One of the first things that a reinsurance claims person looks at when receiving a claim notice for the first time is whether the notice from the ceding insurer complies with the notice requirements of the reinsurance contract. In other words, is the reinsurer hearing about this claim for the first time after judgment has been entered or after a settlement has occurred? If so, does the reinsurer have a valid late notice defense to payment? We have discussed late notice previously in our IRMI.com Reinsurance Commentaries.
Some time ago (I won’t date myself), the late notice defense was used with some frequency by reinsurers to avoid paying claims that were arguably presented late. When these disputes went to court, the courts would look to the notice rules applicable to direct insurance companies and determine whether those rules applied equally to reinsurance. Back then, if a policyholder failed to give its insurer prompt or timely notice of the claim, the insurer could disclaim coverage in many jurisdictions. Many courts and arbitrators adopted that view in the reinsurance context and upheld late notice defenses to payment where notice was demonstrably late.
After some years, however, the tide turned and in many jurisdictions insurance companies were no longer permitted to avoid coverage just because the insured provided late notice of the claim. Instead, to avoid coverage, the insurance company had to show that it was prejudiced by the late notice. Many states enacted laws codifying this principle. On the reinsurance side, the tide also changed with many courts holding that a reinsurer cannot avoid its obligations under a reinsurance contract just because the ceding insurer’s claim notice was late, but that the reinsurer also had to show that it was prejudiced by the late notice.
Prejudice had to be real and not speculative. For example, an argument that the reinsurer was deprived of the right to associate in the underlying claim (which reinsurers rarely exercised) typically was not enough to demonstrate prejudice. There had to be a showing of actual economic prejudice. For example, the actual loss of retrocessional protections because of commutations prior to notice of the claim is one that is often used. Without a showing of actual prejudice the courts in many jurisdictions reasoned that late notice, just by itself, was not enough to relieve a reinsurer of its obligation to pay claims under a reinsurance contract.
I say many jurisdictions because there are still some jurisdictions where prejudice does not need to be shown and a reinsurer is likely to prevail on a defense of late notice if the notice is late. And that brings us to the reason for this post.
The United States Court of Appeals for the Second Circuit, has now, in two Summary Orders, applied the law of Illinois to determine whether a reinsurer’s defense of late notice could be sustained without a showing of prejudice. Under the Second Circuit’s interpretation, Illinois law allows a reinsurer to avoid a claim based on a late notice defense without having to demonstrate that the cedent’s late notice caused prejudice to the reinsurer. Under New York law, on the other hand, a showing of prejudice is necessary to sustain a late notice defense. Thus, the application of Illinois law, as interpreted by the Second Circuit not to require a showing of prejudice, makes all the difference in the world to whether the reinsurer’s late notice defense will be sustained.
The two cases are AIU Ins. Co. v. TIG Ins. Co., 557 F. App’x 24 (2d Cir. 2014) and Granite State Ins. Co. v. Clearwater Ins. Co., No. 14-1494-cv, 2015 U.S. App. LEXIS 5278 (2d Cir. Apr. 2, 2015). Both are Summary Orders, which means that they do not have precedential effect. Both involve ceding insurers and reinsurers from the same respective family of companies. Both hold that the notice by the ceding insurer was late and that the defense of late notice was valid without the need for a showing of prejudice. In both cases the court rejected the argument that Illinois law was in flux on this issue and that the prejudice rule should apply. Forum shopping anyone?