When Is Prejudice Required?
A Day of Confusion at the Fifth Circuit
One of the black letter principles of insurance law in Texas is the requirement of prejudice to support a carrier’s claim of late notice under an automotive or general liability policy. The requirement goes way back over 30 years to the Texas Supreme Court’s decision in Members Mutual Insurance Company v. Cutaia (476 S.W.2d 278) in 1972. A key portion of that discussion was that the Texas Supreme Court made it clear that it would not judicially insert a prejudice requirement into all insurance contracts, but rather left it up to the state legislature or the Texas Department of Insurance to decide when, and if, to tack one on. In other words, the Court decided to act like a court, not an ersatz legislature. Reasonable, right? Well, apparently the Federal Fifth Circuit Court of Appeals no longer thinks so.
A bit of history
For over three decades the Texas Board of Insurance (now the Texas Department of Insurance) has required that an insurer show prejudice when denying coverage for a policyholder’s failure to give prompt notice of a claim when it is a basis for denying coverage–but only for certain types of insurance policies. The prejudice requirement has been expressly limited to general liability and automobile policies and does not apply to homeowners, directors and officers, employee liability or any number of other types of coverages.
Indeed, back in 1972 the Texas Supreme Court in Cutaia said:
It is a better policy for contracts of insurance to be changed by the public body charged with their supervision, the State Board of Insurance, or by the legislature, rather than for this Court to insert a provision that violations of conditions precedent will be excused if no harm results from their violation. Cutaia at 278.
The State Board of Insurance later expressed its agreement with the Court and issued a Board Order in 1973 mandating a showing of prejudice, but only as to automobile and general liability policies. Since that time, the Texas Supreme Court has had many opportunities to extend the requirement to other types of insurance, but has refused to do so. The Department of Insurance has also had ample opportunities and has not done so. The state courts in Texas have also refused to judicially create new prejudice rules. In other words, current Texas law is hardly a mystery.
Now, on the other hand, the Federal courts have been more aggressive. The Federal Fifth Circuit Court of Appeals in Hansen Production Company v. American Insurance Company, 108 F3d 627 (5th Cir. 1997), speculated in 1997 that since the modern trend in the country was to require proof of prejudice on all insurance, it was likely that the Texas Supreme Court sooner or later would come out of the dark ages and apply the same standards. But Hansen, while guessing what the Texas Supreme Court may do in the future, did not impose its view and ignore the existing law of Texas. To the contrary, it respected and acknowledged the authority of Texas courts to decide Texas law.
Along came Ridglea
When, in late January, the Fifth Circuit issued its stunning decision in Ridglea Estate Condominium Association v. Lexington Ins. Co., 2005 WL121877 (Jan. 21, 2005), finding that a prejudice requirement should be applied to all insurance policies issued in Texas, many of us were perplexed. The policy in Ridglea was a property policy; one of the types of insurance never before found to include a prejudice requirement. The Court went so far as to say that it believed prejudice should apply to all insurance.
Why would the Fifth Circuit judicially create a prejudice requirement for all types of insurance policies despite the clear conflict with a prior decision of the Texas Supreme Court, the Department of Insurance and even prior decisions of the Fifth Circuit? I presume the three-judge panel understood what it did, so what is the message? Possibly that Federal Courts know best.
Why is that so bad? Shouldn’t the Fifth Circuit be able to decide for itself what it thinks Texas law is (or should be) when considering a case under diversity jurisdiction? The answer is yes, but only where the law is unclear. Every federal court is, under U.S. Supreme Court authority, bound to follow the rulings of the highest court of the state whose law it is applying. The Texas Supreme Court in Cutaia had specifically limited the prejudice requirement to certain types of policies. Even Hansen recognized that it would require an action of the Texas Supreme Court to alter the current law of the state.
You ask, isn’t the Ridglea court at least required to follow prior rulings of earlier panels of the Fifth Circuit? Given that Hansen and other prior Fifth Circuit decisions have not found a prejudice requirement in policies other than general liability and automobile policies, wouldn’t imposing such a requirement now be improper? The answer is yes. This Fifth Circuit panel decided not only that it was not bound by the Texas Supreme Court, but implicitly overruled prior panels of the Fifth Circuit by adopting a prejudice requirement for property policies.
This decision ignores all distinctions that had been made by Texas courts between various types of insurance policies, including “claims-made” and “occurrence-based” policies. The magnitude of this act of judicial hubris is hard to overstate.
As the carrier notes in its brief seeking rehearing en banc, litigation of insurance issues is a large part of litigation in the state and Federal Courts in Texas and should be carefully addressed. “Maintaining the uniformity of the Texas insurance law is of utmost importance because multitudes of insurance policies have been issued in reliance upon that law.”
When a court, state or federal, decides to unilaterally overrule a Texas Supreme Court case and radically rewrite Texas insurance law, it is doing great harm to policyholders and carriers alike.
The carrier in Ridglea is seeking review of the three-judge decision by the entire Fifth Circuit. While en banc reviews are rare, this particular review should be taken because of its direct assault upon Texas law. Let us hope that the rest of the Fifth Circuit is paying attention and withdraws and rethinks this mistaken opinion.
Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P.