July 23, 2014
In its 2005 decision Friedland v. Travelers Indem. Co., the Colorado Supreme Court altered liability insurance law in Colorado by adopting the “Notice-Prejudice Rule.” 105 P.3d 639 (Colo. 2005). Prior to Friedland, Colorado courts strictly followed policy language that defined the procedure for notifying insurers of a claim and the process of settling a claim. If a claim was not reported and settled according to the procedure in the policy, an insured was barred from receiving any payment for the claim. Under the new rule established in 2005, an insurer can only be relieved of liability if it can show that the late notice had a prejudicial effect. The court decided to adopt the new rule because of the public policy objectives of making it easier to compensate tort victims and because of the inequity of insurers’ receiving a windfall and the insured not receiving policy benefits due to a technicality. Id. at 645.
If an insurer was not prejudiced by the unilateral actions of an insured in settling or asserting a defense to a claim prior to notice, the insurer is still liable under the policy for payment on the claim under the Notice-Prejudice Rule. Prejudice is not present if, “had [the insurer] received notice, [the insurer] could not have obtained any materially better outcome. Id. at 648. The test for determining if an insurer was prejudiced is as follows:
(1) there is a presumption of prejudice to the insurer in instances where the insured provides notice after disposition of the liability case, (2) the insured has the burden of going forward with evidence to dispel this presumption, (3) if such evidence is presented, the presumption loses any probative force it may have, and (4) it is then up to the insurer to go forward with the evidence that actual prejudice existed.
Id. at 648 (citing Marez v. Dairlyland Ins. Co., 638 P.2d 286(Colo. 1981))
If the insured is able to rebut the presumption of prejudice, the burden then shifts back to the insurer to show that the conduct was prejudicial by a preponderance of the evidence.
Additionally, a presumption of prejudice is not created in a situation where the insurer is told of a suit prior to its settlement, even if such delay is unreasonable. If this situation occurs, the insurer must prove that they were prejudiced.
The Notice-Prejudice Rule should shape the way that both insurers and insureds approach claims. For insureds, it is always important to notify the insurer in a timely fashion to allow the insurer to participate in the claim process. While an unreasonable delay in reporting no longer results in the automatic voiding of a claim, there are still significant obstacles to payment – and late notice can, at a minimum, create a threat of expensive litigation to determine if prejudice to the insurer was present. For insurers, it is important to contemplate the true level of prejudice that late or non-existent notice caused, especially for large claims. Because of the potential liability at stake for the insured, it is highly likely that the insured will litigate claims denied because of late notice. Insurers should take the potential costs of litigation into account when deciding whether to approve or deny a claim, even if prejudice is arguably present, since potential legal costs could add up to more than the liability for the original claim.
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A recent Colorado case has demonstrated an application of the Notice – Prejudice rule and provides a helpful framework for understanding the rule and its implications. In Stresscon Corp. v. Travelers Prop. Cas. Co. of America, a dispute arose between an insured and an insurance company on a claim that was settled after the insurer was notified, but without its input and before a lawsuit was filed against the insured. The insurer argued that since the settlement violated the policy’s “No Voluntary Payments” clause, it should not be liable for the claim. 2013 COA 131 (Colo. App 2013). The “No Voluntary Payments” clause is the provision included on the standard general liability coverage form released by the Insurance Services Office that is designed to prevent insureds from making payments without the insurer’s input.
First, the insurer argued that the Notice-Prejudice Rule was inapplicable because there was a settlement prior to the filing of a suit against the insured, and advocated that the court adopt a bright-line rule that the notice-prejudice rule should not apply in instances when no actual lawsuit is filed. The court expressly rejected this line of reasoning, citing Kesinger v. Commercial Standard Insurance Co., 70 P.2d 776 (Colo. 1937), which advocates for a case-by-case analysis based on the specific facts of each suit when determining if a notion of fairness requires that a claim be paid. This ruling is essentially an early version of the Notice-Prejudice Rule and is influenced by the same policy concerns that caused the Friedland court to adopt it.
The Stresscon court then discussed various aspects of the trial testimony to determine if sufficient evidence existed to find that the insured could get past the presumption of prejudice discussed above. If prejudice to the insurer was not present, the claim would be paid. Going through the steps of the Notice-Prejudice analysis, the court determined that the liability was “reasonably clear” because the damages could be calculated accord to the contract, the insured obtained all material information that was necessary to analyze the claim,the settlement represented an arms-length transaction,and that the amount of the settlement did not constitute overpayment. Stresscon, 2013 COA 131 at ¶ 52.
The facts demonstrated that prejudice was not evident under the first steps of the analysis, and the burden shifted back to the insurer to prove by a preponderance of the evidence that prejudice was present. This element of the Notice-Prejudice analysis is a question of fact for the jury, and the insurer needs to prove a specific instance of prejudice. It is not enough for the insurer to prove that there was a possibility of prejudice, but instead, there must be a substantial likelihood that it could have avoided or reduced the insured’s loss. Id. at ¶ 53. In Stresscon, the insurer ultimately could not prove that there was prejudice, and was held liable to the insured.
Stresscon illustrates how the Notice-Prejudice Rule has become an important issue that all parties should consider when thinking about insurance claims and legal fees. For the insurer, even though it was entitled to a presumption of prejudice, this presumption was overcome by the insured who presented significant evidence of a lack of prejudice. Following the ruling, not only was the insurance company still liable under the policy to its insured, but it had pay the legal fees associated with a declaratory judgment trial and subsequent appeal. The insured was also put in a less-than-optimal position by settling the case without the insurer’s input. Because it went forward and paid the claim without notice to the insurer, the insurer was entitled to examine the conduct of the insured through a microscope in order to attempt to establish prejudice. While the insured ultimately received the payments under the policy, there was a high degree of risk that it would be unsuccessful, and it also was required to incur the cost of the proceedings, which included expert witness fees, to secure payment. Had the insured provided timely notice, this could have been avoided.
The adoption of the notice-prejudice rule has greatly changed the way that parties to an insurance contract should handle their claims. While insureds now have a new avenue of recovery that was previously unavailable, it is expensive, time-consuming, and risky. Similarly, while insurers are entitled to deny claims based upon late notice, a thorough analysis of the facts and of potential prejudice should be conducted prior to denial to ensure that such denial will be upheld if legal proceedings ensue. It is very important to contact an attorney who is knowledgeable about insurance law in Colorado when a loss is sustained or a claim is submitted.