Case Briefs

Untimely Notice under a Claims-Made Policy

Most insurance policies include a provision requiring that an insured provide notice of an occurrence or claim within some measurable time frame. Such a provision may require that notice be provided “promptly,” “immediately,” or “as soon as possible.” Insurers have contended that, under the law of some jurisdictions, failure to give timely notice as required by the policy requires a forfeiture of coverage otherwise available under the policy ' even in the absence of prejudice to the insurer. The law of most jurisdictions provides that an insurer cannot rely on untimely notice to defeat coverage unless the insurer can demonstrate that it was prejudiced by the untimely notice.

Last year, as reported in our February 2008 issue, the Texas Supreme Court confirmed that “an insured's failure to timely notify its insurer of a claim or suit does not defeat coverage if the insurer was not prejudiced by the delay.” PAJ, Inc. v. The Hanover Insurance Co., 243 S.W.3d 630, 636-37 (Tex. 2008).

Because PAJ involved an “occurrence-based” policy, however, insurers have argued that it should not apply to “claims-made” policies.

In a major victory for insureds with claims-made policies, the Texas Supreme Court handed down two decisions on March 27, 2009, each of which confirms that an insurer must demonstrate prejudice in order to avoid coverage under a claims-made policy on the basis of untimely notice. Financial Industries Corp. v. XL Specialty Ins. Co., No. 07-1059, __ S.W. 3d __, 2009 WL 795529 (Tex. Mar. 27, 2009); Prodigy Communications Corp. v. Agricultural Excess & Surplus Ins. Co., No. 06-0598, __ S.W. 3d __, 2009 WL 795530 (Tex. Mar. 27, 2009).

In Financial Industries, the Fifth Circuit asked the Texas Supreme Court to answer the following certified question: “Must an insurer show prejudice to deny payment on a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is nevertheless given within the policy's coverage period?” Financial Industries Corp. v. XL Specialty Insurance Co., 259 Fed. Appx. 675, 678 (5th Cir. 2007). The prompt-notice provision at issue stated that “the Insured shall give written notice to the Insurer of any Claim as soon as practicable after it is first made.” Financial Industries, 2009 WL 795529, at *1. On March 27, 2009, the Texas Supreme Court announced its decision to “answer the certified question in the affirmative and hold that an insurer must show prejudice to deny payment on a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is given within the policy's coverage period.” Id. at *2.

Likewise, the Texas Supreme Court in Prodigy Communications held that “[i]n a claims-made policy, when an insured notifies its insurer of a claim within the policy term or other reporting period that the policy specifies, the insured's failure to provide notice 'as soon as practicable' will not defeat coverage in the absence of prejudice to the insurer.” 2009 WL 795530, at *7.

The decisions in Financial Industries and Prodigy Communications continue a pro-insured trend by the Texas Supreme Court in recent years.

Food Spoilage Covered

On Aug. 14, 2003, problems with the interconnected North American electrical grid resulted in a four-day electrical blackout over much of the northeastern United States and eastern Canada. Plaintiffs, a group of supermarkets, suffered losses due to food spoilage and other loss of business. Having paid a $5.5 million premium for insurance, including a supplemental policy covering damage due to the loss of electric power (the “Extension”), plaintiffs turned to their insurer, Liberty Mutual, to pay for their losses. Liberty, however, denied coverage, contending that coverage under the Extension was only triggered in case of “physical damage” to off-premises electrical plant and equipment and that, despite the blackout, the electrical grid suffered no “physical damage” and, therefore, there was no coverage.

The parties brought their dispute concerning the meaning of the term “physical damage” before the New Jersey Superior Court, Law Division, which granted summary judgment in favor of Liberty Mutual holding that the grid was not physically damaged because it could be returned to service after the interruption. Plaintiffs appealed the ruling to the Appellate Division of New Jersey Superior Court.

Writing for the appellate court, Judge Susan L. Reisner held that “the undefined term 'physical damage' was ambiguous and that the trial court construed the term too narrowly, in a manner favoring the insurer and inconsistent with the reasonable expectations of the insured. Such construction was contrary to New Jersey's common law rules of interpretation, which require ambiguous policy terms to be construed in favor of the insured. Further, coverage clauses are interpreted liberally whereas exclusions are strictly construed. Lastly, insurance contracts should be interpreted to give effect to the reasonable expectations of the insured. The court reasoned that the electrical grid was “physically damaged” because it was (temporarily) physically incapable of performing its essential function of providing electricity.

The court relied upon the following key facts in reaching its decision:

• Plaintiffs sought and obtained the Extension to have insurance coverage for food spoilage and other losses due to loss of power from utilities;
• Plaintiffs did not negotiate the Extension or any of its provisions; and
• The term “physical damage” was not defined in the Extension or in the underlying policy.

Based on these facts, the court found that the average policy holder in plaintiffs' position would have understood the term “physical damage” to include the temporary shutdown of the electric grid. Further, the court held, the insurer bore the burden of defining its policy exclusions more clearly if it intended for its policy to be construed narrowly, especially given the lack of negotiating power the plaintiffs had in determining the terms of the policy. Accordingly, the court reversed the trial court's decision and ordered that summary judgment be entered in favor of the plaintiffs on the issue of coverage under the Extension.

Roberta Anderson, a member of this newsletter's Board of Editors and a partner at K&L Gates, contributed the first case brief. Dennis Brown, a member of this newsletter's Board of Editors and a partner at Edwards Angell Palmer & Dodge, contributed the second case brief.

Untimely Notice under a Claims-Made Policy

Most insurance policies include a provision requiring that an insured provide notice of an occurrence or claim within some measurable time frame. Such a provision may require that notice be provided “promptly,” “immediately,” or “as soon as possible.” Insurers have contended that, under the law of some jurisdictions, failure to give timely notice as required by the policy requires a forfeiture of coverage otherwise available under the policy ' even in the absence of prejudice to the insurer. The law of most jurisdictions provides that an insurer cannot rely on untimely notice to defeat coverage unless the insurer can demonstrate that it was prejudiced by the untimely notice.

Last year, as reported in our February 2008 issue, the Texas Supreme Court confirmed that “an insured's failure to timely notify its insurer of a claim or suit does not defeat coverage if the insurer was not prejudiced by the delay.” PAJ, Inc. v. The Hanover Insurance Co. , 243 S.W.3d 630, 636-37 (Tex. 2008).

Because PAJ involved an “occurrence-based” policy, however, insurers have argued that it should not apply to “claims-made” policies.

In a major victory for insureds with claims-made policies, the Texas Supreme Court handed down two decisions on March 27, 2009, each of which confirms that an insurer must demonstrate prejudice in order to avoid coverage under a claims-made policy on the basis of untimely notice. Financial Industries Corp. v. XL Specialty Ins. Co. , No. 07-1059, __ S.W. 3d __, 2009 WL 795529 (Tex. Mar. 27, 2009); Prodigy Communications Corp. v. Agricultural Excess & Surplus Ins. Co. , No. 06-0598, __ S.W. 3d __, 2009 WL 795530 (Tex. Mar. 27, 2009).

In Financial Industries , the Fifth Circuit asked the Texas Supreme Court to answer the following certified question: “Must an insurer show prejudice to deny payment on a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is nevertheless given within the policy's coverage period?” Financial Industries Corp. v. XL Specialty Insurance Co. , 259 Fed. Appx. 675, 678 (5th Cir. 2007). The prompt-notice provision at issue stated that “the Insured shall give written notice to the Insurer of any Claim as soon as practicable after it is first made.” Financial Industries, 2009 WL 795529, at *1. On March 27, 2009, the Texas Supreme Court announced its decision to “answer the certified question in the affirmative and hold that an insurer must show prejudice to deny payment on a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is given within the policy's coverage period.” Id. at *2.

Likewise, the Texas Supreme Court in Prodigy Communications held that “[i]n a claims-made policy, when an insured notifies its insurer of a claim within the policy term or other reporting period that the policy specifies, the insured's failure to provide notice 'as soon as practicable' will not defeat coverage in the absence of prejudice to the insurer.” 2009 WL 795530, at *7.

The decisions in Financial Industries and Prodigy Communications continue a pro-insured trend by the Texas Supreme Court in recent years.

Food Spoilage Covered

On Aug. 14, 2003, problems with the interconnected North American electrical grid resulted in a four-day electrical blackout over much of the northeastern United States and eastern Canada. Plaintiffs, a group of supermarkets, suffered losses due to food spoilage and other loss of business. Having paid a $5.5 million premium for insurance, including a supplemental policy covering damage due to the loss of electric power (the “Extension”), plaintiffs turned to their insurer, Liberty Mutual, to pay for their losses. Liberty, however, denied coverage, contending that coverage under the Extension was only triggered in case of “physical damage” to off-premises electrical plant and equipment and that, despite the blackout, the electrical grid suffered no “physical damage” and, therefore, there was no coverage.

The parties brought their dispute concerning the meaning of the term “physical damage” before the New Jersey Superior Court, Law Division, which granted summary judgment in favor of Liberty Mutual holding that the grid was not physically damaged because it could be returned to service after the interruption. Plaintiffs appealed the ruling to the Appellate Division of New Jersey Superior Court.

Writing for the appellate court, Judge Susan L. Reisner held that “the undefined term 'physical damage' was ambiguous and that the trial court construed the term too narrowly, in a manner favoring the insurer and inconsistent with the reasonable expectations of the insured. Such construction was contrary to New Jersey's common law rules of interpretation, which require ambiguous policy terms to be construed in favor of the insured. Further, coverage clauses are interpreted liberally whereas exclusions are strictly construed. Lastly, insurance contracts should be interpreted to give effect to the reasonable expectations of the insured. The court reasoned that the electrical grid was “physically damaged” because it was (temporarily) physically incapable of performing its essential function of providing electricity.

The court relied upon the following key facts in reaching its decision:

• Plaintiffs sought and obtained the Extension to have insurance coverage for food spoilage and other losses due to loss of power from utilities;
• Plaintiffs did not negotiate the Extension or any of its provisions; and
• The term “physical damage” was not defined in the Extension or in the underlying policy.

Based on these facts, the court found that the average policy holder in plaintiffs' position would have understood the term “physical damage” to include the temporary shutdown of the electric grid. Further, the court held, the insurer bore the burden of defining its policy exclusions more clearly if it intended for its policy to be construed narrowly, especially given the lack of negotiating power the plaintiffs had in determining the terms of the policy. Accordingly, the court reversed the trial court's decision and ordered that summary judgment be entered in favor of the plaintiffs on the issue of coverage under the Extension.

Roberta Anderson, a member of this newsletter's Board of Editors and a partner at K&L Gates, contributed the first case brief. Dennis Brown, a member of this newsletter's Board of Editors and a partner at Edwards Angell Palmer & Dodge, contributed the second case brief.