Law and Insurance

A Contractual Indemnification May Apply in a Two-Party Dispute, Says Texas Court

BP Products N. Am. Inc. v. J.V. Industrial Cos., LTD, # H-07-2369 (S.D. Tex. April 21, 2010) see Decision

Forgive me for yet another indemnification decision, but this is a rare case: adjudication of a indemnity dispute in which the injured plaintiff is also the indemnified party.  Usually, a third party sues the indemnitee, who then seeks defense and indemnification from the indemnitor.  Some judges have held that contractual indemnity applies only to third-party disputes, but, as this case shows, Texas law allows contractual indemnification to remedy breach-of-contract claims, unless the indemnity clause says otherwise.

BP Products hired J.V. Industrial to reinstall metal couplings on heat exchangers at BP's refinery.  BP alleges that J.V. mixed up the couplings, a mistake that resulted in a fire that destroyed BP's property.  The parties' contract contained the following agreement:

J.V. shall reimburse BP for, defend, indemnify, and hold BP harmless from and against all liability, costs (including reimbursement of all attorneys' fees and other costs of defense), loss, damage, expense, claims ..., suits, fines, and penalties on account of any and all ... damage to or loss or destruction of of any property (including without limitation, the [Contract Work]  and the property of J.V. and BP] arising directly or indirectly out of or in connection the performance of this Contract, whether caused or contributed to in whole or in part by the concurrent, joint, active, or passive negligent act or commission of BP or J.V.], except that J.V. assumes no liability for the sole negligent acts of BP.

In the lawsuit that followed, J.V. denied any responsibility for the damage and challenged BP's reliance on the indemnity clause, arguing that the provision applied only to third-party actions brought against BP.

The court first determined that, without regard to who brings the claim, the indemnity met Texas's "Fair Notice" requirements as stated in Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505 (Tex. 1993) (holding that the indemnity must expressly include the indemnitee's fault and appear in conspicuous type).  The court noted the absence of conspicuous type but acknowledged the parties' stipulation that J.V. was actually aware of the provision, which excuses lack of conspicuousness.

On the key issue, the court found that a party to the contract could recover for its own damage if the indemnity provision was written to permit this recovery.  Earlier Texas cases illustrate the principle:

1. In Kellog Brown & Root Int'l, Inc. v. Altanmia Comm. Mfg Co., 2008 WL 5114962 (S.D. Tex. Dec. 3, 2008), Altanmia's agreement "to bear, without right of reimbursement, the full risk of loss or damage" to certain vehicles used in performance of the contract did not obligate Altanmia to indemnify Kellog, because the provision did not expressly provide for indemnification of claims asserted between the parties.
2. By contrast, in Radiant Systems, Inc. v. American Scheduling, Inc., 2006 WL 2583266 (N.D. Tex. Sept. 7, 2006), Radiant's agreement (as the successor of the purchaser of software in question) "to be liable for 'Losses' resulting from the breach or falsity of any covenant or agreement made by the Purchaser," was held to specifically contemplate a suit for breach of contract by one party against the other.

The court noted that J.V.'s indemnity explicitly applied to the property held by the contracting parties, which necessarily affords BP a remedy for damage to its property.

We have in this case, therefore, two important lessons and one enigma.

First, the indemnity will include recovery for damage to the indemnitee's property only if the provision explicitly includes that right.  From the Radiant case, it should be enough if the provision covers loss or damage resulting from breach of the contract itself.

Second, this case provides comfort for those drafting high powered merger and buy-sell agreements that list each party's "reps and warranties," and then provide that indemnification will be the sole remedy for any breach of those reps and warranties.  It's nice to find some authority that this kind of indemnity is enforceable.

The enigma:  Do all indemnity agreements need to meet the Dresser test, described above?  Before addressing enforceability in a two-party dispute, the BP court first asked if the indemnity met the Dresser test.  I wager that it would come as a shock to most corporate lawyers who draft merger and buy-sell agreements to learn that they must add that the indemnity applies even if the indemnitee is negligent.  The purpose of this kind of indemnity is meant to cover one party's breach of contract that damages another party to the contract.  Why put in express-negligence language?

In the Dresser case, and in all other Texas Supreme Court cases discussing the Dresser test, the court was concerned with third-party claims against the indemnitee arising from the parties' joint contract operations.  The Dresser test is meant to prevent the unfairness of one party shifting liability for its own negligence to the other (presumably innocent) party, unless the contract explicitly says that the indemnitor is responsible even if the indemnitee is at fault.  However, that concern is not present when the contracting parties simply want the breaching party to reimburse the other party.

This snake in the grass bears watching.

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

www.tklaw.com

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

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

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

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

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

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

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

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

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

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

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

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

Landlord's policy provides:

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

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

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

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

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

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

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

David. S. White, Thompson & Knight LLP

www.tklaw.com

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.