Usually, a contracting party must establish that a breach was “material” before she may recover for breach of contract. Similarly, an insurer usually must show that it was prejudiced by the failure of its insured to provide notice of a liability insurance claim “as soon as practicable” before it may deny coverage on the basis of late notice. A recent decision of the New Jersey Appellate Division ignored the first principle and rejected the second. A big step backwards in New Jersey insurance law jurisprudence.
New Jersey has always protected policyholders against nullification of their liability insurance coverage on the basis of a purported delay in providing notice of a claim unless the carrier can show that it was prejudiced by the delay. The phrase carriers most often use in the notice provisions of their liability policies is that the insured must bring a claim or suit to the attention of the carrier “as soon as practicable.”
Strictly speaking, a violation of that requirement could occur on the very day — in fact, at the very minute — that a policyholder gets served with a complaint. The word “practicable” means “able to be done or put into practice successfully.” In most circumstances that one can imagine, a policyholder is “able” to forward a claim to his insurer on the same day that the complaint comes in. Except in rare cases, where the policyholder is indisposed in some way that prevents him from mailing a copy of the complaint for some period — such as while undergoing and recovering from surgery, for example — the strict enforcement of the provision requiring notice “as soon as practicable” would require a court to void coverage for any delay whatsoever following the minute or two after the insured was physically and mentally capable of putting the complaint into an envelope and dropping it in a mailbox.
The courts of most states will not void coverage on the grounds of late notice unless the insurer can establish that it has been prejudiced in some way by the delay in receiving notice of a claim.
Courts have almost universally recognized that nullification of insurance coverage by such a strict interpretation of the notice provision of a policy would not only be absurd, it would violate public policy. It would give insurance companies a windfall in premiums without having to provide any bargained-for coverage in most cases; it would do violence to an insured’s reasonable expectations of protection; and it would harm a great many of the victims of insureds’ negligence, who would otherwise have a source of compensation for their injuries but for the occurrence of a slight and harmless delay in letting the carrier know of a covered claim under the policy.
This is why the courts of most states will not void coverage on the grounds of late notice unless the insurer can establish that it has been prejudiced in some way by the delay in receiving notice of a claim. This requirement essentially enforces the legal principle that an actionable breach of contract will lie only if the breach is material. An immaterial breach — that is, one that does no harm to the non-breaching party — will not justify either a claim for damages or the rescission of the contract.
The courts of New Jersey, especially, have always been particularly reluctant to nullify liability insurance coverage on the basis of late notice. In New Jersey, an insurer must show “appreciable prejudice” due to the delay in providing notice if it seeks to get out of coverage on late notice grounds. “Appreciable prejudice” has been interpreted to mean that a meritorious defense to the claim against the policyholder has been “irretrievably lost” in the period between when notice could have been provided and when it was actually provided. For example, “smoking gun” documents have been lost or destroyed, or witnesses with personal knowledge of exculpatory evidence have died, in the interim between the filing of the complaint against the insured and the notice the insured provided to the carrier.
Under this standard, New Jersey courts have rejected an insurer’s late-notice defense even after judgment has been entered against the insured in the underlying case, so long as the carrier is capable of reconstructing the circumstances of the accident. See Morales v. National Grange Mut. Ins. Co., 423 A.2d 325, 330 (N.J.Super. 1980).
Under a claims-made policy, coverage will apply only if a claim is both made against the policyholder and reported to the insurance company during the policy period.
The discussion thus far applies to the notice provisions of an “occurrence” liability policy. Coverage is triggered under such a policy by an “occurrence,” that is, by an accident that causes third-party bodily injury or property damage during the policy period. Sometimes, an injury-causing accident can occur in one policy period but the injury will not become manifest for many years later. Latent disease caused by the inhalation of asbestos is one example of this. In such a circumstance, the policyholder bargained for protection — and the insurer bargained to provide it — against claims that crop up years (sometimes even decades) after the negligence that caused the initial harm. The same calculus does not apply to policies that are issued on a “claims-made” basis.
Under a claims-made policy, coverage will apply only if a claim is both made against the policyholder and reported to the insurance company during the policy period. In other words, and in contrast to an “occurrence” policy, the insurer will never be responsible for providing coverage under a claims-made policy after the policy expires. New Jersey courts, and the courts of other states to have a addressed the issue, have concluded that the notice provisions of a claims-made policy are enforceable and they do not require an insurer to show that it was prejudiced by notice of a claim that was provided after the expiration of the policy. If the claim against the insured comes in during the policy period and the carrier receives notice after the policy period, the carrier will have a valid and enforceable late-notice defense under a claims-made policy. The corollary, of course, is that the carrier will not have a late-notice defense as long as it receives notice of a claim during the policy period.
On June 6, however, a New Jersey appellate court nullified a policyholder’s coverage on a late-notice defense even though the claim was made against the policyholder and reported to the carrier within the policy period. The decision, Templo Fuente De Vida Corp. v. National Union Fire Ins. Co. of Pittsburgh, PA, Docket No. A-4516-12T1 (App. Div. June 6, 2014) (get a copy here), is a significant step backwards in New Jersey jurisprudence. It violates the accepted principle of contract law that liability does not attached to any old breach of a contract; liability attaches only to a material breach. It also undermines — unfairly in favor of insurers — one of the most important principles justifying the sale of claims-made coverage: The principle of certainty.
While the facts of the underlying claim in Templo Fuente are sufficiently complex to cause MEGO (My Eyes Glaze Over), the facts of the coverage case are simplicity itself. The policy period of the claims-made Directors’ & Officers’ liability policy at issue was January 1, 2006 to January 1, 2007. It required the insured to give written notice of a claim “as soon as practicable” and during the policy period. The complaint was served on the insured on February 21, 2006. The insured provided written notice of the complaint on August 28, 2006. Both the claim and the notice were well within the policy period.
Nevertheless, the Appellate Division held that the six-month delay between the insured’s receipt of the complaint and the written notice to the insurer was not “as soon as practicable.” What is more, the court rejected the policyholder’s argument that the carrier should have to show that it was prejudiced by the six month delay. It held, instead, that, since this was a claims-made policy, the “prejudice” standard that applies under “occurrence” coverage has “no application whatsoever” to claims-made coverage. Here is why the decision is wrong, as a matter of coverage law, as a matter of contract law, and as a matter of policy.
First, the decision relies on a 1963 case by the New Jersey Appellate Division that found a delay of five and one half months in providing notice under an occurrence policy did not constitute notice “as soon as practicable.” Accordingly, the Templo Fuente court found itself “constrained” to conclude that a six-month delay was untimely as a matter of law. The problem with this reasoning is that the case upon which it relied for this ruling,Associated Metals and Minerals Corp. v. Dixon Chemical & Research, Inc., 82 N.J.Super. 281, 197 A.2d 569 (App. Div. 1963), was decided five years before the New Jersey Supreme Court decided the case that imposed a prejudice requirement on carriers seeking to disclaim coverage on the ground that they had not received notice “as soon as practicable.”
It is well and good to conclude that a five-and-a-half-month delay is untimely — it probablyis untimely in most cases — but it is also now the law of New Jersey that a carrier must show appreciable prejudice from an untimely notice before it can get out of coverage on that basis. It is no longer enough, as it was when Associated Metals was decided, for the carrier simply to show untimeliness. In short, had the Associated Metals case been decided in 1969, instead of 1963, it would have come out differently and the Templo Fuentes court would not have been relying upon it to support the outcome.
Second, the Templo Fuentes decision relied on the Supreme Court’s opinion inZuckerman v. National Union Fire Ins. Co., 100 N.J. 305, 495 A.2d 395 (1985). In that case, a legal malpractice suit was filed against the policyholder three months before the policy expired but the policyholder neglected to give notice of the claim until six months after the policy period. In those circumstances, the New Jersey Supreme Court held that the carrier could rely on the failure to comply with the claims-made notice provision and that there was no need to show prejudice resulting from the untimely notice. Among the issues the Zuckerman court resolved was one of first impression: Whether claims-made coverage violates public policy.
The court found, not surprisingly, that it does not. In reaching that conclusion, the court discussed the factual and philosophical differences between occurrence policies, which can apply prospectively but never retrospectively (the injury must occur during the policy period but not before), and claims-made policies, which can apply retrospectively (to pre-policy negligence that gives rise to a claim during the policy period) but never prospectively. The court validated claims-made coverage based in part on the utility to both carriers and policyholders in the certainty of fixing the exposure to risk against which the policy protects. “The obvious advantage to the underwriter issuing ‘claims made’ policies,” the Zuckerman court said, “is the ability to calculate risks and premiums with greater exactitude since the insurer’s exposure ends at a fixed point, usually the policy termination date.”
That is the bargain the carrier on a claims-made policy strikes with the policyholder: As long as both the claim and the notice of the claim occur during the policy period, it will not be denied on the basis of late notice. At the same time, the carrier’s exposure to liability will never extend beyond the end of the policy period. By setting the terms of the bargain in this way, the insurance industry has given rise to a reasonable expectation on the part of policyholders that their claims-made coverage will be available as long as notice is provided before the policy terminates. Viewing the value to the insurer of claims-made coverage in the way the Zuckerman court describes it, providing notice of a claim before the end of the policy period is, without more, a material part of the bargain.
The Templo Fuente decision imposes a notice requirement within the notice requirement and then attaches the severest penalty possible to the failure to meet the “internal” notice requirement.
Nullification of coverage is a draconian remedy. It destroys the bargain the parties reached in a contract in which (1) all of the bargaining power resides with the carrier; (2) the contract language is written solely by the carrier and sold on a take-it-or-leave-it basis; and (3) the insurer has already obtained everything required of the policyholder up front, that is: The full payment of premiums.
The Templo Fuentes decision upsets the balance reached in this bargain by imposing on the insured a notice requirement within the notice requirement. It then attaches the severest penalty possible to the insured’s failure to meet the “internal” notice requirement, even where the insurer has suffered no harm whatsoever from the delay.
The end result is a “gotcha” that advances none of the principles upon which courts have validated the sale of claims-made coverage. It permits the carrier to void the bargained-for coverage after it has accepted the insured’s premiums, without ever having to establish, as all other parties to contracts must do, that it has suffered any material detriment at the hands of the other contracting party. It creates a windfall that carriers could never have considered when they established the premium to charge for coverage that was designed to provide full protection straight through to the end of the policy period, but not beyond.
If the value to the underwriter of a claims-made policy is that it establishes a hard-stop to the duration of coverage, there is no reasoned justification for gratuitously creatingadditional value to the underwriter by moving the hard-stop backwards at the expense of the insured and without any reduction in premiums. Doing so destroys the certainty that claims-made coverage is supposed to provide in the first place.
Of course, there is no reason to write the requirement of notice “as soon as practicable” out of a claims-made policy. If the carrier can show that it was prejudiced by a delay in notice, even where the claim was made and reported within the policy period, then it should be able to get out of coverage. In that circumstance, the breach of the requirement to provide notice “as soon as practicable” will be material. The breach — if that’s what it was — in Templo Fuente was, by definition and as a matter of fact, immaterial. It therefore did not justify voiding the insured’s coverage.
Policyholder counsel will hope that the Templo Fuente decision gets appealed to the New Jersey Supreme Court. It is hard to imagine, in light of New Jersey jurisprudence on the notice issue, that the Supreme Court would affirm the nullification of coverage on account of an immaterial breach of the amorphous “as soon as practicable” provision in a claims-made policy.