Cracking the Morse Code:When An Insurer Must Show Actual Prejudice

Courts across the country haven’t taken too kindly to insurers using technicalities or blaming their insureds to deny coverage and Maryland is no exception. Legislatures’ displeasure with insurers’ knack for finding devils in details sharpens where insurers deny coverage even though the insured’s mistakes caused no real problems. The Maryland General Assembly has therefore encoded (and the state courts have adopted) the so-called “prejudice rule” – an insurer can’t deny coverage without showing it was actually prejudiced by whatever the insured supposedly didn’t do.

Specifically, Md. Code, Ins. (“IN”) § 19-110 states:

An insurer may disclaim coverage on a liability insurance policy on the ground that the insured or a person claiming the benefits of the policy through the insured has breached the policy by failing to cooperate with the insurer or by not giving the insurer the required notice only if the insurer establishes by a preponderance of the evidence that the lack of cooperation or notice has resulted in actual prejudice to the insurer.

How § 19-110 impacts other statutory, insurance-related procedures has been a matter of legal wrangling since it was first enacted in 1964 – but a new decision by the Court of Special Appeals suggests both that the rule is confined to its terms and trumped where other insurance mechanisms come into play. Though Morse v. Erie Insurance Exchange, No. 0511 (Md. Ct. Spec. App. 2014), deals with a limited issue involving uninsured-motorist benefits, the Court’s analysis of § 19-110 has larger implications for the provision’s application to all liability policies.

The case arose from a 2007 car accident caused by Ms. Smallwood, who carried a $15,000 insurance policy with Nationwide not sufficient to cover Ms. Morse’s damages. Ms. Morse carried an uninsured-motorist policy with Erie that required her, before agreeing to any settlement, to get the company’s consent pursuant to IN § 19-511 – a statutory provision laying out procedures to be followed when an insured is offered an underinsured motorist’s policy limits. Nationwide did make such an offer, which she relayed to Erie.

Before Erie could decide what to do, Ms. Morse accepted the offer. When she later sought her uninsured motorist benefits from Erie, coverage was denied for failing to provide proper notice – more on that later – and obtain the company’s consent to settlement in conformance with § 19-511. Here’s how that statute works.

Pursuant to § 19-511(a), a person offered insurance policy limits to settle a claim must send a copy of the offer via certified mail to any insurer providing applicable uninsured-motorist coverage. After the insurer receives that notice, it can, within 60 days, choose to withhold consent to settlement, in which case it has to pay those limits directly to its insured but retains subrogation rights against the liable party. § 19-511(b)-(d). If, on the other hand, the insured provides notice of the offer and never hears back from the insurer, or if the insurer withholds consent but doesn’t timely pay over the limits, the insured can accept the settlement offer and the insurer will be deemed to have not been prejudiced. Id. at (e).
Ms. Morse clearly hadn’t obtained Erie’s consent, as required by the contract, or even given Erie the 60 days it had under § 19-511(b) to decide whether to consent or not. Construing this all as a failure to give notice, she argued that coverage could not be denied unless, pursuant to § 19-110, the insurer could show it was actually prejudiced. She also contended that the common-law prejudice rule adopted by Maryland courts was broader than § 19-110 and would also apply to her claim in full.

For its part, Erie never asserted – and did not assert in the appeal – that it had been prejudiced by any of Ms. Morse’s missteps. The Court of Special Appeals, with Judge Moylan writing for the panel, nevertheless sided with Erie, holding that Ms. Morse couldn’t seek refuge in § 19-110 if she hadn’t complied with the mandatory procedures of § 19-511: “The § 19-110 prejudice rule is not a safe harbor that would excuse noncompliance with § 19 511.” Slip Op. at 9. The Court began by observing that § 19-110, by its terms and as suggested by the legislative history, only applies to failures to provide notice or failures to cooperate, and therefore wouldn’t apply to Ms. Morse’s failure to obtain Erie’s consent to settlement. (Relying on established case-law, the Court easily disposed of her somewhat flimsy contention that a failure to obtain consent is practically the same as a failure to provide notice.)

As for the common law prejudice rule, the Court interpreted it as only applying to failures to provide notice, though perhaps broader in the types of insurers it would cover, such as insurance pools and excess insurers. Because § 19-110 and the common-law prejudice rule didn’t apply to Ms. Morse’s failures to obtain consent – and as she never contended that she complied with her contractual obligation to follow § 19-511 – the case presumably could have ended there. However, the Court went a bit further (unnecessarily, perhaps) to hold generally that, because “[w]e cannot apply one statute to excuse Morse’s noncompliance with another statute[, §19-110] does not apply where a disclaimer of coverage is based on an insured’s failure to comply with the § 19-511 settlement procedure.” Slip Op. at 26.

The Court held that an insurer could, entirely “irrespective of prejudice,” deny coverage for a failure to abide by § 19-511 – which “effectively writes into all uninsured motorist policies a consent to settle clause that applies where the settlement offer would exhaust liability policy limits” – whenever not involving cooperation or notice. Id. at 27. This extra conclusion gave rise to a rather rare occurrence in the Court of Special Appeals: a dissent. Taking up the pen to break with the panel, Judge Woodward argued that actual prejudice is relevant to § 19-511.

That’s because, he noted, § 19-511 doesn’t say a thing about what happens if a person fails to comply with it. (Quick practice note: Don’t assume a remedy for a statutory violation that isn’t explicitly articulated, no matter how obvious it may seem!) That Erie decided an insured’s failure to abide by the statute permitted it to categorically deny coverage didn’t necessarily make it so – rather, Judge Woodward offered, the lack of a remedy should be considered in light of the statutory purpose and policy. Both the majority and dissent agreed that § 19-511 was designed to protect the insured (and not the insurer) by giving it the right to collect offered policy limits without substantial delay.

Requiring a showing of actual prejudice to deny coverage for failure to abide by § 19 511, Judge Woodward thought, was a remedy more in line with Maryland’s public policy than allowing the insurer to deny coverage outright. Oddly, Judge Woodward did not find that actual prejudice necessary in this context need arise from § 19-110 – rather, it seems, he believed it to be inherent in the purpose and policy of § 19-511 itself. Certiorari has been granted at the Court of Appeals to decide which of the two opinions will prevail. In the meantime, a few observations about the decision are worth noting.

First, if § 19-110 doesn’t apply to § 19-511 unless there is a failure to cooperate or provide notice, it presumably doesn’t apply (outside of those two circumstances) to any insurance statute affecting the insurer’s duty to provide coverage. Simply put, an insurer must show only that it was actually prejudiced if the insured failed to cooperate or provide notice. The decision could therefore produce a broader windfall to liability insurers in general.

Second, both the majority and the dissent play the statutory construction game a little fast and loose. The majority takes a plain reading of § 19-110 to limit its application to failures to cooperate or provide notice. Then – though it doesn’t appear necessary – it reads a remedy (automatic denial of coverage) into § 19-511 that the plain language doesn’t support.

For the dissent’s part, it finds the remedy of § 19-511 to be ambiguous, which would normally cause the Court to look to the legislative history. Instead, Judge Woodward jumps right to vague considerations of policy and purpose to read into § 19-511 an “actual prejudice” requirement that, absent reliance on common law or § 19-110, seems to come out of nowhere. If it was clear from the legislative history that the General Assembly intended that an insured’s failure to abide by § 19-511 would relieve the insurer of providing coverage, that would seem to settle the issue more concretely than the dissent’s chosen analysis here.

Although neither side expressly adopts a harmonious reading of the plain language of §§ 19-110 and 19-511 – consistent readings of statutes always being a prerogative of appellate courts – there may be a possible way to do so. Start with two basic premises: One, if an insured is denied coverage because of a failure to cooperate or provide notice, the insurer must show actual prejudice under § 19-110; two, if an insured follows § 19-511, the insurer is estopped from claiming it was prejudiced. Instead of unconditionally denying coverage for an insured’s failure to follow § 19-511, however, the insurer could merely be permitted to use that failure to demonstrate (in addition to any related contractual violations) prejudice under § 19-110.

If that reasoning seems to deprive § 19-511 of much effect, keep in mind that the insurer can protect itself by incorporating § 19-511 into the contract – just as Erie did here. In this way, the analysis of Morse would begin and end with the insurer’s denial of coverage based on a contractual consent to settle clause (mirroring § 19-511), which didn’t trigger the § 19-110 actual-prejudice requirement. Note, however, that Ms. Morse also failed to provide proper notice under § 19-511 – such that, alternatively, the insurer could have, in accordance with § 19-110, attempted to show actual prejudice (i.e., an impact on its subrogation rights) flowing from that failure. In sum, Ms. Morse would lose for failing to obtain the insurer’s consent, in violation of her contract; § 19-511 would only enter the picture if it was necessary to consider her failure to provide notice.

For more information, please contact Chris Mincher at (410) 385-2225 or at cmincher@silvermanthompson.com.