On Aug. 29, 2019, the California Supreme Court issued a highly anticipated opinion, Pitzer College v. Indian Harbor Ins. Co., 8 Cal. 5th 93 (2019), answering two questions certified from the Ninth Circuit as a matter of first impression regarding California's notice-prejudice rule:

(1) Is California's common law notice-prejudice rule a fundamental public policy for the purpose of choice of law analysis?

(2) If the notice-prejudice rule is a fundamental public policy, does it apply to the consent provision of an insurance policy governing a contamination claim in California?

The notice-prejudice rule generally requires the insurer to prove that it has been prejudiced before disclaiming coverage on late notice grounds. The consent provision or "no voluntary payment provision" prohibits an insured from settling a claim or incurring non-emergency expenses for which it will seek coverage without the prior consent of its insurer. This article will analyze the court's answers to these questions, discuss the potential impact of the court's decision on the insurance industry at large, and offer guidance to underwriters, claims handlers, and coverage counsel in the wake of this decision.

Background

Pitzer College involved a California university's claim for remediation expenses under a pollution and remediation legal liability policy (PARLL). Notably, the insured did not timely notify its carrier of a pollution event, and further failed to obtain its carrier's consent before remediating the site.

When the insured finally informed its carrier, seven months later, by filing a claim for its remediation costs, its insurer denied coverage. The policy specifically required the insured to notify its carrier of any loss as soon as practicable, and obtain its carrier's consent prior to incurring any remediation expenses.

Although the policy contained a New York choice of law provision, the insured filed a coverage action in the Central District of California, where the loss is located, and argued for the application of California law. Pitzer College v. Indian Harbor Ins. Co., CV 13-5863-GW (EX), 2014 WL 12558276 (C.D. Cal. May 22, 2014). On summary judgment, the district court held that New York law applied and, as a result, the insurer didn't need to demonstrate prejudice in order to disclaim coverage on late notice grounds. Therefore, the district court granted the insurer's motion for summary judgment because the insured did not provide timely notice as a matter of law and did not comply with the policy's consent provision. The court further noted that the insurer would not have prevailed if California law, which requires an insurer to demonstrate substantial prejudice, governed the matter. The insured appealed the decision to the Ninth Circuit, which certified the aforementioned questions to the California Supreme Court.

California Supreme Court Decision

The court began its evaluation of the first question with a thorough analysis of California's choice of law rules, which permits overriding a policy's choice of law provision if it "([i]) conflicts with a state's fundamental public policy, and ([ii]) the state has a materially greater interest in the determination of the issue than the contractually chosen state." 8 Cal. 5th 93 at 100. In holding that the notice-prejudice rule is a fundamental public policy of California, the court relied on the factors considered by other courts faced with that same question, including if the right protected by the rule is one that can be waived by the parties, if the rule protects against otherwise inequitable results, and if it promotes and protects the public interest.

The court also noted that "the essential part of an insurance policy is 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.'" Id. at 105. With that, the court expressly limited its decision to the first prong of the choice of law analysis and left it to the Ninth Circuit to determine which state has a materially greater interest in the issue, thus determining which state's law governs the late-notice issue. Y2K Textile, Inc. Corp.-5-ecisionll the report, I can send a link to a 4th  See Pitzer Coll. v. Indian Harbor Ins. Co., 779 Fed. Appx. 495, 495-96 (9th Cir. 2019) (remanding these issues back to the district court to decide, if necessary).

The court then began its evaluation of the second question by examining the purpose of consent provisions, which may include: limiting unnecessary expenditures, enabling the insurer to approve and control costs, protecting the insurer's subrogation rights, and, in the context of a pollution remediation policy, it protects against the destruction of relevant evidence. The court concluded that because these purposes are so similar to those pertaining to notice provisions, the notice-prejudice rule should also apply to consent provisions. In so extending the application of the notice-prejudice rule, the court noted that in contrast with third-party insurance, where consent provisions are crucial to the insurer's ability to control the defense and settlement of claims, an insurer has no need for unimpaired control over claims handling in a first-party setting. Thus, the court held that California's notice-prejudice rule only applies to consent provisions in first, but not third, party policies.

The court, however, left it for the Ninth Circuit to decide whether the subject PARLL was a first- or third-party policy and if the notice-prejudice rule applies to the consent provision at issue. See Pitzer, 779 Fed. Appx. at 495-96 (remanding these issues back to the district court to decide, if necessary).

Takeaways

The court's decision to dub California's notice-prejudice rule a fundamental public policy will very likely increase the likelihood of litigation due to the uncertainty surrounding the application of choice of law provisions. We anticipate the policyholder's bar will attempt to further extend the application of the prejudice rule to other contractual duties of the insured and assert that common law principles from other jurisdictions should be recognized as "fundamental public policies." Given the court's distinction between first- and third-party policies in regards to consent provisions, we also anticipate increased litigation on whether a policy provides first- and third-party coverages, and whether the notice rule applies to a hybrid policy/claim.

We also anticipate that parties will be more likely to file suit without negotiation because other jurisdictions may not consider the notice-prejudice rule a fundamental public policy, or may have statutory support for enforcing a designated state's substantive law where the contract value exceeds a certain monetary threshold. See, e.g., N.Y. Gen. Oblig. Law § 5-1401 (McKinney) (parties to contracts for transactions exceeding $250,000 may agree that New York law governs whether or not it bears a reasonable relation to the state).

From a business standpoint, the court's decision will also impact underwriters, who may need to thoroughly consider the nature and location of the risk, the choice of law jurisdiction, whether a choice of law provision would be upheld, and the favorability of the law in each jurisdiction. These considerations may even cause some insurers to reduce their exposure in California, thereby decreasing competition and increasing the cost to consumers.

The enforceability of a policy's choice of law provision can often turn on the jurisdiction of the court hearing the issue, and whereas this issue is now prone to having a dispositive impact on the ultimate coverage question, we expect more "race to the courthouse" situations, where parties seek to plant the flag in the more favorable jurisdiction by filing first. In response, insurers may consider being proactive and filing early declaratory relief actions.

Insurers should also strongly contest arguments to override a policy's choice of law provision and implore the court to respect the capacity and autonomy of individuals that enter into contracts with negotiated terms and equal bargaining power, particularly in the commercial setting. Otherwise, inequity may result where insureds obtain more coverage than either party intended or bargained for.

For example, courts have implicitly recognized that insurance policies may not necessarily be contracts of adhesion when negotiated by an insurance broker or industry group on behalf of the insured and/or where the parties have equal bargaining power. See Am. Home Products v. Liberty Mut. Ins. Co., 565 F. Supp. 1485, 1490, 511 (S.D.N.Y. 1983) (finding that due to the insured's involvement in negotiating its manuscript policy, the policy was an arms-length contract, not a contract of adhesion); Y2K Textile v. Lexington Ins. Co., G036524, 2006 WL 3617920, at *5 (Cal. Ct. App. Dec. 13, 2006) (unpublished) (holding that because the terms were negotiated by the insured's broker, the broker was responsible if the insured misunderstood or was misled as to the coverages it purchased).

Regardless of the outcome of this case on remand, the court's decision to dub California's notice-prejudice rule a fundamental public policy will significantly impact the insurance industry and likely lead to increased coverage litigation.

Steven P. Nassi is a partner and Landon J. Green is an associate at Goldberg Segalla.