If your business gets hit with a demand letter or lawsuit, your first inclination might be to get rid of the problem as soon as possible. In the tech world, particularly for companies that are just getting off the ground, the last thing you need is expensive litigation to burden your bottom line, or adverse publicity that could give an edge to your competitors.
Most business owners procure basic insurance protection as part of their standard business operations. As the business grows, insurance coverage and limits are broadened. But the pressure to get rid of claims fast can make even the most prudent business executive take a “settle now, check other boxes later” approach. This might be a big mistake—and one that could be easily remedied by taking some simple early steps.
Most insurance policies contain “no action” and/or what is known as “no voluntary payment” or “no voluntary settlement” clauses. These clauses typically look like this:
No insured will, except at that insured’s own cost, voluntarily make a payment, assume any obligation or incur any expense other than for first aid, without our [that is, the insurer’s] consent.
Providing notice of a claim is step one to getting insurance involved. But, even if you provide notice of a claim, you still cannot agree to resolve a suit against you without the insurance company’s consent. Notice is a policy condition just like the no action and no voluntary payment provisions. But violating the latter provisions can be far more consequential.
In most states, if you are late in providing notice of a claim, you might still be able to get the benefits of your insurance coverage because the majority of courts have held that an insurance company must show actual prejudice caused by a late tender. See, e.g., Shell Oil Co. v. Winterthur Swiss Ins. Co., 12 Cal. App. 4th 715, 763 (1993); Oregon Automobile Ins. Co. v. Salzberg, 85 Wn. 2d 372, 376-77 (1975). So, if you receive a demand or get served with a lawsuit, and wait several months to tender that claim, you might still be alright unless there was actual prejudice (and in some states, substantial prejudice) to the insurance company—in other words, unless the insurance company was actually (and potentially substantially) harmed by your late notice, which the insurer typically has the burden of proving.
But, in some jurisdictions, like California, if you settle a case without insurance company consent, the insurance company does not have to show prejudice—rather, compliance with clauses like the no action clause is -considered a condition precedent to coverage, and coverage will be forfeited by a failure to comply regardless of any prejudice to the insurer. See, e.g., Hamilton v. Maryland Cas. Co., 27 Cal.4th 718, 726 (2002) (insurer has the absolute right to decide whether to settle or not). This is a huge penalty for a company that might have been otherwise completely justified and acted prudently by settling a claim early for a relatively low amount.
To be sure, in some states, like Washington, the courts still apply an actual prejudice standard even if you settle a case without insurance company consent. Public Utility Dist. No. 1 of Klickitat County v. International Ins. Co., 124 Wn.2d 789 (1994). But, given that some states (like California) are not consistent in their application of the actual prejudice standard, it is extra important to be aware of this risk before resolving a claim.
Here are some basic suggestions:
- Build time into the settlement of claims to involve your insurer
- Give your insurer a meaningful opportunity to be involved
- Convey the reasons to your insurer for an accelerated timeline for settlement
Enlisting the assistance of your broker can sometimes help speed up the process and ensure that the right communication channels are established. Keeping these suggestions in mind can also protect against some of the hidden risks in your insurance policy. For example, some insurance policies insert a choice-of-law provision that might be different from your headquarters location. If the policy states that New York law applies, for example, you may face obstacles to coverage even if you operate out of Washington state. If possible, push back on onerous choice‑of-law provisions before you bind coverage. But, to avoid hidden barriers to coverage that might be buried in form endorsements, incorporate the safeguards above into your process for handling claims.
As we know, insurance doesn’t necessarily cover all claims or demands. And there might be some very good reasons to resolve a claim without insurer involvement. The claim might fall outside coverage, for example, or you might have a high retention or deductible that effectively eliminates coverage for certain claims. But, these strategic and business decisions should be vetted with your team—including your in-house legal counsel and/or coverage counsel—before you resolve disputes, and not as an afterthought. An early resolution might be an extremely prudent course of action for your company—just make sure that you also take your insurance assets into account.
 This rule is not followed in some jurisdictions, like New York, and several southern states, so be careful to investigate applicable law.