Texas Supreme Court Rejects Insurer’s Late Notice Defense Under a Claims-Made Policy

04/20/2009

In Prodigy Communications Corp. v. Agricultural Excess & Surplus Insurance Co., the Texas Supreme Court held late last month that, “[i]n a claims-made policy, when an insured notifies its insurer of a claim within the policy term or other reporting period that the policy specifies, the insured’s failure to provide notice ‘as soon as practicable’ will not defeat coverage in the absence of prejudice to the insurer.”

The case arose after Prodigy Communications, a subsidiary of AT&T, Inc., merged with FlashNet Communications, Inc. FlashNet was insured under a Directors’ and Officers’ Liability policy issued by Agricultural Excess & Surplus Insurance Company (“AESIC”). The policy also provided coverage to FlashNet for a securities claim. Before the merger, FlashNet purchased a three-year “Discovery Period” extending coverage to any post-merger claims brought against either Prodigy or FlashNet between May 31, 2000 and May 31, 2003. The notice provision required, as a condition precedent to coverage, that the insureds give AESIC notice of any claim made during the Discovery Period as soon as practicable, but in no event later than ninety days after the expiration of the Discovery Period.

In November, 2001, a class action lawsuit was filed against FlashNet, alleging violations of the federal securities laws. Prodigy was served in June, 2002, but did not give notice of the lawsuit to AESIC until June, 2003. AESIC denied the claim on the grounds that notice had not been given “as soon as practicable” even though (1) notice had been provided prior to the expiration of the ninety day drop-dead date, and (2) it was not prejudiced by its failure to receive earlier notice.

Prodigy retained Werner Powers, a partner in the Insurance Practice Group at Haynes and Boone, to sue AESIC. Both the trial court and the Dallas Court of Appeals held that Prodigy forfeited its insurance coverage for failure to give timely notice, irrespective of AESIC’s lack of prejudice. The Texas Supreme Court reversed, holding that the fundamental principle of contract law that only a material breach of contract will excuse the other party’s performance applied even though compliance with the notice provision was a condition precedent to coverage. The Court then determined that Prodigy’s failure to provide notice “as soon as practicable” was not a material breach of the policy because such notice was not an essential part of the parties’ agreement in that AESIC would not have been able to “close its books” on the policy, i.e., foreclose the possibility of any claims being made which would trigger coverage under the policy, until ninety days after the Discovery Period expired.

Since most corporate policies covering liability for directors and officers and professional errors and omissions are “claims-made” policies, Prodigy will preclude claims-made insurers in Texas (and likely elsewhere given the Prodigy court’s citation to substantial authority outside of Texas in support of its analysis) from taking advantage of a “gotcha” to avoid coverage when there is a delay in giving notice of a claim to a carrier, but notice is still given within the policy period and the carrier is not prejudiced by the delay. Prodigy may also have implications in Texas beyond just insurance contracts given its holding that only a material breach of a condition precedent will excuse the other party’s obligation to perform.

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