In Pitzer College v. Indian Harbor Ins. Co. (No. S239510, filed 8/29/19), the California Supreme Court held that California’s notice-prejudice rule is a fundamental public policy in the insurance context, supporting the application of California law under a choice of laws analysis. In addition, the Court held that the rule generally applies to consent (aka “no voluntary payments”) provisions in first party insurance policies but not to consent provisions in third party liability policies.
Pitzer College discovered soils contamination while building a new dormitory. Under pressure to complete construction before the start of the school year, Pitzer proceeded to remediate the soils, incurring $2 million in expense. Pitzer submitted a claim to Indian Harbor, which provided Pitzer insurance covering legal and remediation expenses resulting from pollution conditions discovered during the policy period.
The policy contained a notice provision requiring Pitzer to provide oral or written notice of any pollution condition to Indian Harbor and, in the event of oral notice, to “furnish … a written report as soon as practicable.” In addition, a consent provision required Pitzer to obtain Indian Harbor’s written consent before incurring expenses, making payments, assuming obligations, and/or commencing remediation due to a pollution condition. The consent provision had an emergency exception for costs incurred “on an emergency basis where any delay … would cause injury to persons or damage to property or increase significantly the cost of responding to any [pollution condition],” in which case Pitzer was required to notify Indian Harbor “immediately thereafter.” Lastly, a choice of law provision stated that New York law governed all matters arising under the policy.
A federal district court in California held that New York law applied and that New York’s strict common law no-prejudice rule barred coverage where timely notice was not provided, entering summary judgment for Indian Harbor. The district court also held that the consent condition had been violated, barring coverage on that ground as well. The court noted that if prejudice were required, summary judgment would have been improper. Uncertain about the district court’s application of New York law, the 9th Circuit Court of Appeals certified a question to the California Supreme Court whether the notice-prejudice rule is a “fundamental public policy” in California, thus affecting the choice of laws analysis.
The Pitzer court said that in California, if there is a fundamental conflict between the chosen state’s and California law, the court must then determine whether California has a “materially greater interest than the chosen state in the determination of the particular issue….” (Citing Rest., § 187, subd. (2).) And if California has a materially greater interest than the chosen state, “the choice of law shall not be enforced, for the obvious reason that in such circumstance [California courts] will decline to enforce a law contrary to this state’s fundamental policy.”
The Pitzer court analyzed the history of the notice-prejudice rule to conclude that “California’s notice-prejudice rule is a fundamental public policy of California. The rule is based on the rationale that the essential part of the contract is insurance coverage, not the procedure for determining liability, and that ‘the notice requirement serves to protect insurers from prejudice,… not … to shield them from their contractual obligations through ‘a technical escape-hatch.’’’  Prejudice is a question of fact on which the insurer has the burden of proof.  The insured’s delay does not itself satisfy the burden of proof.  The insurer establishes actual and substantial prejudice by proving more than delayed or late notice. It must show ‘a substantial likelihood that, with timely notice, and notwithstanding a denial of coverage or reservation of rights, it would have settled the claim for less or taken steps that would have reduced or eliminated the insured’s liability.’  In the context of third party coverage, for example, the insurer must show that timely notice would have enabled it to achieve a better result in the underlying third party action.”
In addition to notice, the Pitzer court also analyzed the policy’s consent (“no voluntary payments”) condition, reaching a split result as between first and third party coverages, and saying that “a consent requirement serves a role beyond the requirement to give prompt notice of a coverage event.”
As regards, first party coverage the Pitzer court concluded that “at core, the purposes [requiring showing prejudice for a consent condition] are much the same as those pertaining to notice provisions. They all facilitate the insurer’s primary duties under the contract and speak to minimizing prejudice in performing those duties. For these reasons, the notice-prejudice rule makes good sense for consent provisions in first party policies just as it does for notice provisions.”
However, “[in] third-party insurance policies … consent provisions, sometimes called “no voluntary payment” provisions, ‘are designed to ensure that responsible insurers that promptly accept a defense tendered by their insureds thereby gain control over the defense and settlement of the claim.’” Citing Jamestown Builders Inc. v. General Star Indemnity Co. (1999) 77 Cal.App.4th 341, 346, the Pitzer court said that “consent clauses mean that ‘insureds cannot unilaterally settle a claim before the establishment of the claim against them and the insurer’s refusal to defend in a lawsuit to establish liability…. In short, the provision protects against coverage by fait accompli.’  The insurer’s duties to defend and settle a lawsuit are crucial to its coverage obligations.” Thus, the Pitzer court confirmed that prejudice is not a required showing for a consent condition to bar third party coverage.
There was no dispute that Pitzer College had incurred remediation expense without giving notice or obtaining the consent of Indian Harbor, but having concluded that a consent clause may or may not require a showing of prejudice depending on whether the policy provides first or third party coverage, the Pitzer court was ultimately forced to return the matter to the 9th Circuit Court of Appeals for further consideration, because Pitzer and Indian Harbor disputed whether the wording of Indian Harbor policy provided first or third party coverage, because it responded to both claims made against insureds and remediation expense for pollution conditions discovered during the policy period, without apparent regard to a claim being made. Analysis of the policy wording had not been part of the question certified to the Supreme Court, requiring a further determination by the federal court.