowners.
There is another thing that bothers me about the outcome here, and that is the fact that the carrier was on this risk throughout the entire relevant period — when the underlying lawsuit was first filed, when the amended complaint was filed, and when the notice of claim was sent. This isn’t a case where the coverage has moved to a different carrier between the policy period when Judge Bernal determined the claim was first made and the policy period when notice was provided. The carrier had been provided with a series of three annual premiums to provide coverage to protect against the kind of lawsuit involved here.
There is no suggestion that the purported late notice in any way prejudiced the carrier. Indeed, the issue of prejudice from the late notice does not appear to have been involved in this dispute, undoubtedly because California is among the states that generally hold that the notice-prejudice rule does not apply to claims-made insurance policies. (The notice prejudice rule precludes insurers from asserting late notice as a coverage defense unless the late notice has prejudiced the insurer).
I think this may be the kind of case that justifies the exception to the rule about the notice-prejudice rule not applying to claims-made policies. As discussed here, some states allow the notice prejudice rule to apply to claim-made policies where (as in this case) (a) the underlying claim was made during the term of one policy, (b) the insured was thereafter continuously insured under renewals of that policy and (c) the insured provided notice during one of those renewal terms. Were these principles to be applied here, the insurer would have been able to deny coverage in this case (and thereby work a hardship on the homeowners) only if it could have shown that the HOA’s delay in providing notice prejudiced the insurer.
Beyond these legal arguments, I think the circumstances in this case also underscore the merits of the inclusion in the policy’s notice provisions of a verbal formulation that is currently becoming popular in certain management liability insurance policies. As discussed in detail in a recent guest blog post on this site by my good friend Joe Monteleone (here), the notice provisions of some D&O policies recently have been revised to include language along these lines:
If the Insured fails to provide notice of such Claim to the Insurer as required under this Section, the Insurer shall not be entitled to deny coverage for the Claim based solely upon late notice unless the Insurer can demonstrate that its interests were materially prejudiced by reason of such late notice.
For reasons he details in his guest blog post, Joe is not necessarily a fan of the inclusion of this language. However, I think a case like this one shows why the inclusion of this kind of language could provide a way to try to balance out the equities a little bit more and perhaps ameliorate the hardships that can arise when the late provision of notice results in coverage preclusion. The inclusion of this language would certainly eliminate the dispute about whether or not the notice prejudice rule applies in the context of claims-made policies. (I should hasten to add that this language has only relatively recently become available in the marketplace, and even still it is far from universally available. At the time the homeowners’ association’s coverage was placed, these kinds of provisions were not generally available in the marketplace.)
There is a particular reason why I am bleating on and on about the late notice issues. It has to do with the fact after spending more than two decades in the early part of my career on the carrier side of the aisle, I have spent the last ten years on the policyholder side. Based on those last ten years, I am here to tell you this: late notice happens. Delayed notice is provided to insurers all the time. Delays in providing notice happen for all sorts of reasons or for no reason at all. Usually the delay arises because the person within the organization who knows about the lawsuit is not the same person within the organization who knows about the organization’s insurance. In this case, it wouldn’t surprise me to find out that at the point where these homeowners got tangled up in a foreclosure dispute with El Dorado, it simply didn’t occur to any of them that their insurance would be relevant to the dispute. Indeed, even when El Dorado filed its action to try to defeat the foreclosure action, it simply didn’t occur to anybody that it was a dispute to which its insurance would be relevant.
With all due respect to Judge Bernal, I have am not as persuaded as he is that the late notice here fairly can be characterized as “inexcusable.” If I were to characterize the delay in providing notice that occurred here, I would describe it as “normal” or “par for the course” or “basically, just the kind of thing that happens when any process requires the involvement of people.”
To be sure, the provision of notice of claim is a “condition precedent” to coverage. As I have noted elsewhere, policyholders as well as insurers have duties under the insurance policy. Policyholders should be diligent both in protecting their interests and in fulfilling their duties under their policies. But in simple recognition that the delayed provision of notice is a regular occurrence, the inclusion in the policy of the kind of “prejudice required” language that I discussed above would ensure that the policy’s notice provisions are not enforced in a way that works a hardship on the policyholders and could help to ensure that the notice provisions are enforced consistently with the balance of the equities.
Special thanks to the several loyal readers who sent me a copy of Judge Bernal’s opinion.