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Legal prejudice

Maryland law generally prohibits an insurer from denying liability insurance coverage on grounds of late notice unless it can show that the untimely reporting caused actual prejudice.

Given the sense of dread that must come with being sued, it is amazing how often – and how long – defendants can sometimes delay in putting their insurance carriers on notice of claims.  And yet, it happens time and again.  These delays can run afoul of contract clauses inserted by carriers to facilitate prompt investigation of claims, which require prompt notice of accidents, occurrences and/or claims as “conditions precedent” to coverage.

In some states – and in Maryland before 1964 – courts strictly upheld these notice provisions as mandatory “conditions precedent” to coverage.  In 1964, however, a carrier denied coverage on grounds that notice was given one month after an accident.  This drew the “prompt and decisive”[i] attention of the Maryland legislature, which thenceforth prohibited insurers from disclaiming coverage on grounds of late notice (or lack of cooperation) unless the insurer could show actual prejudice from the delay.[ii]  Thereafter, Maryland courts have construed notice provisions as non-obligatory covenants rather than strict conditions precedent.

At the time of enactment, most liability policies were written on an “accident” or “occurrence” basis.  Since then, more policies were written on a claims-made basis, where risks could be more easily quantified and rated, and premiums calculated to match.  Initially, it was an open question whether the statutory prejudice requirement would apply to these policies.  Like bubblegum attached to the sole of a shoe, however, it soon became clear that the prejudice requirement could not be easily dislodged from a late notice disclaimer.

The prejudice requirement was applied very quickly to “claims-made” policies.  This seemed logical.  An occurrence policy provides coverage if there is bodily injury or property damage during the policy period; a claims-made policy provides coverage if there is a claim made against the insured during the policy period.  Under either scenario, notice to the carrier is simply a subsequent requirement after coverage has already attached.  But “claims-made-and-reported” policies seemed different.  From the insurer’s viewpoint, coverage under these policies is not implicated until a claim is both “made” against the insured and “reported” to the insurance company; this provides predictability in anticipating claims, with corresponding benefits on premiums.  Under these policies, the failure to timely report seemed not to be merely “late notice,” but an absence of the very event that implicates coverage in the first place.  In other words, a “condition precedent” to coverage.  Sound familiar?

So insurers continued to deny coverage under these policies for claims made against an insured during the policy but not reported to the carrier until after the policy period, despite the absence of actual prejudice.  This rationale seemed to be supported by a pair of earlier decisions of the Maryland Court of Appeals.[iii]  But all this changed on Feb. 24, 2011, when the court held that a showing of prejudice was required to deny coverage on late notice grounds, even under a policy that defined a “claim” to mean one made against the insured and reported to the insurer. [iv]

The full import of that case, Sherwood Brands Inc. v. Gt. Am. Ins. Co., is not yet clear; for now, this state-law question has generated conflicting authorities in the federal courts.  Two federal trial judges have ruled that no showing of prejudice is required to deny coverage under a claims-made-and-reported policy. [v]  In later affirming one of these rulings, the Fourth Circuit articulated and rested its holding on a quite different ground, namely, that actual prejudice had in fact been shown.[vi]  Two other trial judges have held that the prejudice requirement does apply to claims-made-and-reported policies.[vii]

Overall, this may not bode well for the insurer’s position, and in handling claims or rating such policies in the future, a prudent insurer should assume that late notice alone is not enough deny coverage under a claims-made-and-reported policy, assuming the claim against the insured itself is within the coverage period.  One day, this may all be clarified further.  In the meantime, prejudice is the word of the day.  Have you noticed?

[i] Sherwood Brands, Inc. v. Great Am. Ins. Co., 418 Md. 300, 311 (2011).

[ii] Md. Code Ann. Ins. § 19-110 (originally enacted in Chapter 185 of the Acts of 1964).

[iii] St. Paul Fire & Mar. Ins., Co. v. House, 315 Md. 328 (1989); T.H.E. Ins. Co. v. P.T.P. Inc., 331 Md. 406 (1993).

[iv] Sherwood Brands, 418 Md. at 333.

[v] Minnesota Lawyers Mut. Ins. Co. v. Baylor & Jackson, PLLC, 852 F.Supp.2d 647 (D.Md. 2012) (Bredar, J.); Financial Indus. Reg. Auth. v. Axis Ins. Co., 951 F.Supp.2d 826 (D.Md. 2013) (Grimm, J.).

[vi] Minnesota Lawyers Mut. Ins. Co. v. Baylor & Jackson, PLLC, 531 F.App’x 312 (4th Cir. 2013).

[vii] McDowell Bldg., LLC v. Zurich Am. Ins. Co., 213 WL 5234250 (D.Md. Sept. 17, 2013) (Bennett, J.); Navigators Spec. Ins. Co. v. Medical Benefits Adm’rs of Md., Inc., 2014 WL 768822 (D.Md. Feb. 21, 2014) (Hollander, J.).