Law and Insurance

Conflict of Interest Issue Eludes Court

Downhole Navigator, L.L.C. v. Nautilus Ins. Co., No. 4:10-0695 (S.D. Tex. May 9, 2011)

The bargain universally made between the policyholder and the liability insurer is that insurer promises to defend and indemnify the policyholder against all the risks of legal liability alleged in the lawsuit, and in return, the insurer has the right to call the shots on the best way to defend the lawsuit, including the right to select the defense attorney.  However, that right to control the defense may shift if the lawsuit alleges one or more claims that the insurer believes are not covered by the insurance policy, and the insurer notifies the policyholder that the insurer is defending subject to its right to deny coverage for this, that, and the other uncovered claim.  The "reservation of rights" letter, which the insurer is required to send to preserve its coverage defenses, may put the policyholder in the driver's seat if (and this is the big if illustrated by this case) the insurer's reservation of rights creates a "conflict of interest" between the insurer and the policyholder.

This shift of control of the defense became a fixture of Texas law in North County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685, 688 (Tex. 2004).  The Texas Supreme Court held that a conflict of interest created by a reservation of rights letter would shift to the policyholder the right to select defense counsel on the insurer's nickle.  However, the Court said that, if an insured rejects the insurer's defense without a sufficient conflict, the insured loses the right to recover defense costs.  So what constitutes a "sufficent conflict"? 

The test is deceptively simple.  "[W]hen the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends, the conflict of interest will prevent the insurer from conducting the defense." Id.at 689.  A example of this is the lawsuit alleging that John Doe either was negligent when he smashed into his neighbor's tree, or he did it on purpose because he had a heated argument with the neighbor an hour before the accident.   The neighbor bringing the lawsuit is probably hedging his bets.  It's easier to prove negligence, but he has a shot at even more damages if he can convince a jury that the act was intentional.  However, the defendant's insurance policy covers negligence but not deliberate acts.  Presumably, the insurer will send a reservation of rights letter, explaining to the insured that it will defend the lawsuit because negligence is alleged, but the insurer will not pay any damages should the jury find the damage was intentional.

This letter creates a conflict of interest because the facts to be adjudicated at trial (did he act with intent or negligence?) are the same that determine coverage or not.  Unpacking this a little, the core concern is that the attorney hired by the insurer, who probably depends on the goodwill of insurance companies for her daily bread, might work against the defendant's best interests and, ever so slightly, nudge the development of the case to highlight the heated argument and benefit the insurer.

 In the Downhole case, an oil drilling company was sued after it allegedly "slacked off" over the drill and caused various forms of damage:

including. but not limited to: loss of profit; loss of business opportunity; loss of investment opportunity; loss of value of lease; loss of minerals; cost of delay in performance, anticipated remedial costs and other damages.

The driller sought defense and indemnity, and Nautilus sent a reservation of rights letter, which stated:

Nautilus Insurance company will provide your company wit a defense to these claims.  However,Nautilus reserves all rights to disclaim any duty to indemnify for claims and judgments which fail to seek "damages" under the policy, as further set forth below.

The policy covers only "property damage," defined as physical injury to tangible property.  The lawsuit alleged a host of damages that are not "property damage," such as delay damages, loss of investment, and other non-tangible economic losses.  Yet the lawsuit at least potentially alleges physical injury to the well itself.  So, did the reservation of rights create a conflict of interest?

The magistrate judge said no.  "The question for the court, then is whether the 'facts to be adjudicated' in the lawsuit are the 'same facts upon which coverage depends."  The court then reasoned that, because the lawsuit alleged that the driller was negligent, that is not an issue upon which coverage depends.  The court was using as its yardstick a case called Housing Authority of Dallas v. Northland Ins. Co., 333 F. Supp.2d 595, 601 (N.D. Tex. 2004), in which the coverage determnation turned on whether the alleged wrongful conduct was willful or not.  The magistrate judge in the Downhole case concluded that Northland did not apply since willfulness was not alleged.

But that misses the point.  The conflict of interest frequently arises from alternative allegations of negligent and willful conduct, but that is not the only issue that can create the conflict.  In this case the driller argued that the conflict resided in the alternative forms of damage, some of which were not covered.  So a defense lawyer hired by the insurer could nudge the development of the case in such a way as to emphasize the uncovered damages or to fail to develop any evidence of physical damage to the well.  And voila, the jury awards nothing but intangible losses that the insurer happily refuses to pay.  How is that not a conflict of interest?

The district court judge might want to review this one.

David S. White, Thompson & Knight LLP

www.tklaw.com

"Governmental Authority" In Pollution Exclusion Does Not Include Cities, Says Texas Court

Dallas National Ins. Co. v. Sabic Americas, Inc., No. 01-08-00758-CV (Tex. App.--Houston [First Dist.] March 10, 2011) See Decision

This case is worth a look for two reasons.  First, it shows that it is still possible (maybe I should say, now possible) to obtain some pollution coverage in a commercial general liability policy.  Second, the court held that the term, "governmental authority" was ambiguous.  Policyholder-side lawyers throughout Texas will add this to a list of cases finding ambiguous policy terms.  They can be the silver bullets of coverage litigation.

Sabic was one of scores of defendants sued by cities and municipal water districts alleging that their water supply systems were contaminated by methyl tertiary butyl ether (MTBE) that the defendants had added to their petroleum products since the 1970's.  The plaintiffs alleged that Sabic and others knew or should have known the unique dangers that MTBE would cause to groundwater and sought:(1) removal of contaminants from groundwater, (2) testing and monitoring of groundwater, and (3) recovery of damages, both for testing and monitoring and for damage to water wells and other property.

The insurer, Dallas National, had issued CGL policies to Sabic from 2003-2007, but refused to defend or indemnify on 3 grounds: the suit does not allege "property damage," Sabic knew of the loss well before 2003, and the pollution exclusion barred coverage.  The court curtly dismissed the first two arguments (the suit explicitly alleged property damage, and the plaintiffs alleged both intent and negligence, so voiding a known-loss defense).  The pollution exclusion, however, gave the court pause.  The provision excluded coverage for:

any loss, cost, or expense arising out of any: (a) request, demand, order or statutory or regulatory requirement that any insured or others test for, monitor, clean up, remove, contain, treat, detoxify or neutralize, or in any way respond to, or assess the effects of "pollutants": or

(b) claim or suit by or on behalf of a governmental authority for damages because of testing for, monitoring, cleaning up, removing, containing treating, detoxifying or neutralizing, or in any way responding to, or assessing the effects of "pollutants."

The court accepted the insurer's premise that there would be no duty to defend if the plaintiffs were "governmental authorities."  Sabic won, however, by persuading the court that the term was ambiguous.  Ok.  Stop here for a minute.  How could the court believe that cities and municipal water districts were not "governmental authorities"?  Before answering, it is important to understand two important rules of policy construction in Texas.  First, the court may not consider any evidence beyond the terms of the policy and the pleading (although the insurer may have missed a step by not asking the court to take judicial notice of state statutes creating the various plaintiffs).  Second, The policyholder wins by persuading the court that its interpretation of the disputed exclusion is merely reasonable, even if the insurer's interpretation is also reasonable, or even more reasonable.

Sabic argued that "governmental authority," in the context of this pollution exclusion, should be limited to a government agency that has some authority to issue and/or enforce environmental cleanup demands or orders.  After noting that the term was undefined in the policy, the court distinguished  several cases offered by the insurer that characterized munipalities as "governmental authorities."  These cases, said the court, were not dealing with CGL interpretation issues.  From there, it was a short step to finding that, all in all, Sabic's interpretation was not unreasonable, so Dallas National is flushed.

Reading between the lines, I think the insurer became overconfident.  How could cities not be governmental authorities?  But I doubt it would have had to look very far to find insurance cases that identify municipalities or water districts as governmental authorities, or at lease as governmental somethings.  Having no insurance cases even in the ball park left the court free to make what seems to be a pretty bold distinction.

In Texas, "governmental authority" in any exclusion is now fair game for policyholders to attack as ambiguous.

David S. White, Thompson & Knight LLP

www.tklaw.com

Extrinsic Evidence Admissible to Find No Duty to Defend, Says 5th Circuit

Atlantic Cas. Ins. Co. v. Gonzalez, No. 10-20296 (5th Cir. November 24, 2010) see Decision

Only in Texas does a court have to fudge the law a little to get around the state's absolute "8-corner" rule to reach what is obviously the correct result.  The 8-corner rule, also called the "complaint allegation rule," bars a court from considering any evidence beyond the terms of the insurance policy and the allegations in the complaint to determine whether a liability insurer owes a duty to defend its insured in a lawsuit.  Most states follow this rule but none so strictly as Texas, which adopted an arguably absolute application of this rule in Guideone Elite v. Fielder Road Baptist Church, 197 S.W.3d 305 (Tex. 2006).  The problem with an absolute application of this principle is that a plaintiff can plead a covered case out of coverage or, as attempted here, an uncovered case into coverage, simply by manipulating the allegations in the lawsuit.

The plaintiff was electrocuted while working for a friend, who was working as an independent contractor for the insured, PV Roofing Corp.  As a result, the plaintiff lost both arms and and legs and sued PV Roofing.  The plaintiff's original petition alleged that he was an employee of the insured.  He amended that pleading and alleged merely that he was working at home.  Later, in a third and then a fourth amended petition, the plaintiff alleged explicitly that he was not an employee or independent contractor of PV Roofing, but was "engaged in residential roofing" and had control over "the job."  PV Roofing sought defense and indemnification from its CGL carrier, Atlantic Casualty, which denied coverage.

The policy contained an exclusion barring coverage for:

(i) "bodily injury" to any "employee" arising out of or in the course of (a) Employment by the insured; or (b) Performing duties related to the conduct of any insured's business

(ii) "bodily injury" to an "contractor" arising out of or in the course of performing services of any kind for which the insured may become liable in any capacity . . .

The policy defines "employee" to include any person "hired, leased, contracted or volunteering for the purpose of providing services to or on behalf of any insured, whether or not paid for such services" (the plaintiff alleged that he was not paid).

Can anyone reasonably believe that the plaintiff did not meet this definition of an "employee"?  Yet he explicitly alleged in his most recent pleading that he was not an employee or contractor.  Under the 8-corner rule, the court is supposed to take the allegations as they are on face value and not consider any other evidence beyond the allegations.

In fact, the court considered extrinsic deposition evidence that the plaintiff was working at the direction of a PV Roofing contractor.  In doing so, the court fudged a little, as I said.  First, the court noted that "Gonzalez has not contested this testimony or the use of this extrinsic evidence."  However, that is not relevant to whether the court may consider that extrinsic evidence.  On that point, the court relied on a 1993 5th Circuit decision permitting consideration of extrinsic evidence "when a petition's factual allegations are insufficient to determine if there is a possible case for coverage."  W. Heritage Ins. Co. v. River Entm't, 998 F.2d 311 (5th Cir. 1993).  The court did not consider whether this 1993 decision might no longer represent Texas law on the subject after the Guideone decision, which I think is the fudge factor here.  The court upheld judgment for Atlantic and refused to find a  duty to defend.

The result is certainly correct.  However, I don't think the court needs to consider extrinsic evidence.  The allegation that the plaintiff was not an employee is more legal than factual, a point the court mentioned, and only factual allegations are relevant to the coverage analysis.  More compelling than the absence of factual allegations is the logical disconnect between the plaintiff's seeking legal liability from PV Roofing and his denial of any outside control over his work.  I think the court should be permitted, even within the 8-corner rule, to draw the necessary inference, from the plaintiff's own allegations, that PV Roofing's legal liability must be based on some control by the defendant.  The factual allegations are certainly vague but necessarily imply that PV Roofing had some responsibility for Gonzalez's work; otherwise, how could he seek to hold the insured legally liable? 

Also, the policy itself excludes bodily injury to a contractor performing services "for which any insured may become liable in any capacity."  If PV Roofing may be held liable, then the exclusion applies, and the policy applies only if legal liability is sought against he insured.  Coverage is a logical impossibility.

The point here, however, is that Texas's absolute 8-corner rule should be modified to allow courts some leeway to consider extrinsic facts.  Otherwise, plaintiffs may manipulate a defendant's coverage simply by artful pleading.

 David S. White, Thompson & Knight LLP

www.tklaw.com

 

Federal District Judge Says Texas' "Eight-Corner" Rule Is No Longer Law. Really?

David Lewis Builders v. Mid-Continent Cas. Co., No. 4:09-CV- 218-A (N.D. Tex. April 1, 2010), see Lewis Decision

This otherwise unremarkable decision denies defense and indemnity liability coverage to a homebuilder who had to repair or replace its own work, something excluded under exclusions j.(5) and (6) in standard CGL policies.  What is remarable, however, is an observation made in footnote 3 of the decision that the so-called "eight-corners" or "complaint-allegation " rule no longer applies under Texas law.  Say what?

I have frequently commented on "eight-corner" cases.  In fact, my very first post on this blog in April 2007 highlighted the strickness with which Texas courts apply the rule (see Good for the Gander- Strict "Complaint-Allegation Rule Not Always Beneficial for Policyholders) Under this rule, upheld by the Texas Supreme Court in GuideOne Elite Ins. Co. v. Fielder Road Baptist Church, 197 S.W.3d 305, 308 (Tex. 2006), a liability insurer's duty to defend its insured must be determined only with reference to the insurance policy and the pleading or complaint in the lawsuit.  A court is instructed not to consider any "extrinsic evidence" that might impact coverage, and so far, the high court has not recognized any exceptions to this strict rule.

For example, the Texas Supreme Court a few months ago upheld a lower court decision that a general contractor was not entitled to a defense of a claim that alleged liability for property damage only against the general, who, however, was covered only for work performed by a subcontractor.  Well, guess what, the subcontractor in fact caused the damage, and the general offered evidence to establish the fact.  (See my post, Policyholder Wins Big In Texas High Court Duty-To-Indemnify Decision).  The court reaffirmed that the insurer owed no duty to defend (because the pleading was silent on the crucial fact that established coverage), but the court accepted the evidence to require the insurer to indemnify.  The point is, the "eight-corner" rule in Texas is tighter than a tick.

So why does a federal district court judge say that it is no longer Texas law?  The court cites to an 2006 case, B. Hall Contracting Inc. v. Evanston Ins. Co., 447 F.Supp.2d 634, 644-46 (N.D. 2006) rev'd on other grounds, 273 F. App'x 310 (5th Cir. 2008), which was authored by the same judge (see B. Hall Decision).  In the B. Hall case, the court held that alleged property damage fell within exclusion j(5) and (6), just as in the Lewis case, so no duty to defend.  But the court went on to explain another reason for denying the duty to defend that depended on consideration of extrinsic evidence. 

The policy before the court required the insurer to "pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies."  The court noted that this wording "is different from the wording found in most liability policies, in that it does not say that [the insurer] 'will defend any suit brought against [the insured] seeking damages, even if the allegations of the suit are groundless, false or fraudulent.'"  The court then considered that the "eight-corner" rule somehow depended on the groundless-false-or-fraudulent language in the policies the judge was accustomed to seeing, citing the GuideOne case that affirmed the "eight-corner" rule based on the broader duty owed under the duty to defend.  The B. Hall court then concluded that the language of the policy before it "makes the duty to pay and the duty to defend co-extensive."  In other words, the "eight-corner" rule is dead in Texas.

However, respectfully, this conclusion over-reads GuideOne and does not comport with the insurance industry's own understanding of the current duty-to-defend language.  Standard ISO (i.e., Insurance Services Office, which promulgates standard forms for the industry) CGL policies dropped the groundless-false-fraudulent formula after 1985 and has used the language in the B. Hall policy for 20 years before that case was decided.  ISO's own annotated treatise on the CGL policy addressed the very point raised in B. Hall:

Before the introduction of the 1986 commercial general liability form, the insurer's obligation to defend claims against the insured extended explicitly to allegations that were "groundless, false or fraudulent."  That language does not appear in the 1986 and subesequent CGL editions and its removal has occasionally raised questions as to whether the duty to defend is narrower than under older versions of CGL coverage.  Under the current language, the insurer's duty to defend does not in any way depend on whether the allegations made against the insured are true:

We will have the right an duty to defend the insured against "suit" seeking those damages [i.e., damages becasue of "bodily injury" or "property damage" to which this insurance applies].

In other words, as long as it is alleged that insured has caused injury or damage of a kind insured against by the poloicy--even if the insured did not in fact cause such injury or damage--the insurer is entitled to a defense against those charges.

[Annotated Commercial General Liability Insurance, IRMI, 15th printing 2008, at p. v.c.12].  I fail to see anything in the post-1985 formula that would offer greater inducement to consider extrinsic evidence than the older language.  Whether Texas courts should entertain some reasonable exceptions to their strict interpretation of the rule is another question.

Thus, B. Hall's report of the demise of the "eight-corners" rule appears to be greatly exaggerated.

David S. White, Thompson & Knight LLP

www.tklaw.com

Court Finds Patent Infringement A Covered Advertising Injury

Hyundai Motor America v. National Union Fire Ins. Co. of Pittsburgh, No. 08-56527 (9th Cir. April 5, 2010) see Decision

This decision is a reminder of the potentially enormous value to businesses ensnared in intellectual-property litigation of an often-overlooked provision in just about every commercial general liability (CGL) policy, covering advertising injury.  This case is particularly remarkable because the court found that a patent-infringement allegation triggered the insurer's duty to defend, which almost never happens.  But even in copyright, trademark, trade dress, and other disputes over intellectual property that more readily trigger advertising-injury coverage, defendant companies often fail to check their CGL policies to see if their insurer might owe them at least a defense.  These type of cases usually cost millions to defend because the company's life blood may be at stake.  So, if your company is sued, check your CGL policy for the following:

Advertising Injury.  We are used to thinking of CGL policies covering bodily injury and physical damage to property, but standard policies also cover an odd assortment of offenses such as false imprisonment, invasion of privacy, wrongful eviction, malicious prosecution (my favorite), and advertising-injury offenses.  The insuring agreement is simple:  "[This insurance applies to:] "advertising injury caused by an offense committed in the course of advertising your goods, products or services . . .   "Advertising injury" is defined in this case as any of the following offenses:

1. Oral or written publication of material that slanders or libels a person or organization or disparages a person's or organizations goods, products, or services;
2. Oral or written publication of material that violates a person's right of privacy;
3. Misappropriation of advertising ideas or style of doing business; or
4. Infringement of copyright, title, or slogan.

The last two on the list are particularly apt in copyright, trademark, and trade dress litigation.

Two caveats: (1) the alleged injury must occur in the course of advertising, and (more tricky) (2) many jurisdictions, including Texas, also require that cause of the injury must be the advertising activity itself, not something else, such as the sale of the product being advertised.  Patent infringement usually fails this test because the injury is typically the sale of the infringing product, not the advertising.  This brings us to the Hyundai case.

Hyundai's Patent Infringement.  Hyundai, like most major corporations, maintains a website which  allows users to "build your own" (BYO) vehicle by navigating a series of menus of different colors, engine types, transmission types, and other options.  A customer may use a similar BYO feature to select customized parts.  A company called Orion IP, LLC holds patents for a "method of generating customized product proposals for potential customers of an automobile product."  Orion sued, alleging that Hyundai's BYO features infringed Orion's patents.  Hyundai sought a defense under its CGL policy, arguing that Orion alleged "misappropriation of advertising ideas."  The insurer denied the claim.  A jury found against Hyundai and awarded $34 million to Orion.  Hyundai then sued its insurer, seeking reimbursement of its defense costs but not the amount of the jury verdict.  (Not sure why Hyundai did not also seek coverage for damages, but advertising injury is often the tail wagging the dog -- only a tiny part of the lawsuit alleges advertising injury, which is enough to snag a defense but no more).

The coverage case was decided under California law, but the result would probably be the same in Texas and other jurisdictions.  The court first defined "advertising" as "widespread promotional activities directed to the public at large," which did not, however, encompass "solicitation."  The insurer had argued that use of a website entailed one-on-one solicitation, not advertising.  The court disagreed.  "A website is plainly directed to the public at large; therefore, the BYO feature constitutes 'advertising.'"

Misappropriation of Adverting Ideas.  The insurer next attempted to distinguish between the advertisement and the patented product and argued that the alleged injury concerned the patented product being advertised rather than the content of the advertisement.   The court again rejected the insurer's position.  Noting that patent infringement can qualify as an advertising injury if the patent involves "any process or invention which could reasonably be considered an advertising idea."  Here, said the court, "Orion patented a method of displaying information to the public at large for the purpose of facilitating sales."  In other words, Hyundai was using an advertising technique that was itself patented.  Thus, the infringement suit alleged an advertising injury.

Patent infringement fails to trigger coverage in most cases because the plaintiff complains that the defendant infringed the patent by manufacturing, advertising, and selling the patented product.  Courts routinely hold that the mere allegation that the product was advertised does not trigger coverage, because the advertising activity is not what caused the injury.  Sale of the patented product is the infringing activity.  That is why patent infringement is rarely covered.

However, insureds usually have a fair chance of receiving a defense in lawsuits in which the advertising, not the sale, caused the injury.  For example, if I infringe your copyright by advertising my product or service, and the advertisement includes material you copyrighted, the lawsuit should trigger the duty to defend because copyright infringement is an enumerated offense and the injury cannot be separated from the advertisement.  Even easier to cover are allegations over usurping trade dress or style of doing business in the course of advertising.  

Keep on your litigation check list: Is advertising injury alleged?

David S. White

www.tklaw.com

5th Circuit Decision Is a School for Drafting Indemnity and Insurance Clauses

Travelers Lloyds Ins. Co. v. Pacific Employers Ins. Co., No. 07-20157 (5th Cir. April 6, 2010), see Decision

Upon learning the other day that the indemnity (or "hold harmless") provision in a ground lease was unenforceable for failing to meet the Texas "express-negligence" straight-jacket, a landlord client of mine sighed, "whenever I see the words, 'indemnification' or 'insurance,' my eyes glaze over."  True the world over.

This case is a tutorial for landlords (and other additional-insureds/indemnitees) on the fundamental difference between the indemnification clause and the insurance-procurement clause lurking in just about every lease.  Also shows why the indemnity is unenforceable.  The case is also notice-worthy for its (potentially troublesome) decision requiring the additional-insured's liability insurer to contribute to defense and indemnity under the so-called "other-insurance" clause in the insurance policy.

Insurance and Indemnity Clauses.  The lease between commercial tenant Best Buy and Landlord, which is typical in the real estate world, includes two separate clauses:

Tenant's Insurance.  Tenant shall obtain and keep in force at Tenant's expenses [sic] . . . commercial general liability insurance [specified amounts omitted].  Said insurance shall name Tenant as named insured and Landlord as additional insured . . .  .

Tenant shall indemnify and hold Landlord harmless from and against any and all claims, actions, demands, liens, costs, damages, expenses, and liabilities whatsoever including, but not limited to, attorneys fees and court costs arising out of any claims of any person or persons on account of: (a) any occurrence in, on or about the Premises . . . (b) the negligence or willful misconduct of Tenant . . . in, on or about the Premises.

A Best Buy patron was injured after slipping from the curb just outside the store.  Suit was brought against both Tenant and Landlord, whose respective insurers were duly notified.  Tenant's insurer refused to defend or indemnify Landlord, arguing that the indemnity was unenforceable, thus relieving it of any duty to defend Landlord as an additional-insured.  Landlord's insurer seems to concede that the indemnity is unenforceable, so let's start there.

Faithful followers of this blog know well why the indemnity is unenforceable because I comment on this vexed issue ad nauseum.  Even though the Tenant promised to hold harmless for all claims anywhere and everywhere, Tenant failed to say the magic words, "even if Landlord is negligent."  Texas's "express-negligence" rule requires an express stipulation in the indemnity clause that the indemnity applies even if the indemnitee is negligent.  Texas law also requires that clause stand out in boldface, all-cap, or other conspicuous lettering.  So, Travelers knew there was no point is arguing that the indemnity was enforceable, because it ain't.  Lesson one:  everybody check your indemnities.

Lesson two: the insurance-procurement clause stands on its own and will trigger coverage even if the indemnity fails.  I'm surprised Pacific even took a run at this argument.  Courts are instructed to ignore the indemnity clause when construing the insurance clause.  The accident occurred "on or about" the leasehold, which is close enough. 

Other-Insurance Clause.  Tenant's insurer next argues that Travelers at least has to share the cost of defense and indemnity by virtue of the "other-insurance" clause in just about every liability policy on the market.  Here Tenant's policy provides:

If other valid and collectible insurance is available to the insured for a loss we cover under this policy, this insurance is excess over that other insurance, unless that insurance is written specifically to apply in excess of the Limits shown in the Declarations.

Landlord's policy provides:

If other valid and collectible insurance is available to the insured for a loss we cover under Coverage A or B of this Coverage Part, our obligations are limited as follows: (a) This insurance is primary except when (b) applies. . . .  (b) This insurance is excess over any of the other insurance . . .  that is valid and collectible insurance available to you if you [Landlord] are added as an additional insured under any other policy.

Not surprisingly, both insurers claimed excess status over the other.  The lower court favored Landlord's insurer, holding that Landlord's additional-insured status met the exception in Tenant's policy that the insurance be written specifically in excess of the Tenant's policy.  The Fifth Circuit, however, disagreed.

The appellate court reasoned that "specifically to apply in excess of the Limits shown in the Declarations" applies only when the Tenant procures excess insurance that explicitly schedules the Pacific policy as underlying the excess policy.  So Travelers has to contribute to the defense and the settlement on an "equal-shares" pro-rata basis.

I said earlier that this holding was "potentially troublesome."  The lease required Tenant to purchase insurance that named Landlord as an additional insured, with no other specifications or restrictions.  I advise clients aspiring to additional-insured status to draft the insurance clause to also require that the named insured's policy be "primary and non-contributory" with the additional-insured's insurance.  How would the Travelers Lloyds court rule if that language was included in this lease?   I am not sure. 

If the lease required primary and non-contributory status, but the Pacific policy did not mirror that requirement in the policy, the court, arguably, would not rewrite the policy.  The result might be the same.  This might give Landlord a breach-of-contract claim against Tenant for failing to procure a policy that complies with the insurance clause, but that would likely give cold comfort to Landlord.  So

Lesson three:  Landlords and all additional-insured wannabees, insist on receiving a copy of the named insured's additional-insured endorsement soon after execution of the lease.  Do not rely on a certificate of insurance, which is not binding on the insurer.  I know this can be a pain, especially if you run a big operation with hundreds of leases.  But I know of no other way to verify that the other's policy matches the contract you spent so much time and attention drafting.  The court will look at the policy; so should you.

Better to add a drop or two of wash to those glazed eyes than lose thousands (millions) in coverage.

David. S. White, Thompson & Knight LLP

www.tklaw.com

Construction Case Shows 8-Corner Rule Dilemma Under Texas Law

Mid-Continent Cas. Co. v. Academy Development, Inc., No. H-08-21 (S.D. Tex. March 24, 2010) see Decision

Another Texas-size dilemma with the duty to defend.  This case illustrates an emerging tension between Texas's draconian 8-corner rule and its long-held policy of construing allegations liberally in favor of coverage.  A liability policy that provides a duty to defend requires the insurer to defend a lawsuit if even one factual allegation potentially triggers coverage.  The court must consider only the policy terms and the allegations in the lawsuit (the 8-corner rule) and construe those allegations liberally in favor of coverage.  But how should the court rule if the allegations are silent about a fact necessary to determine coverage but do not exclude that possibility?

In this homeowner-sues-developer case, the pleadings do not specify when the alleged damage actually occurred, which might have been within the policy period.  Before 2008, this problem would arise rarely, if ever, because we all thought Texas followed the "manifestation" trigger for property damage, fixing the time of an occurrence at the point that the damage manifested itself.  Lawsuits usually alleged when the homeowner first learned of the damage (probably because that date is relevant to show that the claim was not time-barred).  However, in 2008, the Texas Supreme Court suprised us in Don's Bldg. Supply, v. OneBeacon Ins. Co., 267 S.W.3d 20 (Tex. 2008) by holding that damage occurs, well, when it actually occurs, not when it is discovered. 

The court reached its ruling based on the plain meaning of the policy language (covering "property damage caused by an occurrence" within the policy period) but acknowledged that many courts applied a manifestation approach for convenience.  It is often a lot easier to know when damage is first discovered than when it first begins in fact.  This is especially true with building construction.  The owner finds the rotted floor and files suit, usually with no way of pinpointing the actual time damage occurred except sometime after construction began.

Getting back to the dilemma.  The owner alleges when construction began and when the damage was discovered, but nothing else to fix the time of actual damage.  Let's assume about half of that stretch of time falls within the policy period, and half before or after.  Under the 8-corners rule, the court may not consider extrinsic evidence, such as an engineer's expert report fixing the time when water first began seeping in, when the wood first began to decay, when support beams first started to fail.  Should the court hold that the homeowner failed to carry its burden of proof because no allegations show that the alleged damage occurred witin the policy period?  Or should it construe liberally and allow the duty to stand if the allegations, though silent, do not affirmative exclude the possibility that the damage occured within the policy period?

Texas courts split.  Gehan homes, Ltd. v. Employers Mut. Cas. Co., 146 S.W.3d 833 (Tex. App.--Dallas 2004) held that, if the pleadings do not state facts sufficient to clearly bring the case within or without coverage, the insurer should defend, as long as it is clear that potentially, the damage could have occurred within the required time frame.  By contrast, insurance companies rely on the recent Texas Supreme Court case, D.R. Horton-Texas, Ltd. v. Markel Int'l Ins. Co., 300 S.W.3d 740 (Tex. 2009), holding that a homeowner's lawsuit naming only the general contractor did not trigger the duty to defend, even though in fact, a subcontractor, not mentioned in the pleading, performed the defective work, a fact that would have brought the case within coverage.

I have discussed before the abject cruelty of a rule that places the duty to defend, or not, exclusively in the hands of plaintiff's counsel, who may not know or care that the decision to state or omit a fact determines the duty to defend.  (See Another 8-Corner Heartbreaker).  Nor does it help that the 8-corner rule is blind and strikes against policyholders and insurers with equal abandon.  A false allegation of a coverage fact can just as easily trigger undeserved coverage.

I would, however, argue for tilting toward the Gehan Homes approach when the case concerns latent property damage, as here, and the only reason for withholding a defense is silence over when the damage actually occurred.  That fact is so seldom alleged, and coverage is many times so plain, that a rigid application of the 8-corners rule as applied here is unsupportable.  For example, suppose the time from start of construction to discovery of the damage is five years, during which the policyholder had five consecutive policies.  We know that the alleged damage had to have fallen within at least one of the policy periods, but under the reasoning applied in this case, all five insurers would be entitled to summary judgment, even though all five potentially have a duty to defend. 

That is what the rule of liberal construction is for.

David S. White, Thompson & Knight L.L.P. 

http://www.tklaw.com/

Court Curbs Expansive Reach of Absolute Pollution Exclusion

National Cas. Ins. Co. v. Orior Transport, Inc. No. H-09-1539 (S.D. Tex. Feb. 22, 2010), see Decision

The so-called "absolute pollution" exclusion has become a fixture in commercial liability insurance policies for the last two decades.  It is called "absolute" because it excludes damage or injury caused by all releases of pollutants, including the "sudden and accidental" variety that had been routinely covered before the 1990's.  A "pollutant" includes just about any solid, liquid, or gaseous substance more noxious than water, dirt, or pure oxygen.  And a "release" can be no more than an inch or two movement from point A to point B.  In a word, the insurance industry has successfully plied the absolute pollution exclusion to deny claims having nothing to do with environmental pollution, such as the painter who falls off a scaffold from dizziness (caused by paint fumes), and the laborer unloading bags of cement who sustained eye injuries from the dust. 

This case went in favor of the policyholder following some very close parsing by the trial judge.  A trucking company in the business of hauling away salt water refuse from oil wells hired a welding contractor to repair one of its trailers.  Unfortunately, the tank had not been completely emptied from its last job, and some "potentially explosive residue" remained in the trailer.  During the repair, the potential became actual, and an explosion killed the welder.  The decedent's family sued the trucking company who sought coverage under a commercial auto policy with an absolute pollution exclusion.  The insurer refused coverage arguing that the explosion resulted from a release of the gaseous residue.

Before looking at the court's resolution, we need to look at the language of the exclusion itself, which has a few wrinkles found only in some auto policies.  The policy excludes:

"Bodily injury" . . . arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of "pollutants" that are, or that are are contained in any property that is: (1) being transported or towed by, handled, or handled for movement into, onto or from, the covered "auto"; . . . [or] (3) being stored, disposed of, treated or processed in or upon the covered "auto."

This exclusion is triggered only if the pollutant release occurs during one of the enumerated activities.

The judge probably could have decided the issue without considering any of the activities.  The petition simply alleges that the explosion of the residue occurred while the welding was being done -- no explicit allegation of any "discharge, dispersal, seepage, migration, release or escape."  The insurer argued that some kind of release must be inferred.  How else can the welder's spark outside the trailer ignite fumes unless the fumes had escaped from inside the trailer? 

Without conceding the insurer's argument, the judge proceeded to the enumerated activities and found that the residue was not being transported, handled, stored, disposed of, treated or processed.  The insurer again argued that that one had to infer that the residue was present in the trailer only because one of the activities had occurred.  The salt water had been transported for disposal, and the stuff that exploded was residue of those activities.  Therefore, the residue should be treated as the equivalent of the salt water.

The court was unpersuaded.  Orion's motion for summary judgment was granted. 

Although the court didn't elaborate, at work here is the principle that, when determining an insurer's duty to defend, reasonable inferences should be drawn in favor of the policyholder, not the other way.  The insurer's arguments were plausible.  But the right question is whether the court could reasonably determine that, at the moment of the explosion, the residue was not being transported, handled, stored, treated or processed. 

What's in a Name? Insured Loses Coverage By Failing to Inform Insurer of Name Change

VRV Development, L.P. v. Mid-Continent Cas. Co., No. 09-cv-1382 (N.D. Tex. Feb. 3, 2010) see Decision

The insured in this case lost coverage because it changed its name in 2005 from VRV Development, Inc. to VRV Development, L.P. and failed to change the named-insured designation on its liability policy.  Risk managers, take heed! On the named-insured designation, expect no tolerance with the identification of the business.  A corporation is not a limited partnership. A miss is as good as a mile. 

VRV Development, Inc. and its president, Kenny Marchant, are in the land development business, and contracted to build retaining walls on property to be developed into residential subdivisions.  The work began in late 2004 and ended in January 2006.  The company purchased general liability insurance in 2004, and renewed the policy in 2005.  On January 1, 2005, the corporation converted to a limited partnership, with Mr. Marchant as the sole limited partner.

Alas, by January 2007, the walls had begun to crack and tumble.  Lawsuit followed.  VRV Development L.P. submitted timely notice, but Mid-Continent looked at the policies and denied coverage.  The policies didn't cover VRV Development L.P. or Marchant as a limited partner.  The coverage lawsuit followed.

The insured made a valiant effort.  It produced solid evidence that the two companies were, in fact, the same entity.  It supported its argument for coverage with a provision of the Texas Business Organizations Act that an entity converting from one business form to another continues "without interruption" in its new form and retains "all rights, title and interests to real estate and other property owned by the converting entity" without any impairment of rights.

Yet the judge was unmoved.  First, Texas is the strictest of 8-corners jurisdictions.  Show me no extrinsic evidence to determine Mid-Continent's duty to defend.  Second, an insurer gets to choose who it insures. 

"Allowing [VRV] to substitute  a new party to an insurance contract, without Mid-Continent's knowledge or approval, and without giving Mid-Continent the opportunity to evaluate the entity or person it is purportedly insuring, materially rewrites that insurance contract in a way that would seem to contravene existing authority."

The kicker in favor of Mid-Continent is a policy provision that "no person or organization is an insured with respect to the conduct of any current or past partnership, joint venture or limited liability company that is not shown as a Named Insured in the Declarations."

Tragic.  One argument that VRV might make today that it did not have when it filed its summary judgment brief is that the Texas Supreme Court arguably blessed the submission of extrinsic evidence that shows the possibility of a duty to indemnify.  See D.R. Horton-Texas, Ltd. v. Markel Int'l Ins. Co., No. 06-1018 (Tex. Dec. 11, 2009) (See Markel Decision).  See my discussion of Markel here.  Evidence that the conversion to a limited partnership resulted in no substantial change in the business might allow VRV to prevail at the end of the underlying action, requiring Mid-Continent to indemnify even if there was no duty to defend.

But the best advice is to avoid this problem in the first place.  Keep your broker and insurer informed of your business reorganizations.

Federal Court Refuses to Extend Mid-Continent Ruling to Defense Costs

Trinity Universal Ins.Co. v. Employers Mut. Cas. Co., # 08-20532 (5th Cir. January 4, 2010) see Decision

"The more, the merrier" doesn't always hold true in the complicated game of liability insurance.  When you are sued, you would think that having two or more insurers covering your liability would be a good thing, for both you and the insurers, who would be able to share the risk among themselves.  However, in 2007, the Texas Supreme Court stirred up a dust storm in Mid-Continent Ins. Co. v. Liberty Mut. Ins. Co., 236 S.W.3d 765 (Tex. 2007), when it held that an insurer that paid all of a settlement on behalf of its insured, both its own share and the shares owed by other insurers covering the risk, had no remedy to recover the overpayment from the other insurers.

The situation in Mid-Continent is very common.  Multiple insurers do not always agree on what is a just settlement or what each insurer's share should be (although usually the insurance policies contain "other insurance" clauses that pre-allocate the share owed -- usually on a pro-rata or equal-share basis).  So often, one insurer, more risk averse than the others, will take a lead and settle the entire claim.  Then the settling insurer will seek contribution from the others, either by agreement or through litigation.  Either way the policyholder benefits by getting the lawsuit resolved with a minimum of wrangling.

I won't go into the legal reasons for the Mid-Continent result (see my discussion of the case here).  It seemed to be like the traveler in Maine asking for directions and hearing, "You can't get there from here." 

Do I have a right of contribution?  No, you lost that when you put an "other insurance" clause in your policy.

Well, can I enforce my "other insurance" clause against the other insurers?  No, they never signed a contract with you (which is English for "You don't have privity with them").

Then I will seek subrogation from them.  Sorry, the insured was made whole by the settlement, so stepping into the insured's shoes (i.e., subrogation) is not available.

You can't get there from here.  Make no mistake, Mid-Continent is a major pain for insurers, but it is, arguably, really bad for insureds, who now have to rodeo to the bitter end because no one insurer will take the lead.  In fact, one holdout can result in settlement gridlock.

So, what does that have to do with the Trinity Universal case?  The Fifth Circuit Court held that Mid-Continent does not limit the right of an insurer that takes the lead and defends the insured from recovering shares of the defense costs owed by other insurers who also have a duty to defend the insured.  In this case, Employers Mutual decided to take a shot at denying a duty to defend, even though at least two other insurers with similar policies had recognized the futility of Employers' line of argument and agreed to defend.

Employers was immediately sued by the other insurers (who no doubt hoped to get a ruling on the duty to defend before they faced the Mid-Continent dilemma of settling without everybody on board).  The lower court threw the case out accepting Employers' argument that Mid-Continent applied to the duty to defend as well as the duty to indemnify.  The 5th Circuit reversed.

"Other insurance" clauses, reasoned the appellate court, apply only to "loss," which does not include defense costs.  Moreover, unlike the duty to indemnify, an obligation that is "several and independent," the duty to defend is broader and creates "a debt which is equally and concurrently due by" all of the insurers.  Each insurer that owes a duty to defend is obligated to defend the entire case, including uncovered claims.  So, Employers must contribute to the defense.

Trinity Universal may mitigate some of the hardship from the Mid-Continent decision.  Insurers will find no benefit in taking a wild swing at denying a duty to defend and so will more likely take a seat at the table early in the game.  A seat at the table gives all insurers the same access to defense counsel's evaluations of the merits of the case and the likely damages a jury could award.  Thus, the insurers will be more likely to work together.  They may even agree to participate in any settlement agreed to by a majority of the defending insurers, thus obviating Mid-Continent at the settlement stage. 

In for a penny.  We'll see.