Nautilus Ins. Co. v. International House of Pancakes, Inc. 622 F.Supp.2d 470 (S.D.Tex. 2009)
Texas' Prompt Payment Statute (Tex. Ins. Code Sec. 542.054) imposes on slow-pay insurers a penalty of 18% per year on any covered "first-party" claim. Two years ago, the Texas Supreme Court confirmed that a liability insurer's duty to pay defense expenses on behalf of its insured was a "first-party" obligation within the Prompt Payment Statute. (Lamar Homes Inc. v. Mid-Continent Cas. Co., 428 S.W.3d 193 (Tex. 2007)). In this case, Nautilus makes a valiant, though doomed, effort to have the statute itself struck down as unconstitutional on its face or otherwise void for vagueness.
IHOP was sued by a woman alleging that a restaurant manager sexually harassed and raped her. Nautilus denied the claim and refused to defend IHOP and the manager, but the court ruled that Nautilus had a duty to defend IHOP. After Lamar Homes, Nautilus should be liable for reimbursing IHOP's reasonable defense attorneys' fees plus 18% per year without further ado. Nautilus, however, filed a motion for summary judgment solely on the statutory penalty.
I won't go into the arguments that the statute is unconstitutionally vague. Civil statutes are very rarely struck down for vagueness. Although a number of Texas courts before Lamar Homes disagreed over the meaning of the statute, the court observed that it would take a lot more than split decisions in the courts to show unconstitutional vagueness.
But Nautilus fastened on the word "penalty" to argue that, on its face, the statute is "penal" in nature, and must, like any criminal statute, be strictly construed against enforcement. Indeed, the Texas Supreme Court characterized the 18% penalty as "penal in nature." (State Farm Life Ins. Co. v. Martinez, 216 S.W.3d 799 (Tex. 2007). Like a criminal penalty or fine, argued Nautilus, the Prompt Payment Statute should be strictly construed.
Somewhat anticlimatically, the court yawned and asked, "So what"? Even if construed strictly, the law is clear enough to warn the insurer that it must pay an extra 18% of the claim if it wrongly refuses to defend. Moreover, the court noted that often legislatures explicitly abrogate or modify a civil statute to remove the strict-construction rule. The court found that the Texas Legislature had done just that by inserting the instruction that the statute "shall be liberally construed to promote the prompt payment of insurance claims." Pay the defense costs.
This case arguably marks insurers' last stand against application of the Prompt Payment Statute to defense costs due under liability policies, at least in the courts.