Choice of law can frequently be determinative of whether an insurer has liability on a claim. One example of this is with respect to policy provisions requiring the insured to provide prompt notice of a claim to the insurer. California’s notice-prejudice rule, which applies to both first and third party claims, generally allows an insurer to deny coverage based on late notice of the claim only if the insurer establishes substantial prejudice. Campbell v. Allstate Ins. Co. 60 Cal.2d 303, 307 (1963). In contrast, some states do not require a showing of prejudice. For instance, New York applies a notice-prejudice rule to policies issued or delivered in New York, but policies issued outside New York are subject to a no-prejudice rule. As a result, if New York law applies to a California-issued policy, the insurer would not be required to establish prejudice in order to deny a claim based on late notice. Because of this, choice of law, and contractual choice of law provisions, can be dispositive in some cases.
Although California courts generally enforce an insurance policy’s choice of law provision, a long-recognized exception is when the chosen state’s law conflicts with California’s fundamental public policy. See, e.g. Nedlloyd Lines B.V. v. Superior Court, 3 Cal.4th 459 (1992). In a recent decision, Pitzer College v. Indian Harbor Insurance Company, S239510 (August 29, 2019), the California Supreme Court held that the notice-prejudice rule embodies a fundamental public policy which can override a conflicting choice of law provision.
In the Pitzer case, the insured, Pitzer College, purchased an insurance policy issued by Indian Harbor that covered legal and remediation expenses resulting from pollution conditions. Of relevance to this case, the policy required Pitzer to provide timely notice to Indian Harbor of any pollution condition. The policy also required Indian Harbor’s consent before incurring any expenses or beginning remediation. Additionally, the policy contained a choice of law provision which provided that New York law would govern all matters arising under the policy.
In January 2011, Pitzer discovered a pollution condition which required remediation. It commenced remediation in March 2011, and completed remediation work one month later at a cost of $2 million.
Pitzer did not seek Indian Harbor’s consent before commencing remediation, and in fact did not inform Indian Harbor of the claim or the remediation until July 2011. Indian Harbor denied coverage based on the delayed notice and the policy’s consent clause. Pitzer then sued Indian Harbor in state court, and Indian Harbor removed the case to federal court based on diversity jurisdiction. In the district court, Indian Harbor moved for summary judgment, claiming that it had no obligation to indemnify Pitzer for remediation costs because Pitzer had violated the policy’s notice and consent provisions. The district court enforced the policy’s choice of law provision and applied New York law. It granted Indian Harbor’s motion, because, under the New York law applicable to out-of-state policies, the insured’s failure to provide timely notice is ground for denial of coverage, and the insurer need not establish prejudice from the delay. The district court noted that, if California law applied, it would not grant Indian Harbor’s motion because it had not established substantial prejudice from the late notice.
Pitzer appealed to the Ninth Circuit Court of Appeals. The Ninth Circuit then certified two questions to the California Supreme Court:
(1) Is California’s common law notice prejudice rule a fundamental public policy for the purpose of choice of law analysis?
(2) If so, does the notice-prejudice rule apply to the consent provision of the insurance policy in this case?
The California Supreme Court answered both questions in the affirmative.
With respect to choice of law, the California Supreme Court explained that, under California law, the parties’ choice of law generally governs unless (1) it conflicts with a state’s fundamental public policy, and (2) that state has a materially greater interest in the determination of the issue than the contractually chosen state.
As to the first prong, the Court determined that the notice-prejudice rule embodies a fundamental policy of the state for several reasons. First, the note-prejudice rule cannot be contractually waived. Second, the notice-prejudice rule “protects insureds against inequitable results that are generated by insurers’ superior bargaining power.” Third, the “notice-prejudice rule promotes objectives that are in the general public’s interest because it protects the public from bearing the costs of harm that an insurance policy purports to cover.” The Court also noted that the “notice requirement serves to protect insurers from prejudice, . . . not . . . to shield them from their contractual obligations’ through ‘a technical escape-hatch.’”
Notably, the Court did not resolve the second prong regarding whether California has a materially greater interest in the determination of the issue, and deferred that question back to the Ninth Circuit.
The California Supreme Court also found that the notice-prejudice rule applies to the consent provision, but only with respect to first party policies. It explained that the consent provision serves the same purpose as a notice provision: to facilitate the insurer’s primary duties under the contract and minimize prejudice in performing those duties. Because of that, the Court held that denial of coverage (in a first party policy) based on violation of the consent clause requires a showing of substantial prejudice. The Court did, however, note that the ruling regarding the consent provision applies only to first party claims, expressly distinguishing the situation from third party claims. It made no such distinction with respect to the notice provision, and thus that holding arguably applies to both first and third party claims.
The Pitzer decision seems to graft a notice-prejudice rule onto policies, regardless of whether the policy contains a choice of law provision. It remains to be seen how this decision will influence future cases when other policy terms and conditions are at issue in a choice of law analysis.
