Law and Insurance

Court Applies 8-Corner Rule to Loss-Indemnity Liability Policy

Basic Energy Services, Inc. v. Liberty Mutual Ins. Co., #08-CV-78 (W.D. Tex. September 18, 2009)

This case resolves a liability insurer's duty pay defense costs when the policy imposes no "duty to defend" but instead requires the insurer to "reimburse" what the policy describes as the "Allocated Loss Adjustment Expense."  I think this decision is a potentially significant harbinger of how courts might interpret well-worn CGL concepts, like "occurrence," eight-corners," and "that particular part" of an insured's work, under an "indemnification" or "reimbursement" policy, rather than the more common "duty-to-defend" policy.  I say significant because, more and more, we are seeing reimbursement policies replacing duty-to-defend policies.

Basic Energy Services was hired to replace a pump on an oil well.  In the process, Basic pressure tested the well casing and unfortunately dropped the casing into the well damaging the well bore and the casing itself.  This was not a small dollar deal.  The lawsuit against Basic alleged that the damage forced the operator to abandon the well and risk losing the entire value of the well due to loss of production.  So Basic turned to its insurer to cover the damage, including costs of defending the lawsuit.  Liberty challenged coverage.

In many ways, Basic's policy was like most standard CGL policies, covering basically bodily injury or property damages caused by an occurrence.  Most of the exclusions were also typical, including one for property damage to "that particular part" of property Basic worked on.  But the policy explicitly revoked the insurer's duty to defend and included an "Allocated Loss Adjustment Expenses (ALAE)" Endorsement requiring the insurer to reimburse Basic for any ALAE incurred by the insured for any "occurrence."  So, Liberty Mutual has no duty to defend but must reimburse Basic's defense costs.  What's the difference between this arrangement and the "duty to defend"?

First, argues Liberty, note the word, "Allocated."  This policy does not require the insurer to reimburse all of the defense costs, only that portion allocable to covered loss.  And because this allocation cannot be made until after a trial has sorted out what is covered and what is not, the insurer has no obligation to reimburse ALAE until the lawsuit is over.  Indeed, Liberty is correct that a number of courts have held that pure indemnity policies that impose no duty to defend require indemnity only after the insured has incurred the loss (a judgment or settlement), and, in the absence of an advancement clause, this includes defense costs.

The court, however, disagreed.  The policy is silent both on when reimbursement must be made and on any allocation of ALAE (despite the title).  The court held that the insurer must reimburse defense costs as they are incurred.

Second, Liberty had obtained some depositions that arguably proved that a significant portion of the damages were not covered.  Again. note the allocation idea.  Basic countered by asserting that most
Texas of insurance rules, the "eight-corners" rule, that a court may consider only the pleading and policy and not consider any extrinsic evidence, like affidavits or depositions.

This issue put the court in a pickle.  On the one hand, Texas courts have almost universally discussed the eight-corner rule in connection with the duty to defend.  Much of the rationale for requiring insurers liberally to defend allegations that might fall within coverage without resort to actual facts that might clarify murky or spotty allegations emanates from the distinction between the duty to defend and the duty to indemnify, a distinction that the court acknowledges. 

On the other hand, having held that Liberty is obligated to reimburse defense costs as soon as they are incurred, the court must hold either that all defense costs must be paid, or reverse itself and hold that a trier of fact must first resolve which claims are covered and which are not.  "The Court agrees with [Basic] that this reimbursement of defense costs obligation is most analogous to a duty to defend, even which the duty to defend is explicitly disclaimed." 

Liberty also challenged coverage arguing that the alleged conduct was not an "occurrence," and that the exclusion for damage to "that particular part" of the insured's work was excluded.  However, once the court has started down the path of ruling by analogy to duty-to-defend cases, Liberty's arguments are doomed.  Under the Lamar Homes line of cases (see my discussion Lamar Homes Decision), arguments that a contractor's defective work can't be a covered occurrence have been rejected -- but these are duty-to-defend cases.  Likewise, Liberty's argument that the whole well, including casing, bore, and subsurface space, should be considered Basic's "work" has been rejected by a number of state and federal cases.  Only the casing and the pump comprised Basic's particular work.  Damage to the bore and the loss of well itself is not excluded.

Liberty cannot be blamed for arguing that the analogy should go in the opposite direction, away from duty-to-defend cases and toward pure-indemnity cases.  Arguably, this decision could have gone either way.  If other courts follow suit, this decision may be seen in hindsight as a significant precedent expanding duty-to-defend doctrines to other types of policies.

Economic-Loss Doctrine Finds a Back Door in Texas CGL Insurance Case

Century Surety Co. v. Hardscape Construction Specialities, Inc., #06-10930 (5th Cir. Aug. 7, 2009), see Century Decision

 Commercial general liability policies cover injury or damage caused by an "occurrence," which means any kind of accident or condition that causes harm.  For years, the insurance industry has tried to persuade courts to adopt a rule that property damage resulting from poor workmanship, faulty construction or design flaws can not constitute an occurrence because the insured's liability arose from the breach of its contract with the plaintiff.  In other words, insurers wanted to limit CGL coverage exclusively to tort claims, like negligence, and exclude all contract claims.

Two years ago this month, the Texas Supeme Court nixed that theory in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007) (see my discussion at Lamar Homes).  Parties may perform their contracts negligently and cause damage, said the Court; as long as it's accidental, not deliberate, it can be covered as an occurrence.  The Lamar Homes Court also rejected a companion argument urged by insurers that the legal remedy for damage to property that is the subject of the contract, e.g., the home being built by the home builder, is limited by the so-called "economic-loss" doctrine to the plaintiff's economic loss (cost to repair or replace).  Tort remedies, including punitive damages for gross negligence, are not recoverable.  Insurers argued that one consequence of the economic-loss doctrine  was that a contract claim could not be an occurrence.  Wrong, said Lamar Homes.

Enter Hardscape Construction, hired to construct a swimming facility at a residential development.  Hardscape in turn hired a pool contractor who agreed to indemnify Hardscape for liability arising from construction of the pool.  The owner sued Harscape (and everyone else) after cracks appeared and water escaped from the pool, alleging breach of contract, negligence, and several other causes of action.  Hardscape sought coverage under the pool contractor's CGL policy, which covered the insured's assumption of (Hardscape's) tort liability in a written contract (often called "insured-contract" coverage).  The insurer denied coverage based on the same old argument that alleged faulty construction could not constitute an occurrence.  Century also argued that the insured-contract  coverage was explicitly limited to tort, and, despite the negligence cause of action, the allegations were grounded in contract, not tort.

The lower court held that the lawsuit did not allege an occurrence.  On appeal, the Fifth Circuit affirmed, but only on Century's second argument.  Recognizing that Lamar Homes rendered the lower court's reasoning untenable, the court panel examined the tort-only insured-contract clause and asked what is the difference between a tort and a contract cause of action.   First, the panel recognized, the answer is not as simple as looking at the legal theories alleged, in which case, the negligence allegation alone would be enough to settle the question.  Courts must look only to the factual allegations, not the causes of action pled.

The key consideration, under Texas law, is the source of the liability and the nature of the plaintiff's loss.  Turning to the body of Texas cases on the issue, the panel fixed on a pronouncement in Southwest Bell Tel. Co. v. DeLanney, 809 S.W.2d 493 (Tex. 1991) that, "[W]hen the only loss or damage is to the subject matter of the contract, the plaintiff's action is ordinarily on the contract."  If you heard an echo here of the economic-loss doctrine, you would be right; Delanney is the principal case cited by insurers before Lamar Homes to argue that contract claims are not occurrences.  Damage only to the contract works will not justify imposition of tort remedies. 

Having selected Delanney as the governing case, the panel easily concluded that the allegations gave rise only to contract claims and affirmed the lower court's dismissal of Hardscape's claims. 

This is probably correct.  The Lamar Homes Court stated that [the "economic-loss doctrine"] is a liability or remedies doctrine, not a test for insurance coverage."  But it also explicitly held that, in defining "occurrence," the CGL policy did not distinguish between tort and contract remedies.  By contrast, the insured-contract clause clearly does cover only tort remedies.  

The lesson here is that Hardscape should have required the pool contractor to add Hardscape as an additional insured to the contractor's policy in addition to the indemnification.  As an additional insured, Hardscape would not need to rely on the insured contract coverage and could require Century to defend it. 

5th Circuit Corrects Policy Interpretation Error Without Mention of Indemnity Issue

Aubris Resources LP v. St Paul Fire and Marine Ins. Co., No. 07-41272 (5th Cir. April 23, 2009), see Aubris Decision .

This case reverses the lower court's judgment in favor of St Paul concerning the interpretation of limiting language in an additional-insured endorsement.  United Oil and Minerals LP (later purchased by Aubris) hired J&R Valley Oil Services to service United's oilfield properties.  In the contract, J&R agreed to add United as an additional insured to J&R's liability insurance, except for "any obligations for which United has specifically agreed to indemnify" J&R.  The contract also required United to indemnify J&R generally against lawsuits arising from United's negligence.  J&R's general liability policy added as an additional insured any person that J&R agreed in a written contract to add, "if that written contract for insurance specifically requires such coverages."  (I discussed the lower court's decision in an earlier post, here)

An explosion on United's property injured two of J&R's employees who sued United alleging negligence.  St Paul refused to defend asserting that United was not an additional insured for claims that United had agreed to cover in the indemnity clause, namely claims arising from United's negligence.  Because the plaintiffs asserted negligence, their claims fell within the indemnity and thus were excluded from the additional-insured coverage.  The lower court agreed. 

On appeal, the 5th Circuit reversed but not for the reason I suggested in my post.  Aubris argued that the exception, "any obligation for which United has specifically agreed to indemnify J&R" (emphasis added), refers not to the general indemnification clause in the service contract, but to a separate, independent indemnity for a specific claim that the parties might make later.  In other words, should a claim arise, and United agreed in a separate contract that it would indemnify J&R specifically against that claim, then that specific indemnity would be carved out of the additional-insured clause.

The appellate court agreed with Aubris.  To accept St. Paul's argument, reasoned the court, would render the word "specifically" meaningless because the contract contains a general indemnity against all claims arising from United's negligence.  The parties must have intended to carve from insurance coverage only specific instances of United's negligence that would be the subject of a separate agreement.  Therefore, the court reversed and rendered judgment in favor of Aubris.

But I think my point is still valid.  Another reason for ruling in Aubris favor is that the indemnification clause itself is unenforceable under Texas law because it fails to expressly state that United will indemnify J&R even if J&R is negligent.  This is the "express-negligence" requirement that the Texas Supreme Court has consistently reaffirmed.  Without it, the indemnity is pretty much a legal nullity.  So, if J&R could never enforce the indemnity provision against United, how can St. Paul rely on it to limit the scope of the additional-insured endorsement?  Put another way, St. Paul might avoid covering United only if United agreed to indemnify J&R.  But United didn't agree to indemnify J&R because the indemnity is legally insufficient.  Therefore, ST. Paul must defend Aubris.

Indemnification law in Texas borders on the irrational.  Many businesses draft their indemnity agreements without consulting a lawyer, and a good many lawyers don't understand the quirks of Texas law on the subject.  I usually advise my clients to approach contractual risk-shifting agreements with the goal of relying first on insurance  before indemnities.  Insurance is more reliable, and courts are instructed to interpret insurance policies liberally in favor of coverage.  By contrast, courts are supposed to treat indemnities with suspicion.  About half the indemnification agreements I come across are unenforceable.  Courts more frequently err in construing indemnities than insurance policies.

But if you do rely on an indemnification agreement, make sure it meets Texas' tough enforcement standards.

Insurer Must Pay Liability Claim That Policyholder Assigned To a 3rd Party.

Home Owners Management Enterprises, Inc. v. Mid-Continent Cas. Co., No. 05-11370 (5th Cir. Aug. 26, 2008) see Home Owners Decision.

What happens when a policyholder's legal liability is covered by its CGL policy, but a third party has a contractual obligation to the policyholder, unrelated to the CGL insurance, and pays the judgment for the policyholder?  Can the third party recover the judgment from the insurer even though the policyholder no longer owes money on the judgment?  The answer in this case is Yes.  The U.S. Fifth Circuit Court of Appeals held that the policyholder remained legally liable for the purposes of insurance, and the insurer was still obligated to pay a covered claim.

This is a home construction defects case, which was pending when the the Texas Supreme Court ruled in Lamar Homes, Inc. v. (you guessed it) Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007) that construction defects could be the result of accidental conduct, and so constitute covered "occurrences" under a CGL policy.  Presumably, insurers are bringing fewer and fewer of these type suits.

The Builder sold a house to Mr. and Mrs. Homeowner.  The sales contract included a limited warranty underwritten by Warranty Underwriter Insurance Co. (WUIC).  Homeowners discovered structural and cosmetic damages resulting from construction defects and sued WUIC and Builder.  As required under the warranty, WUIC paid an arbitration award to Homeowners. 

Here's where the plot thickens.  The warranty agreement requires Builder to indemnify WUIC for any payments under the warranty, and Builder was insured under astandard Mid-Continent CGL policy.  WUIC demanded reimbursement from builder, and Builder ended up assigning to WUIC Builder's rights under the CGL policy.

Builder early on had submitted a claim for defense and indemnity to Mid-Continent, who denied the claim mostly for reasons removed by the Lamar Homes decision.  After WUIC paid the award, it sued Mid-Continent, who again denied coverage but this time based on this argument:

Even if Builder's faulty construction was covered under the policy, Builder no longer owes anything to Homeowners and so no longer has legal liability.  The policy covers only the insured's legal liability.  Therefore, Mid-Continent's obligation under the policy was extinguished when WUIC paid the award on behalf of Builder.

The court said it was "not impressed with the argument."  The policy did not specify to whom the insured was legally liable, and Builder remained liable for its conduct.  It made no difference for coverage purposes that Builder's liability was now owed to WUIC, not Homeowners.  WUIC was entitled to step into Builder's shoes and enforce its claim for reimbursement to Mid-Continent.

Texas' "Express-Negligence" Rule Can Nullify Indemnities In Standard Form Construction Contracts

For almost a century, the construction industry in the U.S. has relied on standard contract forms promulgated by the American Institute of Architects (AIA).  I have frequently commented on the peculiarities of Texas law governing the enforceability of indemnification agreements in contracts, and nowhere are indemnities more used than the construction industry.  AIA form contracts have evolved over the years, but one particular iteration of the indemnification clause, A201 subparagraph 4.18.1 (1976) is still frequently incorporated into construction contracts today.  It is unenforceable under Texas law.

This indemnity is as follows (I paraphrase the unimportant parts) contractor will indemnify and hold harmless the owner and others from claims, etc. arising from the contractors performance of the contract and attributable to the contractor's negligence in whole or in part, regardless of whether or not . . . caused in part by a party indemnified hereunder.  This last phrase is the part that causes the trouble.  A common sense reading of this phrase suggests that a lawsuit alleging legal liability against both the contractor and the owner for, say, an injury at the construction site would trigger the contractor's obligation to indemnify the owner.  The allegations necessarily imply that the injury was caused in part by the contractor and in part by the party indemnified hereunder, the owner.

However, under Texas law, commons sense and logic do not always apply or prevail.  Texas has adopted the strictest rules against enforcement of any state in the nation.  Referred to as the "express negligence" test, the rule requires the contract to state expressly that the contractor, the indemnitor, agrees to indemnify the indemnitee against the indemnitee's own negligence.  (For earlier discussions of this rule, see Court Finds Indemnity's Express-Negligence Language Enforceable, Another “Additional-Insured” Coverage Riddle: Court Misses Key Distinction, and Texas's Express-Negligence Rule Strikes Again) 

The AIA provision indemnifies not against the owner's partial negligence, but rather against its partial causation of the injury.  Texas courts are instructed not to infer anything in the indemnification clause, including the inference of legal liability for negligence from the allegation that the owner helped cause the injury.  In fact, this point makes sense because simply causing an injury is not enough to subject someone to legal responsibility for causing the injury.  I may set in motion a chain of events that ends up crashing an airliner hundreds of miles away: admittedly an unlikely example of the butterfly effect.  In law, the distinction is between but-for cause and proximate cause.  A plaintiff must prove that my negligent conduct was the proximate cause of the injury to obtain a judgment. 

A sample of Texas cases refusing to enforce this indemnity language includes:

• Gilbane Bldg. Co.  v. Keystone Structural Concrete, Ltd., 2007 Tex. App. LEXIS 5903 (Tex. App.- Houston [1st Dist.] July 26, 2007);
• Cabo Constr., Inc. v. R S Clark Constr., Inc., 2007 Tex. App. LEXIS 2880, .(Tex. App.-Houston [1st Dist.] April 12, 2007);
• Delta Air Lines, Inc. v. ARC Sec., Inc., 164 S.W.3d 666 (Tex. App.-Fort Worth 2005);
• J.M. Krupar Constr. Co. v. Rosenberg, 95 S.W.3d 322 (Tex. App.- Houston [1st Dist.] 2002);
• Lee Lewis Constr., Inc. v. Harrison, 64 S.W.3d 1 (Tex. App. Amarillo 1999)

It is sobering to think that there are some jurisdictions that do not permit a party to indemnify another for the others negligence.  Texas won't enforce the agreement unless the contract says the party is indemnifying for the other's negligence.

Parties Under Contractual Indemnity Obligation May Seek Equitable Subrogation -- So What's New?

Frymire Engineering Co. By and through Real Part In Interest, Liberty Mutual Ins. Co. v. Jomar Int'l, Ltd., #06-0755 (Tex. June 13, 2008), see Frymire Decision.

I am not sure why this case was ever a problem.  It looks like a run-of-the-mill insurance subrogation case, but for some reason both the lower courts and the Texas Supreme Court approached the subrogation issue as if Liberty Mutual wasn't involved.  So, the lower courts got hung up on the issue of whether a manufacturer of a defective product owes a "debt" to the injured plaintiff and whether payment under a contractual indemnity agreement is "voluntary."  The result is a helpful clarification that a contractual indemnitor, here Frymire, that pays a loss does not lose its equitable subrogation rights against a third-party tortfeasor.

For those lucky enough not to have grappled with subrogation issues before, subrogation is the right to collect a payment for a loss made on behalf of the person primarily responsible for causing the loss.  Typically, insurance companies that pay to or on behalf of insureds seek subrogation from some third party primarily responsible for the loss or liability.  The insurance company has a contractual right under its policy to seek subrogation.  However, in this case, the court considered Frymire's equitable subrogation right, meaning one not based on contract or statute, but based on inherent principles of fairness.

Frymire contracted with a general contractor to install air conditioning at a hotel.  Frymire installed a valve manufactured by Jomar. The valve leaked causing extensive damage.  Frymire had agreed both to indemnify the general contractor and hotel owner and to purchase liability insurance (Liberty Mutual).  Accordingly, the hotel sued Frymire for contractual indemnity.  (Note that the hotel could have sued in tort or breach of contract rather than contractual indemnity, which appears to be the sticking point for the lower court.)  Liberty Mutual paid $458,496 on behalf of Frymire.  Liberty Mutual next brought a subrogation suit to recover its payment from Jomar alleging that the valve was defective.  As the Court observed (see below), this kind of subrogation suit happens all the time.

But Jomar argued that Liberty Mutual had no standing to bring its subrogation suit because Frymire had no standing to sue Jomar.  The Court demolished Jomar's argument with a solid reaffirmation of the doctrine of equitable subrogation, to wit: one not acting voluntarily that has paid a debt that another party should have paid, may recover from the other to prevent the other's unjust enrichment.  Jomar obtained summary judgment, affirmed on appeal, that Frymire lacked standing to assert its claims because it could not establish a right to equitable subrogation.  Specifically, because Frymire paid the hotel to satisfy its own contractual indemnity obligation, the payment was voluntary and did not unjustly enrich Jomar.

The Texas Supreme Court reversed this holding and accepted Frymire's argument that (1) the indemnity payment extinguished the debt primarily owed by Jomar; (2) the indemnity payment was involuntary because it was made under a contractual obligation; and (3) Jomar would be unjustly enriched if it escaped liability for its defective product.  The Court confirmed that tort liability could be considered a "debt" for purposes of applying equitable subrogation.  Moreover, one paying under a contractual obligation is not a volunteer and may seek subrogation.  The Court noted that insurance companies have contractual obligations to pay losses to or on behalf of insureds and seek subrogation all the time.

Which raises my original question: why isn't this case being treated as one in which the insurance company is asserting its routine right to subrogation?  Liberty Mutual paid the claim to the hotel.  Liberty Mutual is the party seeking payment from Jomar. 

Whatever the answer, this case should strengthen the rights of commercial entities of all kinds that step up to the plate and promptly pay claims to resolve business disputes and then seek to recover from the party that should have paid the claim.

"Assumption of Liability" Exclusion Misapplied In Coverage Lawsuit

Underwriters at Lloyd's of London v. Gilbert Texas Constr., 245 S.W.3d 29 (Tex. App.-- Dallas 2007, pet. filed May 7, 2008)

This decision appears to jump the tracks when analyzing the effect of a common CGL policy exclusion for "liability assumed in a contract."  Everyone in the case, Lloyd's, the court, even the insured, appear to agree that the exclusion applies in this case (the insured tries to rely on exceptions to the exclusion), but I think they all misunderstand what it is that is excluded.  So it is worth a look.

Gilbert contracted with the Dallas Area Rapid Transit Authority, a state agency, to help construct a commuter rail system.  Gilbert allegedly breached some of its duties under the contract prompting an adjacent landowner to sue DART and Gilbert.  Gilbert's primary insurer defended it, and Gilbert was able to get all of the tort allegations case dismissed under governmental immunity, leaving only breach of contract claims (apparently, the plaintiff landowner asserted that it was a third-party beneficiary under the DART contract).  Gilbert then settled the breach of contract claims.

It is unclear at this point what happened to Gilbert's primary insurer, but Gilbert's excess insurer, Lloyd's, denied a demand to pay the settlement based on the "assumed liability exclusion" (Lloyd's denial letter also asserted a separate breach of contract exclusion, but that defense is never mentioned in the decision).  Most CGL policies contain this provision that excludes damages which the insured is obligated to pay "by reason of the assumption of liability in a contract or agreement."  Since Gilbert was sued for failing to perform duties it had assumed in the contract, the parties agreed that this exclusion applied and went on to other issues.  But they all appear to misread the exclusion.

It is not an "assumption of duties" exclusion; it excludes "liabilities" assumed by contract.  When I agree to dig a ditch and protect nearby structures in doing so, I undertake contract duties.  If I breach those duties, I may be liable to the parties or beneficiaries of the contract, but that is not what the "assumption of liability" exclusion is about.  To assume liability means that I agree to indemnify and hold someone harmless from legal liability to third parties.  The Gilbert Court converts the "assumption of liability" exclusion into a "breach of contract" exclusion, which is a different animal.

It is now clear that a breach of contract lawsuit may be covered by a CGL policy.  (Lamar Homes, Inc. v. Mid-Continent Cas. Co., 239 S.W.3d 236 (Tex. 2007), discussed at Lamar Homes Decision).  Therefore, the mere fact that all tort claims against Gilbert were dismissed does not mean the contract claims do not fall with coverage, and nothing is said about Gilbert's agreements to assume the liability of anyone else.

This case does not implicate the "assumption of liability" exclusion.

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.

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.

 

California Supreme Court Strikes Down Contractual Exculpation of Gross Negligence: Texas Is Still On the Fence

City of Santa Barbara v. Superior Court (Janeway), 161 P.3d 1095 (Cal. 2007).  See case at Janeway Decision.

In July of this year, the California High Court held that contractual releases of future claims for gross negligence in the context of sports and recreational programs were unenforceable as against public policy.  The case is well worth reading not only because of the court's thorough analysis of competing legal principles under California law (the freedom to contract vs. maintaining a reasonable standard of care in community life requiring wrongdoers to recompense injured parties), but also for its wide-ranging examination of the law of other states.  However, the court had little to say about Texas law on this issue because the Texas Supreme Court has never addressed the issue, and Texas state courts are divided. (A good analysis of this issue under Texas law is provided in Ryan S. Holcombe, "The Validity and Effectiveness of PreInjury Releases of Gross Negligence in Texas," 50 Baylor L. Rev. 233 (Winter 1998).

In Texas, as in most other states, a contract involving recreational or sports activities may contain a release or indemnity clause (a release voids liability entirely; an indemnity shifts liability to another) that is enforceable against ordinary negligence if it meets Texas's peculiar "Fair Notice" requirements. (For a discussion of these requirements, see Risk Shifting Agreements).  In effect, the release (indemnity) must expressly state that it releases (indemnifies against) the releasee's own negligence, and the release must be stated in boldface or other conspicuous language.

"Ordinary negligence" is the failure to use that degree of care that a reasonable person would exhibit under the same or similar circumstances.  "Gross negligence," under Texas's (again) peculiar standard is defined in Sec. 41.001 of the Texas Civil Practice and Remedies Code as:

conduct (A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and (B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.

California and most other states define gross negligence as either a "want of even scant care" or "an extreme departure from the ordinary standard of conduct."  In the Janeway case, a girl drowned while participating in a county summer camp for developmentally disabled children.  Camp counselors were aware of the girl's propensity to seizures, and the girl's designated mentor was aware that the girl had suffered a mild seizure a short time before the incident, but she was allowed to dive into a pool and drowned when the counselor's attention was diverted for a few seconds.  The Court held that the parents' release was effective to release ordinary negligence but not gross negligence.

Some courts in Texas reason that negligence and gross negligence are not separate torts, and a release that is effective against ordinary negligence should also release gross negligence.  See Newman v. Tropical Visions, Inc., 891 S.W.2d 713 (Tex. App. --San Antonio 1994, write denied).  At least one other court has held that a release from gross negligence is against public policy and should not be enforced.  See, e.g., Smith v. Golden Triangle Raceway, 708 S.W.2d 574 (Tex. App.--Beaumont 1986, no writ).  The Texas High Court has yet to decide the issue.

My best guess is that Texas will follow California on this issue.  Cases like Newman that put negligence and gross negligence in the same bucket rely on pre-1990's thinking before the Texas Supreme Court decided Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 23 (Tex. 1994), which established a brighter line between negligence and gross negligence.  The Moriel court observed that juries were not given a sufficient criterion for deciding when punitive damages for gross negligence were appropriate.  Logically, the reasoning in Moriel suggests that negligence and gross negligence should be considered separate categories.