Notice of Circumstances Sent to Underwriter Does Not Constitute Notice of a Claim Under Claims-Made-and-Reported Policies

The United States District Court for the Northern District of California, applying California law, has held that an insured bank did not comply with the notice requirements in its claims-made-and-reported excess policies when it emailed a “notice of circumstance” to an underwriter during the renewal process. Heritage Bank of Commerce v. Zurich Am. Ins. Co., 2023 WL 25710 (N.D. Cal. Jan. 3, 2023). The court also held that the insolvency exclusion in the followed policy served as an independent bar to coverage.

The insured bank procured follow-form first- and sixth-layer excess policies that ran from August 2018 to August 2019. During the pendency of the policies, in connection with the renewal process for the next policy year, the bank emailed the underwriter a “notice of circumstance,” which attached the bank’s notice of a claim to its primary carrier and a legal hold letter regarding a bank client which had allegedly engaged in a Ponzi scheme and later declared bankruptcy.    

After the policy period ended in August 2019, the insured sought coverage from the excess insurer in connection with the client’s bankruptcy proceeding and two civil lawsuits against the bank filed during the 2018-2019 policy period. The excess insurer denied coverage because it did not receive notice of the claims during the policy period. In the ensuing coverage litigation, the court held that the bank’s correspondence to the underwriter regarding the lawsuits did not satisfy the notice requirement because insurers do not have a duty to investigate unless notice is sent to the claims department as required under the applicable policy, and that a notice of a potential claim (which was what the bank had sent to the underwriter) likewise fails to satisfy the requirement for reporting claims under claims-made-and-reported policies. The bank was given leave to amend its initial complaint, and, upon amendment, the excess insurer filed a second motion to dismiss.

In granting the second motion to dismiss, the court held that the bank did not comply with the notice requirements in the excess policies. First, the court noted the bank’s admission that “its notice of circumstance [does not] serve[] as a substitute for notice of an actual claim,” and pointed out that the bank’s correspondence with the primary insurer showed that the bank understood how to provide notice of a claim.  Second, the court rejected the bank’s argument that the substantial compliance doctrine applied to excuse the bank’s notice to the underwriter. The court noted that California case law has “explicitly rejected the argument that a party ‘substantially complies with the ‘to whom’ requirement … when it provides any kind of notice to any kind of agent of [the insurer] during the policy period[.]’” Third, the court held that the “equitable excuse of a condition precedent” did not apply because the bank did not comply with the express notice requirements in the excess policies.  Fourth, the court rejected the bank’s argument that it is the custom and practice for underwriters to send notices of circumstances to the claims department, noting that this was “an unreasonable inference based on extrinsic evidence” and that adopting such an inference “would seriously undermine insurers’ ability to ever set [their] own procedures.”

The court also held that an insolvency exclusion in the underlying followed policy operated as an independent bar to coverage. The insolvency exclusion barred coverage for “Loss on account of any Claim: based upon, arising from, or in consequence of: the insolvency of any bank, banking firm, broker, or dealer in securities, or any other person or entity, or the inability of any such entity or person to make any payment or settle or effect any transaction of any kind[.]” In determining that the exclusion applied to preclude coverage not only for a bankruptcy proceeding but also for two related civil actions, the court emphasized that the exclusion’s “arising from” lead-in language is “given a broad interpretation when used in an exclusion,” and, applying that construction, concluded that the two civil actions were “broadly linked” with and resulted from the bankruptcy proceeding and thus were barred.