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If you’ve been reading Coverage Opinions of late you’ve seen me take issue with certain aspects of the American Law Institute’s “Principles of the Law of Liability Insurance” Project. In general, my beef has been with certain proposed Principles that open the door to insureds securing coverage for intentional conduct. At the heart of a liability policy is that coverage is tied to the concept of fortuity. But certain draft ALI Principles seem intent on altering this cornerstone of a liability policy. These are not the only ALI Principles that divert from majority positions and, if adopted, would constitute a shift in the law. The ALI Principles’s stated mandate is to develop “coherent doctrinal statements based largely on current state law, but also grounded in economic efficiency and in fairness to both insureds and insurers.” Principles that constitute a shift in the law are not that.
By way of comparison, suppose 26 states apply Rule A to a coverage issue, 13 states apply Rule B and 11 states are silent or have no clear rule. If the ALI drafters choose to adopt Rule A, that is surely important, and not everyone will agree, but the decision is at least a “coherent doctrinal statement based largely on current state law.”
Here’s a look at another draft ALI Principle that seems to depart from the project’s mandate. Chapter 3 of the ALI Principles, next up on the table, addresses policy Conditions. The language of §42 is dense but I believe what it is saying is that, for an insurer to disclaim coverage based on the insured’s failures to cooperate, obtain consent before incurring any expense or provide timely notice of a claim, it must prove that it was caused to incur “substantial prejudice.” It’s not a secret that insurers have generally not fared well in their efforts to be relieved of policy obligations on the basis that their insured did not provide notice of a claim in a timely manner. First, as a starting point, even when claims are reported months after they should have been, that is oftentimes not late enough to serve as a breach of the policy’s notice requirement. What’s more, even when a claim is sufficiently tardy, to qualify as having formally breached the policy’s notice requirement, the insurer usually must prove that it was prejudiced by the insured’s delayed notification in order for such breach to serve as a basis to exclude coverage. And prejudice is frequently difficult for insurers to establish (at least courts think so). For these reasons, insurers have had a difficult go at it when attempting to disclaim coverage for defense and indemnity on the basis that their insured did not provide notice of a claim in a timely manner.
This being so, it is probably not going to ruffle too many insurer feathers if an ALI Principle is adopted stating that (for an occurrence policy) an insurer must establish prejudice to disclaim coverage based on late notice. Whether the test is “prejudice” or “substantial prejudice” is a different issue but not relevant to the discussion here.
But there is a close cousin (sibling, even) to late notice where insurers’ fortunes have been significantly different. There are times when an insurer is not seeking to completely disclaim coverage for defense and indemnity on account of late notice. Rather, the insurer is only asserting that is has no obligation to reimburse its insured for defense costs incurred by the insured prior to the time that the insured placed the insurer on notice of the claim. These are referred to in coverage circles as “pre-tender defense costs.” [Chrissie Hynde’s favorite coverage issue.] Pre-tender defense cost can be no small issue. Even if the pre-tender period is relatively brief, the defense costs racked up during this time could have been substantial. Think how active litigation can be right after a complaint is filed. Not to mention that the defense expenses are being incurred by non-panel counsel.Unlike their unimpressive results in disclaiming all coverage for defense and indemnity on the basis of late notice, insurers have done remarkably well in avoiding any obligation to pay for pre-tender defense costs. Court decisions have not been, er, in the middle of the road.
Why have insurers been so much more successful when it comes to pre-tender defense costs? In general, some courts are unwilling to saddle an insurer with an obligation to pay for defense costs that it had no ability to control. Other courts conclude that the duty to defend does not arise until the insurer receives notice of the claim. And some courts rule in favor of insurers on the basis that an insured that incurs defense costs, prior to providing notice to the insurer, has breached the policy’s “voluntary payments” provision. At the heart of these decisions is that, unlike when it comes to late notice, insurers are generally not obligated to pay for pre-tender defense costs – even if they were not prejudiced by them.
The difference between late notice and pre-tender defense costs, even within the same state, can be dramatic. For example, New Jersey courts have not put out a welcome mat for insurers when it comes to late notice. The Garden State sets a very high burden on insurers seeking to disclaim coverage for defense and indemnity on the basis of late notice—requiring a likelihood of appreciable prejudice. But when the issue is pre-tender defense costs, New Jersey courts have served insurers Country Time on the porch, holding that an insurer is only obligated to pay for that portion of the defense costs arising after it was informed of the facts triggering the duty to defend—and no showing of prejudice is required. Several examples abound of states whose standards between late notice and pre-tender defense costs are this diametric.
The clear majority rule nationally is that insurers are not obligated to pay for pre-tender defense costs–even if they were not prejudiced by them. More specifically, the national scorecard on coverage for pre-tender defense costs (based on any court in a state addressing the issue) – updated through July 2014 -- looks like this: 21 states preclude coverage without the insurer needing to prove prejudice; 6 states preclude coverage only if the insurer can prove prejudice; and 23 states have no instructive authority.
But despite this lopsided score favoring no prejudice required, the ALI Principles seem to be requiring an insurer to establish “substantial prejudice” to disclaim coverage for pre-tender defense costs. Admittedly, §42’s substantial prejudice requirement, for the insured’s failures to cooperate, obtain consent before incurring any expense or provide timely notice of a claim, does not specifically state that it encompass pre-tender defense costs. But that seems to be what it is saying.
Incidentally, and respectfully, the Comment to §42, under the heading “Voluntary-payment conditions” is blank, except to say “still researching.” It is also possible that, when §42 was being drafted, it was just not considered that, when it comes to late notice, there is a related issue where the rules are much different. So it is still possible that the ALI drafters will conclude that, for purposes of pre-tender defense costs, §42 is not a coherent doctrinal statement based largely on current state law.
Coverage Opinions is a bi-weekly (or more frequently) electronic newsletter reporting or providing commentary on just-issued decisions from courts nationally addressing insurance coverage disputes. Coverage Opinions focuses on decisions that concern numerous issues under commercial general liability and professional liability insurance policies. For more information visit www.coverageopinions.info.
The views expressed herein are solely those of the author and not necessarily those of his firm or its clients. The information contained herein shall not be considered legal advice. You are advised to consult with an attorney concerning how any of the issues addressed herein may apply to your own situation. Coverage Opinions is gluten free but may contain peanut products.
Randy Maniloff is Counsel at White and Williams, LLP in Philadelphia. He previously served as a firm Partner for seven years and transitioned to a Counsel position to pursue certain writing projects including Coverage Opinions . Nonetheless he still maintains a full-time practice at the firm. Randy concentrates his practice in the representation of insurers in coverage disputes over primary and excess obligations under a host of policies, including commercial general liability and various professional liability policies, such as public official’s, law enforcement, educator’s, media, computer technology, architects and engineers, lawyers, real estate agents, community associations, environmental contractors, Indian tribes and several others. Randy has significant experience in coverage for environmental damage and toxic torts, liquor liability and construction defect, including additional insured and contractual indemnity issues. Randy is co-author of “General Liability Insurance Coverage - Key Issues In Every State” (Oxford University Press, 2nd Edition, 2012). For the past twelve years Randy has published a year-end article that addresses the ten most significant insurance coverage decisions of the year completed.
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