When a policyholder first learns that they are facing litigation (or any third-party claim), they are immediately confronted with many pressing concerns. The primary concern is mounting a robust defense against the new claim. In such circumstances, it is unsurprising that a policyholder sometimes incurs defense costs before they can provide notice of the claim to their insurer.
Yet, when policyholders request reimbursement for defense costs incurred prior to notice, most insurers refuse to pay in the first instance, even if they have otherwise accepted coverage. Policyholders – who are often relieved to at least have coverage going forward – may assume that pre-notice defense costs are never covered, and, as a result, frequently do not pursue payment of these costs. However, as cases from numerous jurisdictions demonstrate, insurance often covers pre-notice defense costs.
Last year, for example, two federal courts required insurers to cover pre-notice defense costs. See CH Properties, Inc. v. First American Title Insurance Co., No. CIV. 13-1354 FAB, 2014 WL 4417772 (D.P.R. Sept. 9, 2014); Episcopal Church in South Carolina v. Church Insurance Company of Vermont, 53 F. Supp. 3d 816 (D.S.C. 2014). Both courts reviewed decisions nationwide, held that those cases requiring coverage for pre-notice defense costs were rightly decided, and required insurers to pay pre-notice defense costs (even those incurred long before the insureds provided notice).
CH Properties, Episcopal Church, and the cases cited therein all follow a simple and compelling logic. First, where an insurer has the right to control the defense of a claim, that right typically begins as soon as a claim arises. CH Properties, 2014 WL 4417772, at *9. Next, an insurer’s duty to defend (including its obligation to pay defense costs) must arise at the same time as its attendant right to control the defense, as any other rule “creates a time gap between the insurer’s right to control the defense and its duty to provide one.” Id. Finally, in most jurisdictions, an insurer can limit coverage based on late notice only where it can also show it was prejudiced by the untimely notice. Id. This so-called notice-prejudice rule means that late notice has no impact on the insurer’s coverage obligations (including the duty to defend) unless prejudice is shown. Thus, because the duty to defend begins when a claim arises and late notice (absent prejudice) typically has no impact on the duty to defend, an insurer must cover defense costs from the beginning of a claim, regardless of when notice is provided. Episcopal Church, 53 F. Supp. 3d at 829.
While some earlier decisions reached the opposite conclusion, a close reading of these rulings demonstrates that “[i]n none of those cases . . . does the court give any reasoned basis for such an approach.” Sherwood, 347 Md. at 46. Rather, these courts appear to be “parroting a conclusion” that may have some “rational basis” only in the minority of jurisdictions that do not accept the notice-prejudice rule, but that “no longer is justified” in the majority of states applying the notice-prejudice rule. Id. at 47. Not only is the rule obligating insurers to pay pre-notice defense costs already the rule in many states, it is also the better approach, especially in any jurisdiction applying the notice-prejudice rule.
Therefore, while the importance of providing prompt notice cannot be overstated, policyholders should not forget that in many instances they may be entitled to recover defense costs incurred prior to the notice of a claim.