In our September 2002 commentary, Late Notice in Reinsurance Claims: Does Prejudice Matter?, we discussed how different states react to the reinsurer's defense to payment under a reinsurance contract based on the reinsured's failure to promptly notify the reinsurer of the underlying claim. Some states equate late notice on a direct basis with reinsurance and some states do not. Some states require a showing of prejudice and some do not.
Since that time, a number of new court decisions have been handed down on late notice. We begin with recent case law in New York on the direct side, and then move to some new late notice cases in the reinsurance context. The divergence among the states has not cleared up, but reinsureds and reinsurers now have a little more guidance on the use of the late notice defense.
As mentioned in the 2002 commentary, good faith compliance with notice provisions in reinsurance agreements will avoid opening the door to a late notice defense in the first place.
The New York Court of Appeals Speaks
In two recent decisions decided on the same April day this year, New York's highest appellate court, the New York Court of Appeals, addressed the defense of late notice by a primary insurer against its insured. In one case, the no-prejudice rule held fast and in the other case, the insurer was required to show prejudice before it could disclaim coverage based on late notice. Why the disparate results from the same court on the same day?
As the New York Court of Appeals explained, it has long been the rule in New York that where a primary insurance contract requires notice as soon as practicable after an occurrence, the absence of timely notice by the insured to the insurer is a failure to comply with a condition precedent. As a matter of law, this failure allows the insurer to disclaim coverage without showing any prejudice. The public policy here is that strict compliance with the contract allows the insurer to investigate the claim in a timely manner, establish adequate reserves, exercise early control of claims, and protects the insurer against fraud or collusion.
Notice of Claim
The no-prejudice rule has been applied in New York under various scenarios, including supplementary underinsured/uninsured motorist insurance ("SUM") and excess insurance. The no prejudice rule was not applied, however, where the insured gave late notice of a lawsuit, but had given prompt notice of the accident. In that case, the insurer was required to show prejudice before it could disclaim coverage under the insurance policy's SUM provisions.
In one of the recent New York cases, the court again refused to apply the no prejudice rule where the insured had given the insurer notice of the accident, but did not make a claim under the SUM coverage until nearly 2 years after the accident. A showing of prejudice by the insurer was required because the notice of accident was sufficiently prompt to promote the valid policy objective of curbing fraud and collusion. To disclaim SUM coverage, held the court, the insurer had the burden of proving prejudice from the late notice of the SUM claim.
Notice of Lawsuit
In the second case decided on that same April day, the New York Court of Appeals addressed whether the no prejudice rule applied to disclaiming coverage solely based on late notice of a lawsuit. Because the notice was late, the court ruled that the insurer need not show prejudice. Notice of the lawsuit was given after a default judgment was entered and after the case was set for trial. The late notice of the lawsuit was the first notice the insurer received; there was no prior notice given of the claim as had occurred in the other cases.
In the context of liability insurance, the court held that late notice of lawsuit "is so likely to be prejudicial … as to justify the application of the no prejudice rule." So under New York law, if an insured gives timely notice of a claim, late notice of a lawsuit or a SUM claim will not allow the insurer to disclaim coverage without showing prejudice.
Interestingly, the New York Court of Appeals noted in one of the April cases that in reinsurance, the no-prejudice rule has not been applied and that the reinsurer is required to show prejudice before it can be relieved of its obligations under a reinsurance contract.
Late Notice in Reinsurance Since 2002
Now that we have updated some law on direct insurance late notice defense issues, we now move to reinsurance where there have been a few cases since 2002. A federal circuit has spoken on late notice along with a number of federal district courts. The latest circuit court ruling, interpreting New Jersey law, reversed the district court decision that we referred to in our 2002 Commentary and held that, under New Jersey law, a reinsurer must demonstrate prejudice to prevail in its late notice defense.
In predicting how the New Jersey Supreme Court would rule, the circuit court determined that there was no reason to conclude that the general contract principle requiring prejudice as a condition precedent to forfeiting insurance benefits based on late notice in primary contracts should not apply to reinsurance contracts. The court found that the notice provisions in a reinsurance contract are less significant than in a primary contract where the primary insurer has to defend the insured. The court stated that "ritualistic adherence to prompt notice clauses in reinsurance contracts in the absence of prejudice" merely provides the reinsurer with an easy escape from its obligations under the reinsurance contract. At least three federal circuits have held that a reinsurer must show prejudice to prevail on a late notice defense.
In the federal district courts, the decisions have been diverse. In a New York federal court, the question was whether the notice clause was a condition precedent to the reinsurer's liability. If the clause were a condition precedent, then under New York law, the reinsurer would not have to show prejudice to avoid its obligations. If the notice clause were not a condition precedent, then the reinsurer has to show prejudice to prevail.
The court determined that the notice clause was not a condition precedent and held that the reinsurer must prove it was prejudiced by the late notice to avoid its obligations. Prejudice, the court reminded the parties, means tangible economic injury, which it held the reinsurer could not demonstrate. As often is the case, disputed facts prevented the court from definitively ruling on this dispute without a trial.
In Kansas, a reinsurer also was required to show substantial prejudice to be relieved of its reinsurance obligations because of the reinsured's late notice. Although the Kansas Supreme Court had not ruled on this issue, the federal court extended the primary rule requiring a showing of prejudice by the insurer to reinsurance predicting that the state court would do the same.
Yet in Illinois, a federal court interpreting Illinois law held that a reinsurer did not have to show prejudice to avoid its obligations on a series of claims that were reported late in violation of a notice clause that was a condition precedent to coverage. Under Illinois law, if the notice clause is a condition precedent, an insurer or a reinsurer need not show prejudice to prevail.
Our conclusion in 2002 is the same today. Different states apply different prejudice or no-prejudice rules to a late notice defense by an insurer or reinsurer. Some states distinguish between primary insurers and reinsurers and others treat them the same. Where the notice of claims clause is a condition precedent, however, most courts do not require that the reinsurer show prejudice to prevail on a late notice defense.