Choosing The Right Time to Give Notice Under A Claims-Made Policy

On the other hand, if the policyholder fails to report a "notice of circumstance" which later becomes a claim, coverage could be denied under the earlier policy for failure to satisfy the policy's reporting requirements.

Recently, two cases dealt with this dilemma, exposing a split over how strictly courts will interpret the reporting requirements found in a claims-made policy.

In the first case, titled Root v. American Equity Insurance, Co., a California Appeals Court (Fourth Appellate District) applied equitable considerations to determine that a claim noticed after the policy period was nevertheless covered. In Root, the complaint was served on the last day of the policy period and the insured immediately notified the insurer of the claim.

In the second case, titled Precis v. Federal Insurance Co., a federal district court in Texas was far less forgiving. The court ruled that coverage was precluded when the insured did not strictly comply with the reporting requirements set forth in the policies. The Precis court ruled that two letters sent by the plaintiffs in the underlying action to the insured over eight months before any action was filed should have been reported to the carrier. Because the insured did not report the claim until the next policy period, after the actual suit was filed, the court ruled that coverage was precluded under both policy periods.

In both cases, the policies contained similar reporting requirements. The policies required that the policyholder give written notice of any claim "as soon as practicable" during the policy period. Neither policy contained an extended reporting provision.

Nevertheless, despite the fact that the claims in both cases were noticed after the policy period, the courts came to strikingly different conclusions. The difference turned on how much leeway the courts were willing to give the insureds so that the result was "fair."

The underlying claim in Root involved an attorney malpractice action which was not served on the insured until the last day of the policy period. Several days before being sued, the attorney received a call from a legal journal about the action, but thought the call was a prank. When the complaint was finally served, the attorney was on vacation and unable to report the claim until several days after the policy period had expired.

The court ruled that fairness required the court to ignore the policy's strict reporting requirements and find coverage.

The Precis court was not as forgiving. In that case, Precis Inc. apparently received letters from several of its customers complaining that they had lost money and demanding compensation. The letters were received during the 2002-to-2003 policy period. Federal Insurance Co. was Precis' D&O carrier at that time.

Precis, however, never reported the letters to Federal. Instead, it waited until a complaint was filed and served, which did not occur until at least three months after the 2002-to-2003 policy period expired. By this time, Zurich American Insurance Company was providing the D&O coverage–not Federal. Both Zurich and Federal denied coverage.

The court agreed with both carriers.

The court ruled that the "demand" letters were claims, which needed to be reported under the Federal policy in order for coverage to exist. Coverage, therefore, was excluded under the Federal policy for failure to satisfy the policy's reporting requirements.

Coverage also was excluded under the Zurich policy based on the known-loss doctrine. This doctrine prevents an insured from obtaining coverage for a loss which the insured knew about before the policy was issued.

What is interesting about the two cases is how little the courts differ in their reasoning compared to how much the courts differ in their conclusions.

In both cases, the courts refused to apply what has been termed the "notice-prejudice rule." That rule prevents an insurer from denying coverage based on the reporting requirements unless the insurer was actually prejudiced by the lateness of notice.

Instead, the courts both ruled that the reporting requirements were "conditions precedent" to coverage–in other words, the reporting requirements needed to be met before any coverage would arise under the policies. The only real difference between the cases, therefore, is the Root court's decision to consider issues of fairness in a way that would overrule the explicit reporting requirements set forth in the policy.

These cases raise interesting questions for D&O policyholders facing investigations and other informal inquiries that might not themselves constitute a claim.

On the one hand, if these insureds fail to report those claims, they could find themselves in the same circumstance as Precis–failing to report something that a court later deems was a claim.

On the other hand, if they do report these circumstances, they open themselves up to the known-loss doctrine.

The wild card, therefore, will be the extent to which courts are willing to consider a fairness argument, like the one used in Root. Such arguments are inherently subjective, leaving a level of uncertainty with respect to coverage that does not benefit either the insured or the insurer.

John D. Hughes is a partner, and Steven D. Morris an associate in the Insurance and Reinsurance Department of Edwards & Angell. Mr. Hughes may be reached at JHughes@EdwardsAngell.com, and Mr. Morris may be reached at SMorris@EdwardsAngell.com. Edwards & Angell is a 350-attorney national law firm focusing on private equity & venture capital, financial services and technology.

Art caption (for envelope art)

In one case involving the issue of late notice, a court ruled that letters sent by the plaintiffs to the insured months before they filed suit against the insured should have been reported to a D&O carrier when they were received.

Pullquote or Art Caption for Rock/Hard Place==Dilemma Art

Between A Rock and A Hard Place.Insureds face a dilemma with respect to "notice of circumstance" when they move coverage from one carrier to another. Reporting before the policy period ends could prompt the new carrier to deny coverage when a suit is filed during the next policy period. Failing to give notice, however, may prompt a denial from the prior carrier.