CHAPTER 7 CONDITIONS, WARRANTIES, AND EXCLUSIONS

• Jurisdiction: United States

A. Conditions

The word "condition" in contract law refers to an event, the occurrence or non-occurrence of which alters the previously existing relations of the parties to a contract by creating or extinguishing a legal duty. The condition in an insurance policy imposes duties on the insured (the promisor) and gives a corresponding right to the insurer (the promisee). Breach of a condition in an insurance policy gives the insurer legal justification for refusing to perform its obligations under the policy.

1. Condition Precedent

A condition precedent is an act or event, other than a lapse of time, that must exist or occur before a duty to perform something promised arises. Consistent with the plain meaning of the term "provided that," courts in other jurisdictions have recognized that use of this phrase will generally create a condition precedent.

The notice provision in an insurance contract acts as a condition precedent. A condition precedent is a promise made by a party to the contract to do something called for by the policy before that person can expect any action by the other party to the contract. A party claiming insurance coverage has the burden of establishing compliance with all provisions of the insurance policy which are precedent to his right to recover, and the notice provision is such a condition precedent. In addition, a person has a duty to examine the coverage provided and is charged with acquiring knowledge of the contents of his or her own policy. Courts have further concluded that when notice under an insurance contract is required, an insurer may deny coverage when notice is not given because the delay would prejudice the insurer in protecting its interests.

Most states now recognize the "notice-prejudice rule." Under the notice-prejudice rule, an insured who gives late notice of a claim to his or her insurer does not lose coverage benefits unless the insurer proves by a preponderance of the evidence that the late notice prejudiced its interests. Under that rule, an insurer can deny benefits only where its ability to investigate or defend the insured's claim was compromised by the insured's failure to provide timely notice.

In California FAIR Plan Ass'n v. Garnes, A143910 (Cal. Ct. App. May 26, 2017), the Court of Appeal change the meaning of a condition precedent in the FAIR Plan policy that required actual replacement of property before the insured was entitled to receive the difference between actual cash value and replacement value. The Court of Appeal dealt with California Insurance Code § 2051.5, subdivision (a), and concluded that

it does not require insureds to repair or replace as a "condition precedent" to recovery of replacement costs. Rather, it implicitly allows the FAIR Plan or other insurers to include a provision in the policy requiring the insured to repair or rebuild in order to collect "the full replacement cost." However, it requires the insurer in the meantime to pay "the actual cash value of the damaged property" until the damaged property is repaired or rebuilt, and then to pay the difference between actual cash value and full replacement cost once the repair or rebuilding is completed.

The court wrote:

Under § 2051.5, subdivision (a), under a replacement policy that requires repair, rebuilding, or replacement, the owner is entitled to actual cash value in the same amount as an [Actual Cash Value (ACV)] policyholder, at the outset, but in addition, is entitled to the difference between actual cash value and full indemnity (replacement costs without depreciation) at the conclusion of repair or rebuilding. There is no anomaly in this result. The two types of policyholders are treated the same before completion of repair or rebuilding, but the replacement policyholder ultimately receives an additional payment, and is therefore better off than the ACV policyholder, once repair or rebuilding is complete.

In Certain Interested Underwriters at Lloyd's, London v. Bear, LLC, 2017 WL 2180401, No. 3:2015cv00630 (S.D. Cal. May 17, 2017), the repair clause in a property insurance policy is not an exclusion, but is instead a condition precedent.

Had [the insured] satisfied these conditions precedent, the policy would have provided $17.25 million of coverage for the loss of the Polar Bear. Additionally, it is undisputed that the 2010 Proposal explained the effect of the Repair Clause on the Underwriters policy. Despite the warning, Bear ultimately chose the Underwriters policy and consented to its terms."

When a policy provides that in the event of loss or damage to covered property, the insured must provide a sworn proof of loss document (as is required by the standard California fire policy) that includes inventories, costs, and values of the lost property, and must allow inspection of property, books, and records,¹ the burden is on the insured to initiate and support a claim. Failure to comply with the proof of loss requirement amounts to the insured's failure to meet a condition precedent sufficient to allow the insurer to reject the entire claim.

2. Notice of Claims Condition

If the insured can demonstrate substantial compliance with the notice provision and provide a valid excuse for failing to meet a strict compliance standard, then the burden shifts to the insurer, who must demonstrate, in order to be relieved of liability, both that the notice provision is a condition precedent to coverage and that it suffered prejudice. Both the fact of the violation of the conditions of the policy, and that prejudice resulted there from, are matters of affirmative defense, which must be pleaded and proved by the insurer.

A claims made and reported policy is aptly named: it requires that a claim be both made and reported to the insurer during the policy period for the coverage to apply. Insureds who know of a claim against them must report it to the insurer before the expiration of the policy or lose all coverages. The language of an insurance contract, like any other contract, governs its interpretation. The language should be clear and explicit, and should not involve an absurdity.

In Insurance Co. of State of Pennsylvania v. Associated Int'l Ins. Co., 922 F.2d 516 (9th Cir. 1990), the notice clause in a policy issued by the Insurance Company of the State of Pennsylvania (ICP) read: "The insured is required to notify promptly of any occurrence which in ICP's estimate might result in judgment in an amount sufficient to involve this certificate of reinsurance."

ICP contended that the condition for giving this notice is the reinsured's (ICP's) subjective determination that the reinsurance certificate will be impacted by claims made against the original insured (Fibreboard) or, when notice of claim is received. ICP contended that it had provided prompt notice. The court wrote:

In this case, the notice provision of the contract uses the term "claim" twice. First, the notice provision states that ICP is required to notify Associated "when notice of claim is received." Secondly, the contract states that Associated may join "in the defense . . . of any claim, suit or proceeding involving this certificate of reinsurance." The language of the contract makes it clear that the more general term "claim," in the provision requiring notice when a claim is received, encompasses the more specific terms "claim, suit or proceeding" in the provision allowing Associated to join in the defense. Indeed, California courts have broadly defined the term "claim" as an "‘assertion, demand or challenge of something as a right; the assertion of a liability to the party making it to do some service or pay a sum of money . . . .'" Williamson & Vollmer Eng'g, Inc. v. Sequoia Ins. Co., 64 Cal. App. 3d 261, 269, 134 Cal. Rptr. 427, 431 (Cal. Ct. App. 1976).

Under California decisional law, it is settled that an insurer, in order to avoid liability on the basis of a breach of the notice clause, must establish actual and substantial prejudice. Whether this "notice-prejudice rule" applies to a reinsurer is an issue of first impression in the state of California.

In order to disregard the prejudice requirement, the notice provision must be construed as a condition precedent. In the absence of clarity, stipulations for notice will not be construed as conditions precedent if reasonably open to other construction.

The Ninth Circuit concluded that "although ICP breached the notice provision in the ICP-Associated reinsurance contract, Associated did not demonstrate the substantial prejudice required under California law to be relieved of its obligation under the contract."

B. Warranties

Certain policies contain the term "warranty." A warranty in an insurance policy is a special kind of representation or promise made by an insured where the person seeking insurance promises that the statements of fact are absolutely true, that they know that the insurer is relying on the truthfulness of the statements, and that each statement of fact is material to the decision of the insurer to insure or not to insure.

Warranties in insurance contracts are of two different types:

1. affirmative and

2. promissory.

An affirmative warranty asserts an existing fact or condition which appears on the face of the policy or is attached thereto and made a part thereof. It is limited in time to the moment of the application.

A promissory warranty applies to the date of the application and the future. It is a statement of a promise to keep a certain fact or set of facts in existence throughout the period of a policy. Failure to comply during the effective dates of the policy is a breach of a material warranty that invalidates the policy.

The breach of a single warranty, at the time of the application, keeps the policy from attaching to the risk. Nothing is or was insured because the insurer and the insured never agreed on the terms of the contract of insurance. The insurer was deceived and the contract is void or voidable.

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