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Breach Of Cooperation And Notice Requirement Clauses Require Substantial Prejudice To Deny Coverage

Insurance companies frequently take aggressive coverage positions and deny coverage when they believe their insured is not cooperating or has failed to provide notice of a claim within a reasonable period of time.


Would you like to know how to establish coverage when the insurance company denies coverage based upon its insured’s breach of the cooperation and notice clauses of the policy?  If so, read on.

Crackhead Craig Chronicles, Chapter 41

Crackhead Craig’s nephew from West Virginia, Billy Bob Craig, was visiting his uncle in San Diego.  Crackhead was tied up at work at Jimmy “The Bud” Weedman’s new recreational marijuana dispensary and couldn’t go with his nephew to Mission Beach.  Crackhead lent Billy Bob his monster truck.  Billy Bob was driving along Mission Boulevard and became distracted when he saw so many pretty girls walking along the sidewalk.  Billy Bob had seen nothing like that in West Virginia.  While whistling out his window at a group of girls, Billy Bob ran through a red traffic signal and collided with a vehicle operated by Eggshell Eddie.  The property damage was moderate, but Eggshell Eddie suffered several fractures to his spine and was hospitalized for three weeks in ICU. 

Billy Bob returned the truck to his uncle and told him he had collided with a lamp post in a parking lot.  Crackhead Craig was insured by Allsnake Insurance Company, but did not notify Allsnake of the damage to the truck because he didn’t want his premiums to increase.  Billy Bob became worried his uncle would find out the truth and caught the first bus out of town.  Crackhead Craig did not know how to contact Billy Bob since he did not return to his home in West Virginia and none of his relatives knew where he had gone.  

Eggshell Eddie retained Attorney Seickem Bulldog to represent him in his claims against Billy Bob Craig.  Attorney Bulldog submitted a settlement demand to Allsnake.  Allsnake contacted Crackhead Craig, who informed Allsnake he had lent the truck to Billy Bob but that he had no notice of the accident with Eggshell Eddie and had been told by Billy Bob that the truck had collided with a lamppost.  Crackhead Craig provided Allsnake with Billy Bob’s last known address and his cell phone number.  Allsnake wrote letters to Billy Bob and left messages on his voicemail, but Billy Bob never responded to Allsnake.  Allsnake notified Attorney Bulldog it was denying coverage for the loss because Billy Bob had breached the cooperation clause and had also failed to notify them of the accident as required by the policy. 

Attorney Bulldog filed suit against Billy Bob Craig, arranged service of process by publication, and thereafter obtained a default judgment for $1.2 million.  Attorney Bulldog filed a second lawsuit under Insurance Code section 11580 against Allsnake to enforce the judgment.  Allsnake answered the complaint and moved for summary judgment on the basis that there was no coverage under the policy because Billy Bob Craig had breached the cooperation clause by failing to return its phone calls or respond to its letters and had also breached the notice requirement that required him to give notice of the accident within a reasonable period of time.

Attorney Bulldog filed his own motion for summary adjudication, requesting the court to declare that the defenses of the breach of the cooperation clause and the failure to provide a timely notice of the accident were without merit as a matter of law because Allsnake had not established facts that it suffered substantial prejudice by the lack of cooperation or the lack of notice.  The motions were consolidated to be heard simultaneously by Judge Solomon.

Breach of Cooperation Clause and Notice Requirements Require Carrier to Establish Substantial Prejudice

The interpretation of an insurance policy is generally a question of law and follows the general rules of contract interpretation.  (MacKinnon v. Truck Ins. Exchange (2003) 31 Cal.4th 635, 647.)  However, courts are mindful of the “disparate bargaining status of the parties” in the insurance context (Gray v. Zurich Insurance Co. (1966) 65 Cal.2d 263, 270.)  Therefore, “coverage clauses are interpreted broadly so as to afford the greatest possible protection to the insured [while] exclusionary clauses are interpreted narrowly against the insurer.”  (Reserve Insurance Co. v. Pisciotta (1982) 30 Cal.3d 800, 807-808.)

Although an injured party may sue the insurer on the insurance policy pursuant to Insurance Code section 11580 after obtaining judgment against the insured, the insurance company may still assert any defenses based upon a breach by the insured of a condition of the policy such as a cooperation clause, but the breach cannot be a valid defense unless the insurer was substantially prejudiced.  (Campbell v. Allstate Ins. Co. (1963) 60 Cal.2d 303, 305.)  Substantial prejudice must also be shown when asserting the coverage defense of the breach of any notice provision.  (Id. at p. 306.)  The burden of establishing substantial prejudice is on the insurer.  (Id.)

Even where express language in an insurance policy requires the insured’s cooperation and timely notice of a claim to the insurer, the courts have modified or supplemented the language on essentially public policy grounds to require the insurer to establish it was substantially prejudiced by the breach of those clauses.  (Rosen v. State Farm General Ins. Co. (2003) 30 Cal.4th. 1070, 1081.)

To demonstrate substantial prejudice from the lack of timely notice or the breach of the cooperation clause, an insurer must show it lost something that would have changed the handling of the underlying claim.  To establish actual prejudice, the insurer must show a substantial likelihood that, with timely notice, and notwithstanding its denial of coverage or any reservation of rights, it would have settled the claim for less or taken steps that would have reduced or eliminated the insured’s liability.  (Belz v. Clarendon America Ins. Co. (2007) 158 Cal.App.4th 615, 632.)  Prejudice will not be presumed simply from the insured’s failure to cooperate even though the failure interferes with or otherwise prevents a thorough and prompt investigation of the accident.  The burden is upon the insurer to prove substantial prejudice.  (Id. at p. 632.)

Some carriers have rewritten their policies to make notice of the claim as a condition precedent to coverage.  However, the courts have held that such attempts to make notice a condition precedent to coverage are “… insufficient to defeat California’s strong public policy behind the notice-prejudice rule.”  (Service Management Systems, Inc. v. Steadfast Ins. Co., 216 F.Appx. 662, 664 (9th Cir. 2007); See also, Rosen v. State Farm General Ins. Co., supra, 30 Cal.4th at p. 181.)

Where the insurance company erroneously denies coverage based upon the lack of cooperation or notice, the insured is no longer obligated to request a defense or to otherwise notify the insurer of the service of the summons and complaint.  (Samson v. Transamerica Ins. Co. (1981) 30 Cal.3d 220, 239.)  While the insured owes no duty to cooperate with the carrier after coverage has been denied, an insurance company may still raise the defense of collusion against any third-party claimant where there was a stipulated judgment of an excessive amount against the insured because such conduct breaches the insured’s duty of the cooperation clause and also breaches the covenant of good faith and fair dealing.  (Andrade v. Jennings (1997) 54 Cal.App.4th 307, 327.)

The notice prejudice rule has also been applied to life insurance policies.  In one case, the insured became disabled due to cancer and was unable to pay her premiums for her life insurance policy.  The insured failed to notify the life insurance carrier of her disability.  The life insurance carrier sent several notices of its intention to cancel the life insurance policy for the insured’s failure to pay the premiums.  The insured died of cancer.  Her heirs brought suit against the life insurance carrier and contended that their mother (the insured) had been relieved of her obligation to pay further premiums once she became disabled due to a separate provision of the life insurance policy that relieved her of that premium payment obligation.  The life insurance carrier argued that the insured had failed to notify it of her disability and therefore the waiver of premium provision was not triggered.  The court agreed with the heirs and held that the notice prejudice rule came into play and there was no substantial prejudice to the life insurance carrier of the lack of notice of the disability since the facts establish that she was disabled due to her cancer, which relieved her of any obligation to pay further premiums on her policy.  Since that separate provision of relieving her of an obligation to pay for the premiums was triggered by her disability, the cancellation based upon the failure to pay the premiums was improper and ineffective.  (See Lat v. Farmers New World Life Ins. Co. (2018) 28 Cal.App.5th 212, 220.) 

The rule of requiring substantial prejudice to avoid late notice has been generally held inapplicable to claims-made professional liability insurance policies.  Under most professional liability insurance policies, the policyholder is required to notify the carrier of any claims or suspected claims that might be brought against the insured.  If the insured fails to give timely notice in writing to the insurance carrier as required by the claims-made policy, the claim is generally barred even absent a showing of prejudice by the insurance company.  (Pacific Employers Ins. Co. v. Superior Court (1990) 221 Cal.App.3d 1348, 1357.)  The courts have distinguished between generally liability and automobile insurance policies which are occurrence policies and professional liability policies which are claims-made policies.  (Id. at p. 1357-1361.)  The courts will not relieve an insured from failing to provide timely notice of a claim in a professional liability setting when the policy is a claims-made type policy.  (Id.)  However, the court may still excuse the late notice based upon the application of equitable principles.  (Root v. American Equity Specialty Ins. Co. (2005) 130 Cal.App.4th 926, 947-948.)

In the hypothetical situation involving Eggshell Eddie, Allsnake suffered no prejudice by the lack of notice or cooperation by its insured.  It learned of the claim when it received the settlement package from Attorney Bulldog.  While the lack of any response from Billy Bob may have interfered with its investigation, Allsnake could still have investigated the accident and obtained the traffic collision report, talked to witnesses referenced in the report, and viewed the damages to Eggshell’s vehicle and Crackhead Craig’s vehicle.  Liability was reasonably clear by Billy Bob’s failure to keep a proper lookout and traveling at an unsafe rate of speed, which ultimately led to his vehicle colliding with the vehicle operated by Eggshell Eddie.  It could review and analyze Eggshell Eddie’s medical records provided by Attorney Bulldog and negotiate a reasonable settlement.  Instead of trying to reduce its exposure, Allsnake simply denied the claim based upon the cooperation and notice provisions of its policy.  Based upon the lack of substantial prejudice, Allsnake should lose its motion and Eggshell Eddie should win his motion to establish there was coverage.  Since the judgment was entered following prove-up hearing, there would be no basis for Allsnake to contend that the judgment was entered by way of collusion with Billy Bob.

Conclusion

Insurance companies frequently take aggressive coverage positions and deny coverage when they believe their insured is not cooperating or has failed to provide notice of a claim within a reasonable period of time.  California law is strong and clear that a carrier has the burden of proof to establish that it was substantially prejudiced by the lack of cooperation or the untimely notice.  Whenever a carrier asserts those defenses, point out the lack of any facts to establish substantial prejudice to the insurance company.  Should the insurance company continue to deny coverage, file suit, have default judgment entered and a finding made by the court on the value of the claim, and thereafter pursue your direct action against the carrier.  In your direct action, move for summary adjudication to have those defenses stricken and have the court order there was no evidence of substantial prejudice.


This article was also published in the Trial Bar News. The APA citation for the Trial Bar News article is as follows:

Copley, R. K. (2019). Breach of cooperation and notice requirement clauses require substantial prejudice to deny coverage. Trial Bar News, 42(2), 11-12, 28-29.

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