Summary
recognizing "the common law principle that implicit in every contract is the obligation of each party to act in good faith"
Summary of this case from Blondell v. AhmedOpinion
No. 9
Filed 8 July 1981
1. Insurance 96.1 — notice to insurer of accident — unexcused delay — insurer's obligation to defend An unexcused delay by the insured in giving notice to the insurer of an accident does not relieve the insurer of its obligation to defend and indemnify unless the delay operates materially to prejudice the insurer's ability to investigate and defend.
2. Insurance 96.1 — notice to insurer of accident — timeliness — test of insurer's obligation to defend When faced with a claim that notice of an accident was not timely given to an insurer, the trier of fact must determine: (I) whether the notice was given as soon as possible; (2) if not, whether the insured has shown that he acted in good faith, e.g., that he had no actual knowledge that a claim might be filed against him; and (3) whether the insurer's liability to investigate and defend was materially prejudiced by the delay.
ON discretionary review of the decision of the Court of Appeals reported at 46 N.C. App. 427, 265 S.E.2d 467 (1980), reversing and remanding the judgment of Bailey, Judge, entered 17 May 1979 in Superior Court, WAKE County.
Johnson, Patterson, Dilthey Clay, by Robert M. Clay, Robert W. Sumner and Sanford W. Thompson IV, for plaintiff-appellant.
Nye, Mitchell, Jarvis Bugg, by Charles B. Nye, for defendant-appellee.
Justice MEYER dissenting.
The primary question on this appeal is whether failure of an insured to comply with a provision in an insurance policy which requires him, as a condition precedent to coverage, to give the insurer notice of an accident "as soon as practicable," of itself relieves the insurer of its obligations under the policy.
Appellant, Great American Insurance Company (Great American), brought this declaratory judgment action to determine its obligations under a liability insurance contract with the defendant-appellee. This dispute arose out of an automobile accident the facts of which are bitterly disputed. This much is certain: On 6 April 1976 defendant C. G. Tate Construction Company (Tate) was engaged in a highway project on U.S. Highway 221 north of Spartanburg, South Carolina. Tate's job was to widen the existing two-lane road to four lanes. The job required the use of numerous pieces of heavy equipment to grade the shoulders, to fill in low spots and to haul away excess dirt. At about three o'clock that afternoon a gasoline tanker owned by State Petroleum, Inc., and driven by Robert Allen Thomas collided with a car driven by Norma Jean Pegg. Shortly after the collision the gasoline in the tanker caught fire and exploded. Both drivers escaped before the explosion and, although seriously injured, survived the accident.
The controversy concerning the accident centers around its cause and the directions in which the vehicles were traveling Pegg, Thomas and another motorist who witnessed the accident claim that Pegg was traveling south and Thomas north when Tate's front-end loader backed out onto the road in the northbound lane causing Thomas to swerve to the left and collide head-on with Pegg's car. Several Tate employees and an eyewitness who viewed the accident from her patio testified that both vehicles were traveling north, that the car slowed or stopped, and that the tanker braked sharply, jackknifed and rolled over the car. According to these witnesses, the front-end loader was parked about ten feet from the edge of the highway and was not involved in the accident.
Officers of Tate testified that they did not notify Great American, its liability carrier, of the accident because its employees who saw the accident said that Tate was not involved. The local news media, however, ran stories attributing fault to Tate, and the investigating policeman testified that on the evening of the accident he told Tate foreman A. G. Foster that Pegg's version of the accident differed considerably from the version given by Tate employees and that she claimed that a piece of Tate's equipment backed into the road causing the tanker to swerve and collide head-on with her car. Foster denied that he had been informed of Pegg's claims but admitted that he knew that the local news media had assigned fault to Tate.
Tate never reported the accident to Great American. Great American did not learn of Tate's potential involvement in the accident until 3 May 1978, some twenty-seven days after it occurred, by way of a letter from Space Petroleum Company Thomas' employer, and by way of a telephone call from Thomas' lawyer. Great American is the workers' compensation carrier for Space Petroleum and the 3 May 1978 communications involved a workers' compensation claim for injuries sustained by Thomas in the accident.
Plaintiff Great American initiated this action for declaratory relief seeking a judgment that it has no obligation to defend or indemnify Tate in any suit arising out of this accident because Tate failed to notify Great American of the incident "as soon as practicable." In its answer Tate alleged that it did not notify the plaintiff of the accident because all the information received by its officers and directors indicated that Tate was not involved and that it knew of no potential involvement until contacted by the plaintiff.
The matter was heard on depositions and live testimony in the Superior Court, Wake County by Judge Bailey who sat without a jury. At the conclusion of the evidence Judge Bailey found, inter alia, that Tate knew or should have known of its potential involvement in the accident shortly after it occurred and that its failure to notify the plaintiff was unjustified. Based on his findings of fact Judge Bailey concluded that:
Defendant's unjustified and inexcusable failure to give plaintiff notice of the accident on April 6, 1978 "as soon as practicable" constituted a violation of a condition precedent to coverage under plaintiff's policy of insurance, and, as such, releases plaintiff from its obligation under the policy for the accident on April 6, 1978.
On appeal, the Court of Appeals reversed and held that in order to escape its duty to defend and indemnify an insurer must show not only unjustified delay in giving notice but also that it suffered prejudice because of the delay. Because no findings had been made on the issue of prejudice, the Court of Appeals remanded the case to the trial court for consideration of that issue.
We denied plaintiff's original petition for discretionary review on 15 August 1980. However, on 4 November 1980 we allowed plaintiff's petition for reconsideration and granted discretionary review.
II. A.
The sole issue with which we are confronted on this appeal is the effect to be given the provision in the policy insuring defendant requiring that written notice be given the insurer "as soon as practicable." More precisely, we must decide whether to continue to apply traditional contract principles and hold that failure to comply strictly with this condition precedent releases the insurer from its obligation to defend and indemnify or to reject the traditional approach and embrace the modern view that this provision although denominated by the policy as a condition precedent should be construed in accord with its purpose and with the reasonable expectations of the parties. For the reasons discussed below we adopt the modern view and construe this provision according to the reasonable expectations of the parties. Accordingly, we hold that an unexcused delay by the insured in giving notice to the insurer of an accident does not relieve the insurer of its obligation to defend and indemnify unless the delay operates materially to prejudice the insurer's ability to investigate and defend.
In its briefs and arguments before both appellate courts plaintiff correctly argued that prior decisions of this Court dictate a contrary result. Notice provisions in a liability insurance contract were first considered by this court in Peeler v. United States Casualty Co., 197 N.C. 286, 148 S.E. 261 (1929). In Peeler plaintiff sought satisfaction of a judgment rendered against defendant's insured by claiming a right to enforce the insured's policy with defendant as a third party beneficiary. The policy in question required that notice of an accident be given to the insurer "as soon as practicable." Defendant-insurer did not receive notice of the accident until after the trial of Peeler's action against its insured had begun, approximately a year-and-a-half after the accident. Although there was no provision in the policy which made the notice provision a condition precedent, this Court held that the notification provision was of the essence of the contract and, thus, a condition precedent to coverage. Therefore, we held that plaintiff's claim was barred as it matter of contract law.
We again employed the strict contractual approach to construction of notice provisions in Muncie v. Travelers Insurance Co., 253 N.C. 74, 116 S.E.2d 474 (1960). The facts in Muncie were similar to those in Peeler. The plaintiff in Muncie was involved in an automobile accident with defendant's insured against whom she secured judgment. She sued the defendant-insurer to satisfy her judgment against its insured. The insurer did not receive notice from its insured until some eight months after the accident and plaintiff offered no evidence which explained or justified the delay. This Court held that the trial judge erred in instructing the jury that the burden of proof was on the insurer to show that notice had not been given within a reasonable time and that it was prejudiced by failure to give timely notice. In so holding, we employed the traditional contract analysis: Freedom of contract is constitutionally guaranteed and provisions in private contracts, unless contrary to public policy or prohibited by statute, must be enforced as written. Because the policy makes the giving of notice a condition precedent, the party seeking to enforce the contract has, under general common law contract principles, the burden of pleading and proving strict compliance. Since notice was given eight months after the accident and plaintiff presented no evidence to justify or explain the delay, notice was not given "as soon as practicable" as a matter of law:
Notice without explanation for the delay, given eight months after the happening of the accident, resulting in injuries as serious as depicted by plaintiff's judgment against Crosby, cannot be said to be given "as soon as practicable." Since plaintiff has failed to establish compliance with the conditions or to justify the delay, it follows that she has failed to establish her right to maintain the action.
Id. at 81, 116 S.E.2d at 479.
On the basis of this language the Court of Appeals distinguished Muncie as applying only when no explanation for the delay was given. Limiting Muncie strictly to its facts paved the way for the Court of Appeals to adopt a new rule for cases in which some explanation was offered. We cannot agree with that court's reasoning. The reasoning in Muncie, summarized above, allows no consideration of prejudice. The language relied on by the Court of Appeals merely amounts to a statement of when the question of timely notice becomes one of law properly decided by the court. See First Citizens Bank Trust Co. v. Northwestern Insurance Co., 44 N.C. App. 414, 261 S.E.2d 242 (1980). Muncie squarely stands for the proposition that strict contract law applies to the interpretation of insurance policies.
We reaffirmed our adherence to the strict contractual approach enunciated by Peeler and Muncie in Fleming v. Nationwide Mutual Insurance Co., 261 N.C. 303, 134 S.E.2d 614 (1964). In an opinion by Justice Moore, this Court stated:
No part of the insurance contract may be ignored. The giving of notice is a condition precedent to insurer's liability. The burden of proof is upon plaintiff to show that notice was given as soon as practicable. . . . "Notice without explanation for the delay, given eight months after the happening of the accident, resulting in injuries . . ., cannot be said to be given `as soon as practicable.' Since plaintiff has failed to establish compliance with the condition or to justify the delay, it follows that she has failed to establish her right to maintain the action."
Id. at 306, 134 S.E.2d at 616 (quoting Muncie v. Travelers Insurance Company, 253 N.C. at 81, 116 S.E.2d at 479).
This line of cases reflects the traditional reasoning applied by courts in construing insurance contracts: Parties have freedom to contract and, absent a violation of law or public policy, courts will enforce those contracts as written. If the insurance contract makes notice a condition precedent to recovery or if notice is of the "essence" of the contract, the party seeking to enforce the contract has the burden of pleading and proving strict compliance with the notification requirement. Although this Court, on occasion, has been more liberal in its decisions as to whether the notice was given "as soon as practicable," we have never departed from the strict contractual approach. Clearly, under Peeler, Muncie and Fleming failure to give timely notice, of itself, defeated plaintiffs' attempt to enforce the policy without regard to whether the delay materially prejudiced the insurer's ability to defend the claim.
A delay in giving notice because of physical or mental incapacity has been held not to violate the requirement that notice be given "as soon as practicable." E.g., Rhyne v. Jefferson Standard Life Ins. Company, 196 N.C. 717, 147 S.E. 6 (1929). A delay due to inability to discern any injury has also been held to be excusable. Ball v. Employers' Assur. Corp., 206 N.C. 90. 172 S.E. 878 (1934).
We have, however departed from the strict contractual approach when construing cooperation clauses in insurance contracts and have held that, in order to relieve an insurer of its obligations, the failure to cooperate must be both material and prejudicial. Henderson v. Rochester American Insurance Co., 254 N.C. 329, 118 S.E.2d 885 (1961). The following language from Henderson is, perhaps, a harbinger of the holding in this case: The provisions of liability insurance policies imposing as conditions to liability the duty of insured to give notice of accidents and cooperation in the defense of actions which might result in a judgment against insured are, except where otherwise provided by statute, binding on the parties. Properly interpreted, they will be enforced. Muncie v. Insurance Co., 253 N.C. 74; Peeler v. Casualty Co., 197 N.C. 286, 148 S.E. 261. The provisions are to be given a reasonable interpretation to accomplish the purpose intended, that is, to put insurer on notice and afford it an opportunity to make such investigation as it may deem necessary to properly defend or settle claims which may be asserted, and to cooperate fairly and honestly with insurer in the defense of any action which may be brought against insured, and upon compliance with these provisions to protect and indemnify within the policy limits the insured from the result of his negligent acts. An insurer will not be relieved of its obligation because of an immaterial or mere technical failure to comply with the policy provisions. The failure must be material and prejudicial. Ball v. Assurance Corp., 206 N.C. 90, 172 S.E. 878; Mewborn v. Assurance Corporation 198 N.C. 156, 150 S.E. 887; Hunt v. Fidelity Co., 174 N.C. 397, 93 S.E. 900; MacClure v. Casualty Co., 229 N.C. 305, 49 S.E.2d 742, where it is said: "While there is some contrary authority, the better reasoned cases hold that the failure to co-operate in any instance alleged must be attended by prejudice to the insurer in conducting the defense. Blashfield, Automobile Law, Vol. 6, sec. 4059. p. 78" Id. at 332, 118 S.E.2d at 887.
The holdings of these cases were in accord with the then-prevailing majority view. Recently, however, many courts have rejected the strict contractual approach and interpreted notice conditions in insurance contracts in accord with the reasonable expectations of the parties. E.g., State Farm Mutual Automobile Insurance Co. v. Milam, 438 F. Supp. 227 (S.D.W. Va. 1977); Johnson Controls, Inc. v. Bowes, 1980 Mass. Adv. Sh. 1831, 409 N.E.2d 185 (1980); Cooper v. Government Employees Insurance Co., 51 N.J. 86, 237 A.2d 870 (1968); Brakeman v. Potomac Insurance Co., 472 Pa. 66, 371 A.2d 193 (1977); Pickering v. American Employers Insurance Co., 109 R.I. 143, 282 A.2d 584 (1971). For a discussion of this developing trend and the Court of Appeals' opinion in this case see Note, 17 Wake Forest L. Rev. 141 (1981). Under this theory, the question becomes whether the insurer has been prejudiced by the delay in receiving notice. The reasons for the trend away from the application of strict contract law to insurance cases were aptly stated by the Supreme Court of Pennsylvania:
The rationale underlying the strict contractual approach reflected in our past decisions is that courts should not presume to interfere with the freedom of private contracts and redraft insurance policy provisions where the intent of the parties is expressed by clear and unambiguous language. We are of the opinion, however, that this argument, based on the view that insurance policies are private contracts in the traditional sense, is no longer persuasive. Such a position fails to recognize the true nature of the relationship between insurance companies and their insureds. An insurance contract is not a negotiated agreement; rather its conditions are by and large dictated by the insurance company to the insured. The only aspect of this contract over which the insured can "bargain" is the monetary amount of coverage.
Brakeman v. Potomac Insurance Company, 472 Pa. at 72, 371 A.2d at 196. The New Jersey Supreme Court gave its reasons for rejecting the strict contractual approach thusly:
[W]e have recognized that the terms of an insurance policy are not talked out or bargained for as in the case of contracts generally, that the insured is chargeable with its terms because of a business utility rather than because he read or understood them, and hence an insurance contract should be read to accord with the reasonable expectations of the purchaser so far as its language will permit. And although the policy may speak of the notice provision in terms of "condition precedent," . . . nonetheless what is involved is a forfeiture, for the carrier seeks, on account of a breach of that provision, to deny the insured the very thing paid for. This is not to belittle the need for notice of an accident, but rather to put the subject in perspective. Thus viewed, it becomes unreasonable to read the provision unrealistically or to find that the carrier may forfeit the coverage, even though there is no likelihood that it was prejudiced by the breach. To do so would be unfair to insureds. It would also disserve the public interest, for insurance is an instrument of a social policy that the victims of negligence he compensated. To that end companies are franchised to sell coverage. We should therefore be mindful also of the victims of accidental events in deciding whether a forfeiture should be upheld.
Cooper v. Government Employees Insurance Co., 51 N.J. at 93-94, 237 A.2d at 873-74 (citations omitted).
We agree with both statements. The terms of an insurance contract are not bargained for in the traditional sense. Insurance policies are offered on a take-it-or-leave-it basis and, frequently, the only term over which the insured has any say is the amount of coverage. Strict interpretation of the notice requirement leads to harsh results: failure to notify the insurer within a reasonable time, for whatever reason, relieves the insurer of its obligations to defend and indemnify, the essence of the contract, even though it may have suffered no prejudice whatsoever as a result of the delay. Rejection of the strict contractual approach means that the interpretation of the notice provision will be guided more by its purpose — the reason for its inclusion in the insurance contract — than by its seemingly conclusive terms. Additionally, adoption of the modern rule of reasonable expectations promotes the social function of insurance coverage: providing compensation for injuries sustained by innocent members or the public. The rule we adopt today has the advantages of promoting social policy and fulfilling the reasonable expectations of the purchaser while fully protecting the ability of the insurer to protect its own interests. While under the new reasonable expectation rule the number of claims insurers will be obligated to defend may rise, this is no justification for continued application of the rule we now reject. Our decision merely tells insurers that they are obligated to defend when the delay in receiving notice has not prejudiced their ability to investigate or otherwise defend the claim, an obligation which, in the reasonable expectation of the purchaser, should exist. Because it takes prejudice into account, the new rule does not affect the ability of the insurer to investigate and defend. Thus the risk undertaken by the insurer remains unchanged. Accordingly, we hereby overrule the Peeler-Muncie-Fleming line of cases and hold that failure of an insured to notify its insurer of an accident "as soon as practicable" does not relieve the insurer of its obligations under the contract unless the delay operates materially to prejudice the ability of the insurer to investigate and defend.
The rule we adopt today places the notice requirement in its proper context. No condition of timely notice will be given a greater scope than required to fulfill its purpose. Simply put, the scope of the condition precedent which will relieve an insurer of its obligations under an insurance contract, is only as broad as its purpose: to protect the ability of the insurer to defend by preserving its ability fully to investigate the accident, e.g., Peeler v. United States Casualty Co., 197 N.C. 286, 148 S.E. 261. If, under the circumstances of a particular case, the purpose behind the requirement has been met, the insurer will not be relieved of its obligations. If, on the other hand, the purpose of protecting the insurer's ability to defend has been frustrated, the insurer has no duty under the contract. This equitable approach to the interpretation of notice requirements in insurance contracts has the advantages of providing coverage whenever in the reasonable expectations of the parties it should exist and of protecting the insurer whenever failure strictly to comply with a condition has resulted in material prejudice.
Unquestionably, the requirement that a liability insurer be given notice of a relevant event "as soon as practicable" is an essential part of the insurance contract. Without it, the insurer would be required to defend claims which it never had the opportunity adequately to investigate. It was the importance of the notice requirement that led to the adoption of a strict contractual approach:
In insurance of this character it is a matter of first importance to the insurer, who may be forced to become the real defendant in a lawsuit against the insured . . ., to be speedily informed of all the facts and witnesses concerning a possible litigation. In a very little time the facts may in a great measure fade out of memory, or become distorted, witnesses may go beyond reach, physical conditions may change, and, more dangerous than all, fraud and cupidity may have had opportunity to perfect their work. Therefore this stipulation is vital to the contract . . . .
Travelers Insurance Co. v. Myers, 62 Ohio St. 529, 539, 57 N.E. 458, 459 (1900), overruled on other grounds, Employers' Liability Assur. Corp. v. Roehm, 99 Ohio St. 343, 124 N.E. 223 (1919), quoted in Peeler v. United States Casualty Company, 197 N.C. at 290, 148 S.E. at 263. The clear purpose of the notice provision is to protect the ability of the insurer to prepare a viable defense by preserving its ability fully to investigate the accident. It follows, then, that if the delay in giving notice has not materially prejudiced the ability of the insurer to defend the claim, its obligations under the insurance contract should not be excused.
B.
There remains the question of which party should have the burden of proof on the issue of prejudice. The authorities are split on this issue. Some hold that because the insured is seeking relief from the literal meaning of the terms of the contract, he should bear the burden of showing that his delay has not materially prejudiced the insurer. E.g., Hartford Accident Indemnity Co. v. Lochmandy Buick Sales, Inc., 302 F.2d 565 (7th Cir. 1962); Dairyland Insurance Co. v. Cunningham, 360 F. Supp. 139 (D. Colo. 1973). Other jurisdictions have reasoned that the burden of showing prejudice should be on the insurer because it is seeking to escape its obligation to defend and indemnify, the very thing which it is paid to do. E.g., State Farm Mutual Automobile Insurance Co. v. Milam, 438 F. Supp. 227; Cooper v. Government Employees Insurance Co., 51 N.J. 86, 237 A.2d 870. "[A]lthough the policy may speak in terms of `condition precedent' . . . . nonetheless what is involved is a forfeiture, for the carrier seeks, on account of a breach of that provision, to deny the insured the very thing paid for." Id. at 93-94, 237 A.2d at 873.
We believe the sounder rule to be that requiring the insurer to prove that it has been materially prejudiced by the delay. If the insurer has the burden of proving prejudice, then when it receives a delayed notification the rule will encourage the insurer to make a prompt preliminary investigation of the claim to protect its interests. An investigation may reveal that the delay has materially prejudiced the insurer, and, in that event, the insurer may deny coverage and either wait for a suit against it or file suit for declaratory relief. If, on the other hand, the preliminary investigation reveals that the ability of the insurer to investigate and defend has not been materially prejudiced, the insurer presumably, will proceed with the claim and the question of coverage will never reach the courts. Additionally, the insurer, because it is an expert in investigation of accidents, is in a much better position to know what factors are relevant to its ability to investigate and to recognize prejudice An insured would be in a far less enviable position if he had the burden of showing an absence of prejudice. Indeed, the insured would be forced to prove a negative. Placing the burden of showing prejudice on the insurer encourages an adequate investigation by the qualified party at the earliest possible time. These factors lead us to conclude that the burden of proof on the issue of prejudice is properly placed on the insurer.
As the Court of Appeals indicated, among the relevant factors to be considered by a jury in deciding whether the insurer has been prejudiced are:
the availability of witnesses to the accident; the ability to discover other information regarding the conditions of the locale where the accident occurred; any physical changes in the location of the accident during the period of the delay; the existence of official reports concerning the occurrence; the preparation and preservation of demonstrative and illustrative evidence, such as the vehicles involved in the occurrence, or photographs and diagrams of the scene; the ability of experts to reconstruct the scene and the occurrence; and so on.
46 N.C. App. at 437, 265 S.E.2d at 473. Proof of existence of any of the above factors is not determinative; the insurer must also show that the changed circumstance materially impairs its ability to investigate the claim or defend and, thus, to prepare a viable defense. Often, proof of the changed circumstance itself will give rise to an inference of prejudice; for example, proof of the unavailability of a sole independent eyewitness.
We do not intend the above list of factors to be exclusive. Circumstances which may cause prejudice to an insurer are as varied and as numerous as the circumstances surrounding automobile accidents. We merely intend the above list to be illustrative. A more complete discussion of prejudicial factors will have to wait a case-by-case development
C.
The rule which we adopt today amounts to a reversal of a long line of previous cases upon which insurers have justifiably relied. Lest this decision be perceived as encouraging dilatory tactics in the notification of the insurer and, thus, as being unfair to insurers, we also now impose the requirement that any period of delay beyond the limits of timeliness be shown by the insured to have been in good faith. Anyone who knows that he may be at fault or that others have claimed he is at fault and who purposefully and knowingly fails to notify ought not to recover even if no prejudice results. Equity dictates that a bad faith delay in notifying an insurer, even though no material prejudice results should bar the insured from enforcing the policy. This requirement is in accord with the common law principle that implicit in every contract is the obligation of each party to act in good faith. 17 Am. Jur.2d, Contracts 256 (1964).
D.
The effect of this decision is to create a three-step test for determining whether the insurer is obliged to defend. When faced with a claim that notice was not timely given, the trier of fact must first decide whether the notice was given as soon as practicable. If not, the trier of fact must decide whether the insured has shown that he acted in good faith, e.g., that he had no actual knowledge that a claim might be filed against him. If the good faith test is met the burden then shifts to the insurer to show that its ability to investigate and defend was materially prejudiced by the delay.
We agree with the result reached by the Court of Appeals albeit on a somewhat different basis. We also agree with that court that the case must be remanded for further proceedings because the trial court refused to consider the question of prejudice because, in its opinion, that question "does not arise." Although the record discloses that evidence relevant to the question of prejudice was before Judge Bailey, we deem that it would be unfair to Great American to remand for additional findings only. This case reverses well-established law upon which Great American has justifiably relied. Justice demands that it be given the opportunity to present its claim in light of the newly imposed requirements. Additionally, while Judge Bailey found that the delay was "unjustified," there is no finding concerning defendant's good faith. For these reasons, further proceedings are required to allow the parties to present additional evidence relevant to the issues of good faith and prejudice.
The decision of the Court of Appeals is modified and affirmed. This cause is remanded to that court with instructions to remand to the Superior Court, Wake County, for further proceedings not inconsistent with this opinion.
Modified and affirmed.