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Commentary: Insurance Company Flinch Test Backfires in Court

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Don't be surprised if the first response you get from your insurance company is a denial when you file a claim or ask it to defend a claim against you or your company.  Many insurance companies use the “flinch test.” They first deny claims, hoping that the insureds will drop the matter.  Don’t let your company get away with that practice.  Make certain that you really do not have coverage before dropping the matter.

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Most Colorado contractors and subcontractors carry comprehensive general liability (CGL) insurance.  Since their policies are on forms prepared by insurance company-sponsored organizations, CGL insurance policies are neither comprehensive nor general.

Also, they are (purposely) not easy to understand.

Because of those factors, most courts interpret insurance-speak in favor of policyholders and against the insurance companies. Even the Colorado General Assembly has passed laws that attempt to provide for the inequality between insureds and insurers in the interpretation of insurance policy language. Colorado also has laws designed to punish insurance companies for unreasonable delay or denial of insurance coverage. The result would require the company to pay twice the amount of the covered benefit plus court costs and attorneys’ fees.

A recent Colorado Court of Appeals decision highlights a typical struggle between the contractor and the contractor’s insurance carrier. The contractors (husband and wife) had gotten a written notice from the homeowner of a number of alleged defects in the construction of a home they built.

The contractors turned the matter over to their insurance carrier. The insurance company denied coverage, claiming that the claims were not within the insurance company’s coverage period.  The flinch test! The contractor and owner then proceeded to mediation and the contractors paid $140,000 to settle the homeowner’s claim for defective construction.

The contractors sued their insurance company. The trial court jury found that there was coverage and the insurance company was stuck with damages and its insured’s attorneys’ fees both for trial and the appeal. If the denial was unreasonable, the insurance company could be liable for double the amount of the benefit plus attorneys’ fees.

In the appeal, the insurance company had argued, unsuccessfully, that it had no duty to its insured to take action when they received a Construction Defect Action Reform Act (CDARA) notice.  That is a notice of defects required by law under the Colorado Construction Defect Action Reform Act designed (somewhat clumsily) to:

• provide relief for construction defects,

• afford contractors opportunities to cure or pay for repairs before being sued, and

• require owners to give that notice before initiating legal actions.

The court of appeals ruled that the CDARA notice was in effect “a suit” under the terms of the policy that required the insurance company to take action on behalf of the insured by addressing and responding to that notice. The court decided that the CDARA notice was a “civil proceeding” under the insurance policy language, in effect an “alternative dispute resolution” proceeding.
In reaching that conclusion, the court of appeals relied upon the insurance policy language, construing the language, as courts usually do, in favor of the insured. 

That exercise would no longer be necessary because in 2010 the Colorado legislature enacted a law specifically requiring insurance companies duties to defend when a CDARA notice is received by its insured who promptly submits the notice to its insurance company for action.

Another issue raised in the case was whether the contractors waived their rights under the policy because they did not give the company notice of the mediation and did not get the company’s consent to their settlement. The court ruled that since the company had denied coverage, the insureds were excused from further notice to the company and from obtaining the company’s consent to the settlement.

The contractors in that case did not fall victim to their insurance company’s flinch test. They won.

Albert B. Wolf is a principal in the Denver law firm of Wolf Slatkin & Madison P.C. 

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