                   United States Court of Appeals,

                              Fifth Circuit.

                              No. 96-20407.

   HANSON PRODUCTION COMPANY, Neil E. Hanson, Chris W. Douglas,
Steven M. Morris, Erik G. Hanson, Monico Properties, Inc., Chris N.
Hanson, Michael E. Hanson, Ben A. McCarthy, Glen E. Vague, John J.
Surko, T & M Petroleum, Inc., T.D. Gholson, Patricia Dean Boswell,
Hamill Energy Company, Pvt 85 Ltd., Thru Line, Inc., Keystone,
Inc., Sid R. Bass, Inc., Lee M. Bass, Inc., Perry R. Bass, Inc.,
Perry R. Bass, Trustee, and Vivian L. Smith, Estate, Plaintiffs-
Appellants,

                                     v.

    AMERICAS INSURANCE COMPANY and Southern Marine & Aviation
Underwriters, Inc., Defendants-Appellees.

                              April 1, 1997.

Appeal from the United States District Court for the Southern
District of Texas.

Before POLITZ, Chief Judge, and REAVLEY and DENNIS, Circuit Judges.

     REAVLEY, Circuit Judge:

     The issue in this diversity case under Texas law is whether a

surplus lines insurer, in order to avoid its coverage obligations,

must show prejudice where the insured has failed to provide prompt

notice of a claim.      Because we conclude that the Supreme Court of

Texas would require proof of prejudice, we reverse.

                                BACKGROUND

     In    1985   appellant    Hanson       Minerals     Company,   a   Texas

corporation, entered into operating agreements pertaining to a

Texas oil and gas prospect.         In 1989 and 1990, per its agreement

with the non-operators, Hanson procured two comprehensive general

liability (CGL) and three excess liability policies from appellees

Americas    Insurance     Company     and     Southern     Marine   Aviation

                                      1
Underwriters, Inc. (the insurers).       The insurers are surplus lines

insurers under Texas law, as discussed below.

     In October 1991 other parties to the lease sued Hanson in

state court. These plaintiffs alleged that Hanson had breached its

contractual    obligations   and    negligently   operated    the   leased

property.     In an amended petition filed in August of 1993, the

plaintiffs claimed that Hanson, through its over-production of oil

and gas, had damaged the reservoir.        Hanson argues that a claim

asserting an occurrence under the policies was not made in the

underlying suit until the amended petition was filed, since the

original petition did not allege bodily injury or property damage

covered by the policies.

     On January 25, 1994, Hanson first notified the insurers of the

underlying suit and demanded a defense.           The notice was sent

twenty-seven months after service of the original petition in the

underlying suit, and five months after service of the amended

petition.   The underlying suit went to trial in August of 1994, and

Hanson settled the suit for $795,000 in November of 1994.             The

insurers refused to fund the settlement.

     The Southern Marine primary policy requires the insured to

notify the insurer "immediately" of any occurrence under the policy

likely to result in a claim.       The Americas primary policy requires

that the insured notify the insurer of an occurrence under the

policy "as soon as practicable," and that the insured "immediately"

notify the insurer of a claim or suit against the insured.            The

excess policies also have notice requirements.               Both primary


                                     2
policies provide that "[n]o action shall lie against the [insurer]

unless, as a condition precedent thereto, there shall have been

full compliance with all of the terms of this policy."

     Shortly after the settlement of the underlying suit, Hanson

sued the insurers, asserting breach of contract and other claims.

The district     court   granted      summary     judgment      in   favor    of   the

insurers, agreeing with them that under Texas law the notice

required in the primary policies was a condition precedent to the

insurers'   coverage     obligations,       and    that    a    policy   condition

requiring notice "immediately" or "as soon as practicable" is

construed   to   mean    within   a   reasonable     time       in   light    of   the

circumstances.1     The    court      concluded     that       the   notice   Hanson

provided was untimely as a matter of law, and therefore Hanson was

barred from recovery under the primary policies, regardless of

whether the insurers had been prejudiced by the late notice.

     The district court also ruled that the insurers were not

liable under the excess policies because (1) Hanson failed to offer

summary judgment evidence that the primary layer of coverage had

been exhausted, and (2) the excess policies exclude coverage for

liabilities not covered by the primary policies, and Hanson's claim

under the primary policies were not covered due to the late notice.

                                  DISCUSSION

         We agree with the parties that Texas law governs this

diversity suit, since by statute Texas law governs any insurance


     1
      See McPherson v. St. Paul Fire & Marine Ins. Co., 350 F.2d
563, 566 (5th Cir.1965) (interpreting Texas law).

                                        3
policy "payable to any citizen or inhabitant of this State."2    Our

goal, sitting as an Erie court, is to rule the way the Texas

Supreme Court would rule on the issue presented.3 We are persuaded

that the Texas court would rule that the insurers cannot prevail on

their late notice defense unless they were prejudiced.

     This issue was raised in Members Mut. Ins. Co. v. Cutaia, 476

S.W.2d 278 (Tex.1972).     The plaintiff Cutaia had an automobile

insurance policy with defendant Members Mutual.        Cutaia had an

accident with Smith, also insured by Members Mutual.   Smith did not

notify Members Mutual of the accident until five months after it

occurred.    The policy, like the CGL policies in our case, provided

that "no action shall lie against the [insurer] unless, as a

condition precedent thereto, there shall have been full compliance

with all of the terms of this policy."4   The insurer refused to pay

Cutaia after he won a judgment against Smith, because Smith failed

to comply with the notice requirement.     The court held that this

policy provision was a condition precedent to liability regardless

of whether the insurer was harmed or prejudiced by the late notice,

and rendered judgment in favor of the insurer.

     In Cutaia the court recognized "the apparent injustice which

results in this particular case,"5 but concluded that "the matter


     2
      TEX. INS.CODE ANN. art. 21.42 (West 1981).
         3
       Browning Seed, Inc. v. Bayles, 812 F.2d 999, 1002 (5th
Cir.1987).
     4
      Id. at 278.
     5
      Id. at 281.

                                  4
of rewriting the insurance provisions in question is properly

within the prerogative of the State Board of Insurance or the

Legislature."6

      Probably in response to Cutaia, in 1973 the State Board of

Insurance issued orders requiring a mandatory endorsement in Texas

general liability and general automobile policies stating that a

failure to give notice under the policy does not bar coverage

unless the insurer has been prejudiced.7                 Board Order No. 23080,

covering    general      liability   policies,         requires   an    endorsement

stating that "unless the company is prejudiced by the insured's

failure to comply with the requirement, any provision of this

policy requiring the insured to give notice of action, occurrence

or loss, or requiring the insured to forward demands, notices,

summons or other legal process, shall not bar liability under this

policy."8    The order also provides that this endorsement "must be

attached to all General Liability policies issued or delivered in

Texas."     In 1987 Board Order 23080 was superseded by Board Order

No. 50602, which maintains the same prejudice requirement.

      The Board's authority to require this endorsement in general

liability    policies      appears   to       derive    from   its   authority    to

promulgate standard forms, which may be used by the insurer in lieu

of   its   own   form,   and   the   statutory         requirement     that   general

      6
       Id. at 278.
      7
      See American States Ins. Co. v. Hanson Indus., 873 F.Supp.
17, 27 (S.D.Tex.1995); Chiles v. Chubb Lloyds Ins. Co., 858 S.W.2d
633, 635 (Tex.App.—Houston [1st Dist.] 1993, writ denied).
      8
       See Chiles, 858 S.W.2d at 635.

                                          5
liability policies must be approved by the Board.9                  This statutory

authority, however, only extends to policies issued by a licensed

insurer.10       The policies in our case are surplus lines insurers.

A surplus lines insurer is an unlicensed insurer.11                       By statute

Texas allows unlicensed insurers to sell policies in the state if,

among     other   requirements,       the   insurance     is     placed   through   a

licensed surplus lines agent, and insurance "cannot be procured

from licensed insurers after diligent effort."12                         The statute

recognizes that the placing of such policies is "a matter of public

interest," and is allowed in limited circumstances "as a result of

difficulty in obtaining coverage from licensed insurers."13                        The

insurers     offered     affidavits      from   a     supervisor    in    the   Texas

Department of Insurance stating that the surplus lines policies in

this case are not subject to Board Order Nos. 23080 and 50602.

     Even though Cutaia has not been expressly overruled, and even

though     the    Insurance    Board's      mandatory    endorsement       requiring

prejudice from late notice apparently does not apply to surplus

lines policies, we are persuaded that the Texas Supreme Court would

require a showing of prejudice in our case.

     We     believe     the   court   would     opt    for   a   uniform    rule    of

construction, reasoning that surplus lines insurers are surely

     9
        TEX. INS.CODE ANN. art. 5.13-2, § 8 (West Supp.1997).
     10
          Id. at § 2.
     11
          TEX. INS.CODE ANN. art. 1.14-2, § 2(b) (West Supp.1997).
     12
          Id. at § 3.
     13
          Id. at § 1.

                                            6
aware that their policies, like all policies issued to Texas

residents, are subject to Texas law and the rules of construction

followed by the Texas courts.             We note that nothing we can find in

the Insurance Code suggests that the Legislature intended to

deprive the Texas Supreme Court of its traditional authority, under

the common law, to adopt rules of construction for insurance

policies, as it does for all contracts.

      We are strongly influenced by the Texas Supreme Court's

decision    in    Hernandez       v.   Gulf      Group   Lloyds,    875   S.W.2d    691

(Tex.1994), decided over two decades after Cutaia.                     In Hernandez,

the daughter of the plaintiffs was killed in an automobile accident

involving another driver.              The other driver was solely at fault.

The   parents     and    daughter      had       uninsured/underinsured      motorist

coverage provided in their policy with the defendant insurer.

Without the consent of the insurer, the plaintiffs settled with the

other driver for the modest limits of his insurance coverage, and

sought recovery from their insurer under the underinsured motorist

coverage.        The    insurer    refused        coverage   on    grounds   that   the

plaintiffs had failed to obtain the insurer's consent to the

settlement.      The policy had a settlement-without-consent clause,

excluding coverage where the insured settles with any person who

may be legally liable for the injury without the insurer's consent.

The clause provided that "insurance does not apply ... to bodily

injury or property damage with respect to which the insured ...

without written consent of the company, make[s] any settlement with




                                             7
any person ... who may be liable therefore...."14

     The court held that the insurer must show prejudice despite a

dissent that cited Cutaia and wrote:               "[T]his case is not about a

breach of contract.        This case is about coverage....               In refusing

to impose a prejudice requirement, this Court [in Cutaia ] stated

that even       though    an   injustice       might    occur   by    disallowing    an

otherwise       valid    claim,   this     Court       should   not    overreach     it

boundaries and imply new standards into insurance contracts."15

     The majority in Hernandez held that "an insurer may escape

liability on the basis of a settlement-without-consent exclusion

only when the insurer is actually prejudiced by the insured's

settlement with the tortfeasor."16                 The court's reasoning was

straightforward.          It   recognized        that    insurance     policies     are

contracts subject to general rules of contract construction.                         It

noted that a fundamental tenet of contract law is that "when one

party to a contract commits a material breach of that contract, the

other party       is    discharged   or    excused       from   any    obligation    to

perform."17      It then held that where the insurer is not prejudiced

by the breach, the breach is not material, the insurer has not been

deprived of the benefit of the bargain, and it should not be

relieved of its obligation to provide coverage.

      We believe that the reasoning of Hernandez applies with equal

     14
          Id. at 694 (Enoch, J., dissenting).
     15
          Id.
     16
          Id. at 692.
     17
          Id.

                                           8
if not greater force to a notice-of-occurrence, notice-of-claim, or

notice-of-suit clause.        The fundamental principle of contract law

recognized in Hernandez—that a material breach by one contracting

party excuses performance by the other party, and an immaterial

breach does not—is equally applicable to notice cases.                  In the

words of Hernandez, "an insurer who is not prejudiced by [the

breach] may not deny coverage...."18          If anything, we believe that

the failure to give notice of a claim poses a smaller risk of

prejudice than failure to obtain consent to a settlement.               In many

instances of untimely notice of a claim, the insurer is not

prejudiced     at   all,   and   ultimately   may   not   face   any   coverage

obligation. Conversely, in many if not most cases where an insured

settles a case without the insurer's consent, the insurer faces at

least some liability.        If the Texas Supreme Court does not presume

prejudice in a settlement-without-consent case, we are persuaded

that it would not presume prejudice in a failure-of-notice case.

     We also believe that the Texas Supreme Court would consider

the law of other jurisdictions.            In Hernandez the court did so.19

Our court has also recognized that, where the state's highest court

has not provided clear guidance, we may look to the rule in other

jurisdictions in conducting our Erie analysis.20 A leading treatise

recognizes as the majority rule that the insurer is not required to



     18
          Id. at 693.
     19
          Id. at 693 n. 4.
     20
          Browning Seed, 812 F.2d at 1002-3.

                                       9
prove prejudice to prevail in a lack of notice case.21 However, the

same treatise notes, in a lengthy footnote in its pocket part, a

modern trend in favor of requiring proof of prejudice.22 We believe

the   Texas   Supreme   Court   would    follow   this   modern     trend,   as

Hernandez is entirely consistent with it.

      Because we conclude that the district court based its summary

judgment on an incorrect interpretation of Texas law, we remand the

case for further proceedings.

      REVERSED and REMANDED.




      21
      8 JOHN A. APPLEMAN & JEAN APPLEMAN, INSURANCE LAW   AND   PRACTICE § 4732
(1981).
      22
       Id. at n. 10 (Supp.1995) (citing Healy Tibbitts Const. Co.
v. Foremost Ins. Co., 482 F.Supp. 830 (N.D.Cal.1979);        Weaver
Bros., Inc. v. Chappel, 684 P.2d 123 (Alaska 1984) (noting "modern
trend" in favor of considering prejudice); Ramos v. Northwestern
Mutual Ins. Co., 336 So.2d 71 (Fla.1976); Champion v. Panel Era
Mfg. Co., 410 So.2d 1230 (Fla.App.1982);       Ouellette v. Maine
Bonding & Cas. Co., 495 A.2d 1232 (Me.1985); Washington v. Federal
Kemper Ins. Co., 60 Md.App. 288, 482 A.2d 503 (1984);       Johnson
Controls, Inc. v. Bowes, 381 Mass. 278, 409 N.E.2d 185 (1980);
Morales v. National Grange Mut. Ins. Co., 176 N.J.Super. 347, 423
A.2d 325 (1980); Great American Ins. Co. v. C.G. Tate Constr. Co.,
303 N.C. 387, 279 S.E.2d 769 (1981); Lusch v. Aetna Cas. & Surety
Co., 272 Or. 593, 538 P.2d 902 (1975); Halsey v. Fireman's Fund
Ins. Co., 68 Or.App. 349, 681 P.2d 168, (1984);       Pickering v.
American Employers Ins. Co., 109 R.I. 143, 282 A.2d 584 (1971); A
& W Artesian Well Co. v. Aetna Cas. & Sur. Co., 463 A.2d 1381
(R.I.1983)). See also Campbell v. Allstate Ins. Co., 60 Cal.2d
303, 32 Cal.Rptr. 827, 384 P.2d 155 (1963); Brakeman v. Potomac
Ins. Co., 472 Pa. 66, 371 A.2d 193, 195, 198 (1977) (adopting
prejudice requirement and noting "a trend of late in several
jurisdictions away from the classic contractual approach towards a
view that considers prejudice to the insurance company as a
material factor in determining whether to relieve the insurance
company of     its  coverage   obligations  by   virtue   of   late
notification.").

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