The opinion
United States Court of Appeals,
Fifth Circuit.
No. 96-20407.
HANSON PRODUCTION COMPANY, Neil E. Hanson, Chris W. Douglas,
Steven M. Morris, Erik G. Hanson, Monico Properties, Inc., Chris N.
Hanson, Michael E. Hanson, Ben A. McCarthy, Glen E. Vague, John J.
Surko, T & M Petroleum, Inc., T.D. Gholson, Patricia Dean Boswell,
Hamill Energy Company, Pvt 85 Ltd., Thru Line, Inc., Keystone,
Inc., Sid R. Bass, Inc., Lee M. Bass, Inc., Perry R. Bass, Inc.,
Perry R. Bass, Trustee, and Vivian L. Smith, Estate, Plaintiffs-
Appellants,
v.
AMERICAS INSURANCE COMPANY and Southern Marine & Aviation
Underwriters, Inc., Defendants-Appellees.
April 1, 1997.
Appeal from the United States District Court for the Southern
District of Texas.
Before POLITZ, Chief Judge, and REAVLEY and DENNIS, Circuit Judges.
REAVLEY, Circuit Judge:
The issue in this diversity case under Texas law is whether a
surplus lines insurer, in order to avoid its coverage obligations,
must show prejudice where the insured has failed to provide prompt
notice of a claim. Because we conclude that the Supreme Court of
Texas would require proof of prejudice, we reverse.
BACKGROUND
In 1985 appellant Hanson Minerals Company, a Texas
corporation, entered into operating agreements pertaining to a
Texas oil and gas prospect. In 1989 and 1990, per its agreement
with the non-operators, Hanson procured two comprehensive general
liability (CGL) and three excess liability policies from appellees
Americas Insurance Company and Southern Marine Aviation
1
Underwriters, Inc. (the insurers). The insurers are surplus lines
insurers under Texas law, as discussed below.
In October 1991 other parties to the lease sued Hanson in
state court. These plaintiffs alleged that Hanson had breached its
contractual obligations and negligently operated the leased
property. In an amended petition filed in August of 1993, the
plaintiffs claimed that Hanson, through its over-production of oil
and gas, had damaged the reservoir. Hanson argues that a claim
asserting an occurrence under the policies was not made in the
underlying suit until the amended petition was filed, since the
original petition did not allege bodily injury or property damage
covered by the policies.
On January 25, 1994, Hanson first notified the insurers of the
underlying suit and demanded a defense. The notice was sent
twenty-seven months after service of the original petition in the
underlying suit, and five months after service of the amended
petition. The underlying suit went to trial in August of 1994, and
Hanson settled the suit for $795,000 in November of 1994. The
insurers refused to fund the settlement.
The Southern Marine primary policy requires the insured to
notify the insurer "immediately" of any occurrence under the policy
likely to result in a claim. The Americas primary policy requires
that the insured notify the insurer of an occurrence under the
policy "as soon as practicable," and that the insured "immediately"
notify the insurer of a claim or suit against the insured. The
excess policies also have notice requirements. Both primary
2
policies provide that "[n]o 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."
Shortly after the settlement of the underlying suit, Hanson
sued the insurers, asserting breach of contract and other claims.
The district court granted summary judgment in favor of the
insurers, agreeing with them that under Texas law the notice
required in the primary policies was a condition precedent to the
insurers' coverage obligations, and that a policy condition
requiring notice "immediately" or "as soon as practicable" is
construed to mean within a reasonable time in light of the
circumstances.1 The court concluded that the notice Hanson
provided was untimely as a matter of law, and therefore Hanson was
barred from recovery under the primary policies, regardless of
whether the insurers had been prejudiced by the late notice.
The district court also ruled that the insurers were not
liable under the excess policies because (1) Hanson failed to offer
summary judgment evidence that the primary layer of coverage had
been exhausted, and (2) the excess policies exclude coverage for
liabilities not covered by the primary policies, and Hanson's claim
under the primary policies were not covered due to the late notice.
DISCUSSION
We agree with the parties that Texas law governs this
diversity suit, since by statute Texas law governs any insurance
1
See McPherson v. St. Paul Fire & Marine Ins. Co., 350 F.2d
563, 566 (5th Cir.1965) (interpreting Texas law).
3
policy "payable to any citizen or inhabitant of this State."2 Our
goal, sitting as an Erie court, is to rule the way the Texas
Supreme Court would rule on the issue presented.3 We are persuaded
that the Texas court would rule that the insurers cannot prevail on
their late notice defense unless they were prejudiced.
This issue was raised in Members Mut. Ins. Co. v. Cutaia, 476
S.W.2d 278 (Tex.1972). The plaintiff Cutaia had an automobile
insurance policy with defendant Members Mutual. Cutaia had an
accident with Smith, also insured by Members Mutual. Smith did not
notify Members Mutual of the accident until five months after it
occurred. The policy, like the CGL policies in our case, 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."4 The insurer refused to pay
Cutaia after he won a judgment against Smith, because Smith failed
to comply with the notice requirement. The court held that this
policy provision was a condition precedent to liability regardless
of whether the insurer was harmed or prejudiced by the late notice,
and rendered judgment in favor of the insurer.
In Cutaia the court recognized "the apparent injustice which
results in this particular case,"5 but concluded that "the matter
2
TEX. INS.CODE ANN. art. 21.42 (West 1981).
3
Browning Seed, Inc. v. Bayles, 812 F.2d 999, 1002 (5th
Cir.1987).
4
Id. at 278.
5
Id. at 281.
4
of rewriting the insurance provisions in question is properly
within the prerogative of the State Board of Insurance or the
Legislature."6
Probably in response to Cutaia, in 1973 the State Board of
Insurance issued orders requiring a mandatory endorsement in Texas
general liability and general automobile policies stating that a
failure to give notice under the policy does not bar coverage
unless the insurer has been prejudiced.7 Board Order No. 23080,
covering general liability policies, requires an endorsement
stating that "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."8 The order also provides that this endorsement "must be
attached to all General Liability policies issued or delivered in
Texas." In 1987 Board Order 23080 was superseded by Board Order
No. 50602, which maintains the same prejudice requirement.
The Board's authority to require this endorsement in general
liability policies appears to derive from its authority to
promulgate standard forms, which may be used by the insurer in lieu
of its own form, and the statutory requirement that general
6
Id. at 278.
7
See American States Ins. Co. v. Hanson Indus., 873 F.Supp.
17, 27 (S.D.Tex.1995); Chiles v. Chubb Lloyds Ins. Co., 858 S.W.2d
633, 635 (Tex.App.—Houston [1st Dist.] 1993, writ denied).
8
See Chiles, 858 S.W.2d at 635.
5
liability policies must be approved by the Board.9 This statutory
authority, however, only extends to policies issued by a licensed
insurer.10 The policies in our case are surplus lines insurers.
A surplus lines insurer is an unlicensed insurer.11 By statute
Texas allows unlicensed insurers to sell policies in the state if,
among other requirements, the insurance is placed through a
licensed surplus lines agent, and insurance "cannot be procured
from licensed insurers after diligent effort."12 The statute
recognizes that the placing of such policies is "a matter of public
interest," and is allowed in limited circumstances "as a result of
difficulty in obtaining coverage from licensed insurers."13 The
insurers offered affidavits from a supervisor in the Texas
Department of Insurance stating that the surplus lines policies in
this case are not subject to Board Order Nos. 23080 and 50602.
Even though Cutaia has not been expressly overruled, and even
though the Insurance Board's mandatory endorsement requiring
prejudice from late notice apparently does not apply to surplus
lines policies, we are persuaded that the Texas Supreme Court would
require a showing of prejudice in our case.
We believe the court would opt for a uniform rule of
construction, reasoning that surplus lines insurers are surely
9
TEX. INS.CODE ANN. art. 5.13-2, § 8 (West Supp.1997).
10
Id. at § 2.
11
TEX. INS.CODE ANN. art. 1.14-2, § 2(b) (West Supp.1997).
12
Id. at § 3.
13
Id. at § 1.
6
aware that their policies, like all policies issued to Texas
residents, are subject to Texas law and the rules of construction
followed by the Texas courts. We note that nothing we can find in
the Insurance Code suggests that the Legislature intended to
deprive the Texas Supreme Court of its traditional authority, under
the common law, to adopt rules of construction for insurance
policies, as it does for all contracts.
We are strongly influenced by the Texas Supreme Court's
decision in Hernandez v. Gulf Group Lloyds, 875 S.W.2d 691
(Tex.1994), decided over two decades after Cutaia. In Hernandez,
the daughter of the plaintiffs was killed in an automobile accident
involving another driver. The other driver was solely at fault.
The parents and daughter had uninsured/underinsured motorist
coverage provided in their policy with the defendant insurer.
Without the consent of the insurer, the plaintiffs settled with the
other driver for the modest limits of his insurance coverage, and
sought recovery from their insurer under the underinsured motorist
coverage. The insurer refused coverage on grounds that the
plaintiffs had failed to obtain the insurer's consent to the
settlement. The policy had a settlement-without-consent clause,
excluding coverage where the insured settles with any person who
may be legally liable for the injury without the insurer's consent.
The clause provided that "insurance does not apply ... to bodily
injury or property damage with respect to which the insured ...
without written consent of the company, make[s] any settlement with
7
any person ... who may be liable therefore...."14
The court held that the insurer must show prejudice despite a
dissent that cited Cutaia and wrote: "[T]his case is not about a
breach of contract. This case is about coverage.... In refusing
to impose a prejudice requirement, this Court [in Cutaia ] stated
that even though an injustice might occur by disallowing an
otherwise valid claim, this Court should not overreach it
boundaries and imply new standards into insurance contracts."15
The majority in Hernandez held that "an insurer may escape
liability on the basis of a settlement-without-consent exclusion
only when the insurer is actually prejudiced by the insured's
settlement with the tortfeasor."16 The court's reasoning was
straightforward. It recognized that insurance policies are
contracts subject to general rules of contract construction. It
noted that a fundamental tenet of contract law is that "when one
party to a contract commits a material breach of that contract, the
other party is discharged or excused from any obligation to
perform."17 It then held that where the insurer is not prejudiced
by the breach, the breach is not material, the insurer has not been
deprived of the benefit of the bargain, and it should not be
relieved of its obligation to provide coverage.
We believe that the reasoning of Hernandez applies with equal
14
Id. at 694 (Enoch, J., dissenting).
15
Id.
16
Id. at 692.
17
Id.
8
if not greater force to a notice-of-occurrence, notice-of-claim, or
notice-of-suit clause. The fundamental principle of contract law
recognized in Hernandez—that a material breach by one contracting
party excuses performance by the other party, and an immaterial
breach does not—is equally applicable to notice cases. In the
words of Hernandez, "an insurer who is not prejudiced by [the
breach] may not deny coverage...."18 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.
We also believe that the Texas Supreme Court would consider
the law of other jurisdictions. In Hernandez the court did so.19
Our court has also recognized that, where the state's highest court
has not provided clear guidance, we may look to the rule in other
jurisdictions in conducting our Erie analysis.20 A leading treatise
recognizes as the majority rule that the insurer is not required to
18
Id. at 693.
19
Id. at 693 n. 4.
20
Browning Seed, 812 F.2d at 1002-3.
9
prove prejudice to prevail in a lack of notice case.21 However, the
same treatise notes, in a lengthy footnote in its pocket part, a
modern trend in favor of requiring proof of prejudice.22 We believe
the Texas Supreme Court would follow this modern trend, as
Hernandez is entirely consistent with it.
Because we conclude that the district court based its summary
judgment on an incorrect interpretation of Texas law, we remand the
case for further proceedings.
REVERSED and REMANDED.
21
8 JOHN A. APPLEMAN & JEAN APPLEMAN, INSURANCE LAW AND PRACTICE § 4732
(1981).
22
Id. at n. 10 (Supp.1995) (citing Healy Tibbitts Const. Co.
v. Foremost Ins. Co., 482 F.Supp. 830 (N.D.Cal.1979); Weaver
Bros., Inc. v. Chappel, 684 P.2d 123 (Alaska 1984) (noting "modern
trend" in favor of considering prejudice); Ramos v. Northwestern
Mutual Ins. Co., 336 So.2d 71 (Fla.1976); Champion v. Panel Era
Mfg. Co., 410 So.2d 1230 (Fla.App.1982); Ouellette v. Maine
Bonding & Cas. Co., 495 A.2d 1232 (Me.1985); Washington v. Federal
Kemper Ins. Co., 60 Md.App. 288, 482 A.2d 503 (1984); Johnson
Controls, Inc. v. Bowes, 381 Mass. 278, 409 N.E.2d 185 (1980);
Morales v. National Grange Mut. Ins. Co., 176 N.J.Super. 347, 423
A.2d 325 (1980); Great American Ins. Co. v. C.G. Tate Constr. Co.,
303 N.C. 387, 279 S.E.2d 769 (1981); Lusch v. Aetna Cas. & Surety
Co., 272 Or. 593, 538 P.2d 902 (1975); Halsey v. Fireman's Fund
Ins. Co., 68 Or.App. 349, 681 P.2d 168, (1984); Pickering v.
American Employers Ins. Co., 109 R.I. 143, 282 A.2d 584 (1971); A
& W Artesian Well Co. v. Aetna Cas. & Sur. Co., 463 A.2d 1381
(R.I.1983)). See also Campbell v. Allstate Ins. Co., 60 Cal.2d
303, 32 Cal.Rptr. 827, 384 P.2d 155 (1963); Brakeman v. Potomac
Ins. Co., 472 Pa. 66, 371 A.2d 193, 195, 198 (1977) (adopting
prejudice requirement and noting "a trend of late in several
jurisdictions away from the classic contractual approach towards a
view that considers prejudice to the insurance company as a
material factor in determining whether to relieve the insurance
company of its coverage obligations by virtue of late
notification.").
10