Under the so-called “notice-prejudice Rule” applicable in some jurisdictions, insurers can deny coverage for claims based on the policyholder’s late provision of notice of claim only in the event that the late notice materially prejudiced the insurer. In a recent decision, the California Supreme Court, ruling on questions certified to the Court from the Ninth Circuit, held that the notice-prejudice rule represents a “fundamental public policy” under California law potentially sufficient to override the choice of law provision in the parties’ insurance contract. The Court also held that the notice-prejudice rule also applies to the consent to incur expense provisions in first-party insurance policies. As discussed below, there are a number of interesting aspects to the court’s ruling. The California Supreme Court’s August 29, 2019 decision in Pitzer College v. Indian Harbor Insurance Company can be found here.
Pitzer College discovered contaminated soil on a location on which it had planned to build a dormitory. The College undertook site remediation work in March 2011, which it successfully completed one month later at a total cost of $2 million.
The College maintained an environmental remediation insurance policy. However, the College did not obtain the insurer’s consent before commencing remediation or paying the remediation costs. Indeed, the College did not inform the insurer of the remediation until July 2011, three months after the remediation was completed and six months after the College detected the contamination.
The insurer denied coverage for the college’s remediation costs based on the College’s failure to provide timely notice of claim and failure to obtain the insurer’s consent for the remediation costs. The College initiated an action for declaratory relief and for breach of contract. The insurer filed a motion for summary judgment, which the district court granted.
The district court, applying New York law in light of the choice of law provision in the college’s insurance policy, held that summary judgment was warranted because the College did not provide timely notice of claim. The district court held that under New York law the insurer did not have to show that it was prejudiced by the late notice. The district court also held that summary judgment was separately warranted because the college did not comply with the Policy’s consent provisions before incurring the remediation expenses. The College appealed the district court’s ruling.
On appeal, the College argued under relevant choice of law principles that because the notice-prejudice rule represents a “fundamental public policy” in California that the district court should have applied California law to the late notice issue, rather than New York law, notwithstanding the provision in the policy designating the law of New York law to be applied to policy interpretation.
The August 29, 2019 Opinion
In an August 29, 2019 Opinion written by Justice Ming Chin for a unanimous court, the California Supreme Court ruled, “in line with California’s strong preference to avoid technical forfeitures of insurance policy coverage,” that the state’s notice-prejudice rule is a “fundamental public policy,” and that the notice prejudice rule applies to consent provisions in the context of first party liability coverage.
In reaching these determinations, the Court first noted that under applicable choice of law principles, the parties’ contractual choice of law provision generally governs unless it conflicts with the state’s fundamental public policy and the state has a materially greater interest in the determination of the issue than the contractually chosen state.
The Court then noted that California’s notice prejudice rule requires an insurer to prove that the insured’s law notice of a claim “has substantially prejudiced the ability to investigation and negotiate payment of the insured’s claim.”
In considering the question of whether the notice prejudice rule represents a fundamental California public policy, the Court considered the three reasons for establishing the rule.
First, the rule overrules the parties express intentions in a defined notice term, “preventing a technical forfeiture of insurance benefits unless the insurer can show that it was prejudiced by the insured’s late notice.”
Second, the notice prejudice rule “protects insureds against inequitable results that are generated by insurers’ superior bargaining power.”
Third, the rule “promotes objectives that are in the general public’s interest because it protects the public from bearing the costs of harm that an insurance policy purports to cover.”
Based on these considerations, the Court concluded that California’s notice-prejudice rule is “a fundamental public policy of California,” because the notice requirement “serves to protect insurers from prejudice, not to shield them from their contractual obligations through a technical escape-hatch.”
But while the Court concluded that the notice-prejudice rule represents a fundamental California public policy, the question under applicable choice of law principles as to whether or not the California notice-prejudice rule applies depends on the determination of the further question of whether or not California has a “materially greater interest” than New York in determining the coverage issue. The California court left it to the Ninth Circuit (and presumably to the district court) to determine which state has the materially greater interest, in order to conclude whether California rather than New York law applied.
In determining, under the second question certified by the Ninth Circuit, whether the notice-prejudice rule applies to the policy’s consent provisions, the California court first noted that the same rationale for the application of the notice-prejudice rule to the policy’s notice provisions apply to the policy’s consent provisions. The Court observed that “at core,” the “purposes” of the consent provisions are the same as with respect to the notice provisions; they both “facilitate the insurer’s primary duties under the contract and speaking to minimizing prejudice in performing those duties.”
In considering these issues, the Court drew a distinction between first-party insurance policies and third-party insurance policies. The Court noted that because of third-party insurer’s right to control the defense and settlement of claims, California’s appellate courts have generally refused to find the notice-prejudice rule applicable to consent provisions in third-party policies. By contrast, in first party policies, the insurer’s duty to defend and settle claims is not crucial to the insurer’s coverage obligation, and the insurer does not exercise the same contractual control over the potential loss.
For these reasons, the Court said, “failure to obtain consent in the first party context is not inherently prejudicial, and the usual logic of the notice-prejudice rule should control.” The Court held that the notice-prejudice rule is applicable to a consent provision in a first-party policy “where the coverage does not depend on the existence of a third party claim or potential claim.”
However, the parties disagreed whether the policy involved in this dispute provides first-party coverage or third-party coverage. The Court said that the resolution of this question is beyond the scope of the questions certified by the Ninth Circuit, and therefor the Court left it to the Ninth Circuit to determine what type of policy is at issue.
While the California Supreme Court’s determinations on the certified questions unquestionably are beneficial to the interests of policyholders, it remains to be seen whether or not Pitzer College ultimately will benefit from the Court’s determinations.
On the late notice issue, the College will be able to rely on California’s notice-prejudice rule only if it is able to show in subsequent proceedings that California has a “materially greater interest” than New York in the determination of the issue.
On the consent to incur expenses issue, the College will be able to argue that the notice-prejudice rule applies only if it is able to establish in subsequent proceedings that the policy at issue is a first-party policy rather than a third-party policy.
And of course, even if the college establishes that the notice-prejudice rule applies to these issues, the college will only prevail if it is established that the late notice and failure to obtain consent did not prejudice the insurer’s interests.
Just the same, the California Supreme Court’s determinations will be useful to other policyholders. First and foremost, the California Court’s determination that the notice-prejudice rule represents a “fundamental public policy” of the state underscores the significance of notice-prejudice principles, which should add weight to the policyholder’s arguments opposing insurer’s efforts to try to deny coverage based on the alleged late provision of notice of claim.
The California Court’s determinations of the certified questions are also helpful for policyholders opposing late notice defenses because of what the Court said about the reasons for the notice-prejudice rule under California law. The rule, the Court said, is consistent with the state’s “strong preference to avoid technical forfeitures of insurance policy coverage.” This preference under state law to avoid forfeitures represents a substantial basis on which to oppose late notice defenses and other procedural defenses to policy coverage.
That said, there are also limitations on the usefulness to policyholders of the California Court’s determinations on the certified questions. For example, the California Court’s determination that the notice-prejudice rule applies to the policy’s consent provisions is limited with respect to first party policies only; this aspect of the Court’s determinations would not be helpful to policyholders seeking coverage under third-party liability policies.
There is a further aspect of the Court’s analysis that I think is worth further consideration. That is, that the Court’s determinations on the notice of claim issue in effect holds that the importance of the notice-prejudice rule under California law is sufficient that it could in effect override the choice of law provisions in the policy.
As a general matter, I am not a big fan of extra-contractual principles that negate bargained-for provisions in parties’ insurance contracts. On the other hand, I have also recognized that applicable legal principles are of course incorporated into all contracts. My concern about the application of these general principles is usually couched in terms that if these principles are going to be applied to override express policy provisions, the principles should be narrowly applied.
In that regard, I think it is noteworthy that the California Supreme Court ultimately did not determine that the fundamental California public policy regarding the notice prejudice rule overrode the choice of law provision in the parties’ contract; indeed, with respect to both certified questions, the Court said that there are still remaining issues of fact (or perhaps mixed issues of fact and law) that need to be determined in order to conclude whether or not the notice prejudice rule did or did not in fact apply to either the notice of claim issue or the consent issue.
There are two other considerations that are worth addressing whenever late notice and notice-prejudice issues come up. First, while there are considerations on which policyholders can seek to rely to try to argue that their late provision of notice should not preclude issue, the more important point is that well-advised policyholders will seek to implement procedures and practices to try to avoid the late provision of notice in the first place. Second, it is increasingly common at least in the D&O insurance context for provisions to be incorporated directly into the policy specifying that the insurer will not seek to deny coverage based on the late provision of notice unless the insurer can show that the late notices caused the insurer material prejudice. Both of these considerations represent important means by which policyholder can try to protect themselves from the kinds of conflicts that this insurance dispute represents.
I know for many readers, issues relating to choice of law principles can seem obscure. However, as I have noted in recent posts (for example, here), the court’s determination of which jurisdiction’s law applies can be outcome determinative. In addition, the authors of a recent guest post criticized the Delaware courts for asserting that their state’s laws apply to coverage disputes to which traditional choice of law principles arguably would have suggested that the laws of a different jurisdiction can apply. The fact is that while choice of law issues may seem obscure, they can prove to be very important in the context of insurance coverage disputes.
The obvious remedy to address the possibility of disputes over the choice of law applicable to insurance policy coverage questions is for the parties to the policy to include a choice of law provision in their policy. As this insurance coverage dispute shows, there may be limitations to how much parties may be able to accomplish by including a choice of law provision. As I alluded to above, there is a larger dispute here about whether, when, and to what extent extra-contractual legal principles should override expressly bargained-for policy provisions.