Enforceability of “Voluntary Payments” Provisions
/Enforceability of “Voluntary Payments” Provisions
By David A. Gauntlett*
Introduction
Standard Commercial General Liability (“CGL”) policies contain a “Voluntary Payments” clause, which states the insurer must not “voluntarily make a payment, assume any obligation, or incur any expense for damages [or] loss[.]”[1] Courts have recognized that this language cannot be enforced literally as it is written.[2] Litigation over these provisions typically focuses on the actions of the policyholder, but, interpreted broadly, these provisions could allow insurers to bypass state laws requiring prejudice for late notice. Furthermore, they may incentivize insurers to delay their decisions of whether to defend in the hope that the underlying lawsuit will resolve itself. Neither of these practices should be tolerated by the courts.
Policy Provisions Should Not Override State Laws Requiring Prejudice
In states where an insurer’s duty to defend is triggered the moment a Complaint is filed, the provision is generally only enforced if the insurer is prejudiced.[3] New York appears to be the only potential exception among the Complaint-trigger jurisdictions[4] that may allow enforcement without prejudice. A federal judge noted in dicta that a “Voluntary Payments” provision would create a “narrow exception to this [Complaint-trigger] rule” that would allow an insurer to effectively side-step the state’s prejudice requirement.[5] To support this conclusion, the judge cited Smart Style,[6] but such reliance is problematic for five reasons.
First, Smart Style predated New York’s passage of a statute preventing insurers from denying claims based on late notice absent prejudice to the insurer.[7] In passing that statute, the New York legislature was clear in their intent to stop insurers from denying valid claims based on mere technicalities.[8] The “technicality” nature of the “Voluntary Payments” provision is especially clear when the insured is entitled to independent counsel, meaning the insurer could not have been prejudiced by its inability to control the defense.[9]
Second, the policyholder’s attorney in Smart Style was inexperienced as coverage counsel and failed to raise several important points. As a result, the rule that New York courts must narrowly construe a “Voluntary Payments” provision because it reduces coverage[10] was not raised by counsel or addressed by the Smart Style court.
Third, Three cases were cited by the court as a basis for the enforcement of the “Voluntary Payment”—two from California[11] and one from Rhode Island.[12] Neither of these forums make filing of the lawsuit the trigger to secure policy benefits, in contrast to the law of New York. Although the court recognized this rule, it did not recognize the impact of the distinction when discussing the cited cases.
Fourth, California historically may have allowed insurers to deny coverage based on late notice without prejudice due to a “Voluntary Payments” provision,[13] but a recent case suggests otherwise.[14] This shift in California policy, along with the distinction of New York embracing the Complaint-trigger rule, invalidates the Smart Style court’s reliance on California cases as authority.
Fifth, the court allowed defense counsel to continue after recognition of a defense, but it never analyzed whether the agreement to defend was subject to a Reservation of Rights (“ROR”) that would have secured the right to independent counsel from the start. The policyholder also never demanded an ROR that would have precipitated a right to independent counsel.[15] This is critical as a right to independent counsel would have undermined the court’s rationale for enforcing the provision.[16]
These facts necessarily led to a perception that the insured was not entitled to policy benefits prior to notice. Also worth noting is that Federal Judge Denny Chin, author of the Smart Style decision, did not rule in favor of the policyholder in any electronically published coverage case during his 15 years as a Federal District Judge.
Constructive Denial Undermines “Voluntary Payments” Provision
While insurers denying pre-tender defense fees based on a “Voluntary Payments” provision is inherently problematic,[17] an extreme situation might feature an insurer strategically prolonging its “investigation” of the claim while the underlying action approaches resolution. This would enable the insurer to monitor the case’s progress and assess the amount of post-tender fees. It could then decide between (1) denying the entire claim and directly implicating the late-notice statute or (2) accepting the defense, paying the post-tender fees, and relying on the “Voluntary Payments” provision to deny pre-tender fees.
Delaying in this manner risks the underlying action concluding during consideration. This could serve as a constructive denial of the claim, regardless of the insurer’s eventual decision. In many states, delay on its own is sufficient for a constructive denial.[18] One federal court applying New York law stated “the length of the delay is not the only factor that courts consider . . . [.] [A] plaintiff bears the burden of demonstrating discriminatory intent.”[19] That intent is readily evident where the insurer fails to respond to a defense request until the publicly available docket of the underlying action reveals an imminent settlement. While most jurisdictions have yet to address this issue, a failure to agree to defend during the pendency of the action has to be treated as a constructive denial of a defense, regardless of whether the insurer later accepts its defense responsibilities.
Conclusion
As more states adopt statutes preventing denials for late notice, insurers are turning to “Voluntary Payments” provisions to bypass legislative intent and continue denying claims based on technicalities. Some states have been quick to shut down such efforts. In those others, insurers may try to game the system by delaying decisions. Policyholders must enforce their rights if that delay becomes a constructive denial, either due to resolution of the underlying action or exceeding a statutory requirement for time to respond to the claim.
*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 514-5662 or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.
[1] Many policies contain substantially similar language. The quoted provision here is taken from Navigators’ Form NAV NP3 + Cyber (07/16) CGL coverage.
[2] Smart Style Indus. v. Pa. Gen. Ins. Co., 930 F. Supp. 159, 164 (S.D.N.Y. 1996).
[3] See, e.g., Episcopal Church v. Church Ins. Co., 53 F. Supp. 3d 816, 828 (D.S.C. 2014) (“Plaintiff's duty to provide notice of a suit is a covenant under the Policy, not a condition precedent to CIC-VT's duty to defend [and therefore requires a showing of prejudice from the insurer].”)
[4] Consol. Edison Co. of N.Y. v. Lexington Ins. Co., 2015 S.D.N.Y. LEXIS 101339, *26 (S.D.N.Y. July 30, 2015) (“In New York, an insurer's duty to defend is triggered by the filing of a complaint containing allegations that could possibly bring the action within the scope of coverage . . . .”)
[5] Consol. Edison, 2015 S.D.N.Y. LEXIS 101339 at *26.
[6] Smart Style Indus. v. Pa. Gen. Ins. Co., 930 F. Supp. 159, 163 (S.D.N.Y. 1996).
[7] N.Y. Ins. Law § 3420(a)(5).
[8] Hernandez Castillo v. Prince Plaza, LLC, 981 N.Y.S. 2d 906, 908 (N.Y. Sup.Ct. Mar. 3, 2014) (“As reflected in the legislative history of the amendment, it is both fair and good public policy that liability claims against insurers be resolved on the merits rather than on technicalities.”)
[9] See David A. Gauntlett, California Supreme Court’s Pitzer Opinion Unearths New Opportunities to Revisit Prior Insurer Denials of Policy Benefits, https://www.gauntlettlaw.com/news/california-supreme-court-pitzer-opinion-unearths-new-opportunities-to-revisit-prior-insurer-denials-of-policy-benefits (Oct. 3, 2019).
[10] Adelphia Communs. Corp. v. U.S. Specialty Ins. Co. (In re Adelphia Communs. Corp.), 638 B.R. 506, 515 (Bankr. S.D.N.Y. 2022) (“[A]ny exclusions to coverage must be strictly construed and read narrowly, with any ambiguity construed against the insurer.”)
[11] Faust v. Travelers, 55 F.3d 471 (9th Cir. (Cal.) 1995); Crystal Geyser Water Co. v. American Motorists Ins. Co., No. C-94-1531, 1995 WL 590330 (N.D. Cal. Sept. 28, 1995).
[12] Michaud v. Merrimack Mut. Fire Ins. Co., 1994 U.S. Dist. LEXIS 19930 (D.R.I. Nov. 16, 1994).
[13] Burgett, Inc. v. Am. Zurich Ins. Co., 875 F. Supp. 2d 1125, 1128 n.4 (E.D. Cal. 2012), as corrected (Aug. 24, 2012) (“The court notes that Defendant also argues that the no-voluntary payment provision in its policy with Plaintiff also negates any obligation to pay pre-tender costs. Because the court finds that, under California law, the duty to Defendant does not arise until tender, and thus, Defendant is not required to pay pre-tender expenses, the court does not reach this issue.”)
[14] Pitzer Coll. v. Indian Harbor Ins. Co., 8 Cal. 5th 93, 97 (2019) (Concluding that, absent prejudice, “California's strong preference to avoid technical forfeitures of insurance policy coverage” prevented enforcement of a “Voluntary Payments” provision in the first-party context.)
[15] Sea Tow Servs. Int'l v. St. Paul Fire & Marine Ins. Co., 211 F. Supp. 3d 528, 548 (E.D.N.Y. 2016) (“The New York Court of Appeals has held that when a conflict of interest exists between the insurer and the insured, then the obligation to defend includes an obligation to pay reasonable attorneys' fees for independent counsel for the insured.”)
[16] Smart Style, 930 F. Supp. at 164 (“Penn General had no opportunity to control the litigation or to influence the litigation strategy, as it had not been placed on notice of the lawsuit.”)
[17] Setting aside the public policy concerns, “Voluntary Payments” provisions are typically restricted to specific payments, such as “damages” and “loss,” the latter of which is usually a defined term. Neither term ordinarily includes defense expenses.
[18] See, e.g., Anderson v. Va. Sur. Co., 985 F. Supp. 182, 192 (D. Me. 1998) (“The Unfair Claims Practices statute permits insureds to bring civil actions against their insurers for . . . ‘failing to acknowledge and review claims, which may include payment or denial of a claim, within a reasonable time following receipt of notice by the insurer of a claim by an insured arising under a policy.’”)
[19] Logan v. Matveevskii, 175 F. Supp. 3d 209, 230 (S.D.N.Y. 2016).