Insurer Must Show Prejudice to Enforce Proof of Loss Provision in California

A California court of appeals recently determined that a proof of loss condition in a first party insurance policy is subject to the notice-prejudice rule. According to the decision, an insurer cannot avoid its coverage obligations due to a policyholder’s failure to furnish a sworn proof of loss unless the insurer was prejudiced by the breach. The issue has caused much confusion among parties and courts, and the appellate court’s decision is a step toward more clarity, albeit a step based on questionable legal analysis.

Insurance policies typically require the insured to notify the insurer of a potential claim, to submit a sworn proof of loss and to cooperate with any investigation. Courts have interpreted these different provisions with varying degrees of flexibility for the insured. California courts have held that notice provisions and cooperation clauses are subject to the “notice-prejudice rule,” which requires an insurer to show it was prejudiced by an insured’s failure to comply with such provisions before it can deny coverage on the basis of the insured’s breach. But there is some question as to whether a proof of loss requirement in a first party policy requires the insurer to demonstrate prejudice. This question was presented in the recent case, Henderson v. Farmers Group, Inc., 210 Cal. App. 4th 459 (2012).

The case arose from a number of homeowners’ claims against their insurer for damages stemming from a California wildfire. All fire insurance policies in California must include standard form provisions which are provided by California statute. The statutorily mandated provisions include a requirement that the insured provide a sworn proof of loss to the insurer within sixty days after the loss. Here, the homeowners failed to submit sworn proofs of loss to the insurer within the required sixty-day period and the insurer refused to cover the homeowners’ losses. The trial court found that the proof of loss requirement was a condition precedent to coverage, not subject to the notice-prejudice rule, and the homeowners’ failure to comply with the provision relieved the insurer of its obligation to provide coverage. But on appeal, the appellate court reversed the decision, holding that in order to enforce a defense based upon the homeowners’ failure to provide timely proof of loss, the insurer needed to show it was substantially prejudiced by the breach.

The insurer’s position was based on two arguments, both of which were largely ignored by the appellate court. The insurer first pointed to the California Supreme Court’s decision in White v. Home Mutual Insurance Company, 128 Cal. 131 (1900), which held that a proof of loss requirement in a fire insurance policy was “doubtless a condition precedent, the performance of which by the plaintiff is indispensable to the right of recovery…” The court stated that where the policy specifies a definite time period, “neglect or delay beyond such time in furnishing proofs will be fatal [to the claim]…”

The insurer’s second argument emphasized the statutory origin of the sixty-day proof of loss requirement. The insurer argued that a statutorily imposed deadline is not subject to a non-statutory prejudice requirement created by the court. The Supreme Court of California has determined that a clause in an insurance policy authorized by statute is deemed consistent with public policy. Prudential-LMI Com. Ins. v. Superior Court, 51 Cal.3d 674 (1990). Based on this notion, the insurer in this case challenged the insured’s ability to ignore a deadline which is provided by statute and challenged the court’s ability to interpret such a deadline loosely to the benefit of the insured.

But the court of appeals had no problem ignoring the policy’s clear language or the rule of White, and expanded the application of the notice-prejudice rule to proof of loss conditions.

Rather than addressing the validity of White, the court relied on the more recent decision in Campbell v. Allstate Insurance Company, 60 Cal. 2d 303 (1963). Campbell dealt specifically with notice provisions and cooperation clauses—not with the distinct proof of loss condition—and held that such conditions are subject to the notice-prejudice rule. As conceded by the appellate court, Campbell did not address proof of loss requirements, but the court highlighted language from the Campbell decision that stated, “An insurer may assert defenses based upon a breach by the insured of a condition of the policy such as a cooperation clause, but the breach cannot be a valid defense unless the insurer was substantially prejudiced thereby.” The court reasoned that Campbell applied to proof of loss conditions because “there is nothing in the language or reasoning of the opinion that excludes them”—a questionable statement, especially in light of the decision in White.

In addition to its reliance on Campbell, the court was heavily influenced by California’s public policy against “technical forfeitures,” which advocates for a finding of coverage, if possible, to avoid an unreasonable or undue forfeiture based on a mere technicality. Interestingly, the court here cited this policy against technical forfeitures to excuse compliance with a provision that the legislature endorsed and that, by law, is deemed consistent with public policy.

Nevertheless, in an effort to protect policyholders, the court found that proof of loss conditions are subject to the notice-prejudice rule. The court of appeals has decided that insurance policies are malleable contracts that will bend to the equitable demands of policyholder protection. The decision interprets Campbell to have overruled White and is a significant step expanding the application of the notice-prejudice rule. Policyholders will undoubtedly welcome the expansion, but insurers in California should be aware of their increased obligations should the decision stand.