Who Cares About Policy Conditions? Why These Sometimes Overlooked Policy
Provisions Matter
Who Cares About Policy
Conditions? Why These
Sometimes Overlooked Policy
Provisions Matter
Tonya Newman
Neal, Gerber & Eisenberg, LLP
Chicago, Illinois
Andrew Deutsch
Meagher & Geer, PLLP
Minneapolis, Minnesota
Steven Weisman
McCarter & English, LLP
Newark, New Jersey
Diego Garcia
Thompson Coe Cousins & Irons, LLP
Houston, Texas
I. Introduction
Policy conditions are those insurance policy provisions that are oftentimes overlooked. The
conditions are not part of the insuring agreement or exclusions in insurance policies. They might
even be placed at the end of the policy, where it is easy to forget they are there. However, policy
conditions can impact the coverage available under the policy. On the one hand, the insured’s
failure to comply with the policy conditions can result in the loss of coverage under the policy.
On the other hand, the insurer can waive the right to assert a policy condition that is not enforced.
This paper discusses several important policy conditions that affect claims under all types of
insurance policies. Although this paper is not a 50-state survey, it does provide an overview of the
common issues and majority and minority trends for courts in different jurisdiction interpreting
and applying policy conditions.
This paper has four parts. First, this paper discusses the cooperation clause and the notice
provisions, which are typically found in all insurance policies. Second, issues are covered that
arise with excess insurance in determining whether underlying insurance has been exhausted.
Third, is consideration of consent to settle provisions and hammer clauses, which are often
contained in directors and officers and professional liability policies. Last, this paper discusses
important policy provision unique to first-party insurance policies such as the insured’s obligation
to provide or make available documents and records, examinations under oath, proofs of loss, and
appraisal.
II. The Cooperation Clause.
Insurance contracts commonly feature a “cooperation clause” that requires the insured to
cooperate with the insurer’s investigation and handling of a claim. This raises the possibility that
the insured will not recover if it does not cooperate. In general, however, noncooperation will
preclude recovery only if the insurer is actually prejudiced.
To this end, most jurisdictions place the burden on the insurer to prove that it was actually
prejudiced by the noncooperation. See Charter Oak Fire Ins. Co. v. Interstate Mech., Inc., 2013
U.S. Dist. LEXIS 111668, *13 (D. Ore. May 7, 2013) (noting that under Oregon law the insurer
must establish that “[the] insured’s failure to cooperate prejudiced the insurer”); Staples v.
Allstate Ins. Co., 176 Wn. 2d 404, 410 (Wash. 2013) (“The burden of proving noncooperation is
on the insurer,” which must show “it has been actually prejudiced.”); Kaufman v. Broad
Monterey Bay v. Travelers Prop. Cas. Co. of Am., 2012 U.S. Dist. LEXIS 100005, *26 (N.D. Cal.
July 18, 2012) (insurer’s performance is excused if the noncooperation caused substantial
prejudice, which is the insurer’s burden to show); Heubel Material Handling, Inc. v. Universal
Underwriters Ins. Co., 861 F. Supp. 2d 1003, 1011 (W.D. Mo. Mar. 21, 2012) (insurer must
prove that substantial prejudice resulted from the noncooperation).
A recent Illinois appellate court decision illustrates what appears to be the majority approach.
Progressive Direct Ins. Co. v. Jungkans, 972 N.E.2d 807, 812-14 (Ill. App. Ct. 2012).
In Jungkans, the insurer denied coverage on the ground that the insured violated the cooperation
clause by releasing one of the underlying tortfeasors without consulting the insurer. The insurer
argued that this had cut off its right of subrogation. The trial court found prejudice and entered
summary judgment in the insurer’s favor.
The Illinois Appellate Court reversed. The court held that the policyholder’s failure to notify the
insurer of the settlement did not prejudice the insurer, because the settling tortfeasor was
judgment-proof. “[T]he mere right to sue the tortfeasor,” the court noted, “is of no value if there
is no reasonable likelihood of obtaining a judgment that is worth the cost of litigation.” Id. at 814.
Noting that the insurer had produced “no evidence” that the tortfeasor had any assets, the court
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concluded that the insurer was not entitled to summary judgment—indeed, the court held that the
insured was entitled to judgment as a matter of law. Id. at 815 (emphasis in original).
On the other hand, the minority view presumes prejudice to the insurer if the insured “fails to
prove substantial compliance” with the cooperation clause. See Simpson v. U.S. Fid. & Guar. Co.,
562 N.W.2d 627, 631 (Iowa 1997). However, even under this approach, the presumption of
prejudice is rebuttable if the insured makes a satisfactory showing of lack of prejudice. Id. at 632.
The underlying rationale for the majority approach is that an insured should not be denied
coverage on the basis of a loss to the insurer that is a technical or illusory. By requiring insurers
to demonstrate prejudice, the law prevents them from obtaining undeserved windfalls at the
expense of their insureds. The minority approach, by contrast, interprets policy language more
strictly and is less willing to read past that language to avoid an arguably inequitable outcome.
III. Notice Provisions.
Similarly, in many jurisdictions, an insured’s violation of a “notice” provision will relieve the
insurer of liability only if the insurer establishes that it was prejudiced by the lack of notice. See,
e.g., Sherwood Brands, Inc. v. Great Am. Ins. Co., 13 A.3d 1268, 1270 (Md. 2011); Stresscon
Corp. v. Travelers Prop. Cas. Co. of Am., 2013 COA 131, ¶ 26 (Colo. Ct. App. 2013) (“Colorado
does not strictly enforce notice-of-claim language in insurance policies unless the lack of notice
from the insured prejudiced the insurer.”); Ansul, Inc. v. Employers Ins. Co., 2012 WI App 135, ¶
24 (Wis. Ct. App. 2012) (as long as notice is provided within a year of the time required by the
policy, insurer must show it was prejudiced to evade liability) (citing Wis. Stat. § 631.81);
Chartis Specialty Ins. Co. v. RCI/Herzog, 2012 U.S. Dist. LEXIS 87803, *32 (W.D. Wash. June
25, 2012) (insurer must “show that the late notice … caused it actual and substantial prejudice”)
(quotation omitted).
Courts following this approach are often following state statutes. For example, in Sherwood
Brands, the insured failed to notify its third-party liability insurer within 90 days of the policy
period’s expiration, which the policy required it to do. The trial court granted summary judgment
to the insurer without requiring a demonstration of how it had been prejudiced by the late notice.
The court noted the policy’s specific language—“[N]otice shall be given … in no event later than
90 days after the end of the policy period”—and concluded that the insurer was not required to
show “actual prejudice.” 13 A.3d at 1273-74. On appeal, Maryland’s high court reversed, holding
that, under the relevant Maryland statute, an insurer “is required to demonstrate how it was
prejudiced by [the insured’s] late-bestowed notice.” Id. at 1270.
Other courts have developed the same rule through case law. For an extreme example, consider
State v. National Union Fire Insurance Company, 56 So. 3d 1236 (La. Ct. App. 2011). There, the
insured did not give notice to its insurer until several years after the underlying tort. The insurer
moved for summary judgment but “did not submit any evidence of actual prejudice.” Id. at 1246.
The trial court denied the insurer’s motion for summary judgment, and the appellate court—
recognizing that the notice was far from “prompt”—affirmed. Id. The appellate court explained
that the purpose of a notice provision is to prevent prejudice to the insurer, not to provide an
“escape-hatch” through which insurers can avoid the “fundamental protective purpose” of
insurance contracts. Id. (quotation omitted). (Note that the appellate court also held that the
insured was similarly not entitled to summary judgment, finding a genuine issue of fact as to
whether the insurer was prejudiced. Id. at 1246-49.)
Some states, meanwhile, are more favorable to insurers. In Florida, for example, the breach of an
insurance policy’s notice provision creates a rebuttable presumption of prejudice to the insurer.
See Wheeler’s Moving & Storage, Inc. v. Markel Ins. Co, 2012 U.S. Dist. LEXIS 125726, *14
(S.D. Fla. Sept. 4, 2012) (“Florida law provides that the failure to give timely notice creates a
rebuttable presumption of prejudice to the insurer.”). The insured carries the burden of showing a
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lack of prejudice. Id. As one Florida court explained in declining to adopt the “modern trend”
described above, a notice provision creates a condition precedent to a claim, and the burden of
proof should be on the party seeking to avoid a condition precedent. Bankers Ins. Co. v. Macias,
475 So. 2d 1216, 1218 (Fla. 1985).
In 1997, the Connecticut Supreme Court identified Florida as being the only state out of ten
surveyed that “requires insureds to prove lack of prejudice.” Reichhold Chems. v. Hartford
Accident & Indemn. Co., 703 A.2d 1132, 1142 (Conn. 1997). However, Florida is not alone.
Ohio, for example, applies a similar approach, albeit with a bit of nuance. Under Ohio law, to
determine whether a notice provision has been breached, the court first asks whether the insured
provided notice within a “reasonable time” in light of the circumstances. Burlington Ins. Co. v.
PMI Am., Inc., 862 F. Supp. 2d 719, 735 (S.D. Ohio 2012) (quotation omitted). If the delay was
reasonable, then the insured did not breach the notice provision. But, if the delay was
unreasonable, then the court presumes prejudice, which the insured must then rebut. Id. Indiana
courts have also applied a presumption of prejudice, rebuttable by the insured, when notice is
unreasonably late. Miller v. Dilts, 463 N.E.2d 257 (Ind. 1984).
Similarly, Michigan courts have, in some contexts, held that an insurer need not prove prejudice
when the insured failed to comply with notice provisions under the policy. As the Michigan
Supreme Court put it, if a notice provision does not contain a prejudice requirement, reading such
a requirement into the provision would “frustrate” the parties’ right to freedom of contract.
DeFrain v. State Farm Mut. Ins. Co., 817 N.W.2d 504, 505 (Mich. 2012) (interpreting uninsured
motorists policy with provision requiring notice within 30 days of accident). Cf. Koski v. Allstate
Ins. Co., 572 N.W.2d 636 (Mich. 1998) (requiring insurer to prove prejudice if insured does not
comply with policy provision requiring notice “immediately” or “within a reasonable time”).
Not all exhaustion provisions in excess policies are alike. Understanding the differences and how
courts apply those distinctive provisions may be critical to determining whether an excess insurer
is obligated to pay for otherwise covered liability that exceeds primary policy limits.
IV. Special Issues for Excess Insurance: Exhaustion of Underlying
Insurance.
Like other coverage disputes, policy language (and jurisdiction) matters when considering
conditions in excess insurance policy. One should have an understanding of the excess policy
language before providing advice on how or whether to resolve a coverage dispute with a primary
insurer concerning underlying liability that could result in damages that exceed the primary
policy limits.
A. Decisions requiring actual payment by underlying insurer of
underlying policy limits to trigger excess coverage.
Recently, in Quellos Group LLC v. Federal Insurance Co., No. 68478-7-1 (Wash. Ct. App. Nov.
12, 2013), the Court of Appeals of Washington strictly construed language in two excess policies
finding that the policyholder, Quellos Group, could not recover loss in excess of its primary
policy from its excess insurers after Quellos settled with its primary insurer for less than the
primary policy’s limits, even after the policyholder agreed to pay the difference between the
settlement amount and the full limit of the underlying primary policy.
Quellos, an investment management company, faced threats of litigation from its clients and
Federal government investigations concerning an allegedly fraudulent tax shelter Quellos had
developed. In 2006 and 2007, Quellos settled with its clients for approximately $35 million.
Quellos also incurred approximately $45 million in defense fees and other costs in connection
with investigations and audits by the IRS, a U.S. Senate subcommittee and the U.S. Attorneys’
Office concerning the tax shelter. Quellos sought to recover these amounts from its insurers.
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Quellos had primary coverage under several American International Specialty Lines Insurance
Company (AISLIC) claims-made Investment Management Insurance policies. Federal Insurance
Company (first-layer) and Indian Harbor Insurance Company (second-layer) provided excess
coverage. The Federal excess policy provided that coverage “shall attach only after the insurers of
the Underlying Insurance shall have paid in legal currency the full amount of the Underlying
Limit.” Quellos Group, No. 68478-7-1, *13 (emphasis original). The Indian Harbor excess policy
similarly provided that coverage “will attach only after all of the Underlying Insurance has been
exhausted by the actual payment of loss by the applicable insurers thereunder.” Id. at *15
(emphasis original).
Quellos and AISLIC, engaged in a coverage dispute regarding the underlying claims, settled their
dispute with AISLIC paying half ($5 million) of its $10 million primary policy limits. Quellos
satisfied the $5 million gap, then sought from Federal and Indian Harbor all amounts in excess of
the AISLIC primary policy’s $10 million limit. Federal and Indian Harbor denied coverage on the
ground that although the otherwise covered loss exceeded the AISLIC primary policy’s limits, the
underlying primary insurance had not been exhausted by payment of loss; therefore, the insurers
argued, they had no obligation to pay any portion of the underlying loss incurred by Quellos.
Quellos and the excess insurers filed summary judgment motions on whether the failure to
exhaust primary coverage through actual payment by the primary insurer barred coverage under
the excess policies. The lower court dismissed Quellos’s claims against Federal and Indian
Harbor, ruling that under the plain and unambiguous language of the excess policies, the limits of
the primary policies were not exhausted.
The Washington Court of Appeals affirmed. Applying Washington law, but also examining
decisions in other jurisdictions, the appeals court found that the Federal and Indian Harbor excess
policies clearly and unambiguously did not provide coverage unless and until the underlying
insurance was exhausted by the underlying insurer’s payment “in legal currency” or by the
underlying insurer’s “actual payment” of a claim, respectively. Id. at *16-17. The court also
found that the phrase “only after” in the excess policies’ insuring clauses did not transform the
exhaustion requirement into a condition precedent to coverage; rather, that language merely
reflected the “distinguishing characteristic and function of an excess policy.” Quellos Group, No.
68478-7-1, *16-17.
Finally, the court rejected Quellos’ policy argument that a literal interpretation of the excess
policies’ exhaustion requirement violated the public policy of promoting settlements. It found that
public policy should not “override the unambiguous exhaustion language” in the excess policies.
Significantly, the court noted the availability to Quellos of alternative policy language allowing a
policyholder to pay the full amount of underlying policy limits to trigger excess coverage and
held that it would enforce as written unambiguous language dictating how the underlying
insurance must be exhausted. Id. at *20.
The Quellos Group opinion follows a number of decisions in other jurisdictions in which courts
apply a textual reading of exhaustion language requiring actual payment by low(er) level insurers,
including the following. For example, in Comerica Inc. v. Zurich Am. Ins. Co., 498 F. Supp. 2d
1019, 1020 (S.D. Mich. 2007), the policyholder settled five class action suits for a total of $21
million. Its primary insurer disputed coverage under policies with limits totaling $20 million, but
settled with its policyholder and contributed $14 million towards the class action settlement. Id.
The policyholder paid the balance of $6 million and sought coverage under its excess policy. Id.
Its excess insurer, however, denied coverage on the ground that the underlying insurer did not
exhaust its limits by payment of loss, which the excess policy required. Id.
The excess insurer’s policy contained two provisions relating to exhaustion. The first, titled
“Depletion of Underlying Limit(s),” stated:
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In the event of the depletion of the limit(s) of liability of the “Underlying
Insurance” solely as a result of actual payment of loss thereunder by the
applicable insurers, this Policy . . . shall continue to apply to loss as excess over
the amount of insurance remaining. . . . In the event of the exhaustion of the
limit(s) of liability of such “Underlying Insurance” solely as a result of payment
of loss thereunder, the remaining limits available under this Policy shall continue
. . . for subsequent loss as primary insurance.
Id. at 1022.
The “Maintenance of Underlying Insurance” provision stated:
All of the “Underlying Insurance” scheduled in Item 3. of the Declarations shall
be maintained during the “Policy Period” in full effect, except for any reduction
of the aggregate limit(s) of liability available under the “Underlying Insurance”
solely by reason of payment of loss thereunder.
Id. at 1023.
The Michigan district court rejected the policyholder’s argument that filling the $6 million gap
was the “functional equivalent” of exhausting the primary policy. Id. at 1030. The court reasoned
that “Comerica had a fundamental disagreement with its primary insurer as to whether [it] was
liable for any amount of the settlement. That dispute did not directly involve [the excess insurer],
and Comerica did not have a right to tie [the excess] to any aspect of its settlement with [the
primary] without [the excess insurer’s] consent.” Id. at 1032. But see Pereira v. National Union
Insurance Co., No. 04 Civ. 1134, 2006 WL 1982789, *7 (S.D.N.Y. Jul. 12, 2006) (ruling that to
excuse the excess insurers from providing coverage on account of the underlying insurer’s
insolvency would provide a windfall to the excess insurers and stating the Comerica rationale was
“reasonable,” but it is not “the only reasonable interpretation”).
In Qualcomm, Inc. v. Certain Underwriters at Lloyd’s, London, 161 Cal. App. 4th 184, 188 (Ct.
App. 2008), the policyholder settled several lawsuits with its employees and disputed coverage
with its primary carrier. The primary insurer disputed coverage but agreed to settle with
Qualcomm for $16 million. Id. The policyholder sought coverage above $20 million from its
excess insurer, which argued that its policy did not attach until the primary policy exhausted by
payment of policy limits. Id.
The excess policy’s “Limit of Liability” section stated, “Underwriters shall be liable only after
the insurers under each of the Underlying policies have paid or have been held liable to pay the
full amount of the Underlying Limit of Liability.” Id. at 195. The trial court and Court of Appeals
agreed with the excess insurer. Id. It held:
In our view, the phrase “have paid … the full amount of ($20 million),”
particularly when read in the context of the entire excess policy and its function
as arising upon exhaustion of primary insurance, cannot have any other
reasonable meaning that the actual payment of no less than the $20 million
underlying limit.
Id. The California Court of Appeals concluded:
Whatever merit there may be to conflicting social and economic considerations,
they have nothing whatsoever to do with our interpretation of the unambiguous
contractual terms. If contractual language in an insurance contract is clear and
unambiguous, it governs, and we do not rewrite it ‘for any purpose.’
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Id. at 204 (citation omitted); see also Citigroup, Inc. v. Federal Ins. Co., 649 F.3d 367 (5th Cir.
2011) (finding, despite slightly inconsistent exhaustion language in the policies at issue, that the
policies dictated that “the primary insurer pays the full amount of its limits of liability before
excess coverage is triggered” and that “the use of the phrase ‘payment of loss’ establishes that the
underlying insurer must make actual payment to the insured in order to exhaust the underlying
policy”); Great American Insurance Co. v. Bally Total Fitness Holding Corp., No. 06 C 4554,
2010 WL 2542191 (N.D. Ill. June 22, 2010) (requiring exhaustion by payment to trigger excess
coverage); Goodyear Tire & Rubber Co. v. National Union Ins. Co. of Pittsburgh, No. 08-1789,
2011 WL 5024823, *1 (N.D. Ohio Sept. 19, 2011) (holding that the excess insurer charged a
premium consistent with its expectation that its policy would not attach unless the underlying
insurance was exhausted by payment of the full amount of its limits).
B. The Second Circuit’s decision in Zeig v. Massachusetts Bonding &
Insurance Co. and other decisions that do not require actual
payment of underlying policy limits to trigger excess coverage.
With its ruling in Quellos, Washington joins a growing number of jurisdictions that have departed
from the traditional view of this exhaustion issue set out in the Second Circuit’s 1928 decision in
Zeig v. Massachusetts Bonding & Insurance Co., 23 F.2d 665 (2d Cir. 1928). The policyholder in
Quellos, in fact, relied on Zeig to support its argument that public policy favoring settlements
should supersede unambiguous exhaustion language (requiring payment of a loss that fully
exhausts the limits of underlying insurance by an underlying insurer).
In Zeig, a policyholder sought coverage under an excess burglary first party insurance policy for
amounts exceeding the limits of three underlying policies. The limits of the underlying policies
totaled $15,000, but the policyholder settled his claims with those insurers for $6,000. The excess
policy applied “only after all other insurance herein referred to shall have been exhausted in the
payment of claims to the full amount of the expressed limits of such insurance.” 23 F.2d at 665.
The excess insurer argued that its policy applied only after full payment of the underlying policy
limits.
Judge Learned Hand, however, affirmed the lower court’s finding that the policyholder had a
right to coverage under the excess policy:
The clause provides only that it be ‘exhausted in the payment of claims to the full
amount of the expressed limits.’ The claims are paid to the full amount of the
policies, if they are settled and discharged, and the primary insurance is thereby
exhausted. There is no need of interpreting the word ‘payment’ as only relating to
payment in cash. It often is used as meaning the satisfaction of a claim by
compromise, or in other ways. To render the policy in suit applicable, claims had
to be and were satisfied and paid to the full amount of the primary policies. Only
such portion of the loss as exceeded, not the cash settlement, but the limits of
these policies, is covered by the excess policy.
Id. at 666. In rejecting the excess insurer’s argument, the Second Circuit offered the following
rationale that many other courts adopting Zeig quote to support their decisions:
The defendant argues that it was necessary for the plaintiff actually to collect the
full amount of the policies for $15,000, in order to ‘exhaust’ that insurance. Such
a construction of the policy sued on seems unnecessarily stringent. It is doubtless
true that the parties could impose such condition precedent to liability upon the
policy, if they chose to do so. But the defendant had no rational interest in
whether the insured collected the full amount of the primary policies, so long as
it was only called upon to pay such portion of the loss as was in excess of the
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limits of those policies. To require an absolute collection of the primary
insurance to its full limit would in many, if not most, cases involve delay,
promote litigation, and prevent an adjustment of disputes which is both
convenient and commendable. A result harmful to the insured, and of no rational
advantage to the insurer, ought only to be reached when the terms of the contract
demand it.
Id.
Several courts have adopted the pro-settlement reasoning espoused in Zeig. In HLTH Corp. v.
Agricultural Excess and Surplus Ins. Co., No. 07C-09-102 RRC, 2008 WL 3413327, *4 (Del.
Super. Ct. Jul. 31, 2008), for example, the excess policy at issue stated:
Only in the event of exhaustion of the Underlying Limit by reason of the insurers
of the Underlying Insurance, or the insureds in the event of financial impairment
or insolvency of an insurer of the Underlying Insurance, paying in legal currency
loss which, except for the amount thereof, would have been covered hereunder,
this policy shall continue in force as primary insurance, subject to its terms and
conditions and any retention applicable to the Primary Policy, which retention
shall be applied to any subsequent loss in the same manner as specified in the
Primary Policy.
The court followed Zeig and rejected Comerica and Qualcomm as “contrary to the established
case law of New Jersey and Delaware.” Id. at *14-15. It held that “the excess policy was triggered
when the underlying policy limit was reached by the total costs incurred by the insured,
regardless of whether the total payments to the insured reached those limits, because the excess
insurance company could not possibly claim to have a stake in whether the insured actually
received all of the underlying insurance limits.” Id. at *14. The court also based its decision on
public policy favoring settlements:
Settlements avoid costly and needless delays and are desirable alternatives to
litigation where both parties can agree to payment and leave other separately
underwritten risks unchanged. The Court sees unfairness in allowing the excess
insurance companies in the instant case to avoid payment on an otherwise
undisputedly legitimate claim. Therefore, to the extent that Plaintiffs’ defense
costs exceed any loss they may have imposed on themselves by accepting
settlements with underlying insurers for less than the policy limit, the Court holds
that those underlying policies have been exhausted as a matter of law.
Id. at *15.
The HLTH Corp. court cited, inter alia, Westinghouse Elec. Corp. v. Am. Home Assur. Co.,
which had reasoned that “a policy may be ‘functionally exhausted’ by a settlement. By settling,
an insurer is released from its obligation to provide further coverage under the policy, even
though the full policy limits may not have been paid.” No. 07C-09-102, 2004 WL 1878764, *6
(N.J. Super. Ct. Jul. 8, 2004). See also Maximus Inc. v. Twin City Fire Ins. Co., 856 F. Supp. 2d
797, 801-04 (E.D. Va. 2012) (finding ambiguous excess language stating it applies “only after all
applicable Underlying Insurance with respect to an Insurance Product has been exhausted by
actual payment under such Underlying Insurance” and holding the policyholder could fill the gap
left by a settlement with underlying insurers to reach its excess limits); Reliance Ins. Co. v.
Transamerica Ins. Co., 826 So.2d 998 (Fla. Dist. Ct. App. 2001) (rejecting a literal interpretation
of exhaustion language in excess policy that provided coverage “only after all primary insurance
is exhausted” and “align[ing] [itself] with Zeig”); Schmitz v. Great American Assurance Co., 337
S.W.3d 700, 706-07 (Mo. 2011) (finding unambiguous an excess insurer’s “obligation to pay
claims was not dependent on the underlying insurer exhausting its limits. The two requirements
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for [the excess insurer] to ‘promptly pay’ occurred once [the underlying insurer] was obligated to
pay the full amount of the underlying limits of insurance and the amount of loss was finally
determined.”); Rummel v. Lexington Ins. Co., 945 P.2d 970, 981 (N.M. 1997) (where excess
policy provided that it would “not attach unless and until the Insured’s Underlying Insurance has
paid or has been held liable to pay the total applicable underlying limits,” holding it would be
“senselessly redundant” to further require the policyholder to actually pay the underlying insurers
the full limits of those policies” in order to reach its excess layer); Drake v. Ryan, 514 N.W.2d
785, 789 (Minn. 1994) (finding that excess insurer would not suffer prejudice if the policyholder
is not required to actually pay the limits of the underlying insurance and deferring, in large part,
to public policy favoring settlements).
V. Taking a Hammer to the Consent to Settle Provision in Directors &
Officers and Professional Liability Policies.
A. Consent to settle provisions.
Directors & Officers and professional liability policies typically provide insureds with the express
right to consent to (or reject) a proposed settlement of a liability suit. The insurer is required to
obtain the consent of the policyholder to any potential settlement of such underlying suits. Some
consent to settle provisions provide:
(The insurer is empowered to) make such investigation and negotiation and, with
the written consent of the insured, such settlement of any claim or suit as the
company deems expedient. . . .
See e.g., Lieberman v. Employers Ins. of Wausau, 84 N.J. 325, 329 (1980). While others provide:
The Company shall have the right to make any investigation it deems necessary
and with the written consent of the insured, said consent not to be unreasonably
withheld, any settlement of any claim covered by the terms of this policy.
See e.g., Clauson v. New England Ins. Co., 254 F.3d 331, 336-37 (1st Cir. 2001) (emphasis
added).
In Lieberman, Employers Insurance of Wausau issued to Lieberman (a physician) a malpractice
insurance policy. Employers defended Lieberman in an underlying malpractice lawsuit.
Lieberman had executed a consent to settle within the limits of the insurance policy. Lieberman,
84 N.J. at 331. Following Lieberman’s receipt of information indicating possible fraud or
malingering on the part of that the malpractice plaintiff, Lieberman sent a letter to Employers
purportedly revoking his prior consent to settle. Id. at 332. Employers rejected Lieberman’s
revocation, stating “Regretably (sic), based upon consents that were previously given,
negotiations have been in progress prior to receipt of your letter and accordingly, must advise you
we are unable to comply with your request.” Id. Eventually, Employers settled the malpractice
lawsuit for $50,000, which was within the policy’s $200,000 liability limit. Id. at 333. The
settlement, together with one other settlement, resulted in the imposition of a 150% premium
surcharge on Lieberman for three years. Id.
Lieberman sued Employers seeking recovery of the surcharge premium. 1 “The gravamen of
Lieberman's complaint was that Employers, by executing a settlement of the [malpractice] claim
1
Lieberman also sued his defense counsel for legal malpractice on the ground that counsel
breached his duty to Lieberman inherent in their attorney-client relationship. The New Jersey
Supreme Court affirmed the underlying finding of malpractice based on counsel’s “fail[ure] to
inform Lieberman of the clear conflict of interests and his subsequent failure either to withdraw
from the case completely or to terminate his representation of either the insured or the insurer”
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without effective consent, had breached its contract of insurance with Lieberman.” Id. at 334.
While the trial court dismissed Lieberman’s lawsuit, the Appellate Division reversed and
remanded for trial on the issue of damages. The New Jersey Supreme Court affirmed the
Appellate Division’s judgment.
Even where absent from a policy, some courts will read such consent to settle provisions in as a
matter of law and/or public policy, absent an express provision to the contrary. For example, in
Saucedo v. Winger, 22 Kan. App. 2d 259 (1996), the Kansas appellate court held that where “the
policy at issue simply does not say if [insurer] has the exclusive right to settle,” it “consequently
must be interpreted” to require the consent of the policyholder. Id. at 268.
B. The hammer clause.
To the extent a claim may be settled at low cost, insurers generally will want to take advantage of
that opportunity, thus avoiding a potentially large verdict, while simultaneously avoiding the
substantial defense costs which would otherwise have accrued at trial. Insurers, therefore, have
added over the years the so-called “hammer clause” to consent to settle provisions. Such clauses
limit (with variations) the insurer’s liability to the amount of the proposed settlement forgone by
the policyholder.
“Hammer clauses” vary. The most common, sometimes termed the “full” hammer, strictly limits
the insurer’s liability to the amount of the proposed settlement, also freezing the insurer’s defense
cost obligation to the amount accrued at that time:
The Company shall not settle any claim without the written consent of the named
insured, except for claims involving alleged libel or slander on the part of the
insured. If, however, the named insured shall refuse to consent to any settlement
recommended by the Company, and shall continue litigation at the trial level or at
the appellate level in connection with such claim, then the company's liability for
that claim shall not exceed the amount for which the claim would have been
settled plus the cost and expenses incurred with the Company's consent up to the
date of such refusal to settle.
Security Ins. Co. of Hartford v. Schipporeit, 69 F.3d 1377, 1383 (7th Cir. 1995) (emphasis
added). Other full hammer clauses provide that the insurer may withdraw its defense of its
insured:
The Company shall have the right to make any investigation it deems necessary
and with the written consent of the insured, said consent not to be unreasonably
withheld, any settlement of any claim covered by the terms of this policy. If the
Insured shall refuse to consent to any settlement or compromise recommended by
the Company and acceptable to the claimant, and elects to contest the claim, suit
or proceeding, then the Company's liability shall not exceed the amount for
which the Company would have been liable for damages if the claim or suit or
proceeding had been so settled or compromised, when so recommended. The
Company shall have no liability for claims expenses accruing thereafter and the
Company shall have the right to withdraw from the further defense thereof by
tendering control of said defense to the Insured.
Clauson, 254 F.3d at 336-37 (emphasis added).
and “active participation thereafter in the actual settlement of the claim against the wishes of his
client, the insured.” Id. at 340.
10
Some policies create a type of “modified” hammer, which limits the insurers liability to the
amount of the proposed settlement plus a percentage of certain additional costs. These provisions,
in effect, force the policyholder to share in the risk of a future settlement or judgment within the
insurance policy’s liability limits.
C. Analysis/application of the hammer clause.
In Security Insurance, supra, the insurer recommended that the contractor-policyholder pay
$5,000 (an amount within the policy’s deductible) as part of an arrangement to remediate
defective work that was the subject of a property damage suit against the policyholder and two
separate entities. Id. at 1383. The underlying plaintiff’s acceptance of the proposed settlement,
however, was contingent not only on the $5,000 payment by the policyholder, but also on similar
payments from a group of co-defendants. Id. The policyholder refused and the deal fell through.
Id. at 1379.
The insurer sought a declaratory judgment that it owed neither a continuing duty to defend, nor
any indemnification above the $5,000 offer. The court disagreed, ultimately ruling that the $5,000
payment did not constitute a “settlement” within the meaning of the policy. “[The insurer] would
read the term ‘settlement’ in the insurance contract to mean any agreement which might move the
dispute toward ultimate resolution.” Id. “But the term ‘settlement’ in this provision makes sense
only if it means a full and final disposition of a claim, and that assumes that a release of liability
will be issues.” Id. Thus, the Seventh Circuit affirmed the district court’s ruling that the insurer
owed a continuing duty to defend and indemnify its policyholder, notwithstanding the hammer
clause contained in the policy.
In Clauson v. New England Insurance Co., 254 F.3d 331 (1st Cir. 2001), the court also
considered a full hammer clause:
The Company shall have the right . . . with the written consent of the insured,
said consent not to be unreasonably withheld, [to] settle[] any claim covered by
the terms of this policy. If the Insured shall refuse to consent to any settlement . .
. , then the Company’s liability shall not exceed the amount” of the
recommended settlement.
Id. at 336-37. The clause also allowed the insurer to withdraw from the defense of its insured
following a refusal to settle. The ultimate issue considered by the First Circuit was whether the
hammer clause was triggered categorically by the policyholder’s refusal to settle, or whether the
clause remained dormant unless such refusal to settle was deemed “unreasonable.”
The insured attorney sought coverage under his professional liability policy for a judgment
entered against him in a legal malpractice lawsuit. The insured attorney had received a defense
from his insurer under the policy. After a non-binding arbitration resulted in an award of $20,000,
the insured rejected the award, contrary to the recommendation of the insurer and his counsel. Id.
at 334. The insurer invoked the policy’s hammer clause that limited its exposure to the amount of
the rejected settlement. Id. at 334-35. Thereafter, the underlying plaintiff’s counsel and the
insured’s counsel agreed that the arbitrator's award, plus interest, would be a reasonable basis for
settlement. However, the insured again refused to consent to a settlement. Id. at 335. The insurer
informed its insured that his refusal was unreasonable and that its liability would be limited to the
amount of the rejected settlement. Id.
Following a bench trial in the underlying malpractice lawsuit, a $97,716.50 judgment was entered
against the insured. The insurer limited its payment to $29,000, relying on the policy’s hammer
clause. The insured then sued its insurer for the entire judgment.
The insurer contended that while the first sentence of the hammer clause gives a reasonable
insured the ability to frustrate settlement, the second sentence, with its reference to "any
11
settlement," limits the insurer’s liability to the amount of a rejected settlement offer that it
recommends and is acceptable to the claimant, whether the rejection by the insured is reasonable
or not. The insured, it argued, therefore received all he was due under the policy when the insurer
paid $29,000 after the entry of the final judgment. The insured contended that both sentences
must be read together to limit the insurer’s liability only when its policyholder’s refusal to settle
is unreasonable.
The First Circuit agreed with the insured (and the district court) and adopted the district court’s
reasoning:
By preventing the insurer from settling without the insured’s consent and
prohibiting the insured from unreasonably withholding consent, that provision, in
effect, confers upon the insured the right to reasonably withhold consent. . . . At
the very least, [insurer’s] reading of the policy would render meaningless the
provision prohibiting consent from being unreasonably withheld. If coverage
were reduced to the amount of a proposed settlement even where the insured
reasonably refuses to consent, the prohibition against unreasonably withholding
consent would be superfluous. Coverage would be reduced whether the insured
acted reasonably or unreasonably.
Id. at 337-38 (quoting 83 F.Supp.2d 278, 282 (D. R.I. 2000)). Accord Freedman v. United
National Insurance Co., No. CV 09-5959, 2011 WL 781919 (C.D. Cal., Mar. 1, 2011) (following
Clauson and holding “[t]he ‘Hammer Clause’ may be invoked only if the insured unreasonably
refuses to consent to a settlement.”). The First Circuit ultimately held that “[b]ecause the district
court found that [the policyholder] had been reasonable when he rejected [the underlying
plaintiff’s] settlement offers, a finding that [the insurer] does not challenge on appeal, [the
insurer’s] obligations extend to the full policy limits.” Id. at 336.
The court also considered and distinguished Schipporeit, supra, finding that although that
decision supported the proposition that “consent to settlement provisions shift risk to the insured
every time an offer is refused … the policy in that case did not distinguish between the reasonable
and unreasonable rejection of settlement offers.” Id. at 338 n.5.
Consent to settle clauses can expressly enhance an insured’s control over the settlement of a
liability lawsuit. While the inclusion of a hammer clause may be viewed by policyholders as a
limitation on coverage otherwise available under an insurance policy, insurers may view it as a
way to try to balance an insurer’s and policyholder’s respective rights and risks under an
insurance policy. Ultimately, the reasonableness of the insured’s refusal to consent to a settlement
will be the touchstone issue of any dispute where a “hammer clause” requires the insured to
unreasonably refuse to consent to a settlement in order to limit the insurer’s liability.
VI. Conditions under first-party insurance policies.
Unlike liability policies, which provide indemnity to third parties, first-party policies provide
indemnity to the insured directly. A first-party policy might provide coverage for damage to
buildings such as a house or dwelling under a homeowners policy, or business or rental property
under a commercial property policy. An insured might also have first-party insurance for other,
non-building property such as business personal property owned by the insured, accounts
receivable, or inventories of the insured’s product or goods. Other examples of first-party
policies, or first-party coverage in policies, include collision or comprehensive auto coverage and
uninsured / underinsured motorists coverage.
First-party policies that provide the insured with direct indemnity coverage differ from liability
policies in some ways. For example, insurers and insureds often have different rights and duties
under first-party policies. Those rights and duties are typically based on the need for the insurer to
conduct an investigation into, and determine payment for, losses where there is no lawsuit or
12
other outside source of facts or information. Until the insurer can conduct an investigation, the
only information available to the insurer is typically the insured’s initial report of the loss or
damage. And the initial report of loss or damage might be limited to the date the insured noticed
the loss and possibly the cause of the loss. As a result, the typical insurance policy conditions in
first-party policies are often intended to allow investigation of the claim by the insurer.
Conditions in first-party policies therefore usually address issues that commonly arise during the
investigation and to allow the insurer to obtain information from an examination of the insured.
This might include requirements permitting the insurer to inspect damaged property or review the
insured’s records or documents.
Failure to comply with the policy conditions can delay payment to the insured or result in
forfeiture of coverage. Some of the policy conditions in first-part policies are the same as in
liability policies. Those provisions include cooperation clauses and notice provisions requiring
prompt notice of a claim. See, e.g., Neff v. Pierzina, 629 N.W.2d 177 (Wis. 2001) (holding
insurer’s denial of coverage was proper because the insureds failed to comply with the policy’s
notice requirements). Other conditions, like the insurer’s duty to investigate a claim, might be
considered implied under the policy. See Silberg v. California Life Ins. Co., 113 Cal. Rptr. 711,
11 Cal. 3d 452, 521 P.2d 1103 (1974) (insurer has implied duty of good faith and fair dealing,
which includes promptly investigating claims and paying for covered losses). And some
provisions, as discussed in this section, are only typically seen in first-party policies.
In addition, first-party policies are often encountered in situations involving property insurance.
Because some states regulate or legislate the terms of property insurance for damage or loss
caused by fire (and also sometimes other causes, such as hail), policies providing coverage for
fire (or other) losses might require certain mandatory provisions. In many jurisdictions, for
example, statutes dictate the minimum terms of coverage for “standard” fire insurance policies.
See, e.g., Mich. Code § 500.2833 (statutory provisions for standard fire insurance policy,
including mandatory policy provisions and coverage); Minn. Stat. § 65A.01 (providing statutory
provisions for the “Minnesota standard fire insurance policy”); N.Y. Ins. Law § 3404 (providing
the “standard fire insurance policy of the state of New York”); Wis. Stat. § 631.83 (requiring that
“[a]n action on a fire insurance policy must be commenced within 12 months after the inception
of the loss”). Thus, conditions in first-party policies providing coverage for fire or other losses are
sometimes required or provided by statute.
Because the conditions in first-party policies differ from liability policies, those conditions merit
special consideration for insureds, insurers, and their respective attorneys. This section of the
paper discusses typical policy conditions under first-party policies that impact coverage. Those
policy conditions include the insured’s obligation to produce or allow inspection of records
requested by the insurer, submit to an examination under oath, and provide a proof of loss. This
section of the paper also discusses appraisal provisions, which can function as a policy condition.
A. Producing or allowing inspection of records and documents.
A common condition in first-party policies requires the insured to “as often as we reasonably
require . . . [p]rovide us with records and documents we request and permit us to make copies.”
Courts generally agree that an insurer may request records or documents related to the claim or
loss, including records and documents related to the insured’s finances and income at the time of
the loss. E.g., Powell v. U. S. Fid. & Guar. Co., 88 F.3d 271 (4th Cir. 1996); Pisa v. Underwriters
At Lloyd’s, London, 787 F. Supp. 283, 285 (D.R.I.), aff’d 966 F.2d 1440 (1st. Cir. 1992); Stover
v. Aetna Cas. & Sur. Co., 658 F. Supp. 156, 160 (S.D. W. Va. 1987); Rymsha v. Trust Ins. Co.,
746 N.E.2d 561, 564 (Mass. Ct. App. 2001); Keith v. Allstate Indem. Co., 19 P.3d 1077, 1080
(Wash. Ct. App. 2001); Herman v. Safeco Ins. Co. of Am., 17 P.3d 631, 635 (Wash. Ct. App.
2001); State Farm Fire & Cas. Ins. Co. v. Walker, 459 N.W.2d 605 (Wis. Ct. App. 1990);
Ransom v. Selective Ins. Co., 550 A.2d 1006 (N.J. Super. 1988).
13
As long recognized by courts, requiring the insured to comply with requests for information
allows the insurer to obtain information and evidence from the insured that is relevant to the
insurer’s investigation and coverage determination. Claflin v. Commonwealth Ins. Co., 110 U.S.
81, 94-95 (1884) (“The object of the provisions in the policies of insurance, requiring the assured
to submit himself to an examination under oath, to be reduced to writing, was to enable the
company to possess itself of all knowledge, and all information as to other sources and means of
knowledge, in regard to the facts, material to their rights, to enable them to decide upon their
obligations, and to protect them against false claims.”)
Of course, the insured has no obligation to produce documents he or she does not have. But the
insured’s refusal or failure to produce documents requested by the insurer is a breach of the
policy conditions. If the breach is material, coverage is barred under the policy. Hudson Tire Mart
v. Aetna Cas. & Sur. Co., 518 F.2d 671 (2d. Cir. 1975); Southern Guar. Ins. Co. v. Dean, 172
So.2d 553 (Miss. 1965); Weissberg v. Royal Ins. Co., 240 A.D.2d 733, 659 N.Y.S.2d 505 (1997);
Herman v. Safeco Ins. Co. of Am., 17 P.3d 631 (Wash. Ct. App. 2001).
Many courts have held that an insurer cannot avoid its coverage obligations for the insured’s
breach of the cooperation clause unless there is prejudice to the insurer. Belz v. Clarendon Am.
Ins. Co., 69 Cal.Rptr.3d 864, 158 Cal.App.4th 615 (2007); Piser v. State Farm Mut. Auto. Ins.
Co., 938 N.E.2d 640, 648 (Ill. App. Ct. 2010) (“[I]t is well settled that unless the alleged breach
of the cooperation clause substantially prejudices the insurer in defending the primary action, it is
not a defense under the contract.”) (internal quotation omitted); Dreaded, Inc. v. St. Paul
Guardian Ins. Co., 904 N.E.2d 1267, 1272 (Ind. 2009) (to prove cooperation clause violation
requires insurer to “show actual prejudice from an insured’s noncompliance with the policy’s
cooperation clause before it can avoid liability under the policy”) (citation omitted); Emigrant
Mortgage Co., Inc. v. Washington Title Ins. Co., 78 A.D.3d 1112, 1114, 913 N.Y.S.2d 251, 253
(2010) (denial of coverage only appropriate if insured “engaged in an unreasonable and willful
pattern of refusing to answer material and relevant questions or to supply material and relevant
documents”); Martinez v. ACCC Ins. Co., 343 SW 3d 924 (Tex. Ct. App. 2011).
By contrast, courts in some jurisdictions, such as in New York, have held that prejudice is
irrelevant in considering a breach of a cooperation clause. See, e.g., Allstate Ins. Co. v. United
Int’l Ins. Co., 16 A.D.3d 605, 792 N.Y.S.2d 549 (N.Y. App. Div. 2005). However, even those
courts might require the insurer to demonstrate something more than the mere fact of the
insured’s breach of the policy condition to avoid coverage. For example, New York courts have
employed a three-part test to determine if the insured’s lack of cooperation will bar coverage. The
three-part test requires that the insurer demonstrate “(1) that it acted diligently in seeking to bring
about the insured’s cooperation, (2) that the efforts employed by the insurer were reasonably
calculated to obtain the insured’s cooperation, and (3) that the attitude of the insured, after his or
her cooperation was sought, was one of willful and avowed obstruction.” Id., 16 A.D.3d at 606.
In effect, the New York three-part test results in a “very heavy burden” for the insurer to prove
that the insured deliberately failed to cooperate. Id.
B. Examinations under oath.
The insured’s failure to comply with other policy conditions can also result in a denial of
coverage. First-party policies typically give the insurer the right to request that the insured submit
to an examination under oath. Some policies also allow the insurer to request an examination
under oath of an insured separately from any other insureds, or to examine representatives for the
insured. Similar provisions in policies providing coverage for wage loss, disability, or medical
expense benefits might give the insurer the right to request the insured submit to an independent
or compulsory medical examination.
Under the policy, the insured is required to submit to the examination under oath as a condition to
recovering for any loss or damage covered by the policy. An examination under oath is like a
14
deposition in that the witness—the insured—is sworn and the testimony is recorded. While a
deposition is conducted as part of discovery in the course of litigation, an examination under oath
is conducted by the insurer as provided in the policy. Thus, the examination under oath is
governed by the insurance policy, not by rules of civil procedure. See United States Fidelity &
Guaranty Co. v. Welch, 854 F.2d 459, 461 (11th Cir.1988) (“We agree with [the insurer] that its
right to obtain sworn statements arises from the policy provisions and is contractual in nature, and
is not to be confused with procedures authorized by statute for taking depositions.”).
Typically, after having an opportunity to review the transcript from an examination under oath
and make corrections, the insured must swear or affirm that the testimony is truthful. For
example, the policy might state that the insured is required to “submit to examination under oath,
while not in the presence of another insured, and sign the same, within a reasonable time of our
request.” The policy, statutes, or common law might also give the insured an express right to have
counsel present, at the insured’s own expense, for the examination under oath.
Courts in many jurisdictions have upheld an insurer’s denial of coverage based upon an insured’s
failure to submit to an examination under oath. Saucier v. U.S. Fid. & Guar. Co., 765 F. Supp.
334 (S.D. Miss. 1991); Stover v. Aetna Cas. & Sur. Co., 658 F. Supp. 156 (S.D. W. Va. 1987).
Abdelhamid v. Fire Ins. Exch., 182 Cal. App. 4th 990 (Cal. Ct. App. 2010); Western Nat’l Ins.
Co. v. Thompson, 797 N.W.2d 201 (Minn. 2011); Patenaude v. Safeco Ins. Co. of America, 639
N.W.2d 224 (Wis. Ct. App. 2001). Courts in a majority of jurisdictions have held that failure to
submit to an examination under oath is a material breach of the policy. Watson v. National Surety
Corp., 468 N.W.2d 448, 451 (Iowa 1991) (“The majority of courts have consistently held that
failure to submit to questions under oath is a material breach of the policy terms and a condition
precedent to an insured’s recovery under the policy.”) (citing Pervis v. State Farm Fire & Cas.
Co., 901 F.2d 944 (11th Cir. 1990); West v. State Farm & Cas. Co., 868 F.2d 348 (9th Cir. 1989)
(per curiam); Stover v. Aetna Cas. & Sur. Co., 658 F. Supp. 156 (S.D. W. Va. 1987); Kisting v.
Westchester Fire Ins. Co., 290 F. Supp. 141 (W.D. Wis. 1968), aff’d, 416 F.2d 967 (7th Cir.
1969); Warrilow v. Superior Court, 142 Ariz. 250, 689 P.2d 193 (Ct. App. 1984); Standard Mut.
Ins. Co. v. Boyd, 452 N.E.2d 1074 (Ind. Ct. App. 1983); Allison v. State Farm Fire & Cas. Co.,
543 So. 2d 661 (Miss. 1989); Azeem v. Colonial Assurance Co., 96 A.D.2d 123, 468 N.Y.S.2d
248 (1983), aff’d, 62 N.Y.2d 951, 479 N.Y.S.2d 216, 468 N.E.2d 54 (1984); Perrotta v. Farmers
Ins. Exch., 47 S.W.3d 569 (Tex. App. 2001); 5A J. Appleman & J. Appleman, Insurance Law &
Practice § 3549 (1970); 13A G. Couch, Couch on Insurance 2d § 49A:361 (M. Rhodes rev. ed.
1982); 44 Am. Jur. 2d Insurance § 1364, § 1366 (1982)). See also Krigsman v. Progressive
Northern Ins. Co., 864 A.2d 330 (N.H. 2005); Spears v. Tennessee Farmers Mutual Insurance
Co., 300 S.W.3d 671 (Tenn. Ct. App. 2009).
But some courts have held that the insured’s failure to submit to an examination defeats coverage
only if the insurer was prejudiced. For example, in State Farm Mut. Auto. Ins. Co. v. Curran, the
court noted that an insured might still be able to recover under the policy if the “breach of the
policy was clearly inconsequential as it pertained to the merits of [the] claim . . . .” 83 So. 3d 793,
806 (Fla. Dist. Ct. App. 2011), rev. granted 86 So.3d 1114 (Fla. 2012). In other instances, the
insured might be given the opportunity to correct the deficiency by submitting to the examination
under oath to preserve the right to bring suit or recover proceeds under the policy. Lidawi v.
Progressive County Mut. Ins. Co., 112 S.W.3d 725, 735 (Tex. Ct. App. 2003) (“Depending on
how the policy is written, an insurer’s proper remedy to enforce a condition precedent is
abatement rather than barring the claim.”) (citations omitted).
C. Proofs of loss.
First-party insurance policies also typically require the insured to provide the insurer a proof of
loss that states the nature and extent of the loss. The policy might require that the proof of loss be
submitted within a certain time after the loss, or within a certain time after the insurer requests the
proof of loss. Typical provisions require that the proof of loss identify the time and cause of loss;
15
the value of the property or amounts claimed; the interests of all insureds and any other persons in
the property involved, including all liens on the property; other insurance that may cover the loss;
and an inventory, receipts, or other documentation for any amounts claimed under the policy. The
policy also might require that the insured swear or affirm that the amounts submitted in the proof
of loss are true and accurate to the best of the insured’s knowledge.
The proof of loss provision in first-party policies allows the insurer to evaluate its obligations
under the policy by requiring the insured to present necessary information on the claim. “The
purpose of those requirements is to enable the insurer to form an intelligent estimate as to whether
the claim comes within the terms of the policy, to prevent fraud, and to enable the insurer to make
an investigation to determine its rights and liabilities.” 1 Allan D. Windt, Insurance Claims and
Disputes, § 3:3 (6th ed.) (West 2013).
Submission of a proof of loss is typically a condition to recovering under the policy. In a majority
of jurisdictions, coverage is not defeated unless the insurer demonstrates that the failure to
provide a proof of loss prejudiced it. 1 Windt, Insurance Claims and Disputes, § 3:3 (citing Nathe
Bros., Inc. v. American Nat. Fire Ins. Co., 615 N.W.2d 341, 348-49 (Minn. 2000); Resolution
Trust Corp. v. Moskowitz, 868 F. Supp. 634, 638-39 (D.N.J. 1994); Smith v. North Carolina Farm
Bureau Mut. Ins. Co., 321 N.C. 60, 361 S.E.2d 571, 575 (1987); Perry v. Middle Atlantic
Lumbermens Ass’n, 373 Pa. Super. 554, 542 A.2d 81, 89 (1988); Oritani Sav. & Loan Ass’n v.
Fidelity & Deposit Co. of Maryland, 744 F. Supp. 1311, 1315 (D.N.J. 1990); Federal Deposit
Ins. Corp. v. Aetna Cas. and Sur. Co., 744 F. Supp. 729, 734 (E.D. La. 1990); ACF Produce, Inc.
v. Chubb/Pacific Indem. Group, 451 F. Supp. 1095, 1098-99 (E.D. Pa. 1978); Zuckerman v.
Transamerica Ins. Co., 133 Ariz. 139, 650 P.2d 441, 445 (1982); Maryland Cas. Co. v. Clements,
15 Ariz. App. 216, 487 P.2d 437, 443 (1971); Pannell v. Missouri Ins. Guaranty Ass’n, 595
S.W.2d 339, 348 (Mo. Ct. App. 1980); Schultz v. Queen Ins. Co., 399 S.W.2d 230, 234 (Mo. Ct.
App. 1965); Tell v. Cambridge Mut. Fire Ins. Co., 150 N.J. Super. 246, 375 A.2d 315, 319 (Dist.
Ct. 1977); Foundation Reserve Ins. Co. v. Esquibel, 94 N.M. 132, 607 P.2d 1150, 1152 (1980);
Judge v. Celina Mut. Ins. Co., 303 Pa. Super. 221, 449 A.2d 658, 660 (1982); Fishel v. Yorktowne
Mut. Ins. Co., 254 Pa. Super. 136, 385 A.2d 562, 565 (1978); Cooley v. John M. Anderson Co.,
443 A.2d 435, 437 (R.I. 1982); Siravo v. Great American Ins. Co., 122 R.I. 538, 410 A.2d 116
(1980); Pickering v. American Employers Ins. Co., 109 R.I. 143, 282 A.2d 584, 593 (1971);
Commercial Bank of Bluefield v. St. Paul Fire and Marine Ins. Co., 175 W. Va. 588, 336 S.E.2d
552, 557 (1985). In addition, some courts will consider whether the insured’s failure to submit a
proof of loss was justified or excused if the insured substantially complied with the proof of loss
requirements. See, e.g., Nathe Bros., 615 N.W.2d at 348 (holding that “failure to submit a sworn
proof of loss in a timely manner will not necessarily bar recovery on a policy” absent specific
policy language to the contrary).
In other jurisdictions, failure to complete a proof of loss is not a bar to suit but can delay or bar
recovery under the policy. Mason v. St. Paul Fire & Marine Ins. Co., 82 Minn. 336, 85 N.W. 13
(Minn. 1901); Schmitt v. Mutual Serv. Cas. Ins. Co., No. C4-95-748, 1995 WL 507623 (Minn.
App. Aug. 29, 1995); Shafighi v. Texas Farmers Ins. Co., No. 14-12-00082-CV, 2013 WL
1803609 (Tex. App. April 30, 2013).
Courts in some jurisdictions, however, have held that the insurer need not prove prejudice to
defeat coverage if the insured does not submit a proof of loss. For example, in a case applying
Texas law, the Fifth Circuit Court of Appeals held that the insured’s two-year delay in submitting
a proof of loss was unreasonable and did not comply with the policy obligation to submit a proof
of loss “as soon as practicable.” U.S. v. Indiana Bonding and Sur. Co., 625 F.2d 26, 30 (5th Cir.
1980). See also Barnes v. State Farm Fire and Cas. Co., 623 F. Supp. 538, 541-42 (E.D. Mich.
1985) (holding coverage was barred after insured failed to submit signed proof of loss within 60day period required by policy); Aetna Cas. & Sur. Co. v. Harris, 218 Va. 571, 239 S.E.2d 84, 8889 (1977) (no coverage available to insured that failed to submit proof of loss and had no
evidence to demonstrate reasonable and substantial compliance with proof of loss provisions).
16
D. Appraisal.
First-party policies applying to property damage typically contain an appraisal provision that
provides a process for the insured and insurer to resolve disputes about the amount of loss short
of litigation. A typical appraisal provision might state as follows:
If we and you disagree on the amount of loss, either may make written demand
for an appraisal of the loss. In this event, each party will select a competent and
impartial appraiser and notify the other of the appraiser selected within 20 days
of such demand. The two appraisers will select an umpire. If they cannot agree
within 15 days upon such umpire, either may request that selection be made by a
judge of a court having jurisdiction. Each appraiser will state the amount of the
loss. If they fail to agree, they will submit their differences to the umpire. A
decision agreed to by any of the two will be binding as to the amount of loss.
As stated in the typical provision above, an appraisal panel will usually consist of the two
appraisers—one appraiser named by the insured and one named by the insurer—and the umpire,
selected by the appraisers. Appraisal is an informal process to resolve disputes about the amount
of coverage available under an insurance policy and is distinguishable from arbitration. Smithson
v. United States Fid. & Guar. Co., 186 W. Va. 195, 202, 411 S.E.2d 850, 857 (1991) (“The
narrow purpose of an appraisal and the lack of an evidentiary hearing make it a much different
procedure from arbitration.”) Appraisal can therefore be an efficient means that is less costly and
lengthy than litigation and concludes with a binding appraisal award or other determination
issued by the panel.
But appraisal cannot determine coverage under the policy absent an express provision or
agreement by the parties to submit insurance coverage disputes to appraisal. This is because
courts, not an appraisal panel, determine liability under the policy. See Wells v. American States
Preferred Ins. Co., 919 S.W.2d 679, 685 (Tex. App. 1996) (causation issues bearing on coverage
could not be determined by appraisal panel); Merrimack Mut. Fire Ins. Co. v. Batts, 59 S.W.3d
142, 150 (Tenn. Ct. App. 2001) (“[A]n appraisal determines only the amount of loss, without
resolving issues such as whether the insurer is liable under the policy.”). Thus, even after
appraisal, the insurer retains the right to deny coverage for the claim. And after appraisal is
completed, either the insured or insurer may seek a judicial determination on existence or scope
of coverage available under the policy for the appraisal award.
Because appraisal is a less formal process of determining disputes regarding the amount of loss,
the appraisal panel, or the umpire, may determine what means or methods will be used by the
panel to deliberate, consider, and determine the amount of the loss. The umpire might decide
what information is needed for the appraisal and what process the appraisal panel will use, with
or without input from the appraisers. See, e.g., Allstate Ins. Co. v. Suarez, 833 So. 2d 762, 766
(Fla. Dist. Ct. App. 2001) (umpire selected by appraisers had authority to conduct appraisal in an
informal manner as it was “difficult to imagine that a formal arbitration hearing was within the
contemplation of the parties” under the appraisal provision in the policy).
However, courts in some jurisdictions also consider appraisal as subject to the rules or statutory
provisions for arbitration. See Khawaja v. State Farm Ins. Cos., David A. Brooks Enters. v. First
Sys. Agencies, 370 N.W.2d 434, 435 (Minn. App. 1985) (appraisal under insurance policy subject
to arbitration statute with respect to considering and awarding interest on the amount of loss).
Similarly, a complex appraisal might take on characteristics that are more like arbitration such as
consideration of evidence or witness testimony. In Amerex Group, Inc. v. Lexington Ins. Co., the
appraisal panel had considered documentary and testimonial evidence, which included direct and
cross-examination of witnesses. 678 F.3d 193 (2d Cir. 2012). After appraisal, the insured
challenged the appraisal award, and argued that the appraisal panel failed to conduct an
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appropriate hearing. The Second Circuit Court of Appeals disagreed, holding that the panel had
the ability to determine how best to obtain information necessary for its valuation decision. The
court stated, “In conducting [the appraisal], the [p]anel followed precisely the ‘informal’ practice
appropriate to appraisal proceedings, rather than the kind of formal, trial-type procedures,
including extensive discovery, that are typical of litigation.” Id. at 207.
In some circumstances, courts have held that there are preconditions to demanding appraisal. For
example, under Florida law, a federal district court noted that an appraisal demand is only
possible if there is a dispute between the insured and insurer on the amount of the loss and any
preconditions under the policy have been met, including a timely demand for appraisal before
filing suit. 200 Leslie Condo. Ass’n, Inc. v. QBE Ins. Corp. No. 10-61984, 2011 WL 2470344
(S.D. Fla. June 21, 2011). As a result, there must be sufficient information available to determine
whether there is, in fact, a dispute on the amount of the loss. See id. To determine whether a
dispute exists could require investigation of the claim by the insurer, submission of a proof of loss
by the insured, or some other initial expression of disagreement on the amount of loss.
By contrast, some courts have held that appraisal is not conditioned on any requirements as long
as there is a dispute between the insurer and insured on the amount of the loss. See EDM Office
Services, Inc. v. Hartford Lloyds Ins. Co., No. 10-3754, 2011 WL 2619069 (S.D. Tex. July 1,
2011) (insurer may demand appraisal at any time there is a dispute on the amount of loss, and
other policy provisions on claim handling are not conditions precedent to appraisal). Under this
view, appraisal can be demanded by either party if there is a likely or near-certain dispute over
the valuation under the policy.
Still other courts have considered appraisal a precondition to filing a lawsuit. In a recent decision
by the Minnesota Supreme Court, for example, the court held that the appraisal panel could
consider issues of causation that might bear on coverage under the policy. Quade v. Secura Ins.,
814 N.W.2d 703, (Minn. 2012). In reaching its conclusion, the court observed “that appraisal is a
process that is generally intended to take place before suit is filed. Appraisal is generally
understood to be a condition precedent to suit.” Id. at 708 (citing Levine v. Lancashire Ins. Co.,
66 Minn. 138, 148-49, 68 N.W. 855, 859-60 (1896); State Farm Lloyds v. Johnson, 290 S.W.3d
886, 895 (Tex. 2009)).
Like other policy conditions, appraisal can be waived. The insurer can waive the right to appraisal
if it denies coverage for the claim. Chambers v. Home Ins. Co. of New York, 29 Ala. App. 34, 37,
191 So. 642, 644 (1939) (“[A] denial of liability by an insurer on a policy of insurance, issued by
the insurer, amounts to a waiver of an arbitration, or appraisal, clause incorporated in said
policy.”). But see Rogers v. State Farm Fire and Cas. Co., 984 So. 2d 382, 392 (Ala. 2007)
(holding that insurer did not waive right to appraisal by participating in litigation as there was no
prejudice to insured, and appraisal was not initially proper when insurer denied coverage and
insured and insurer disputed cause of loss).
Appraisal can also be waived if an appraisal demand is not timely, or if a party acts inconsistent
with the right to appraisal, such as by pursuing coverage litigation or participating in coverage
litigation. See Gray Mart, Inc. v. Fireman’s Fund Ins. Co., 703 So. 2d 1170, 1173 (Fla. Dist. Ct.
App. 1997) (“[W]e have little trouble concluding that Fireman’s Fund has waived its right to the
appraisal process by actively litigating this cause until its motion for summary judgment was
denied on the eve of trial and that Gray Mart would therefore be prejudiced if it was forced to
proceed with the appraisal process at this late stage of the proceedings.”). See also Lundy v.
Farmers Group., Inc., 750 N.E.2d 314, 320 (Ill. App. Ct. 2001) (insurer waived right to appraisal
when demand appraisal was made years after initial payment and 10 months after insured sued).
Contra Johnson v. Mut. Serv. Cas. Ins. Co., 732 N.W.2d 340, 346 (Minn. Ct. App. 2007)
(appraisal demand timely if made within two-year suit limitation period under the policy).
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Although it is unlike other policy conditions, the appraisal provision in first-party policies can
operate like a policy condition. And, when properly exercised, it can be a useful tool in resolving
disputes between the insurer and insured regarding the amount of the loss.
VII.
Conclusion.
Insurance policy conditions can have significant impacts on whether coverage is available under
the policy. As discussed in this paper, there are common issues and general trends for interpreting
and applying common insurance policy conditions. Whether addressing policy conditions on
behalf of an insured or an insurer, however, it is best to carefully review the language and the
applicable law. If the insurance policy conditions are ignored, it can mean the difference between
the existence or denial of coverage.
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