Law and Insurance

Federal Court Reaffirms That Co-Insurers Have No Right of Contribution Under "Other Insurance" Clause

Trinity Universal Ins. Co., Utica National Ins. and National American Ins. Co. v. Employers Mutual Cas. Co., #H-07-0878 (S.D. Tex. May 15, 2008)

This result looks bad for the insurance company plaintiffs, but the real losers in the long run will be policyholders.  Here, the Houston Federal District Court dutifully followed the Texas Supreme Court's holding in Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W.3d 765 (Tex. 2007) (see my discussion at Mid-Continent Decision) that a co-insurer that wrongfully refuses to contribute its lawful share of a settlement paid by other defending co-insurers owes no duty to pay any reimbursement to those insurers despite its agreement to do so under the "other insurance" clause in its policy.  In effect, the "other insurance" clause is rendered at best meaningless, at worst a positive hindrance to the defending insurer's right to seek contribution from the non-paying insurer.  Why?

Most general liability policies contain some form of "other insurance" or "pro rata" clause to apportion responsibility for payment of defense costs and indemnity when other valid and collectible insurance is available to cover the insured's liability.  This happens frequently, as in the Trinity Universal case.  The insured, Lucy Masonry, was hired to install all the masonry work and facade items for construction of a hospital.  Unfortunately for all concerned, the design called for one of those disastrous synthetic "exterior insulation and finish systems" (EIFS) that seem to be responsible for about half of all construction lawsuits in the last five years.  The system failed, Lucy M. was sued, and about four insurers were summoned to defend and indemnify it in the litigation.  All but one insurer agreed to defend.  Employers Mutual's policy, however, contains an EIFS exclusion, and it denied coverage.  All the policies contained substantially similar "other insurance" clauses, so the three defending carriers brought a declaratory judgment action against EM while the underlying lawsuit was pending.

Because the lawsuit alleged faulty workmanship both inside the building and in the facade, the Court held that EM had a duty to defend, which EM had breached.  But that didn't matter.  Because all the policies contained "other insurance" clauses, the defending insurers lost their common law right of contribution from co-insurers, and their contractual rights were "several and independent of each other, not joint."  What does that mean?  The insurers cannot enforce contractual rights against other insurers with whom they have no contractual relationship.  Lucy M. can enforce contractual rights against EM, but the insured has no damages to assert against EM because Trinity et al. is paying the defense costs.

Moreover, the paying insurers have no subrogation rights against EM because, by definition, subrogation means stepping into the insured's shoes and asserting whatever rights the insured had to recover loss from third parties, like EM.  But at no time did Lucy M. have any loss, since the other insurers covered the defense from the beginning.  Also, the Trinity Court reiterated that a defending insurer owes a complete defense and may not pay the insured only its pro rata share.  Trinity and the others are just suck with the bill.

Unless fixed by the Legislature, this trap will result in fewer insurer offers to defend under reservation.  In the future we can expect co-insurers to refuse to contribute defense costs unless all the other co-insurers also agree to pay.  If one insurer refuses, the others cannot start paying on pain of losing any ability to later get contribution.  It is anybody's guess whether an insurer that reserves it right to refuse to defend pending adjudication of a co-insurer's coverage defenses will be subject to a bad faith claim by the insured.  The Texas Supreme Court has long held that an insurer may agree to defend subject to a reservation of rights to challenge coverage.  Of course, the insurer must then go ahead and defend.  Here, the insurer will try reserve its right to withhold defense payment until it can bring the non-payer to the table.

Whatever the outcome, co-insurers will likely be less willing to offer a defense than before.  Bad news for policyholders.

New York High Court Dodges Critical Analysis of Causal Connection With Additional Insured's Work

Worth Construction Co. v. Admiral Ins. Co., # 52 (N.Y. May 1, 2008) See Worth Constr. Decision

Another additional-insured puzzler, this time resolved by the New York High Court.  The issue: Does a liability insurer have to cover an additional insured general contractor for workplace injuries occurring on the named insured subcontractor's work site but not caused by the named insured's negligence?  Most of the time, both in New York and in Texas, the answer is yes (see my discussion of the Texas Supreme Court ruling in Evanston v. Atofina Decision that only a broad, loose causal connection is required between the named insured's conduct/operations and the injury; on New York law, see Impulse Enterprises/F&V Mech Plumbing and Heating v. St. Paul Fire & Marine Ins. Co., 282 A.D.2d 266 (N.Y Sup. 2001: "The focus of [an additional-insured endorsement] such as St. Paul invokes is not on the precise cause of the accident but the general nature of the operation in the course of which the injury was sustained").  Here, however, the New York Court reached the opposite result based on the peculiar facts of the case.  I think a Texas court would disagree.

Worth, the general contractor on a building project hired Pacific to construct a staircase, which required two separate operations.  Pacific first installed the stairs.  Other subcontractors then poured concrete to form walls around the stairs, after which Pacific was to return to the site to install the handrails.  After Pacific had built the staircase, but before the walls were completed, an iron working subcontractor slipped and fell on fireproofing that had been applied to the stairs by yet another subcontractor.  Pacific was not working on the site at the time and had nothing to do with the application of the fireproofing.  The injured worker sued Worth (but not Pacific) alleging, among other things that the staircase was negligently constructed (this, for me is the crucial fact).  Pacific had agreed to add Worth as an additional insured to Pacific's liability policy, so Worth submitted the claim for defense and indemnity to Pacific's insurer, Admiral.

Admiral denied the claim arguing that the injury did not arise out of Pacific's work.  Worth sued Admiral and asserted that, because the injury occurred on the staircase that Pacific constructed, the claim fell within the scope of the additional-insured endorsement.  After all, said Worth, New York law says look only at the general scope of the operations, not the negligence of Pacific, the named insured (see above). The lower courts agreed, but the Court of Appeals reversed.

One of the peculiarities of this case, which decisively influenced the High Court, was that Worth admitted in the underlying lawsuit that Pacific was not negligent.  Given this admission and the fact that Pacific was not even on the site at the time, the Court determined that the connection between the accident and Pacific's work was too remote.  Here is the critical holding:

Once Worth admitted that its claims of negligence against Pacific were without factual merit, it conceded that the staircase was merely the situs of the accident.  Therefore, it could no longer be argued that there was any connection between [the] accident and the risk for which coverage was intended. [Emphasis added].

But isn't the location of an accident typically the determining factor in applying addition-insured provisions?  What distinction does the Worth Court make when it says Worth conceded that the staircase was merely the "situs" of the accident.  Why use the Latin word instead of the English, "site"?  Beware of lawyers (and judges) when they revert to Latin; they may be trying to finesse or obfuscate a difficult point.  Here I cannot say that the Court exactly nailed the point by saying that the accident only happened on the stairs, therefore "it could no longer be argued that there was any connection between the accident and the risk for which coverage was intended."  Why can't it be argued?  Listen to it:  "Worth should be covered because the accident occurred when the guy slipped on the stairs that Pacific built, and -- by the way -- the guy said in his lawsuit that he slipped because the stairs were negligently constructed." 

Rather than revert to latinisms and circumlocutions (is that Latin?), the Court should spell out its reasoning to allow the parties to recognize what makes an accident too remote from the named insured's conduct to trigger coverage.  Admittedly, this is a close case.  We are left to wonder, for example, why Worth didn't go after the policy of the subcontractor that applied the fireproofing.  How long had Pacific been off the job?  Is fireproofing fundamentally separate from the stairway itself?  It would have been a service to us all if the Court had spelled it out and said what aspect of Pacific's operations was dispositive.

If the case were presented under Texas law, the allegation in the underlying complaint should have removed any objection to coverage.  Texas follows a strict application of the 8-corners rule, and the plaintiff's allegation that he slipped because the stairway was negligently constructed should preclude a court from considering any other evidence, including Worth's admission of non-negligence.  That plus the situs of the accident should be enough under the Atofina Court's decision (see above) to make this an easier case under Texas law.

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.

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.

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.

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. 

"Loss in Progress" Challenge to Duty to Defend Rejected By Texas Court

Maryland Cas. Co. v. South Texas Medical Clinics, P.A., No. 13-06-089 (Tex. App.--Corpus Christi, January 10, 2008)  See Maryland Cas. Decision.

This decision is notable primarily for the court's rejection of the insurer's fortuity, or "known-injury," defense, which insurers seem to be asserting with increasing frequency these days, particularly after a "known loss" limitation was added to standard CGL policies in 2001.  See Insurers Lose First Challenge to "Known Loss" Exclusion in CGL Policies, for discussion of a similar case.  Maryland Cas.'s assertion of this defense is all the more noteworthy because it was combined with the defense that the underlying pleadings were too vague to trigger a duty to defend.  In other words, the insurer rejected any obligation to defend because (1) the insured knew before it purchased the policy that it was engaging in wrongful conduct, and (2) the plaintiff's allegations of wrongful conduct were too vague to trigger coverage.  Do these two positions seem inconsistent to anyone else?

Texas Medical and its president and chief surgeon were sued by former employees for sexual discrimination, negligence, intentional infliction of emotional distress and invasion of privacy involving alleged "closed door" hypnosis sessions that for a period of 9 years the plaintiffs were "forced" to undergo.  Specifically, the chief surgeon allegedly detained the plaintiffs and prevented them from leaving the sessions by using a "alyce clamp," which allegedly injured one of the plaintiffs.  The defendants sought defense and indemnity from their CGL insurers arguing that lawsuit alleged false imprisonment that was covered by the policy.

Maryland argued that it had issued policies to the medical center for only 6 of the 9 years of alleged abuse, and the insured knew when it first purchased the insurance that it was engaging in the allegedly harmful closed-door sessions.  This, says Maryland, violated the fortuity doctrine that bars purchasing insurance to cover a known existing loss or a loss in progress.  ["A loss in progress occurs when the insured is, or should be aware of an ongoing progressive loss at the time the policy is purchased," observed the court.] 

The court rejected this argument because there was no evidence in the record that the insured had even received any complaints about the sessions, and Maryland could not point to any other basis for arguing that the insureds knew or should have know that an ongoing loss was in progress.

Maryland next argued that the lawsuit never actually alleged false imprisonment.  However, the court compared the factual allegations with the legal elements of a false-imprisonment action and found that the lawsuit at least potentially alleged conduct that could support such a claim, even though the court admitted to having no idea what an alyce clamp was.

Finally, the insurer argued that it should be able to allocate defense costs and pay only two-thirds of the total defense costs for the time it actually covered the insured.  Maryland argued that this allocation issue was one of first impression under Texas law.  Wrong, said the court.  Settled Texas case law has held for a decade that the duty to defend could not be allocated based on "time on the risk" or any other allocation theory.

Court Finds Indemnity's Express-Negligence Language Enforceable

XL Specialty Ins. Co. v. Kiewit Offshore Services, LTD, No. 06-41785 (5th Cir. January 2, 2008).  See XL Specialty Decision

The legal issue in this case is whether an indemnification clause in a construction contract is enforceable under Texas law, thus requiring the subcontractor's insurer to defend the indemnitee general contractor.  Both the lower court and the Fifth Circuit held that it is enforceable.  The wonder is why the insurer challenged coverage in the first place.  I suspect that indemnification law is so tricky and misunderstood in Texas that XL thought its denial was worth a shot.  Thus, this case presents yet another teachable moment about the arcane operation of the "express negligence" rule under Texas law.

Kiewit was the general contractor performing welding services on the Skyway Bridge San Francisco Bay Project and hired a subcontractor to do the welding.  An employee of the sub was killed in an explosion when working in a closed space.  The families of the deceased sued both Kiewit and the sub.  The subcontract required the sub to purchase insurance, add Kiewit as an additional insured to the liability policy, and indemnify Kiewit against liability.  The sub's insurer refused to defend or indemnify Kiewit against the lawsuit.  The case does not say why the insurance failed to cover Kiewit as an additional insured.  Instead, the courts focused on whether the insurer had a duty to defend Kiewit by virtue of the indemnity clause in the subcontract.  (General liability policies typically cover its insured's enforceable indemnification obligations)

The indemnification required the sub: "To defend and indemnify [and save harmless Kiewit] against any and all claims . . . on account of acts or omissions of [Sub] whether or not caused in part by the active or passive negligence or other fault of [Kiewit]; provided however ... not if such claims . . . are caused by the sole negligence of [Kiewit]."  [Emphasis added.  Actually the original clause is all-capped to meet a requirement under Texas law that indemnifications must be conspicuous.]

Texas law is almost unique in requiring that indemnifications must meet the "express-negligence" test, that is, must expressly state that the indemnitor [sub] will indemnify the indemnitee [Kiewit] against the indemnitee's negligence, or words that that effect.  Several Texas courts, including at least one Texas Supreme Court, have held that the language quoted above meets the express negligence test.  In other words, it is enough for me to agree to defend and indemnify you against [all claims arising from the contract operations, or the premises, or whatever else we are contracting about] whether or not you are negligent.

XL tried to distinguish other cases by arguing that this subcontract used different causal language than that approved by the Texas courts.  This contract covered liability "on account of" the sub's acts or omissions.  The other cases approved clauses covering liability "arising out of" the indemnitor's conduct.  However, the Fifth Circuit refused to accept this reasoning.  It is true that in other contexts, the Texas Supreme Court has held that "arising out of" connotes much broader causality than other causal phrases, like "due to," but Texas courts have never judged indemnification clauses on the breadth of the causal phrase used to link the liability to the conduct.  And in this case, because the sub's employee was performing the welding, no reasonable judge will quibble over whether accident arose out of the welding operation or was on account of the welding operation. 

There might have been an issue if a Kiewit employee had been doing the welding that the sub should have been doing.  Would the accident then have been "on account of" the sub's conduct?  Probably the answer is yes, simply because the courts do not appear to look very closely at causation.  It is hard enough to evaluate the express-negligence language.

Given that most of the indemnification clauses I review in my practice do not meet the express-negligence test (because most rational indemnitor's do want to cover the indemnitee's negligence), this case is a good illustration of what the courts are looking for.  Really and truly, under Texas law, if the indemnity does not explicitly include the indemnitee's own negligence, it is not enforceable.

 

5th Circuit Asks Texas Supreme Court To Clarify Prejudice Requirement For Late Notice Under Claims-Made Policies

Note: the following question may have been resolved by the subsequent Texas Supreme Court decision in PAJ, Inc. v. Hanover Ins. Co., 05-0849 (January 11, 2008) holding that an insurer must in all cases show prejudice caused by late notice when the insured fails to give notice "as soon as practicable."

XL Specialty Ins. Co. v. Financial Indus. Corp., No. 06-51683 (5th Cir. December 19, 2007).  See text of opinion at Certified Question.

The federal appellate court here certifies to the Texas High Court an interesting and murky question about a liability insurer's duty to defend a lawsuit even though the policyholder breached the claims-made policy requirement to give the insurer notice of the claim "as soon as practicable after it is first made."  A most suitable problem with which to end 2007.

The insured's management liability policy covered liability for specified conduct but only if the claim against the insured was made within the policy period, in this case between March 12, 2005 and March 12, 2006, and reported promptly to the insurer, as stated above.  Financial was sued on June 5, 2005 for breach of contract and fraud (assume this is covered conduct) but failed to send XL notice of the lawsuit until early January 2006, seven months after the claim was made but within the policy period.  Both parties stipulated in court that the notification breached the prompt-notice requirement in the policy but did not prejudice XL. 

The 5th Circuit judges recognized that Texas law was settled on two issues:

1. Concerning claims based on bodily injury or property damage, breach of a late-notice clause would not excuse a liability insurer's obligation to defend unless the insurer could show that the breach was material, i.e., caused prejudice to the insurer's rights under the policy; and
2. Under a claims-made type policy, an insured's failure to provide notice of a claim within the policy period (or any allowed reporting period after expiration of the policy) automatically excused the insurer from having to defend or indemnify the claim.

The distinction between an "occurrence" type and a "claims-made" type policy is crucial to understanding the court's dilemma in this case.  "Occurrence" policies cover the insured's liability for claims asserting that the covered accident, event or conduct (the "occurrence") occurred within the policy period, without regard to when the claim was actually asserted or the lawsuit filed against the insured.  By contrast, "claims-made" policies respond to claims asserted against the insured within the policy period, without regard to when the event or conduct occurred giving rise to the claim (although most claims-made policies impose a retroactive date limiting how far into the past the coverage will extend). 

Courts generally have recognized that, in the absence of actual prejudice to the insurer, late notice of a claim or lawsuit under an occurrence policy is generally less significant than under claims-made policies because a central benefit-of-the-bargain to the claims-made insurer is the certainty of a relatively short window of exposure to risk.  After the policy period expires (and any specified reporting period, usually a month unless a longer reporting period is purchased), the insurer can close its books on the policy.  However, the occurrence policy theoretically must be left open forever, as some insurers of asbestos and pollution risks know all too well.  The insured company that can find the old occurrence policy from half a century before can demand coverage as long as the lawsuit alleges that the pollution or asbestos exposure fell in part within the policy period.

With that distinction in mind, courts will not allow an insured to sit on a claim until after the claims-made policy is over and then send late notice to the insurer.  Even if this insurer cannot prove that it was prejudiced by the late notice, courts draw a bright line at the termination of the policy period because closure of risk was a central right the claims-made insurer bargained for (if one can say insurance policies are the result of bargaining).  Prompt notice to the occurrence insurer is arguably less of a central concern, as long as no prejudice results.

But what about the case at issue?  What if notice is given within the policy period of a claims-made policy but not "as soon as practicable"?  And what if the claim does not arise from bodily injury or property damage, as in this case?  (The XL court noted a split among Texas appellate decisions, some holding that prejudice must be shown in all cases, and others restricting the prejudice requirement strictly to bodily injury/property damage cases, including one currently on review before the Texas Supreme Court holding that advertising-injury claims do not require a showing of prejudice).

Thus:  "We certify the following determinative question of law to the Supreme Court of Texas: Must an insurer show prejudice to deny payment of a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is nevertheless given within the policy's coverage period?"

With any luck, we will have the Supreme Court's answer before New Years Day 2008.

California Court Rescues CGL Coverage From the Jaws of Broad Auto Exclusion

Essex Insurance Company v. City of Bakersfield, 154 Cal. App. 4th 696 (Cal. App. 2007)

This case illustrates the court's use of California's "reasonable expectations" doctrine to restore a city's coverage under its commercial general liability (CGL) policy for liability arising the others' use of automobiles, despite a policy amendment that excluded liability arising from the use of any autos.  This case also serves as a useful illustration of, by way of deviation from, when CGL policies typically cover car accidents and when auto policies should apply.

In this case, the city was hosting an annual fundraising event and posted exit signs from the event that channeled departing traffic onto a state highway.  The driver of a tractor trailer swerved to avoid a departing vehicle resulting in a collision and injuries.  Lawsuit followed including allegations against the city for creating a dangerous condition that helped  cause the accident.  No city vehicles were involved, and none of the vehicles or divers involved were connected with the city.  City sought a defense from its CGL insurer, Essex, which denied coverage on the basis of an exclusion in the policy for bodily injury "arising out of the ownership, non-ownership, maintenance, use or entrustment to others of any auto."

In an insurance coverage action, the lower court applied the exclusion as written and granted judgment to the insurer.  Even though the allegation against the city did not involve the use of an auto, clearly the injuries "arose out of" the auto accidents.  Note that the city's commercial auto policy would not cover this kind of accident because it did not involve an "auto" owned, rented or used by the city.  So how did the City of Bakersfield manage to purchase a liability insurance package with a gap so large you could drive a truck through it, so to speak?

Typically, CGL and auto insurance are designed to be mutually exclusive.  Policyholders expect to be covered for bodily-injury claims one way or the other.  The typical CGL policy responds to injury actions that do not involve the insured's use of a motor vehicle; if the accident allegedly arose out of the insured's use of a covered auto, including loading and unloading of same, then its auto policy should cover the accident.  (The standard "Aircraft, Auto, or Watercraft" exclusion in a CGL policy excludes injuries "arising from the ownership, maintenance, use or entrustment to others of any ... 'auto' ... owned or operated by or rented or loaned to any insured.")  The typical auto policy covers, more or less, what the CGL policy excludes.

Under this standard arrangement, one would expect Bakersfield to be covered by the CGL policy because the accident did not arise from an auto connected with the city.  However, for whatever reason, Bakersfield's CGL policy excluded accidents arising from any autos whatsoever, including those that would not trigger coverage under the city's auto policy. 

The appellate court found that the city had a "reasonable expectation" that its CGL policy would cover accidents allegedly caused by a dangerous condition not involving any city autos and reversed the lower court.  The reviewing court noted that the city could not purchase insurance from any source that would cover this kind of accident, if the auto exclusion was allowed to stand as written.  That is true.  But I question the court's explanation that the city would have reasonably expected the amended exclusion to apply only to those accidents that in some way involved city vehicles.  The broader amendment seemed tailored to do just that.  A state, like Texas, that does not have this kind of reasonable-expectation magic wand would leave the city without coverage, at least in the absence of some kind of fraud-in-the-inducement evidence that the insurer told the policyholder that the exclusion would not have this broad effect.

The lesson for the policyholder is to lay its CGL and auto policies side-by-side and make sure cost-saving amendments (I am guessing the city got a lower premium fro the broader exclusion) do not leave unintended coverage gaps.

8-Corner Rule of Interpretation Trumps Actual Facts Under Homeowners Policy

Gomez v. Allstate Texas Lloyds, #2-06-233 (Tex. App., November 1, 2007) (see case at Gomez v. Allstate)

This case turns on Texas's strict application of the "complaint allegation" or "8-corner" rule that a court must determine a liability insurer's duty to defend with reference only to the terms of the insurance policy and the factual allegations in the lawsuit. In this case, 6 year old Austin Gomez was playing at a friend's house and was injured when the friend's mom placed him on a four-wheeler with no protective gear and allowed him to operate the vehicle.  Austin's parents sued.  The homeowner insurer defended under a reservation of rights but sought a declaratory judgment that the injuries were excluded from coverage under a motor vehicle exclusion.  The Gomez parents argued that the motor vehicle in question was a recreational type vehicle, which was excepted from the exclusion and therefore covered when the vehicle is "owned by an insured while on the residence premises."  In fact, Austin was on a street at the time of the accident.

The court agreed with the insurer that the exclusion was unambiguous, and the exception to the exclusion applied only if the accident occurred on the insured premises.  However, the court also agreed with the plaintiffs that the lawsuit did not allege that the accident occurred away from the premises.  Accordingly, the court reversed summary judgment for the insurer and remanded the case for trial.

Court Finds Exceptions to Texas' Strict 8-Corner Rule

Roberts, Taylor and Sensabaugh, Inc. v. Lexington Insurance Co., H-06-2197 (S. D. Tex. Sept. 5, 2007)

Texas is probably the strictest follower in the nation of the so-called 8-corner rule that an insurer's duty to defend must be determined without reference to any extrinsic evidence beyond the 8 corners of the lawsuit complaint and the insurance policy.  The Texas Supreme Court declined to apply any exception to this rule in GuideOne Elite Ins. Co. v. Fielder Road Baptist Church, 197 S.W.3d 305 (Tex. 2006) where the complaint alleged that a youth minister accused of sexual improprieties was employed by the insured church during the policy period, but extrinsic facts would have shown that he was fired before the policy began.  Other cases have left policyholders without coverage even though extrinsic facts would have established a duty to defend.  (See Good for the Gander.)

However, the GuideOne Court did not absolutely close the door on possible exceptions, and the federal Fifth Circuit Court of Appeals has suggested that Texas law would allow extrinsic evidence where "[I]t is initially impossible to discern whether coverage is potentially implicated and when the extrinsic evidence goes solely to a fundamental issue of coverage which does not overlap with the merits of or engage the truth or falsity of any facts alleged in the underlying case."  Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523, 531 (5th Cir. 2004).

In the recent Roberts, Taylor case, a general contractor hired a sub on a municipal project, requiring the sub to procure insurance naming the general as an additional insured for liability arising from the sub's work on project.  The sub in turn hired a sub sub, whose employee was injured and sued the general.  The lawsuit didn't allege any facts about the sub or for whom the employee was performing work at the time of the accident.  The sub's insurer admitted that the general was an additional insured under the policy but refused to defend because the lawsuit did not allege that the injured employee of the sub sub was working on a project for the sub or that the sub was working for the general.  The additional insured general naturally asked the court to recognize an exception (or two) to the strict 8-corner rule and admit evidence that the sub sub's work was within the scope of the sub's covered work.

The federal district court decided that this situation met the criteria justifying the exceptions suggested in the Loving Home case.  The pleadings were silent on the applicable subcontracts under which the sub sub's employee was working, and evidence of these subcontracts would not engage the truth or falsity of the plaintiff's allegations.  Therefore, the insurer had a duty to defend the additional insured.

However, in reaching its decision, the court ignored the insurer's argument, which appears to be a good one, that the evidence of the general's contract with the sub did in fact engage the truth or falsity of the allegations in the complaint, in the same way that the actual termination date of the youth minister affected the church's liability in the GuideOne case.  If the general had no subcontract with the sub, wouldn't that affect the general's legal liability to a sub sub's employee?  Arguably, the Roberts, Taylor decision raises more problems than it solves about how Texas courts should view possible exceptions to the 8-corner rule.

Texas Insurance Code Delay Penalty Held Applicable To Defense Costs

Lamar Homes, Inc. v. Mid-Continent Casualty Co., #05-0832 (Tex. August 31, 2007)

In addition to deciding important insurance coverage issues regarding liability insurers' duty to defend construction defect lawsuits (see discussion at CGL Coverage of Construction Defects), the Texas Supreme Court also decided a 7 year controversy over the application of a statutory penalty imposed on insurers that delay handling and payment of "first party claims."  Article 542 (formerly 21.55) of the Texas Insurance Code allows policyholders to exact damages of 18% per annum for insurers' missing specific deadlines, including payment, of "first party claims," those "made by an insured or policyholder under an insurance policy or contract or by a beneficiary named in the policy or contract that must be paid by the insurer directly to the insured or beneficiary." 

This provision clearly applied to claims under first-party policies, such as homeowners and fire insurance.  Courts also readily applied the penalty to the underinsurerd/uninsured coverage in auto policies (although part of the liability component of an auto policy, the payment of UM/UIM damages is made directly to the policyholder).  What about liability insurers' obligation to pay defense costs for policyholders in defending covered lawsuits?  Is that a "first party" obligation?   The Lamar Homes Court says yes.

Texas courts have split.  Beginning with Sentry Inc. Co. v. Greenleaf Software, Inc., 91 F. Supp.2d 920 (N.D. Tex. 2000), some courts have agreed with the policyholder that, although the obligation to indemnify or pay damages or settlements on behalf of insured is third-party, payment of defense costs is first-party.  Damages are paid to the claimants; defense costs are paid to the insureds' lawyers.  Insurers countered by arguing that the Legislature never intended for the penalty to apply to CGL or other third-party type policies.  Also, applying art. 542 to the duty to defend was unworkable because the statutory deadlines are tied to specific acts, primarily payment of a demand for money.  A policyholder's request for a defense is not a demand for payment of a specific sum as much a invoking the right to require such payment in the future.  This was the primary basis for the Dallas Court of Appeals decision rejecting the insured's 542 claim in TIG Ins. Co. v. Dallas Basketball, Ltd., 129 S.W. 3d 232 (Tex. App.- Dallas 2004).

In Lamar Homes, the Court held that the obligation to pay defense costs was first-party in nature, so art. 542 would apply to delayed payment of defense costs under liability policies.  The Court recognized the problem raised by TIG but did not elaborate or provide a solution.  See Lamar Homes Decision.  Moreover, the dissenting opinion did not even raise the 542 issue.  Therefore, policyholders may seek recovery of delay damages for covered defense costs when the insurer misses one of the statutory deadlines (e.g., written acknowledgment of the claim within 15 bus. days, payment at least after 60 days).

What are the practical implications?  First, the threat of an 18% additional penalty should pressure insurers to offer to defend more claims than before, if only under a reservation of rights.  Many issues remain unresolved, but it would appear that an insurer who refuses to defend and later loses a coverage contest will have to pay the 18% penalty.  The safer course for insurers will be to pay defense costs but reserve rights to contest coverage for settlements or judgments.

Second, policyholders will have to heed the warning of TIG.  The clock will probably not begin on the running of the 18% until the insurer's failure to pay an actual invoice submitted to the insurer for payment.  In other words, sending a demand for defense at the outset of litigation will not trigger the deadlines under art. 542.  Only when defense cost invoices are sent does the insurer have to calendar the required responses and payment.  A good illustration of this is the Greenleaf Software case mentioned above, in which the insured demanded a defense in 1997.  After the insurer refused to defend, the insured defended itself in the underlying case and eventually settled the case.  Approximately 12 months after first demanding a defense, the insured forwarded all of the defense costs invoices to the insurer along with the settlement and demanded payment of all of it.  The court ruled that art. 21.55 (now 542) applied to the defense invoices, and the 18% began to accrue the earlier of 60 days after the invoices were submitted in 1998 or the date the coverage lawsuit was filed.  Policyholders are advised to review the statute carefully and tailor demands for payment to the language of the statute.

Texas High Court Allows CGL Coverage of Construction Defects

Lamar Homes, Inc. v. Mid-Continent Casualty Co., #05-0832 (Tex. August 31, 2007)

In a watershed decision, the Texas Supreme Court has decided that a commercial general liability (CGL) insurer must defend insured contractors and builders against lawsuits alleging damage caused by the insured's construction defects.  The critical insurance coverage issues are whether a contractor's defective work could constitute an "occurrence" (basically, an accident) and whether damage to the insured's construction work (as opposed to other property that the insured did not work on) could constitute "property damage" (physical injury to or loss of use of tangible property).  This decision resolves one (or perhaps two) of the biggest insurance-coverage debates of the decade and will have lasting influence on how other coverage disputes will be analyzed under Texas law over the basic insuring language of the now ubiquitous CGL policy insuring agreement .

Facts.  The homeowner plaintiffs sued the builder, Lamar Homes, after discovering cracks and leaks attributed to faulty construction of the foundation.  The builder's CGL insurer refused to defend or indemnify the lawsuit asserting that: (1) the alleged faulty workmanship was not an occurrence because it was the result of deliberate conduct (i.e., breaching one's contract), not an accident; and (2) damage to an insured's own work or products could not be property damage under the "economic loss rule" (barring a plaintiff from recovering tort damages for economic losses resulting from a breach of contract). 

Economic-Loss Rule.  If I buy a defective toaster that explodes, my claim against the seller is limited to my economic loss, the remedy allowed under contract law (what I paid for the toaster), unless the explosion also damaged other property or caused bodily injury, in which case I can recover tort damages for the seller's negligence (or - the jackpot - punitive damages if I can prove gross negligence).  The insurer in Lamar Homes asserted that CGL policies cover only torts, not breach of contract.  Therefore, damage to the insured's work cannot be property damage under a CGL policy.

Occurrence.  The court first found that faulty workmanship could be the result of accidental conduct because a deliberate act can be performed negligently.  Much ink has been spilled on this issue, to which the Court has added the following formulation paraphrasing one of its earlier decisions:

[A] claim does not involve an accident or occurrence when either direct allegations purport that the insured intended the injury (which is presumed in cases of intentional tort) or circumstances confirm that the resulting damage was the natural and expected result of the insured's actions, that is, was highly probable whether the insured was negligent or not.

The Court was careful to say that "whether an insured's faulty workmanship was intended or accidental was dependent on the facts and circumstances of the particular case."  Presumably, if the insured deliberately substituted an inferior ingredient or used substandard materials to cut costs, the defective workmanship would not be a covered occurrence.  If, on the other hand, the defective work was the result of shoddy work by shirking employees, the builder could not be denied a defense. 

But the thing to remember is that this is a duty-to-defend case.  The Court restricts its analysis to the allegations in the pleadings, not to the actual facts of the particular case.  From now on, a lawsuit alleging negligent workmanship, without much detail, will trigger the CGL insurer's duty to defend.

Property Damage.  The second issue is perhaps even more important.  If a court relies on the economic-loss rule to bar CGL coverage for a property-damage claim because it "sounds in contract," does that mean that conduct in the performance of a contract could never be covered?  If even part of a plaintiff's claim was breach of contract, a court might be persuaded to dismiss it because it "sounds in contract".  The Lamar Homes Court short-circuited the whole line of inquiry by putting the economic-loss rule out of insurance law.  "It is a liability defense or remedies doctrine, not a test for insurance coverage."  More importantly, the Court held that CGL policies are not restricted to covering torts. 

Dissent.  Three Justices filed a vigorous dissent, primarily attacking the majority's rejection of the economic-loss rule.  "Selling damaged property is not the same thing as damaging property."  The dissent also argues that the Court is following the minority view of courts across the country, but the majority dispute this assertion.

In the final analysis, as the Court observes, CGL policies will not necessarily cover defective workmanship because so-called "business-risk" exclusions target for elimination damage to the insured's work and replacement of the insured's defective products.  Nevertheless, as the Dissenting Opinion points out, the practical effect in many cases will be that small subcontractors, who typically bear the responsibility for covering the general contractor and the owner in construction mishaps, will end up carrying a larger portion of the risk, and their premiums may rise.  Also, insurers will almost surely be required to defend more construction-defect lawsuits.

The Lamar Homes Court also holds that a Texas statute allowing a penalty for delayed payment of "first-party claims" does applying to defense costs an insured incurs under a CGL policy.  But that is an issue for another day.

5th Circuit Asks Texas Supreme Court To Determine Effect of Actual Notice When Insured Fails To Forward Lawsuit

Note: Texas Supreme Court answered this question in the negative (see my discussion at Crocker Opinion).

Crocker v. National Union Fire Ins. Co., 466 F. 3d 347 (5th Cir. 2006)

Two Texas federal district courts have reached opposite answers to the following question: When the insured is sued and fails to send a copy of the lawsuit to the liability insurer as required by the policy, may the insurer refuse to cover the claim or defend the lawsuit, even though the insurer had actual knowledge of the lawsuit?  The US District Court for the Western District of Texas said no in Crocker.  However, recently, in East Texas Medical Center Regional Health System v. Lexington Ins. Co. (E.D. Tex. July 12, 2007), a court in the Eastern District said yes.  So the 5th Circuit wants the Texas High Court to sort it out.

The facts of the two cases are somewhat different, but the fundamental question is, I believe, the same.  In Crocker, a nursing home employee allegedly injured a patient who sued both the employee and the nursing home.  The nursing home's liability policy also covered the employee as an additional insured.  Unfortunately, the employee was fired soon after the accident and did not know that he was entitled to a defense from the insurer.  The insurer and the attorney it hired to defend the nursing home had a copy of the lawsuit and knew that the employee was a defendant.  Indeed, the attorney even deposed the employee.  Yet no one told the employee that he was entitled to a cost-free defense.  Despite some attempts to contact the employee, the insurer admits that it never told him the insurer would provide a defense.  The case resulted in a judgment against the employee, which the insurer refused to cover because the employee failed to forward a copy of the lawsuit to the insurer.  The lower court ruled in favor of coverage based on the insurer's actual knowledge of the lawsuit.

East Texas Medical Center (ETMC) had a claims-made malpractice liability policy under which it was responsible for paying and handling the first $2 million of covered claims.  The policy nonetheless required ETMC to provide notice of claims and copies of lawsuits to the insurer.  It was ETMC's practice to enter new claims and track their progress in a computer database made available to the insurer.  The claim in question was asserted and recorded a few weeks before the policy expired.  At first, ETMC did not think the claim would exceed its $2 million deductible.  Several months after the policy expired, however, ETMC learned at a deposition the serious nature of the injuries and sent written notice to the insurer, who denied the claim.  The court in the coverage lawsuit found that ETMC breached the policy by failing to forward suit papers to the insurer within the policy period, as required by the claim-made policy.  The court held that the insurer's actual awareness of the claim from the database did not excuse the insured from having to send the insurer the lawsuit.  Further, the court refused to consider whether the insured's failure prejudiced the insurer because of the claims-made nature of the policy (i.e., courts routinely hold that an insurer does not need to prove that failure of notice prejudiced the insurer's interests.)

Risk managers of companies that self-insure substantial layers of liability risk should take special note of the ETMC case.  I have noticed that many risk managers are reluctant to report claims where, as in this case, the insured is responsible for investigating and paying most small claims.  Too often a sleeper claim comes along which doesn't loom large as a multi-million risk until well into litigation.  Then it may be too late.  Most insurance companies will assert notice defenses available to them.  The best advice is to notify early and often.

Another “Additional-Insured” Coverage Riddle: Court Misses Key Distinction

Aubris Resources, LP, f/k/a United Resources, L.P. v. St. Paul Fire & Marine Ins. Co., (N.D. Tex.  July 26, 2007)

 

In this case, it appears both the court and the additional insured may have missed the key issue in determining whether an insurance company had a duty to defend an additional insured.  United Resources (“United”) entered an Oilfield Services term Agreement with J&R Valley Oilfield Service, Inc. (“J&R”) in which J&R agreed to purchase liability insurance and add United as an additional insured to the policy.  The agreement also contained several indemnity clauses including one requiring United to indemnify and hold harmless J&R for liabilities caused by United’s negligent acts.  (Note well: as discussed below, this indemnity is not enforceable and will not in fact obligate United to indemnify J&R.  For as fuller discussion of this vexed issue under Texas law, see Risk Shifting Agreements Article).  J&R procured a policy issued by St Paul Fire and Marine Insurance Company (“St Paul”) that contained an endorsement adding United as an additional insured to the policy.  However, the endorsement excluded “obligations for which United has specifically agreed to indemnify [J&R].”

 

A J&R employee was injured at the work site and later died.  His family and estate sued United for negligence.  The plaintiffs initially sued J&R but later dropped it from the lawsuit.  United sought defense and indemnity from St Paul who denied coverage based on the indemnity exclusion.  St Paul argued that the lawsuit alleged a claim for which United was required by the Oilfield agreement to indemnify J&R, which falls squarely within the exclusion.  The court agreed.

 

The court held that that United had agreed to indemnify J&R for United’s negligence.  The plaintiffs alleged that United was negligent.  The policy excluded claims for which United was obligated to indemnify J&R.  End of story.  No coverage.  But no one in the case, neither United nor the court, focused on the fact that the indemnity fails to meet Texas’s “fair notice” rule that an indemnity must expressly state that it covers the indemnitee (J&R) against the indemnitee’s negligence.  The Oilfield Agreement protects J&R only against the indemnitor’s negligence and so fails to pass muster under Texas law.  United would be justified in refusing to defend or indemnify J&R against any claim seeking legal liability against J&R. 

 

Therefore, the lawsuit is not an “obligation” of United to defend or indemnify J&R and should not trigger the indemnity exclusion in the policy.

Can Construction Damage Caused by Poor Workmanship Ever Be Covered By a CGL Policy? Federal District Court Takes a Step Closer To Saying “No”

Note: The decision in this case has been superseded by the Texas Supreme Court ruling in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 2007 WL 2459193 (Tex. August 31, 2007). See Lamar Homes Decision

 

Charlton v. Evanston Insurance Co., Cause No. SA-06-CA-480-H (W.D. Tex. June 29, 2007)

 

The issue in the Charlton case has divided Texas courts for years.  Standard (and even nonstandard)commercial general liability (CGL) insurance policies cover bodily injury and property damage caused by an "occurrence," defined typically as an accident or exposure to harmful conditions.  Property damage is defined as physical injury to tangible property.  When, as in this case, a building contractor is sued for damage caused by poor workmanship, does the CGL insurer have a duty to defend the lawsuit?

 

The insured builder says, "yes" because the defective construction was not intentional but the result of workers' negligence.  Isn't negligence conduct what you buy liability insurance to cover?  The insurer says, "No," the lawsuit is basically one over a breach of contract and warranty.  If the builder fails to comply with its contractual obligations to perform in a workmanship manner, that is a business decision and creates a business risk, which general liability insurance is not designed to cover.

 

Can the allegation of defective workmanship be a covered occurrence under a CGL policy?  The Texas Supreme Court has before it (and has had since November 2005) the Lamar case on that very issue. 

In Charlton v. Evanston Insurance Co., Charlton sued his insurance company, Evanston Insurance, alleging that the insurer failed to provide a defense that it owed under a CGL policy in an underlying lawsuit that alleged that Charlton failed to properly and appropriately provide construction services, materials, and management and caused improper finish grade work, out-of-plumb walls, improperly installed stucco, and similar damages.  The suit also alleged that real and personal property was damaged as a result of water intrusions at the property caused by the faulty workmanship.

 

            Evanston denied coverage, and the court agreed. Although the court noted a split of authority on this issue, it held that the underlying lawsuit had not alleged an occurrence because the allegations “sounded in contract and not in tort.”  What does that mean?  Basically, it means that the underlying lawsuit alleged breach of contract and warranty, not negligence.  Breach of contract “sounds in contract,” and negligence (breach of a duty of care) sounds in tort.  However, the underlying lawsuit brought against Charlton alleged both breach of contract/warranty and negligence.  Never mind said the court.  Despite artful pleading and conclusory allegations of negligence, “the gravamen of Casey’s petition” was breach of contract and warranty.  Ergo, no occurrence.

 

            The court also found no allegation of property damage.  Rather, the court found that the damages sought against Charlton were all “economic damage,” which basically means that the value of the property was diminished without sustaining physical damage.  The court characterized the damage allegation as, in a nutshell, the house that was promised was not the house that was received. The court noted in a foot note that it would have held for the insurance even if it had found an alleged occurrence and property damage because two exclusions applied.

 

            I think the court’s “sounds-in-contract” approach to the occurrence issue is not correct because it short-circuits the true inquiry into whether or not the damage was cause by accidental performance.  In the construction industry, and in many others as well, business operations are performed under contracts.  Lawsuits over faulty construction will invariably, as in Charlton, allege both breach of contract/warranty and negligence.  To hold that the “gravamen” of the lawsuit “sounds in contract” and ignore the negligence allegation is simply to ignore the issue and find in favor of the insurer.

 

            More productive is to examine the factual allegations and ask if the complaint is really about workers making honest mistakes as opposed to choices to take short cuts or substitute faulty materials.  For example, compare decisions in Michigan Mut. Ins. Co. v. Alliance Construction (2005 WL 2297505, S.D. Tex. Sept. 21, 2005) in which a builder did not use a ribbed slab design foundation as called for in the specifications resulting is foundation failures with Courtland Custom Homes v. Mid-Continent Cas. Co., (2005 U.S. Dist. LEXIS 17453, S.D. Tex.) in which subcontractors basically did a sloppy job and wood rot developed from water drainage defects.  The court in Michigan held that the decision to ignore the specifications and substitute different materials was not accidental.  It was a business decision.  In Courtland, the court found that the contractor’s negligent oversight of the work was an occurrence.

 

            In Charlton, the allegations included failure to supervise subcontractors and failure to properly manage the work.  Arguably, property damage was alleged as failing to manage the work “caused damage to other property at the residence which now requires repair.”  In short, the Charlton court arguably did not consider the factual allegations but selected a conceptual approach, not followed by most Texas courts, which is certain to rule out coverage in construction defect cases.

California Court Broadens “Advertising Injury” Coverage in Standard CGL Policy

Tosoh Set v. Hartford Fire Ins. Co.

2007 Cal. App. Unpub. LEXIS 3452  (Cal. Ct. App., April 30, 2007)

Introduction:   

In a case of first impression in California (and untested under Texas law), a California Court Appeals arguably made it easier for a policyholder to obtain coverage for product/s