Law and Insurance

Supreme Court Finds No Broad Prohibition of Insurance Covering Punitive Damages -- But . . .

Fairfield Ins. Co. v. Stephens Martin Paving, LP, # 04-0728 (Tex. Feb. 15, 2008), see Fairfield Decision

In this long-awaited decision, the Texas Supreme Court answers the Federal Fifth Circuit's certified question: "Does Texas public policy prohibit a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence?"  The short answer:

[W]e answer that the public policy of Texas does not prohibit [such coverage].  However, without clear legislative intent to generally prohibit or allow the insurance of exemplary damages arising from gross negligence, we decline to make a broad proclamation of public policy here but offer some considerations applicable to the analysis in other cases.

So, this decision probably ends all challenges in Texas by workers' compensation (WC) insurers to Employer's-Liability coverage of punitive damages for gross negligence.  Also, the Court appears to firmly shut the door on uninsured-underinsured motorist coverage for a tortfeasor's punitive damages. But otherwise, unless a statute prohibits or allows specific punitive-damage coverage, just about every other type of liability insurance coverage is left open for future case-by-case development.

The Court agreed unanimously only on the result and those portions of the opinion concerning the WC policy and Texas law on exemplary damages.  Justice Hecht, joined by three other justices, wrote a separate discussion of the all-important "Public Policy Considerations."  However, it appeared to me that all nine justices were in general agreement that insurance coverage of punitive damages would offend Texas public policy in some circumstances. 

At the risk of oversimplifying, the Court agreed that the sole purpose of punitive damages is to punish a wrongdoer.  Other purposes evident in days gone by, such as making an example to others or to compensate a plaintiff, have been dropped from the statutory scheme defining gross negligence and punitive damages.  Thus, where punitive damages may have some purpose other than to punish, such as compensation, coverage is less likely to offend public policy.  The clearest example of this is the WC scheme itself, created by the Texas Constitution, that appears to allow a decedent's survivors to seek punitive damages for an employer's gross negligence as a form of compensation.  It may be for this reason that the Court appears to bless this coverage without any balancing of factors like the culpability of the employer, or whether the employer is an individual or a corporation.

The Court recognized a public-policy interest against shifting responsibility for paying punitive damages to an insurer where doing so would undermine or eliminate the punitive purpose of the remedy.  Two examples: 

1. Uninsured/underinsured motorist insurance is meant to compensate an insured drivers for their own injuries when the tortfeasor fails to have adequate liability insurance.  However, punitive damages fail to punish the tortfeasor if payment is shifted from the tortfeasor to an insurer, even if the tortfeasor is judgment-proof. 
2. By contrast, a corporation whose employees are grossly negligent in their work or production may cause severe injury resulting in punitive damages against the corporation.  In this case, it may make little difference whether payment is shifted to an insurer or to the corporation (actually to the customers of the corporation).  Accordingly, it probably would not offend public policy to allow the insurer to cover the corporation.  The answer might be different, however, for a sole proprietor, or where the CEO was deeply involved in the offensive conduct.

The Court weighs other considerations, all of which will be grist for the mill of future coverage litigation.  Rather than lay the issue to rest, this decision provides ammunition to both insurers and policyholders for non-WC challenges over public-policy challenges to coverage for punitive damages.

Delayed Dissent Filed In Lamar Homes Case Against Applying Delay Penalty To Defense Costs

In August of this year the Texas Supreme Court issued a groundbreaking decision in Lamar Homes, Inc. v. Mid-Continent Cas. Co., 50 Tex. Sup. Ct. J. 1162 (Tex. August 31, 2007) that resolved two long-standing controversies: "occurrence" and "property-damage" coverage for defective construction (see my discussion, Texas High Court Allows CGL Coverage of Construction Defects), and application of a statutory delay penalty in first-party claims to defense costs under third-party liability parties (see my discussion at Texas Insurance Code Delay Penalty Held Applicable to Defense Costs).  Notably, three justices dissented on the construction-defects issue but not on the delay statute.  Now, the three dissenting justices have weighed in with a vengeance against the notion that an insurer's obligation to pay defense costs as part of its duty to defend under a liability policy could be a "first-party claim" under Tex. Ins. Code Sec. 21.55 (now Art. 542).

From their opening salvo, "[S]ince Reconstruction prompt-payment penalties applied to some insurance claims in Texas, but never to a liability carrier's duty to defend," the dissenters attacked the majority's reasoning on numerous grounds.  First, the majority had distinguished between a "first-party claim" (one payable to the insured) from "first-party insurance" (that indemnifies the insured's loss).  The dissenters demonstrated that the terms "first party" and "third party" had consistently and exclusively been applied over the years and under several statutes to the traditional distinction between third-party liability insurance and first-party indemnity insurance.  The majority's distinction was a completely novel one.

Second, the dissent launched a three-part attacked against the logic of applying the notion of "first-party claim" to the duty to defend.  The duty to defend is not a payment obligation, according to the dissent, it's a service obligation.  Second, reimbursement of defense costs is not the same as paying a claim under the policy contract because the insurer typically pays less to defense counsel it chooses than counsel hired by the insured after the insurer has denied the defense obligation.  Third, the dissent argued that defense costs are not "paid directly to the insured" as the statute definition requires, and payment to defense counsel is not, as the majority stated, "a distinction without a difference."

The dissent also forcefully argued that "the very operation of the statute precludes applying it to the duty to defend."  In effect, the dissent argued that applying the terms of the statute to the duty to defend is like forcing a square peg into a round hole (my analogy).  To make a fit, the majority must dispense with certain provisions required under the statute, such as securing a final proof of loss.  Moreover, if the test of a "first-party claim" is that the insurer pays money directly to the insured, then, the dissent points out, reimbursing the insured for a judgment or settlement it paid is just as much a "first-party" payment as reimbursing defense costs.

The dissent is unlikely to persuade the majority to change its ruling, so it remains to be seen how the courts will work out the details of how the delay penalty will be applied to the duty to defend.

Strong Reaction Reported Against Texas Supreme Court Decision

A couple of months ago, I commented on the Texas Supreme Court's decision in Entergy Gulf States v. Summers (see Premises Owners May Obtain Exclusive Remedy) which construed Sec. 406.123 of the Texas Labor Code to allow a premises owner (in this case a refinery) to agree in a written subcontract to pay premiums on workers' compensation insurance protecting the subcontractor's employees, and in return receive the benefit of the bar against common law negligence lawsuits by those employees.  Nobody questions this arrangement between a general contractor and a subcontractor.  The only controversy was whether a premises owner could function as its own general contractor.  The Entergy court held that it could even though the labor statute explicitly prohibited this before the 1993 recodification of the Labor Code.

Now it appears this decision has set off a minor fire storm of sorts.  In Monday's edition of the Quorum Report, which reports on Texas politics, a story appeared that certain Texas Legislators were surprised and shocked that the Supreme Court would interpret the recodification to effect a substantive change in the law.  See Quorum Report.  "Recods," as they are called are not supposed to create new law or make substantive changes in existing law.  In the Entergy case, the Court acknowledged this precept but held that the plain wording of the statute controlled.  What are the Legislators exercised about?

Robert Duncan (R- Lubbock) is quoted as saying that the Legislature has had multiple opportunities to extend the workers' compensation bar to premises owners but has opted not to.  In this view, the Supreme Court has created a new kind of immunity for a much broader class than was intended.

Admittedly, the Entergy decision could open the door to agreements between all sorts of players, landlords, retail operations, even homeowners (?).  However, the arrangement only applies if the premises owner purchases the workers' compensation insurance for the subcontractor's employees.  This arrangement occurs frequently in the oil patch and in the construction industry, and, for a number of reasons makes commercial sense.  So it remains to be seen what, if anything the Texas Legislature will do.  In the meantime, we might be on the look out for innovative agreements by parties trying to shoehorn into the Entergy immunity.

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.

Premises Owners May Obtain Exclusive-Remedy Defense Under Texas Labor Code

Entergy Gulf States, Inc. v. Summers, No. 05-0272 (Tex. August 31, 2007)

This recent case clarifies the distinction under Texas law between a premises-owner and a "General Contractor" and holds that an owner acting as its own general contractor may obtain the protection under the Texas Labor of restricting an injured employee's remedies to workers' compensation benefits.  John Summers worked as the employee of International Maintenance Corp. (IMC) which contracted to perform construction and maintenance at Entergy Gulf States's plant.  The parties' contract provided that Entergy was a statutory employer that would procure workers' compensation coverage for IMC's employees.

Section 406 of the Texas Labor Code provides that a "general contractor" may enter a written contract to provide worker's compensation coverage for a subcontractor's employees, which makes the general contractor the employer of the subcontractor's employees for purposes of the workers' compensation laws.  A "general contractor" is defined as "a person who undertakes to procure the performance of work or a service, either separately or through the use of subcontractors." (Tex. Labor Code Sec. 406.123 (e)).

The lower appeals court had followed earlier cases and held that a general contractor had to enter a prime contract with another [an owner] and then agree to subcontract all or part of that work to a subcontractor.  This interpretation was based on language in the Labor Code that was changed in 1993 revisions when the Code was recodified, ostensibly "without substantive change."  Nevertheless, the Texas Supreme Court held that a court must give effect effect to a statute's clear and specific wording despite a generic statement disclaiming substantive changes.  The current statute contains no limitation on the definition and permits an owner to qualify as a general contractor on its own behalf.

Accordingly, it is now clear that premises owners may contract with contractors and obtain the benefits of the exclusive remedy of the the workers' compensation laws.

Texas Insurance Code Delay Penalty Held Applicable To Defense Costs

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

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

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

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

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

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

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

Texas Governor Signs Joint Resolution Opposing Federalization of Insurance Regulation

Governor Rick Perry today signed a joint Senate and House resolution of the 80th Legislature affirming support of continued state regulation of the insurance industry and opposing pending congressional legislation that would allow federal chartering of insurance companies.  See Federal Regulation of Insurance Industry.  The Independent Insurance Agents of Texas (IIAT) drafted the resolution sponsored by Texas State Sen. Kip Averitt and State Rep. Craig Eiland.  The resolution emphasizes the advantages of state regulation because it provides stronger consumer-protection laws and more streamlined and  prompt attention to problems.

IIAT President-Elect Frank Swingle announced his support for the resolution saying that, "Independent agents understand the need for efficient and effective regulation of our business, but we don't believe that that can be achieved in Washington, and neither do Texas lawmakers."  The resolution is being distributed to President George Bush, U. S. representatives and senators, as well as selected senior officials.  For a fuller discussion of this resolution see Insurance Journal: "Gov. Signs Texas Agents' Resolution Opposing Federal Regulation"

Court Holds that Retrocedant’s Action Against Its Reinsurer Is Not a “Third-Party Claim” Subject to 21.55 Delay Penalty Under Texas Insurance Code

Houston Casualty Co. v. Lexington Insurance Co. (4:05 -cv-01804)

 

        This case forces the reader to understand some technical terminology used in the world of reinsurance.  An insurance company that insures a primary insurer’s insurance risks is called a reinsurer.  When a reinsurer gets insurance to cover its reinsurance risk, that arrangement is called “retrocession.”  The reinsured in this arrangement is called a “retrocedant,” and the reinsurer, a “retrocessionaire.” 

 

In this case, a Magistrate Judge of the Southern District of Texas in a Memorandum and Recommendation ruled that a retrocedant’s claim for indemnity against its retrocessionaire was not a “first-party claim” within the meaning of section 21.55 of the Texas Insurance Code (now codified at 542.051 through 542.061).  Houston Casualty, the retrocedant, filed objections to the recommendation, but the district judge has not yet ruled on the matter. 

 

        The facts are pretty straightforward.  Gulfstream Insurance, the primary insurer, paid its insured for property damage.  Gulfstream made a claim against Houston Casualty, its reinsurer, based on that payment.  Houston Casualty paid Gulfstream and then made its own claim for retrocession reinsurance from Lexington, the retrocessionaire.  Lexington refused to pay.  In the litigation that followed, the district court granted Houston Casualty summary judgment on its claim for coverage.  Houston Casualty also claimed that Lexington was liable for statutory late-payment penalties under the prompt-payment provisions of sections 21.55 of the Insurance Code.

 

        The relevant code provisions impose a statutory penalty of 18% for failure to pay a “first-party claim” within sixty days if an insurer is found liable under a “policy of insurance.” The magistrate judge therefore had to decide, as a matter of first impression, whether:  (1) a reinsurance (here retrocession) policy is a “policy of insurance” under the statute; and (2) whether Houston Casualty’s claim was a “first-party claim.”

 

        As to the first, the magistrate judge found “little reason to regard reinsurance as anything other than a variant of a standard insurance policy.”  “The only departure from the norm is that the parties are designated as ‘reinsurer’ and ‘reinsured,’ (actually, judge, its “retrocedant” and “retrocessionaire” in this case) in order to distinguish them from the parties to the original policy.”  He therefore found that the reinsurance contract was a “policy of insurance.”  As to the second, however, the magistrate judge found that Houston Casualty’s claim for reinsurance was not a first-party claim:  “Any reinsured’s claim against another reinsurer is entirely derivative the original insured’s loss, and necessarily a third party claim.”  Accordingly, he recommended that the district court dismiss Houston Casualty’s claims for late-payment penalties with prejudice.

 

Chalk up another victory for the retrocessionaires.

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