Loyola Consumer Law Review

Volume 9 | Issue 4 Article 15

1997

Substantial Compliance: Substantially ErroneousDoctrineJack LeyhaneAttorney, Condon & Cook, Chicago, IL.

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Recommended CitationJack Leyhane Substantial Compliance: Substantially Erroneous Doctrine, 9 Loy. Consumer L. Rev. 353 (1997).Available at: http://lawecommons.luc.edu/lclr/vol9/iss4/15

Feature Article

Substantial Compliance:Substantially Erroneous Doctrine

by Jack Leyhane

I. INTRODUCTION

The insurance business is a multi-billiondollar industry. The agreements betweenpolicyholders' and insurers affect every aspectof a policyholder's life, including health,housing, cars, and employment. Most consum-ers never think about their insurance policiesuntil a loss occurs, such as a theft or the de-struction of their home or business by fire.Only then do policyholders typically consulttheir policies to determine what steps theymust take to obtain indemnification under thepolicies.

Few consumers realize that an insurancepolicy, in essence, is simply a contract betweena policyholder and an insurance company. Likeany contract, an insurance contract is construedstrictly against its drafter, the insurer. "[T]hepurpose of an insurance contract is indemnityand therefore the policy should be liberallyconstrued with uncertainty resolved in favor ofthe insured. However, the general rules whichfavor the insured must yield tothe paramount rule of reasonableconstruction which guides allcontract interpretations." 2 It is Jackhow a court strikes this balance Cook,,c- between liberal constructionwith a view toward fulfilling the regularpurpose of indemnification and Leyhanthe paramount rule of reasonableconstruction - that determines Univerthe outcome in many insurance frequencases.

In this article, we consider the litigatisituation where a policyholder columnpresents a claim on his or her entitledown policy. Insurance policies

frequently list detailed steps that a policyholdermust follow in order to recover on the claim. Ifa court interprets the contract language liter-ally, consumers can be denied coverage byfailing to fulfill a condition precedent in theinsurance contract that may seem, to some, likea technicality. When courts do this, they arerequiring "strict compliance" on the part of thepolicyholder with all of the terms and condi-tions of the policy in order for the policyholderto recover on an insurance claim. Many courtsdo not require strict compliance. Instead, agrowing number require "substantial compli-ance" with the terms and conditions of thepolicy in order for a policyholder to recover onan insurance claim.

The definition of "substantial compliance"varies greatly with the jurisdiction. Somecourts, as will be discussed below, requirepolicyholders to make a good-faith attempt tocomply with the provisions of the policy.Others require almost nothing of policyholders,and allow policyholders to refuse to providethe insurance company with the informationneeded to complete its investigation.

Leyhane is a member of Condon &

Chicago litigation boutique whichly represents insurers and their insureds.

e is a 1980 graduate of Loyolasity Chicago School of Law. He is a

:t author and lecturer on insurance andn topics and co-authors a monthly

in the Chicago Daily Law Bulletin

'"Insurance Issues."

Loyola University Chicago School of Law * 3531997

This article examines how courts in Illinoisand across the nation have interpreted insur-ance contracts in the context of litigationbetween a policyholder and insurance com-pany. Each of these approaches has pro-nounced effects on the likelihood that fraudwill occur, directly affecting the cost of insur-ance premiums. For those states that haveadopted a "substantial compliance" approach,this article recommends an approach thatcourts in those states should take in applyingthis doctrine. This approach will enable courtsto balance the interests of individual policy-holders attempting to recover on particularclaims with the interests of premium-payingconsumers as a whole.

II. BACKGROUND

A. The Process of Recovering onan Insurance Policy

Generally, insurance policies require policy-holders who want to recover on insuranceclaims to do four things. First, policyholdersmust notify the insurer of a loss within arelatively short period of time. Second, theymay be asked to submit a "proof of loss" to theinsurer. This is a form used in the insurancebusiness which requires the insured to providespecific factual information about the loss,such as the cause and origin of the loss and theamount claimed under. the policy. The form issigned by the insured and notarized. Third, ifthe insurance company requests it, policyhold-ers must submit to an examination under oath("EUO"). An EUO has some similarities to adeposition, in that, as the name suggests, thepolicyholder gives testimony under oath,usually before a court reporter. Also like adeposition, the policyholder has a right to havecounsel present, but counsel's role is morecircumscribed than in a deposition. Finally,policyholders must produce all related finan-cial documents.

These provisions are found in virtually everyinsurance policy providing property coverage,

from an individual renter's policy, to complexcommercial forms covering skyscrapers ormulti-site industrial risks. In many jurisdic-tions, these provisions have been consideredconditions precedent to recovering under thepolicy.

Consumers should realize, however, that this"formal" claim handling is not required everytime a policy claim is presented. As a practicalmatter, with the exception of the notificationrequirement, insurers do not seek compliancewith these requirements unless fraud by thepolicyholder is suspected. (Detailed investiga-tion of every single claim would be prohibi-tively expensive.) The cooperation provisionsof the insurance policy exist for the purpose ofallowing an insurer to identify and resistsuspected fraudulent claims. As the UnitedStates Supreme Court explained in Claflin v.Commonwealth Insurance. Co.:

The object of the provisions in thepolicies of insurance, requiring theassured to submit himself to anexamination under oath, to be re-duced to writing, was to enable thecompany to possess itself of allknowledge, and all information as toother sources and means of knowl-edge, in regard to the facts, materialto their rights, to enable them todecide upon their obligations, and toprotect them against false claims.3

Based on information gleaned from itsinvestigation, the insurance company musteither pay the claim or deny payment. If theinsurance company denies the claim, a policy-holder can sue the insurance company for abreach of the policy. This is known as a "first-party claim." In deciding first-party claims,courts must frequently examine whether thepolicyholder cooperated with the insurancecompany in conducting its claim investigation.However, to the detriment of consumersgenerally, the requisite level of policyholdercooperation is eroding in many jurisdictions.

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B. Why Insurance Companies NeedPolicyholders to Cooperate (and WhyConsumers Want Policyholders to DoSo).

As a private entity, an insurer's ability toobtain information following a loss from thirdparties, even public agencies, is quite limited.An insurer's only protection against fraudulentclaims is the limited investigative proceduresauthorized by its policies. Different jurisdic-tions take differentapproaches in requiringpolicyholder cooperation.In those jurisdictions thatdeem an insured's obliga- The NItions following a loss tobe conditions precedent that as manto recovery under thepolicy, a policyholder's property/casfailure to cooperate isfatal to recovery on a fraudulefirst party claim. Thoughthe term is not used in the Americanscases, we can refer tothese as "strict compli- billioiance" jurisdictions todistinguish these fromstates which hold that apolicyholder must only"substantially comply"with these traditional conditions precedent. Instates where courts require other than "strictcompliance" from policyholders, the courts, inessence, are requiring less than full coopera-tion from policyholders. Whether the courts ofa particular jurisdiction will require strictcompliance or allow "substantial compliance"can thus significantly affect the quantity andquality of information that an insurance com-pany will be able to collect from its policy-holders.

As applied, particularly in Illinois, this"substantial compliance" doctrine has theundesirable effect of eviscerating the obliga-tions created by the policy, if not actuallyencouraging non-compliance by the policy-

holder, at the direct expense of the insurer'sability to investigate claims promptly andthoroughly. While there are no figures specifi-cally addressing the financial impact of Illi-nois' substantial compliance doctrine, anypolicy that discourages the investigation ofinsurance fraud can be presumed to have asignificant effect on the wallets of premium-paying consumers.

Consumers feel this effect primarily throughthe fallout of insurance fraud. A dishonest

policyholder, perpetrat-ing a fraud, can, in somestates, make only mini-mal efforts at policy

.B estimates compliance and still bein "substantial compli-ance" with the condi-

as 10 % of all tions of the policy. TheS claims are policyholder can thereby

lty liavoid summary judg-and cost ment and guarantee

himself a jury trial.

much as $20 Faced with the expenseof a trial, an insurer may

a year. opt to settle claims inthese circumstances,allowing the policy-holder to complete theperpetration of the fraud.

In this country, insur-ance fraud is widespread and extremely detri-mental to consumers. The National InsuranceCrime Bureau ("NICB") calls insurance fraudthe second most costly white collar crime inthe United States, second only to tax evasion.The NICB estimates that as many as 10% of allproperty/casualty claims are fraudulent andcost Americans as much as $20 billion a year.4Consumers ultimately absorb this $20 billioncost through higher insurance premiums. TheNICB contrasts its $20 billion estimate of theannual cost of insurance fraud with the $17billion in damage done by Hurricane Andrew,to date the costliest natural disaster in UnitedStates history. In order to help prevent insur-ance fraud and, ultimately, the increase in

Loyola University Chicago School of Law 9 355

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consumers' premiums, courts should requirepolicyholders to cooperate with insurancecompanies' investigations.

Not only do consumers as a whole needpolicyholders to comply with insurance com-panies' investigations, insurance companiesthemselves also need policyholder cooperationso that they can comply with state regulatoryrequirements. For example, Illinois, like moststates, imposes a statutory obligation oninsurers not to engage in the "unfair claimspractice" of refusing "to pay claims withoutconducting a reasonable investigation based onall available information."5 Under currentIllinois common law, an Illinois insurer is notentitled to deny claims without conducting areasonable investigation; however, an insurerhas no right to compel a policyholder's mean-ingful cooperation in a post-loss investigation.This leaves insurance companies with theresponsibility to investigate claims and littlepower to conduct such investigations.

Courts can empower insurance companiesby requiring policyholders to comply with thepolicy's terms and conditions and cooperate inclaim investigation. This cooperation wouldenable insurance companies to fulfill theirstatutory duty of conducting reasonable inves-tigations. Although claim investigations areinitiated because of a suspicion of fraud, not allinvestigations result in declination (the refusalto pay the claim). Often, where the insuredwillingly cooperates in the insurer's investiga-tion, those initial questions which gave rise tothe request for formal claim handling areresolved in favor of the policyholder.

In the absence of policyholder cooperation,and without meaningful enforcement of policycooperation provisions, the insurance companyhas two choices when faced with apolicyholder's claim that raises a suspicion offraud. First, it can deny the questionable claimand face the expense of litigation if a policy-holder decides to sue. Second, it can pay thequestionable claim, even though the claimappears to be fraudulent. Both of these optionsresult in substantially increased costs to the

insurance company - costs which are passedto the policyholder in the form of increasedpremiums.

III. THE TRADITIONAL APPROACH:STRICT COMPLIANCE WITHTHE COOPERATIONPROVISIONS OF THEINSURANCE CONTRACT

Some jurisdictions continue to requirepolicyholders' strict compliance with allconditions in insurance contracts. NorthCarolina's Fineberg v. State Farm Fire andCasualty Co.6 illustrates this approach. In thiscase, after a fire at his home, Mr. Fineberg'sinsurance company sent him several lettersdemanding an EUO. Fineberg failed to appearfor an EUO, citing poor health. He had suf-fered five heart attacks, and he feared that thestress of an EUO might trigger a sixth one.Fineberg did provide a statement to his insur-ance company and later submitted a proof ofloss. Furthermore, he was willing to answerquestions if submitted to him in writing.7 Theinsurance company refused to accommodatehim and denied his claim. Fineberg filed suit.

The insurer moved for summary judgmenton the basis of Fineberg's failure to submit toan EUO. Fineberg responded by producing anaffidavit which attested to his troubled medicalhistory. His cardiologist submitted an affidavitverifying the policyholder's health problemsand noting the link between stress and heartattacks.

The Fineberg court held that compliancewith the EUO requirement was a conditionprecedent to bringing suit against the insurer.'"A 'condition precedent' is defined as an eventwhich must occur, or an act which must beperformed by one party to an existing contractbefore the other party is obligated to per-form."9 A condition precedent must be per-formed before the contractual obligationbecomes binding on the parties. Where thecondition precedent is not satisfied, the obliga-tions of the parties end. The court stated,

356 9 Loyola Consumer Law Reporter Volume 9, number 4

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"[W]e are not persuaded by plaintiff's argu-ments that the [statement given to the insur-ance company] constituted an examinationunder oath for purposes of compliance." 10 Asin any contract, a party failing to comply witha condition precedent in the contract cannotrecover in a suit on that contract. Under thisstrict-compliance approach, a policyholdermust comply with the policy requirements orthe insurance company has no obligation topay the claim. There is no in-between level ofpolicyholder cooperation where the policy-holder can "substantially comply" with policyrequirements and still obtain coverage.

Florida also continues to require strictcompliance as demonstrated in Goldman v.State Farm Fire General Ins. Co." In thiscase, Richard and Patricia Goldman obtained ahomeowners/tenants policy from State FarmFire General Insurance Company in June of1992. Four months later, the Goldmans re-ported a burglary and submitted a proof ofloss. State Farm requested the Goldmans'EUOs. The Goldmans' attorney asked that theexaminations be rescheduled from their origi-nal date. The Goldmans then filed suit againstthe insurance company, alleging breach ofcontract and claiming to have complied withall conditions precedent to recovery on thepolicy. When he filed the complaint, theGoldmans' attorney suggested that the EUOsbe renoticed as depositions. State Farm re-fused, and again requested EUOs.

State Farm moved for summary judgment,arguing that the policyholders' filing suitwithout submitting to examinations was amaterial breach of the policy and a failure tosatisfy a condition precedent to filing suit onthe policy. In response, the Goldmans arguedthat they never actually refused to submit totheir examinations under oath, they onlywanted them rescheduled. In addition, theGoldmans filed affidavits stating that they hadcomplied with State Farm's requests "to thebest of their ability." 2

The trial court granted summary judgment,and the appellate court affirmed, finding that

State Farm was not required to show that itwas prejudiced by the policyholders' noncom-pliance in order to obtain summary judg-ment.'3 The Goldman court analyzed numer-ous cases from Florida and other jurisdictionsbefore concluding that the policy provisionsrequiring the policyholders to submit to EUOswere conditions precedent to coverage, andthat prejudice was unnecessary where a viola-tion of a condition precedent was at issue. 14

Like North Carolina and Florida, Illinois hasrequired strict compliance of the terms of aninsurance contract. Strict compliance was therule in Illinois in 1897 when the Illinois Su-preme Court held that production of apolicyholder's books and records, when re-quested, is a reasonable condition precedent torecovery in a first party claim.'5 This rule heldfirm in Illinois for almost ninety years.

Perhaps the last Illinois case to require strictcompliance was Horton v. Allstate InsuranceCo. 6 In that case, Horton's home was dam-aged by a fire which both parties agreed mayhave been intentionally set.17 Horton submitteda proof of loss, and Allstate rejected it. Allstateasked Horton to file an amended proof andsubmit related documentation. These docu-ments included "books of account, bills, [and]invoices [as well as] tax returns, utility bills,and pleadings pertaining to his bankruptcypetition."'8 Rather than comply, Horton filedsuit. The trial court granted summary judgmentto Allstate based on Horton's noncompliance.On appeal, the court affirmed the trial court'sholding and stated:

[P]laintiff was under a contractualobligation to produce those docu-ments expressly specified in thepolicy ... Because the [P]laintiff didnot fulfill this condition precedent orattempt to excuse his noncompliance,we find that his suit against Allstatewas barred under the policy forfailure to comply with a conditionprecedent to which the parties hadboth agreed. 9

Loyola University Chicago School of Law e 3571997

Even though the court refused to allowHorton to recover, the court's language openedthe door to recovery to those policyholderswho admitted that they had not fully compliedwith the conditions of the insurance policy.The Illinois court suggested that if policyhold-ers could make an excuse for their noncompli-ance, they might be allowed to recover. Withthis, the court started to erode the traditionaldoctrine of strict compliance in Illinois.

IV. A BROAD VIEW OFSUBSTANTIAL COMPLIANCE INILLINOIS: Piro v. Pekin Insurance

Only three years after Horton, in Piro v.Pekin Insurance Co.,a0 the substantial compli-ance doctrine made its Illinois debut. In thiscase, Charles Piro owned Piro T.V., Heating &Air Conditioning, Inc. A fire destroyed thecorporate premises, and he filed a claim withhis insurance company. After submitting hisproof of loss, Piro submitted to an EUO fivemonths after the fire. However, Piro failed toproduce financial records and informationrelevant to his financial motive to stage a fireor inflate his losses resulting from an acciden-tal fire. The insurance company rejected theclaim, insisting on "strict compliance with allpolicy provisions."'" Instead of complyingwith the insurance company's request forinformation, Piro filed suit. The insurer movedfor summary judgment. The trial court grantedsummary judgment to the insurance company.The appellate court reversed, stating:

The question whether [P]laintiffs'disclosures after defendant's motionfor summary judgment came too lateto comply with the disclosure provi-sions of the policy is not an appropri-ate question to decide on motion forsummary judgment. Whether a partyhas committed a breach of contract isgenerally a question of fact.

We express no opinion as towhether the instant [D]efendant candemonstrate on remand that it wouldbe inequitable to permit plaintiffs tocomply with the policy at such a latedate. If [D]efendant can demonstratethe existence of a question of fact asto whether it was prejudiced, theissue becomes one of substantialcompliance and is for the jury.2

Thus, the Fifth District of the Illinois Appel-late Court created a requirement that theinsurance company show prejudice resultingfrom the policyholder's failure to comply withthe policy provisions. By imposing a prejudicerequirement on the policy, a court essentiallyexcuses a policyholder's non-cooperation.Consider the prejudice to the insurer in thiscircumstance. The insurer is prejudiced byhaving to pay a fraudulent claim - but it cannot know whether a particular suspicious claimis really an attempted fraud unless it is allowedto complete its investigation - with theinsured's cooperation. The insurer becomestrapped in a vicious circle, left to hope that itcan develop a basis upon which to prove fraudduring the discovery phase of litigation on thepolicy - long after any possible investigativetrail suggested by the facts of the loss hasgrown cold.

This rule enables a policyholder to sue aninsurance company for failure to pay a claimeven if the policyholder himself has not com-plied with any of the cooperation provisions ofthe policy. By forcing insurance companieseither to pay claims they strongly suspect to befraudulent or risk lawsuits on every claim theydeny, the Illinois courts have increased theincentives for dishonest policyholders toattempt fraud and increased premium costs forhonest consumers.

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A. First District Follows the FifthDistrict in Adopting SubstantialCompliance

The First District of the Illinois AppellateCourt subsequently adopted this prejudice-based test in Pick v. Associated IndemnityCorp.23 In this case, Harold Pick, reported tohis homeowners' insurance company a theft ofpersonal property valued at over a quarter-million dollars. Four months later, the insurerrequired Pick to produce various financialdocuments relating to the purchase of theproperty allegedly stolen or other proof ofownership, prior claim information, and prop-erty settlement agreements from the Pick'sprevious divorces.

Pick did not comply, and the insurer deniedhis claim. The insurer withdrew its decision,however, when Pick agreed to produce therequested documents and submit to an EUO.Over a year after the fire, the parties began anEUO; however, Pick's attorney terminated theexamination mid-stream, and Pick failed toproduce the documents that he had agreed tosubmit.24 The insurance company attempted toreschedule the EUO several times and per-sisted in its document request.25 The partiesnever resumed the examination because eitherthe policyholder or his attorney canceled eachscheduled date.26 The insurer continued in itsunsuccessful demand for financial documentsand eventually declined the claim due to Pick'spolicy non-compliance.

In response, Pick filed suit, and the insur-ance company filed a motion for summaryjudgment relying on Horton.27 The Pick courtchose to follow the Fifth District's Piro insteadof its own Horton. The Pick court noted:

In Horton, plaintiff failed to resubmita proof of loss and failed to produceany documents requested. Here,plaintiff has arguably made someattempt to comply with the policy.Although plaintiff may not havebeen as cooperative as the insured in

Piro, he did produce certain docu-ments and eventually appeared for anexamination under oath, although itwas not completed. These facts show[P]laintiff made some attempt tocomply with the policy provisionswhich is [sic] similar to the situationpresented in Piro. Whether[P]laintiff's actions amounted tosubstantial compliance with thepolicy is a question of fact andtherefore, summary judgment in[D]efendant's favor was improper.28

With this decision, a second Illinois courtadopted an extremely broad view of substantialcompliance. Although the Illinois SupremeCourt had not spoken on the issue (and still hasnot), with the adoption of the substantialcompliance doctrine, the Fifth and First Dis-trict Illinois Appellate Courts fundamentallychanged the way insurance contracts are readin Illinois to the detriment of honest Illinoisconsumers.

B. The First District Again UsesSubstantial Compliance to Evisceratethe Provisions of an InsuranceContract

The First District of the Illinois AppellateCourt reaffirmed the view that any tenuousstab at compliance was sufficient to raise aquestion of "substantial compliance" in Patelv. Allstate Insurance Co. 29 In that case, anapartment building insured by Allstate suffereda fire, and the policyholder, Babu Patel, sub-mitted a proof of loss claiming $118,942.00.Patel appeared for an EUO but did not produceany of the financial documents Allstate re-quested.3" The insurance company likelyrequested the documents to determine if Patelhad a motive to burn the building. Patel statedthat these documents were either in the posses-sion of a bankruptcy trustee or that all debtsrelating to the building had been paid by themortgage company since it had assumed

Loyola University Chicago School of Law * 3591997

management of the building.'But Patel stated that he could not have been

involved in the fire because, at the time of thefire, he was out of the country.3 2 There aremany ways to corroborate such an alibi: astamped passport, for example, or a usedairline ticket. Even Patel's disclosure of hisflight number might have given Allstateenough information to investigate the truth ofPatel's assertion. Although Patel's attorneypromised full cooperation, neither Patel nor hisattorney ever provided the requested informa-tion to corroborate Patel's alibi or financialposition. Subsequently, Allstate rejected Patel'sclaim due, in part, to Patel's failure to cooper-ate with its investigation. Patel, like Pick andPiro before him, filed suit. The district courtgranted summary judgment to Allstate, holdingthat plaintiff's failure to produce the requesteddocuments precluded recovery under theinsurance policy. The appellate court reversed,again distinguishing the facts of this case fromHorton.33 In noting that Patel had stated thatcertain documents were either inaccessible orin control of third parties, the court held that:

In the present case, unlike Horton,[P]laintiff made some attempt tocomply with the provisions of thepolicy. As in Pick and Piro, Patelappeared for an examination underoath and provided some of therequested information. In addition,Patel provided explanations for hisfailure to fully comply withdefendant's requests. Thus, theactions of the [P]laintiffs in thepresent case can be distinguishedfrom those of Horton, where theinsured filed suit without respondingto, or attempting to excuse his failureto respond to, Allstate's request forrecords and documentation.

We believe the facts in this caseare sufficient to raise the issue ofwhether [P]laintiffs substantiallycomplied with the terms of the policy

and, therefore, summary judgmentwas improper.34

Although Patel and his attorney maderepeated promises of cooperation, they dis-closed nothing.35 Nonetheless, the appellatecourt still reversed the granting of summaryjudgment in favor of the insurance company. Aclose reading of Patel suggests an Illinois courtmay be willing to find "substantial compli-ance" if an insured makes any effort to createthe mere appearance of cooperation. Thepolicyholder intent on committing insurancefraud is thus well advised to repeatedly prom-ise cooperation; empty promises alone may besufficient to create a triable issue of factregarding whether the insured has sufficientlycooperated.

Illinois Eviscerates Virtually AllObligations of Policyholders:Crowell v. State Farm

Crowell v. State Farm Fire and CasualtyCo.,36 the most recent Illinois case consideringthe substantial compliance doctrine, reinforcesthis impression. The facts of Crowell should beparticularly troublesome to consumers worriedabout the costs of insurance fraud.

Crowell was the subject of a criminal arsoninvestigation because of the loss for which hemade a claim. Crowell showed up for an EUObut failed to answer relevant and materialquestions concerning his financial status andwalked out of the examination before it wasconcluded.37 He refused to produce PaulaHunter, who had been living with Crowell atthe time of the fire, for examination despite thecarrier's demands.3"

State Farm denied coverage; Crowell sued.As in the other cases, the insurer moved forsummary judgment. Crowell responded to themotion by noting that he was not representedby counsel at his examination, and that manyquestions seemed irrelevant and immaterial tohim. Now that the criminal arson chargesagainst Crowell had been dropped, he was

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willing to give a deposition and "answer allmaterial questions with the guidance of hisattorney.

39

As in the other cases, the trial court grantedsummary judgment; the Appellate Courtreversed, holding:

[P]laintiff's conduct does notdemonstrate the type of consistent,obstinate, and permanent refusal tocooperate present in those cases inwhich summary judgment wasallowed based on breach of thecooperation clause of the policy.Plaintiff should have been given theopportunity by the trial court to curehis noncompliance upon his offer todo so prior to the entry of summaryjudgment.4 °

The Crowell court stated that the insurancecompany must demonstrate some prejudicebefore the question of plaintiff's "late compli-ance ... becomes one of substantial compli-ance.., for the jury."'" This holding prompteda vigorous dissent from Presiding JusticeWilliam A. Lewis:

[T]his was not a case of the plain-tiff failing to understand the terms ofthe policy. He simply refused tocomply with his agreement. Themajority has now written a newclause into the insurance policy thatsays that the insured can refuse tosubmit to an oral examination, refuseto produce members of his house-hold, and refuse to submit requesteddocuments until ordered by the court.This ruling abrogates the duties ofthe insured under the policy for nodiscernible reason. There are noteven public policy reasons suggestedfor doing so.42

Thus, according to Crowell, a policyholdercan refuse to cooperate with the insurance

company's investigation, wait for a claim to bedenied, and sue the insurance company for itsalleged noncompliance with the insurancecontract. The insurance company must thenprove how the information it has not receivedaffected its rights. This requires an insurer toprove a negative. Such an approach can onlyencourage insurance fraud. It gives license todishonest policyholders to stonewall investiga-tions and greatly increases the chances that a"fraud attempted" will be successful.

V. NEW YORK, NEW JERSEY, ANDIOWA: A RATIONALCOMPROMISE

Between Illinois' overly broad version ofsubstantial compliance and the rigid NorthCarolina and Florida strict compliance ap-proach, there is a middle ground. New York,New Jersey, and Iowa have adopted an ap-proach which sometimes allows a policyholderthe opportunity to cure his or her noncompli-ance but also allows courts to evaluate thedegree of willfulness of an insured's non-compliance on summary judgment.43

In these states, as in all American jurisdic-tions, the courts do not resolve fact questionson summary judgment. Rather, courts addressthe substance of a policyholder's complianceas a contract construction issue, which is atraditional question of law. To illustrate whythis approach does not grant the power toresolve fact questions to courts reviewingsummary judgment motions, consider thefollowing cases in which this approach hasbeen adopted. For example, in Davis v. AllstateInsurance Co., the Appellate Division of theNew York Supreme Court granted the insurer'ssummary judgment motion based on thepolicyholder's noncooperation.' The policy-holder alleged that he was the victim of twofires at the insured property on different dates.He submitted his proof of loss to Allstate fivemonths after the fires. A consultant hired bythe insurance company determined that one orboth of the fires had been intentionally set.45

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Allstate then requested that the policyholdersubmit to an EUO.

Although the policyholder appeared withcounsel on the appointed date, the examinationdid not proceed because the policyholderinsisted on tape recording the proceedings andAllstate's attorney refused to be taped.46 Theparties volleyed letters back and forth concern-ing the proposed taping of the examination.Additionally, the policyholder did not complywith Allstate's demand for the production ofcertain financial documents because he be-lieved that these documents were beyond thescope of Allstate's "permissible inquiry. ' 47

Davis filed suit, and Allstate moved forsummary judgment. The trial court denied themotion. The appellate court reversed, lookingat the totality of the circumstances surroundingDavis's refusal to cooperate and finding thatDavis's "failure to cooperate was willful" and"a material breach of the policy." Thus, theNew York appellate court required the policy-holder to cooperate significantly with theinsurance company's investigation in order tomaintain a suit against his insurance company.The court's refusal to eviscerate thepolicyholder's obligations under the contractprotected both the insurance company andconsumers from fraud.48

One might not ordinarily consider a determi-nation of "willfulness" to be a matter of law.However, a New Jersey case, DiFrancisco v.Chubb Insurance Co. ,49 clarifies that courtsfollowing this approach are not making inap-propriate factual determinations. The policy-holder, Robert DiFrancisco, controlled corpo-rations that owned two restaurants. He made an$87,253 claim to his homeowner's carrier fortwo burglaries that allegedly took place at hishome. The insurance company sought personalfinancial information from DiFrancisco, anddemanded his tax returns and records pertain-ing to the two restaurants. DiFrancisco refusedto produce corporate records but did submit tothree EUOs. 50

The insurance company questioned thevalidity of the policyholder's claim for several

reasons. First, DiFrancisco did not report thefirst burglary for over a month. The court notedthat between the first burglary andDiFrancisco's report to the insurance company,DiFrancisco experienced serious financialproblems.5" Additionally, he did not report thesecond burglary for 10 months after it alleg-edly occurred - after the insurance companyhad already closed its file on the first claim.Moreover, the insured's ex-wife was appre-hended by police at the policyholder's pre-mises during the second "burglary." She"allegedly admitted removing bedroom furni-ture from the house[,] claiming it was her[s]."The policyholder did not press charges againsthis ex-wife, however, out of consideration, hesaid, for their children.52

When DiFrancisco advised his carrier of thefirst burglary loss, he indicated that the totalamount of his claim was $25,000, even thoughthe initial police report on this incident put thevalue of the items stolen at only $10,020. 5

1

Later, the value of his claim skyrocketed to the$87,253 figure mentioned above. 54 He deniedever telling the police that his claim was onlyfor $10,000; he likewise denied ever telling hisinsurance agent that this claim was only for$25,000. 51 Finally, the insurance company alsodoubted the validity of DiFrancisco's claimbecause he suffered heavy business lossesduring this period.56

The insurance company denied the claimbecause the policyholder failed to producerequested documents and misrepresented andconcealed material facts. DiFrancisco sued.The insurance company moved for summaryjudgment, citing DiFrancisco's failure toproduce documents and his misrepresentations.The trial court granted summary judgment, andthe appellate court affirmed on the basis ofDiFrancisco's failure to produce the requestedcorporate records. The appellate court cited aline of New York cases which "have recog-nized that delays in obtaining requested infor-mation frequently result in 'a material dilutionof the insurer's rights."' 57 In addition, the courtconcluded that the demand for corporate

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records was "highly relevant to the insurer'sinquiry concerning plaintiff's financial abilityto have acquired the items and his potentialmotive for committing fraud by arranging theloss or exaggerating its magnitude."58 Theparticular categories of records requested were"reasonable and specific in light of theseconcerns." 59 The policyholder's failure toproduce the requested documentation couldonly be seen as "constituting a willful refusalto comply with the terms of his insurancecontract." This failure "materially diluted" theinsurer's rights.6°"Thus, no legal orequitable basis existsin these circum-stances for giving the The Newinsured 'anotherchance' to produce Jersey cases vathe records with-held."'61 cooperation c

The New York andNew Jersey cases insisting on "stlvalidate the policycooperation clauses They recognizewithout insisting on"strict compliance." be an elementThey recognize thatthere must be an order for theelement of substancein order for the reasonably asspolicyholder toreasonably assert compi"substantial compli-ance."

This is not awholly subjective determination, nor oneforeign to contract law. For example, the term"substantial compliance" is frequently used inthe context of construction contracts. As theIllinois Supreme Court stated in WE. EricksonConstruction, Inc. v. Congress-KenilworthCorp,"a purchaser who receives substantialperformance of a building contract must paythe price bargained for, less an offset fordefects in what he received as compared towhat strict performance would have given

him. 62 Citing a 1919 case,63 the Ericksoncourt defined "substantial" in this context asmeaning "in substance; in the main; essential,including material or essential parts."' In A. W.Wendell & Sons, Inc. v. Qazi, the IllinoisAppellate Court read Erickson to mean that:"[s]ubstantial performance of a contract meansperformance of all necessary to accomplish thepurpose of the contract. '65 In Wilmette Part-ners v. Hamel, the Illinois Appellate Courtfound that the "doctrine of substantial perfor-mance is relevant only where the contractor isin technical breach of contract." 66

A home buildermight expendthousands of

ork and New dollars and hun-dreds of labor-

date the policy hours withoutcreating a habitable

uses without structure. That,however, would not

et compliance." constitute "substan-tial performance"

hat there must because "[an]important factor in

f substance in determiningwhether a builder

)licyholder to has renderedsubstantial perfor-

t "substantial mance is the actualreceipt of benefits

nce." by the purchaser/owner."67 TheErickson courtstated, "'[tihe

question of whether there has been substantialperformance of the terms and conditions of acontract sufficient to justify a judgment infavor of the builder for the contract price isalways a question of fact."' 68 A contractor cannot just scratch a vacant lot with a bulldozer,walk off the job and then sue on the construc-tion contract and claim that there is a questionof fact regarding whether the contractor has"substantially complied" with a contract tobuild a house.69

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Because a building contractor's performanceunder a construction contract is ordinarily aquestion of fact, it can be only imperfectlyanalogized to a policyholder's cooperationobligations following a loss. However, as thebuilding cases make clear, an important factorin the latter situation would be whether theinsurer has actually received the "benefits" ofthe policyholder's partial compliance, specifi-cally, information with which it can complete agood-faith investigation into the merits of thepolicyholder's claim. Delay alone operates todeny the insurer the benefits to which it isentitled under the cooperation provisions.

Why substantial compliance might be aquestion of fact in a building case, but not inan insurance case, is explained by realizingthat, in the building contract situation, theentire contract is being evaluated; in the insur-ance context, it is the policyholder's owncompliance with conditions precedent that is atissue.70 In other words, the courts in a firstparty insurance case are being asked to deter-mine whether there has been a failure of acondition precedent to recovery under thepolicy; if the condition has not been met, therecan be no question of the insurer's breach. Inthis context, a court's willingness to allow"substantial" as opposed to "strict" compliancewith the condition may be seen as consistentwith the law's traditional reluctance to enforcecontract provisions that result in forfeitures.

It is fairly easy to see that in Piro, Pekin,Patel, Crowell, Davis, and DiFrancisco, theinsureds could not reasonably be said to havesubstantially complied with their policy obliga-tions notwithstanding the varying results inthese cases. It is likewise easy to constructsituations where a court could rule, as a matterof law, that the insured had indeed substan-tially complied with his policy obligations. Ifthe policyholder is requested to produce 12months worth of checking account statementsto show financial wherewithal to acquirerecently purchased goods allegedly stolen in ahome burglary, but can only find 10 or 11statements and readily signs an authorization

for the bank to provide those that are missing,it might be possible to argue that the insuredhas not strictly complied with the insurer'srequest for information. On the other hand,could anyone doubt that such a "failure"should be deemed merely technical or that thepolicyholder's compliance with this requestwas substantial? Enforcement of the policycondition precedent under these circumstanceswould impose a forfeiture on merely technicalgrounds, and no jurisdiction, even the so-calledstrict compliance jurisdictions likely wouldconclude that such a claim would be denied forfailure of a condition precedent in that case.

The author's object is to formulate a generalrule regarding how courts should treat ques-tions of an insured's substantial complianceand still honor policy conditions precedent.Brown v. Danish Mutual Insurance Ass'n,71

provides a workable blueprint for such a rule.Duane Brown reported a theft of $13,820 inantique articles from the basement of hisfarmhouse.72 Within a month of this loss,Brown provided his insurance company aproof of loss and inventory forms. In themeantime, however, the local sheriff's officehad informed the insurance company that thetheft seemed suspicious.73

Danish elected to require Brown to submitto an EUO. Brown refused and told Danishthat he had no intention of submitting at anytime in the near future.74 Danish sent a secondnotice, advising him specifically that suchrefusal was a breach of the insurance contractand would cause Danish to deny the claim.Brown again declined to appear.7 5 Danishdenied his claim. In response, Brown sued,alleging breach of the insurance contract andbad faith. Danish moved for summary judg-ment, and the trial court granted the motion.

On appeal, Brown argued that the trial courterred in determining that his refusal to submitto an EUO "amounted to a failure to substan-tially comply with the terms of the insurancepolicy. 76 Citing Watson v. National SuretyCorp.,77 the Brown court noted that the IowaSupreme Court had found that submission to

364 * Loyola Consumer Law Reporter Volume 9, number 4

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an EUO is a condition precedent to apolicyholder's recovery on a policy, but thatstrict compliance with this provision is notrequired. It is, however, the policyholder whobears the burden of proving that he or she hassubstantially complied with the policy require-ment."8 The insurer might have to justify thereasonableness of requirements (as the insurerpersuaded the courts in DiFrancisco that therequests for business records were germane tothe homeowner's claims), but it is the insuredwho must carry the burden of showing that hisor her compliance with these requests wasreasonable in the circumstances.79 This con-struction is reasonable because any party to acontract containing conditions precedent mustdemonstrate that these conditions were ful-filled in order to enforce the contract. More-over, this approach benefits individual policy-holders because they are not unduly burdenedby overly technical requirements, and consum-ers benefit because fraud-fighting policyprovisions can be meaningfully enforced.

The Brown court recognizes that policycooperation obligations are conditions prece-dent to recovery. These cooperation provisionshelp insurers prevent fraud and help policy-holders know that they fail to comply withthese provisions at their own risk. Yet theBrown court would not strictly enforce theseprovisions; it would not permit a claim to beforfeited because the insured made sometechnical or unimportant misstep in presentinga claim. Upholding policy cooperation provi-sions helps everyone involved. The policy-holder must explain why he or she could notfully comply, and the insurer is not obliged todemonstrate that it was prejudiced because itcould not act on information it does not haveand which the insured refused to provide.

VI. RECOMMENDED GUIDELINES

In the author's view, it is unlikely that anyjurisdiction that has abandoned strict compli-ance can be persuaded to return that standard.Harsh as it may seem in some applications,

"strict compliance" has the virtue of predict-ability and provides the strongest disincentiveto commit fraud. Moreover, in those instanceswhere a policyholder really believed that thecarrier's request for particular documents wasoverbroad or unduly intrusive, the policyholdercould always seek a declaration of his or herrights under the insurance contract.

For those states that have shifted to a "sub-stantial compliance" approach, however, theIowa, New Jersey, and New York cases dis-cussed herein suggest a reasonable way toapply the doctrine. What constitutes "substan-tial compliance" must be a question of law forthe court to decide on a summary judgmentmotion, rather than a question of fact, becausethe issue of whether the condition precedent torecovery has been sufficiently fulfilled, is inessence, an issue of contract constructionappropriate for judicial determination. Theremay be a factual dispute concerning what thepolicyholder produced in response to theinsurer's requests, but if the facts of thepolicyholder's partial compliance are estab-lished, the court should be able to determinewhether the policyholder's partial compliancesufficiently fulfills the condition precedent andrises to the level of "substantial compliance."

VII. CONCLUSION

In sum, the insurer has bargained in thecontract for tools to protect itself against falseclaims; these tools are essential to effectuatethe purpose of the insurance policy - indem-nification - unless, of course, one wants toseriously argue that an insurer should not carewhether a given claim is valid or fraudulent.Surely an insurer owes an obligation topromptly pay all valid claims; just as surely,however, an insurer owes its stockholders andthe consumers who pay its premiums, a dutynot to pay fraudulent claims. Where a policy-holder denies the insurer the effective ormeaningful use of the tools designed to ferretout fraud, the policyholder has not "substan-tially complied" with its policy obligations.

Loyola University Chicago School of Law * 3651997

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"Policyholder" and "consumer" will be usedinterchangeably throughout this article because policy-holders are consumers of insurance services.

I Travelers Ins. Co. v. P.C. Quote, Inc., 570 N.E.2d

614, 617 (Ill. App. Ct. 1991) (citation omitted).

3 110 U.S. 81, 94-95 (1884).

4 NATIONAL INS. CRIME BUREAU, "INSURANCE FRAUD:

THE $20 BILLION DISASTER" 1 (1995).

1 215 ILL. COMP. STAT. § 5/154.6(n) (West 1997).While an insurer's commission of an improper claimpractice does not give rise to a private right of action,see Van Vleck v. Ohio Casualty Insurance Co., 471N.E.2d 925, 926 (I11. App. Ct. 1984), the commission ofany improper claims practice may subject the carrier topenalties imposed by the Illinois Department of Insur-ance, see 215 ILL. COMP. STAT. § 5/154.6 (West 1997).

6 438 S.E.2d 754, 755 (N.C. Ct. App. 1994).

7 An Examination Under Oath ("EUO") on writtenquestions does not satisfy the policy requirements. InBoston Insurance Co. v. Mars, 148 So. 2d 718, 720(Miss. 1963), the court stated, "[We] are of the opinionthat the provision in the policy of insurance for anexamination... under oath contemplated an examina-tion by the question and answer method, wherein theanswer to one question may suggest the next question tobe asked by the examiner." The offer by the insured'sattorney to provide "all available information, includingcopies of insurance policies and mortgage papers" and"have his clients answer any list of written questions thatthe insurance company may care to furnish" did notmake the insurer's request for EUO "unreasonable." Id.Refusal to submit to an EUO was therefore "a violationof the express provisions of the insurance policy, andresulted in a forfeiture of their right to recover under thepolicy." Id.

'See Fineberg, 438 S.E.2d at 755.

9 Fineberg, 438 S.E.2d at 756

'oSee id.

"660 So. 2d 300, 303 (Fla. Dist. Ct. App. 1995).

I ld. at 302.

13 See id.

14 Id. at 303-04.

See Niagara Fire Ins. Co. v. Forehand, 48 N.E.830, 831 (Ill. 1897).

16 467 N.E.2d 284, 285 (Ill. App. Ct. 1984).

17 See id. at 284.

18 Id.

" Id. at 286 (emphasis added).

20 514 N.E.2d 1231 (Ill. App. Ct. 1987).

21 Id. at 1233.

22 Id. at 1234-35 (citations omitted).

23 547 N.E.2d 555, 560 (Ill. App. Ct. 1989).

24 See id. at 558.

' See id.

26 See id.

27 See Horton, 467 N.E.2d at 285.

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" See id. at 195-96.

29 570 N.E.2d 357, 360 (Ill. App. Ct. 1991).

31 See id. at 359.

3' See id.

32 See id.

33 See id. at 361.

34See id.

31 See id. at 359.

36 631 N.E.2d 418 (Ill. App. Ct. 1994).

31 See id. at 419.

38 See id.

4 Unlike a court reporter's transcript, there is noguarantee of integrity or accuracy in an easily editedtape recording.

47 See Davis, 612 N.Y.S. 2d at 196.

48 Id. (citations omitted); see also, Antao & Chuang

v. St. Paul Fire & Marine Ins. Co., 639 N.YS.2d 322,323 (N.Y App. Div. 1996) (affirming dismissal ofplaintiff's punitive damage claims but finding"plaintiff's substantial compliance warrants a finalopportunity to seek relief pursuant to the policy").

'9 662 A.2d 1027 (N.J. Super. Ct. App. Div. 1995).

'o See id. at 1030.

5' See id. at 1029-30.

52 See id.

13 See id. at 1029-30.

54 See id. at 1030.39 Id. at 419.

40Id. at 421. 15 See id.

41 Id.

42 Id.

43 Lentini Brothers Moving & Storage Co. v. NewYork Property Insurance Underwriting Association is anearly example of this phenomenon. 422 N.E.2d 819, 820(N.Y 1981). In Lentini, Plaintiff stipulated that it filedsuit rather than comply with the insurer's requests forsubmission of a proof of loss and for examination underoath. In affirming summary judgment for the insurer, theNew York Court of Appeals found that thepolicyholder's mistaken belief that it had only twomonths to file suit after after the insurer's requests didnot excuse the policyholder's failure to respond to theinsurer's requests. See id. at 820.

612 N.Y.S.2d 195, 196 (N.Y. App. Div. 1994).

56 See id. For example, just before the first burglaryallegedly occurred, the managers of one of thepolicyholder's restaurants stole $100,000. See id. at1029. The policyholder then put $80,000 into the otherrestaurant but was never able to draw an income from it.See id.

57 DiFrancisco, 662 A.2d at 1032 (quoting Evans v.International Ins. Co., 562 N.Y.S.2d 692, 694 (N.Y. App.Div. 1990)).

58 Id.

591d. at 1033

' See id.

Loyola University Chicago School of Law 9 367

28 547 N.E.2d at 560.

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62 503 N.E.2d 233, 237 (Ill. 1986).

63 People ex rel. Peterson v. Omen, 124 N.E. 860,

863 (111. 1919).

64 WE. Erickson, 503 N.E.2d at 237.

65 626 N.E.2d 280, 289 (Ill. App. Ct. 1993).

66 594 N.E.2d 1177, 1187 (I11. App. Ct. 1992)(emphasis added).

67 Weidner v. Szostek, 614 N.E.2d 879, 882 (Ill. App.

Ct. 1993).

6 8 WE. Erickson, 503 N.E.2d at 236 (quoting

Petersen v. Hubschman Constr. Co., 389 N.E.2d 1154,1160 (I11. 1979)).

69 In M.J. Oldenstedt Plumbing Co. v. K-Mart, 629

N.E.2d 214, 220 (Ill. App. Ct. 1994) (citations omitted)the court explained:

70 SeeVuagniaux v. Korte, 652 N.E.2d 840, 842 (I11.App. Ct. 1995).

7' 550 N.W.2d 171 (Iowa Ct. App. 1996).

72 See id. at 173.

71 See id.

74 See id.

71 See id.

76 Id. at 173-74.

77 468 N.W.2d 448 (Iowa 1991).78 Brown, 550 N.W.2d at 174.

79 See id.

A builder who fails to substantially performa contract is not entitled to the contractprice. Rather, the "builder's right is, under atheory of quantum meruit, a right to recoveronly reasonable compensation for valuereceived by the purchaser over and abovethe injury suffered by the builder's breach."

368 - Loyola Consumer Law Reporter Volume 9, number 4

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Loyola University Chicago School of Law - 3691997