Consider a common situation: Your client has a professional liability insurance policy with a policy period from June 1, 2018, to June 1, 2019. On August 1, 2018, your client forwards to you a letter from Company X, alleging that your client’s services on a major project resulted in damages. Company X demands payment by August 31 or it will seek resolution in court. Being an excellent attorney, you send a strong response on August 31 pointing out not only that your client rendered exceptional services but that your client is still owed unpaid amounts for its services. Following a months-long letter campaign that proves fruitless, Company X files a lawsuit on June 1, 2019, against your client and related entities. The very next day, June 2, you diligently tender this claim to your client’s professional liability carrier. Two weeks later, you are surprised to receive the insurance carrier’s denial letter. Three years later, your client forwards to you a lawsuit filed by Company Y arising from the same project. You once again promptly tender the filing to the insurance carrier, but two weeks later you once again receive a denial letter for this new claim. What went wrong?
As explained below, failing to fully appreciate or understand how a claims-made-and-reported policy functions can cause you to lose millions of dollars in coverage for your client. See, e.g., CheckRite Ltd., Inc. v. Ill. Nat’l Ins. Co., 95 F. Supp. 2d 180, 192 (S.D.N.Y. 2000) (“[T]here is no coverage under a claims-made policy where the insured fails to notify the insurer of a claim by the end of the policy period (or extended reporting period, if any).”). Keeping in mind a few critical points will help to avoid this outcome.
Timing Is Critical under Claims-Made-and-Reported Policies
Every insurance policy has a coverage grant. The coverage grant defines what coverage the insurance carrier is providing, subject to exclusions and other conditions found in the policy. A standard commercial general liability (CGL) policy has a very broad coverage grant that generally covers an accident that results in bodily injury or property damage during the policy period. The standard CGL policy’s coverage grant says nothing about when a claim is made against the policyholder or when the policyholder must give notice of a claim to the insurance carrier. Rather, somewhere among the “Conditions,” a CGL policy generally provides that the policyholder must give notice of a claim “as soon as practicable” or within some other period of time. Importantly, because the reporting requirement is made as a policy condition and is not part of the coverage grant itself, many jurisdictions apply the “notice-prejudice rule.” The notice-prejudice rule generally provides that untimely notice of a claim to the insurance carrier will not defeat the policyholder’s coverage unless the insurance carrier can show that it has been prejudiced by the delay—in practice, a high bar for the insurance carrier to meet.
Claims-made-and-reported policies (such as professional liability, directors’ and officers’ liability, and cyber liability) are different. For these policies, the coverage grant itself is limited to situations where a claim has been made against the policyholder during the policy period and the policyholder has reported that claim to the insurance carrier within the policy period (or sometimes within a brief period of time following the close of the policy period). While courts will often apply the notice-prejudice rule for occurrence-based policies, courts will not create coverage beyond what is within the coverage grant in a claims-made-and-reported policy. In practice, this creates some stomach-churning results. If a policyholder is sued for a matter falling squarely within its insurance policy but tenders the claim even one hour past the deadline, it will lose all coverage. This is true even though the policyholder would have full coverage if it had notified the insurance carrier just one hour before. No rules of equity will save the policyholder from these drastic consequences. See Prof’ls Direct Ins. Co. v. Wiles, Boyle, Burkholder & Bringardner Co., LPA, 2009 WL 4281263, at *9 (S.D. Ohio Nov. 24, 2009) (“The existence of a cut-off date is integral to a claims-made policy, as it is a distinct characteristic of such a policy that directly relates to rate setting.”) (internal quotation marks omitted).
Misunderstanding the “Claim”
Losing coverage through late notice is exactly what happened with the Company X claim. Most insurance policies define a “claim” to include not only a lawsuit but also a written demand for damages or equitable relief. As a result, receiving a written letter creates one of the most commonly overlooked dangers that results in a complete loss of coverage. In our example, the “claim” was made on August 1, 2018—well within the policy period of June 1, 2018, to June 1, 2019. To fall within the coverage grant, however, the policyholder also had to give the insurance carrier notice of the claim by no later than June 1, 2019. Sadly, after receiving the formal complaint on June 1, the policyholder did not notify the insurance carrier until June 2—a day too late. Nor would the client have coverage under the next year’s policy because the claim was made during the prior year’s policy. You and your client are simply out of luck, although your client may now start eyeing your professional liability policy for your failure to advise it to timely notify its insurance carrier. Sometimes, however, these policies contain an extended reporting period that courts will apply in these situations. See, e.g., Cast Steel Prods., Inc. v. Admiral Ins. Co., 348 F.3d 1298, 1303 (11th Cir. 2003) (finding that the extended reporting period applied where policy was renewed). Be sure to fully analyze the policy and all of its reporting deadlines, including potential extensions, in order to maximize your client’s chances of coverage.
Related Claims—Your Mistake Lives in Perpetuity
To make matters worse, many claims-made-and-reported policies provide that claims arising out of the same or related facts are considered a single claim and relate back to when the first of such related claims was made. In our example, the claim made by Company Y arose from the same project as that involved in Company X’s claim. Accordingly, an insurance carrier will likely take the position that these are related claims. Given the prior late notice for the Company X claim, the new claim from Company Y will also be precluded from coverage. Conversely, once a policyholder has timely notified the insurance carrier of a claim, related claims arising in the future should be covered under the prior policy without any late notice worry.
Other Matters to Consider
In addition to keeping an eye open for demand letters and treating them the same as a lawsuit for insurance purposes, the following are a few other issues to consider in getting coverage under a claims-made-and-reported policy.
Notice of circumstances. Most of these policies allow the policyholder to provide notice of circumstances that may lead to a future claim. Suppose, for example, that instead of demanding payment in its letter, Company X had instead simply informed your client that its services were deficient and that Company X reserved its rights to seek damages, to the extent any arose, in the future. Providing a “notice of circumstances” to the insurance carrier will result in a future claim arising from those circumstances to be deemed made and reported during the policy period in which the notice of circumstances is made. Not only can this help to avoid late notice in the future, but future policy applications will likely require a policyholder to list any known circumstances that will likely lead to a claim. Providing a notice of circumstances can help a policyholder avoid getting stuck between not having coverage on a prior policy because there was no actual “claim” and not having coverage on a current policy because it knew of circumstances that would likely lead to a claim before the policy incepted (the “known loss” exclusion).
Multiple defendants or uncovered causes of action—the allocation provision. Note that in the example of Company X, not only the client but also related entities were named as defendants in the lawsuit. Sometimes the insurance policy will include some related entities but not others as insureds, either intentionally or because of oversight during the underwriting process. Where the insured is named as a defendant alongside related entities that are not insureds, or where a lawsuit includes both potentially covered claims and uncovered claims (collectively known as “mixed actions”), it will become important to look at the policy’s allocation provision.
There are three general possibilities for what may be provided: (1) the allocation provision states that defense costs are covered 100 percent where both insureds and uninsureds are defendants or where both covered and uncovered claims are alleged, or in both circumstances; (2) the allocation provision states that defense costs in these mixed actions must be allocated between covered and uncovered defendants and allegations; or (3) there is no allocation provision. Even where there is no allocation provision, a strong advocate should argue for the insurance carrier to pay 100 percent of defense costs. See, e.g., High Point Design, LLC v. LM Ins. Corp., 2016 WL 426594 (S.D.N.Y. 2016) (“[T]he amount that should be allocated to the non-covered parties, and thus not recouped from the insurer, are any ‘additional expenses’ which would not have occurred but for the inclusion of the non-covered defendants.”); Aetna Cas. & Sur. Co. v. PPG Indus., Inc., 554 F. Supp. 290, 296 (D. Ariz. 1983) (“If the complaint filed against the insured alleges several causes of action, some of which are not covered by the policy but one or more are within its terms, the insurer is bound to defend the action.”).
Is it really a claims-made-and-reported policy? Some jurisdictions recognize a distinction between a claims-made-and-reported policy—where a claim must both be made and reported during the policy period—and a simple claims-made policy, where the coverage grant simply requires a claim, but not necessarily notice to the insurance carrier, within the policy period. In certain of these jurisdictions, a policyholder can argue that the notice-prejudice rule applies to a claims-made policy. See, e.g., Fin. Indus. Regulatory Auth., Inc. v. Axis Ins. Co., 951 F. Supp. 2d 826, 837–38 (D. Md. 2013) (holding that an insurer that denies a claim based on late notice must demonstrate prejudice if the policy is a “claims-made” policy, but not if it is a “claims-made-and-reported” policy).
Claims-made-and-reported policies present many potential traps for the unwary. The first step every litigator should take upon receiving notice of any dispute involving a client is to analyze whether some third party, and specifically an insurance carrier, provides coverage for the dispute. Doing so can avoid the awkward situation of informing your client that it lost millions of dollars in insurance because you failed to timely advise it to inform the insurance carrier.
Jonathan G. Brinson is a shareholder in the Phoenix, Arizona, office of Polsinelli.
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