Montana Supreme Court Adopts Notice-Prejudice Rule

In 2011, the Montana Supreme Court issued its decision in Steadele v. Colony Ins. Co., 2011 MT 208, 361 Mont. 459, 260 P.3d 145 (2011) concluding that compliance with the notice requirement in an insurance policy was a condition precedent to coverage barring recovery under the policy unless the requirement was met or waived. The Court in Steadele considered application of the notice-prejudice rule without expressly using that term in the analysis.

In Steadele, homeowners sued a contractor regarding defects in their home and in December 2008 took a default judgment when the defendant contractor failed to appear. Colony Insurance Company insured the contractor but never received notice of the controversy or the lawsuit until several months after judgment had been entered. The Montana Supreme Court held that the notification requirements under the policy constituted a condition precedent to coverage and that the failure of notification resulted in a bar to recovery from the insurance company. Because Colony did not receive notice until after a judgment was entered against its insured, the Court in Steadele found that the failure to give notice was not de minimis and, therefore, the insurance company was “prejudiced in that it was deprived of the ability to investigate, to locate witnesses, to appoint counsel, to engage in discovery, to negotiate a settlement, and to develop a trial strategy.”

Because the Montana Supreme Court did not expressly reference the notice-prejudice rule in Steadele, there has been some confusion on the issue as to whether the Court was actually adopting the notice-prejudice rule in Montana. This confusion came to a head recently. In Atlantic Cas. Ins. Co. v. Greytak, 350 P.3d 63, 2015 MT 149 (Supreme Ct. Mont. decided May 29 2015), the Montana Supreme Court accepted jurisdiction to answer a certified question from the United States Court of Appeals for the Ninth Circuit concerning whether Montana law applied the “notice-prejudice” rule. The certified question was as follows:

Whether, in a case involving a claim of damages by a third party, an insurer who does not receive timely notice according to the terms of an insurance policy must demonstrate prejudice from the lack of notice to avoid defense and indemnification of the insured.

Justice McGrath, speaking for the majority, answering the question “yes, an insurer who does not receive timely notice according to the terms of an insurance policy must demonstrate prejudice from the lack of notice to avoid defense and indemnification of the insured.” The majority opinion was careful not to identify under what factual circumstances an insurance company can establish that it has been actually prejudiced.

However, Justices Rice and McKinnon issued special concurring opinions making clear their view that the notice-prejudice rule only applies to cases where the failure to notify is de minimis. Justice Rice, in his concurrence, was concerned about sharp lawyering practices in abusing the notice-prejudice rule. According to Justice Rice, “[t]he rule is not intended to provide claimants and insureds a litigation Petri dish in which to grow stipulated judgments in the dark while the insured is relieved of its contractual obligations to involve the insurer.” According to Justice Rice, the notice-prejudice rule “merely excuses failure of [the notice] duty when a ‘technical’ violation does not prejudice the insurer.”

Justice McKinnon observed that she agreed with Justice Rice’s assessment that, where a default judgment has been entered against the insurance company as a result of the lack of notice, prejudice exists as a matter of law. Justice McKinnon would adopt a limited exception to the notice-prejudice rule providing that prejudice to the insurer will be presumed as a matter of law when an insured fails to notify the insurer of a pending lawsuit until after the judgment has been entered. Justice McKinnon explained the reasoning behind limiting the notice-prejudice rule:

The reasoning behind the inapplicability of the notice-prejudice rule in such circumstances—[where notification to the insurer comes after a judgment has been entered]—is that the insured has presented the insurer with a fait accompli by delaying notice until after judgment. The delay renders completely ineffective the purpose of the contractual notice requirement, as the insurer cannot exercise any of its rights to investigate, defend, control, or settle the suit. Where the insurer has not been notified of a pending claim until after judgment, it is deprived of the benefit of a material term of the contract, and thereby prejudiced because it is not able to investigate the allegations, locate witnesses, appoint counsel of its choice, negotiate a settlement, or develop its own trial strategy.

Both Justices Rice and McKinnon would have gone beyond the majority’s opinion, by identifying default judgment cases as causing prejudice, as a matter of law.