Prejudice is a factor in establishing late notice under general liability policies in the majority of jurisdictions nationwide. Yet, courts and legislatures in various states take widely divergent approaches to the types of evidence that may establish prejudice and the burdens of proving—or disproving—prejudice. Below are some of the variations concerning proof of prejudice. While establishing prejudice presents challenges to insurers, a well-developed case that takes into account the applicable standards can prove valuable in enabling insurers to enforce notice conditions in their policies.
Courts have generally erected four variations of where the burden lies in cases in which notice is at issue. First, the minority view is that unexcused or unreasonably late notice voids coverage without any showing of prejudice. This is known as the no prejudice rule. See, e.g., S. Guar. Ins. Co. v. Thomas, 334 So. 2d 879, 883 (Ala. 1976) ("whether the insurer was prejudiced by the delay is immaterial" to a determination of whether a policyholder's late notice was reasonable); Greenway v. Selected Risks Ins. Co., 307 A.2d 753, 756 (D.C. 1973) (holding that it is "abundantly clear that actual prejudice to the carrier is not a necessary element in the defense" where the "policy contain[s] a provision making compliance with the notice requirements expressly a condition precedent to liability on the part of the insurer"); and Las Vegas Star Taxi, Inc. v. St. Paul Fire & Marine Ins. Co., 102, Nev. 11, 14, 714 P.2d 562, 564 (1986) (adopting a no prejudice requirement and stating that to require proof of prejudice "emasculates both the letter and spirit of the insurance contract").
In a variation of the no prejudice approach, a handful of courts have held that, if the policy does not make timely notice a condition precedent to recovery and does not provide a specific penalty for failure to give notice of the claim or failure to forward suit papers, the insurer remains liable unless the delay prejudiced the insurer. In other words, prejudice is presumed only under the limited circumstances based on policy language. See, e.g., Coastal Ref. & Mktg., Inc. v. U.S. Fid. & Guar. Co., 218 S.W.3d 279, 286 (Tex. App. 2007).
A third approach to where the burden lies in proof of prejudice cases holds that late notice voids coverage only if the insurer establishes that the late notice was a breach of contract that prejudiced the insurer's position. This approach places the burden to establish prejudice upon the insurer. See, e.g., Holt v. Utica Mut. Ins. Co., 157 Ariz. 477, 484, 759 P.2d 623, 630 (1988) (en banc) ("It is the insurer's burden to show actual prejudice before it can avoid liability under the insurance policy").
A fourth approach holds that an unreasonable delay in providing notice results in a rebuttable presumption that the insurer has been prejudiced. This approach places the initial burden on the policyholder to prove no prejudice. However, if the policyholder sustains that burden, then the burden shifts back to the insurer to prove prejudice. For example, in Aetna Casualty & Surety Co. v. Murphy, 206 Conn. 409, 538 A.2d 219 (1988), the Connecticut high court stated that:
[I]n our judgment, a proper balance between the interests of the insurer and the insured requires a factual inquiry into whether, in the circumstances of a particular case, an insurer has been prejudiced by its insured's delay in giving notice of an event triggering insurance coverage. If it can be shown that the insurer suffered no material prejudice from the delay, the nonoccurrence of the condition of timely notice may be excused because it is not, in Restatement terms, "a material part of the agreed exchange."
Id. at 417-18, 538 A.2d at 223; Bankers Ins. Co. v. Macias, 475 So. 2d 1216, 1218 (Fla. 1985) ("If the insured breaches the notice provision, prejudice to the insurer will be presumed, but may be rebutted by a showing that the insurer has not been prejudiced by the lack of notice."); Neff v. Pierzina, 245 Wis. 2d 285, 305, 629 N.W.2d 177, 187 (2001) ("[The insured's] failure to provide timely notice within one year of the accident created a presumption that [the liability insurer] was prejudiced by the lack of notice.").
An illustration of the complexity surrounding burdens of proof can be found in Friedland v. Travelers Indemnity Co., 105 P.3d 639 (Colo. 2005). Friedland involves a CERCLA suit in which an officer of a bankrupt policyholder defended the suit himself for over four years, eventually reaching a $20 million settlement. Id. at 641-42. Six months later, he learned that he might have additional insured status under the company's policy, and at that time first provided notice. The Friedland court cited prior Colorado authority that erects a two-step approach for late notice. See Clementi v. Nationwide Mut. Fire Ins. Co., 16 P.3d 223 (Colo. 2001); Marez v. Dairyland Ins. Co., 638 P.2d 286 (Colo. 1981). Under Clementi and Marez, the court first must determine whether notice was untimely and delay was unreasonable. If the answer is that the delay was indeed untimely and unreasonable, then the court must determine whether the insurer was prejudiced by late notice, with the burden on the insurer to establish prejudice. Clementi, 16 P.3d at 230-32.
The Friedland court modified this approach by inserting an additional step that provides that where notice occurs after settlement of the underlying case, a presumption of prejudice arises in favor of the insurer. Friedland, 105 P.3d at 646-48. In that circumstance, the policyholder must put forth evidence of the absence of prejudice. Id. The Friedland court then explained the various types of evidence that the policyholder might present in rebuttal, focusing on "evidence that, in the conduct of his defense and settlement of the CERCLA claims against [the policyholder], all material information that could have been obtained was obtained, all legitimate defenses were raised, [the policyholder's] liability in the case was reasonably clear under the facts and the law, and [the insurer], had it received notice, could not have obtained any materially better outcome than what [the policyholder] obtained without [the insurer's] assistance." Id. at 648. The court concluded that if the policyholder successfully rebuts the presumption of prejudice, then the burden reverts to the insurer to show by a preponderance of evidence that it suffered actual prejudice. Id. at 649.
As demonstrated in the cases above, the approaches to burdens of proof of prejudice vary significantly among states, and many states have not yet firmly defined such burdens. As Friedland illustrates, proving or disproving prejudice can be complex, with potentially dispositive implications. For example, whether or not the insurer or the policyholder has the burden can impact whether summary judgment is granted. That is because if a party with the burden of proof fails to come forth with evidence at the summary judgment stage, then summary judgment can be granted against it. Otherwise, prejudice generally involves issues of fact for trial, and the burdens impact which party must set forth proof, typically by a preponderance of evidence.
Further, in attempting to prove prejudice, some courts require that "actual" prejudice be shown. Certain courts have held that, where the insurer has the burden of proving prejudice, it is not enough to show that it might have done something differently had it received timely notice, but that the insurer must point to concrete evidence that it would have achieved a better result or that some material evidence was lost. See Gazis v. Miller, 186 N.J. 224, 892 A.2d 1277 (2006) (holding that the insurer is required to prove "appreciable prejudice"); Roberts Oil Co. v. Transam. Ins. Co., 113 N.M. 745, 756, 833 P.2d 222, 233 (1992) (stating that the insurer "must demonstrate substantial prejudice as a result of a material breach of the insurance policy by the insured before it will be relieved of its obligations under a policy") (emphasis in original).
California may be the most stringent in requiring that the insurer show actual prejudice. For example, in Shell Oil Co. v. Winterthur Swiss Insurance Co., 12 Cal. App. 4th 715, 763, 15 Cal. Rptr. 2d 815, 846 (1993), which has been restated on numerous occasions, the court stated that "in order to demonstrate actual, substantial prejudice from lack of timely notice, an insurer must show it lost something that would have changed the handling of the underlying claim." The Shell Oil court goes on to state that "[t]o establish actual prejudice, the insurer must show a substantial likelihood that, with timely notice, and notwithstanding any denial of coverage or reservation of rights, it would have settled the claim for less or taken steps that would have reduced or eliminated the insured's liability." Id. Therefore, the insurer under this standard must make a concrete showing that it would have achieved a better result had notice been timely provided.
Thus, under this approach, proof of actual prejudice may require a showing that material witnesses have died, documents have been lost or destroyed, or, as in environmental cases, the site has been altered. For example, in Ormet Primary Aluminum Corp. v. Employers Insurance of Wausau, 88 Ohio St. 3d 292, 303, 725 N.E.2d 646, 655 (2000), the Ohio high court held that there was no coverage because the insurer suffered actual prejudice as a matter of law due to a 16-year delay by a policyholder in notifying the insurer of its potential liability. However, the court declined to reach the issue of whether the policyholder presented proof to rebut the presumption, holding that "reasonable minds could only conclude that the [insurer] suffered actual prejudice from the delay." Id. Thus, if possible, an insurer would be well-advised to make this showing with specifics, such as who has died and what he or she would have said, rather than by pointing to generalized categories of evidence.
Some courts, on the other hand, have been less stringent. For example, in Washington v. Federal Kemper Insurance Co., 60 Md. App. 288, 295-96, 482 A.2d 503, 507 (1984), abrogated on other grounds by, Sherwood Brands, Inc. v. Hartford Accident & Indemnity Co., 347 Md. 32, 698 A.2d 1078 (1997), the Maryland intermediate appellate court held that, where an underlying judgment has been entered, "it is impossible for the carrier to demonstrate to the court what witnesses it might have discovered, what defense it might have made, and what disposition it might have reached in settlement." This approach taken by the Washington court moves away from an "actual" prejudice requirement.
There are various types of evidence that may or may not support a showing of prejudice. At times, an insurer may be reticent to press a late notice defense if prejudice is required. However, there are a number of circumstances in which an insurer has been able to prevail where prejudice is required.
One type of prejudice that might not be apparent at first blush is the impact that untimely notice may have on an insurer's internal operations. A line of cases recognizes that a basis for a no-prejudice rule is "to allow the insurer to protect itself from fraud by investigating claims soon after the underlying events, to set reserves, and to take an early and active role in settlement discussions." E.g., Argo Corp. v. Greater N.Y. Mut. Ins. Co., 4 N.Y.3d 332, 827 N.E.2d 762 (2005). However, even in jurisdictions where prejudice is required as an element of establishing a late notice defense, an insurer should consider whether to present evidence that late notice materially hinders the insurer's operations as a type of prejudice.
For example, an insurer might put on expert testimony by a claims executive or a former regulator to point out how the internal operations of the insurer work and are affected by timely and untimely notice. A potential advantage of such a showing is that this evidence is readily accessible to an insurer and does not depend on information or evidence in the control of the policyholder or third persons. The insurer can also coordinate this showing across several claims.
However, a countervailing consideration may be the extent to which such a showing risks opening up an insurer's internal operations. For example, issues may arise, especially in states requiring "actual" prejudice, as to the extent that an insurer's internal reserving activities may become subject to scrutiny in a coverage action.
Another type of potential prejudice is the entry of a default judgment in the underlying case. Certain courts have held that a default judgment is per se prejudice. See Prince George's County v. Local Gov't Ins. Trust, 388 Md. 162, 193, 879 A.2d 81, 100 (2005) (holding that an insurer is "prejudiced as a matter of law when the [policyholder] fail[s] to notify the [insurer] of the incident, claim, and lawsuit until after an adverse judgment [is] entered"). Conversely, other courts have disagreed that entry of default judgment is per se prejudice, suggesting that not even a conclusive default establishes prejudice. See Belz v. Clarendon Am. Ins. Co., 158 Cal. App. 4th 615, 632, 69 Cal. Rptr. 3d 864, 874 (2008) ("[P]rejudice is not shown simply by displaying end results; the probability that such results could or would have been avoided absent the claimed default or error must also be explored.") (internal citations omitted).
In Belz, not only was there a default as to liability once the insurer received notice, but the insurer was unable to vacate the default or introduce evidence on the amount of damages. Id. Nevertheless, the appellate court held that the insurer can only establish prejudice sufficient for a late notice defense if it can show that it could have prevailed in the underlying action or could have settled for a smaller amount than the judgment. Id.
Yet another potential type of prejudice may arise from notice received on the eve of trial. In Filley v. Ohio Casualty Insurance Co., 805 S.W.2d 844, 846-48 (Tex. App. 1991), the Texas intermediate appellate court sustained a jury finding of prejudice under this circumstance, where it was coupled with the policyholder's unavailability to assist at trial. On the other hand, in Coastal Refining, also from Texas, the insurer was unable to establish prejudice as a matter of law where it received notice shortly before trial, but delayed in any investigation. Coastal Refining, 218 S.W.2d at 296. Therefore, an insurer that receives notice shortly before trial would be well-advised to take immediate steps to prepare the case and to document its efforts. Of course, this may lead to a circumstance in which any prejudice is mitigated, including if the court were to grant a continuance. However, on balance, when prejudice is a consideration, a court might look unfavorably upon an insurer's inaction in responding to a belated notice.
An additional type of prejudice may occur when settlement is consummated before notice. See Friedland, 105 P.3d at 648 ("However, in a case such as the one before us, where notice is not given until after settlement, we must assume that the insurer had none of these opportunities; thus, prejudice must be presumed."); see also Motiva Enters., LLC v. St. Paul Fire & Marine Ins. Co., 445 F.3d 381, 386 (5th Cir. 2006) ("An insurer's right to participate in the settlement process is an essential prerequisite to its obligation to pay a settlement. When, as in this case, the insurer is not consulted about the settlement, the settlement is not tendered to it and the insurer has no opportunity to participate in or consent to the ultimate settlement decision, we conclude that the insurer is prejudiced as a matter of law."). Similarly, especially when the policy at issue gives the insurer the right to participate in the defense and settlement, some courts have found prejudice when the insurer has been denied the opportunity to participate in the selection of counsel and in settlement negotiations. See, e.g., Liberty Mut. Ins. Co. v. OSI Indus., Inc., 831 N.E.2d 192, 204 (Ind. Ct. App. 2005) (stating that "in the period before [the policyholders] tendered notice, [the insurer]: (1) was denied the opportunity to offer settlement or guide the course of litigation; (2) was not given the opportunity to select an attorney more familiar with insurance defense to defend the suit; and (3) was unable to negotiate the amount of attorney's fees . . . . As such, [the insurer] is not liable for any fees or costs incurred by [the policyholder] prior to [notice]."). Indeed, some courts have recognized that an insurer may be prejudiced by being denied the opportunity to apply its experience in handling specific types of claims, to select from its panel of experienced counsel, and to use experts that it has employed successfully in the past. See id.
This sort of prejudice evidence may be distinct from a requirement of "actual" prejudice, as it focuses more on loss of the insurer's rights in general and less on what may have been done differently in the specific claim. Nevertheless, an insurer should consider whether to put on proof concerning its general practice of selecting counsel and participating in the management of the defense, though, as noted, this may present some potential risk by opening up other claims to discovery and litigation.
Another type of prejudice is loss of evidence. In circumstances in which an insurer can establish that material witnesses have died or are unavailable, or that their memories have faded, or documents or other evidence have been lost or destroyed, then certain courts have sustained a finding of prejudice. For example, in Fireman's Fund Insurance Co. v. ACC Chemical Co., 538 N.W.2d 259, 266 (Iowa 1995), the court stated that the insurers were prejudiced when:
Five years had passed since the occurrence. The appearance of the site had been changed. At least one key witness had died, many had left, and many relevant documents had been destroyed. The witnesses who were available could not reasonably be expected to fully recall the events of five years earlier. These insurers were deprived of any opportunity to negotiate with the EPA or provide any input, except their money, on the consent decree. [The policyholder] had already spent millions on remediation and had obligated itself to spend millions more before it notified these insurers that they were expected to pay these expenses . . . . We conclude under all the circumstances that, even viewing the evidence in the light most favorable to the plaintiff, these insurers were prejudiced by the late notice.
Id.; see also E. Prods. Corp. v. Cont'l Cas. Co., 58 Mass. App. Ct. 16, 23, 787 N.E.2d 1089, 1095 (2003) (holding that death of a witness and destruction of relevant business records "constituted prejudice to [the insurer] as a matter of law").
Much of the discussion of prejudice in the case law focuses on prejudice with regard to the defense of the underlying claim. However, a handful of cases also discuss the prejudice associated with an insurer's inability to determine its coverage obligations based on lost evidence. Thus, where applicable, an insurer should press the argument that the loss of evidence has both hindered the defense of the underlying claim and the insurer's ability to determine the existence and scope of coverage. An example in the environmental context may be issues arising from migration of contamination if the site has changed over time prior to notice, which affects coverage issues such as trigger, allocation and the owned property exclusion.
Lastly, there are other non-traditional notice type provisions that can come into play. For example, pollution exclusions sometimes have time element provisions that provide limited coverage for abrupt events reported to the insurer during a specific timeframe, such as 72 hours. However, whether such clauses are characterized as notice clauses or terms of coverage may impact whether or not prejudice is relevant if the insurer is notified outside of the specified time frame. See Matador Petroleum Corp. v. St. Paul Surplus Lines Ins. Co., 174 F.3d 653 (5th Cir. 1999); Certain Underwriters at Lloyd's London v. C.A. Turner Constr. Co., 112 F.3d 184 (5th Cir. 1997). In Matador, the United States Court of Appeals for the Fifth Circuit addressed the dichotomy of notice provisions, in which prejudice is relevant, and coverage provisions, in which prejudice is not a factor. The Fifth Circuit reasoned that, in occurrence based policies, notice is generally included to aid the insurer in administration of its coverage of claims. Matador, 174 F.3d at 658-60. Thus, if the insurer's administration is not prejudiced, then coverage is not barred by late notice. On the other hand, the court pointed to claims-made policies, in which the timing of notice is a term of coverage. In such cases, prejudice often is not an element. The Matador court concluded that the time-element provision, with respect to prejudice, is irrelevant. Id. Thus, in implementing non-traditional notice provisions, an insurer should consider whether such provisions are linked to administration of claims or whether an argument can be made that they are terms of coverage.
In sum, it is important for insurers to be cognizant of applicable state law when evaluating a potential late notice defense. In particular, insurers must determine whether prejudice is required in asserting a notice defense, and if so, who bears the burden of proof of prejudice. In addition, insurers should evaluate all options of proving prejudice, from the death of witnesses to lost documents or even from the impact on an insurer's internal operations to management of the defense.