New York's No Prejudice Rule

The New York “no prejudice” rule has most often arisen in the insurance context when an insured fails to provide timely and/or adequate notice. More specifically, an insured's failure to satisfy a policy requirement that it provide the insurer with timely notice of an accident or occurrence or claim “vitiate[d] the contract[,]” Deso v. London & Lancashire Indemnity Co. of America, 3 N.Y.2d 127, 129 (1957), and the insurer did not need to show prejudice in order to assert that defense. Security Mutual Insurance Co. of New York v. Acker-Fitzsimons Corp., 31 N.Y.2d 436, 440 (1972). However, in 2008, the New York legislature amended the statute governing liability insurance to require prejudice to the insurer for a disclaimer of coverage on the ground of late notice. N.Y. Insurance Law ' 3420(a)(5). The new requirement, although only applicable to policies issued or delivered on or after Jan. 17, 2009, has generated considerable commentary in the four years since its enactment, much of which has depicted it as heralding a “sea change” in New York law.

What has received somewhat less attention is the fact that the 2008 legislation left untouched the “no prejudice” rule as it relates to the breach of policy conditions other than timely notice, and that as a result the traditional rules of contract interpretation continue to play a critical role in the resolution of disputes involving insurance policies governed by New York law. Most notably, New York courts have continued to enforce policy provisions requiring an insured to obtain its insurer's consent to settlement.

Indeed, it was in the same year that the notice-prejudice requirement was enacted by the New York legislature that the Court of Appeals, in Vigilant Insurance Co. v. Bear Stearns Companies, Inc., 10 N.Y.3d 170 (2008) ' without so much as mentioning the word “prejudice” ' upheld the denial of $45 million in coverage demanded by Bear Stearns based on the former's failure to obtain its insurers' consent to a global settlement with federal and state regulatory authorities. Finding the policy provision against unconsented settlement unambiguous, and rejecting the insured's argument that the settlement did not become final until it obtained court approval, the Court matter-of-factly set forth the simple conclusion of no coverage:

As a sophisticated business entity, Bear Stearns expressly agreed that the insurers would “not be liable” for any settlement in excess of $5 million entered into without their consent. Aware of this contingency in the policies, Bear Stearns nevertheless elected to finalize all outstanding settlement issues, and executed a consent agreement before informing its carriers of the terms of the settlement. Bear Stearns therefore may not recover the settlement proceeds from the insurers.

10 N.Y.3d at 178.

Notably, Bear Stearns did argue to the Court of Appeals that the breach of the consent requirement should not preclude coverage of the settlement because the insurers did not submit evidence that the breach prejudiced the insurers; the court simply chose to ignore that argument. Lamden, et al., “Recent Developments in Insurance Coverage Litigation,” 44 Tort Trial & Insurance Practice Law Journal 551 (2009).

The decision by the Court of Appeals in Bear Stearns was perhaps not surprising given the deep roots that enforcement of unambiguous contract provisions has in New York law. Indeed, New York courts had routinely enforced consent to settlement provisions in cases before Bear Stearns. See, e.g., TLC Beatrice International Holdings, Inc. v. CIGNA Insurance Co., 2000 WL 282967 (S.D.N.Y. 2000), aff'd sub nom. Lewis v. CIGNA Insurance Co., 234 F.3d 1262 (unpublished), 2000 WL 1654530 (2d Cir. 2000) (breach of consent requirement precluded coverage to estate of corporation's CEO and chairman for its settlement of a shareholders' derivative action); R. Ferraro Collision, Inc. v. Universal Underwriters Insurance Co., 850 N.Y.S.2d 491 (1st Dep't 2008) (insurer of auto body shop properly denied coverage for value of shop's customer's stolen vehicle where shop owner, without consent of insurer, allowed customer to “keep” amounts owed to shop as “payment” for loss of vehicle).

Other Court Rulings

In the years since Bear Stearns, other New York courts have similarly denied coverage to policyholders that failed to obtain their insurer's consent to settlement. The cases have involved a wide range of underlying factual scenarios. Illinois National Insurance Co. v. Tutor Perini Corp., 2012 WL 5860478 (S.D.N.Y. Nov. 15, 2012) (settlement of liabilities arising out of failures in construction project); Sunham Home Fashions, LLC v. Diamond State Insurance Co., 813 F. Supp.2d 411, 417 (S.D.N.Y. 2011) (settlement of copyright infringement action); Continental Casualty Co. v. ACE American Insurance Co., 2009 WL 857594 (S.D.N.Y. 2009) (settlement of insured's liability for claims handling losses); Bear Wagner Specialists, LLC v. National Union Fire Insurance Company of Pittsburgh, PA, 2009 WL 2045601 (N.Y. Sup. July 7, 2009) (settlement of criminal actions for which insured sought to recover defense costs).'

Thus, the Bear Stearns decision represents the opposite of the “sea change” supposedly implemented by ' 3420(a)(5): it reflects the traditional approach of New York courts to breach of insurance contract provisions ' i.e., the same approach they take to the breach of any other contractual provisions. In short, when it comes to consent to settlement provisions, the unqualified rule of Coleman v. New Amsterdam Casualty Co. ' “[w]hen the condition was broken, the policy was at an end” ' remains the standard.”

However, insurers still face challenges to the enforcement of these provisions. Policyholders have tried to argue that the right to consent can be forfeited through waiver and/or estoppel, relying, for example, on a Court of Appeals statement that “[W]here an insurer unjustifiably refuses to defend a suit, the insured may make a reasonable settlement or compromise of the injured party's claim, and is then entitled to reimbursement from the insurer, even though the policy purports to avoid liability for settlements made without the insurer's consent[.]” Isadore Rosen & Sons, Inc. v. Security Mutual Insurance Co. of New York, 31 N.Y.2d 342, 347 (1972). Nothing in Isadore Rosen or any other Court of Appeals precedent, however, contemplates or permits an unconsented settlement in a case where an insurer simply raises questions about coverage or reserves its rights.”

Drawing a Distinction

Indeed, New York courts faced with this issue have recently drawn a distinction between a complete and utter “repudiation” of the policy prior to the time of a policyholder's settlement, which may excuse compliance with contractual conditions, and a mere “disclaimer,” or reservation of rights, which will not. PB Americas Inc. v. Continental Casualty Company, 690 F. Supp.2d 242, 250 (S.D.N.Y. 2010); Bear Wagner Specialists, LLC v. National Union Fire Insurance Company of Pittsburgh, PA, 2009 WL 2045601 (N.Y. Sup. 2009). PB Americas and Bear Wagner both relied on an Appellate Division case involving first-party coverage, Seward Park Housing Corp. v. Greater New York Mutual Insurance Co., 836 N.Y.S.2d 99, 105 (1st Dep't 2007), which explained that “repudiation of a policy exists only where a plaintiff establishes that the insurer has committed an anticipatory breach by disclaiming the intention or the duty to shape its conduct in accordance with the provisions of the contract.” Thus, an insurer who “appeal[s] to the[] authority” of the contractual provisions and “endeavor[s] to apply them” has not repudiated the policy even if it denies coverage.

For example, the insurer in Seward Park, “[f]ar from immediately or summarily rejecting the plaintiff's claim and proofs of loss,” thoroughly investigated the matter and then sent the insured a “seven-page letter detail[ing] the results of” its investigation and “explain[ing] the denial of coverage with reference to policy provisions and exclusions. In other words, it was an explanation with reference to the terms of the contract.” Id.

Applying the Seward Park analysis in situations where policyholders sought to excuse compliance with consent to settlement provisions, the PB Americas and Bear Wagner courts both respected the distinction between an utter repudiation on the one hand and a more nuanced disclaimer on the other. And while the PB Americas court was not prepared to apply the distinction to resolve disputed facts in the context of the carrier's motion to dismiss, in Bear Wagner, the court rejected the insured's argument that its insurers' denials of coverage for certain civil actions constituted a “repudiation” that excused the insured's failure to timely notify the insurers of, and obtain their consent to settle, subsequent criminal actions for which they sought coverage of defense costs.

The court pointed out that the denial letters “never stated that all future claims would be denied, and even provided Bear Wagner with the opportunity to submit additional information for a re-evaluation of the claim by the insurers.” 2009 WL 2045601 at *7.

Similarly, in TLC Beatrice International Holdings, Inc. v. CIGNA Insurance Co., supra ' which predated the repudiation/disclaimer line of cases but was predicated on a similar analysis ' the court found that an insurer's letter which “by its terms, was explicitly 'a preliminary disclaimer of coverage,'” which “expressly invited” the insured “to provide legal or factual information that might reveal [the insurer's] preliminary position to have been inaccurate,” and of whose “invitation” the insured “availed itself promptly,” “did not constitute a disclaimer with any degree of finality whatsoever[,]” and therefore did not excuse the insured from its obligation to obtain the insurer's consent to settlement. 2000 WL 282967 at *5.

Analysis

As the foregoing cases demonstrate, the repudiation/disclaimer distinction may enable an insurer to preserve its right to consent to settlements while also raising its defenses to coverage. However, consistent with the New York case law, a carrier, depending on the facts of the case, may want to consider providing a policyholder with an explanation of its disclaimer or reservation of rights, to convey its willingness to consider new facts or other considerations, and/or may want to ask the policyholder to keep the carrier apprised of developments in the underlying litigation.

Finally, policyholders seeking to excuse the failure to comply with consent to settlement provisions have also tried to argue that insurers allegedly waived their rights to enforce the contractual requirement through conduct manifesting acquiescence in the settlement. Although obviously fact-specific, a handful of decisions from the Second Circuit Court of Appeals have addressed such arguments.

In one instance, an excess insurer told the primary insurer to “handle the matter as it saw fit[.]” General Star National Insurance Company v. Universal Fabricators, Inc., 2011 WL 2315159 (2d Cir. 2011) (unpublished). In another case, the Second Circuit found that two insurers who initially consented to part of a settlement were deemed to have consented to the rest of the settlement where the policyholder “sufficiently notified” them of an additional cost of the proposed settlement “so as to allow them to withhold consent,” and they failed to do so. MBIA, Inc. v. Federal Insurance Co., 652 F.3d 152, 170 (2d Cir. 2011).

Thus, rather than excusing a breach of the requirement that the policyholder seek and obtain the insurer's consent to settlement, these cases essentially found that consent had in fact been requested, and either implicitly granted or unreasonably withheld, under the specific fact pattern at issue. But in cases where consent has not been requested, and notwithstanding the changes enacted by the New York legislature with regard to notice provisions, New York law continues to uphold and enforce the contractual requirement of consent to settlement as a condition precedent to coverage.”'

Elaine Panagakos is an Associate with the Washington, DC, office of Crowell & Moring LLP.

New York law has traditionally been more faithful than that of many jurisdictions to the principle that an insurance contract, like any other, is “to be construed according to the sense and meaning” of its terms and, if those terms are clear and unambiguous, they are to be “taken and understood in their plain, ordinary, and proper sense.” Preston v. Aetna Insurance Co. , 193 N.Y. 142 (1908).

As the New York Court of Appeals once more colorfully put it, “Unless we are prepared to adopt the theory of the cynic that language was invented for the purpose of concealing thought, we have no right to disregard the clear provisions which defendant inserted in the policy and which plaintiff accepted.” Johnson v. Travelers Insurance Co. , 269 N.Y. 401 (1936). This respect for the written word in the contract of insurance has resulted in New York's rule that an insured which breaches a policy condition is barred from recovery in the same manner as any other contracting party which breaches
a condition of a contract, without any attendant requirement that the insurer demonstrate prejudice as a result of the breach. As succinctly stated by Justice Cardozo, “When the condition was broken, the policy was at an end[.]” Coleman v. New Amsterdam Casualty Co. , 247 N.Y. 271, 277 (1928).

The 'No Prejudice' Rule

The New York “no prejudice” rule has most often arisen in the insurance context when an insured fails to provide timely and/or adequate notice. More specifically, an insured's failure to satisfy a policy requirement that it provide the insurer with timely notice of an accident or occurrence or claim “vitiate[d] the contract[,]” Deso v. London & Lancashire Indemnity Co. of America , 3 N.Y.2d 127, 129 (1957), and the insurer did not need to show prejudice in order to assert that defense. Security Mutual Insurance Co. of New York v. Acker-Fitzsimons Corp. , 31 N.Y.2d 436, 440 (1972). However, in 2008, the New York legislature amended the statute governing liability insurance to require prejudice to the insurer for a disclaimer of coverage on the ground of late notice. N.Y. Insurance Law ' 3420(a)(5). The new requirement, although only applicable to policies issued or delivered on or after Jan. 17, 2009, has generated considerable commentary in the four years since its enactment, much of which has depicted it as heralding a “sea change” in New York law.

What has received somewhat less attention is the fact that the 2008 legislation left untouched the “no prejudice” rule as it relates to the breach of policy conditions other than timely notice, and that as a result the traditional rules of contract interpretation continue to play a critical role in the resolution of disputes involving insurance policies governed by New York law. Most notably, New York courts have continued to enforce policy provisions requiring an insured to obtain its insurer's consent to settlement.

Indeed, it was in the same year that the notice-prejudice requirement was enacted by the New York legislature that the Court of Appeals, in Vigilant Insurance Co. v. Bear Stearns Companies, Inc. , 10 N.Y.3d 170 (2008) ' without so much as mentioning the word “prejudice” ' upheld the denial of $45 million in coverage demanded by Bear Stearns based on the former's failure to obtain its insurers' consent to a global settlement with federal and state regulatory authorities. Finding the policy provision against unconsented settlement unambiguous, and rejecting the insured's argument that the settlement did not become final until it obtained court approval, the Court matter-of-factly set forth the simple conclusion of no coverage:

As a sophisticated business entity, Bear Stearns expressly agreed that the insurers would “not be liable” for any settlement in excess of $5 million entered into without their consent. Aware of this contingency in the policies, Bear Stearns nevertheless elected to finalize all outstanding settlement issues, and executed a consent agreement before informing its carriers of the terms of the settlement. Bear Stearns therefore may not recover the settlement proceeds from the insurers.

10 N.Y.3d at 178.

Notably, Bear Stearns did argue to the Court of Appeals that the breach of the consent requirement should not preclude coverage of the settlement because the insurers did not submit evidence that the breach prejudiced the insurers; the court simply chose to ignore that argument. Lamden, et al., “Recent Developments in Insurance Coverage Litigation,” 44 Tort Trial & Insurance Practice Law Journal 551 (2009).

The decision by the Court of Appeals in Bear Stearns was perhaps not surprising given the deep roots that enforcement of unambiguous contract provisions has in New York law. Indeed, New York courts had routinely enforced consent to settlement provisions in cases before Bear Stearns. See, e.g., TLC Beatrice International Holdings, Inc. v. CIGNA Insurance Co., 2000 WL 282967 (S.D.N.Y. 2000), aff'd sub nom. Lewis v. CIGNA Insurance Co. , 234 F.3d 1262 (unpublished), 2000 WL 1654530 (2d Cir. 2000) (breach of consent requirement precluded coverage to estate of corporation's CEO and chairman for its settlement of a shareholders' derivative action); R. Ferraro Collision, Inc. v. Universal Underwriters Insurance Co. , 850 N.Y.S.2d 491 (1st Dep't 2008) (insurer of auto body shop properly denied coverage for value of shop's customer's stolen vehicle where shop owner, without consent of insurer, allowed customer to “keep” amounts owed to shop as “payment” for loss of vehicle).

Other Court Rulings

In the years since Bear Stearns, other New York courts have similarly denied coverage to policyholders that failed to obtain their insurer's consent to settlement. The cases have involved a wide range of underlying factual scenarios. Illinois National Insurance Co. v. Tutor Perini Corp., 2012 WL 5860478 (S.D.N.Y. Nov. 15, 2012) (settlement of liabilities arising out of failures in construction project); Sunham Home Fashions, LLC v. Diamond State Insurance Co. , 813 F. Supp.2d 411, 417 (S.D.N.Y. 2011) (settlement of copyright infringement action); Continental Casualty Co. v. ACE American Insurance Co., 2009 WL 857594 (S.D.N.Y. 2009) (settlement of insured's liability for claims handling losses); Bear Wagner Specialists, LLC v. National Union Fire Insurance Company of Pittsburgh, PA, 2009 WL 2045601 (N.Y. Sup. July 7, 2009) (settlement of criminal actions for which insured sought to recover defense costs).'

Thus, the Bear Stearns decision represents the opposite of the “sea change” supposedly implemented by ' 3420(a)(5): it reflects the traditional approach of New York courts to breach of insurance contract provisions ' i.e., the same approach they take to the breach of any other contractual provisions. In short, when it comes to consent to settlement provisions, the unqualified rule of Coleman v. New Amsterdam Casualty Co. ' “[w]hen the condition was broken, the policy was at an end” ' remains the standard.”

However, insurers still face challenges to the enforcement of these provisions. Policyholders have tried to argue that the right to consent can be forfeited through waiver and/or estoppel, relying, for example, on a Court of Appeals statement that “[W]here an insurer unjustifiably refuses to defend a suit, the insured may make a reasonable settlement or compromise of the injured party's claim, and is then entitled to reimbursement from the insurer, even though the policy purports to avoid liability for settlements made without the insurer's consent[.]” Isadore Rosen & Sons, Inc. v. Security Mutual Insurance Co. of New York , 31 N.Y.2d 342, 347 (1972). Nothing in Isadore Rosen or any other Court of Appeals precedent, however, contemplates or permits an unconsented settlement in a case where an insurer simply raises questions about coverage or reserves its rights.”

Drawing a Distinction

Indeed, New York courts faced with this issue have recently drawn a distinction between a complete and utter “repudiation” of the policy prior to the time of a policyholder's settlement, which may excuse compliance with contractual conditions, and a mere “disclaimer,” or reservation of rights, which will not. PB Americas Inc. v. Continental Casualty Company , 690 F. Supp.2d 242, 250 (S.D.N.Y. 2010); Bear Wagner Specialists, LLC v. National Union Fire Insurance Company of Pittsburgh, PA, 2009 WL 2045601 (N.Y. Sup. 2009). PB Americas and Bear Wagner both relied on an Appellate Division case involving first-party coverage, Seward Park Housing Corp. v. Greater New York Mutual Insurance Co., 836 N.Y.S.2d 99, 105 (1st Dep't 2007), which explained that “repudiation of a policy exists only where a plaintiff establishes that the insurer has committed an anticipatory breach by disclaiming the intention or the duty to shape its conduct in accordance with the provisions of the contract.” Thus, an insurer who “appeal[s] to the[] authority” of the contractual provisions and “endeavor[s] to apply them” has not repudiated the policy even if it denies coverage.

For example, the insurer in Seward Park, “[f]ar from immediately or summarily rejecting the plaintiff's claim and proofs of loss,” thoroughly investigated the matter and then sent the insured a “seven-page letter detail[ing] the results of” its investigation and “explain[ing] the denial of coverage with reference to policy provisions and exclusions. In other words, it was an explanation with reference to the terms of the contract.” Id.

Applying the Seward Park analysis in situations where policyholders sought to excuse compliance with consent to settlement provisions, the PB Americas and Bear Wagner courts both respected the distinction between an utter repudiation on the one hand and a more nuanced disclaimer on the other. And while the PB Americas court was not prepared to apply the distinction to resolve disputed facts in the context of the carrier's motion to dismiss, in Bear Wagner, the court rejected the insured's argument that its insurers' denials of coverage for certain civil actions constituted a “repudiation” that excused the insured's failure to timely notify the insurers of, and obtain their consent to settle, subsequent criminal actions for which they sought coverage of defense costs.

The court pointed out that the denial letters “never stated that all future claims would be denied, and even provided Bear Wagner with the opportunity to submit additional information for a re-evaluation of the claim by the insurers.” 2009 WL 2045601 at *7.

Similarly, in TLC Beatrice International Holdings, Inc. v. CIGNA Insurance Co., supra ' which predated the repudiation/disclaimer line of cases but was predicated on a similar analysis ' the court found that an insurer's letter which “by its terms, was explicitly 'a preliminary disclaimer of coverage,'” which “expressly invited” the insured “to provide legal or factual information that might reveal [the insurer's] preliminary position to have been inaccurate,” and of whose “invitation” the insured “availed itself promptly,” “did not constitute a disclaimer with any degree of finality whatsoever[,]” and therefore did not excuse the insured from its obligation to obtain the insurer's consent to settlement. 2000 WL 282967 at *5.

Analysis

As the foregoing cases demonstrate, the repudiation/disclaimer distinction may enable an insurer to preserve its right to consent to settlements while also raising its defenses to coverage. However, consistent with the New York case law, a carrier, depending on the facts of the case, may want to consider providing a policyholder with an explanation of its disclaimer or reservation of rights, to convey its willingness to consider new facts or other considerations, and/or may want to ask the policyholder to keep the carrier apprised of developments in the underlying litigation.

Finally, policyholders seeking to excuse the failure to comply with consent to settlement provisions have also tried to argue that insurers allegedly waived their rights to enforce the contractual requirement through conduct manifesting acquiescence in the settlement. Although obviously fact-specific, a handful of decisions from the Second Circuit Court of Appeals have addressed such arguments.

In one instance, an excess insurer told the primary insurer to “handle the matter as it saw fit[.]” General Star National Insurance Company v. Universal Fabricators, Inc., 2011 WL 2315159 (2d Cir. 2011) (unpublished). In another case, the Second Circuit found that two insurers who initially consented to part of a settlement were deemed to have consented to the rest of the settlement where the policyholder “sufficiently notified” them of an additional cost of the proposed settlement “so as to allow them to withhold consent,” and they failed to do so. MBIA, Inc. v. Federal Insurance Co. , 652 F.3d 152, 170 (2d Cir. 2011).

Thus, rather than excusing a breach of the requirement that the policyholder seek and obtain the insurer's consent to settlement, these cases essentially found that consent had in fact been requested, and either implicitly granted or unreasonably withheld, under the specific fact pattern at issue. But in cases where consent has not been requested, and notwithstanding the changes enacted by the New York legislature with regard to notice provisions, New York law continues to uphold and enforce the contractual requirement of consent to settlement as a condition precedent to coverage.”'

Elaine Panagakos is an Associate with the Washington, DC, office of Crowell & Moring LLP.