(September 2019) - In Pitzer College v. Indian Harbor Ins. Co., ___ Cal 5th ______ (August 29, 2019), the California Supreme Court answered a certified question from the United States Ninth Circuit Court of Appeals relative to whether the "notice - prejudice rule" constitutes a fundamental public policy under California law, negating a choice of law provision in an insurance policy. In addition, the California Supreme Court held that the notice-prejudice rule applies to consent clauses in first party insurance policies.
The questions answered by the California Supreme Court relate to a coverage dispute between the Claremont University Consortium ("CUC") and Indian Harbor Insurance Company ("Indian Harbor") in connection with a claim for reimbursement of remediation and cleanup costs incurred with respect to the removal of pollutants from a construction site on the Pitzer College ("Pitzer") campus located within the CUC.
On January 10, 2011, Pitzer discovered darkened soils at the construction site for a new dormitory on campus. By January 21, 2011, Pitzer determined that remediation would be required. With pressure to complete the dormitory prior to the start of the 2012 – 2013 academic year, Pitzer conferred with environmental consultants who determined that the least expensive and most expeditious option was to remove lead from the soil on-site using a transportable treatment unit ("TTU "). Pitzer reserved one of the two TTUs that were licensed for use in Southern California and began the treatment process. Remediation work commenced on March 9, 2011 with the setup of the TTU and was completed one month later at a total cost of $2 million.
Pitzer did not obtain Indian Harbor's consent before commencing the remediation or paying remediation costs. Pitzer did not place Indian Harbor on notice of the remediation claim until July 11, 2011, approximately 3 months after it completed remediation and six months after it discovered the darkened soils.
The Indian Harbor policy contain three provisions at issue in connection with Pitzer's claim for reimbursement of remediation costs. The supreme court described these provisions as follows:
The Policy contains three provisions pertinent to our review. First, a notice provision requires Pitzer to provide oral or written notice of any pollution condition to Indian Harbor and, in the event of oral notice, to "furnish...a written report as soon as practicable." Second, a consent provision requires Pitzer to obtain Indian Harbor's written consent before incurring expenses, making payments, assuming obligations and/or commencing remediation due to a pollution condition. Pursuant to an emergency exception to this consent provision, however, if Pitzer incurs costs "on an emergency basis where any delay . . . would cause injury to persons or damage to property to any [pollution condition]", then Pitzer is not required to obtain Indian Harbor's prior written consent, but it is required to notify Indian Harbor "immediately thereafter". Third, a choice of law provision states that New York law governs all matters arising under the Policy.
Based on the above provisions, Indian Harbor declined coverage of Pitzer's claim for reimbursement of remediation costs. Thereafter, Pitzer sued Indian Harbor in Los Angeles County Superior Court. Such suit was removed by Indian Harbor to the United States District Court. Subsequently, the district court held that potential coverage was not afforded under the Indian Harbor policy for Pitzer's remediation claim. The district court based its decision on the choice of law provision in the policy requiring application of New York law. Such law includes a strict no-prejudice rule with respect to policies issued and delivered outside of New York. Applying the strict no-prejudice rule, the district court held that Pitzer's delay in notifying Indian Harbor of the remediation of the site until after it had been completed violated the notice provision in the Indian Harbor policy and also violated the consent provision in such policy.
Thereafter, Pitzer appealed the district court's decision to the Ninth Circuit Court of Appeals, which in turn, certified questions to the California Supreme Court addressing the notice-prejudice rule and application of the consent clause in the Indian Harbor policy.
The California Supreme Court held that the notice-prejudice rule constituted a fundamental public policy. As such, the choice of law clause in the Indian Harbor policy conflicted with the fundamental public policy of California. The California Supreme Court reasoned as follows in connection with determining that the notice-prejudice rule constituted a fundamental public policy:
The first reason for establishing the notice-prejudice rule as a fundamental policy of our state is that notice-prejudice rule cannot be contractually waived and, thus, restricts freedom of contract. When it applies, the rule prevents enforcement of a contractual term. It overrides the parties' express intentions for a defined notice term, preventing a technical forfeiture of insurance benefits unless the insurer can show it was prejudiced by the insured's late notice
. . .
Second, the notice-prejudice rule protects insureds against inequitable results that are generated by insurers' superior bargaining power. We have consistently recognized that insurance contracts typically are "inherently unbalanced" and "adhesive", which "places the insurer in a superior bargaining position." (Egan v. Mutual of Omaha Ins. Co., (1979) 24 Cal.3d 809, 820; see Kransco v. American Empire Surplus Lines Ins. Co. (2000) 23 Cal.4th 930, 494 ["A fundamental disparity exists between the insured, which performs its basic duty of paying the policy premium at the outset, and the insurer, which, depending on a number of factors, may or may not have to perform its basic duties of defense and indemnification under the policy"].
. . .
The third criterion for establishing a fundamental policy is also satisfied in this case: 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. (Campbell, supra, 60 Cal.2d at p. 306.) Where California has an important interest at stake, there is no reason why that interest is any less valid or worthy of consideration because it was developed in court decisions and not by legislative action.
. . .
Based on the foregoing reasoning, we conclude that California's notice-prejudice rule is a fundamental public policy of California. The rule is based on the rationale that the essential part of the contract is insurance 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.'""
In addition, the California Supreme Court held that the notice - prejudice rule applies to consent provisions in first party policies. The supreme court declined to determine whether the Indian Harbor Policy constituted a first or third party policy. However, the supreme court reasoned as follows in connection with applying the notice-prejudice rule to first party policies:
No California court has addressed whether the notice-prejudice rule should be extended to a consent provision in the context of first party coverage. In a true first party context, there is no claim of liability for the insurer to defend and hence no logical need for it to retain unimpaired control over the claims handling. Thus, the reasons courts have refused to apply the notice-prejudice rule to consent provisions in third party policies generally do not apply to first party overage. Primarily, in a first party policy, the insurer's duty to defend and settle potential claims is not crucial to its coverage obligations. Compared with third party coverage, the insurer simply does not exercise the same contractual control over the potential loss or occurrence, which can happen long after the policy period has expired. (Montrose, supra, 10 Cal.4th at p.663)
For these reasons, failure to obtain consent in the first party context is not inherently prejudicial, and the usual logic of the notice-prejudice rule should control, in the absence of a coverage requirement for a third party claim or potential claim. Where the insurer owed no duty to defend against third party claims, the insured's failure to seek the insurer's consent to remediate a loss implicates risks that, while perhaps different in degree, are not so dissimilar to those in failing to provide notice of a loss to warrant departure from a case-by-case analysis of prejudice. For these reasons, we hold that California's notice-prejudice rule is applicable to a consent provision in a first party policy where coverage does not depend on the existence of a third party claim or potential claim.
While the California Supreme Court held that the notice - prejudice rule applied to consent provisions in first party policies, it specifically held that such rule does not apply to voluntary payments clauses in third-party policies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.