In Wake of New York Federal Court Decision, Ceding Companies and Reinsurers Must Consider Whether Late Claim Notice Violates Good Faith

 

Above:  Colodny Fass& Webb Associate Timothy Fordham Stanfield

 

By Timothy Fordham Stanfield, Esq.

 

Introduction

In determining whether late notice may be used as a legal basis to deny a claim and depending on the jurisdiction, most practitioners only think about whether the claim notice is a condition precedent to coverage or if the insurer or reinsurer is able to establish prejudice.  In light of the recent U.S. Southern District Court of New York decision, attorneys and claims representatives defending ceding companies and reinsurers now must also consider whether the late notice violated their duty of utmost good faith or uberrimae fidei.  As the summary below explains in the case of  The Insurance Company of the State of Pennsylvania v. Argonaut Insurance Company – U.S. Dist. Ct., S.D.N.Y. (August 6, 2013), late notice analysis for reinsurance professionals – certainly in New York – is now much more complicated and unpredictable.

 

Background

Kaiser Cement Corporation (“Kaiser”), a producer of products containing asbestos, purchased excess insurance coverage from the defendant, The Insurance Company of the State of Pennsylvania (“ICSOP”) in 1974.  Argonaut Insurance Company (“Argonaut”) agreed to reinsure ICSOP for a portion of the policy limit sold to Kaiser. 

As the devastating effects of asbestos came to light in the 1980s, Kaiser faced thousands of lawsuits alleging bodily injury and property damage caused by its asbestos-laden products during the time period of 1980 through 1996.  In one of these actions, ICSOP sued to enforce the terms of the 1974 reinsurance contract against Argonaut.  Argonaut argued it was not obligated to pay the claim because ICSOP breached its contractual duty to provide timely notice of an event that might trigger Argonaut’s reinsurance obligations. 

The U.S. District Court for the Southern District of New York’s August 6, 2013 opinion identified California law as controlling in this dispute, holding that ICSOP breached its contractual obligation to provide timely notice to Argonaut. 

Going forward, a trial will be held to determine whether Argonaut can demonstrate that it suffered actual and substantial prejudice from the breach, and whether ICSOP’s gross negligence or bad faith excuses Argonaut from demonstrating prejudice.

 

About this Case

In 1974, Kaiser acquired excess umbrella insurance from ICSOP covering the policy period from January 1, 1974 through January 1, 1977.  The 1974 ICSOP Policy provided “umbrella” coverage above the $500,000 limit of the primary policy held by Kaiser up to a limit of $5,000,000 per occurrence.  The 1974 ICSOP policy had no aggregate limits.  Like many reinsurance contracts, the Facultative Certificate required ICSOP to give prompt notice to Argonaut that its reinsurance obligations might be triggered.

Despite several opportunities between 1989 and 2009, the court held that ICSOP failed to provide Argonaut with notice that Argonaut’s reinsurance obligation might be triggered by Kaiser’s asbestos litigation.  Argonaut argued that ICSOP should have provided notice in 1989 or no later than April 2000.  In addition to the legal actions initiated against Kaiser in the late 1980’s, the cross-claims asserted against ICSOP by Kaiser would have required ICSOP to provide notice to Argonaut, since the insured’s 2002 cross-claim against ICSOP constituted a “claim” within the meaning of the reinsurance agreement.  Argonaut did not notify ICSOP of the claim until 2009. 

The court found that ICSOP should have notified Argonaut of the claims made in relation to Kaiser’s asbestos lawsuits as early as 1989, and certainly no later than April of 2000.  Since ICSOP failed to provide notice to Argonaut until 2009, ICSOP failed to meet its contractual notice obligations. 

ICSOP conceded that its initial notice tendered in 2009 was untimely, but ICSOP asserted there was a genuine dispute regarding whether Argonaut had constructive notice.  California courts have recognized that constructive notice to a co-insurer satisfies the obligation to give notice under an insurance policy. 

ICSOP’s sole support for its constructive notice argument was speculation that Argonaut may have received notice in 2002 pursuant to a different reinsurance agreement between ICSOP and Argonaut, known as the Miscellaneous Special Business Treaty (“MSB Treaty”).   The 1974 ICSOP Policy was one of the policies that fell within a class of policies or book of business covered by the MSB Treaty.  

ICSOP contended that, if received, this notice would have alerted Argonaut to the possibility that the reinsurance agreement could have been triggered.  ICSOP pointed to two notices generated by ICSOP’s computer system with respect to the MSB Treaty in 2000 and 2002.  According to ICSOP, these notices were sent to Guy Carpenter, AIG’s reinsurance broker, in 2000 and 2002, and would have satisfied its notice obligation.  ICSOP evidently concedes, however, that the 2000 notice never reached Argonaut. In addition, inspection of Guy Carpenter and Argonaut’s files uncovered neither notice.  The court found ICSOP had not presented evidence from which a reasonable trier of fact could conclude that Argonaut had notice of any facts relating to the claim in 2002 that would have put Argonaut on notice of a potential claim.

Under California law, an insurer may assert defenses based upon a breach by the insured of a condition of the policy, such as a notice clause, but the breach cannot be a valid defense unless the insurer was substantially prejudiced by the breach.  The burden of proving such prejudice is placed on the reinsurer.  Where the reinsurer has lost the right to associate itself with the underlying litigation due to late notice, the loss of that right will only establish prejudice if the reinsurer shows that the results of the litigation would have been different with its participation. 

Argonaut was judged to have submitted sufficient evidence to raise a genuine issue of disputed fact with respect to whether it was prejudiced in at least two ways by ICSOP’s breach of the notice provision:  (1) that Argonaut’s participation in the litigation would have resulted in not merely an earlier settlement, but a more advantageous one as well; and (2) that Argonaut had previous claims adjustment experience with settling asbestos claims. 

Argonaut also submitted evidence suggesting that the 1974 ICSOP Policy exhibited a number of characteristics that would have raised a “red flag” for Argonaut, had it received earlier notice.  In particular, Argonaut notes that its $1,000,000 per-occurrence indemnification obligation under the Facultative Certificate was significantly higher than its average obligation under its treaty reinsurance agreements, which constituted the bulk of its business.  According to Argonaut, the fact that the Facultative Certificate was written without an aggregate limit would have also raised a red flag.  Under the circumstances, however, a reasonable trier of fact could conclude that Argonaut was substantially prejudiced by ICSOP’s provision of late notice.

Of critical importance, the court explained that Argonaut might be relieved of its burden to show prejudice if it could demonstrate that ICSOP acted in bad faith in not providing Argonaut with timely notice.  This exception to the requirement to show prejudice arises from the unique relationship between ceding companies and reinsurers. 

According to the U.S. Court of Appeals for the Second Circuit, because information concerning the underlying risk lies virtually in the exclusive possession of the ceding insurer, a very high level of good faith is required to ensure prompt and full disclosure of material information without causing reinsurers to engage in duplicative monitoring.  The Second Circuit concluded that a ceding insurer’s failure to provide prompt notice will entitle a reinsurer to relief without showing prejudice if (1) the ceding insurer deliberately deceives a reinsurer or (2) the ceding insurer fails to implement routine practices and controls to ensure notification of claims to reinsurers. 

Although California courts have not decided whether to recognize a bad faith exception to the notice-prejudice rule in the reinsurance context, the Second Circuit predicted that it would recognize such an exception.

 

Should you have any questions or comments, please contact Colodny Fass& Webb.

 

 

Click here to follow Colodny Fass& Webb on Twitter (@CFTLAWcom)

 

 

 

To unsubscribe from this newsletter, please send an email to Brooke Ellis at bellis@cftlaw.com.