Why it matters

In a blow to policyholders, the Colorado Supreme Court determined that an insured could not be indemnified for a settlement agreement reached without providing notice of the claim to the insurer, upholding the validity of the policy's "no-voluntary-payments" clause. Stresscon, a concrete subcontractor, reached a deal with its contractor over a construction accident before litigation was initiated—and before notifying Travelers Property Casualty Company about the claim. When Travelers refused to indemnify the settlement agreement, relying upon a no-voluntary-payments clause in the policy, Stresscon sued. A trial court and an appellate court sided with the policyholder but the state's highest court reversed. The policy provision unambiguously excluded any payments made or obligations assumed without the insurer's consent regardless of whether or not the insurer could demonstrate prejudice, the Colorado Supreme Court wrote, and therefore, Stresscon's deal with the contractor fell outside the scope of coverage. Three members of the court dissented, writing that the state's existing rule requiring insurers to demonstrate prejudice from a failure to comply with a notice requirement should be extended to no-voluntary-payments provisions, a standard clause in commercial general liability policies.

Detailed discussion

A serious construction accident occurred in July 2007. The general contractor sought damages from Stresscon, a subcontracting concrete company, and the parties entered into a settlement agreement before the general contractor had filed suit or initiated arbitration.

Stresscon turned to Travelers Property Casualty Company to indemnify the deal, but the insurer refused pursuant to a clause in the policy that stated: "No insured will, except at that insured's own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent."

The policyholder filed suit and a jury awarded Stresscon damages for bad faith breach of the insurance contract. An appellate panel affirmed the verdict, relying upon the Colorado Supreme Court's 2005 decision inFriedland v. Travelers Indemnity Co. In that case, the court held that insurers are required to demonstrate prejudice from an insured's failure to comply with a notice requirement of its insurance contract.

Extending the holding in Friedland, the appellate court found the no-voluntary-payments provision could relieve Travelers of indemnification only if the insurer suffered prejudice from Stresscon's settlement. Travelers appealed again and the Colorado Supreme Court reversed.

Reviewing the policy considerations that provided the justification for the notice-prejudice rule, the Colorado Supreme Court said they did not apply with the same force to no-voluntary payment-provisions. The timely notice requirements of the occurrence policy in Friedland was a technicality from which insurers could "reap a windfall," the court explained, and did not define the scope of coverage.

"[A]n insurance policy is a contract, the unambiguous terms of which must be enforced as written, unless doing so would violate public policy," the court wrote. "[T]he contract clause at issue in this case, far from amounting to a mere technicality imposed upon an insured in an adhesion contract, was a fundamental term defining the limits or extent of coverage. This so-called 'no voluntary payments' clause clearly excluded from coverage any payments voluntarily made or obligations voluntarily assumed by the insured without consent, for anything other than first aid. The insurance policy emphatically stated that any such obligations or payments would be made or assumed at the insured's own cost rather than by the insurer."

The no-voluntary-payments clause does not impose a duty on the insured to do anything "whether for the purpose of assisting in the insurer's investigation or defense of a claim, or otherwise," nor does it impose a duty on the policyholder to refrain from doing something, the court noted.

Instead, the no-voluntary-payments clause "actually goes to the scope of the policy's coverage," the court said. "Rather than a provision purporting to bar an insured from voluntarily making payments or incurring expense without the consent of the insurer, for the breach of which the insurer would be absolved of compliance with its obligations under the policy, the no-voluntary-payments provision makes clear that coverage under the policy does not extend to indemnification for such payments or expenses in the first place, and instead, the no-voluntary-payments clause merely specifies that as uncovered expenses they will not be borne by the insurer."

Depriving an insurer of its choice to defend or settle in the first instance has important practical implications for the risks that insurers undertake and the premiums paid by insureds, the court explained, and enforcement of the provision "can hardly be characterized" as reaping a windfall.

Extending the Friedland notice-prejudice rule "would treat no-voluntary-payments clauses of insurance contracts, including the one in this case, as nothing more than a technicality, unenforceable in the absence of prejudice, whether or not any actions of the insurer had exposed its insured to an excess judgment," the court said. "The result of such a rule would be to ignore the competing interests and risks of collusion or fraud … and would effectively deny insurers the ability to contract for the right to defend against third-party claims or negotiate settlements in the first instance. Public policy demands no such restriction on the right to contract."

The court reversed the jury verdict and remanded the case, ordering the trial court to enter a directed verdict for Travelers.

To read the opinion in Travelers Prop. Cas. Co. v. Stresscon Co., click here.