Law and Insurance

Policyholders Win Big in Texas High Court Duty-to-Indemnify Decision

D.R. Horton-Texas, Ltd. v. Markel Int'l Ins. Co., No. 06-1018 (Tex. Dec. 11, 2009) (See Markel Decision)

The holding of this decision seems unremarable -- even if a liability insurer has no duty to defend, it might have a duty to indemnify, based on actual facts proven at trial -- the practical implications are probably huge.  Before Markel, everyone more or less assumed that an insurance company winning summary judgment that it had no duty to defend automatically won dismissal of the case because the rule was: no duty to defend, no duty to indemnify.  Now that has changed.

D.R. Horton-Texas is a general contractor sued for defects in home construction.  The defective work was performed by a subcontractor, but the plaintiff sued only the GC and did not mention anything about subcontractors.  The GC is an additional-insured under the sub's CGL policy and notified the insurer of the suit.  Markel denied coverage because the additional-insured endorsement would cover the GC only for claims arising from the sub's operations.  Since Texas is, as I have pointed out ad nauseum (see, e.g., Another 8-Corner Rule Heartbreaker) a strict 8-corner rule state, extrinsic evidence of the sub's actual role in the construction is not admissible on duty to defend.  Because the pleading is silent on the existence of subs, GC is not entitled to a defense.

GC sued Markel, who won summary judgment despite GC's deposition evidence of the sub's role.  Now, here's the thing.  Markel also won summary judgment that it had no duty to indemnify GC as well based on Farmers Tex. County  Mut. Ins. Co. v. Griffin, 955 S.W.2d 81 (Tex. 1997), which held that an insurer who has no duty to defend has no duty indemnify when the same reasons that negate the duty to defend will likewise negate the duty to indemnify.  Ever since 1997, insurers routinely got dismissed from the coverage action once they won summary judgment on duty to defend.  But, as the Markel Court observes, that is only because everyone ignored the highlighted part of the holding in Griffin.

Unlike the duty to defend, which is based solely on the allegations in the lawsuit, the duty to indemnify is based on the actual facts established at trial.  GC introduced summary judgment evidence that the alleged defects were the work of the named insured sub.  Even though that evidence was not admissible on the duty to defend, the Court held that it was evidence relevant to the duty to indemnify.  Therefore, the Court reversed the part of the judgment granting Markel summary judgment on the duty to indemnify. 

Why is this decision potentially huge?  Before Markel, insurers with colorable objections against defending the underlying lawsuit had little incentive to negotiate and settle coverage claims because summary judgment relatively early in the litigation on duty to defend ended the ball game.  If the insurer lost at the summary judgment stage, then it might come to the settlement table for reasonable negotiations.  Now, winning the duty-to-defend issue will no longer end the lawsuit in many cases, particularly where the 8-corner rule is barring evidence that establishes coverage, as in this case.

A second practical implication is that insurers may no longer be allowed to routinely move to strike extrinsic evidence from summary judgment pleadings.  Before Markel, courts would exclude extrinsic evidence as irrelevant to the duty to defend.  Now, however, such evidence may be necessary to show the possibility of a duty to indemnify and so avoid summary judgment under Griffin on the duty to indemnify. 

Time will tell if Markel results in more settlements at an earlier stage.

Another 8-Corners Rule Heartbreaker for Insurer

Middlesex Ins. Co. v. PBC Operations, L.P., No. A-08-CA-305-SS (W.D. Tex. November 5, 2009) see case

Texas's 8-corners rule can just be torture.  In this advertising injury case, the judge reconsiders his earlier ruling that the "first-publication" exclusion barred the insurer's duty to defend trade dress infringement claims that allegedly began more than 7 years before the policy issued.  For the record, the exclusion excludes coverage for allegations of otherwise covered trade dress infringement "arising out of oral or written publication of material whose first publication took place before the beginning of the policy period."  So why is the judge rethinking the obvious?

Because, says policyholder's counsel, the underlying pleading alleges trade dress violations before the policy period, but nowhere alleges "publication."  Under the adamantine, no-peak-at-anything-outside-the-pleading-without-exception 8-corners rule in Texas, you, judge, may not consider the insurer's affidavits and deposition testimony (including PBC's website) that proves earlier publication.

So the judge takes a second look.  The pleading reads:

[Plaintiff] at no time consented to defendant's use of [Plaintiff's] trademarks or tradde dress for any purpose, including the advertising of an [of Plaintiff's] products.  As a result of defendant's unlawful marketing and sale of conterfeit goods, [Plaintiff] has suffered injury to its reputation and good will.  In addition, [Plaintiff] has suffered injury in the form of lost sales in an amount yet to be determined. [Emphasis added]

The court then carefully scrutinizes the legal reach of "publication" under existing case law and determines that "publication" is not the same thing as manufacturing, marketing, distributing or selling.  "Alleging sales or vague allusions to advertising and marketing, without allegations printed or oral materials issued for public distribution, is not sufficient evidence of publication, even under the broadest definition."

By Hercules!, as the ancients would say, that is tight.  The court acknowledges that some form of publication must necessarily be inferred for the alleged trade dress offense to be actionable.  But, there it is, the 8-corners rule in action.

We feel insurer counsel's pain.  Indeed, we must, because the 8-corners rule, like justice, is blind and can strike policyholder as well as insurer.  I have commented on this fact before (See Good for the Gander II).    Certainly the court cannot be faulted for setting aside common sense and taking a closer look at actual allegations and following the law.  At some point, the Texas Supreme Court may find a way to create some exceptions, but, until then, we are all at the mercy of plaintiffs' lawyers and their choice what to plead or not.

Additional Insured Deprived of Coverage Under 8-Corners Rule - Again

Colony Insurance Co. v. Peachtree Construction, LTD., No. 4-08-CV-135-Y (October 14, 2009), see Peachtree Construction Decision

Texas's unusually strict adherence to the "complaint-allegation" or "8-corners" rule can be especially perilous for additional-insureds, a group typically including general contractors, commercial landlords, and oil companies, who have the clout to require subcontractors and tenants to add them as additional insureds to the subordinate's liability insurance.  Additional insureds are usually covered only when the accident arises from the named insured's activities.

The 8-corners rule precludes a court from considering any evidence to resolve an insurer's duty to defend other than the 4 corners of the pleading and the 4 corners of the policy.  All too often, as in this case, an injured plaintiff, often in his zeal to tag the defendant with the deepest pockets, fails to sue the named insured subcontrator or even allege that it exists.  (Often the plaintiff is the subcontractor's employee and is barred by the workers' compensation laws from suing the employer).

When that happens, the subcontractor's insurer refuses to defend its additional insured because the pleading fails to allege that the injury arose out of the subcontractor's work.  The insurer almost invariably wins dismissal of the insurance claim because the judge is barred from considering the abundant proof that in fact the named-insured subcontractor's work was the cause of the injury.  Texas is, I believe, the only state that recognizes no exceptions to the 8-corner rule to avoid law-is-an-ass ridiculous results.  I would welcome any corrections if this is not the case.

Here, Peachtree Construction was building a road and hired Cross Roads LP to install warning signs and barriers.  A passing motorcyclist lost control and crashed at the site.  The surviving spouse sued Peachtree alleging that the crash was the result of negligent placement of barriers and failure to post warning signs, matters squarely within Cross Road's contractual responsibilities.  However, the pleading did not mention Cross Roads.

Although Peachtree was an additional insured under Cross Road's general liability policy, the insurer refused to defend for the reasons described above.  In the ensuing coverage litigation, the judge refused to admit the subcontract or other evidence establishing Cross Road's role in the construction, again for reasons described above.

Compare this result with one in a similar case I discussed last year.  See 8-Corners Rule Requires Close Look at Factual Allegations, Says Fifth Circuit, in which the court put on its Sherlock Holme's cap and searched the pleadings with a magnifying glass to find traces in the pleadings that potentially implicated the involvement of a subcontractor in the allegations.  But the 5th Circuit had more to go on than here.  At least the the subcontractor was mentioned in that case.  In Peachtree, nothing was said to justify an inference supporting coverage.

So, what can an additional insured do in this situation?  It might try to challenge the pleadings in the underlying case by filing "special exceptions" in Texas state court or a motion for a more definite statement under Rule 12 (e) in federal court, devices designed to force the plaintiff to replead with greater detail.  Should Peachtree have pointed out to the plaintiff that Cross Roads was the subcontractor responsible for the signage and barriers, the plaintiff might have repled and at least mentioned the subcontractor.

Failing that, Peachtree might bring Cross Roads into the lawsuit as a third-party defendant, which might prompt the plaintiff to add the subcontractor as an additional defendant.

But these are cumbersome strategms that could fail.  The rationale behind the 8-corner rule is sound.  The insurer should have to take the pleadings as given and defend without developing extrinsic evidence early in a case to avoid coverage.  But the rule arguably gives the underlying plaintiff too much control over coverage.  Plaintiffs motivated to bring a deep pocket insurance company to the settlement table may plead or omit allegations just to trigger the duty to defend.  On the other hand, a plaintiff seeking to deprive the defendant of a fund to pay for the defense, may falsely plead out of coverage. 

It seems only fair that the parties to the insurance contract have some means of addressing obvious and egregious manipulation of the pleadings.

Court Finds Texas Insurance Code Delay Penalties Accrue Invoice By Invoice

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

In my last post, I called this case a potential harbinger of how Texas courts might interpret CGL policies that revoke the duty to defend (see Court Applies 8 Corner Rule to Loss-Indemnity Policy).  The case also addresses another open issue under Texas law by prescribing a methodology for calculating penalties an insurer must pay under Texas' delay statute for denial of the duty to defend (or refusal to advance defense costs under a loss-indemnity policy).

Section 542.051 of the Texas Insurance Code (formerly Art. 21.55) imposes a penalty of 18% per annum on the amount of a 1st-party claim that an insurer delays or refuses to pay.  The Lamar Homes decision in 2007 resolved in favor of policyholders a long-standing controversy over whether the statute applies to the defense-payment compoment of a 3rd-party liability policy (see my post Delay Penalty Held Applicable to Defense Costs).  However, Lamar Homes did not spell out the way the penalty should be calculated.  The statute keys payment of the penalty on the insurer's delay or failure to pay a "first-party claim."  Lamar Homes held that the policyholder's claim for defense is a first-party claim but did not define when and how that claim is made for purposes of calculating the 18% penalty.

Does the penalty begin to accrue from the time the insured demands a defense?  From the time defense fees are first incurred?  From the time defense-cost invoices are submitted to the insurer?  Not until the insurer is adjudged liable?  If the insured submits defense bills monthly, is each bill a new "claim" starting its own 18% calculation (implied in Primrose Operation Co. v. National Am. Ins. Co., 382 F.3d 546, 555 (5th Cir. 2004))?

The Basic Energy case elects the latter option and holds that the "penalties apply at the time an insurer improperly denies a first-party claim and, thus, fails to meet its obligation within the ... statutory deadline."  The court noted that Basic Energy tendered notice of the underlying lawsuit and claims for insurance on November 12, 2007.  The insurer denied the claim on February 13, 2008.  "Thus, the Court finds that the date that Defendant improperly denied Plaintiff's first claim was February 13, 2008."  In a footnote, the Court stated that Basic Energy would have to provide further evidence of its defense invoices for the court to determine "the precise damages and from what date interest may apply."  

Although the Court could have elaborated the method in greater detail, I see no other way to read the footnote than to follow the method suggested in Primrose Operations:  a new interest calculation begins on each separate invoice from the time it is submitted through final judgment against the insurer.  The denial date, February 13, 2008, may or may not be the date to begin accrual of the penalties.  If the insured submitted invoices before the denial date, the penalty should being to accrue as early as the 15th business day after the insurer received the invoice or any "items, statements, or forms required by the insurer to secure final proof of loss."  (See Tex. Ins. Code Sec. 542.056 stating that the insurer must accept or reject a claim within 15 business days after receiving required items).  Once the insurer denies the claim, then presumably the insurer has waived any right to delay accrual by requesting "items statements or forms."

The key point for policyholders: for greatest recovery, submit each separate defense invoice to the insurer for payment as soon as possible.

A number of open issues regarding Sec. 542.051 remain that future courts will need to resolve.  (For example, other than the invoice itself, what "items, statements, or forms" could an insurer require before accepting or rejecting a claim?)  However, by following the suggestion of the Primrose Operation case, this court has put the invoice-accrual method for calculating delay damages on a more solid footing.

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.

Texas Court Wrestles With Number-of-Occurrences Puzzle in Pollution Cases

Pennzoil-Quaker State Co. v. American Int'l Specialty Lines Ins. Co., # H-08-2025 (S.D. Tex. September 4, 2009)

Certain issues of insurance law have become hopelessly fubar.  "Number of occurrences" under Texas law is one of those issues.  Most general liability policies provides "per occurrence" limits, say up to $1 million for each occurrence.  If a particular loss involved 2 occurrences rather than just 1, then claimants could recover up to double what they could get if only 1 occurrence was involved.  This was the fight after the twin towers fell on 9/11.  The insurers argued that 1 coordinated plot meant only 1 occurrence.  The policyholder urged that 2 towers brought down by 2 airplanes must involve 2 occurrences.  Insurers won.

But why is the issue hopelessly screwed up?  Because half the time, policyholders want as many occurrences as possible (to maximize per-occurrence limits), and half the time insurers want multiple occurrences.  If the issue is, as in this case, how many per-occurrence deductibles must be paid, the shoe is on the other foot, and the parties switch sides of the argument; insurers argue for multiple deductibles.  I believe that most of the inconsistencies in the case law on number-of-occurrences is due to courts unconsciously pulling for policyholders.  Ironically, in this case, the confusion worked against the insured.

Pennzoil has a refinery in one Louisiana city. In a 4 month period in 2001, Pennzoil was hit with 5 separate lawsuits brought by numerous residents near the refinery complaining of physical ailments and property damage caused by the release of various pollutants into groundwater and air.  All 5 cases were consolidated.  The insurer agreed the suits were covered and agreed to defend, but only after Pennzoil first paid deductibles totaling $10 million (5 deductibles of $2 million each).  Not surprisingly, Pennzoil argued that 1 deductible was due because all the alleged releases were part of "the same, related or continuous Pollution Condition," as defined in the deductible clause.

The court decided the issue in favor of the insurer after an exhaustive analysis of the rules and guidelines other courts have contributed over the years, which I submit are hopelessly inconsistent.  The insurer argued for 5 separate "Pollution Conditions" (really no different than "occurrences") because the 5 lawsuits alleged: (1) releases from a fire on January 18, 2000; (2) exposures from a release on November 4, 2001; (3) continuous releases into the groundwater; (4) continuous releases into the air; and (5) releases of various substances that differ from one suit to the next.

I plead guilty to over-simplifying the issues somewhat, and I do not in any way impugn the court's painstaking attempt to correctly apply existing law.  But I am not sure that some of the distinctions between one type of release from another are persuasive.  For example, the White lawsuit alleged release of benzene, but the Daughtry suit alleged releases of "benzanthracene, benopyrene, bis(2-Ethylhexly)phthalate, benzo(b)floanthene, benzo(k)floranthene, and chrysene, but not benzene."  Not being a chemist, I couldn't say if the substances listed in Daughtry could not accurately be called "benzene," but I suspect the differing allegations are more a function of the plaintiff attorneys' attention to detail than a matter of differing releases from the refinery.  The question is, do the distinctions stand up to scrutiny, or, as Pennzoil, argues, do they all more or less allege a continuous hodge-podge of related releases.

I also suspect this one is going up  on appeal.

Texas' Prompt Payment Statute Held Not Unconstitutional

Nautilus Ins. Co. v. International House of Pancakes, Inc. 622 F.Supp.2d 470 (S.D.Tex. 2009)

Texas' Prompt Payment Statute (Tex. Ins. Code Sec. 542.054) imposes on slow-pay insurers a penalty of 18% per year on any covered "first-party" claim.  Two years ago, the Texas Supreme Court confirmed that a liability insurer's duty to pay defense expenses on behalf of its insured was a "first-party" obligation within the Prompt Payment Statute.  (Lamar Homes Inc. v. Mid-Continent Cas. Co., 428 S.W.3d 193 (Tex. 2007)).  In this case, Nautilus makes a valiant, though doomed, effort to have the statute itself struck down as unconstitutional on its face or otherwise void for vagueness.

IHOP was sued by a woman alleging that a restaurant manager sexually harassed and raped her.  Nautilus denied the claim and refused to defend IHOP and the manager, but the court ruled that Nautilus had a duty to defend IHOP.  After Lamar Homes, Nautilus should be liable for reimbursing IHOP's reasonable defense attorneys' fees plus 18% per year without further ado.  Nautilus, however, filed a motion for summary judgment solely on the statutory penalty.

I won't go into the arguments that the statute is unconstitutionally vague.  Civil statutes are very rarely struck down for vagueness.  Although a number of Texas courts before Lamar Homes disagreed over the meaning of the statute, the court observed that it would take a lot more than split decisions in the courts to show unconstitutional vagueness.

But Nautilus fastened on the word "penalty" to argue that, on its face, the statute is "penal" in nature, and must, like any criminal statute, be strictly construed against enforcement.  Indeed, the Texas Supreme Court characterized the 18% penalty as "penal in nature."  (State Farm Life Ins. Co. v. Martinez, 216 S.W.3d 799 (Tex. 2007).  Like a criminal penalty or fine, argued Nautilus, the Prompt Payment Statute should be strictly construed.

Somewhat anticlimatically, the court yawned and asked, "So what"?  Even if construed strictly, the law is clear enough to warn the insurer that it must pay an extra 18% of the claim if it wrongly refuses to defend.  Moreover, the court noted that often legislatures explicitly abrogate or modify a civil statute to remove the strict-construction rule.  The court found that the Texas Legislature had done just that by inserting the instruction that the statute "shall be liberally construed to promote the prompt payment of insurance claims."  Pay the defense costs.

This case arguably marks insurers' last stand against application of the Prompt Payment Statute to defense costs due under liability policies, at least in the courts.

5th Circuit Reverses Faulty Denial of Coverage for Foundation Repair Lawsuit

Wilshire Insurance Co. v. RJT Construction, LLC, No. 08-50925 (5th Cir. August 26, 2009)

A homeowner hired RJT Construction in 1999 to raise, level and stablize the foundation that had shifted as a result of water damage from a plumbing leak.  In late 2005, the owner noticed cracks in walls and ceilings and sued RJT for negligent repairs.  RJT sought defense and indemnity from Wilshire, who denied the claim and brought a lawsuit to determine coverage.

The lower court granted summary judgment favoring Wilshire holding that the alleged damages were excluded by this exclusion:

[T]his policy shall not apply to any claim of liability . . . caused by, resulting form, attributable or contributed to, or aggravated by the subsidence of land as a result of landslide, mudflow, earth sinking or shifting, resulting from your operations or your subcontractor's operations.

The lower court reasoned that the owner had alleged that the foundation shifted which caused a subsidence that caused the cracking.  On appeal, the Fifth Circuit disagreed.  "The [lower] court focused on the movement of the foundation.  But the exclusion focuses on the movement of land, not the foundation."  The owner never alleged that the land moved.  That exclusion does not apply.  But the appellate court also addressed other defenses that Wilshire had raised.

First, Wilshire apparently argued that the allegedly faulty construction that caused the damage occurred before the policy was issued (June 2004).  The Texas Supreme Court recently rejected the "discovery" rule that property damage "occurs" when the damage is first discovered; rather, coverage is triggered when property actually sustains physical injury.  (See Don's Building Supply, Inc. v. OneBeacon Ins. Co., 267 S.W.3d 20 (Tex. 2008), discussed here).   The appellate court agreed that the first manifestaton of damage was not the triggering event, but neither was it when the faulty work was performed.  In this case, held the Fifth Circuit, the cracks are themselves property damage, not just the manifestation of damage.  Therefore, cracking in late 2005 triggered coverage within the policy period.

Second, Wilshire argued that the alleged foundation damage fell within the "your work" exclusion.  Damage to the named insured's work or any part of it is not covered.  Accordingly, damage caused by the foundation work is not covered.  Not so, said the court.  Don't forget those darned cracks.  Wilshire is correct that damage to the foundation is not covered, but RJT never worked on the walls or ceilings.  Cracked walls and ceilings damaged by the faulty work does not fall within the exclusion. 

Reversed in favor of RJT. 

Insurer Waived Its Right To Appraisal. Why Did It Wait?

Financial Management Internat'l, Inc. d/b/a/ The Summit Sports Club v Mt. Hawley Ins. Co., #M-08-267 (S.D. Tex. Aug. 17, 2009).

The court in this case denied Mt. Hawley's Motion to Compel Appraisal because it delayed until a year into the coverage lawsuit.  The insurance dispute is over water damage at the sports club caused by a burst pipe.  The insured brought the lawsuit alleging that Mt. Hawley refused to pay for the damage.  We are not told any more than that about the coverage issues.  We are told that the insurer removed the state court case to federal case, answered complaints, attended hearings, participated in discovery and mediation, and a year into the case, sought to invoke its right to appraisal.

Appraisal is a process provided in most property policies to short cut insurance disputes over the dollar amount of damage independent of disputes over whether the claim is covered in the first place.  Once it becomes clear that the parties disagree over how much repairs or replacement costs, either party has the right to invoke the appraisal clause.  Once invoked, the clause spells out the appraisal process, which usually requires each party to select a qualified appraiser, who get together and select an umpire.  Each appraiser provides its estimate of the damage amount, and the umpire then sides with one side or the other. 

The appraisers are not supposed to decide coverage issues, only the amount to repair or replace.  Sometimes, however, it is impossible to put a dollar figure on the damage unless the scope of damage is defined.  For example, an insured's roof may have sustained both hail damage (covered under the policy) and damage from ordinary wear and tear (not covered).  In order to estimate the cost to repair, the appraisers arguably must distinguish hail damaged shingles from worn-out shingles.  This would require determining not only the cost to repair the damage but also the cause of the damage.  Texas law, however, has not clearly established that appraisers may make causation determinations.

Back to our case.  We may guess that Mt. Hawley balked at paying for the repairs because it had a causation defense.  The water damage from the busted pipe, in Mt. Hawley's view, caused only part of the damage, and the insurer refused to pay for repair of the part that it thought was already damaged from earlier leaks or just wear and tear.  This is just a guess, but the timing of Mt. Hawley's motion is interesting.

Mt. Hawley filed its motion to compel appraisal on July 15, 2009.  On July 3, 2009, the Texas Supreme Court issued its decision in State Farm Lloyds v. Johnson, #06-1071 (Tex. 2009) (see my discussion, Johnson Decision), holding that in certain situations, like the illustration described above, appraisers may decide causation issues before litigation in order to realize the cost-saving benefits of the appraisal process.  Mt. Hawley argued that it could not have anticipated that the Johnson decision would permit appraisers to resolve causation.

The court, however, agreed with Summit that the insurer waived its right to appraisal by litigating the dispute for a year.  The Johnson court based its decision in part on the cost benefits of appraisal before litigation, which is considerably more expensive.  Once the cost-saving is lost, and the issues are before the court in litigation, it is too late for appraisal.

As I stated in my discussion of Johnson, appraisal usually benefits the insurer, particularly when homeowners are seeking coverage.  Insurers are more familiar with the process and have appraisers they have used in the part.  We can expect to see insurers invoke the process more frequently.  They can't do so, however, if litigation is underway.

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.