Defense Digest

PROOF OF LATE NOTICE IS KEY IN DIRECT ACTION STATUTE DEFENSE

By Patrick Bailey, Esq.*

Recently, the United States Court of Appeals for the Third Circuit decided in Brooks v. American Centennial Insurance Company, 327 F. 3rd 260, 2003 U.S. App. LEXIS 8551, that where an insurance carrier has the burden to prove lack of notice of a claim, it may not prevail on a summary judgment motion without sufficient evidence.

In Brooks, the plaintiff, Dennis Brooks, sought coverage from the defendant, American Centennial Insurance Company ("ACI"), for an injury he suffered while loading heavy machinery onto a truck owned by Eazor Express, for which ACI provided excess insurance coverage. The plaintiff suffered this injury in 1981 and brought a negligence action against Eazor in the Court of Common Pleas of Allegheny County, which went to trial in 1993. Eazor underwent bankruptcy proceedings in 1991, and by the time the action was brought in 1993, it ceased to exist. The plaintiff then sought recovery from ACI pursuant to the Pennsylvania Direct Action Statute, which allows him to "stand in the shoes of Eazor" to assert against ACI any claim which Eazor could have asserted. No defense was offered at Brooks' trial and judgment was entered for $5,979,482.80. One million dollars of the judgment was the responsibility of the underlying carrier, while the balance was payable by ACI. ACI refused to pay, and argued that its policy conditioned coverage upon prompt notice of any impending claim. ACI further argued that the first time it learned of the plaintiff's suit was in July of 1996, some three years after the verdict.

Eazor was a trucking company headquartered in Pittsburgh, Pennsylvania. At the time of the plaintiff's incident, he was an employee of Gulf Oil Corp. and was involved in loading industrial field pumps onto an Eazor truck. While moving an 850 pound pump, it slid off the cart and caused Brooks to be thrown against a wall, thereby sustaining disabling injuries.

Eazor maintained multi-layer general liability insurance for personal injury claims. At the first level, it was self-insured up to $150,000.00 per claim. The Lloyd's of London provided coverage at the second level for claims between $150,000.00 to $350,000.00. At the third level, North Star Reinsurance Corporation ('North Star") provided coverage from $350,000.00 to $1 million. At the final level, ACI provided coverage from $1 million to $5 million.

Brooks' suit was brought initially against Eazor and Gould's, the pump manufacturer, in 1983. However, the case did not proceed to trial until 1993, two years after Eazor's bankruptcy case was closed.

In 1992, Guarantee Insurance, in coordination with North Star, retained counsel for Eazor. The plaintiff then dismissed Gould's from the action and settled with Guarantee Insurance for $100,000.00, the limits of its responsibility towards Eazor. These dismissals left Eazor as the only defendant in this action. As per instructions, Eazor's counsel did not defend the case actively. At trial no defense was offered, no contrary medical evidence was presented, no vocational expert testimony proffered regarding Brooks' ability to hold a job, and further, no argument regarding contributory negligence of the plaintiff. The court held in favor of Brooks and awarded $3 million in compensatory damages and $2,979,482.80 in punitive damages for a total judgment of $5,979,482.80.

In July of 1986, approximately three years after the verdict, plaintiff's counsel wrote to ACI advising it of the verdict and demanding that it pay $4 million in satisfaction of the judgment. ACI responded that it never heard of Brooks, had no notice or knowledge of his claim against Eazor, his lawsuit, or the 1993 trial and verdict. Under the ACI policy, it required that notice be given "upon the happening of an occurrence reasonably likely to involve ACI." Further, it provided that ACI shall have the right and opportunity to associate with the insured in the defense and control of any claim or proceeding reasonably likely to involve its coverage layer. ACI further argued that, under Pennsylvania law, an insurer is relieved of any obligation to indemnify its insured for a claim where the insured fails to provide timely notice of its claim and the insurer suffers prejudice as a result.

ACI further argued that under Brakeman v. Potomac Ins. Co., 572, Pa. 66, 371 A.2d 193 (Pa. 1977), it had been prejudiced as it was not provided timely notice of the claim nor was it given an opportunity to provide a defense. It was further prejudiced in that no one conducted an independent medical examination of the plaintiff or even prevented a defense at trial. ACI denied Brooks' claim.

Brooks brought a declaratory judgment against ACI in the District Court of the Western District of Pennsylvania claiming that ACI was liable for the amount of the plaintiff's recovery in excess of $1 million. ACI moved for summary judgment claiming lack of notice under Brakeman. The District Court granted summary judgment for ACI on the grounds that the plaintiff's late notice had prejudiced ACI.

On appeal, the Circuit Court reversed the District Court's grant of summary judgment on the grounds that ACI's records were insufficient to rule out the possibility that ACI received timely notice of Brooks' claim.

Under Brakeman, the Supreme Court held that, in order for an insurance company to be relieved of its obligation under a liability policy on the grounds of late notice, the insurance company is required to prove that the notice provision was, in fact, breached, and that the breach resulted in prejudice to its position. Id. at 198.

The Circuit Court, in evaluating evidence based on the Brakeman holding, was satisfied that ACI was prejudiced in that it was unable to:

1) Investigate the claim prior to trial;

2) Interview witnesses or retain counsel;

3) Present several defenses to its liability, including contributory or comparative negligence, assumption of risk and contribution or indemnification by a third party tortfeasor (Gould);

4) Obtain an independent medical examination of Brooks;

5) Present a defense as to damages;

6) Engage in discovery concerning the plaintiff's alleged injuries and present its own medical experts at trial;

7) Retain a vocational expert and present other available evidence that the plaintiff was capable of holding a job;

8) Engage in settlement negotiations; and

9) Appeal the $6 million, unchallenged verdict.

However, the Circuit Court reviewed the notice requirement and based its decision primarily thereon.

Although Brooks believed that his claim was worth $10 million, which implicated the ACI coverage level, he claimed he owed no notice to ACI, for ACI's contract calls for the insured, that is, Eazor, to notify the insurer when the insured expects the claim to impact the insurer's coverage layer. The plaintiff represented that, although the Pennsylvania Direct Action Statute allows him to stand in Eazor's shoes for the purpose of pursing an insurance claim, that statute did not shift to him the burden of notifying ACI. The Third Circuit found that argument untenable because Eazor ceased to exist in 1991, two years before the plaintiff's claim went to trial. If the duty to notify ACI remained with Eazor, even after its dissolution, ACI's notice provision would be a dead letter, a result that was illogical in light of the fact that ACI was a de facto defendant on the plaintiff's claim. ACI also argued that the late receipt of notice violated its contractual rights to associate it with a defense, and that under the Pennsylvania Direct Action Statute, ACI may assert against the plaintiff any claim that it might otherwise have asserted against Eazor. In other words, even if the Direct Action Statute did not shift to the plaintiff the duty to notify ACI, it nonetheless allowed ACI to assert lack of notice against Brooks.

The Circuit Court based its decision primarily on the testimony provided by Luann Petrellis, the Senior Vice-President and Manager of ACI's claims department. Petrellis stated that Brooks' July, 1996, letter was the first notice that ACI received concerning the claim. She formulated that opinion after checking the underwriting file obtained from The Underwriters, Inc. (TUI, ACI's managing general agent) which contained no evidence of any claim. She also checked ACI's computer system, which reflected no notice prior to that received in July of 1996. Further, she testified that while Darrah and North Star might have learned of the plaintiff's complaint in a timely fashion, neither was an authorized agent of ACI.

Of key importance was the fact that Petrellis' testimony may have been inadmissible for summary judgment purposes as she had no first-hand knowledge of ACI's policies during the time in question since she joined them in 1992. Petrellis knew very little about the policies and procedures ACI employed regarding writing excess insurance policies prior to 1985, when it stopped doing so. Further, she did not know whether ACI had a practice of obtaining copies of underlying insurance policies or if there was any mechanism for communicating with underlying insurers and confirming the status of their policies. Moreover, the records that Petrellis consulted were too incomplete to support her statement that ACI never received notice. Although she testified that she consulted The Underwriters, Inc. underwriting file, she admitted that ACI had difficulty getting TUI's documents:

There at some time may have been a much more extensive file. I do not know. I produced to you what we had, everything that was left. For many years, these files were warehoused somewhere in North New Jersey. I don't know if it was under lock and key. Things could have been moved. Ultimately, what we got is what we got.

Based on Petrellis' testimony, the Circuit Court ruled that ACI's evidence was insufficient to rule out the possibility that they received notice of Brooks' claim through the Underwriter, Inc. Petrellis reviewed at least some of the documents that TUI had in its possession. She relied on them in reaching her conclusion that ACI had received no notice of Brooks' claim prior to 1996. However, Petrellis could not state with certainty that she had reviewed all the documents ACI had received from TUI. She stated that "there, at one time, may have been a more extensive file." Based on that testimony, the Circuit said:

Summary Judgment is improper in face of such uncertainty, for we are required to assume that Petrellis failed to examine a substantial number of records regarding Eazor that ACI had received from TUI. As Petrellis' testimony was the only evidence offered to prove lack of notice, we conclude that the question whether ACI received timely notice of Brooks claim is best left to the Trier of Fact.

Indeed, any other outcome would condone ACI's failure to maintain competent records, a policy outcome directly at odds with Brakeman's determination that lack of notice is an affirmative defense to be pled and proved by the insurer.

Based on the Circuit Court's ruling, the following may be implied:

1) Under the Pennsylvania Direct Action Statute, a plaintiff may stand in the shoes of an insurer to pursue an insurance claim against a higher level insurance carrier;

2) The plaintiff, in standing in the insurance carrier's shoes, may have assumed the burden of timely notice to the higher level carrier of his claim.

3) Notice of a claim through other than authorized agent may be deemed as acceptable notice to the insurance carrier;

4) Maintaining less than excellent, complete and competent records is insufficient to meet the Brakeman standard for proving lack of notice as an affirmative defense.

By this ruling, insurers have to strengthen their office procedures and change some of their practices in dealing with insureds. Insurers are now required to maintain complete and competent records at all times. They further should verify and maintain contact with insureds regarding any claim that may impact the insurer's coverage layer. Clear lines must be delineated showing what agents are authorized to accept notice of claims. Underwriting departments and insureds must be given strict guidelines regarding reporting claims to higher level insurers. Finally, an all around communication policy must be adopted regarding notifying insurance carriers at all levels of any potential claim which may impact them to prevent any surprise or recurrence of Brooks v. American Centennial Insurance Company.

* Patrick is an associate in our Philadelphia, PA office. He can be reached at (215) 575-2606 or pbailey@mdwcg.com.