HNRK Coverage Corner

Last month, the Eighth Circuit held that a policyholder that failed to notify its insurers about an explosion at an oil well within the timeframe specified in an exception to the pollution exclusion could not invoke that exception even where the insurers did not object to the late notice when they denied the insurance claim. 

In XTO Energy, Inc. v. Commerce & Industry Insurance Co., the court reversed a $25 million judgment for the policyholder, holding that a North Dakota law that insurers waive a late notice defense if they do not make “prompt and specific objection” to the late notice did not apply where the notice is a condition to an exception to a policy exclusion.  The court also held that the insurer did not need to show that it had been prejudiced by the late notice to deny coverage. 

Background

XTO Energy Inc. (“XTO”) owned and operated an oil and gas well in North Dakota and hired Missouri Basin as a contractor.  Under a “knock-for-knock” agreement, Missouri Basin agreed to indemnify XTO against claims by Missouri Basin’s employees and subcontractors and to carry liability insurance supporting that obligation.  Missouri Basin bought primary and umbrella policies from Berkley National Insurance (“Berkley”) and a $25 million second-layer umbrella policy from Commerce and Industry Insurance (“Commerce”).  

The Commerce policy excluded bodily injury “arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of Pollutants anywhere at any time.”  

A “time element exception” lifted the exclusion only if five conditions were met:

1. the release was abrupt and unintended;
2. it began on a specific date during the policy period;
3. the insured learned of it within seven days;
4. it was “reported in writing to us within (21) calendar days of becoming known to the Insured”; and
5. the insured made reasonable efforts to mitigate damage caused by the pollution.

XTO’s well exploded on June 18, 2016.  One worker was killed and several others were severely burned.  XTO sought coverage for what it paid to resolve claims brought by the victims, and Berkley sought a declaratory judgment that it owed no indemnity obligation.  XTO responded with counterclaims and a third-party complaint against Commerce.

At the district court, XTO admitted that it did not notify its insurers about the explosion within the 21-day window specified in the exception to the pollution exclusion.  Nevertheless, the district court ruled for XTO on two grounds.  First, it held that Commerce waived the notice requirement in the exception under North Dakota’s waiver statute because its denial-of-coverage letter did not object to the late notice (Commerce only raised a late notice defense during discovery in the coverage litigation).  Second, the district court held that, under Finstad v. Steiger Tractor, Inc., 301 N.W.2d 392 (N.D. 1981), late notice forfeits coverage only where the insurer shows prejudice, which Commerce could not do.  The court entered judgment against Commerce for $25 million plus interest, fees, and costs.  

Requiring a Policyholder to Satisfy a Condition to an Exception Is Not a Late-Notice Defense

The Eighth Circuit reversed.  The court quickly disposed of XTO’s threshold argument that the pollution exclusion did not apply to bodily injuries.  The plain language of the pollution exclusion covered such injuries if caused by “pollutants” (of which oil and gas fell within the definition).

The Circuit spent more time addressing the waiver question.  North Dakota has a statute that provides:

Delay in the presentation to an insurer of notice or proof of loss is waived if the delay is caused by any act of the insurer, or if the insurer fails to make a prompt and specific objection.

XTO argued that under this law (and there was no disagreement that North Dakota law governed the coverage dispute), Commerce’s failure to promptly object to the late notice meant that it was precluded from arguing that XTO could not invoke the exception to the pollution exclusion. 

The Circuit disagreed.  It held that North Dakota’s waiver statute applies to an insurer’s late notice defense but does not stop an insurer from denying coverage on “a substantively different defense.”  Here, Commerce was asserting a pollution exclusion defense, not a late notice defense. 

The Circuit rejected XTO’s argument that Commerce’s reliance on the 21-day notification condition was really a late-notice defense in substance.  The notification requirement was a condition XTO had to satisfy to invoke the exception, not a defense Commerce had to assert. And because XTO did not give timely notice, the exception never applied, and Commerce’s denial of coverage rested on the pollution exclusion rather than on late notice.  Put differently, the court held that North Dakota’s waiver statute reaches only late-notice defenses, and thus Commerce had no obligation under that law to object to XTO’s failure to satisfy the notice condition of the exception.  

No Prejudice Requirement Where the Deadline and Its Consequence Are Explicit

The Circuit also rejected XTO’s argument that under the North Dakota Supreme Court’s decision in Finstad, Commerce was required to show that it had been prejudiced by the late notice in order to deny coverage.  In Finstad the policy at issue required notice “within twenty days or as soon thereafter as is reasonably possible,” and did not state the consequences of late notice.  In rejecting XTO’s argument, the Eighth Circuit reasoned that the Finstad decision rested in part on construing that ambiguity against the insurer.

The Commerce policy, by contrast, set a definite period and stated a definite consequence. Reading Finstad as XTO urged would “insert an unwritten prejudice requirement into every insurance contract with a notice provision or a coverage exclusion with a time element exception.”

Finally, the court rejected XTO’s argument that the Commerce policy’s follow-form clause incorporated the “hostile fire” and “additional insured” exceptions in Berkley’s pollution exclusion.  The follow-form clause made Commerce’s coverage “subject to” its own terms and exclusions.  Because the two pollution exclusions conflicted, Commerce’s controlled.

Conclusion

XTO turns on the difference between a notice condition that the policyholder must satisfy to invoke an exception and a late-notice defense that the insurer must raise.  Because the Commerce policy created a notice condition and stated the consequences of missing the deadline, neither North Dakota’s waiver statute nor Finstad’s prejudice rule could revive the exception, and XTO’s exposure stayed outside the coverage it sought.