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HARRISBURG AREA COMMUNITY COLLEGE v. PACIFIC EMPLR

March 25, 1988

Harrisburg Area Community College, Plaintiff
v.
Pacific Employers Insurance Company, Defendant


William W. Caldwell, District Judge.


The opinion of the court was delivered by: CALDWELL

William W. Caldwell, District Judge

 I. Introduction.

 Each party has requested summary judgment pursuant to Fed. R. Civ. P. 56. Plaintiff, Harrisburg Area Community College (HACC), sued defendant, Pacific Employers Insurance Company (PEIC), for refusing to reimburse HACC for money it had to repay the federal government. HACC had erroneously received funds under a federal grant program which were used to cover the cost of providing courses for student prisoners at a state prison. At the times pertinent to this action plaintiff had in effect with the defendant insurer an errors and omissions policy purportedly covering the loss. Defendant contends that plaintiff's failure to comply with certain conditions precedent in the policy absolves it from liability. Defendant also contends that plaintiff suffered no loss within the meaning of the policy. There are no factual disputes and disposition of the motions turns on the applicable law. Accordingly, this case is suitable for disposition by summary judgment. We will examine the motions under the well established standard. See Peters Township School District v. Hartford Accident and Indemnity Co., 833 F.2d 32 (3d Cir. 1987).

 II. Background.

 On August 31, 1981, HACC signed a Program Participation Agreement with the United States Department of Education to administer the Pell Grant Program. The Agreement required HACC to comply with the program regulations set forth at 34 C.F.R. ยง 690 et seq. During the 1980-1984 award years, HACC ran an educational program at the State Correctional Institution at Camp Hill, Pennsylvania, and used Pell Grants to finance the expenses of the student prisoners. In computing the amount of each student's Pell Grant, HACC used a formula which included $ 1,100 for room and board costs. The inclusion of this item for incarcerated students was erroneous, and could have been used only if the prisoner was paying more than fifty percent of his room and board. *fn1" Each student's account at HACC was credited in varying amounts from funds supplied by the government to HACC from the Pell Grant program. No money was ever given directly to a prisoner.

 The government discovered the erroneous calculations in a routine audit in June of 1984 and so notified HACC on July 12, 1984. The amount of overpayments for the four program years at issue totalled $ 92,772.00. There is no evidence, and defendant does not contend, that the miscalculations were anything but an honest mistake on the part of HACC. The College pursued fruitless administrative appeals through 1984 and 1985, culminating in a final letter of denial from the government, dated January 6, 1986. By that time, HACC had already satisfied its obligation to the government by agreeing to take less in Pell Grant funds over a period of time. On or about March 13, 1986, HACC finally notified defendant of the situation and sought coverage under the policy. PEIC has resisted payment and has presented the following defenses.

 III. Discussion.

 A. Pennsylvania Law Requires the Insurance Company to Show Prejudice Before Denying Coverage Even When Notice Is Given After a Claim Has Been Paid by the Insured.

 PEIC argues that it has no duty to indemnify under the contract because plaintiff failed to comply with conditions 1, 2 and 4 of the "Conditions - Claims" portion of the policy. Condition 1, the notice provision, in pertinent part, provides that "as a condition precedent to the right of protection afforded by this insurance, the Insured shall, as soon as practicable, give to the Company written notice . . . ." Condition 2, the consent clause, provides, in pertinent part, that the "Insured shall not, except at personal cost, make any payment, admit any liability, settle any claims, assume any obligation, or incur any expenses without the written consent of the Company." Condition 4, the no-action clause, provides, in pertinent part, that "no action shall lie against the Company unless, as a condition precedent thereto, the Insured shall have fully complied with all terms of this policy . . . ." Defendant contends none of these conditions were complied with because HACC negotiated with the federal government on its own, concluded the matter for which it now seeks coverage from PEIC, and did not timely notify the company of the controversy.

 In making this argument, defendant recognizes that in Pennsylvania late notice alone is not sufficient to void coverage. Rather, under Brakeman v. Potomac Insurance Co., 472 Pa. 66, 371 A.2d 193 (1977), an insurance company, defending against liability on the basis of late notice from the insured, must show it was prejudiced. Defendant seeks to avoid the Brakeman rule in this case on two grounds. First, Brakeman dealt solely with the notice provision of an insurance contract while here defendant argues that the consent provision has been violated as well. Second, relying upon Metal Bank of America, Inc. v. Insurance Company of North America, 360 Pa.Super. 350, 520 A.2d 493 (1987), defendant contends that it has been prejudiced as a matter of law by HACC's handling and payment of the government's claim before giving notice to defendant, thereby precluding PEIC from exercising its right under the contract to control the investigation and settlement of a claim it has been called upon to pay. Defendant cites cases from other jurisdictions to support its argument. See, e.g., Lusalon, Inc. v. Hartford Accident and Indemnity Co., 23 Mass. App. Ct. 903, 498 N.E.2d 1373 (1986), aff'd on other grounds, 400 Mass. 767, 773 n.9, 511 N.E.2d 595, 599 n.9 (1987). Plaintiff counters that Metal Bank, in light of Brakeman, must have been based upon some prejudice to the company unarticulated in the opinion and that, to the extent it can be read to permit an insurance company to avoid liability without showing actual prejudice, it is contrary to Brakeman which we must follow in this diversity action. *fn2"

 Metal Bank, as plaintiff notes, is not clear-cut, but it is factually distinguishable from the instant case and is therefore not persuasive authority for the defendant. As the Pennsylvania Superior Court's opinion illustrates, Metal Bank was a complex case on liability and damages. In Metal Bank, the insured brought a declaratory judgment action attempting to obtain coverage from various insurance companies after it had defended an environmental pollution action brought against it by the federal government. The 1980 government suit had its origin in a 1972 environmental discharge. There were various federal investigations and contacts with the insured during the subsequent years dealing with this and other alleged discharges into the Delaware River. Two insurers did not receive notice of the action until some two years after its commencement and another not until it was joined as an additional defendant in the declaratory judgment action brought by Metal Bank in 1983.

 Affirming the lower court's decision in favor of the insurance companies based upon prejudice as a matter of law from the late notice, the superior court noted that:

 
In the instant case, we have an insured which for almost 10 years participated in negotiations with the federal and state governments over an alleged oil spill. At the termination of complex negotiations it was finally sued in 1980 by the EPA for damages in excess of $ 2,000,000.00. During the legal proceedings it was represented by its own counsel who defended the appellant in the legal action. It was not until ten years after the original oil spill and two years after protracted litigation commenced that the insured even advised the insurers that it was having any problems. We are dealing with a sophisticated insured, advised by counsel for many years, which had done nothing to alert its insurance carriers that they may be exposed to substantial liability caused by the polluting of public waters by the insured.

 Id. 360 Pa.Super. at 359, 520 A.2d at 498.

 The court also commented upon a letter sent by Metal Bank to one of its insurers:

 
The letter indicates that a settlement was already a fait accompli, and the insurers, who were being called upon to provide funds for the settlement had no opportunity to control the proceedings or in any way protect themselves. As noted in Brakeman, supra, the reason for timely notice to the insurer is to enable it to gain early control of the proceedings and to give it an opportunity to investigate and acquire information about the case. All of this was denied to the insurers in 1982, as the facts were stale and the litigation had been in progress for some two years. Litigation involving EPA and Metal Bank was very complicated and involved many defendants.

 Id. at 360, 520 A.2d at 498 (footnote omitted).

 The court then proceeded to discuss cases in which prejudice to the insurer was found as a matter of law when notice was given after judgment or verdict had been entered against the insured. Defendant's interpretation of Metal Bank is therefore correct. At least one other court has so interpreted the case. See Solvents Recovery Service v. Midland Insurance Co., 218 N.J. Super. 49, 526 A.2d 1112 (1987) (Metal Bank found prejudice as a matter of law).

 It is also obvious, however, that the superior court concluded that the insurance companies had shown actual prejudice from the late notice. Thus, the court noted that:

 Id. at 360-61, 520 A.2d at 498-99.

 It also found significant that:

 
the passage of time over so many years could result only in dimming memories and the shifting of relationships between individuals and Metal Bank. At least two supervisory personnel of Metal Bank at the Cottman office died during the intervening years between 1972 and 1982. Even the President of Metal Bank testified that he could not remember many events pertaining to the case because of the passage of time. A former plant manager of Metal Bank could not be found and ...

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