In Travelers Property Casualty Co. v. Stresscon Corp., ___ P.3d ___, 2016 CO 22 (Colo. No. 13SC815, April 25, 2016), the Colorado Supreme Court reversed the Colorado Court of Appeals’ decision which held that the notice-prejudice rule—which requires an insurer to show prejudice as a result of a policyholder’s delay in giving notice of a claim in order to deny coverage for the claim—does not apply to the “no voluntary payments” provision in a Comprehensive General Liability (CGL) insurance policy.

In a 4-3 decision, the court held that the notice-prejudice rule, which it first applied to first-party insurance policies in Clementi v. Nationwide Mutual Fire Insurance Co., 16 P.3d 223 (Colo. 2001), and later extended to third-party occurrence-based policies in Friedland v. Travelers Indemnity Co., 105 P.3d 639 (Colo. 2005), does not apply when the policyholder makes voluntary payments in settlement of a claim in contravention of a policy’s “no voluntary payments” provision. The insured, Stresscon, was a concrete subcontractor that was sued by the general contractor over an accident caused by a crane operator who was Stresscon’s subcontractor. Stresscon entered into a settlement agreement with the general contractor without having contacted its liability insurer, Travelers. Stresscon settled the accident-related claim, along with other unrelated and concededly uncovered claims against Stresscon, without differentiation as to amount, and then sued Travelers for coverage of the settlement and for bad faith under the common law and Colo. Rev. Stat. § 10-3-1116. Stresscon prevailed at trial and was awarded damage for breach of contract and bad faith.

In the trial court and Colorado Court of Appeals, Travelers argued that Stresscon was not entitled to coverage due to its violation of the policy’s “no voluntary payments” clause by settling with the general contractor without notifying Travelers of the loss or payment, and without seeking Travelers’ permission for or approval of the settlement. Both lower courts rejected Travelers’ argument, with the Court of Appeals holding that the notice-prejudice rule of Friedland applies to “consent to settle” and “no voluntary payments” clauses and requires the insurer to prove that it suffered prejudice as a result of the insured’s voluntary settlement of a claim without the insurer’s notice or consent. The Court of Appeals concluded that “forfeiting insurance benefits when the insurer has not suffered any prejudice would be a disproportionate penalty and provide the insurer a windfall based on a technical violation of the policy.” Stresscon Corp. v. Travelers Property Casualty Co., 2013 COA 131, ¶ 45 (Colo. App. Nos. 11CA1239 & 11CA1582, Sept. 12, 2013).

The Colorado Supreme Court disagreed with the Court of Appeals, finding that the justifications for the notice-prejudice rule in Clementi and Friedland did not extend to the “no voluntary payments” provision. First, the court noted that neither Clementi nor Friedland dealt with or addressed a “no voluntary payments” provision, such that there was no precedent for extending the notice-prejudice rule to “no voluntary payments” provisions: “Whatever the state of the law in this jurisdiction may have been with regard to the no-voluntary-payments provision in Friedland, or the one at issue before us today, it was neither addressed nor directly impacted by our decision to extend our notice-prejudice rule in Friedland.”

Next, the court “did not find our justification for adopting a notice-prejudice rule in Clementi and Friedland to apply with the same force to the enforcement of agreements not to incur costs or obligations on behalf of an insurer without the insurer’s consent.” Citing “the freedom to contract,” which the court observed “is especially important in the insurance industry, where the terms of a policy distribute risk and define the very product that is bargained for,” the court determined that the “no voluntary payments” provision “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 is because the “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.”

Accordingly, the court concluded, unlike the notice requirements in Clementi and Friedland, which place an affirmative duty on the insured to give timely notice of a claim in order to invoke coverage, “the no-voluntary-payments clause in this case does not purport to 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 insured to refrain from doing something the doing of which would violate the terms of the contract and call for an appropriate remedy,” the court explained, inasmuch as “voluntarily making a payment, assuming an obligation, or incurring an expense necessarily entails affirmative, and voluntary, action on the part of the insured.” Instead, the court held, “the no-voluntary-payments clause of the contract at issue here actually goes to the scope of the policy’s coverage.” As the court explained, the “no voluntary payments” clause means that coverage does not extend to payments made by the policyholder without the insurer’s consent:

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.

Thus, the court concluded, “While there will virtually always be room for debate about the contours of any particular no-voluntary-payments clause, whether the insured acts out of ignorance of the coverage or by design, in an attempt to deprive the insurer of its contractually-granted choice to provide a defense or settle the claim, or for some other reason altogether, the enforcement of such a provision according to its terms can hardly be characterized as ‘reap[ing] a windfall’ by invoking a technicality to deny coverage.”

Because the lower courts erred in applying the notice-prejudice rule to Stresscon’s violation of the “no voluntary payments” provision in Travelers’ policy, the Colorado Supreme Court reversed the denial of Travelers’ directed verdict motion and remanded with directions to vacate the jury verdict (including the verdict on Stresscon’s bad faith claims) and to direct a verdict instead for Travelers.