Paj, Inc. v. Hanover Ins. Co.

Decision Date11 January 2008
Docket NumberNo. 05-0849.,05-0849.
Citation243 S.W.3d 630
PartiesPAJ, INC., d/b/a Prime Art & Jewel, Petitioner, v. THE HANOVER INSURANCE COMPANY, Respondent.
CourtTexas Supreme Court

Baxter W. Banowsky, Scott D. Levine, Banowsky, Betz & Levine, P.C., Dallas TX, for Petitioner,

R. Lynn Fielder, Fisk & Fielder, P.C., Sidney H. Davis Jr., Touchstone Bernays Johnston Beall & Smith, LLP, Dallas TX, for Respondent.

Elizabeth Bloch, Brown McCarroll, L.L.P., Austin, Frederick B. Wulff, Hughes & Luce LLP, Dallas, Douglas Alexander, Alexander Dubose Jones & Townsend, LLP, Austin, TX, for Amicus Curiae.

Justice O'NEILL delivered the opinion of the Court, in which Chief Justice JEFFERSON, Justice BRISTER, Justice MEDINA, and Justice GREEN joined.

In this, case, we must decide whether an insured's failure to timely notify its insurer of a claim defeats coverage under the policy if the insurer was not prejudiced by the delay. We hold, as we did in Hernandez v. Gulf Group Lloyds, that an immaterial breach does not deprive the insurer of the benefit of the bargain and thus cannot relieve the insurer of the contractual coverage obligation. 875 S.W.2d 691, 692 (Tex.1994). Accordingly, we reverse the court of appeals' judgment, render judgment that the insurer could not deny coverage because of untimely notice, and remand the remaining issues to the trial court.

I.

PAJ, Inc., a jewelry manufacturer and distributor, purchased a commercial general liability ("CGL") policy from Hanover Insurance Company that covered, among other things, liability for advertising injury. The policy required PAJ to notify Hanover of any claim or suit brought against PAJ "as soon as practicable." In 1998, Yurman Designs, Inc. demanded that PAJ cease marketing a particular jewelry line, and a month later sued PAJ for copyright infringement. Initially unaware that the CGL policy covered the dispute, PAJ did not notify Hanover of the suit until four to six months after litigation commenced.

PAJ brought this suit against Hanover seeking a declaration that Hanover was contractually obligated to defend and indemnify PAJ in the copyright suit, and asserting several extracontractual claims. The parties stipulated that PAJ failed to notify Hanover of the Yurman claim "as soon as practicable" and that Hanover was not prejudiced by the untimely notice. Both, parties moved for summary judgment on the notice issue based on these undisputed facts. The trial court granted Hanover's motion and denied PAJ's, holding that Hanover was not required to demonstrate prejudice to avoid coverage under the policy. The court of appeals affirmed. 170 S.W.3d 258, 259. We granted PAJ's petition for review to determine the effect on coverage when an insured fails to timely notify its insurer of a claim but the insurer suffers no harm as a result.

II.

The Hanover policies issued to PAJ provide coverage for "advertising injury," which the policy defines to include injury arising out of copyright infringement. The policy contains a prompt-notice provision that requires PAJ to notify Hanover of an occurrence or an offense that may result in a claim "as soon as practicable." The parties dispute whether the policy's prompt-notice requirement constitutes a condition precedent or merely a covenant. Hanover contends the policy language creates a condition precedent, the failure of which defeats coverage under the policy irrespective of prejudice to the insurer. See Hohenberg Bros. Co. v. George E. Gibbons & Co., 537 S.W.2d 1, 3 (Tex.1976). PAJ, on the other hand, contends the prompt-notice language creates a covenant, the breach of which excuses performance only if the breach is "material." See Centex Corp. v. Dalton, 840 S.W.2d 952, 956 (Tex.1992). PAJ further asserts that even if the policy language creates a condition precedent to coverage, Texas law nonetheless requires an insurer to demonstrate prejudice before it may avoid coverage based on untimely notice. We agree with PAJ that only a material breach of the timely notice provision will excuse Hanover's performance under the policy.

III.

Hanover pins its analysis on our decision in Members Mutual Insurance Co. v. Cutaia, 476 S.W.2d 278 (Tex.1972), and that is where we will begin. The policy at issue in Cutaia required the insured to forward any suit papers immediately to the insurer and provided that "no action shall lie against the [insurer] unless, as a condition precedent thereto, there shall have been full compliance with all of the terms of this policy." Id. at 278 (emphasis added). The insured failed to forward the suit papers to his insurer until five months after the occurrence in question. Id. at 278-79. Stipulating that it had suffered no harm, the insurer denied liability, contending a condition precedent to coverage had not been met. Id. at 279. We agreed that the insured's failure to timely comply with the policy's forwarding condition precluded the insurer's liability whether or not prejudice resulted. Id. at 281. But we emphasized "the apparent injustice which results in this particular case," and deferred consideration of the issue to the State Board of Insurance or the Legislature. Id.

The State Board of Insurance responded the very next year by issuing Board Order 23080, which requires a mandatory endorsement to all Texas CGL policies that precludes forfeiture of coverage for an insured's failure to comply with notice or forwarding conditions unless the insurer is prejudiced thereby. See State Board of Insurance, Revision of Texas Standard Provision For General Liability Policies—Amendatory Endorsement-Notice, Order No. 23080 (Mar. 13, 1973).

The endorsement provides:

As respects bodily injury liability coverage and property damage liability coverage, unless the company is prejudiced by the insured's failure to comply with the requirement, any provision of this policy requiring the insured to give notice of action, occurrence or loss, or requiring the insured to forward demands, notices, summons or other legal process, shall not bar liability under this policy.

Id. It is important to note that, at the time the State Board of Insurance created this endorsement, there was no standard coverage for advertising injury,1

Two decades after Board Order 23080 became effective, we decided Hernandez. 875 S.W.2d 691. There, the insured sought recovery under the uninsured/underinsured motorist provision of an automobile policy. The insurer denied liability because the insured had settled the underlying claim without the insurer's consent in violation of the policy's "settlement without consent" exclusion. Applying "fundamental principles] of contract law," we held that when one party to a contract commits a material breach, the other party's performance is excused. Id. at 692. In determining the materiality of a breach, we said, courts must consider, among other things, "the extent to which the nonbreaching party will be deprived of the benefit that it could have reasonably anticipated from full performance." Id. at 693 (citing RESTATMENT (SECOND) OF CONTRACTS § 241(a) (1981)). Without distinguishing between covenants and conditions or classifying the exclusion as one or the other, we concluded that the insured's breach of the settlement-without-consent provision was immaterial and thus the insurer could not avoid liability under the policy. Id. at 694. Notably, we recognized that "[m]ost other jurisdictions presented with this issue have likewise imposed a prejudice requirement, primarily on public policy grounds."2 Id. at 693 n. 4. The sole dissenting justice in Hernandez posited, as Hanover does here, that Cutaia likewise involved a coverage condition and thus precluded liability irrespective of harm. Id. at 694 (ENOCH, J., dissenting). The Court apparently rejected this position.

Since our decision in Hernandez, courts and several major, treatises have acknowledged Texas as a state that has adopted a notice-prejudice rule. See, e.g., Ridglea Estate Condo. Ass'n v. Lexington Ins. Co., 415 F.3d 474, 480 (5th Cir.2005) (relying on Hernandez and stating that Texas requires a showing of prejudice for insurer to avoid coverage because of untimely notice under an occurrence policy, even for types of insurance not covered by Board Order 23080); Booking v. Gen. Star Mgmt. Co., 254 F.3d 414 (2d Cir.2001) (citing Hernandez and stating Texas courts allow an insurer to deny coverage only for a material breach of its insurance contract); Hanson Prod. Co. v. Ams. Ins. Co., 108 F.3d 627, 630-31 (5th Cir.1997) (same); ERIC MILLS HOLMES, 22 HOLMES' APPLEMAN ON INSURANCE LAW AND PRACTICE § 139.4 (2d ed.2003). In Hanson, for example, the Fifth Circuit read Hernandez to require a demonstration of harm for an insurer to avoid its coverage obligation when the insured fails to comply with a policy's prompt-notice provision. 108 F.3d at 630. Summarizing our holding as "a material breach by one contracting party excuses performance by the other party, and an immaterial breach does not," the Fifth Circuit concluded this "fundamental principle of contract law" applied with equal or greater force to notice clauses:

If anything, we believe that the failure to give notice of a claim poses a smaller risk of prejudice than failure to obtain consent to a settlement. In many instances of untimely notice of a claim, the insurer is not prejudiced at all, and ultimately may not face any coverage obligation. Conversely, in many if not most cases where an insured settles a case without the insurer's consent, the insurer faces at least some liability. If the Texas Supreme Court does not presume prejudice in a settlement-without-consent case, we are persuaded that it would not presume prejudice in a failure-of-notice case.

Id. at 631. The Fifth Circuit noted "a modern trend in favor of requiring proof of prejudice" in this context and emphasized that in Hernandez, our Court considered the...

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