New Mexico Supreme Court Requires Insurers To Defend When They Have Actual Notice of a Suit; Not So in Texas

Garcia v. Underwriters at Lloyd's, London, Op. # 2008-NMSC-018 (N.M. March 13, 2008).  See Garcia Opinion.

Although Texas and New Mexico share a border, they appear to be on opposite poles of the insurance planet, at least on this issue.  The Supreme Court of New Mexico holds in the Garcia opinion that a liability insurer's duty to defend is presumptively triggered when it receives actual notice that a lawsuit has been filed against its insured, not, as under Texas law, when the insured forwards the suit papers and demands a defense.  To overcome the presumption that it must defend, the insurer has to prove that the insured turned down the insurer's offer of defense or was unresponsive or uncooperative.

The rule in Texas, recently reaffirmed by the Texas Supreme Court, is that an insurer is under no obligation to "gratuitously subject itself to liability" by offering to defend an insured who has not asked for a defense or forwarded suit papers to the insurer.  See National Union Fire Ins. Co. v. Crocker, 246 S.W.3d 603, 608 (Tex. 2008) (holding that additional insured was not entitled to a defense absent written demand on the insurer, even though the additional insured was unaware that his employer's policy would cover him as well and so did not request a defense, and the insurer was defending the co-defendant employer in the same lawsuit and knew the employee was covered and paying for his own defense).  See my discussion of the Crocker decision at Liability Insurer Has No Duty to Inform Additional Insured That Coverage Exists. 

The Crocker Court's rationale is that the policy typically states that the insured's actual demand and submission of the suit papers is a condition precedent in the policy, and the condition serves the essential purposes of (1) facilitating timely and effective defense and (2) triggering the duty to defend by notifying the insurer that a defense is expected.  If this rule seems somewhat overly protective of the insurer's interests, you are not alone.

The approach adopted in the Garcia decision is animated by the contrary policy of protecting the reasonable interests of insureds.  The facts in Garcia are a little messy, involving the vagaries of New Mexico probate process (indeed, the reason Lloyd's took no action to defend the insured's estate sued in a dram shop lawsuit was that its New York counsel misread New Mexico probate law and assumed the probate court had no jurisdiction over the tort action).  Moreover, the Court acknowledged that fact issues existed on whether the estate administrator adequately demanded a defense (apparently, the administrator also misunderstood New Mexico probate law and thought that he did not have the authority to demand a defense and instead urged Lloyd's to petition the probate court for the right to defend the estate -- at this point my teenage son would write "LOL").  In other words, the New Mexico Supreme Court did not have to make a new law.  It just wanted to.

The Garcia Court held that the burden of communicating about the defense should fall on the insurer.  The insurer knows, reasoned the Court, that most of the time insureds will want the benefit of a defense.

Why then should the insurer receive the benefit of a rule requiring written tender . . .?  Such a rule requires an insured to jump through meaningless hoops towards an absurd end: telling the insurer something it already knows.  Such a rule injects a degree of gamesmanship into the insurer-insured relationship without providing any valid corresponding benefit.  In fact, the only benefit of such a rule is to create a possibility--where none otherwise exists--for an insurer to escape an obligation it otherwise owes its insured.

(Quoting Federated Mut. Ins. Co. v. State Farm Auto. Ins. Co., 668 N.E.2d 627, 632-33 (Ill. App. Ct. 1996).

Nor does the insurer have to learn of the lawsuit from any particular source.  "We hold that, for the purposes of determining when an insurer's duty to defend arises, 'actual notice means notice from any source sufficient to permit the insurer to locate and defend the insured.'" (quoting Illinois Founders Ins. co. v. Barnett, 710 N.E.2d 28 (Ill. Ct. App. 1999)).  The Garcia Court found that a question of fact existed whether the administrator's letter constituted a rejection of a a defense (that was never offered) and sent the parties back down to the lower court for trial on this issue (at least there weren't sent into the jungle of New Mexico probate jurisdiction).

So which is the better approach?  The Garcia Court did not discuss the possibility that unscrupulous plaintiffs could collude with insureds to give the insurer just enough actual notice of the lawsuit to trigger the duty to defend and then obtain a monster default judgment before the insurer can find the insured and tender a defense.  Although this is possible, many jurisdictions, including Texas, have fairly forgiving procedures for overturning default judgments, particularly when the real party in interest, here, the insurer, has been unfairly excluded from participating. 

On balance, it is easier to picture instances of unfairness to the insured, as in Crocker, than to the insurer, particularly when the insured is unsophisticated and does not know of the available policy benefits.  Absolving the insurer of any obligations whatsoever unless the insured affirmatively demands a defense gives the insurer every incentive to keep mum even when the insurer knows that the insured is ignorant of its rights.  Additional insureds in commercial contexts often do not even know the identity of the insurer.  The rule adopted in Garcia seems less likely to lead to unfair results for either party and, when it does, is probably easier to fix through review procedures.