Neither Cedent nor Reinsurer Able to Show Prejudice
as a Result of Late Notice
In a dispute over reinsurance coverage, a New York court ruled that
a reinsurer could not meet its high burden of showing prejudice from
the cedent’s late notice. The cedent, Granite State, is an AIG
member insurance company which issued an excess policy to nonparty Kaiser. Granite State then entered into a facultative certificate
with the defendant-reinsurer Clearwater to reinsure a portion of the
Kaiser policy.
Kaiser suffered a number of asbestos-related losses, and was
involved in coverage litigation with its various insurers beginning in
2000. Based on projections of massive losses, Granite State and
other AIG companies settled with Kaiser, agreeing to pay up to the
AIG companies’ product limit in quarterly installments over 10 years.
The settlement was approved in 2006. Payment to Kaiser was made
using a “horizontal bathtub” approach, in which payments were
allocated evenly to all policies at the same layer of coverage, starting
with the lowest limits first. Under this approach, Granite State did not
begin to bill Clearwater until 2010 — and did not provide formal
notice of the potential for claims against Clearwater before that date
— as required by the certificate.
Under these facts, Clearwater argued that Granite State knew or
should have known that losses would reach the Kaiser policy during
the pendency of the underlying coverage litigation. By the time that
litigation settled in 2006, it was essentially a certainty. Therefore,
Clearwater argued, Granite State failed to provide prompt notice of
the potential claims, as required. Furthermore, Clearwater asserted
that it was prejudiced by such failure, because it commuted a
retrocessional agreement in 2006 in exchange for a stipulated
amount, and would not have done so had it known of the potential
for losses under the certificate in a timely fashion. In turn, Granite
State asserted that Clearwater’s late notice argument was itself
untimely. Clearwater originally disclaimed coverage without
referencing late notice, and first raised the defense two years later
during this litigation.
Applying California law, the court first determined that Clearwater
had not waived its right to assert a late notice defense. Granite State
could not show any misconduct on the part of Clearwater, nor could
it prove that it detrimentally relied on Clearwater’s delay. Turning
then to Clearwater’s late notice defense, the court found that
although California law may allow a reinsurer to obtain constructive
notice of a potential claim, the documents that Granite State sent to
Clearwater were too general to put Clearwater on notice that the
Kaiser policy might be affected. However, the court found that
Clearwater did not suffer prejudice as a result of delayed notice of
the claim, despite having commuted its retrocessional agreement.
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Under California law, “the only prejudice sufficient to allow an insurer
to avoid liability based on late notice is found in those cases where
the insurer actually demonstrated that there was a substantial
likelihood that it could have either defeated the underlying claim
against its insured, or settled the case for a smaller sum than that for
which its insured ultimately settled the claim.”
Clearwater also asserted several additional arguments, premised
upon conditions precedent to performance under the reinsurance
certificate. Of particular note, Clearwater alleged that Granite State
breached the certificate’s warranty of retention, because it did not
retain for its own account the amount expressly specified in the
certificate. Instead, Granite State entered into an inter-pooling
agreement with the other AIG companies, pursuant to which Granite
State’s liability under the policy was transferred to and assumed by
those companies. Granite State argued that as a matter of custom
and practice, an inter-company pooling agreement among affiliates
is not considered a violation of a reinsurance retention warranty.
Under New York law, custom and usage may not alter unambiguous
contract terms. However, because the New York court applied
California law, the outcome was different. In California, extrinsic
evidence such as industry customs may reveal a “latent ambiguity” in
seemingly unambiguous contract terms. As a result, there was a
question of fact as to whether Granite State breached the warranty
of retention. Furthermore, because a supposed “follow the fortunes”
clause did not employ any language referring to the cedent’s claims
handling decisions, it was not a true follow the fortunes clause and
the defendant reinsurer, Clearwater, was free to challenge Granite
State’s allocation of insurance proceeds to the underlying claims.
Finding multiple questions of fact, the court denied both crossmotions for summary judgment.
IMPACT: Parties should not rely too heavily on a late notice defense,
unless they can meet the high threshold the courts have set for
demonstrating prejudice. Additionally, under California law, the
deeply entrenched customs and practices of the reinsurance industry
may serve to alter otherwise unambiguous contract language.
Read the full decision here.
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