United States: California Supreme Court Applies Notice-Prejudice Rule To Violation Of First-Party Consent Provision As A Predicate To Policy Forfeiture, But Confirms That No Prejudice Is Required To Enforce A Third-Party "No Voluntary Payments" Provision

Pitzer College v. Indian Harbor Insurance Company, — P.3d –, 2019 WL 4065521 (2019); California Supreme Court, Case No. S239510 (Aug. 29, 2019).

On certified questions by the Ninth Circuit Court of Appeals, the California Supreme Court in Pitzer College v. Indian Harbor Insurance Company examined notice and consent provisions under both first-party and third-party coverage – despite the parties' dispute as to the type of policy coverage at issue.

During construction of a new college dormitory, Pitzer College discovered darkened soils indicative of pollution contamination. Because of pressure to complete construction before the next academic year, Pitzer spent $2 million to remediate the pollution without giving notice to Indian Harbor Insurance Company, which covered Pitzer for legal and remediation expenses. When Pitzer sought to recover the remediation expenses under its insurance policy, Indian Harbor denied coverage based on Pitzer's failure to give notice as soon as practical and its failure to obtain the insurer's consent before incurring the expenses. Pitzer sued for declaratory relief and breach of contract.

Applying New York law because of a choice of law provision in the policy, the California district court granted summary judgment in favor of Indian Harbor. As the court explained, for policies issued and delivered outside of New York, like Pitzer's policy, New York law did not require the insurer to prove any prejudice resulting from the insured's late notice. Thus, Pitzer's failure to timely notify Indian Harbor of the "pollution condition" negated coverage. The district court also separately found that Pitzer had violated the policy's consent provision – barring Pitzer's right to seek reimbursement of the remediation costs.

As a threshold matter, the California Supreme Court examined the choice of law issue – that is, whether New York or California law governed application of the notice provision, which mattered because of significant differences between each state's laws. The Court explained that the parties' selection or choice of law generally governs unless: (1) it conflicts with a state's fundamental public policy; and (2) that state has a materially greater interest in the determination of the issue than the contractually chosen state.

The Court concluded that "California's notice-prejudice rule is a fundamental public policy" of the state. As a defense to coverage, the rule requires an insurer to prove substantial prejudice because of an insured's failure to give timely notice of a loss or claim. "The insured's delay does not itself satisfy the burden of proof." Rather, the insurer must show "a substantial likelihood that, with timely notice . . . it would have settled the claim for less or taken steps that would have reduced or eliminated the insured's liability." (Internal quotes and citation omitted.) Thus, in the third-party liability context, "the insurer must show that timely notice would have enabled it to achieve a better result in the underlying third party action."

But, in the context of the choice of law analysis, the Court stopped there – returning the issue to the Ninth Circuit to determine "whether California has a materially greater interest than New York in determining the coverage issue, such that the contract's choice of law would be unenforceable because it is contrary to our fundamental public policy."

Nevertheless, the Court continued to analyze whether California's notice-prejudice rule extends to consent provisions under first-party coverages. In other words, in the context before it, whether Indian Harbor had to show substantial prejudice arising from Pitzer's voluntary payment of the remediation expenses without the insurer's consent to support a claim denial. The Court concluded that "the notice-prejudice rule makes good sense for consent provisions in first party policies as it does for notice provisions." It reasoned that both notice and consent provisions are ancillary to the insured's duty to pay premiums in exchange for the insurer's duty to defend, indemnify or cover losses or remediation expenses. Both provisions are intended to protect the insurer's interests in performing its duties. But, according to the Court, strict enforcement of those provisions without substantial prejudice to the insurer would allow the insurer "to reap the benefits flowing from the forfeiture of the insurance policy." (Citation omitted.)

Thus, the Court concluded that "the notice-prejudice rule . . . applies to consent provisions in first party insurance policies."

The Court, however, contrasted its holding with the enforcement of consent or "no voluntary payment" provisions under third-party liability coverage. In the context of third-party liability coverage, an insurer that accepts its insured's tender of defense takes control over the defense and settlement of the claim. As a result, consent provisions under liability coverages generally preclude the insured from unilaterally settling claims. Because of the insurer's right to control the defense and settlement of claims, California courts have refused to apply the notice-prejudice rule to an insured's violation of a "no voluntary payments" provision in third-party policies.

Ultimately, despite its examination of California law governing notice and consent provisions, the Court could not determine if the notice-prejudice rule applied to the consent provision of Pitzer's policy. That is because the parties disputed whether the remediation coverage reflected first-party or third-party coverage. That issue was left for the Ninth Circuit to resolve.

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