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When is Notice of an Insurance Claim Untimely?

That was the question that the United States Court of Appeals for the Seventh Circuit answered in the case, The Hanover Insurance Company v. R.W. Dunteman Company, et al, decided on October 24, 2022.  The case was an action brought by Hanover against its insureds seeking a declaration that it was not required to defend or indemnify the insureds against a lawsuit, because the insureds had not provided timely notice of the insurance claim.

The Underlying Lawsuit

Before the Hanover lawsuit, there was an underlying lawsuit that involved a family drama.  And, like many family dramas, the issue was who gets the money when Mom and Dad die.

During their marriage, Mom owned a minority interest in two companies owned and operated by Dad, Du-Kane Asphalt Company and Crush Crete, Inc.  Dad also owned an interest in a family business, R.W. Dunteman Company, separately from Mom.  The couple had five children, a daughter and four sons.  The four sons worked in the business and were shareholders in the three companies.  The daughter apparently was not involved in the business.

Mom and Dad divorced in 2009, and both died in 2017.  The daughter was named Executrix of Mom’s estate.  A dispute arose over Mom’s percentage interest in Du-Kane Asphalt and Crush Crete, Inc.  The sons claimed that, over time, Mom’s interest in the two companies had been reduced, so that, upon her death, she owned ten percent of Du-Kane Asphalt and Crush Crete.  The daughter claimed that Mom had actually owned twenty-four percent of Du-Kane Asphalt and Crush Crete and that, after the divorce, her father and her brothers had fraudulently diluted Mom’s interest in the two companies.  In August, 2017, Mom’s estate filed the underlying lawsuit.

So, How is This a Case About Insurance?

The reason that this case is about insurance is that, for a two-year period, Du-Kane Asphalt Company, Crush Crete, Inc., R.W. Dunteman Company and the four sons were insured under two separate Directors, Officers and Entity Liability policies issued by Hanover.  Each policy was a Claims-Made policy.  The first policy coverage period was March 31, 2017 – March 31, 2018, (the “2017 D&O Policy”) and the second policy coverage period was March 31, 2018 – March 31, 2019, (the “2018 D&O Policy”).

As stated above, Mom’s estate filed a complaint in August, 2017, during the policy coverage period of the 2017 D&O Policy.  However, for some reason, the lawsuit only named Du-Kane Asphalt Company as a defendant, even though the complaint alleged that the four sons, as Directors and Officers of the three companies, had fraudulently conspired to dilute Mom’s share in Du-Kane Asphalt and Crush Crete.  In addition, the lawsuit did not seek money damages; only a declaration that Mom’s interest in Du-Kane Asphalt and Crush Crete was twenty-four percent, not ten percent.  The insureds did not file a claim with Hanover under the 2017 D&O Policy after service of the original complaint.

In July, 2018, after a period of discovery, the estate filed an amended complaint, which broadened the allegations, added the other two companies and the four sons as defendants and asked for money damages.  The amended complaint was filed during the policy coverage period of the 2018 D&O Policy.  At that point, the defendants filed a claim with Hanover under the 2018 D&O Policy.

Hanover denied the claim because the lawsuit had first been filed in August, 2017, during the policy coverage period of the 2017 D&O Policy, and no claim had been filed during that policy’s reporting period.  Hanover said that the amendment of the complaint in July, 2018, was not a new claim, even though the amended complaint added new causes of action and new defendants and asked for money damages.

After it denied the claim, Hanover filed this lawsuit seeking a declaration upholding its denial of coverage under the 2017 D&O Policy and the 2018 D&O Policy.  The District Court ruled in favor of Hanover, and the Appeals Court affirmed.

What is a Claims-Made Policy?

In order to understand why Hanover won in both courts, it is necessary to have an understanding of a Claims-Made insurance policy.

A Claims-Made policy is issued for a defined coverage period, typically a 12-month period.  It requires that an insurance claim both accrue and be reported during the coverage period.  By requiring timely reporting of a claim, an insurance company has a better sense of outstanding claims and its resultant liability and can more accurately price its policies.  This generally redounds to the benefit of the insured by reducing overall premiums.

“The purpose of a claims-made policy is to allow the insurance company to easily identify risks, allowing it to know in advance the extent of its claims exposure and compute its premiums with greater certainty.” Uhlich Child.’s Advantage Network v. Nat’l Union Fire Co. of Pittsburgh, 929 N.E.2d 531, 537 (Ill. App. Ct. 2010). Because the insurer has a clearer picture of its risk exposure, it “in turn may offer insureds more-available and less-expensive policies.” Mkt. St. Bancshares, 962 F.3d at 952.

The trade-off, however, is that the insured must comply with strict reporting requirements to get the benefit of this less expensive coverage. If a claim was made in one policy period but reported in another, then the insurer owes no duty to defend or indemnify.

The opposite of a Claims-Made policy is an Occurrence policy.  Under that type of policy, the event that gives rise to a claim – the occurrence – must take place during the policy coverage period.  However, the claim based on that occurrence may not be asserted and reported for several years after the expiration of the policy coverage period.  The result is that an insurance company may not know the number of claims that have been incurred, but not reported, at the end of any policy coverage period and also may not know the full extent of its potential liability.  For that reason, an Occurrence policy is much more expensive than a Claims-Made policy.

There was no dispute in this case that the 2017 D&O Policy and the 2018 D&O Policy were Claims-Made policies.  There was also no dispute that the complaint was first filed in August, 2017, only named Du-Kane Asphalt as a defendant and only asked for declaratory relief.  There was no dispute that the amended complaint was filed in July, 2018, and that the amended complaint broadened the allegations, added Crush Crete, R.W. Dunteman and the four sons as defendants and asked for money damages.  There was also no dispute that notice of the lawsuit was not given to Hanover until after the amended complaint was filed.  So, the question for the court was whether notice was timely.

The Original Complaint was the Claim

Hanover argued that the original complaint and the amended complaint, although filed in different policy coverage periods, constituted one claim that was first made when the lawsuit was first filed.  The defendants, on the other hand, argued that there were two separate claims.  The first was the original complaint that only named Du-Kane Asphalt as a defendant and only sought declaratory relief.  The second was the amended complaint filed in July, 2018, which named additional defendants, broadened the allegations of wrongdoing and asked for money damages.  If Hanover was right, then notice given in July, 2018, was not timely under the 2017 D&O Policy.  However, if the defendants were right, then notice given in July, 2018, was timely under the 2018 D&O Policy.  So, who was right?

The defendants argued that the original complaint was not a claim under the 2017 D&O Policy because the estate had not asked for money damages.  It had simply sought a declaration that Mom’s interest in Du-Kane Asphalt at the time of her death was twenty-four percent, rather than ten percent as claimed by Du-Kane Asphalt.  The Court summarily rejected this argument.  The 2017 D&O Policy defined a Claim as including a “civil proceeding commenced by the service of a complaint” against an insured “for a Wrongful Act”.  Further, Wrongful Act included any … alleged act, error, omission, misstatement, misleading statement, neglect, [or] breach of duty” by an insured entity or individual.  The Court held that a lawsuit alleging that Mom’s interest in Du-Kane Asphalt had been fraudulently diluted by the four sons was a Claim alleging a Wrongful Act under the 2017 D&O Policy.  And, since the Claim was not reported during the 2017 D&O Policy’s reporting period, it was untimely and not covered under the 2017 D&O Policy.

The Amended Complaint was Not a New Insurance Claim

Once the defendants lost their argument that the original complaint was not an insurance claim, they could only prevail if they could convince the Court that the amended complaint constituted a new claim, separate and apart from the original complaint.  Their argument was based on the fact that the amended complaint contained new allegations, added new defendants, who were not part of the original complaint, and asked for money damages, rather than declaratory relief.  However, the court did not buy their argument.

The court stated that the new allegations of the amended complaint were related to the allegations of the original complaint.  Both complaints alleged that Mom’s interest in Du-Kane Asphalt and Crush Crete was fraudulently diluted due to the wrongful actions of the four sons.  It would defeat the point of a Claims-Made policy if every amendment of a complaint were to constitute a new insurance claim.

We held that the new damages theory was not a new claim but instead was related to—and thus was part of—the claim that was first made long before the policy period began. Id. at 953. We explained: “[A] ‘claim’ taking the form of ‘a civil proceeding commenced by the service of a complaint’ spans the entire civil action, not just the legal theories and factual allegations in the complaint that commenced the action.” Id. So too here. The estate’s new allegations in the same action built on the claim it first made during the 2017 policy period.

. . . accepting the insureds’ argument would undermine the purpose and ordinary operation of claims-made insurance. It bears repeating that this type of insurance “is geared toward easy identification of the insurer’s risk exposure.” Id. at 954. The insurer gets predictable risk exposure, and the insured pays a lower premium as a result. Id. at 952. The insured’s failure to report a claim in the same policy period in which it was first made makes the insurer’s “risk exposure … significantly more difficult to calculate.” Id. at 955. In short, the insureds can’t have it both ways by reaping the benefits of claims-made insurance without complying with their corresponding policy obligations.

The defendants next argued that the amended complaint was a new claim because it added new defendants.  Crush Crete, Inc., R.W. Dunteman Company and the four sons were not named as defendants in the original complaint.  So, how could they have known that they were required to give notice to the insurance company?  The Court also rejected this argument.

The other companies and the four sons were co-insureds under the 2017 D&O Policy.  In addition, the original complaint alleged wrongdoing on the part of the four sons.  In fact, the wrongful action of the sons in fraudulently diluting Mon’s interest in Du-Kane Asphalt and Crush Crete was the essence of the allegations of the original complaint.  While it could be argued that no claim had been formally asserted against Crush Crete, Dunteman and the four sons, the sons were certainly aware that a complaint alleging wrongdoing on their part had been filed against a company for which they were the Directors and Officers.  At that point, they had knowledge of a potential claim and were required to provide notice to Hanover.  Since the claim against Crush Crete, Dunteman and the fours sons was deemed to have accrued in August, 2017, when the original complaint was filed, notice given in July, 2018, was not timely.

What Lesson Can We Learn From This Case?

It is imperative that you file a claim with your insurance company as soon as you have reason to believe that a claim may occur.  Do not wait to be served with a complaint.  Do not wait for the discovery process or a trial to begin.  And, certainly, do not wait until you are sure that you may be liable for money damages.  By then, it will be too late, and you risk losing the insurance protection for which you have paid.

Of course, there is a caveat.  Insurance law is state-specific.  In this case, the Court applied Illinois law.  The result may have been different had the insureds been in a different state.  But, regardless of your state’s law, you do not want to take a chance.  Contact your insurance company immediately when you become aware of a potential claim, regardless of how remote the possibility may be.

Questions about this case or your insurance policies, contact RMC today at 239-298-8210 or rmc@rmcgp.com.