One of the recurring battles in the continuing wars about whether or not a policyholder’s late provision of notice of claim precludes coverage is the question whether or not the “notice prejudice” rule applies. The notice prejudice rule specifies that the insurer can assert late notice as a coverage defense only if the delayed notice prejudiced the insurer. But if the notice prejudice rule applies, what constitutes “prejudice”? In an April 14, 2016 decision (here), the Fourth Circuit, applying Maryland law, addressed this issue and held that where the policyholder did not provide notice until after a $98.5 million default judgment had been entered in the underlying claim, the insurer was prejudiced and coverage under the policy was precluded. As discussed below, the ruling raises a number of interesting questions and also has wording implications for policy notice provisions.
Background
On June 11, 2008, Amiel Cueto, a disbarred lawyer and convicted felon, acting pro se, filed a lawsuit in Illinois state court alleging that American Bank and ten other banks had improperly failed to fund a real estate venture, causing the deal to collapse.
On June 18, 2008, the complaint and summons were served on CT Corporation as the agent of American Bank for receiving service of process in Maryland. CT transmitted the papers to American Bank’s CFO. However, at that time, American Bank’s CFO had left employment at the bank. Another bank officer later found the complaint and, in late July, forwarded the complaint to the bank’s outside lawyer, who claims he never received the complaint. American Bank failed to respond to Cueto’s complaint. On July 23, 2008, Cueto obtained a default judgment against American Bank of approximately $98.5 million (inclusive of interest and attorney’s fees).
More than six months later, Cueto began efforts to collect on the judgment. American Bank received Cueto’s judgment collection papers on February 13, 2009. The bank provided notice of these proceedings to its insurer, through its broker. The insurer first received notice of the various proceedings on February 25, 2009, approximately eight months after the complaint had first been served on the CT Corporation.
American Bank subsequently was successful in having the default judgment lifted. (Among other things, the bank was able to argue that it not only had nothing to do with Cueto’s transaction, but that it conducted no business in Illinois, thus the Illinois court lacked personal jurisdiction over the bank.) However, the bank incurred costs of approximately $1.8 million in its efforts to resist the default judgment and to have the judgment set aside.
American Bank sought to have its management liability insurer reimburse it for the $1.8 million it incurred in connection with Cueto’s lawsuit and judgment. Its insurer denied coverage for the costs, arguing that the bank had not provided timely notice of claim as required under the policy. The bank contended that it had provided notice of claim as soon as it had actual knowledge of the lawsuit, so it had provided notice to the insurer “as soon as practicable,” as required by the policy. It also argued that in its initial communications regarding the matter the insurer, through its claim representative’s statements, had waived the late notice defense.
The insurer filed an action in federal court seeking a judicial declaration that there was no coverage for the claim under the policy. The bank filed a counterclaim seeking a declaration that the defense costs it incurred were covered. The parties filed cross-motions for summary judgment. The district court granted the insurer’s summary judgment motion and denied the bank’s motion. The bank appealed.
The notice provision in the policy provides that:
The Insureds shall, as a condition precedent to their rights under this Policy, give to the Insurer written notice of any Claim made against the Insureds as soon as practicable, but in no event later than: (a) sixty (60) days after the expiration of the Policy Year in which the Claim was first made.
The April 14 Opinion
In an April 14, 2016 opinion written by Judge Paul V. Niemeyer for a unanimous three-judge panel, the Fourth Circuit, applying Maryland law, affirmed the district court’s grant of summary judgment for the insurer. The Fourth Circuit confirmed the district court’s ruling that the bank had provided late notice of Cueto’s suit and that the insurer had suffered prejudice as a result.
The appellate court first rejected the bank’s argument that because it had supplied the insurer with notice as soon as it had actual knowledge of the claim, it had satisfied the policy’s notice requirements. The court noted that the term “actual knowledge” does not appear in the policy, but that the policy did define the term “Claim” to mean, as relevant here, “a civil proceeding against any Insured person commenced by the service of a complaint or similar pleading. “ Thus, the court said, the “requirement to give notice is triggered not by ‘actual knowledge’ of the claim, but by ‘service of a complaint’ upon an Insured.”
Moreover, the court said, while the policy does not include the words “actual knowledge,” by operation of relevant principles of Maryland agency law, the bank had actual knowledge of the complaint on June 18, 2008, the day the complaint was served on the CT Corporation, its designated agent for receipt of service of process.
The bank sought to avoid the implications of this conclusion by arguing that it was not “effectively served” because, owing to the departure of its CFO, “the suit papers were not routed internally so as to get promptly into the hands of its counsel.” As the district court put it, “through a variety of screw-ups, significant suit papers that should have gotten immediate attention didn’t.” But, the appellate court said, “corporate screw-ups” provide no basis to excuse the bank’s failure to provide timely notice after it was validly served with process.
Having concluded that the bank did not provide notice of claim “as soon as practicable” as required under the policy, the court then turned to the question of whether or not the late notice resulted in “actual prejudice” to the insurer. Maryland Code Section 19-110 provides that an insurer may not rely on the late provision of notice of claim as a defense to coverage unless it can “establish by a preponderance of evidence that the lack of … notice has resulted in actual prejudice to [it].”
The appellate court concluded that the bank’s late provision of notice had resulted in actual prejudice to the insurer. Among other things, the court noted that the bank’s late notice had prevented the insurer the opportunity to participate in the selection of counsel, to speak with counsel, and to discuss credible defense strategies for dismissing Cueto’s suit (including in particular the Illinois court’s lack of personal jurisdiction over the bank). The late notice had denied the insurer the opportunity to involve itself in considering the possibility of settlement negotiations with Cueto prior to entry of the default judgment and prior to the expenditure of $1.8 million incurred to vacate the judgment. In summing up its conclusion on the question of “actual prejudice,” the court said:
When a late notice precludes an insurer from exercising meaningful contractual rights provided to it by the policy – in this case, all contractual rights – we agree with the district court that the insurer had suffered actual prejudice.
Finally, the appellate court rejected the bank’s argument that the insurer had waived its right to assert the late notice. The bank had argued that the statement by the insurer’s claims adjuster to the bank’s in-house counsel, in the days immediately after the notice of claim had been provided to the insurer, that the policy provided coverage for the claim constituted an affirmation of coverage and waiver of the notice defense that bound the insurer. The court concluded that there was nothing on the record to suggest an intention waiver by the insurer of its late-notice defense. Indeed, the record showed there was no discussion of notice issues at all in the conversation on which the bank relied, whereas in contemporaneous written communications, the insurer had indicated its intent to preserve its rights to assert the late notice defense.
Discussion
In numerous posts on this blog (most recently here), I have argued in favor of the rights of policyholders to be able to continue to seek coverage under their policies even where the policyholder has provided late notice of claim to its insurer. As I have often noted, late notice happens frequently, for many reasons, or for no reason at all. In making this argument, I have contended that the insurer ought not to be able to assert the late notice when the late provision of notice did not prejudice it in any way.
Obviously, this argument loses its persuasiveness where the insurer can argue that it was in fact prejudiced by the late provision of notice. It was never going to be an easy argument for the bank here to argue that its late provision of notice should be overlooked when a default judgment of $98.5 million had already been entered before the bank got around to providing its insurer with notice of claim.
The circumstances of this claim represent something of a cautionary tale. Owing to the departure of its CFO and through a series of internal errors – what the district court called “corporate screw-ups” – the bank itself failed to become aware of a potentially serious legal matter. At one level, we can all understand how these kinds of things might happen. On the other hand, the absence of appropriate internal procedures to protect against these kinds of things happening has serious consequences, for the company and for others.
As I emphasized in my series of essays about D&O insurance fundamentals, both parties to the D&O insurance contract have duties under the policy. All D&O insurance policies specify as a condition to coverage that the policyholder must provide notice of claim within the time provisions required under the policy. As this case underscores, it is no excuse to the timely provision of notice of claim that the policyholder does not have internal procedures designed to ensure the timely notice of claim to the insurer.
Just the same, the assertion of a notice defense can work a significant hardship on policyholders. I started my career on the insurer side, as outside counsel and then later as the head of an insurance underwriting facility, but I have spent the last ten years on the policyholder side. Based on a decade on the side of the policyholders, I can tell you that late notice happens. It is a frequently recurring phenomenon, and a recurring problem for policyholders seeking to secure the rights under their insurance policies for which they have paid. Because late notice is routine, I favor a number of revisions to policy notice provisions that protect policyholder from forfeiture of their insurance coverage.
The first of these revisions is to amend the policy’s notice provisions to provide that the policyholder’s duty to provide notice of claim to the insurer is not triggered until one of a short list of specified officers (typically, the CEO, CFO, General Counsel, or Risk Manager) becomes aware of the claim. This kind of provision, which embodies the kind of “actual knowledge” principle on which the bank had sought to rely here, provides policyholders some protection in the circumstances in which its senior managers are not even aware that they need to be taking steps to protect their company’s interests. Indeed, had the policy at issue here included this kind of “top officers’ awareness” provision, the bank might well have been able to preserve coverage under the policy and avoid the judicial determination that coverage was precluded. (I hasten to add that this kind of revision to policy notice provisions was not generally available in the marketplace at the time the bank’s policy was placed.)
The second of these revisions, a policy term that only recently has come into vogue, is a provision incorporating the “notice prejudice” rule directly into the notice terms. This revision includes 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.
This provision would at least eliminate the frequently recurring argument usually raised with respect to claims made insurance policies about whether the notice prejudice rule applies. The provision would make it clear that the insurer could not assert late notice as a defense unless it was able to demonstrate that the late provision of notice had actually prejudiced the insurer.
Of course, even if the policy at issue here had included this kind of provision, it would not have preserved coverage for the bank. As the district court found and the appellate court affirmed, the insurer here was able to demonstrate that, where it did not learn of the claim until after a $98.5 default judgment against the policyholder, its had suffered actual prejudice under the policy. As the appellate court said, where as here the policyholder’s late provision of notice precluded the insurer from “exercising meaningful contractual rights provided it by the policy – in this case, all the contractual rights,” then the insurer can demonstrate actual prejudice sufficient to relieve it of its obligations under the policy.
The question is whether the late provision of notice prevented the insurer from exercising its right under the policy. While that might have been the case here, I still contend that in the absence of this kind of impact on the insurer’s rights under the policy, the insurer’s reliance on late notice as a defense to coverage is not appropriate, as it operates as a forfeiture of coverage that is not warranted or justified.
A Preview of Coming Attractions: One of my most successful ventures over the long period that I have maintained this blog was the D&O Diary Mug extravaganza. Readers may recall that I offered free to anyone who wanted one a coffee mug with this blog’s logo, on the condition that the recipient would send back a picture of the mug and a description of the circumstances under which the picture was taken. This arrangement was a huge success, as witnessed by the many great pictures I received back from readers (refer here for a list of the mug shot posts).
In just a few weeks, this blog will be celebrating its tenth anniversary. With the milestone anniversary coming up, I thought it would be appropriate to do something to memorialize the event, something along the lines of what I did with the D&O Diary mugs. As tempting as it was to do another round of mugs, in the end I decided against it. Not just because it had been done before, but also because, despite our best efforts, so many of the mugs were damaged in shipment. I decided that this time I need to try something a little less prone to accident.
Here at The D&O Diary, we are all about spin control. So to celebrate the blog’s tenth anniversary, instead of coffee mugs, we will be distributing D&O Diary frisbees. The frisbees seem like they would be a less susceptible to damage in transit. Also, they look really cool.
So the deal will be the same – I will send you a D&O Diary tenth anniversary frisbee on the condition that you send back a picture of the frisbee and a description of the circumstances in which the picture was taken. For example, in the picture in the first paragraph of this section, I am holding the frisbee prototype at Horseshoe Lake in Shaker Heights, Ohio. I took the picture last Friday (April 15, 2016). It was a beautiful afternoon, but what was most amazing about the scene was the fact that just a week before, the same location had been blanketed in about six inches of snow.
Don’t send in your frisbee requests yet, though. I am not yet ready to process requests, and so I won’t start accepting frisbee requests until after the blog’s tenth anniversary in early May.
So keep your eyes open for the official announcement of the D&O Diary frisbee offer, in early May. And start thinking now about where you will take your picture of the frisbee.
A Final Note: If you are a cold-blooded animal and you live a place like Northeast Ohio, with its long cold winters, there is nothing better than a day of warm sunshine in April. Come to think of it, that is pretty much true for us warm-blooded animals, too.
