New York Court Predicts California’s Future: Allows Bad Faith Exception in Reinsurance Late Notice Defense

Ins. Co. of the State of Penn. v. Argonaut Ins. Co.
U.S. Dist. Ct., S.D.N.Y. (August 6, 2013)

In this case, the cedent sued its reinsurer when it denied coverage because of late notice of its claim.  Both parties filed a motion for summary judgment arguing the applicability of the late notice defense.  The court granted the reinsurer’s motion.

From 1980-2009, a series of disputes and negotiations arose regarding asbestos claims against the underlying insured.  It was not until 2009, through an “initial loss advice,” that the cedent first provided notice to the reinsurer under their facultative reinsurance certificate. Although the New York federal court applied California law, the parties recognized that both states’ reinsurance laws are nearly identical.  As such, both parties and the court periodically referenced decisions from courts of both states.  In its decision, the court used New York law to clarify portions of California law that were unsettled.

Under both states’ laws, to use the late notice defense, a reinsurer must show: (1) late notice; and (2) prejudice.  Under California law, notice can be either actual or constructive. The reinsurer argued that notice should have been provided in 1989 or no later than 2000.  The court stated that the obligation to give notice arose at the latest in 2002 when a cross-claim was filed against the cedent in an underlying action.

In this case, there was undisputed evidence that the cedent remained neutral on issues in prior disputes over the contract due to the conflicting interests of its multiple clients.  Therefore, the reinsurer may have been able to show prejudice by being denied the opportunity to encourage an earlier settlement. Yet, the court noted that the required showing of prejudice would be difficult to prove.

The court went on to hold that a reinsurer may be relieved from showing prejudice if it could show that the cedent acted in bad faith in failing to provide notice.  This exception arises given the nature of reinsurance relationships-one of “utmost good faith.”  A reinsurer relies on the cedent to be its eyes and ears.  While the California courts have not addressed the bad faith exception to showing prejudice, the New York court found that “it is possible to predict how California’s highest court would rule on the issue.”

The court found the bad faith exception to be appropriate because both states recognize the relationship as one owing the utmost respect which requires all information related to risk to be communicated to the reinsurer and further, where cedents themselves are insurance companies, they are fully familiar with the concept of notice. The New York court predicted California would recognize the exception and allowed discovery to proceed on the bad faith issue.

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