The next wave: Insurance prejudice cases

By | March 20, 2006

Sometimes law practice reminds me of floating on a surfboard out in the bay. You watch and wait, and the waves come rolling in, always in groups, and you are watching for the one perfect wave. Legal issues seem to often follow the same pattern–you wait and watch, and then after a lull, a new set of issues roll in, and you look for the one case that sets the standard.

Take the recent spate of insurance prejudice cases. Several years ago we had a run of opinions involving late notice or consent to settle provisions dealing with the requirement of prejudice to bar coverage. Then the issue became quiet for a while. Now, it appears that a new set of prejudice cases are rolling in. And just as in a set of waves there is usually one to grab, you wonder, which issue or case will be the one to focus on?

The duties of the insured
Let’s start with the basics. Insurance policies impose all kinds of duties on the insured. Beyond simply paying the premium, the insured is commonly required to provide notice of any accident or event that might give rise to coverage “as quickly as practical” (i.e., “Now”). Another duty is to provide any suit papers to the carrier immediately upon receipt. Yet another duty is to cooperate with the carrier in the prosecution of any litigation, and not to settle the case without carrier participation or approval.

The curious thing about these duties is that, while they are “material” and very important to the carrier, the insured is often in no danger if it breaches those duties and the carrier is not clearly harmed. Take late notice for instance. Except in a few jurisdictions, such as New York, an insured is not barred from coverage unless the carrier suffers actual real harm (in insurance law, harm is always referred to as “prejudice”) from the delay in receiving notice of the occurrence or tender of the suit papers. In other words, “No harm, No foul.” Likewise, many jurisdictions require a similar finding of prejudice in connection with any of the insured’s major duties, such as voluntary payments and failure to cooperate. Consequently, in litigation involving breaches of conditions precedent, the key issue is often not the alleged breach, but whether there is harm from the breach.

What is prejudice?
Since a carrier must show prejudice in order to enforce these duties of the insured, the inevitable question is, “What is prejudice?”.

The Texas Supreme Court, back in 1994, tentatively approached prejudice by focusing on the “materiality” of the breach; simply put, did the failure to comply by the insured have a real, or “material” impact on the carrier. In Hernandez v. Gulf Group Lloyds, 875 S.W.2d 691 (Tex. 1994), the Court observed that in determining prejudice the fact finder should consider “the extent to which the non-breaching party will be deprived of the benefit that it could reasonably have anticipated from full performance.”

Similarly, various federal courts have found that prejudice due to late notice depends upon whether the carrier has suffered an adverse change in position due to the insured’s actions.

Still, what circumstances will give rise to harm? One federal court attempted to actually list the types of circumstances where prejudice exists. The Court’s catalogue went:

“Texas courts have found that an insurer was prejudiced from lack of notice by its insured (1) when the insurer, without notice or actual knowledge of the suit, received notice after entry of a default judgment against the insured; (2) when the insurer received notice of the suit, but the trial date was fast approaching, thereby depriving it of an opportunity to investigate the claims or mount an adequate defense; (3) when the insurer received notice of a lawsuit after the case had proceeded to trial and judgment had been entered against the insured; and (4) when the insurer received notice of a default judgment against its insured after the judgment had been final and could not be appealed.”

[Clarendon Nat’l Ins. Co. v. FFE Transportation Services, Inc., 2004 Westlaw 3210604 (N.D. Tex. November 29, 2004)(unpublished).]

Unfortunately, the Court’s attempt to layout the exclusive areas of prejudice does not really appreciate the many circumstances that can lead to adversely affecting the carrier from an insured’s breach. It ignores fact-specific harms that may arise such as where an investigation immediately after an accident would provide new defenses or risk shifting for the insured, or where the delay of the investigation results in rendering an investigation less useful or meaningless. Simply put, attempts to categorize the specifics of prejudice ignore the necessity of reviewing each breach on its own facts and merits.

After a long lull, and obvious confusion as to what constitutes prejudice as outlined by the courts, we now have a spate of new prejudice cases breaking in the last few months. On Jan. 26, 2006, the Fifth Circuit issued an opinion discussing the parameters of prejudice in Donna Rae Gibbons-Markey v. Texas Medical Liability Trust, 2006 Westlaw 166291 (5th Cir. Jan. 23, 2006); and yet another opinion touching on prejudice followed in Motiva Enterprises, L.L.C. v. St. Paul Fire & Marine Ins. Co., No. 05-20139 (5th Cir. Feb. 6, 2006). In addition, there are at least four other federal and state trial court cases exploring the scope of prejudice currently working their way through the trial and appellate courts.

So the next set of prejudice cases are now rolling in. The crest of this wave of cases, so far, is that some trial courts want to treat prejudice as an issue of law (which they can decide summarily) rather than let it go to a jury. For instance, in Motiva, the trial court granted summary judgment against the insured finding prejudice as a matter of law when the carrier was prevented from participating in settlement negotiations. The Fifth Circuit threw out the summary judgment, concluding that prejudice is a fact issue for a jury, rather than subject to judicial fiat. This is significant as there has been several trial court cases in recent years, some of which were appealed, where courts granted summary judgment in similar prejudice cases as a matter of law. In some cases, such as New Era of Networks, Inc. v. Great Northern Ins. Co., the Judge found prejudice existed; while in others, such as Travelers Indemn. Co. v. Presbyterian Healthcare Resources, the judge found no prejudice.

Following Motiva, it is likely that trial courts will be more sensitive to the factual settings surrounding a claim of prejudice and will be more inclined to leave those issues for the jury. This is proper, because the issue of prejudice should be one that the jury addresses. This, of course, can cut both for and against carriers. In Motiva, the court set aside a summary judgment for a carrier and sent it back to the trial court for determination. But in many circumstances, it will be the carrier who is facing a summary judgment from a sympathetic policyholder arguing that the only evidence of prejudice is speculative or circumstantial. Yet, proving prejudice due to delays or lack of cooperation by necessity requires some level of supposition as to what should and could have been done. It is exactly that kind of evidence that should be placed in front of a jury to determine whether the carrier was harmed.

Is Motiva the big wave or the beginning of a lull?

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.

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