Law and Insurance

5th Circuit Asks Texas Supreme Court To Clarify Prejudice Requirement For Late Notice Under Claims-Made Policies

Note: the following question may have been resolved by the subsequent Texas Supreme Court decision in PAJ, Inc. v. Hanover Ins. Co., 05-0849 (January 11, 2008) holding that an insurer must in all cases show prejudice caused by late notice when the insured fails to give notice "as soon as practicable."

XL Specialty Ins. Co. v. Financial Indus. Corp., No. 06-51683 (5th Cir. December 19, 2007).  See text of opinion at Certified Question.

The federal appellate court here certifies to the Texas High Court an interesting and murky question about a liability insurer's duty to defend a lawsuit even though the policyholder breached the claims-made policy requirement to give the insurer notice of the claim "as soon as practicable after it is first made."  A most suitable problem with which to end 2007.

The insured's management liability policy covered liability for specified conduct but only if the claim against the insured was made within the policy period, in this case between March 12, 2005 and March 12, 2006, and reported promptly to the insurer, as stated above.  Financial was sued on June 5, 2005 for breach of contract and fraud (assume this is covered conduct) but failed to send XL notice of the lawsuit until early January 2006, seven months after the claim was made but within the policy period.  Both parties stipulated in court that the notification breached the prompt-notice requirement in the policy but did not prejudice XL. 

The 5th Circuit judges recognized that Texas law was settled on two issues:

1. Concerning claims based on bodily injury or property damage, breach of a late-notice clause would not excuse a liability insurer's obligation to defend unless the insurer could show that the breach was material, i.e., caused prejudice to the insurer's rights under the policy; and
2. Under a claims-made type policy, an insured's failure to provide notice of a claim within the policy period (or any allowed reporting period after expiration of the policy) automatically excused the insurer from having to defend or indemnify the claim.

The distinction between an "occurrence" type and a "claims-made" type policy is crucial to understanding the court's dilemma in this case.  "Occurrence" policies cover the insured's liability for claims asserting that the covered accident, event or conduct (the "occurrence") occurred within the policy period, without regard to when the claim was actually asserted or the lawsuit filed against the insured.  By contrast, "claims-made" policies respond to claims asserted against the insured within the policy period, without regard to when the event or conduct occurred giving rise to the claim (although most claims-made policies impose a retroactive date limiting how far into the past the coverage will extend). 

Courts generally have recognized that, in the absence of actual prejudice to the insurer, late notice of a claim or lawsuit under an occurrence policy is generally less significant than under claims-made policies because a central benefit-of-the-bargain to the claims-made insurer is the certainty of a relatively short window of exposure to risk.  After the policy period expires (and any specified reporting period, usually a month unless a longer reporting period is purchased), the insurer can close its books on the policy.  However, the occurrence policy theoretically must be left open forever, as some insurers of asbestos and pollution risks know all too well.  The insured company that can find the old occurrence policy from half a century before can demand coverage as long as the lawsuit alleges that the pollution or asbestos exposure fell in part within the policy period.

With that distinction in mind, courts will not allow an insured to sit on a claim until after the claims-made policy is over and then send late notice to the insurer.  Even if this insurer cannot prove that it was prejudiced by the late notice, courts draw a bright line at the termination of the policy period because closure of risk was a central right the claims-made insurer bargained for (if one can say insurance policies are the result of bargaining).  Prompt notice to the occurrence insurer is arguably less of a central concern, as long as no prejudice results.

But what about the case at issue?  What if notice is given within the policy period of a claims-made policy but not "as soon as practicable"?  And what if the claim does not arise from bodily injury or property damage, as in this case?  (The XL court noted a split among Texas appellate decisions, some holding that prejudice must be shown in all cases, and others restricting the prejudice requirement strictly to bodily injury/property damage cases, including one currently on review before the Texas Supreme Court holding that advertising-injury claims do not require a showing of prejudice).

Thus:  "We certify the following determinative question of law to the Supreme Court of Texas: Must an insurer show prejudice to deny payment of a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is nevertheless given within the policy's coverage period?"

With any luck, we will have the Supreme Court's answer before New Years Day 2008.

Congress passes 7-Year Terrorism Risk Insurance Extension

On December 18, 2007, the House passed the more modest Senate-approved version of the bill to extend the federally-backed insurance program called the Terrorism Risk Insurance Revision and Extension Act of 2007 (TRIREA).  A good description of the changes to this legislation can be found at CRS Summary of TRIREA.  The key features of the bill are:

• extends the program for 7 years
• federal participation begins at $100 million per incident loss
• applies to domestic as well as foreign acts of terrorism
• requires ongoing reports to Congress on inclusion of coverage for group life and nuclear, biological, chemical and radiological (NBCR) events
• caps federal participation at aggregate $100 billion

The White House has opposed federal participation in the program but is expected to sign this compromise extension.

Insurance Agent Not Responsible for Procuring Complete Coverage In View of Insured's Failure To Read the Policy

FG Holdings, Inc. v. London Am. Risk Specialists, Inc., No. 09-05-522 (Tex. App.— Beaumont, Dec. 13, 2007)  See FG Holdings Opinion

Don’t forget to read your policy.  That’s the lesson of this case, which granted summary judgment for a broker that allegedly failed to obtain the coverage requested by a policyholder to comply with a contractual obligation to procure insurance covering construction-related liability.

 

Trans-Global Solutions, Inc. (“TGS”) entered into a contract with Clark Refining and Marketing, Inc. to build a petroleum coke facility.  Under the contract, TGS had to obtain an all-risk insurance policy covering the full contract value of TGS’s work, including coverage for damage caused by faulty work.  TGS contacted its agent at FG Insurance Services, Inc. (“FG”) to obtain such a policy.  FG forwarded the request to London American Risk Specialists, Inc., a surplus-line broker, which in turn sent it to Liberty Surplus Insurance Corporation.  Ultimately, Liberty agreed to provide the insurance and issued a binder listing the perils covered as “All Risk Including Flood & Earthquake.”

 

Three months later, London American sent the policy to FG, which forwarded it to TGS.  But no one at TGS read the policy, and neither FG nor London American notified TGS that it contained certain exclusions for faulty workmanship.  Of course, TGS made a claim under the policy for damages incurred in the course of its work under the Clark contract, and Liberty denied the claim based on the faulty-workmanship exclusions.

 

TGS sued London American for failing to obtain the requested coverage. (TGS settled similar claims against FG.)  The court granted London American’s motion for summary judgment, holding that, as the insurer’s agent, London American had no duty to explain the policy’s terms to TGS.  More generally, the court noted that Texas courts are unwilling to impose liability on agents for failing to obtain complete coverage and that “[a]n insured has a duty to read the policy and, failing to do so, is charged with knowledge of the policy terms and conditions.”

 

Presumably, had TGS instructed the agent to procure coverage for damage caused by faulty workmanship and the agent came back with the Liberty policy, the result might have been different despite Texas’s strong duty-to-read policy.

Delayed Dissent Filed In Lamar Homes Case Against Applying Delay Penalty To Defense Costs

In August of this year the Texas Supreme Court issued a groundbreaking decision in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 50 Tex. Sup. Ct. J. 1162 (Tex. August 31, 2007) that resolved two long-standing controversies: "occurrence" and "property-damage" coverage for defective construction (see my discussion, Texas High Court Allows CGL Coverage of Construction Defects), and application of a statutory delay penalty in first-party claims to defense costs under third-party liability parties (see my discussion at Texas Insurance Code Delay Penalty Held Applicable to Defense Costs).  Notably, three justices dissented on the construction-defects issue but not on the delay statute.  Now, the three dissenting justices have weighed in with a vengeance against the notion that an insurer's obligation to pay defense costs as part of its duty to defend under a liability policy could be a "first-party claim" under Tex. Ins. Code Sec. 21.55 (now Art. 542).

From their opening salvo, "[S]ince Reconstruction prompt-payment penalties applied to some insurance claims in Texas, but never to a liability carrier's duty to defend," the dissenters attacked the majority's reasoning on numerous grounds.  First, the majority had distinguished between a "first-party claim" (one payable to the insured) from "first-party insurance" (that indemnifies the insured's loss).  The dissenters demonstrated that the terms "first party" and "third party" had consistently and exclusively been applied over the years and under several statutes to the traditional distinction between third-party liability insurance and first-party indemnity insurance.  The majority's distinction was a completely novel one.

Second, the dissent launched a three-part attacked against the logic of applying the notion of "first-party claim" to the duty to defend.  The duty to defend is not a payment obligation, according to the dissent, it's a service obligation.  Second, reimbursement of defense costs is not the same as paying a claim under the policy contract because the insurer typically pays less to defense counsel it chooses than counsel hired by the insured after the insurer has denied the defense obligation.  Third, the dissent argued that defense costs are not "paid directly to the insured" as the statute definition requires, and payment to defense counsel is not, as the majority stated, "a distinction without a difference."

The dissent also forcefully argued that "the very operation of the statute precludes applying it to the duty to defend."  In effect, the dissent argued that applying the terms of the statute to the duty to defend is like forcing a square peg into a round hole (my analogy).  To make a fit, the majority must dispense with certain provisions required under the statute, such as securing a final proof of loss.  Moreover, if the test of a "first-party claim" is that the insurer pays money directly to the insured, then, the dissent points out, reimbursing the insured for a judgment or settlement it paid is just as much a "first-party" payment as reimbursing defense costs.

The dissent is unlikely to persuade the majority to change its ruling, so it remains to be seen how the courts will work out the details of how the delay penalty will be applied to the duty to defend.

Liberty Mutual Expands CGL Coverages For Specific Industries

Aimed at middle-market general liability (“CGL”) customers, Liberty Mutual Group announced 11 automatic coverages designed to address such common gaps as unintentional failure to disclose, mental anguish, coverage for health care professionals,, and coverage for injuries to co-employees resulting from Good Samaritan acts.  See New Coverages for fuller announcement.

Named Liberty Direct Solutions(TM), Liberty Mutual’s new “expanded” property and casualty products are targeted for select industries, including:

• Contractors

• Manufacturers

• Fabricated Metals Manufacturers

• Wholesale Distributors

• Retailers

• Food Processors

• Restaurant Owners

• Real Estate and Commercial Property Managers

• Professional Service Providers and

• Janitorial Service Providers

As the property/casualty market softens, competition increases for new business.  Whether these expanded products prove worth while to policyholders, of course, remains to be seen.  Still, I take this as a hopeful sign of a healthy market.

Texas Supreme Court Decides That Workers’ Compensation Claimant May Appeal Agency Ruling In Her Local District

What’s wrong with Austin, Texas? Nothing, unless you are a widow in El Paso seeking to reverse a determination by the Texas Workers’ Compensation Commission that your late husband was killed while working as an independent contractor, not an employee. Thus, the issue in this case is appellate jurisdiction under the Texas Workers’ Compensation Act. Claimants must challenge a denial of benefits before the TWCC. After exhausting agency appeals, a claimant may file a judicial appeal either in the claimant’s local state district court (if the dispute is over compensability or eligibility for benefits) or in district court in Austin, the state capital, for any other type of claim.

Margarita Morales’ husband died after falling from a ladder while repairing a motel roof in El Paso. She contended that he was an employee of one of three entities: two were insured by the defendants, one was a non-subscriber that did not purchase workers’ compensation insurance. The TWCC affirmed the denial of workers’ compensation benefits, finding that Morales was an independent contractor, and thus had not suffered a “compensable injury.” Morales filed suit in El Paso County to appeal that finding, but the case was dismissed for lack of jurisdiction, and the El Paso Court of Appeals affirmed based on the insurers’ argument that the case did not concern compensability.

The insurers acknowledged that employment-course-and-scope inquiries generally concern compensability. But they argued that when one or more potential employers is a non-subscriber, the worker’s actual employer must be determined as a threshold issue before the compensability issue arises. Therefore, the insurers believed that Austin was a mandatory venue under the Act. The Supreme Court reversed and held that coverage and compensability are not necessarily mutually exclusive concepts in a subscriber/non-subscriber situation as presumed by the insurers. Thus, the general rule still applied, and Morales’ employment status remained merely one relevant factor in the compensability determination.

So now, the El Paso district court will decide whether the TWCC got it right, and Mr. Morales was working as an independent contractor.

Dallas Court of Appeals Refuses To Expand Texas Stowers Duties On Liability Insurers

Cain v. Safeco Lloyds Ins. Co. (Tex. App.--Dallas, November 29, 2007) (See Safeco Decision)

This case features a doomed effort to expand an auto insurer's bad faith liability for allegedly mishandling the defense of a lawsuit.  The plaintiff was a passenger in a car involved in a single car accident.  Safeco insured the driver.  Safeco repeatedly offered to settle the ensuing lawsuit by paying policy limits, but the plaintiff refused and obtained a $4 million judgment at trial.

Taking an assignment of the driver's rights under the policy, the plaintiff sued Safeco seeking damages in excess of the policy limits under bad-faith theories under common law and the Texas Insurance Code, including an unusual claim to extend the insurer's Stowers duties to include negligent defense of the underlying lawsuit.  Under the Texas Stowers doctrine, an insurer of a covered claim is required to exercise that degree of ordinary care and diligence which an ordinary person would exercise in the management of his/her own business in responding to settlement demands within policy limits. (Stowers Furniture Co. v. American Indem. Co., 12 S.W.2d 544 (Tex. Comm'n App. 1929)  The insurer that unreasonably refuses to accept a settlement demand within policy limits would be required to pay a judgment against the insured in excess of the policy limits.

Safeco never received a demand within policy limits, and in fact offered several times to settle for policy limits.  Therefore, Safeco never breached its Stowers duty under current law.  Cain, however, sought to expand current law by arguing that the Stowers doctrine has expanded the duty to provide a reasonable defense to the insured, and Safeco failed to provide a reasonable defense.  For support of this theory, Cain relied on two earlier cases holding that an insurer's duty of care included investigation and preparation of a lawsuit and reasonable attempts to settle.  (Ecotech Int'l, Inc. v. Griggs & Harrison, 928 S.W.2d 644 (Tex. App.-San Antonio, 1996; Wheelways Ins. Co. v. Hodges. 872 S.W.2d 776 (Tex. App. Texarkana 1994). 

The Dallas Court of Appeals refused to expand the Stowers doctrine and pointed out that after the Ecotech and Hodges cases, the Texas Supreme Court abolished the common law duty of good faith and fair dealing under most liability policies (Maryland Ins. Co. v. Head Indus. Coatings & Serv., Inc. 938 S.W.2d 27 (Tex. 1996)) upon which the earlier cases were based and also absolved the insurer of liability for mishandling the defense by defense counsel (State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998)).  Moreover, the Cain Court refused to create new law by expanding the Stowers doctrine beyond the limits prescribed in American Physicians Exch. v. Garcia, 876 S.W.2d 849 (Tex. 1994).

Cain's attorneys are presumably not ignorant of current law.  This case is interesting because it illustrates how the law changes.  Practitioners take a shot at establishing a new defense or (in this case) a new theory for liability.  The canons of legal ethics do not bar attorneys from making arguments for reasonable extensions of existing law when they have a good faith basis for doing so.  Most such attempts do not succeed, particularly in the lower courts.  But hope springs eternal that at some time the idea whose time has come will be received and new law will be made.  The law evolves, for good or ill, by efforts such as this.

Strong Reaction Reported Against Texas Supreme Court Decision

A couple of months ago, I commented on the Texas Supreme Court's decision in Entergy Gulf States v. Summers (see Premises Owners May Obtain Exclusive Remedy) which construed Sec. 406.123 of the Texas Labor Code to allow a premises owner (in this case a refinery) to agree in a written subcontract to pay premiums on workers' compensation insurance protecting the subcontractor's employees, and in return receive the benefit of the bar against common law negligence lawsuits by those employees.  Nobody questions this arrangement between a general contractor and a subcontractor.  The only controversy was whether a premises owner could function as its own general contractor.  The Entergy court held that it could even though the labor statute explicitly prohibited this before the 1993 recodification of the Labor Code.

Now it appears this decision has set off a minor fire storm of sorts.  In Monday's edition of the Quorum Report, which reports on Texas politics, a story appeared that certain Texas Legislators were surprised and shocked that the Supreme Court would interpret the recodification to effect a substantive change in the law.  See Quorum Report.  "Recods," as they are called are not supposed to create new law or make substantive changes in existing law.  In the Entergy case, the Court acknowledged this precept but held that the plain wording of the statute controlled.  What are the Legislators exercised about?

Robert Duncan (R- Lubbock) is quoted as saying that the Legislature has had multiple opportunities to extend the workers' compensation bar to premises owners but has opted not to.  In this view, the Supreme Court has created a new kind of immunity for a much broader class than was intended.

Admittedly, the Entergy decision could open the door to agreements between all sorts of players, landlords, retail operations, even homeowners (?).  However, the arrangement only applies if the premises owner purchases the workers' compensation insurance for the subcontractor's employees.  This arrangement occurs frequently in the oil patch and in the construction industry, and, for a number of reasons makes commercial sense.  So it remains to be seen what, if anything the Texas Legislature will do.  In the meantime, we might be on the look out for innovative agreements by parties trying to shoehorn into the Entergy immunity.