Sherwood Brands, Inc. v. Hartford Accident & Indemnity Co.

WTLNER, Judge. This is a dispute between two allied insurance companies (Hartford) and their insured, Sherwood Brands, Inc. (Sherwood), over whether (1) Hartford breached its duty under the insurance policies to defend Sherwood in an action brought against it by a competitor, Osem Food Industries, Ltd. (Osem), and (2) if it did breach its duty, Hartford is liable for attorneys’ fees and other litigation costs incurred by Sherwood prior June 18, 1991—the date Sherwood notified Hartford of the underlying action by Osem and demanded coverage. Through rulings on a motion for partial summary judgment and a jury verdict, the Circuit Court for Montgomery County determined that Hartford had breached its duty, that the expenses incurred by Sherwood prior to the notice were reasonable, that Hartford was liable to Sherwood for them, but that Sherwood was not entitled to pre-judgment interest. The total judgment entered by the circuit court was for $497,366, of which $100,000 represented the amount paid by Sherwood in settlement of the Osem litigation, $89,237 was for expenses incurred in prosecuting the instant breach of con ³⁵ tract and declaratory judgment action, and the balance was for attorneys’ fees and other expenses incurred in the Osem litigation, some part of which was incurred prior to June 18, 1991.

The Court of Special Appeals, resolving cross-appeals by the parties, held, in relevant part, that (1) because Hartford was not prejudiced by the delay in notification, it was liable for the costs incurred by Sherwood on and after June 18,1991, (2) because Hartford’s duty to defend did not arise until it was notified, it was not liable for any fees or costs incurred prior to that date, despite the absence of prejudice from the delayed notice, and (8) Sherwood was entitled as a matter of law to pre-judgment interest on the amount properly owed to it. Hartford Accident v. Sherwood, 111 Md.App. 94 , 680 A.2d 554 (1996). The court remanded the case so that the circuit court could modify its judgment by excluding expenses incurred prior to June 18, 1991 and adding pre-judgment interest on the remainder. We granted certiorari to consider the one question of whether Sherwood was entitled to reimbursement for reasonable litigation expenses incurred prior to June 18, 1991. 1 We shall hold that it was so entitled and therefore shall vacate the judgment of the Court of Special Appeals.

BACKGROUND Sherwood, a North Carolina corporation, markets and distributes food products. On January 6, 1989, it and other related defendants were sued by Osem in the United States District Court for the Middle District of North Carolina under both the Federal Lanham Act, 15 U.S.C. § 1125 (a), and North Carolina’s unfair and deceptive trade practices law, N.C. Gen. Stat. § 75-1.1 . The gravamen of the three-count complaint was that, since 1984, Osem had been distributing its soup mix in the United States in a unique and distinctive package and that, in 1988, Sherwood developed and began using a package ³⁶ for its competing soup mixes that was virtually identical to Osem’s package.

Osem sought injunctive relief, an accounting, treble and punitive damages, and attorneys’ fees. Sherwood filed no immediate response to the complaint but rather consented to a court order, entered on January 31, 1989, under which it apparently was enjoined from using its then-current soup package. 2 At that point, Hartford had no contractual relationship with Sherwood. On February 23, 1989, Hartford issued a Comprehensive General Liability Insurance Policy to Sherwood. The policy, which ran for a year, was renewed annually in 1990, 1991, and 1992.

Section I of the policy set forth the various coverages. Under one of them—Coverage B—Hartford agreed, subject to the policy limits, to pay “those sums that the insured becomes legally obligated to pay as damages because of ... ‘advertising injury’ to which this insurance applies.” That coverage also vested in Hartford “the right and duty to defend any ‘suit’ seeking those damages.” The insuring agreement provided further that Hartford “may investigate and settle any claim or ‘suit’ at our discretion.” Subject to certain listed exclusions, the coverage applied to “ ‘advertising injur/... caused by an offense committed ... during the policy period[ ] and ... [i]n the course of advertising your goods, products or services.” The term “advertising injury” was defined in Section V of the policy as including the misappropriation of advertising ideas or style of doing business. Section IV of the policy, captioned “Commercial General Liability Conditions,” set forth, among other things, certain duties on the part of Sherwood in the event of an “Occurrence, Claim, or Suit.” They included the duties (1) to notify Hartford “promptly of an ‘occurrence’ which may result in a claim[,]” and (2) if a claim was made or a suit was brought against an insured, to see to it that Hartford received “prompt written ³⁷ notice of the claim or suit[,]” to “immediately” send Hartford copies of legal papers received in connection with the claim or suit, and to cooperate with Hartford in the investigation, settlement or defense of the claim or suit. Finally, as relevant here, Section IV stated that an insured would not, except at its own cost, voluntarily make any payment, assume any obligation, or incur any expense without Hartford’s consent. 3 On February 27, 1989—four days after issuance of the initial policy—Osem supplemented its complaint against Sherwood by adding three new claims for relief.

The Supplement incorporated by reference the initial complaint and added that, “sometime after January 6, 1989,” Sherwood had altered the package it had been using to market its soup but that the new package was “identical or substantially identical” to the old package and was “virtually identical and confusingly similar” to Osem’s unique and distinctive package. The three new claims for relief pled in the Supplement were similar to those pled in the initial complaint—violation of the Lanham Act and North Carolina deceptive trade practices laws—except that they applied to the new package allegedly being used by Sherwood. For convenience, the parties have referred to the initial complaint as involving the “green” package and the new claims for relief in the supplemental complaint as involving the “red” package. 4 No notice was given to Hartford of the Supplement. On August 14, 1989, Osem filed an amended complaint incorporating by reference the initial complaint and the February 27 supplement and adding two additional claims for relief.

The new claims—one for defamation and the other charging unfair competition and deceptive trade practice— ³⁸ were based on the averment that, on or about November 28, 1988, Sherwood disseminated to an Osem customer false and misleading statements concerning Osem and its products. No notice was given to Hartford of that amended complaint. When Osem’s initial complaint was filed, Sherwood employed William Spry, a North Carolina attorney who had been representing an allied company in a breach of contract action against Osem, to represent it. When the supplemental complaint was filed, Sherwood, which, by then, had relocated from North Carolina to Maryland, retained Lawrence Hefter, a District of Columbia attorney, to work with Mr. Spry.

Mr. Hefter was given a $10,000 litigation budget, which he apparently exceeded by a significant amount. In May, 1991, following a fee dispute and an inability to agree on a modified budget, Sherwood replaced Mr. Hefter with Floyd Gibson. It does not appear that either Mr. Spry or Mr. Hefter ever suggested to Sherwood that Osem’s claim might be covered by thé Hartford policy, and Sherwood maintained that it was unaware that the claim might be so covered. Shortly after Mr. Gibson was retained, he raised the prospect with Sherwood and, on June 18,1991, Sherwood notified Hartford of the lawsuit and sent copies of the suit papers.

On July 2, 1991, Hartford acknowledged receipt of the notice but made clear that it was reserving its rights under the policy. It referred to the policy requirement of prompt notice, noted that the June 18 letter was the first notice Hartford had of the claim, and asserted that there was a possibility of prejudice from the late notice and a further possibility, apart from any problem arising from the delayed notice, that an applicable policy was not in effect to cover the claim. On September 18, 1991, Hartford returned the suit papers and declined coverage on the sole ground that, after reviewing the file, it had concluded that “all of the allegations occurred prior to the inception date of the Hartford policy.” No mention was made in that letter about the delay in notification. ³⁹ Faced with that rejection, Sherwood continued to defend the Osem case with its own resources. On November 30, 1992— the eve of trial—Sherwood and Osem reached a settlement, under which Sherwood paid $100,000 to Osem.

On June 25, 1993, it filed this action against Hartford seeking (1) a declaratory judgment that Hartford had a duty to defend and indemnify Sherwood in the Osem action and that it breached its contract by failing to do so, and (2) damages for breach of contract. The principal issue was whether the claims made by Osem arose prior to the inception of the policy, although Hartford also contended that there was no coverage because Osem’s claims did not constitute an “advertising injury” and because, by not disclosing Osem’s claim in its application, Sherwood had made a material misrepresentation. Rejecting the advertising injury and misrepresentation defenses and persuaded that, at a minimum, the allegations relating to the “red package” set forth in the February 27 supplement arose after the policy was issued and that Hartford therefore did have a duty to defend the action, the court, on August 31, 1994, denied Hartford’s motion to dismiss the complaint and granted, in part, Sherwood’s motion for partial summary judgment. On January 26, 1995, the court further concluded that (1) Hartford’s duty to defend encompassed the entire Osem suit, including the claims made in the initial complaint and the defamation claims added in August, 1990, (2) Hartford breached its duty to defend, (3) Hartford was liable for the reasonable costs and attorneys’ fees associated with the defense of the Osem claim, including costs and fees incurred prior to June 18, 1991, as well as the fair and reasonable amount of the settlement, and (4) with respect to the costs and fees incurred prior to June 18, 1991, Hartford was not prejudiced by the timing of the notice.

Upon those findings, it granted the balance of Sherwood’s motion for partial summary judgment. The jury trial was thus limited to damages. By special verdict, the jury found the following costs and fees to be reasonable: $64,960 paid to Mr. Hefter; $102,688 paid to Mr. Gibson; $61,074 paid to Mr. Spry with respect to the trademark claim; $56,069 paid to Mr. Spry with ⁴⁰ respect to the defamation claim; and $100,000 paid in settlement of the Osem claims. In entering its judgment, the court added $23,336 in other litigation expenses and $89,237 for attorneys’ fees in prosecuting the declaratory and breach of contract action, for a total judgment of $497,366.

As we indicated, the Court of Special Appeals held that Sherwood was not entitled to recover costs and fees incurred prior to the date it first notified Hartford of the Osem claim. That holding was based on alternative grounds: (1) the court’s conclusion that Hartford’s duty to defend did not arise until it received that notice, and (2) the policy language precluding Sherwood from voluntarily incurring any expense without Hartford’s consent. Ill Md.App. at 116-17, 680 A.2d at 564-65 . DISCUSSION Introduction As framed by Sherwood in its brief, the question is whether, in light of Maryland Code (1957, 1994 RepLVol.), § 482 of Article 48A (recodified effective October 1,1997 as § 19-110 of the Insurance Article), an insurer is liable for pre-notice fees and costs incurred in the defense of a lawsuit when (1) the insurer breaches its duty to defend after receiving delayed notice of the suit, (2) the insured’s delay in giving notice is unintentional and in good faith, (3) the insurer is not prejudiced by the delay, and (4) the fees and costs are reasonable and would have been incurred by the insurer had timely notice been given.

That articulation invokes a number of questions concerning the various elements, not to mention what the result might be if one or more of those elements is missing. The issue really hinges on when, in the case of a delayed notice, the duty to defend arises and is breached, whether § 482 has any bearing on the insurer’s obligation for prenotification fees and expenses, and the extent to which an insurer’s obligation for pre-notification costs depends on the position it takes after receiving delayed notice. ⁴¹ Nature of the Duty of Notification The obligation of an insured to notify the insurer of a claim subject to a duty to defend is contractual in nature. It is, obviously, a necessary obligation, in that the insurer can hardly be expected to defend an action or claim it knows nothing about, but it is nonetheless an obligation imposed by the insurance contract, subject to any supervening public policy. In some policies, the obligation is clearly phrased as a condition precedent to any action on the policy.

See, for example, Watson v. U.S.F. & G. Co., 231 Md. 266 , 269 n. 1, 189 A.2d 625 , 626 n. 1 (1963), where the policy not only required the insured to give prompt notice of an accident but also stated that no action would lie against the insurer “unless, as a condition precedent thereto” the insured fully complied with all the terms of the policy. We read that language literally and held that, although the condition could be waived and there may be circumstances in which the insurer might be estopped from asserting it as a defense, it was otherwise one “that must be performed before any obligation on the part of the assurer commences.” 231 Md. at 271 , 189 A.2d at 627 . That was the general rule followed by courts throughout the country and was certainly the rule followed by this Court prior to 1966; indeed, even if the language did not use the word “condition,” the duty of notification was regarded as creating a condition precedent to the insurer’s obligation to defend or indemnify, and the lack of any prejudice to the insured from the failure to give prompt notice was immaterial. See Lennon v. Amer.

Farm. Mut. Ins. Co., 208 Md. 424 , 118 A.2d 500 (1955); Employers’ Liability Assurance Corporation v. Perkins, 169 Md. 269 , 181 A. 436 (1935).

That approach has been modified—in some States by common law and in Maryland by statute. In 1964, the General Assembly enacted § 482 of Article 48A. Although initially the statute applied only to automobile liability insurance policies, it was broadened in 1966 to apply to any policy of liability insurance. It currently states: “Where any insurer seeks to disclaim coverage on any policy of liability insurance issued by it, on the ground that ⁴² the insured or anyone claiming the benefits of the policy through the insured has breached the policy by failing to cooperate with the insurer or by not giving requisite notice to the insurer, such disclaimer shall be effective only if the insurer establishes, by a preponderance of affirmative evidence that such lack of cooperation or notice has resulted in actual prejudice to the insurer.” In St. Paul Fire & Marine Ins. v. House, 315 Md. 328, 332 , 554 A.2d 404, 406 (1989), we characterized § 482 as a response to Watson and as making “policy provisions requiring notice to, and cooperation with, the insurer covenants and not conditions.” We added that “[t]he statute measures by the standard of actual prejudice the materiality of any breach of those covenants by the insured for the purpose of determining if the breach excuses performance by the insurer.” Id.

See also T.H.E. Ins. v. P.T.P., Inc., 331 Md. 406, 414 , 628 A.2d 223, 227 (1993). It is thus clear that the Watson approach of regarding notice provisions as conditions, enforceable without regard to prejudice or lack thereof, has not been the law in Maryland for more than three decades. In order to avoid its duty to defend or to indemnify on the ground of delayed notice, the insurer must establish by a preponderance of affirmative evidence that the delay in giving notice has resulted in actual prejudice to the insurer. In this case, as we have observed, although Hartford raised the prospect of claiming prejudice from the delayed notice in its initial response, it ultimately decided not to base its decision on that defense but instead declined to defend the Osem claim on the sole ground that the claim was not covered—that it was based on conduct occurring before the policy was issued.

Only when sued for breach of the policy did the insurer attempt to support its decision by interposing other defenses, principally that the claim did not constitute an advertising injury and that there had been a material misrepresentation, and only in response to Sherwood’s motion for partial summary judgment did Hartford, for the first time, actually interpose the defense of delayed notice. The delay in ⁴³ giving notice, therefore, apparently played no material role in Hartford’s decision not to defend the Osem claim. The fact that Hartford did not use the delayed notice as a ground for refusing to defend and was unable, in any event, to establish legally sufficient prejudice from the delay ultimately will doom its position. That fact does not, however, eliminate the need to consider the bearing a delayed notice may have on when the duty to defend can properly be regarded as arising and having been breached, and it is to those matters that we shall now turn.

Duty to Defend and Breach It is common—almost universal—for liability insurance policies to give the insurer both the right to control the defense of any claim covered by the policy and the duty to provide that defense. See 14 Couch on Insurance 2d § 51.35 at 438 (Rev. ed. 1982 & Supp.1996). These are, essentially, reciprocal or correlative provisions. The right to control the defense,