Clarendon issued a commercial general liability policy to a contractor, Namay. Namay constructed a building for Belz. Belz noticed water leaks in the building. Belz’s counsel advised Namay’s insurance broker that Belz was making a claim under Namay’s insurance policy.
Clarendon hired an adjuster to investigate Belz’s claim. The adjuster met with Belz and inspected the building, but his efforts to contact the insured, Namay, were unsuccessful. Clarendon advised Belz that it could not complete its investigation until after it spoke with Namay. Several months later, Belz inquired as to the status of the claim, and the adjuster told Belz he received no communication from Namay.
About a year after first contacting Namay’s broker, Belz sued Namay and personally served the suit papers on Namay. A default was entered against Namay about a month later. Neither Namay nor Belz notified Clarendon of the suit or the default.
After several more months, Clarendon assigned a new claims person to the file. An investigation revealed that Belz had filed suit and obtained a default against Namay. Clarendon hired defense counsel and attempted to set aside the default, without success. Belz then brought a direct action against Clarendon under California Insurance Code §11580 to recover on the default judgment.
Clarendon asserted it was not liable under the policy provision that "[t]he Company further shall have no liability for any default judgment entered against any insured, nor for any judgment, or settlement or determination of liability rendered or entered before notice to the Company giving the Company a reasonable time in which to protect its and its insured's interest." Belz argued Clarendon had not shown prejudice. Clarendon argued that a showing of prejudice was not required, and alternatively, that it was prejudiced because it was denied an opportunity to thoroughly investigate and to defend the suit. The trial court granted summary judgment to Clarendon, holding that a showing of prejudice was not required.
On appeal, the Court of Appeal noted that the key issue was whether the quoted provision was a notice provision, a cooperation clause, or a no-voluntary-payment provision as,[u]nder California law, an insured's breach of a notice provision or a cooperation clause does not excuse the insurer's performance unless the insurer can show that it suffered prejudice; [but] a breach of a no-voluntary-payment provision does not require a showing of prejudice."
Although the quoted provision was included in the no-voluntary-payment section of the Clarendon policy, the Court concluded that Clarendon must show prejudice. The Court posited that no-voluntary-payment provisions applied to "affirmative" acts by an insured and that "Namay did not pay or settle anything in the underlying suit . . . he did virtually nothing at all." The Court observed that "Namay's default was the result of a lack of notice or failure to cooperate," so Clarendon was required to show prejudice to avoid liability.
The Court quoted Clemmer v. Hartford Insurance Co., 22 Cal.3d 865 (1978), "that prejudice is not shown simply by displaying end results; the probability that such results could or would have been avoided absent the claimed default or error must also be explored." In other words, prejudice could be established by showing that if timely notice had been given, the outcome of the underlying suit would have been more favorable to the insured. Clarendon"s inability to investigate the claim thoroughly or to present a defense in the underlying suit did not establish the requisite prejudice.