Law and Insurance

Insurers May Use In-House Staff Lawyers To Defend Insureds in Texas

Unauthorized Practice of Law Committee v. American Home Assur. Co., #04-0138 (Tex. March 28, 2008) See Law Committee Decision.

The Texas Supreme Court ruled that, despite genuine concerns for potential conflicts of interest, insurers' use of salaried employee-staff lawyers to defend insureds did not constitute an unauthorized practice of law by an insurance company.  However, staff lawyers may be used only where the interests of the insurer and the insured are aligned in defeating the claim against the insured.  Also, the insurer must fully disclose the defense attorney's affiliation with the insurer.

In Texas, the Supreme Court regulates the practice of law and established the Unauthorized Practice of Law Committee to carry out this function.  In this case the Committee ruled that American Home and other insurers violated a statute prohibiting corporations from practicing law when they used in-house staff lawyers to defend insureds.  Corporations may use in-house counsel to represent the corporation's own interests (hence corporate counsel departments in most corporations), but they may not use employee-lawyers to represent unrelated persons.  The Court ruled that insurers with a duty to defend insureds are protecting their own interests when they hire defense counsel because the insurers pay the judgment.

The Committee had condemned the use of staff lawyers in part because of concerns that insurers have greater power over employees than over outside law firms and have been known to limit the attorney's ability to conduct depositions, obtain paper discovery, and hire expert witnesses.  Some insurers have prohibited staff lawyers from informing insureds of the insurer's Stowers obligation to accept reasonable settlements within policy limits.  However, the High Court held that, even if this was true, there is no reason to believe that insurers have any less control over outside counsel, which they can hire and fire at will just like employees.  Also, the Court found no evidence of actual harm ever resulting from the use of in-house attorneys.

Two Justices dissented on the narrow basis that the practice violates the State Bar Act (Sec. 81.101 of the Texas Government Code).  Because the "practice of law" definition in the statute contains no provision for profit or loss considerations, the dissent argued that for-profit corporations, whose board and shareholders are not (necessarily) attorneys limited by professional, ethical and disciplinary rules, cannot legally provide legal services to the public.

Thus employee-attorneys may defend insureds except where the insurer raises substantive coverage defenses.  Does this mean that the policyholder may sue the insurer if the lawyer commits legal malpractice?  In State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998), the Supreme Court held that the insured may not hold the insurer liable for the mistakes of defense counsel because the counsel owes an unqualified duty of loyalty to the insured even when the insurance company hired the attorney.  The American Home opinion says that the insurer's control over outside counsel is substantively the same as over its own employees.  Presumably, the Court would say that the attorney's duties to the insured are the same whether outside or employed, and Traver still controls.  But employers are vicariously liable for the torts of their employees, and nothing in American Home suggests any change in that law.

That question remains for another day.

Normal Legal Principles May Not Apply With Government Backed Insurance Programs

Reynolds v. Southern Farm Bureau Cas. Ins. Co., #SA-06-CV-0700 RF (W.D. Tex. March 13, 2008)

This flood insurance case stands in bold contrast to the last case I described illustrating courts' aversion to the often harsh effects of absolute legal forfeitures.  See Conditions Precedent Continue Under Attack in Insurance Policies.  But the law can be a tricky thing, as the Reynolds case shows.  "Estoppel," not condition precedent, is the legal principle at stake in Reynolds.  Estoppel, as my contracts law professor explained, means nothing more than "shut up!" and bars a party from asserting an otherwise valid legal right under a contract based on that party's earlier conduct inconsistent with that right and the other party's reliance on that conduct.  Example:  The policy requires submission of of proof of loss within 60 days after loss.  Insured asks for a week extension, and the insurer agrees.  The insurer will normally be estopped from enforcing the 60 day deadline based on its earlier indication that it would grant the request for an extension.  In other words, the court will tell the insurer, "shut up" if the insurer tries to assert its legal right to enforce the deadline.

The facts in Reynold are a little more complicated.  in fact, it's hard to see that the insured was treated unfairly, but, as the court observed, it would come to the same result even if the equities tilted dramatically in the insured's favor.  The Reynolds purchased flood insurance under the National Flood Insurance Program (NFIP) for their vacation home.  The floods came -- twice.  After the first flood in 2002, the insureds submitted their proof of loss for the flood damage a couple of months after the 60 day deadline.  However, FEMA granted a waiver, and the Reynolds' claim of $16,000 was paid.

The same home was damaged again after a 2004 flood, a claim for which was again paid under the policy.  However, the Reynolds also submitted an additional proof of loss for more than $40,000 for unreported repairs resulting form the 2002 flood.  FEMA refused to waive the 60 day deadline for these damages, and the Reynolds cried foul: Insurer should be estopped based on its earlier waiver of the deadline.

Under these facts, a court might not have applied estoppel in any case, particularly since the reason given for the refusal was not the 2-year delay but that the repairs were done before any investigation could be made.  But that is not the point.  Let's assume the fact pattern that I stated above.  60 day deadline--insurer agrees in writing to a week's extension--insured relies on the extension and files a week late--insurer denies.  A court would reach the same result under those facts as in the Reynolds case in the absence of FEMA's written acceptance of the extension.

Why FEMA?  The NFIP is a government-backed program under which private insurance companies issue flood policies that are underwritten by the federal government and administered by FEMA.  That makes all the difference.  The normal principles of law and equity that allow courts to bend conditions precedent to favor coverage or shut up insurers that try to assert policy defenses unfairly have no effect before the federal government because of Constitutional reservation and separation of powers.  As the Reynolds court observed (quoting Growland v. Aetna, 143 F.3d 951 (5th Cir. 1998):

When federal funds are involved, the judiciary is powerless to uphold a claim of estoppel because such a holding would encroach upon the appropriation power granted exclusively to Congress by the Constitution.  "Any exercise of power granted by the Constitution to one of the other branches of Government is limited by a valid reservation of congressional control over funds in the Treasury." (citation omitted)

Pretty scary stuff for a homeowner without a law degree (or even with a law degree).  In this case FEMA probably acted fairly.  But even if it acted unfairly, the courts would not interfere.  The lesson is this:  when dealing with a contract with, or backed by, the federal government, authorized approval is crucial.  The adjuster or the insurance company may not, and probably does not, have authority to bind the government.  Any deviation from the terms of the flood policy should be pre-approved by the authorized federal agent.  Who is that?  I don't know.  You might get approval from a FEMA representative, only to learn later that her boss now says she didn't have the authority to grant the approval.  I can only say that right now Michael Chertoff has the requisite authority.

"Conditions Precedent" Continue Under Attack in Insurance Policies

Quihong Liu v. Fidelity & Guar. Life Ins. Co., #06-41224 (5th Cir. March 7, 2008), see Quihong Liu Opinion

"Conditions precedent," long a formidable defense against coverage, have slipped a bit lately.  Traditionally, a "condition precedent" in a contract is treated as an absolute requirement, failing which the other party has no obligation to perform.  An example, addressed by the Texas Supreme Court a couple of months ago, is the notice requirement in a general liability policy.  It was once the law in Texas (and still is in New York) that an insured's failure to send notice of a claim "as soon as practicable" doomed any right to coverage because the policy said prompt notice was a "condition precedent."  In the PAJ case, the Texas High Court re-characterized the condition, in substance if not in name, as a covenant rather than a condition precedent, requiring the insurer to prove prejudice from the late notice before it could deny the claim.  See my discussion in PAJ Decision.

The Quihong Liu decision similarly shoots down a so-called "good health" condition in a life insurance policy by finding that it is not a condition precedent, but a representation.  Mr. Chen applied for a life insurance policy on September 4, 2003 and truthfully answered certain questions about his health.  He also agreed:

[N]o insurance will take effect unless and until both of the following conditions are satisfied during [applicant's] lifetime and while [applicant's] health is a stated in this application: (1) this policy is delivered to an accepted by the Owner; and (2) the full initial premium . . . is paid at our Home Office.  [Emphasis Added].

A few days later, Mr. Chen was diagnosed with lung cancer.  Two days after the diagnosis, the policy was delivered to Mr. Chen, who died shortly after that.  The insurer refused to pay the death benefit arguing that the condition precedent of pending good health was not met, even if the application was accurate.

The court observed that "Texas law strongly disfavors warranties and conditions precedent."  Only when the policy contains an unambiguous "good health warranty" demonstrating the parties' clear intent that payment is expressly conditioned on the literal truth of an insurer's certification of good health, will the policy be voided.  The court found that that the phrase, "while health is as stated," either was not a condition precedent (but rather a representation of good health) or the language was ambiguous.  Either way, the court held that the insurer failed to show a misrepresentation and had to pay.

Unlike PAJ in which the Texas Supreme Court simply rode rough shod over a clear condition precedent in order to bring Texas law into line with the majority of other states on the issue, the Fifth Circuit here merely demonstrates customary hostility to conditions precedent and looks for a not impossible reading in favor of coverage.

5th Circuit Rules Out Economic-Loss Doctrine in Failure To Procure Insurance Claim

SMI Owen Steel Co. v. Marsh USA Inc., No. 06-41387 (5th Cir. March 7, 2008) See SMI Opinion.

Last year, the Texas Supreme Court banished the "economic-loss doctrine" from any place in insurance coverage analysis.  See my discussion of the Lamar Homes Opinion.  In the SMI case, the 5th Circuit finds, under Nevada law, that an insured's negligence procurement claim against an insurance broker is not barred under the same doctrine.

In the last decade or so, the economic-loss doctrine has emerged as a powerful defense against any tort claim brought against a defendant in a contractual relationship with the plaintiff.  One court defined the doctrine this way:

Broadly speaking, the economic loss doctrine is designed to maintain a distinction between damage remedies for breach of contract and tort.  The term "economic loss" refers to damages that are solely monetary, as opposed to damages involving physical harm to person or property.  The economic loss doctrine provides that certain economic losses are properly remediable only in contract.  The doctrine has its roots in common law limitations on recovery of damages in negligence actions in the absence of physical harm to person or property.

Giles v. General Motors Accept. Corp., 494 F.3d 865, 873 (9th Cir. 2007).  "The primary purpose of the rule is to shield a defendant from unlimited liability for all of the economic consequences of a negligent act, particularly in a commercial or professional setting, and thus to keep the risk of liability reasonably calculable."  Local Joint Executive Bd. of Las Vegas v. Stern, 651 P.3d 30, 51 (Nev. 1982).  Pushed to its extreme, however, the rule would eliminate any extracontractual causes of action for legal malpractice or, in this case, a broker's negligent failure to procure insurance.

The facts of this case are complicated.  SMI was a subcontractor on a large construction project.  Marsh was the insurance broker procuring a variety of insurance policies for many of the contractors and subs in the project.  SMI was sued for negligent design and fabrication of its part of the project.  Marsh issued several certificates of insurance reflecting that SMI was covered for professional liability when in fact no such coverage was procured (whether Marsh was supposed to procure the coverage is a disputed point, but a jury found that it was but negligently failed to do so).  SMI settled the underlying lawsuit and sued Marsh on several theories.  A jury awarded SMI over $7 million for Marsh's negligence.

Marsh raised two defenses on appeal.  First, Marsh argued that the professional liability policy it would have procured would have excluded the claims against SMI, so Marsh's negligence did not cause any damage.  The court found that sufficient evidence existed to undermine that defense.  Marsh also argued that SMI could not recover under the negligence theory due to the economic-loss rule.  The court reviewed Nevada law and found that Nevada recognized a cause of action against an insurance agent for negligent failure to procure insurance.  Moreover, the court found that, although the Nevada Supreme Court had applied the economic-loss rule in some cases, none of these cases involved alleged violation of a professional, extracontractual duty imposed by law.

In other words, if the alleged violation constitutes a violation of a duty imposed by law, independent of the express duties undertaken in the parties' contract, then the doctrine will not apply.  The Nevada Supreme Court had held in an earlier case that insurance brokers are not obligated to assume the duty of procuring insurance, but when they do so, the law imposes upon them a duty of care to perform non-negligently.  Therefore, the SMI Court held that the economic-loss rule did not apply to failure-to-procure claims against insurance brokers.

And so the economic-loss doctrine loses a bit more of its swagger.

Did Mid-Continent Overrule Garcia?

Earlier, I reported the Texas Supreme Court's decision in Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W.3d 765 (Tex. 2007) that a defending co-insurer, willing to pay something towards settlement for its insured  but refusing to pay its fair share, breached no duties (and owed no reimbursement) to another co-insurer that had paid more than its pro rata share of the settlement. See my discussion, Primary Co-Insurer Owes No Duty.  I suggested that this decision might impede settlements when co-insurers are defending because neither insurer will pay more than its share to effect settlement when it cannot recoup the overpayment from the low balling carrier.

However, another problem is how to square the decision in Mid-Continent with the High Court's decision in American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 855 (Tex. 1994 written by Justice (now Senator) Cornyn), which states in dictum just the opposite of Mid-Continent that co-insurers "must" contribute their share to a settlement. 

Garcia involved multiple malpractice policies over successive years in a "Stowers" action in which the insured doctor alleged that the carriers had failed to accept a reasonable settlement offer within policy limits.  The Court had to decide what the policy limits were when multiple policies had been triggered, and held that an insured may not "stack" the limits of multiple policies that cover the same occurrence.  So, how does one identify the policy limits in that situation?

The Court sought to clarify this question as follows:

If a single occurrence triggers more than one policy, covering different policy periods, then different limits may have applied at different times. In such a case the insured's indemnity limit should be whatever limit applied at the single point in time during the coverage periods of the triggered policies when the insured's limit was highest.  The insured is generally in the best position to identify the policy or policies that would maximize coverage.  Once the applicable limit is identified, all insurers whose policies are triggered must allocate funding of the indemnity limit among themselves according to their subrogation rights.  [Emphasis added]

The no-stacking holding wouldn't apply in the case of multiple concurrent insurers, as in Mid-Continent, but I do not see why the insurers' rights vis a vis co-insurers would be any different.  For more than a decade, practitioners have relied on the methodology prescribed in Garcia for getting the settlement ball rolling when successive policy years are triggered.  The insured picks the policy year, and the carriers fall in line.  Does Mid-Continent overturn Garcia on this point? 

"Insurance companies are not eleemosynary institutions," observed Justice Willett in his concurrence in Mid-Continent.  The next time the insured picks the line a la Garcia, we can be sure the other insurers will raise Mid-Continent as a defense against paying their share.