Unanimous California Supreme Court Rewrites Insurance Policies
The California Supreme Court, in Pitzer College v. Indian Harbor Insurance Company, S239510, Supreme Court of California (August 29, 2019) created a fundamental public policy of the state with regard to the notice-prejudice rule for interpreting insurance contracts and ignored another fundamental public policy that allows for freedom of contract which stands athwart the fundamental public policy allowing adults to enter into legal contracts.
California’s notice-prejudice rule generally allows insureds to proceed with their insurance policy claims even if they give their insurer late notice of a claim, provided that the late notice does not substantially prejudice the insurer. (Campbell v. Allstate Ins. Co. (1963) 60 Cal.2d 303, 307 (Campbell).) The United States Court of Appeals for the Ninth Circuit asked the following:
- Is California’s common law notice-prejudice rule a fundamental public policy for the purpose of choice of law analysis?
- If so, does the notice-prejudice rule apply to the consent provision of the insurance policy in this case?
FACTUAL BASIS FOR RESPONSE
The Claremont University Consortium (CUC) is an umbrella entity that enters into insurance contracts on behalf of the Claremont Colleges, including plaintiff Pitzer College (Pitzer). The CUC purchased an insurance policy (Policy) from defendant Indian Harbor Insurance Company (Indian Harbor) that covered Pitzer for legal and remediation expenses resulting from pollution conditions discovered during the policy period of July 23, 2010 to July 23, 2011.
The Policy contains a notice provision requires Pitzer to provide oral or written notice of any pollution condition to Indian Harbor and, in the event of oral notice, to “furnish . . . a written report as soon as practicable.” Second, a consent provision requires Pitzer to obtain Indian Harbor’s written consent before incurring expenses, making payments, assuming obligations, and/or commencing remediation due to a pollution condition.
Pursuant to an emergency exception to this consent provision, however, if Pitzer incurs costs “on an emergency basis where any delay . . . would cause injury to persons or damage to property or increase significantly the cost of responding to any [pollution condition],” then Pitzer is not required to obtain Indian Harbor’s prior written consent, but it is required to notify Indian Harbor “immediately thereafter.” Third, a choice of law provision states that New York law governs all matters arising under the Policy.
By January 21, 2011, Pitzer determined that remediation would be required. With pressure to complete the dormitory prior to the start of the 2012-2013 academic year, Pitzer conferred with environmental consultants who determined that the least expensive and most expeditious option was to conduct lead removal onsite using a transportable treatment unit (TTU). Pitzer reserved one of the two TTUs that were licensed for use in Southern California and began the treatment process. (Ibid.) Remediation work commenced on March 9, 2011 with the setup of the TTU and was successfully completed one month later at a total cost of nearly $2 million.
Pitzer did not obtain Indian Harbor’s consent before commencing remediation or paying remediation costs. In fact, Pitzer did not inform Indian Harbor of the remediation until July 11, 2011, approximately three months after it completed remediation and six months after it discovered the darkened soils.
On March 16, 2012, Indian Harbor denied coverage based on Pitzer’s failure to give notice as soon as practicable and its failure to obtain Indian Harbor’s consent before commencing the remediation process.
The parties’ choice of law generally governs unless it conflicts with a state’s fundamental public policy, and that state has a materially greater interest in the determination of the issue than the contractually chosen state. If California has a materially greater interest than the chosen state, the court will decline to enforce a law contrary to this state’s fundamental policy.
California’s Notice-Prejudice Rule
California’s notice-prejudice rule requires an insurer to prove that the insured’s late notice of a claim has substantially prejudiced its ability to investigate and negotiate payment for the insured’s claim. A finding of substantial prejudice will generally excuse the insurer from its contractual obligations under the insurance policy, unless the insurer had actual or constructive knowledge of the claim.
Fundamental Public Policy
The difference between a “strong” public policy and a “fundamental” one is essentially semantic when the goal is to protect those with inferior bargaining power in the insurance context. A policy such as the notice-prejudice rule may be considered fundamental because it is connected to concerns of fundamental fairness in the negotiation process.
The notice-prejudice rule cannot be contractually waived and, thus, restricts freedom of contract. “When it applies, the rule prevents enforcement of a contractual term. It overrides the parties’ express intentions for a defined notice term, preventing a technical forfeiture of insurance benefits unless the insurer can show it was prejudiced by the insured’s late notice.” (Emphasis added)
California has long held that insurance contracts typically are inherently unbalanced and adhesive, which places the insurer in a superior bargaining position. The notice-prejudice 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. Where California has an important interest at stake, there is no reason why that interest is any less valid or worthy of consideration because it was developed in court decisions and not by legislative action.
The Supreme Court concluded that California’s notice-prejudice rule is a fundamental public policy of California. The rule is based on the rationale that the essential part of the contract is insurance coverage, not the procedure for determining liability, and that the notice requirement serves to protect insurers from prejudice, not to shield them from their contractual obligations through a technical escape-hatch. The insurer establishes actual and substantial prejudice by proving more than delayed or late notice. It must show a substantial likelihood that, with timely notice, and notwithstanding a denial of coverage or reservation of rights, it would have settled the claim for less or taken steps that would have reduced or eliminated the insured’s liability.
The Supreme Court left to the Ninth Circuit the obligation to decide the remaining issues concerning whether California has a materially greater interest than New York in determining the coverage issue, such that the contract’s choice of law would be unenforceable because it is contrary to our fundamental public policy.
Consent Provision and the Notice-Prejudice Rule
The consent provision here provides that, in the absence of an emergency, “[n]o costs, charges, or expenses shall be incurred without the Company’s written consent, which shall not be unreasonably withheld.” There is no dispute that Pitzer failed to obtain Indian Harbor’s prior written consent and that Pitzer notified Indian Harbor after it had remediated the pollution damage.
The Supreme Court noted that the notice-prejudice rule makes good sense for the consent provisions in first party policies just as it does for notice provisions. A first party insurance policy provides coverage for loss or damage sustained directly by the insured while a third party liability policy, by contrast, provides coverage for liability of the insured to a third party who has been injured because of the insured’s negligence.
The insured must not ignore the damage once it is discovered, or otherwise prejudice the insurer’s ability to investigate and cover the loss. In third-party insurance policies, then, consent provisions, sometimes called “no voluntary payment” provisions, are designed to ensure that responsible insurers that promptly accept a defense tendered by their insureds thereby gain control over the defense and settlement of the claim. In short, the provision protects against coverage by fait accompli.
The insurer’s duties to defend and settle a lawsuit are crucial to its coverage obligations. Because the insurer’s right to control the defense and settlement of claims is paramount in the third-party context, California appellate courts have generally refused to find the notice-prejudice rule applicable to consent provisions in third-party policies. The Supreme Court, strangely, concluded that failure to obtain consent in the first party context is “not inherently prejudicial,” and “the usual logic of the notice-prejudice rule should control.”
Resolving the question whether the Policy’s coverage should be considered first party or third party for purposes of the notice-prejudice rule is beyond the scope of the Ninth Circuit’s question to the Supreme Court and without additional evidence regarding the intent of the parties in forming the Policy, the Supreme Court left to the Ninth Circuit to determine what type of policy is at issue, and the ultimate question of whether the notice-prejudice rule applies to the consent provision here.
In line with California’s strong preference to avoid technical forfeitures of insurance policy coverage, the Supreme Court concluded (1) that our notice-prejudice rule is a fundamental public policy of our state in the insurance context, and (2) the rule generally applies to consent provisions in the context of first party liability policy coverage and not to consent provisions in third party liability policies.
The Supreme Court of California has decided, by making the notice-prejudice rule a fundamental public policy of the state, that people or entities insured – like Pitzer – can ignore material conditions of the policies they acquired by claiming their wrongful actions were not prejudicial to the rights of the insurer. By imposing a burden to prove prejudice, which should have been obvious since an expert testified that had the insurer received notice it could have accomplished the remediation safely and for less money without giving up the insurer’s right of subrogation. In so doing the Supreme Court found the notice-prejudice rule to be a more fundamental public policy than the fundamental public policy that allows people to enter into any contract they wish and to be held to the terms they agreed. Hopefully, the Ninth Circuit will rule based on the facts and evidence of prejudice. See http://zalma.com/blog/insurance-policy-interpretation-governed-by-the-law-of-the-state-where-it-is-to-be-performed/ where the Ninth Circuit concluded that place of performance resolves choice of law.
© 2019 – Barry Zalma
This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States. The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at http://www.zalma.com and firstname.lastname@example.org.
Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.
Over the last 51 years Barry Zalma has dedicated his life to insurance, insurance claims and the need to defeat insurance fraud. He has created the following library of books and other materials to make it possible for insurers and their claims staff to become insurance claims professionals.
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