Commentary and analysis on the
law of insurance coverage
Author: Carl A. Salisbury
It is a fundamental principal of contract law that a claim for breach of a contract requires proof that the breach was “material.” Not just any old violation of a contract term will give rise to liability and damages. If I hire a contractor to build my house and a faucet in one of the bathrooms leaks, I don’t get to claim that he breached our contract. The leaking faucet is immaterial because it doesn’t go to the heart of the agreement. The contractor will have to fix the faucet, but I will still have to pay for the house. Likewise, the breach of a notice provision in an insurance policy is immaterial unless it adversely affects the insurer’s ability to perform its obligations under the contract.
New Jersey has always protected policyholders against nullification of their liability insurance coverage on the basis of a purported delay in providing notice of a claim unless the carrier can show that it was prejudiced by the delay. The phrase that appears most often in the notice provision of a liability policy is that the insured must bring a claim or suit to the attention of the carrier “as soon as practicable.” Strictly speaking, a violation of that requirement could occur on the very day — in fact, at the very minute — that a policyholder gets served with a complaint. The ordinary dictionary definition of the word “practicable” is “able to be done or put into practice successfully.” In most circumstances that one can imagine, a policyholder is “able” to forward a claim to her insurer on the same day that the complaint comes in. Except in rare cases, where the policyholder is indisposed in some way that prevents her from mailing a copy of the complaint for some period — such as while undergoing or recovering from surgery, for example — the strict enforcement of the provision requiring notice “as soon as practicable” would require a court to void coverage for any delay whatsoever following the minute or two after the insured was physically and mentally capable of putting the complaint into an envelope and dropping it in a mailbox.
The courts of New Jersey, especially, have always been particularly reluctant to nullify liability insurance coverage on the basis of late notice.
Courts have almost universally recognized that nullification of insurance coverage by such a strict interpretation of the notice provision of a policy would not only be absurd, it would violate public policy. It would give insurance companies a windfall in premiums without having to provide any bargained-for coverage in most cases, it would do violence to an insured’s reasonable expectations of protection, and it would harm a great many of the victims of insureds’ negligence, who would otherwise have a source of compensation for their injuries but for the occurrence of a harmless delay in letting the carrier know of a covered claim under the policy. This is why the courts of most states will never void coverage on the grounds of late notice unless the insurer can establish that it has been prejudiced in some way by the delay in receiving notice of a claim. This requirement essentially enforces the legal principle that an actionable breach of contract will lie only if the breach is material. An immaterial breach — that is, one that does no harm to the non-breaching party — will not justify either a claim for liability or the rescission of the contract.
The courts of New Jersey, especially, have always been particularly reluctant to nullify liability insurance coverage on the basis of late notice. In New Jersey, an insurer must show “appreciable prejudice” due to the delay in providing notice if it seeks to get out of coverage on late notice grounds. “Appreciable prejudice” has been interpreted to mean that a meritorious defense to the claim against the policyholder has been “irretrievably lost” in the period between when notice could have been provided and when it was actually provided. For example, “smoking gun” documents have been lost or destroyed, or witnesses with personal knowledge of exculpatory evidence have died, in the interim between the filing of the complaint against the insured and the notice the insured provided to the carrier. Under this standard, New Jersey courts have rejected an insurer’s late-notice defense even after judgment has been entered against the insured in the underlying case, so long as the carrier is capable of reconstructing the circumstances of the accident. This is the rule New Jersey courts followed from the time of the decision in Morales v. National Grange Mut. Ins. Co., 423 A.2d 325, 330 (N.J.Super. 1980) until June 2014, when the New Jersey Appellate Division decided the case Templo Fuente De Vida Corp. v. National Union Fire Ins. Co. of Pittsburgh, PA, Docket No. A-4516-12T1 (App. Div. June 6, 2014) (get a copy here).
The discussion thus far applies to the notice provisions of an “occurrence” liability policy. Coverage is triggered under such a policy by an “occurrence,” that is, by an accident that causes third-party bodily injury or property damage during the policy period. Sometimes, an injury-causing accident can occur in one policy period but the injury will not become manifest for many years later. Latent disease caused by the inhalation of asbestos is one example of this. In such a circumstance, the policyholder bargained for protection — and the insurer bargained to provide it — against claims that crop up years (sometimes even decades) after the negligence that caused the initial harm.
The same calculus does not apply to policies that are issued on a “claims-made” basis. Under a claims-made policy, coverage will apply only if a claim is both made against the policyholder and reported to the insurance company during the policy period. In other words, and in contrast to an “occurrence” policy, the insurer will never be responsible for providing coverage under a claims-made policy after the policy expires. New Jersey courts, and the courts of other states that have addressed the issue, have concluded that the notice provisions of a claims-made policy are enforceable and they do not require an insurer to show that it was prejudiced by notice of a claim that was provided after the expiration of the policy. If the claim against the insured comes in during the policy period and the carrier receives notice after the policy period, the carrier will have a valid and enforceable late-notice defense under a claims-made policy. The corollary, of course, is that the carrier will not have a late-notice defense as long as it receives notice of a claim during the policy period.
That is the bargain the carrier on a claims-made policy strikes with the policyholder: As long as both the claim and the notice of the claim occur during the policy period, it will not be denied on the basis of late notice. At the same time, the carrier’s exposure to liability will never extend beyond the end of the policy period. By setting the terms of the bargain in this way, the insurance industry has given rise to a reasonable expectation on the part of policyholders that their claims-made coverage will be available as long as notice is provided before the policy terminates. Viewing the value of the policy from the perspective of the insurer of claims-made coverage, providing notice of a claim before the end of the policy period is, without more, a material part of the bargain.
The record was utterly devoid of even a scintilla of evidence that the carrier was actually deprived of any negotiated right that was material to the obligations the parties had to one another.
The notice provision in Templo Fuente was a hybrid. The policy provided claims-made Directors’ and Officers’ liability coverage but the notice provision required the insured to notify the carrier of a claim not only during the policy period but also “as soon as practicable.” The policy period was January 1, 2006 to January 1, 2007. The complaint was served on the insured on February 21, 2006. The insured provided written notice of the complaint on August 28, 2006. Both the claim and the notice were well within the policy period. Nevertheless, the Appellate Division held that the six-month delay between the insured’s receipt of the complaint and the written notice to the insurer was not “as soon as practicable.” In addition, the court rejected the policyholder’s argument that the carrier should have to show that it was prejudiced by the six-month delay. It held, instead, that, since this was a claims-made policy, the “prejudice” standard that applies under “occurrence” coverage has “no application whatsoever” to claims-made coverage. When the New Jersey Supreme Court accepted certification of the appeal of this decision, most of us who practice insurance-coverage law, myself included, were quite certain that it did so to reverse the Appellate Division’s plainly incorrect holding. Most us, myself included, were wrong.
There were two reasons at the heart of the Supreme Court’s decision to affirm the Appellate Division’s ruling. (You’ll find a copy of the Supreme Court’s opinion here.) First, the court agreed with the carrier’s argument that the failure to provide notice as soon as practicable “deprives the insurer of its negotiated right to associate with the defense, and play a role in settlement if that occurs, thereby limiting the potential exposure of the insurer under the policy’s terms.” It is a very good question how that could have been the case here when there was no evidence that the inability to “associate with the defense” for the period between February and August had any effect whatsoever on the carrier’s ability to mount an adequate defense to the claims against its insured. In fact, neither the Appellate Division nor the Supreme Court engaged in any inquiry at all about that issue because both courts declined to make the insurer establish that any harm whatsoever had occurred during those six months. And the carrier was certainly never required to show that whatever the insured did during that period was in any way different from what the insurer would have done if it had “associated with the defense” during the period from February to August.
In addition, there was no evidence that the carrier was deprived of “playing a role in settlement” during the first six months of the litigation. It is, in fact, highly unlikely that the word “settlement” was ever even mentioned by either party at that early stage of the litigation. Certainly, if depriving the carrier of a role in settlement had been anything more than purely hypothetical, it is hard to fathom that the carrier would have neglected to put the facts relating to that deprivation before the court. In short, the record was utterly devoid of even a scintilla of evidence that the carrier was actually deprived of any negotiated right that was material to the obligations the parties had to one another.
Second, and perhaps more troubling, the Supreme Court affirmed the denial of coverage — essentially the abrogation of the policy for purposes of this claim — based upon “the characteristics of First Independent,” the policyholder. The court found that, since First Independent had fourteen full-time employees, a Human Resources Department, and an insurance broker, it was purportedly a “sophisticated” purchaser of insurance and that it accordingly did not need the same protection from the denial of insurance coverage that “unsophisticated” insureds require. Of course, the premise that a small company such as First Independent has anything resembling equal bargaining power with a multi-billion-dollar insurance carrier is certainly false. With the exception of corporate policyholders whose size and economic wherewithal rival that of insurance companies, themselves, carriers still have essentially all of the real bargaining power in the insurer/insured relationship.
The policies issued to all but the very biggest insureds are always standard Insurance Services Office policy forms, sold exclusively on a take-it-or-leave-it basis. The forms are drafted by the insurance industry’s own trade association and the insured has no negotiating leverage with which to change the terms and conditions of the contracts. Certainly, there was no indication in either of the Templo Fuente opinions to suggest that First Independent, a small business by any objective standard, had ever succeeded in negotiating any of the policy language at issue, or that it might have succeeded in doing so if it had been permitted to try (it would not, in all likelihood, have been permitted to try). Carriers are exempt from the nation’s antitrust laws for purposes of collaborating on underwriting, risk-assessment, premium, and actuarial information. Moreover, even the largest and most sophisticated policyholders in the country employ in-house and outside lawyers who specialize in insurance coverage to help them interpret policy language that is often turbid, difficult-to-follow, and full of industry jargon. In short, the notion that a fourteen-employee insured had anything remotely approaching equal bargaining power with one of the largest financial institutions on the planet was just a terrible basis for dispensing with the decades-old requirement that an insurer prove that a delay in notice had resulted in prejudice.
The end result is a “gotcha” that advances none of the principles upon which courts have validated the sale of claims-made coverage.
Nullification of coverage is a draconian remedy. It altogether destroys the bargain the parties reached in a contract in which (1) all of the bargaining power resides with the carrier, (2) the contract language is written solely by the carrier and sold on a take-it-or-leave-it basis, and (3) the insurer has already obtained everything required of the policyholder up front, that is: The full payment of premiums. The Templo Fuente decision upsets the balance reached in this bargain by imposing on the insured a notice requirement within the notice requirement. It then attaches the severest penalty possible to the insured’s failure to meet the “internal” notice requirement, even where the insurer has suffered no harm whatsoever from the delay.
The end result is a “gotcha” that advances none of the principles upon which courts have validated the sale of claims-made coverage. It permits the carrier to void the bargained-for coverage after it has accepted the insured’s premiums, without ever having to establish, as all other parties to contracts must do, that it has suffered any material detriment at the hands of the other contracting party. It creates a windfall that carriers could never have considered when they established the premium to charge for coverage that was designed to provide full protection straight through to the end of the policy period, but not beyond. If the value to the underwriter of a claims-made policy is that it establishes a hard-stop to the duration of coverage, there is no reasoned justification for gratuitously creating additional value to the underwriter by moving the hard-stop backwards at the expense of the insured and without any reduction in premiums. Doing so destroys the certainty that claims-made coverage is supposed to provide in the first place.
Of course, there is no reason to write the requirement of notice “as soon as practicable” out of a claims-made policy. If the carrier can show that it was prejudiced by a delay in notice, even where the claim was made and reported within the policy period, then it should be able to get out of coverage. In that circumstance, the breach of the requirement to provide notice “as soon as practicable” will be material. The breach — if that’s what it was — in Templo Fuente was, by definition and as a matter of fact, immaterial. It therefore did not justify voiding the insured’s coverage.