Insurers Cannot Avoid Coverage Obligations Based on a “Technicality”

The Colorado Court of Appeals recently reiterated that insurers cannot escape their coverage obligations based on “technicalit[ies]” that do not prejudice the insurer.  See Stresscon Corp. v. Travelers Prop. Cas. Co. of Am., 2013 COA 131, Nos. 11CA1239 & 11CA1582 (Colo. App. Sept. 12, 2013).  Such “technicalit[ies]” long have included a policyholder’s failure to notify its insurer of a claim against it, and a policyholder’s failure to seek its insurer’s consent to settle a lawsuit against it.  Colorado now has applied this principle to foreclose an insurer’s attempt to avoid coverage based on a policyholder’s failure to seek its insurer’s consent to voluntarily settle a claim before a lawsuit has been filed against it.  This decision exemplifies the continued expansion of the prejudice rule – at least in states that already apply the prejudice rule – and solidifies that it is becoming increasingly difficult for insurers to avoid their coverage obligations based on a policyholder’s technical breach of policy conditions.

In Stresscon Corp. v. Travelers Property Casualty. Co. of America, the court addressed whether a pre-suit settlement for which the policyholder had not sought its insurer’s consent was covered by the insurance policy at issue.  The insurer argued that it was not because (1) the policy had a “voluntary payment” exclusion that barred coverage when the policyholder failed to seek consent, and (2) the insurer was prejudiced as a matter of law by the settlement because the policyholder settled the claim before a lawsuit was filed.

The court rejected both arguments and found that the insurance policy obligated the insurer to cover the settlement because the insurer failed to prove that the policyholder’s breach of the consent requirement caused it prejudice, and because “forfeiting insurance benefits when the insurer has not suffered any prejudice would be a disproportionate penalty and provide the insurer a windfall.”  Id. ¶ 29 (citing Lauric v. USAA Cas. Ins. Co., 2009 P.3d 190, 193 (Colo. App. 2009)).  In so holding, the Colorado Court of Appeals expanded its application of the prejudice rule, which requires an insurer to provide coverage despite breaches of certain policy provisions unless the breach of conditions caused the insurer actual prejudice.

In Stresscon, the court applied a presumption of prejudice because the policyholder failed to notify its insurer of a settlement until after the settlement was finalized.  Nonetheless, the policyholder was able to rebut this presumption by presenting evidence that it was reasonably clear that the policyholder would have been liable had the lawsuit been filed, that the policyholder had obtained all information that was material to evaluating the claim against it during settlement negotiations, that the settlement amount was reasonable, that the settlement resulted from arms-length negotiations, and that the insurer could not have obtained a “materially better” outcome had it been involved in settlement.  Id. ¶ 52.  This shifted the burden to the insurer, which failed to prove “the precise manner in which its interests ha[d] suffered” as a result of the policyholder’s pre-suit settlement without consent.  See id. ¶ 33, 53, 62 (quoting Friedland v. Trav. Indem. Co., 105 P.3d 639, 648 n.5 (Colo. 2005)).  Accordingly, the court applied the prejudice rule and found that there was coverage.

Following Stresscon, Colorado now applies the prejudice rule in at least three contexts:  (1) when a policyholder fails to timely notify its insurer of a claim against it; (2) when a policyholder fails to seek consent for a settlement; and (3) when a policyholder fails to seek its insurer’s consent before entering into a pre-suit settlement despite a “voluntary payment” clause.  Colorado’s expanding application of the rule is in keeping with it and other jurisdictions’ recognition that there is an “inequity of an insurer receiving a windfall . . . due to a technicality,” id. (quoting Friedland, 105 P.3d at 645-46), and should encourage policyholders to pursue coverage even if they may not have met all policy conditions.

Gilbert LLP is a Washington-based law firm specializing in litigation and strategic risk management, insurance recovery and complex dispute resolution.