Insurance law generally imposes on a policyholder the duty to give timely notice of claims to its insurance company. Sometimes, because of forgetfulness, ignorance, neglect, or a number of other reasons, companies fail to immediately give notice of loss and potential losses to insurers. In those circumstances, insurers often raise the defense of “late notice.” As a result, a number of courts have devised a “notice prejudice rule” which limits the use of the late notice defense to situations when the delayed notice actually caused prejudice to the insurer.

In St. Paul Mercury Insurance Company v. American Bank Holdings, Inc., the Fourth Circuit, applying Maryland law, addressed the question of what qualifies as “prejudice.” In that case, American Bank Holdings, Inc., did not provide notice to its insurer until after a $98.5 million default judgment had been entered against it in the underlying claim. St. Paul raised the defense of late notice, argued that it was prejudiced, and denied coverage.

Although the bank was eventually successful at overturning the $98.5 million default judgment, it still spent $1.8 million resisting collection on the judgment and having the judgment set aside. All of this was because the underlying complaint had been served on the bank’s CFO, who had left employment at the bank. Another officer later found the complaint and transmitted it to an outside lawyer, who claims he never received the complaint. This procedure was described by the district court as “a variety of screw-ups” such that “significant suit papers that should have gotten immediate attention didn’t.” Writing for a unanimous panel, Judge Niemeyer of the Fourth Circuit explained that “corporate screw-ups” are not a basis to excuse the failure to give timely notice to an insurer, if the corporation expects to be indemnified for the defense of the claim.

“Actual prejudice” was shown in this case by the insurer, because the bank’s failure to give timely notice prevented the insurer from selected counsel, consulting with counsel on the defense of the claim, prevented the timely raising of a personal jurisdiction defense, and prevented the possibility of settlement discussions with the underlying plaintiff either prior to the entry of default judgment or prior to the expenditure of $1.8 million spent to resist and set aside the default judgment. These were all rights which the insurer has under the insurance contract, and all rights which it was not able to exercise because of the bank’s failure to give timely notice. As a result, actual prejudice was shown and St. Paul's declaratory judgment was granted on the basis that it had no duty to pay for American Bank's defense costs.