Law and Insurance

Kidnap and Extortion Policy Claim May Proceed For Loss of Insured's Business Due to Uzbekistan Government Shakedown

Interspan Distribution Corp. v. Liberty Ins. Underwriters, Inc., #H-07-CV-1078 (S.D. Tex., March 31, 2008)

If you are planning to open a business in Uzbekistan, think again, or at least don't go there without a good kidnap/ransom and extortion insurance policy, as this case shows.  Interspan operated a profitable tea importation business in Uzbekistan that unfortunately drew the attention of the oldest daughter of Uzbekistan's authoritarian ruler, Islam Karimov (her name is Gulnara Karimova).  It is apparently well known in international circles that Gulnara has a sweet tooth for seizing profitable enterprises through misuse of government power.  Interspan alleged in its complaint against Liberty that in 2006, Gulnara abducted, held hostage and threatened Interspan personnel and their relatives as part of a scheme to obtain control over its business, seize its assets, and force the company out of Uzbekistan.

So what did gentle Gulnara do?  "Hooded men with machine guns" burst into the house of Eskender Kiamilev, father of Interspan's principal owner, and carried him the Uzbeki jail.  Allegedly, the perpetrators were members of the Committee for National Safety, Uzbekistan's version of the CIA.  The same day, armed government agents Interspan's offices and warehouses in Tashkent. 

Here is where kidnap policy comes into play.  Interspan reported the kidnapping to Liberty, which called on Corporate Risk International (CRI), a global crisis-management firm.  Think of CRI as Russel Crowe in the 2000 movie "Proof of Life" (we will get to the Meg Ryan character in a minute, who has the charming name of Natasha Matkarimova, no relation to Gulnara).  CRI slipped into the shadows of Uzbeki night life and emerge with the story that Gulnara had Eskender arrested and the property seized to frighten and intimidate Interspan into surrendering the entire business to her.  However, CRI, with the help of the US Embassy, managed to extract Eskender from jail due to his status as a former Soviet diplomat.

Not to be deterred, Gulnara went after Mikhail Matkarimova, brother-in-law of Interspan's owner, but he had gone underground.  So she arrested Mikhail's wife, Natasha and had her dragged to the dungeon where, CRI reported, torture and rape awaited her unless Mr. Matkarimova turned himself in.  We are left to speculate whether CRI's Russell Crowe and Natasha fell in love while Mikhail spent 6 months in prison and was denied medical care for a bleeding ulcer.  The complaint against Liberty doesn't go there.

So what has all this got to do with law and insurance?  Interspan ended up turning over the business to Gulnara, after which Mikhail was granted amnesty (he had been tried and sentenced to 3 years probation, fined $10,000, and forced to work for the government for 2 years, kicking back 20% of his salary to the government).  Interspan submitted a claim for "Loss" of the entire business.  Although the policy covered Loss caused by kidnap/ransom or extortion, Liberty denied the claim basically on grounds that Interspan could not sufficiently show that its loss of the business was the result of kidnap or extortion.

The case has some interest to lawyers because the court had to wrestle with the US Supreme Court's decision in Bell Atlantic Corp. v. Twombly, 127 S.Ct. 1955 (2007) to raise the pleading standard that a plaintiff must meet to avoid a motion to dismiss under Rule 12(b)6.  The old pleading standard, articulated in 1957 in Conley v. Gibson, was that a complaint should not be dismissed unless it appeared beyond doubt that the plaintiff could prove no set of facts supporting a claim for relief.  The Twombly Court said this standard was too lenient and held that a complaint must show enough facts to move the claim for relief from the merely "speculative" level to the "plausible."  Courts are now trying to figure out just what that means.

In this case, however, the court denied Liberty's motion to dismiss based in no small part of the ample allegations supplied by CRI's report of Gulnara's past seizures of other businesses using the same hard-knuckled tactics and its report to Interspan that the government would back off if Interspan turned over the business.  As the court observed:

An expert analysis by a crisis-management company specializing in kidnapping, ransom, and extortion, stating that those abducted would be released in exchange for payment in the form of relinquishing the business assets is neither "factually neutral" nor a "formulaic recitation of the elements of a cause of action" (quoting Twombly).

We are not told how much Interspan was seeking.  Perhaps Liberty choked on the number.  Perhaps Liberty was just taking its shot at raising the Twombly bar as high as possible.  Whatever the reason, Liberty was bound to lose.  This movie had to have a happy ending.  I am looking for a sequel that hooks up Russell Crowe with Gulnara. 

U.S. Supreme Court Rejects Contractual Expansion of Judicial Review of Arbitration Awards

Hall Street Assocs., L.L.C. v. Mattel, Inc., No. 06-989 (U.S., March 25, 2008) See Hall Street Decision

In a landmark decision, the United States Supreme Court held that the increasingly popular practice of contracting for expanded judicial review of arbitration awards is not permissible under the Federal Arbitration Act (the "FAA").  This practice was seen as a way to obtain the benefits of arbitration while eliminating one of its drawbacks: limited judicial review.  The Hall Street decision may have the unintended consequence of driving parties away from arbitration.  Since expanded judicial review is now much less available, more parties may opt for traditional litigation with its right to appeal a bad result.

For a fuller discussion of this decision, see Client Alert, published by Thompson & Knight Appellate Practice Specialty Group.

Insurers May Use In-House Staff Lawyers To Defend Insureds in Texas

Unauthorized Practice of Law Committee v. American Home Assur. Co., #04-0138 (Tex. March 28, 2008) See Law Committee Decision.

The Texas Supreme Court ruled that, despite genuine concerns for potential conflicts of interest, insurers' use of salaried employee-staff lawyers to defend insureds did not constitute an unauthorized practice of law by an insurance company.  However, staff lawyers may be used only where the interests of the insurer and the insured are aligned in defeating the claim against the insured.  Also, the insurer must fully disclose the defense attorney's affiliation with the insurer.

In Texas, the Supreme Court regulates the practice of law and established the Unauthorized Practice of Law Committee to carry out this function.  In this case the Committee ruled that American Home and other insurers violated a statute prohibiting corporations from practicing law when they used in-house staff lawyers to defend insureds.  Corporations may use in-house counsel to represent the corporation's own interests (hence corporate counsel departments in most corporations), but they may not use employee-lawyers to represent unrelated persons.  The Court ruled that insurers with a duty to defend insureds are protecting their own interests when they hire defense counsel because the insurers pay the judgment.

The Committee had condemned the use of staff lawyers in part because of concerns that insurers have greater power over employees than over outside law firms and have been known to limit the attorney's ability to conduct depositions, obtain paper discovery, and hire expert witnesses.  Some insurers have prohibited staff lawyers from informing insureds of the insurer's Stowers obligation to accept reasonable settlements within policy limits.  However, the High Court held that, even if this was true, there is no reason to believe that insurers have any less control over outside counsel, which they can hire and fire at will just like employees.  Also, the Court found no evidence of actual harm ever resulting from the use of in-house attorneys.

Two Justices dissented on the narrow basis that the practice violates the State Bar Act (Sec. 81.101 of the Texas Government Code).  Because the "practice of law" definition in the statute contains no provision for profit or loss considerations, the dissent argued that for-profit corporations, whose board and shareholders are not (necessarily) attorneys limited by professional, ethical and disciplinary rules, cannot legally provide legal services to the public.

Thus employee-attorneys may defend insureds except where the insurer raises substantive coverage defenses.  Does this mean that the policyholder may sue the insurer if the lawyer commits legal malpractice?  In State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998), the Supreme Court held that the insured may not hold the insurer liable for the mistakes of defense counsel because the counsel owes an unqualified duty of loyalty to the insured even when the insurance company hired the attorney.  The American Home opinion says that the insurer's control over outside counsel is substantively the same as over its own employees.  Presumably, the Court would say that the attorney's duties to the insured are the same whether outside or employed, and Traver still controls.  But employers are vicariously liable for the torts of their employees, and nothing in American Home suggests any change in that law.

That question remains for another day.

Did Mid-Continent Overrule Garcia?

Earlier, I reported the Texas Supreme Court's decision in Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W.3d 765 (Tex. 2007) that a defending co-insurer, willing to pay something towards settlement for its insured  but refusing to pay its fair share, breached no duties (and owed no reimbursement) to another co-insurer that had paid more than its pro rata share of the settlement. See my discussion, Primary Co-Insurer Owes No Duty.  I suggested that this decision might impede settlements when co-insurers are defending because neither insurer will pay more than its share to effect settlement when it cannot recoup the overpayment from the low balling carrier.

However, another problem is how to square the decision in Mid-Continent with the High Court's decision in American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 855 (Tex. 1994 written by Justice (now Senator) Cornyn), which states in dictum just the opposite of Mid-Continent that co-insurers "must" contribute their share to a settlement. 

Garcia involved multiple malpractice policies over successive years in a "Stowers" action in which the insured doctor alleged that the carriers had failed to accept a reasonable settlement offer within policy limits.  The Court had to decide what the policy limits were when multiple policies had been triggered, and held that an insured may not "stack" the limits of multiple policies that cover the same occurrence.  So, how does one identify the policy limits in that situation?

The Court sought to clarify this question as follows:

If a single occurrence triggers more than one policy, covering different policy periods, then different limits may have applied at different times. In such a case the insured's indemnity limit should be whatever limit applied at the single point in time during the coverage periods of the triggered policies when the insured's limit was highest.  The insured is generally in the best position to identify the policy or policies that would maximize coverage.  Once the applicable limit is identified, all insurers whose policies are triggered must allocate funding of the indemnity limit among themselves according to their subrogation rights.  [Emphasis added]

The no-stacking holding wouldn't apply in the case of multiple concurrent insurers, as in Mid-Continent, but I do not see why the insurers' rights vis a vis co-insurers would be any different.  For more than a decade, practitioners have relied on the methodology prescribed in Garcia for getting the settlement ball rolling when successive policy years are triggered.  The insured picks the policy year, and the carriers fall in line.  Does Mid-Continent overturn Garcia on this point? 

"Insurance companies are not eleemosynary institutions," observed Justice Willett in his concurrence in Mid-Continent.  The next time the insured picks the line a la Garcia, we can be sure the other insurers will raise Mid-Continent as a defense against paying their share.

Texas Supreme Court Does About Face on Frank's Casing Decision: Insurers May Not Reserve a Right of Reimbursement For Uncovered Claims

Excess Underwriters at Lloyd's, London v. Frank's Casing Crew & Rental Tools, Inc., #02-0730 (Tex. Feb. 1, 2008) See Majority Opinion

The Texas High Court first decided this case in May 2005 causing a near fire-storm among policyholder and defense-bar interest groups.  I commented on this reaction and the reasons for it last April (Why Has the Frank's Casing Decision Got Everybody So Upset?).  In a nutshell, the Court originally held that a liability insurer, defending under a reservation of rights, may accept a reasonable settlement offer within policy limits while continuing to reserve its rights to contest coverage and seek reimbursement for amounts allocable to uncovered claims.  The policyholder must repay the insurer even if it does not consent to the insurer's right to reimbursement, as long as the policyholder agrees that the settlement amount is reasonable.

Why the heated response?  The 2005 decision arguably puts the onus on the policyholder to accurately evaluate both the reasonableness of the settlement and the merits of the insurer's coverage defenses, something insureds are rarely experienced at but insurers do for a living.  Also, the defense bar screamed because the original decision appeared to offer the policyholder a way out if it did not agree that the settlement offer was reasonable.  But defense counsel is typically expected to evaluate settlement demands both for the insured and the defending insurer.  However, doing so after the 2005 decision might harm the interests of the insured (by pronouncing the demand as reasonable), but refusing to do so might violate duties owed to the insurer.

So the Supreme Court has now retreated from its original position and decided that the insurer may reserve rights to reimbursement only if that right is stated in the policy or the insured gives "clear and unequivocal consent to the settlement and the insurer's right to seek reimbursement."  In so holding, the Court expands the reasoning it adopted in Texas Ass'n of Counties County Gov't Risk Mgmt. Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000), in which the insurer attempted to reserve a right of reimbursement of a settlement that the insured neither consented to nor opposed (Frank's Casing not only agreed the settlement was reasonable but demanded that Lloyd's accept it). 

The Matagorda County Court recognized that either the insurer or the insured must be left to face a difficult choice.  If the insurer is barred from reserving a right to reimbursement, it must either refuse to accept a reasonable settlement within policy limits, relying on the strength of its coverage defenses, yet risk breaching its Stowers duty to accept a settlement demand within policy limits, or accept the settlement and avoid the risk of extracontractual damages, yet lose forever any right to show that the claim is not covered. 

If the insurer can reserve a right to reimbursement, the insured is put to the hard choice of rejecting the insurer's offer to pay and thereby risk both a much larger judgment plus losing the coverage fight, or accepting the settlement offer and face the risk of reimbursement.  The Court decided to shift the risks of decision to the insurer, holding that, even if the insured agrees that the settlement is reasonable and urges the insurer to accept it, the insurer may not reserve a right of reimbursement without the clear consent of the insured.

Three justices vigorously dissented.  Justice Hecht joined by Green (Dissent 1) argued that "a balanced, practical, and principled rule for resolving the issue presented by this case" is to allow a party disputing its obligation to perform to go ahead and perform the duty but reserve its right to restitution if the other party is benefited beyond what it bargained for in the contract.  (This principle is embodied in The Restatement (Third) of Restitution and Unjust Enrichment, Sec. 35).  Noting that the lower court found that the policy in fact did not cover the alleged claims, and also noting that Frank's Casing was "a substantial business," Justice Hecht argued that the balance of equities should be determined on a case-by-case basis, which the majority rejected.

Justice Wainwright dissented on other grounds (Dissent 2).  He stated, "I would conclude that there is no right to reimbursement.  Absent the parties' entering into a legally enforceable agreement, I do not believe the equities of the parties' respective circumstances alone support allowing a right to recoup the settlement payment."  Yet, in this case, Justice Wainwright would find that by acquiescing to Lloyd's payment, Frank's Casing in fact entered such an agreement.

Assuming no further alterations to this decision, insurers will, from now on, have to choose between continuing to contest coverage or accepting reasonable policy-limit settlement demands.  In Texas, insurers may pursue coverage actions while the underlying lawsuit is pending.  No doubt, we will see an increase in such actions.  Policyholders, who before now blanched at commenting on the reasonableness of demands, are now free to join with the underlying plaintiff in pressuring the insurer to avoid Stowers breaches and accept the demand.

Perhaps most important, we have now recently seen three major coverage decisions from this Court favoring the interests of the policyholder (the PAJ Decision and the Lamar Homes Decision).  Given the number of insurance cases still pending before the Supreme Court, the trend is likely to be significant.

Texas Supreme Court Decides That Workers’ Compensation Claimant May Appeal Agency Ruling In Her Local District

What’s wrong with Austin, Texas? Nothing, unless you are a widow in El Paso seeking to reverse a determination by the Texas Workers’ Compensation Commission that your late husband was killed while working as an independent contractor, not an employee. Thus, the issue in this case is appellate jurisdiction under the Texas Workers’ Compensation Act. Claimants must challenge a denial of benefits before the TWCC. After exhausting agency appeals, a claimant may file a judicial appeal either in the claimant’s local state district court (if the dispute is over compensability or eligibility for benefits) or in district court in Austin, the state capital, for any other type of claim.

Margarita Morales’ husband died after falling from a ladder while repairing a motel roof in El Paso. She contended that he was an employee of one of three entities: two were insured by the defendants, one was a non-subscriber that did not purchase workers’ compensation insurance. The TWCC affirmed the denial of workers’ compensation benefits, finding that Morales was an independent contractor, and thus had not suffered a “compensable injury.” Morales filed suit in El Paso County to appeal that finding, but the case was dismissed for lack of jurisdiction, and the El Paso Court of Appeals affirmed based on the insurers’ argument that the case did not concern compensability.

The insurers acknowledged that employment-course-and-scope inquiries generally concern compensability. But they argued that when one or more potential employers is a non-subscriber, the worker’s actual employer must be determined as a threshold issue before the compensability issue arises. Therefore, the insurers believed that Austin was a mandatory venue under the Act. The Supreme Court reversed and held that coverage and compensability are not necessarily mutually exclusive concepts in a subscriber/non-subscriber situation as presumed by the insurers. Thus, the general rule still applied, and Morales’ employment status remained merely one relevant factor in the compensability determination.

So now, the El Paso district court will decide whether the TWCC got it right, and Mr. Morales was working as an independent contractor.

Texas Appellate Court Strives to Get It Right in Insurance Dispute Over $12,000 Towing Charge.

Canal Ins. Co. v. Hopkins Towing and Recovery, # 12-06-00411CV (Tex. App. Tyler Oct. 24, 2007)

We don't always give enough credit to our courts for the hard work it takes to resolve disputes, even the little one.  The dollar value of a dispute is not always (or even often) the measure of how complicated it can be to resolve, as this case demonstrates.  As the poet observed, "The mountains labored and a mouse was born."  It is a tribute to our judiciary when the mice are treated as worthy of careful scrutiny as the larger species.

On motion for rehearing (i.e., the court already ruled on this case in June but agreed to reconsider arguments) the Tyler Court of Appeals untangled a Gordian knot to resolve an insurance coverage dispute over a $12,690 towing and storage fee for a tractor trailer destroyed in a one vehicle accident on a rural road. (The rig had rolled over requiring the use of special air bags to return tractor and trailer to an upright position.) The driver may or may not have mumbled consent to allow the rig to be towed before being led away on a stretcher (a disputed issue at trial).  The insurer paid for the property damage to the rig but challenged the towing company's right to recover its fees directly from the insurer. 

The statute under which Hopkins sought payment from Canal is section 2303.156 of the Texas Occupations Code, which requires "An insurance company that pays a claim of total loss on a vehicle in a vehicle storage facility [to pay] the operator of the facility any money owed to the operator in relation to delivery of the vehicle to or storage of the vehicle in the facility regardless of whether an amount accrued before the insurance company paid the claim." 

The trial court ruled in favor of the towing company, and the insurer appealed, asserting numerous complicated issues:

1. The owner consented to the tow and storage (which would somehow get Canal off the hook);
2. The vehicle was not a "total loss" (even though evidence at trial proved the repair cost exceeded the fair market value of both tractor ant trailer);
3. The statute only applied if Canal took title to the vehicle;
4. The statute is unconstitutionally vague over what is meant by "total loss" and other terms;
5. The legislative history of the statute shows the law was intended to apply only to a post-tow transfer of title to the insurer;
6. Title didn't transfer to the insurer;
7. The legislative history shows that "total loss" means the wreck has no market value;
8. The statute only applies if the vehicle has been abandoned.

To its credit, the appellate court meticulously examined each issue in detail.  With each new issue, the court patiently defined the standard of review to be applied before discussing the issue.  Where sufficiency of evidence had to be examined, the court quoted trial testimony at length.  The court cited rules governing statutory interpretation and constitutionality.  Only after exhaustive analysis of each challenge did the court come back to its original decision and reassert that Canal had to reimburse the towing and storage charges.

The court earned its pay with this decision.

Arbitration Agreements Are Next To Impossible To Break.

In Re U.S. Home Corporation, et al., #03-1080 (Tex. October 12, 2007)

This decision from the Texas Supreme Court illustrates how difficult it is to get out from under an arbitration clause in a contract.   Because many insurance policies contain clauses requiring any coverage disputes to be decided by arbitration rather than litigation in the courts, this case is worth a comment.  This is actually a ruling on a writ of mandamus rather than the typical appeal of a lower court's disposition of a case on it merits.  Mandamus is a procedure for challenging a lower court's  ruling on a pre-trial matter like a motion to compel discovery, or, as in this case, a motion to compel arbitration in lieu of litigation.

The plaintiffs sued their homebuilders alleging that their houses were built without shower pans.  The contracts signed by the plaintiffs contained clauses requiring that any disputes arising under the contracts will be determined first by mediation and, failing mediation, second by arbitration.  In general, consumers usually believe that they have a better chance of obtaining a favorable outcome before a jury in litigation rather than a panel of industry experts (or dispute resolution experts) on an arbitration panel.  At any rate, the plaintiffs in this case felt that way and sought (and obtained) a court decision that they were not compelled to submit to arbitration.  The builders filed for a writ of mandamus ("mandamus" is a Latin word meaning "we command," and is the name of the procedure in common law whereby a superior court compels a lower court to perform correctly mandatory yet purely ministerial duties).

The Supreme Court granted the writ conditionally (meaning that the Court declared what the lower court should do if the writ were actually drawn up, signed, and wrapped in red tape -- the conditional grant seems less officious).  The following are five arguments frequently raised to avoid arbitration agreements and the Court's reasons for pouring them out:

 

1. The trial court found the arbitration clauses were contracts of adhesion and thus procedurally unconscionable. But the High Court held: “Adhesion contracts are not automatically unconscionable, and there is nothing per se unconscionable about arbitration agreements.”

    

2. The trial court found the arbitration agreements were procured by fraud. But the Court countered:  “The plaintiffs pointed to no evidence of misrepresentations, scienter, or reliance, instead arguing only that the arbitration clause was on the back of their single-sheet contract. As they concede no one prevented them from reading both sides, this is not fraud.. Like any other contract clause, a party cannot avoid an arbitration clause by simply failing to read it.”

    

3. The trial court found the arbitration clauses were not supported by mutual consideration. But, the Court observed, “As both parties agreed to arbitration, this is again simply wrong.”

    

4. The trial court found arbitration would be unduly burdensome and costly. “To sustain such a defense, both the United States Supreme Court and this Court require specific evidence that a party will actually be charged excessive arbitration fees.”

    

5. The trial court found that mediation was a condition precedent to arbitration, and the former having yet to occur the latter could not be compelled. “But while the parties’ agreements clearly contemplated mediation before arbitration, there is no indication they intended to dispense with arbitration if mediation did not occur first.” 

The lesson is that it is almost impossible to avoid arbitration once the parties have agreed to it.

California Court Says Settlements Are not "Damages" Without An Adjudication

Aerojet-General Corp. v. Commercial Union Ins. Co., #CO51124 (Cal. App., Sept. 13, 2007)

This case should serve as a warning to policyholders to read their policies closely (and with their legal hats on).  "Damages" was held to mean "legally obligated to pay or by final judgment be adjudged to pay," and would not include settlements reached out of court, even if the court approved the settlements.  Thus, the policyholder lost its right to recover $175 million, otherwise covered, because it settled rather than submit to actual trial.

Aerojet sought indemnification from several of its excess liability insurers for the cost of remediating groundwater contamination as a result of a number of lawsuits filed in 2000 and 2001.  If the insurers asserted coverage defenses over the merits of the claims, the case doesn't mention them.  It appears that the excess policies were in effect before 1970 and thus, before pollution exclusions.  Aerojet kept the excess carriers informed of the settlement talks but apparently did not obtain their consent to settlements reached with the claimants.

The California Supreme Court has already held in Certain Underwriters at Lloyd's of London v. Superior Court, 16 P.3d 94 (Cal. 2001) [Powerine I] that the term "damages" operated to limit the insurer's obligation to indemnify only to money ordered by a court and would not include environmental cleanup costs required by an administrative agency.  The California Supreme Court in a later opinion in the Powerine case [Powerine II], found that policy language requiring the insurer to indemnify "expenses" as part of the definition of "ultimate net loss" was enough to require an excess insurer to pay.

Unfortunately for Aerojet, its polices did not include the "ultimate net loss" definition or define "damages" in any way that would expand Powerine I's narrow interpretation.  Therefore, the excess insurers were not required to indemnify the (otherwise covered) settlement payments.

While Aerojet's policies were written more than 50 years ago and so contained standard language no longer in use, the lesson to be learned is still valid.  Policyholders should read their policies and have coverage counsel review the language in light of current legal trends.

Texas Insurance Code Delay Penalty Held Applicable To Defense Costs

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

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

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

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

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

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

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

9/11 Court Requires Insurance Company and Attorneys To Pay Sanctions For Deleting E-Version of Policy

Mishandling e-discovery in litigation has become a tremendous trap for unwary and unprepared companies and their counsel.  Indeed recent amendments to the Federal Rules of Civil Procedure impose rules for handling the identification and production of electronically stored records.  For a discussion of these rule changes, see E-Discovery Rule Changes.  Zurich American Insurance Company and its attorneys have become the latest to be hit with costly monetary sanctions for failing to preserve and produce electronic documents.

Judge Alvin K. Hellerstein of the Southern District of New York recently ordered Zurich and two law firms representing it to pay $125 million for failing to produce a 62-page electronic version of of a primary liability policy that was at the center of the insurance dispute over coverage for 9/11 damage to World Trade Center properties.  The version of the policy as it existed (but not yet delivered) on September 11, 2001 gave "additional-insured" status to several entities, including the Port Authority of New York and New Jersey.  But in November of that year Zurich actually delivered a version of the policy that did not include the endorsement.

In subsequent coverage litigation, Zurich denied that the additional insureds were entitled to coverage.  Evidence showed that Zurich deleted the electronic version of the policy that would establish that the underwriters had agreed to include the additional insured endorsement.  However, a paper copy of the e-document later turned up, although attorneys for Zurich refused for almost two years to turn it over to the other side.  The court imposed the sanctions in part to reimburse the additional insureds for the expenses of pursuing discovery of the document.

Federal Court Orders Production of Reinsurance and Loss Reserve Information

A federal magistrate in Kansas recently granted an insured's motion to compel 15 insurers to produce documents relating to reinsurance, loss reserves, claims handling manuals, and document retention policies.  In U.S. Fire Insurance Co. v. Bunge North America, Inc., et al., two insurers filed a declaratory judgment action against the insured, Bunge, and several other insurers seeking a declaration that they were not liable for environmental contamination at three of Bunge’s grain elevator facilities.  Bunge had entered a remediation agreement settling groundwater contamination claims at one of the sites for $4,755,000.

 

Bunge filed counterclaims against the Plaintiff Insurers, cross-claims against the Co-Defendant Insurers, and Third-Party claims against several other issuers, alleging that they acted in bad faith by failing to investigate Bunge's coverage claims in a timely manner, and by failing to accept or reject coverage in a reasonable time.  Bunge also alleged that three of the insurers failed to produce and refused to acknowledge evidence of their policies.

 

The insurers claimed that reinsurance was irrelevant to the interpretation of the policies underlying the declaratory judgment suit, was confidential and proprietary, and that production of reinsurance information was against public interest.  Recognizing a split in federal authority, the court agreed with Bunge's argument that reinsurance materials—and communications between the insurers and their reinsurers—were relevant and discoverable for purposes of: (1) rebutting the insurers’ defense of late notice; (2) Bunge's allegations of bad faith and improper handling of its claims; (3) the insurers' assessment of their potential liability or exposure; (4) the insurers’ admissions regarding coverage; and (5) to reconstruct the terms of policies which were allegedly lost.

 

Because Bunge's counterclaims, cross-claims, and third-party claims directly sought a monetary award, the court distinguished decisions finding that reinsurance agreements are not per se discoverable in declaratory judgment litigation between a policy holder and its insurer that does not involve a damages claim.  Instead, the court approved of cases finding that reinsurance is discoverable under the broad language of Federal Rule 26(a), regardless of the reinsurer’s indirect liability.

 

Regarding Bunge's request for the insurers’ loss-reserve information, the court ruled that such a request was facially relevant to: (1)  the insurers' position that they had no liability for the contaminated sites; (2) Bunge's claims of the insurers' bad faith in investigating and accepting or rejecting coverage within a reasonable time; and (3) Bunge's allegations that certain insurers failed to produce and acknowledge certain relevant policies.  In so ruling, the court expressly rejected as conclusory and without foundation the insurers' arguments that reserve information was merely an estimate of presumed, potential liability made in the ordinary course of business, rather than an actual evaluation of the likelihood of liability or coverage.  The insurers failed to cite any applicable state law or produce evidentiary support establishing their reserve preparation policies.

 

In concluding that reserve information was discoverable, the court approved of federal cases finding that loss-reserve information was relevant not as an admission of liability, but because it was pertinent to other issues, such as the plaintiff’s attempt to rebut a defense, notice, or the defendant’s bad faith.  The court observed that in those cases holding that loss-reserve information was not relevant, that the courts did not examine the specific facts presented, and instead accepted the general proposition that setting reserves is perfunctory, and does not involve an insurer’s evaluation of coverage.  The court believed that it was necessary to determine the relevancy of reserve information on a case-by-case basis by looking to the specific facts presented.  Here, the court found that the timing and establishment of reserve information was relevant to Bunge’s claims of mishandling, bad faith, and breach of the insurers’ duties. 

 

The court also ordered production of certain insurers’ claims handling manuals, based upon Bunge’s assertion that its claims were improperly handled.  The insurers’ argument that these documents’ relevance were outweighed by the harm of disclosure, specifically from the business advantage that their competitors might gain, was rejected.  Finally, the court found that Bunge’s request for the insurers’ document retention policies was facially relevant to Bunge’s claims regarding the allegedly lost policies, but that other requests for documents mentioning or discussing document retention policies were overbroad.  Notably, the court ordered that the parties’ use of reinsurance and claims handling materials was to be limited to the pending litigation, and the parties were prohibited from disclosing reinsurance and reserve information to outside parties.

Homeowner’s Claim Dismissed Because Notice Was Given On The Insurer’s Toll-Free Telephone Rather Than In Writing

The insurance policy required written notice of claims.  However, the insurance company provided a toll-free number for reporting claims.  The policyholder reported the claim by phone, and an adjuster came to the premises.  Insurer tendered a check, but policyholder sued.  In Caddell v. Travelers Lloyds of Texas Insurance Company, a Texas Court of Appeals upheld summary judgment against the policyholder for breaching the policy condition to provide written notice of a claim.  This result seems a little raw, but the court intimates that the policyholder failed to plead defenses that might have defeated summary judgment and failed to provide adequate summary judgment evidence that might have raised a fact question.

 

The plaintiff in Caddell was covered by a casualty policy issued by Travelers Lloyds of Texas Insurance Company that required the policyholder to provide prompt written notice in the event of a loss to covered property.  However, the letter transmitting the policy provided: “For Claim Service call 1-800-CLAIM33.”  In April 2002 the plaintiff had suffered roof damage from a hailstorm.  In July 2002 she became aware of the damage and the growth of mold within the house.  That same month she called the Travelers claim number.  Although she never filed a written response, an inspector came to the insured’s residence and Travelers sent a letter indicating that it would send a check for more than $3,000.  Eventually, the plaintiff filed suit against Travelers alleging for damages and bad faith.

 

Travelers filed a summary judgment motion on grounds that the plaintiff failed to provide the required written notice of loss and failed to mitigate her damages.  The trial court granted a take-nothing summary judgment.  On appeal to the Texarkana Court of Appeals, the plaintiff argued that any failure to comply with the written notice provisions is not fatal unless the insurer is unduly prejudiced.  The court of appeals distinguished those cases because they involved liability policies rather than casualty insurance.  Accordingly, the court affirmed the take-nothing judgment.

 

 

The court noted that plaintiff failed to file any summary-judgment evidence of her own, and her attempts to use Travelers’ evidence failed because Travelers in fact did not file the parts of depositions that the plaintiff tried to cite.  Furthermore, the court suggested that Travelers’ providing a toll-free claims number might raise a question of waiver or estoppel, but the plaintiff neither pled nor pursued the theories.  End of story.  There is obviously a lesson that litigation shortcuts can be fatal.

E-Discovery Mishaps Can Result in Huge Extra Costs and Court Sanctions

Posted by Information Management and E-Discovery Solutions Practice Group

Modern litigation is a recurring fact of life for many companies.  Preservation, collection, and production of information, particularly electronically stored information (ESI) can add enormous expense to any investigation or litigation.  Businesses that are not prepared to preserve, locate, and ultimately collect electronic information may spend significant amounts of money in electronic processing and attorney hours sorting through ESI, including employee e-mail.  And as a word to the wise, courts have imposed costly sanctions (including adverse inference instructions in a number of cases) on companies that failed to comply with preservation and production obligations.  Amendments to the Federal Rules of Civil Procedure and the advisory notes thereto, effective December 1, 2006, have placed some structure on the way ESI is to be handled in federal investigations and litigation, including:

·         ESI production discussed early in a proceeding;

·         Identifying information that is not “reasonably accessible” and whether production is nevertheless required;

·         Retaining and preserving ESI;

·         Applicability of “safe harbor” for existing records retention policies if the policies are properly and timely suspended as a result of the claim or investigation; and,

·         Provisions to allow for the “claw-back” of privileged documents, among other amendments.

To learn more about these amendments, see E-Discovery Rule Changes

Why Has the Frank’s Casing Decision Got Everybody So Stirred Up?

By David S. White

The Texas Supreme court ruled on this case in May 2005.  In response to a furor over the decision, the Court reheard oral argument (a very rare thing) in February 2006.  Now, more than a year later and after numerous amicus briefs submitted by interested parties representing the insurance industry, policyholders and the Texas defense bar, we still wait.  So what’s the big deal about Excess Underwriters at Lloyd’s London v. Frank’s Casing Crew and Rental Tools, Inc., No. 02-0730, 2005 WL 1252321 (Tex. May 27, 2005)? 

On its face, the opinion seems fairly unremarkable.  The decision held that a defending liability insurance company may accept a settlement of a lawsuit that the insured defendant agrees is reasonable and at the same time preserve the insurer’s right later to deny coverage for all or part of the settlement depending on the outcome of a separate coverage lawsuit.  If the insurer prevails, the insured must reimburse the settlement amount.  California adopted this approach in Buss v. Superior Court, 16 Cal. 4th 35 (Cal. 1994).  A few years earlier, the Texas High Court had refused to follow the Buss approach and held in Texas Association of Counties Country Government Risk Management Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000) that an insurer that settled a lawsuit against its insured waived all rights to reimbursement from the insured if the insurer could show that some or all of the insured’s liability was never covered by the policy.  So the Texas Supreme Court has changed course.  Why the firestorm?

There is more at stake here than the Court simply changing its mind.  Frank’s Casing is potentially revolutionary because it may drastically change the traditional roles played in a lawsuit by the policyholder, the insurer, and defense counsel.

Now the Policyholder, Not the Insurer, Has to Be the Expert in Both Evaluating Claims and Insurance Coverage.

First, the ruling appears to shift the burden from the insurance company to the policyholder of figuring out both what is a fair and reasonable settlement and how strong are the insurance company’s coverage defenses.  The Court held that if the insurer has reserved its rights to deny coverage on specific grounds and the policyholder agrees that the settlement demand is reasonable (or urges the insurer to accept the settlement), then the insurer has preserved a right of reimbursement of the settlement upon showing that the claim was not covered by the insurance.  Moreover, the insured may not later argue that the settlement was too high.  If the insurer prevails on its coverage defenses, the policyholder must reimburse the insurer to the extent the settled claims were not covered.  Now the policyholder may have to bear the risk of paying too much in settlement.  The policyholder may also bear the risk of evaluating the insurer’s coverage defenses.  These are matters traditionally within the expertise of insurance companies that handle lawsuits for a living.  Policyholders, particularly if they are not sophisticated in handling lawsuits or in assessing coverage, are at a distinct disadvantage.

The Stowers Duty Is Diluted.

Texas and most states have long imposed a duty of care on insurers to protect policyholders from the risk of a judgment in excess of the policy limits if the insurer receives a settlement demand within policy limits that a reasonable person would accept.  If the insurer refuses to accept the settlement and gambles that defense counsel can avoid a judgment or get a judgment below policy limits, then the insurer bears the risk of having to pay a judgment in excess of the policy limits.  Frank’s Casing potentially absolves the insurer of this duty if the claims in fact are not covered.  So, what should the insured do?  If the insured urges the insurer to accept the settlement, the insured may not later balk at reimbursing the insurer the full settlement amount if the insured loses the coverage suit.  If the insured refuses to consent to the settlement, then the insured may have to pay the entire judgment if it loses the coverage suit — and, even if the insured wins the coverage suit, it might still have to pay any amount of judgment in excess of the policy limits because the insured prevented the insurer from accepting the Stowers demand.  The risks of getting it wrong are all on the insured.

Of course, if the policy clearly doesn’t cover the claim, then the insured has no right to expect the insurer to bear the ultimate liability.  But insurance coverage issues are often within a legal gray area, and even experienced coverage counsel cannot predict with relative certainty how a judge will rule on certain issues.  The insured must now make some hard choices that traditionally were left to the insurance company.

Defense Counsel May Be In an Impossible Position.

The other group complaining about Frank’s Casing is the defense bar.  As discussed above, much depends on the evaluation of the plaintiff’s case at trial, the merits of the case and the amount of likely damages.  Traditionally, defense counsel is in the best position to make that evaluation.  Very often defense counsel is hired by the insurance company to represent the insured defendant and provides case evaluation to both parties.  Arguably, however, the insured’s best option when faced with a plaintiff’s Stowers demand and the insurer’s reservation of rights is to stand mute —not urge acceptance or denial of the settlement demand.  In this way, the insured is neither agreeing that the settlement is reasonable nor preventing the insurer from exercising its own judgment to accept the demand.  However, if defense counsel opines that the settlement is reasonable, the insured may be bound by that opinion because defense counsel represents the insured.  Therefore, counsel might prejudice its client by making its opinion known.  Perhaps defense counsel should also stand mute.  However, even ignoring any duties defense counsel might owe to the insurer, many defense attorneys believe that they have an affirmative duty to provide the evaluation.  They may be damned if they do and damned if they don’t.

Legislation Proposes Dramatic Changes to Texas Civil Court System

Posted by David S. White

Senate Bill 1204, proposed by Senator Robert Duncan, R-Lubbock, has caused a stir among interest and reform groups over changes designed to make the Texas court system more efficient.  Among other things, the bill would convert the larger legislative county courts into district courts and designate certain courts to handle complex civil litigation.  At a March 26, 2007 hearing, several witnesses for the judiciary and the bar expressed concerns about the effectiveness and costs of the innovations.  Justice Linda Yanez, Senior Judge sitting on the Corpus Christi court of Appeals opposed the legislation testifying that it would disenfranchise voters, particularly Hispanic voters.  Texas Supreme Court Chief Justice Wallace Jefferson and former Chief Justice Tom Phillips supported the concepts in the bill but expressed reservations.  A  Representatives for Texans For Lawsuit Reform lauded the proposed legislation as a long-needed attempt to modernize an antiquated system. Texans for Lawsuit Reform.  For a text of the bill see http://www.capitol.state.tx.us/BillLookup/Text.aspx?LegSess=80R&Bill=SB1204