Law and Insurance

Breach of Contract Can Trigger CGL Coverage - A Brief Reminder

Grimes Construction, Inc. v. Great American Lloyds Ins. Co., #06-0332 (Tex. Feb. 29, 2008), reversing 188 S.W.3d 805 (Tex. App.--Fort Worth 2006)  see Grimes Decision

This decision is little more than house clearing after the Texas Supreme Court's pivotal opinion in Lamar Homes,  Inc. v. Mid-Continent Cas. Co., 239 S.W.3d 236 (Tex. 2007) that alleged defective workmanship causing construction damage could constitute an "occurrence" and "property damage" under a CGL policy, even if the claim is one of pure contract, not tort, and the only damage is to the insured's own work.  The allegations in the Grimes suit are substantially similar to those in Lamar Homes.

In fact, one may wonder why the Court took the time to write even the one page per curiam decision that it produced.  Re-reading the appellate court's Grimes decision, I had the feeling that that court was trying a little too hard to sweep under the carpet allegations that, on a fair reading, could potentially trigger a duty to defend.  For example, the court not only discounted the plaintiffs' allegation of negligent workmanship as, "simply a recharacterization of their basic breach of contract and warranty claims," but also held that alleged negligent hiring and supervision were not "occurrences." 

To reach this holding, the court had to distinguish the Texas Supreme Court's King v. Dallas Fire Ins. Co., 85 S.W.3d 185 (Tex. 2002) which held that alleged negligent hiring/supervision of an employee that assaulted a customer was an "occurrence" triggering a duty to defend the employer.  The Grimes court reasoned that the King employee's assault was not within the scope of employment and so was not foreseeable by the employer, whereas damage from the sloppy work of a construction crew was "more foreseeable."  The Grimes court also observed that the policy in King had a separation-of-insureds clause (i.e., the excluded intentional act of one insured should not be imputed to another insured).  The Grimes policy had no such clause.

But this line of reasoning doesn't even make sense.  The workers in Grimes were not accused of intentional conduct, so there was no need to consider separation of insureds.  And I fail to see in the insurance analysis the relevance of the foreseeability of construction damage from sloppy work.  If an injury is foreseeable from non-intentional conduct, does that mean it can't be covered under an accident policy?  It's like saying that a driver should lose coverage because an auto accident foreseeably might result from careless driving.  Foreseeability is an element of proximate cause, which a tort plaintiff must prove to get damages.  If foreseeability is a bar to insurance coverage, no one will ever be covered for a judgment based on negligence.  To be entitled to the judgment, the plaintiff must have proved foreseeability. This is a court trying hard to avoid finding coverage.

So back to today's per curiam reversal (per curiam means the opinion is issued by the court as a whole not signed by specific justices; since they are supposed to be on uncontroversial issues, they tend to be short).  The Court held:

The court of appeals [had concluded] that defective work was a contract claim outside the scope of the CGL's insuring agreement. ...  We rejected similar arguments in Lamar Homes, concluding that labels of tort or contract could not override the language of the insuring agreement.

It may be that the High Court is singling out the Grimes decision for special censure, gentle though it is.

Another Global-Warming Lawsuit Brought Against Private Companies

The New York Times reports today that an Alaskan village has filed a nuisance suit against 5 oil companies, 14 electric utilities, and the country's largest coal company, seeking to hold these defendants liable for the impact of global warming forcing the village to relocate because of flooding.  See Flooded Village Files Suit, Citing Corporate Link to Climate Change. 

This is the latest in the ever-growing number of lawsuits brought against private industries under the rubric of "global warming litigation" (perhaps better known to some lawyers as the Klondike).  So far, courts have been shy about entertaining legal theories allowing recovery in these types of actions (e.g., in Connecticut v. American Electric Power, California v. General Motors Corp., and Comer v. Murphy Oil U.S.A., the plaintiffs' cases are being dismissed either as political questions or based on tenuous causation evidence  see Global Warming Litigation Heating Up for discussion of these cases).

I believe, however, that it is too early to tell whether the courts will eventually recognize a workable (or even unworkable) legal basis for allocating liability for damage that can be tied to climate change.  For example, asbestos plaintiffs watched throughout the 1960's while their cases were dismissed before the Fifth Circuit held in Borel v. Fi breboard Paper Prods. Corp., 493 F.2d 1076 (5th Cir. 1973) that asbestos manufacturers could be held more or less strictly liable despite intermediate sellers or product warnings. 

Although Kivalina, the plaintiff Inupiat village may find it difficult to obtain judgment against Exxon Mobil, Corporation, American Electric Power, Conoco Phillips Company and others, it may be a matter of time before a court salutes at one or another aspect of the claims asserted.

What appears new in this case is the allegation of conspiracy, that the defendants sought to mislead the public about the science of global warming "by convincing the public at large and the victims of global warming that the process is not man-made when in fact it is." 

Whatever happens in this suit, we can expect to see more litigation of this kind.

New York High Court Allows Consequential Damages For Breach of Contract

Bi-Economy, Inc. v. Harleysville Ins. Co. (N.Y. Feb. 19, 2008) (see Bi-Economy Decision)

The highest court of New York has joined a number of other states that have allowed policyholders to recover consequential damages in excess of the policy limits for a first-party insurer's breach of contract.  "Consequential damages" are those that flow naturally and foreseeably from a breach but are beyond the direct damages that the parties actually contemplated, or probably contemplated, when the the contract was made. 

The seminal case illustrating the distinction between ordinary damages and consequential damages is Hadley v. Baxendale (England 1854) in which H., a mill owner, contracted with B., a carrier (we would say trucker today) to transport a broken mill wheel to engineers for repair by a specified date.  B. failed to deliver the wheel on time, and H sued for damages, including the lost profits for the extra time he lost while the mill was shut down.  B. protested that he was never told that H needed the wheel to keep his mill running, and the damages should be limited to those that were generally foreseeable by the parties at the time of contract.  The court agreed with B that a common carrier was not in a position to appreciate the likely effect of a shipping delay of cargo.  Nevertheless, the principle stuck that the party breaching its contract may be liable for indirect or consequential damages, such as lost profits caused by the breach, if the parties could have reasonably foreseen the consequences had they thought about it.

In this case, a meat market sustained inventory and structural damage from a fire.  The company was insured by a policy that covered loss form fire, including "business interruption," a common type of coverage for lost profits over defined period of interruption caused by the insured peril.  The period of interruption in this policy ended with the repair or replacement of the property, but no more than 12 months.  As often happens, the insurer and policyholder disagreed over valuation issues.  The insurer offered much less for the loss than the insured claimed and agreed to pay no more than 7 months of interruption, even though the company never returned to operation.

The dispute was submitted to alternate dispute resolution.  After more than a year, the insured was awarded more than twice what was offered.  The policyholder then sued for breach of contract and bad faith, alleging that the insurer improperly delayed payment for the direct loss and the full amount of its lost profits, and seeking consequential damages for the complete demise of the business, an amount in excess of the policy limits.  The insurer argued that, in addition to other defenses, the policy itself contained several exclusions of "consequential damages."  The lower courts granted the insurer's motion for summary judgment.

The New York Court of Appeals reversed and held that the insured's loss of its business was a foreseeable and probable result of the insurer's refusal to timely pay to restore the property and the lost income.  The dissent argued that the majority was confusing consequential damages with punitive damages.  The majority responded that consequential damages are designed to compensate a party for reasonably foreseeable damages, and so must be measured by actual loss.  Punitive damages, by contrast, are designed to punish or serve as an example and need not bear a close relation to the plaintiff's actual loss.  At any rate, the Court held that limiting an insured to the amount of the policy, "money which should have been paid by the insurer in the first place, plus interest, does not place the insured in the position it would have been had the contract been performed."

A few other states have awarded consequential damages as a bad-faith remedy.  See Lawton v. Great Southwest Fire Ins. Co., 392 A.2d 576 (N.H. 1978) (Allowing only policy limits plus interest would not make policyholders whole or discourage insurers from delaying a reasonable settlement); Beck v. Farmers Ins. Exch., 701 P.2d 795 (Utah 1985)(compensatory damages under policy may exceed policy limits and include damages for economic loss and mental anguish when those damages are reasonably foreseeable).

I am unaware of any Texas case that has awarded consequential damages in excess of the policy limits.  Texas does provide an 18% per annum statutory penalty for delay of payment of a first-party claim (Tex. Ins. Code Sec. 542.051).

Liability Insurer Has No Duty To Inform Additional Insured That Coverage Exists

National Union Fire Ins. Co. v. Crocker, #06-0868 (Tex. Feb. 15, 2008) see Crocker Opinion.

The old adage, "Hard facts make bad law" applies in this case.  A nursing home resident sued the facility and an employee after being injured when the employee allegedly swung open a door and hit the resident.  The employee never answered the lawsuit, and apparently never knew he was covered under the employer's policy.  A jury found that the nursing home, acting "by and through its agents acting within the course and scope of their employment," was not negligent.  The plaintiff's attorney moved to sever the defaulting employee before verdict.  After the take-nothing judgment in favor of the nursing home, the plaintiff obtained a $1 million default judgment against the employee and sought to collect against the nursing home's insurance company.

You see, the insurer knew all along that the employee was an "omnibus" or additional insured under the policy.  The insurer had tried to contact the employee by phone and certified mail regarding his status as an insured and right to a defense under the policy.  Apparently, the attorney hired by the insurer to defend the nursing home tried to speak to the employee at a deposition, but the employee refused to speak to him.  So no wonder that the insurer denied responsibility for the default judgment based on the employee's failure to notify the insurer or send a copy of the lawsuit as the policy required.

When the insurance coverage suit reached the 5th Circuit, the court certified the question to the Texas Supreme Court as follows:

Where an additional insured does not and cannot be presumed to know of coverage under an insurer's liability policy, does an insurer that has knowledge that a suit implicating policy coverage has been filed against its additional insured have a duty to inform the additional insured of the available coverage?

The 5th Circuit also asked if the insurer's actual knowledge of these circumstances establishes lack of prejudice as a matter of law. 

The Texas Supreme Court answered No to both questions.  "[A]n insurer that has not been notified that a defense is expected bears no extra-contractual duty to provide notice that a defense is available to an additional insured who has not requested one."  On the question of whether or not the insurer was prejudiced, the Court distinguished this case from PAJ, Inc. v. Hanover (see my discussion at CGL Insurers Must Prove Prejudice), in which the insured sent late notice to the insurer.  In this case, the Court stated, "[N]otice was not merely late; it was wholly lacking."

Bottom line: "Insurers owe no duty to provide an unsought, uninvited, unrequested, unsolicited defense."

But the facts in Crocker are extreme.  National Union bent over backward to contact the employee.  A jury determined that neither the facility nor its agents (including employees) were negligent before the plaintiff obtained a $1 million default judgment.  By contrast, in most additional-insured late-notice cases, the equities are more balanced or favor the additional-insured.  For example, should the insurer avoid coverage when an additional insured requests coverage during the investigation phase before a lawsuit is actually filed but after the plaintiff has demanded relief?  There may even be extensive pre-suit communications between the additional insured and the insurer in which the former's intent to seek coverage is clear.  As the Crocker Court observed, the insurer's duty to defend is not actually triggered until the lawsuit is filed and conveyed to the insurer.  Yet, if the additional insured fails to forward the lawsuit but continues to correspond about the claim, would the Crocker Court excuse the insurer or call it an unsought, uninvited, unrequested, unsolicited defense?

It appears likely that the PAJ decision will require the insurer to show prejudice before avoiding this type of coverage, which means that, as long as the additional insured sends a complaint (or amended complaint) to the insurer and requests a defense within a reasonable time before trial (some decisions have held that a month or two is reasonable), the duty to defend will be triggered. 

But it is clear that ignorance of one's additional-insured status is no excuse.  That is bad news for so-called "omnibus" insureds, like employees of a named insured company, who do not contract for their additional-insured status and so probably have no idea of their rights to coverage.  For those who become additional insureds by contract with the named insured, simply because the named insured is being defended in a lawsuit, does not mean that the insurer has any obligation to cover additional insureds until they send a copy of the complaint and demand defense and indemnity in their own right.

Supreme Court Finds No Broad Prohibition of Insurance Covering Punitive Damages -- But . . .

Fairfield Ins. Co. v. Stephens Martin Paving, LP, # 04-0728 (Tex. Feb. 15, 2008), see Fairfield Decision

In this long-awaited decision, the Texas Supreme Court answers the Federal Fifth Circuit's certified question: "Does Texas public policy prohibit a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence?"  The short answer:

[W]e answer that the public policy of Texas does not prohibit [such coverage].  However, without clear legislative intent to generally prohibit or allow the insurance of exemplary damages arising from gross negligence, we decline to make a broad proclamation of public policy here but offer some considerations applicable to the analysis in other cases.

So, this decision probably ends all challenges in Texas by workers' compensation (WC) insurers to Employer's-Liability coverage of punitive damages for gross negligence.  Also, the Court appears to firmly shut the door on uninsured-underinsured motorist coverage for a tortfeasor's punitive damages. But otherwise, unless a statute prohibits or allows specific punitive-damage coverage, just about every other type of liability insurance coverage is left open for future case-by-case development.

The Court agreed unanimously only on the result and those portions of the opinion concerning the WC policy and Texas law on exemplary damages.  Justice Hecht, joined by three other justices, wrote a separate discussion of the all-important "Public Policy Considerations."  However, it appeared to me that all nine justices were in general agreement that insurance coverage of punitive damages would offend Texas public policy in some circumstances. 

At the risk of oversimplifying, the Court agreed that the sole purpose of punitive damages is to punish a wrongdoer.  Other purposes evident in days gone by, such as making an example to others or to compensate a plaintiff, have been dropped from the statutory scheme defining gross negligence and punitive damages.  Thus, where punitive damages may have some purpose other than to punish, such as compensation, coverage is less likely to offend public policy.  The clearest example of this is the WC scheme itself, created by the Texas Constitution, that appears to allow a decedent's survivors to seek punitive damages for an employer's gross negligence as a form of compensation.  It may be for this reason that the Court appears to bless this coverage without any balancing of factors like the culpability of the employer, or whether the employer is an individual or a corporation.

The Court recognized a public-policy interest against shifting responsibility for paying punitive damages to an insurer where doing so would undermine or eliminate the punitive purpose of the remedy.  Two examples: 

1. Uninsured/underinsured motorist insurance is meant to compensate an insured drivers for their own injuries when the tortfeasor fails to have adequate liability insurance.  However, punitive damages fail to punish the tortfeasor if payment is shifted from the tortfeasor to an insurer, even if the tortfeasor is judgment-proof. 
2. By contrast, a corporation whose employees are grossly negligent in their work or production may cause severe injury resulting in punitive damages against the corporation.  In this case, it may make little difference whether payment is shifted to an insurer or to the corporation (actually to the customers of the corporation).  Accordingly, it probably would not offend public policy to allow the insurer to cover the corporation.  The answer might be different, however, for a sole proprietor, or where the CEO was deeply involved in the offensive conduct.

The Court weighs other considerations, all of which will be grist for the mill of future coverage litigation.  Rather than lay the issue to rest, this decision provides ammunition to both insurers and policyholders for non-WC challenges over public-policy challenges to coverage for punitive damages.

Additional Insureds' Rights Expanded In Significant Texas Decision

Evanston Ins. Co. v. ATOFINA Petrochem. Inc., # 03-0647 (Tex. February 15, 2008) (See ATOFINA Decision)

Today, the Texas Supreme Court cleared three significant insurance cases, each of which deserves attention.  I think the most significant of the three is the ATOFINA ("Atofina") case.  I will address the other two in subsequent postings.

This case substantially expands the rights of additional insureds under liability policies.  An "additional insured" is typically added to a named insured's policy by virtue of the parties' contract in which the named insured, for example a contractor or commercial tenant, agrees to procure liability insurance and add the general contractor or landlord as an additional insured to the policy for claims that arise from or relate to the contract operations or premises.  If the policy contains a provision, usually an "additional-insured endorsement," that adds such contract parties to the policy, then they become "additional insureds" under the policy. (See discussion, Additional-Insured Coverage)

Atofina expands coverage for additional insureds in at least three important respects:

1. The additional insured is entitled to insured status under the policy even if the accident or injury was caused by the additional insured itself or some agent other than the named insured;
2. "Sole-negligence" exclusions in the additional-insured endorsement will not excuse the insurer from defending additional insureds (even if the additional insured is the only defendant in the lawsuit) if the additional insured alleges that the plaintiff or someone else may also be negligent (this, I think, may have the greatest impact for future cases, as discussed below);
3. Insurers, including excess insurers, that wrongfully refuse to defend an insured (including an additional insured) may not dispute the reasonableness of a settlement amount, if the insured was offered an opportunity to defend or participate in settlement negotiations.

Here are the facts:  Atofina hired a contractor to perform some construction at Atofina's refinery.  The contract required the contractor to indemnify and hold Atofina harmless from claims "except to the extent any loss is attributable to the concurrent or sole negligence . . . of [Atofina]."  The contractor also agreed to procure a primary liability insurance policy with certain minimum limits and an excess policy "following form" (having the same terms) to the primary policy.  The contractor procured this insurance.  The primary policy contained an additional-insured endorsement that excluded the sole negligence of the additional insured.

Contractor's employee fell through a rusted tank and drowned in the fuel oil below. The decedent's family sued the contractor and Atofina for wrongful death (but soon dismissed the contractor leaving Atofina as the sole defendant).  The primary insurer tendered its limits, but Evanston, the excess insurer, denied coverage to Atofina primarily on the basis that the policy did not cover additional insureds for their own negligence (i.e., coverage applied only if the contractor caused the accident at least in part).  Atofina answered the lawsuit and alleged that the decedent was contributorily negligent.  Atofina also sued Evanston for coverage and settled the underlying lawsuit for $6.75 million (all but one million of which it claimed from Evanston).

The trial court granted summary judgment to Evanston, but the intermediate court of appeals reversed in favor of Atofina.  The Supreme Court reviewed the case (twice -- it issued an initial decision in May 2006, which it now withdraws).  Evanston first argued that the underlying policy covers Atofina "only for liability arising out of [the contractor's] ongoing operations [for Atofina] . . ."  The contractor was not hired, argued Evanston, to work on the storage tanks.  Therefore, the liability was not sufficiently connected to the insured operations.

On this issue, the high court recognized a split among Texas cases.  One case, Granite Contr. Co. v. Bituminous Ins. Co., 832 S.W.2d 427 (Tex. App. - Beaumont 2003) imposed a "fault-based" interpretation that bars coverage for an additional insured unless the named insured's conduct caused the accident.  Two other appellate cases, Admiral Ins. Co. v. Trident NGL, Inc., 988 S.W.2d 451 (Tex. App. Houston [1st Dist.] 1999) and McCarthy Bro. Co. v. Continental Lloyds Ins Co., 7 S.W.3d 725 (Tex. App.- Austin 1999) applied a broader theory of causation that allowed coverage for the additional insured as long as the accident occurred more or less within the contract works.  For example, if the named insured is a painting contractor whose employee is injured on the work site by a stray truck driven by, say, a plumbing contractor, the injury bears a close enough connection to the painting contractor's operations to trigger coverage.  It was on the work site and the employee was within the scope of the contract works.  "We do not require proximate cause or legal causation," said the Atofina Court.

This is a significant clarification of Texas law on this point.  Many insurers routinely challenge additional-insured coverage because the accident was not caused by the named insured's operations.  No more.

Second, and most significant.  Evanston argued that the underlying policy excluded the sole negligence of the additional insured, and the Evanston policy, following form, contained the same exclusion.  Since Atofina was the only defendant in the underlying suit, only sole-negligent liability was being alleged.  The high court disagreed, reasoning:

On the record before us, we are unable to determine as a matter of law whether the accident was the product of Atofina's sole negligence.  The Jones family originally sued both Atofina and [the contractor], alleging both parties were negligent.  There were allegations in Atofina's pleadings that Jones himself was contributorily negligent.  [Emphasis added]

The Court held that, without a determination of liability, it was impossible to say whether the exclusion should apply.

The significance of this reasoning is that arguably an insurer's duty to defend must now be determined not simply by an "8 corner" rule (reading the policy and complaint), but also by reading the defendant's answer and perhaps other pleadings.  Courts are not supposed to look at extrinsic evidence (i.e., anything except the 8 corners of the policy and the complaint)  See discussion of this rule, 8 Corner Rule in Texas).  Up until now, if the complaint fails to allege some fact necessary to trigger coverage, then the insured may be denied an otherwise merited defense.  Now it seems the insured is master of its own fate.  By answering that the plaintiff contributed to his own death, Atofina provides the allegation necessary to avoid the sole-negligence exclusion.  Insureds and additional insureds may provide missing allegations in their answers and expand the strict 8 corner to 12 or more corners, so to speak.  The expansion is potentially very significant.

Third, the Atofina Court appears to reaffirm its earlier holding in Employers Cas. Co. v. Block, 744 S.W.2d 940 Tex. 1988), that an insurer that wrongfully refuses to defend may not challenge a subsequent settlement as unreasonable.  This is the only portion of the opinion that drew a strong dissent.  Justice Hecht agreed that Evanston was obligated to cover the additional insured but would have remanded the case to allow Evanston to challenge the amount of the settlement.  The problem that the dissent finds is that Block involved a primary insurer that breached its duty to defend.  Evanston, as an excess insurer, had no duty to defend, at least until the primary policy was exhausted.  Justice Hecht criticized the majority for applying the Block rule when an excess insurer refuses to accept a demand to participate in settlement negotiations.

However, in this case, the primary insurer had already tendered its policy limits, apparently from the very beginning.  While it may be technically true that Evanston's duty to defend was not yet triggered, it may be that both Atofina and the primary insurer were asking Evanston to take over the defense.  The facts are not clear.  Still, the lesson here for policyholders is to invite excess carriers to the negotiation table.  After this decision, they probably will be hard put to refuse, knowing that they may be stuck with whatever settlement is reached in their absence.

"Tension in the Duty To Defend" By Scott Stolley

In a recent article, referenced above, published in Headnotes, a publication of the Dallas Bar Association, (see Tension), Thompson & Knight Partner Scott Stolley identifies four unsettled areas in Texas law governing an insurer's duty to defend.  These include:

• Extrinsic Evidence
• Selection of counsel
• Recoupment of Costs
• Prompt Payment

The Texas Supreme Court recently addressed two of the areas of concern (See Frank's Casing and PAJ Inc.).  Nonetheless, many of the details, raised in Stolley's article, remain to be worked out in subsequent cases.  Worth the read. 

Additional-Insured May Not Access Liability Policy Proceeds For Its Own Damages, Court Finds

Ohio Cas. Ins. Co. v. Time Warner Entertainment Co., # 05-06-01437 (Tex. App.--Dallas, Feb. 6, 2008) Court Opinion

After a string of policyholder victories in the Texas Supreme Court (see Texas Supreme Court About Face), Time Warner appears to be testing the waters with this case.  Time Warner (TW) hired a contractor to install fiber-optic cable around the City of Plano.  In addition to requiring the contractor to carry specified types and amounts of liability insurance, TW's contract also required it to be added as an additional insured to the contractor's CGL policy, a very common arrangement.  TW later sued the sub for negligently causing damage to the work and surrounding property.  Again, not an uncommon development.

TW then sued the contractor's CGL carrier seeking $1.5 million for property damages.  The trial court, for reasons not explained in the decision, granted summary judgment to TW.  On appeal, the court readily agreed with the insurer that TW, as the tort plaintiff, had no right to bring a direct action against the defendant's CGL insurer until it obtained a judgment or a settlement agreed to by the insurer.  Texas, unlike Louisiana, is not a "direct action" state.  Plaintiffs may not skip over defendants and directly sue their liability insurers.

TW then boldly demanded coverage for its damages by virtue of its status as an addition insured under the policy, relying on the recent Lamar Homes decision (see Lamar Homes Decision, holding that defective workmanship may constitute a covered occurrence and cause property damage under a CGL policy -- not a contested issue in the TW suit). 

To its credit, the court patiently analyzed the policy language and concluded that TW could not show any claim alleging TW's legal liability for covered damages.  Quoting Allan Windt's respected treatise, Insurance Claims & Disputes, the court observed, "Third-party liability policies require, as a condition precedent to the insurer's liability, that the insured be liable to a third person, by means of either a judgment or a settlement."

What was TW thinking?  Additional-insured status does not convert a third-party liability policy into a first-party property policy or a construction bond.  However, the court refused to render judgment in favor of the insurer and instead remanded the case to the trial court because the insurance claims were not ripe.  In other words, TW might be sued by Plano or adjacent landowners and so might be entitled to liability coverage at that time.  An adverse judgment now might unfairly impair TW's rights to such coverage.

Texas Supreme Court Does About Face on Frank's Casing Decision: Insurers May Not Reserve a Right of Reimbursement For Uncovered Claims

Excess Underwriters at Lloyd's, London v. Frank's Casing Crew & Rental Tools, Inc., #02-0730 (Tex. Feb. 1, 2008) See Majority Opinion

The Texas High Court first decided this case in May 2005 causing a near fire-storm among policyholder and defense-bar interest groups.  I commented on this reaction and the reasons for it last April (Why Has the Frank's Casing Decision Got Everybody So Upset?).  In a nutshell, the Court originally held that a liability insurer, defending under a reservation of rights, may accept a reasonable settlement offer within policy limits while continuing to reserve its rights to contest coverage and seek reimbursement for amounts allocable to uncovered claims.  The policyholder must repay the insurer even if it does not consent to the insurer's right to reimbursement, as long as the policyholder agrees that the settlement amount is reasonable.

Why the heated response?  The 2005 decision arguably puts the onus on the policyholder to accurately evaluate both the reasonableness of the settlement and the merits of the insurer's coverage defenses, something insureds are rarely experienced at but insurers do for a living.  Also, the defense bar screamed because the original decision appeared to offer the policyholder a way out if it did not agree that the settlement offer was reasonable.  But defense counsel is typically expected to evaluate settlement demands both for the insured and the defending insurer.  However, doing so after the 2005 decision might harm the interests of the insured (by pronouncing the demand as reasonable), but refusing to do so might violate duties owed to the insurer.

So the Supreme Court has now retreated from its original position and decided that the insurer may reserve rights to reimbursement only if that right is stated in the policy or the insured gives "clear and unequivocal consent to the settlement and the insurer's right to seek reimbursement."  In so holding, the Court expands the reasoning it adopted in Texas Ass'n of Counties County Gov't Risk Mgmt. Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000), in which the insurer attempted to reserve a right of reimbursement of a settlement that the insured neither consented to nor opposed (Frank's Casing not only agreed the settlement was reasonable but demanded that Lloyd's accept it). 

The Matagorda County Court recognized that either the insurer or the insured must be left to face a difficult choice.  If the insurer is barred from reserving a right to reimbursement, it must either refuse to accept a reasonable settlement within policy limits, relying on the strength of its coverage defenses, yet risk breaching its Stowers duty to accept a settlement demand within policy limits, or accept the settlement and avoid the risk of extracontractual damages, yet lose forever any right to show that the claim is not covered. 

If the insurer can reserve a right to reimbursement, the insured is put to the hard choice of rejecting the insurer's offer to pay and thereby risk both a much larger judgment plus losing the coverage fight, or accepting the settlement offer and face the risk of reimbursement.  The Court decided to shift the risks of decision to the insurer, holding that, even if the insured agrees that the settlement is reasonable and urges the insurer to accept it, the insurer may not reserve a right of reimbursement without the clear consent of the insured.

Three justices vigorously dissented.  Justice Hecht joined by Green (Dissent 1) argued that "a balanced, practical, and principled rule for resolving the issue presented by this case" is to allow a party disputing its obligation to perform to go ahead and perform the duty but reserve its right to restitution if the other party is benefited beyond what it bargained for in the contract.  (This principle is embodied in The Restatement (Third) of Restitution and Unjust Enrichment, Sec. 35).  Noting that the lower court found that the policy in fact did not cover the alleged claims, and also noting that Frank's Casing was "a substantial business," Justice Hecht argued that the balance of equities should be determined on a case-by-case basis, which the majority rejected.

Justice Wainwright dissented on other grounds (Dissent 2).  He stated, "I would conclude that there is no right to reimbursement.  Absent the parties' entering into a legally enforceable agreement, I do not believe the equities of the parties' respective circumstances alone support allowing a right to recoup the settlement payment."  Yet, in this case, Justice Wainwright would find that by acquiescing to Lloyd's payment, Frank's Casing in fact entered such an agreement.

Assuming no further alterations to this decision, insurers will, from now on, have to choose between continuing to contest coverage or accepting reasonable policy-limit settlement demands.  In Texas, insurers may pursue coverage actions while the underlying lawsuit is pending.  No doubt, we will see an increase in such actions.  Policyholders, who before now blanched at commenting on the reasonableness of demands, are now free to join with the underlying plaintiff in pressuring the insurer to avoid Stowers breaches and accept the demand.

Perhaps most important, we have now recently seen three major coverage decisions from this Court favoring the interests of the policyholder (the PAJ Decision and the Lamar Homes Decision).  Given the number of insurance cases still pending before the Supreme Court, the trend is likely to be significant.