Law and Insurance

Unjustified Severance To Departing Officer Is Uninsurable Disgorement, Says Houston Federal Court

National Union Ins. Co. of Pittsburgh v. U.S. Bank and John Stanley, # 4:07-CV-1958 (S. D. Tex., June 11, 2008)

Because Texas courts rarely have the opportunity to interpret directors and officers (D&O) insurance policies, the U.S. Bank decision is worth a look.  This case concerns D&O coverage, or lack of it, when an insured officer of a failing company was forced to disgorge his $2.27 million severance payment in a bankruptcy proceeding (the company was insolvent at the time), even though the severance had been approved by the board of directors.  The defendant officer sought reimbursement from his D&O insurer.  However, the insurer denied coverage arguing that covered "loss" did not include (1) matters uninsurable under the law, or (2) profit or advantage to which the insured was not legally entitled.  Disgorgement, said the insurer, is both uninsurable and an justified profit.

By the way, the distinction between loss or damage on the one hand and disgorgement or restitution on the other is a hotly contested insurance issue across many jurisdictions and many lines of insurance, not just D&O.  If the insured is simply giving back what it had no right to receive in the first place, then insurance shouldn't provide a windfall to the insured.  But it is not always easy to tell the difference between money damages and disgorgement of money.

In this case, U.S. Bank was in trouble long before the current D&O insurer, National Union, came on the scene.  The bank went through bankruptcy in 1999, and was back in business in 2000 under a reorganization plan that put John Stanley in the driver's seat as CEO for at least three years.  The plan provided for a severance payment of varying amounts depending on whether or not termination was for cause.  The bank continued to fare poorly.  In 2002, the board determined to exercise the termination option.  After tough negotiations (in which Stanley threatened to drag the bank through litigation if he did not get favorable severance terms), Stanley agreed to resign, and the board agreed to characterize his resignation as "termination without cause," allowing Stanley to receive up to $3 million severance.  If he reigned, he got no severance.

Back to bankruptcy court.  The bank was insolvent at the time severance payments were made to Stanley, and the liquidating trustee (curtains for U.S. Bank) sought to recover the payment as an avoidable preference and a fraudulent transfer.  In an adversary action, the bankruptcy court found that Stanley was a bank insider during negotiations of his severance, that he in fact resigned, and thus was entitled to no severance.

Stanley sued National Union for indemnity of the disgorged severance arguing that he incurred a covered loss under the D&O policy.  Stanley argued that he had a clear contractual right to the severance.  He was not giving back that to which he had no right.  Wrong, said the court.  The underlying adversary action determined that he had no contractual right because he resigned voluntarily.  The board action characterizing the resignation as termination for cause was done under threat of litigation and thus was a sham transaction. 

Accordingly, said the court, the payment was both an uninsurable disgorgement and a profit or advantage to which Stanley had no legal right.  Summary judgment for National Union granted.  Case dismissed.

In view of the lower court's determination that Stanley had no contractual right to the severance, this is an easy case for the district court.  However, as mentioned above, it is not always so easy to distinguish loss from disgorgement.  In many transactions, after money has changed hands or securities have been bought and sold, what seems to be loss or damage to the allegedly injured plaintiff can also be called unjust enrichment to the defendant.  So, is the plaintiff recovering damages, or is the defendant disgorging ill gotten gain?  Policyholders should be aware that insurers press the later position frequently and vigorously.

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

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

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

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

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

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

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

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

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

Court's Refusal To Analyze Plain Meaning of "Hostile-Fire" Exception In Pollution Exclusion Burns Insured

Noble Energy, Inc. v. Bituminous Casualty Co., #07-20354 (5th Cir. June 2, 2008) see Noble Energy Decision.

In interpreting insurance policies, courts are supposed to give effect to the plain meaning of the contract language without inquiring into broader considerations of the design or purpose of the provision.  In this case, the court whip-sawed the insured by first refusing to consider the insured's "reasonable expectations" of the scope of an absolute pollution exclusion (because courts just give effect to the language as written), but then artificially limiting  the "hostile-fire" exception by what it was designed to cover, not what it actually said.

Noble Energy was an additional insured under the policy of a contractor hired to dispose of "Basic Sediment & Water" (let's call it gunk) from Noble's storage tanks.  The contractor trucked the gunk to waste facilities, where one day a truck caught fire and exploded when fumes from the gunk seeped into the idling engine.  Death and destruction resulted, and ensuing litigation eventually narrowed to the insurer's refusal to cover Noble's damages due to the absolute pollution exclusion in the policy. 

Pollution exclusions currently enjoy very broad application under Texas law eliminating coverage for all sorts of non-pollution accidents such as tipsy falls from scaffolding due to paint fumes and carbon monoxide deaths caused by careless roofers that covered the chimney with their tool box.  Noble argued that the pollution exclusion was not intended to exclude this type of mishap, but the court, following the Texas Supreme Court's lead, stuck to the plain meaning of the policy.  The fumes from the gunk were a "pollutant," out of which arose the event.

But the pollution exclusion had a hostile-fire exception which states:

[The pollution exclusion clause] does not apply to bodily injury or property damage caused by heat, smoke or fumes from a hostile fire.  As used in the exclusion, a hostile fire means one which becomes uncontrollable, or breaks out from where it was intended to be.

Noble argued that the deaths and injuries were caused by the heat of a hostile fire.  Rather than consider this argument (I can certainly see a counter argument that "heat" and "fire" are not the same thing, and the deaths were cause by explosion, not heat -- but that wasn't raised).  Instead, the court looked to a California federal court decision to infer that the hostile-fire exception applies only if a pre-existing fire causes the pollution.  [Emphasis in original]

But that is not what the policy says.  The court's interpretation is a reasonable inference from the language, but so is Noble's.  I admit, I find the insurer's interpretation more reasonable than Noble's.  But the rules of policy interpretation require a court to give effect to the insured's reasonable interpretation of an exclusion, even if the insurer's interpretation is more reasonable. 

The court should have analyzed Noble's interpretation to determine if it could fit the plain meaning of the exception.  If so, the exception should have applied. Instead, the court jumped to a conclusion, relying on a non-controlling case, that hostile-fire exceptions only apply when the fire causes the pollution.  That is probably what the drafters (insurers) had in mind, but they didn't necessarily draft it that narrowly. 

"Systemic Problems" At Group-Home Facility Held To Prohibit Coverage For Punitive Damages

American Int'l Specialty Lines Ins. Co. v. Res-Care Inc., No. 04-20389 (5th Cir. June 2, 2008) see Res-Care Decision.

In February 2008, the Texas Supreme Court held that punitive damages could be insurable under certain narrow circumstances.  See my discussion of Fairfield Ins. Co. v. Stephens Martin Paving, LP, 246 S.W.3d 653 (Tex. 2008) at Supreme Court Finds No Broad Prohibition of Insurance Covering Punitive Damages - But.  Fairfield found that punitive damages against a grossly negligent employer could be covered under a workers compensation policy because the legislative purpose for allowing those punitive damages was in part to compensate the family of the deceased worker (Texas' workers' compensation law permits a lawsuit against the employer only for wrongful death caused by the employer's gross negligence).  The Court held that public policy did not bar insuring punitive damages when (1) the Legislature expressly allowed such recovery, (2) the purpose was to compensate the plaintiff or deter others, or (3) the insured is a corporation punished for the gross negligence of its employee "[w]here other employees and management are not involved in or aware of an employee's wrongful act."

The Res-Care court addresses the last of the three situations in which punitive damages may be insured.  To appreciate the court's decision to bar insurance from the corporate defendant, we must review the parade of horribles that befell a 37 year old resident at a group-home that provided services for the mentally disabled.  After the resident fell in a hallway and defecated on the floor, an employee poured undiluted bleach on the floor and escorted the other residents outside, leaving the fallen resident in her own feces and bleach for at least an hour before dragging her into a bathroom.  Even then, the resident was not cleaned.  Two other staff members found the resident in the bathroom and put her in clean clothes, treated her with Vaseline, and put her to bed without washing off the bleach.  The resident was not taken to the facility's doctor until 17 hours after the incident.  The doctor diagnosed her with only superficial burns and prescribed pain medication and whirlpool treatments, which were further delayed.  Later, a facility nurse noted the burns but did not follow up until the next day when the resident's skin began peeling off.  She was finally taken to the hospital where she died from complications due to severe burns that covered 40% of her body.

The ensuing lawsuit settled for $9 million, $5 million of which was allocated as punitive damages in a subsequent trial. (Very interesting discussion of the lower court's "Enserch" trial, named after Enserch Corp. v. Shand Morahan & Co., 952 F.2d 1485 (5th Cir. 1992) holding that the allocation between covered and uncovered portions of a settlement must be determined by factfinders in an actual trial -- but that is another issue).  The Res-Care Court affirmed the lower court's finding that Res-Care could not tap insurance to pay for the punitives, not only because several employees appeared grossly indifferent to the resident's shockingly obvious distress, but -- here's the killer -- several prior reports from the state described a level of failure of care that "evidenced systemic problems at the facility."

This case presents a closer call on Fairfield's corporate exception to the public policy bar than might appear on a first reading.  The Res-Care Court could have allowed coverage because management was not aware of the specific treatment in this case.  Remember, coverage should not be denied based on how egregious the employee's conduct was or how badly we may want to deter such neglect.  The sole consideration should be whether the corporation should be punished for the wrongful conduct of its employees.  Had the lower court gone the other way, the appellate court would probably have been justified in affirming that decision as well. 

However, we now have a "systemic problem" prohibition against allowing a corporation to insure against the gross negligence of it employees.  Texas thereby takes a step closer to California's total ban on insuring punitive damages.

How Does The Eastern District of Texas Federal Court Handle A Fraudulent Insurance Claim? Like Any Other Competent Court - By The Law

Jong Mao v. State Farm Lloyds, Inc., #6:07-CV-310 (E.D. Tex. May 20, 2008).

I don't usually comment on personal lines insurance matters, but this attempt to scam a homeowners insurer caught my attention.  The scheme was as brazen as the court's treatment of it was, well, understated.  Boiled down to essentials, the insured purported to rent a house to herself and collect lost rentals paid to herself after a fire.  However, like most fraudulent schemes, this one requires our attention to a shell game of sorts, or at least an attempt at one.

An individual, Jong Ock Mao, aka Jong O. Mao, aka Jong Ock Hahn, or her trust, the "Jong Ock Mao Declaration of Trust Dated July 17, 2001," is the sole shareholder of two corporations: Jong's Consulting, Inc. and MX Oasis, Inc.  In 2005, Jong's Consulting, Inc. purchased a house in Palestine, Texas, and Ms. Mao purchased, in her own name (one of them anyway) a homeowners policy from State Farm Lloyds.  In December 2005, Jong's Consulting leased the property to MX Oasis for a monthly rental fee of $6,000.  Ms. Mao executed the lease (1) as lessor with name, "Jong Ock Mao," and (2) as lessee with the name, "Jong O. Mao."  Fire destroyed the structure and contents on September 25, 2006.

In a footnote, the Court noted that a notice of lis pendens against the property had been filed on August 26, 2006 as a result of a felony indictment against Jong in connection with a California forfeiture action.  But neither State Farm nor the Court paid much attention to that.

At any rate, State Farm was notified and raised a few questions about the part of the insurance claim for lost rent (the policy covered loss of rental value) because Mao appeared to have rented the property from herself.  In a series of letters from her attorneys (she had a least two of them), Ms. Mao explained the various ownership interests of the companies, confirming on the one hand that she was the "sole owner" of both Jong Consulting and MX Oasis, yet also relating that all her interests had been transfered to the Trust in 2001.  No doubt thoroughly confused, State Farm wrote back and rejected the lost rental claim either because Ms. Mao, the sole policyholder, was a separate legal entity from the corporations, which accordingly had no right to policy proceeds, or the companies were her "alter egos," and she was making dummy rental payments to herself.  So she sued.

The court opted for State Farm's first theory and explained that a shareholder is a distinct legal entity from the corporation.  Because only Jong Consulting had the right to receive rental proceeds, and because the policy covered Mao only in her personal capacity, neither Mao nor Jong Consulting was entitled to policy proceeds. 

Reading between the lines, Mao appears to have outsmarted herself.  The court noted in a footnote that it made no difference whether Mao or the Trust was the sole shareholder of the two corporations.  Yet it appears that Mao hoped to get away with her sleight of hand transaction by pretending that a trust is in a sort of no mans land between corporations and individuals.  In other words, she hoped (I think) that her Trust could masquerade as both policyholder and lessor yet avoid the appearance of the same person paying rent to herself.  However, the Court did not waste breath over the existence of the Trust.  It would not have mattered anyway.  In a shell game, it doesn't matter if the shell is a corporation or a trust - they are both fictions.

The Court is to be commended for handling this case quietly and succinctly, no doubt leaving responsibility for more serious action to the State of California and the extradition process.

"Assumption of Liability" Exclusion Misapplied In Coverage Lawsuit

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

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

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

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

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

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

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

Federal Court Reaffirms That Co-Insurers Have No Right of Contribution Under "Other Insurance" Clause

Trinity Universal Ins. Co., Utica National Ins. and National American Ins. Co. v. Employers Mutual Cas. Co., #H-07-0878 (S.D. Tex. May 15, 2008)

This result looks bad for the insurance company plaintiffs, but the real losers in the long run will be policyholders.  Here, the Houston Federal District Court dutifully followed the Texas Supreme Court's holding in Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W.3d 765 (Tex. 2007) (see my discussion at Mid-Continent Decision) that a co-insurer that wrongfully refuses to contribute its lawful share of a settlement paid by other defending co-insurers owes no duty to pay any reimbursement to those insurers despite its agreement to do so under the "other insurance" clause in its policy.  In effect, the "other insurance" clause is rendered at best meaningless, at worst a positive hindrance to the defending insurer's right to seek contribution from the non-paying insurer.  Why?

Most general liability policies contain some form of "other insurance" or "pro rata" clause to apportion responsibility for payment of defense costs and indemnity when other valid and collectible insurance is available to cover the insured's liability.  This happens frequently, as in the Trinity Universal case.  The insured, Lucy Masonry, was hired to install all the masonry work and facade items for construction of a hospital.  Unfortunately for all concerned, the design called for one of those disastrous synthetic "exterior insulation and finish systems" (EIFS) that seem to be responsible for about half of all construction lawsuits in the last five years.  The system failed, Lucy M. was sued, and about four insurers were summoned to defend and indemnify it in the litigation.  All but one insurer agreed to defend.  Employers Mutual's policy, however, contains an EIFS exclusion, and it denied coverage.  All the policies contained substantially similar "other insurance" clauses, so the three defending carriers brought a declaratory judgment action against EM while the underlying lawsuit was pending.

Because the lawsuit alleged faulty workmanship both inside the building and in the facade, the Court held that EM had a duty to defend, which EM had breached.  But that didn't matter.  Because all the policies contained "other insurance" clauses, the defending insurers lost their common law right of contribution from co-insurers, and their contractual rights were "several and independent of each other, not joint."  What does that mean?  The insurers cannot enforce contractual rights against other insurers with whom they have no contractual relationship.  Lucy M. can enforce contractual rights against EM, but the insured has no damages to assert against EM because Trinity et al. is paying the defense costs.

Moreover, the paying insurers have no subrogation rights against EM because, by definition, subrogation means stepping into the insured's shoes and asserting whatever rights the insured had to recover loss from third parties, like EM.  But at no time did Lucy M. have any loss, since the other insurers covered the defense from the beginning.  Also, the Trinity Court reiterated that a defending insurer owes a complete defense and may not pay the insured only its pro rata share.  Trinity and the others are just suck with the bill.

Unless fixed by the Legislature, this trap will result in fewer insurer offers to defend under reservation.  In the future we can expect co-insurers to refuse to contribute defense costs unless all the other co-insurers also agree to pay.  If one insurer refuses, the others cannot start paying on pain of losing any ability to later get contribution.  It is anybody's guess whether an insurer that reserves it right to refuse to defend pending adjudication of a co-insurer's coverage defenses will be subject to a bad faith claim by the insured.  The Texas Supreme Court has long held that an insurer may agree to defend subject to a reservation of rights to challenge coverage.  Of course, the insurer must then go ahead and defend.  Here, the insurer will try reserve its right to withhold defense payment until it can bring the non-payer to the table.

Whatever the outcome, co-insurers will likely be less willing to offer a defense than before.  Bad news for policyholders.

Insurance Agent Held Liable For Faulty Procurement Even Though Insured Failed to Read Policy

Insurance Network of Texas v. Kloesel, #13-05-680 (Tex. App. April 3, 2008), See Kloesel Decision

A little over a month ago, I discussed a Houston Court of Appeals agent-liability decision that an agent wasn't liable for failure to procure requested insurance even though the agent told the policyholder (in direct response to a pointed question on the specific provision in question) that an exclusion would not bar coverage for damage to certain property.  The agent was wrong, and the insurer denied coverage.  See my discussion Houston Court of Appeals Exonerates Agent's Misstatement of Coverage. 

I thought this was an incorrect result.  The Houston court did not even discuss the agent's misrepresentation of the scope of the exclusion and instead focused of what was said in a certificate of insurance.  But surely policyholders must be entitled to rely on the greater expertise of insurance agents on the meaning and import of a particular policy provision, especially when the insured reads the policy, asks the agent about the suspect exclusion, and is told not to worry, the exclusion doesn't bar anticipated coverage.

The Kloesel decision goes the other way and should concern insurance agents.  The Kloesels wanted to procure insurance for the restaurant they owned.  They told their agent they wanted "full coverage" for "all things necessary for a restaurant . . . to stay in business and be protected."  They "wanted to be covered if someone got hurt in some way . . . if a customer got sick or if there was something wrong with the food."  The agent procured a policy that contained a communicable disease exclusion.  Then approximately 90 patrons contracted Hepatitis A transmitted from an employee handling food in the kitchen.  Lawsuits followed.

Insurer denied the claims which fell squarely within the communicable disease exclusion.  In the ensuing coverage litigation against the agent, the Kloesels admitted that they never read the policy and even saw summaries for two or three years before the incident that listed "Communicable Disease Exclusion".  The agent testified that he wasn't an expert in the restaurant industry and assumed that the insureds knew what communicable diseases were.  He thought they wanted food-poisoning coverage, which he got.  Otherwise, he said, he does not tell his customers what coverage they need.  "Only they know what is best for them."

The court upheld a jury verdict in favor of the Kloesels.  Key to the court's decision was the fact that the agent submitted a jury question asking if the Kloesels were contributorily negligent in failing to read and understand the policy terms, to which the jury answered "no."  The court concluded that the finder of fact was entitled to determine whether or not failure to read the policy contributed to the loss.

Of special note, the agent may have been doomed by his own insurance expert, who testified that the agent had no duty because insureds are deemed to read and understand their policies.  So far so good.  The expert then agreed on cross examination that the communicable disease exclusion "is not a desired coverage form" for a restaurant.  What if the Kloesels were your customers?  "It's possible" I would have looked for an alternative.  He also admitted that if he was going to procure coverage for a restaurant, he would want to get coverage for communicable disease.  With friends like that ...

It is also of interest that the court relied heavily on decisions from other states, like New Jersey and Maryland, that may not hold insureds to the same duty-to-read standards as Texas courts.  Thus, the Kloesel court relied on statements such as:

[W]hen [an agent] of repute is employed to effect an insurance against certain risks, the client is entitled to rely upon his instructions being properly carried out.  It is no answer for[the agent] to say: "I handed you the policy and you should have examined it and seen whether it gave you the protection you required." (Quoting Aden v. Fortsh, 776 A.2d 792, 805 (N.J. 2001);

Because "[a]n insured who hires and pays a professional [agent] does so to reduce, if not eliminate the risk that an inadequate policy would be procured," it stands to reason that "[i]nsurance consumers who instruct their [agents] to provide coverage [should be] entitled to have those instructions followed without regard to the insured's failure to detect the [agent's] negligent conduct. (Aden v. Fortsh at 806).

This is a far cry from the Omni Metals case, discussed last month. 

New Mexico Supreme Court Requires Insurers To Defend When They Have Actual Notice of a Suit; Not So in Texas

Garcia v. Underwriters at Lloyd's, London, Op. # 2008-NMSC-018 (N.M. March 13, 2008).  See Garcia Opinion.

Although Texas and New Mexico share a border, they appear to be on opposite poles of the insurance planet, at least on this issue.  The Supreme Court of New Mexico holds in the Garcia opinion that a liability insurer's duty to defend is presumptively triggered when it receives actual notice that a lawsuit has been filed against its insured, not, as under Texas law, when the insured forwards the suit papers and demands a defense.  To overcome the presumption that it must defend, the insurer has to prove that the insured turned down the insurer's offer of defense or was unresponsive or uncooperative.

The rule in Texas, recently reaffirmed by the Texas Supreme Court, is that an insurer is under no obligation to "gratuitously subject itself to liability" by offering to defend an insured who has not asked for a defense or forwarded suit papers to the insurer.  See National Union Fire Ins. Co. v. Crocker, 246 S.W.3d 603, 608 (Tex. 2008) (holding that additional insured was not entitled to a defense absent written demand on the insurer, even though the additional insured was unaware that his employer's policy would cover him as well and so did not request a defense, and the insurer was defending the co-defendant employer in the same lawsuit and knew the employee was covered and paying for his own defense).  See my discussion of the Crocker decision at Liability Insurer Has No Duty to Inform Additional Insured That Coverage Exists. 

The Crocker Court's rationale is that the policy typically states that the insured's actual demand and submission of the suit papers is a condition precedent in the policy, and the condition serves the essential purposes of (1) facilitating timely and effective defense and (2) triggering the duty to defend by notifying the insurer that a defense is expected.  If this rule seems somewhat overly protective of the insurer's interests, you are not alone.

The approach adopted in the Garcia decision is animated by the contrary policy of protecting the reasonable interests of insureds.  The facts in Garcia are a little messy, involving the vagaries of New Mexico probate process (indeed, the reason Lloyd's took no action to defend the insured's estate sued in a dram shop lawsuit was that its New York counsel misread New Mexico probate law and assumed the probate court had no jurisdiction over the tort action).  Moreover, the Court acknowledged that fact issues existed on whether the estate administrator adequately demanded a defense (apparently, the administrator also misunderstood New Mexico probate law and thought that he did not have the authority to demand a defense and instead urged Lloyd's to petition the probate court for the right to defend the estate -- at this point my teenage son would write "LOL").  In other words, the New Mexico Supreme Court did not have to make a new law.  It just wanted to.

The Garcia Court held that the burden of communicating about the defense should fall on the insurer.  The insurer knows, reasoned the Court, that most of the time insureds will want the benefit of a defense.

Why then should the insurer receive the benefit of a rule requiring written tender . . .?  Such a rule requires an insured to jump through meaningless hoops towards an absurd end: telling the insurer something it already knows.  Such a rule injects a degree of gamesmanship into the insurer-insured relationship without providing any valid corresponding benefit.  In fact, the only benefit of such a rule is to create a possibility--where none otherwise exists--for an insurer to escape an obligation it otherwise owes its insured.

(Quoting Federated Mut. Ins. Co. v. State Farm Auto. Ins. Co., 668 N.E.2d 627, 632-33 (Ill. App. Ct. 1996).

Nor does the insurer have to learn of the lawsuit from any particular source.  "We hold that, for the purposes of determining when an insurer's duty to defend arises, 'actual notice means notice from any source sufficient to permit the insurer to locate and defend the insured.'" (quoting Illinois Founders Ins. co. v. Barnett, 710 N.E.2d 28 (Ill. Ct. App. 1999)).  The Garcia Court found that a question of fact existed whether the administrator's letter constituted a rejection of a a defense (that was never offered) and sent the parties back down to the lower court for trial on this issue (at least there weren't sent into the jungle of New Mexico probate jurisdiction).

So which is the better approach?  The Garcia Court did not discuss the possibility that unscrupulous plaintiffs could collude with insureds to give the insurer just enough actual notice of the lawsuit to trigger the duty to defend and then obtain a monster default judgment before the insurer can find the insured and tender a defense.  Although this is possible, many jurisdictions, including Texas, have fairly forgiving procedures for overturning default judgments, particularly when the real party in interest, here, the insurer, has been unfairly excluded from participating. 

On balance, it is easier to picture instances of unfairness to the insured, as in Crocker, than to the insurer, particularly when the insured is unsophisticated and does not know of the available policy benefits.  Absolving the insurer of any obligations whatsoever unless the insured affirmatively demands a defense gives the insurer every incentive to keep mum even when the insurer knows that the insured is ignorant of its rights.  Additional insureds in commercial contexts often do not even know the identity of the insurer.  The rule adopted in Garcia seems less likely to lead to unfair results for either party and, when it does, is probably easier to fix through review procedures.

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. 

Houston Court of Appeals Exonerates Agent's Misstatement of Coverage

Brown & Brown of Texas, Inc. v. Omni Metals, Inc., 2008 Tex. App. LEXIS 2065 (March 20, 2008), See Omni Metals Decision.

If this decision stands, then let the word go forth: customers and additional insureds, never, never rely on a certificate of insurance, insist in all cases on getting a copy of the named insured's policy, and read it carefully. 

The named insured, Port Metal Processing, Inc., stores large coils of steel for processing.  Its customer, Omni Metals, used Port's services over the years and continually asked Port to verify insurance coverage for Omni's products while stored with Port.  Port maintained a bailee's liability policy covering property of others stored in Port's facility, but the policy excluded coverage if Port charged a fee for storage, which it did.  Port obtained the policy from Transcontinental through an agent, Brown & Brown (actually, a predecessor named Poe & Brown -- this case was first appealed in 2000).

Now, here for me is the kicker.  Port's president actually read the policy, noticed the exclusion and asked the agent if the exclusion applied to Omni's product.  The agent said the exclusion only excluded property unrelated to Port's core business, and the steel coils were covered.  The agent issued a number of certificates of insurance over the years for Omni's benefit stating that Port purchased the bailee's liability policy covering "all risks" of direct physical loss to property.  The certificates also had the usual disclaimers the the certificate was informational and did not change the actual terms of the policy.

A fire destroyed Port's warehouse including Omni's product.  Transcontinental denied the claim, and all kinds of litigation followed.  This lawsuit was brought by Omni against both the insurer and agent (earlier litigation with Port had settled).  The trial court dismissed the case based on the exclusion.

One of the oddities of this case is that Houston state courts are subject to the co-extensive jurisdiction of two courts of appeal, in the the 1st and the 14th Districts (the 1st District used to be Galveston, but after the 1900 hurricane practically destroyed the city and other historical developments, the District was moved to Houston).  In 2000, Omni appealed the case, which the clerk randomly assigned to the 14th District.  The appellate court found that both the actual statements and the certificate were actionable misrepresentations and reversed and remanded back to the trial court for fact findings by a jury to determine if Omni relied on the alleged misrepresentations.

The jury brought a verdict favorable to Omni, and the insurer and agent appealed, this time drawing the 1st Court of Appeals.  Ignoring the legal findings of the 14th Court, the 1st Court held that Omni, as a stranger to the policy, could not, as a matter of law, have relied on any statements made to Port, and could not have relied on the certificate of insurance because of the Texas Supreme Court's statement in Via Net v. TIG Ins. Co., 211 S.W.3d 310 (Tex. 2006) that "those who take [certificates of insurance] at face value do so at their own risk."  Reversed and rendered that Omni take nothing.

This decision drew a vigorous dissent (see Dissent) regarding both the majority's disregard of the 14th District's "law of the case" (meaning that a legal decision made on appeal should not be reconsidered on a subsequent appeal of the same case), and its distortion of the Via Net decision, which addressed the applicable statute of limitations in a failure-to-procure insurance case.  Via Net had nothing to do with an agent's liability for misrepresentations in a certificate.

But neither the majority nor the dissent (nor the 14th Court for that matter) drew any distinction between the agent and the insurer, even though Transcontinental asserted that Poe & Brown was not its actual or apparent agent.  Based on the facts related, coverage under the policy is not the issue.   It is the law in Texas that an insurer will not be bound by misrepresentations in a certificate of insurance (barring liability for the agent's misrepresentations).  So I don't see how Transcontinental is on the hook here, unless Poe & Brown was the agent of the insurer (not Port's agent).  The key is the agent's liability for misrepresentation.

Poe & Brown knew that Port charged Omni for storage.  The agent also knew that Omni was asking Port about coverage.  And, asked point blank if the exclusion applied to Omni's product, the agent gave Port a false yet plausible explanation of the exclusion.  Both Port and Omni were justified in accepting the agent's explanation despite what they may have thought the policy said.  This is the dictionary definition of the tort of negligent misrepresentation.

I hope this panel of the 1st District Court of Appeals will reconsider the dissent's arguments.  If not, I hope the 1st District Court of Appeals will reconsider the decision en banc.  If not, I hope the Supreme Court considers the decision.  If not, never, never rely on a certificate of insurance or, for that matter, an agent's explanation of policy language.

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.

Normal Legal Principles May Not Apply With Government Backed Insurance Programs

Reynolds v. Southern Farm Bureau Cas. Ins. Co., #SA-06-CV-0700 RF (W.D. Tex. March 13, 2008)

This flood insurance case stands in bold contrast to the last case I described illustrating courts' aversion to the often harsh effects of absolute legal forfeitures.  See Conditions Precedent Continue Under Attack in Insurance Policies.  But the law can be a tricky thing, as the Reynolds case shows.  "Estoppel," not condition precedent, is the legal principle at stake in Reynolds.  Estoppel, as my contracts law professor explained, means nothing more than "shut up!" and bars a party from asserting an otherwise valid legal right under a contract based on that party's earlier conduct inconsistent with that right and the other party's reliance on that conduct.  Example:  The policy requires submission of of proof of loss within 60 days after loss.  Insured asks for a week extension, and the insurer agrees.  The insurer will normally be estopped from enforcing the 60 day deadline based on its earlier indication that it would grant the request for an extension.  In other words, the court will tell the insurer, "shut up" if the insurer tries to assert its legal right to enforce the deadline.

The facts in Reynold are a little more complicated.  in fact, it's hard to see that the insured was treated unfairly, but, as the court observed, it would come to the same result even if the equities tilted dramatically in the insured's favor.  The Reynolds purchased flood insurance under the National Flood Insurance Program (NFIP) for their vacation home.  The floods came -- twice.  After the first flood in 2002, the insureds submitted their proof of loss for the flood damage a couple of months after the 60 day deadline.  However, FEMA granted a waiver, and the Reynolds' claim of $16,000 was paid.

The same home was damaged again after a 2004 flood, a claim for which was again paid under the policy.  However, the Reynolds also submitted an additional proof of loss for more than $40,000 for unreported repairs resulting form the 2002 flood.  FEMA refused to waive the 60 day deadline for these damages, and the Reynolds cried foul: Insurer should be estopped based on its earlier waiver of the deadline.

Under these facts, a court might not have applied estoppel in any case, particularly since the reason given for the refusal was not the 2-year delay but that the repairs were done before any investigation could be made.  But that is not the point.  Let's assume the fact pattern that I stated above.  60 day deadline--insurer agrees in writing to a week's extension--insured relies on the extension and files a week late--insurer denies.  A court would reach the same result under those facts as in the Reynolds case in the absence of FEMA's written acceptance of the extension.

Why FEMA?  The NFIP is a government-backed program under which private insurance companies issue flood policies that are underwritten by the federal government and administered by FEMA.  That makes all the difference.  The normal principles of law and equity that allow courts to bend conditions precedent to favor coverage or shut up insurers that try to assert policy defenses unfairly have no effect before the federal government because of Constitutional reservation and separation of powers.  As the Reynolds court observed (quoting Growland v. Aetna, 143 F.3d 951 (5th Cir. 1998):

When federal funds are involved, the judiciary is powerless to uphold a claim of estoppel because such a holding would encroach upon the appropriation power granted exclusively to Congress by the Constitution.  "Any exercise of power granted by the Constitution to one of the other branches of Government is limited by a valid reservation of congressional control over funds in the Treasury." (citation omitted)

Pretty scary stuff for a homeowner without a law degree (or even with a law degree).  In this case FEMA probably acted fairly.  But even if it acted unfairly, the courts would not interfere.  The lesson is this:  when dealing with a contract with, or backed by, the federal government, authorized approval is crucial.  The adjuster or the insurance company may not, and probably does not, have authority to bind the government.  Any deviation from the terms of the flood policy should be pre-approved by the authorized federal agent.  Who is that?  I don't know.  You might get approval from a FEMA representative, only to learn later that her boss now says she didn't have the authority to grant the approval.  I can only say that right now Michael Chertoff has the requisite authority.

"Conditions Precedent" Continue Under Attack in Insurance Policies

Quihong Liu v. Fidelity & Guar. Life Ins. Co., #06-41224 (5th Cir. March 7, 2008), see Quihong Liu Opinion

"Conditions precedent," long a formidable defense against coverage, have slipped a bit lately.  Traditionally, a "condition precedent" in a contract is treated as an absolute requirement, failing which the other party has no obligation to perform.  An example, addressed by the Texas Supreme Court a couple of months ago, is the notice requirement in a general liability policy.  It was once the law in Texas (and still is in New York) that an insured's failure to send notice of a claim "as soon as practicable" doomed any right to coverage because the policy said prompt notice was a "condition precedent."  In the PAJ case, the Texas High Court re-characterized the condition, in substance if not in name, as a covenant rather than a condition precedent, requiring the insurer to prove prejudice from the late notice before it could deny the claim.  See my discussion in PAJ Decision.

The Quihong Liu decision similarly shoots down a so-called "good health" condition in a life insurance policy by finding that it is not a condition precedent, but a representation.  Mr. Chen applied for a life insurance policy on September 4, 2003 and truthfully answered certain questions about his health.  He also agreed:

[N]o insurance will take effect unless and until both of the following conditions are satisfied during [applicant's] lifetime and while [applicant's] health is a stated in this application: (1) this policy is delivered to an accepted by the Owner; and (2) the full initial premium . . . is paid at our Home Office.  [Emphasis Added].

A few days later, Mr. Chen was diagnosed with lung cancer.  Two days after the diagnosis, the policy was delivered to Mr. Chen, who died shortly after that.  The insurer refused to pay the death benefit arguing that the condition precedent of pending good health was not met, even if the application was accurate.

The court observed that "Texas law strongly disfavors warranties and conditions precedent."  Only when the policy contains an unambiguous "good health warranty" demonstrating the parties' clear intent that payment is expressly conditioned on the literal truth of an insurer's certification of good health, will the policy be voided.  The court found that that the phrase, "while health is as stated," either was not a condition precedent (but rather a representation of good health) or the language was ambiguous.  Either way, the court held that the insurer failed to show a misrepresentation and had to pay.

Unlike PAJ in which the Texas Supreme Court simply rode rough shod over a clear condition precedent in order to bring Texas law into line with the majority of other states on the issue, the Fifth Circuit here merely demonstrates customary hostility to conditions precedent and looks for a not impossible reading in favor of coverage.

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.

Breach of Contract Can Trigger CGL Coverage - A Brief Reminder

Grimes Construction, Inc. v. Great American Lloyds Ins. Co., #06-0332 (Tex. Feb. 29, 2008), reversing 188 S.W.3d 805 (Tex. App.--Fort Worth 2006)  see Grimes Decision

This decision is little more than house clearing after the Texas Supreme Court's pivotal opinion in Lamar Homes,  Inc. v. Mid-Continent Cas. Co., 239 S.W.3d 236 (Tex. 2007) that alleged defective workmanship causing construction damage could constitute an "occurrence" and "property damage" under a CGL policy, even if the claim is one of pure contract, not tort, and the only damage is to the insured's own work.  The allegations in the Grimes suit are substantially similar to those in Lamar Homes.

In fact, one may wonder why the Court took the time to write even the one page per curiam decision that it produced.  Re-reading the appellate court's Grimes decision, I had the feeling that that court was trying a little too hard to sweep under the carpet allegations that, on a fair reading, could potentially trigger a duty to defend.  For example, the court not only discounted the plaintiffs' allegation of negligent workmanship as, "simply a recharacterization of their basic breach of contract and warranty claims," but also held that alleged negligent hiring and supervision were not "occurrences." 

To reach this holding, the court had to distinguish the Texas Supreme Court's King v. Dallas Fire Ins. Co., 85 S.W.3d 185 (Tex. 2002) which held that alleged negligent hiring/supervision of an employee that assaulted a customer was an "occurrence" triggering a duty to defend the employer.  The Grimes court reasoned that the King employee's assault was not within the scope of employment and so was not foreseeable by the employer, whereas damage from the sloppy work of a construction crew was "more foreseeable."  The Grimes court also observed that the policy in King had a separation-of-insureds clause (i.e., the excluded intentional act of one insured should not be imputed to another insured).  The Grimes policy had no such clause.

But this line of reasoning doesn't even make sense.  The workers in Grimes were not accused of intentional conduct, so there was no need to consider separation of insureds.  And I fail to see in the insurance analysis the relevance of the foreseeability of construction damage from sloppy work.  If an injury is foreseeable from non-intentional conduct, does that mean it can't be covered under an accident policy?  It's like saying that a driver should lose coverage because an auto accident foreseeably might result from careless driving.  Foreseeability is an element of proximate cause, which a tort plaintiff must prove to get damages.  If foreseeability is a bar to insurance coverage, no one will ever be covered for a judgment based on negligence.  To be entitled to the judgment, the plaintiff must have proved foreseeability. This is a court trying hard to avoid finding coverage.

So back to today's per curiam reversal (per curiam means the opinion is issued by the court as a whole not signed by specific justices; since they are supposed to be on uncontroversial issues, they tend to be short).  The Court held:

The court of appeals [had concluded] that defective work was a contract claim outside the scope of the CGL's insuring agreement. ...  We rejected similar arguments in Lamar Homes, concluding that labels of tort or contract could not override the language of the insuring agreement.

It may be that the High Court is singling out the Grimes decision for special censure, gentle though it is.

Liability Insurer Has No Duty To Inform Additional Insured That Coverage Exists

National Union Fire Ins. Co. v. Crocker, #06-0868 (Tex. Feb. 15, 2008) see Crocker Opinion.

The old adage, "Hard facts make bad law" applies in this case.  A nursing home resident sued the facility and an employee after being injured when the employee allegedly swung open a door and hit the resident.  The employee never answered the lawsuit, and apparently never knew he was covered under the employer's policy.  A jury found that the nursing home, acting "by and through its agents acting within the course and scope of their employment," was not negligent.  The plaintiff's attorney moved to sever the defaulting employee before verdict.  After the take-nothing judgment in favor of the nursing home, the plaintiff obtained a $1 million default judgment against the employee and sought to collect against the nursing home's insurance company.

You see, the insurer knew all along that the employee was an "omnibus" or additional insured under the policy.  The insurer had tried to contact the employee by phone and certified mail regarding his status as an insured and right to a defense under the policy.  Apparently, the attorney hired by the insurer to defend the nursing home tried to speak to the employee at a deposition, but the employee refused to speak to him.  So no wonder that the insurer denied responsibility for the default judgment based on the employee's failure to notify the insurer or send a copy of the lawsuit as the policy required.

When the insurance coverage suit reached the 5th Circuit, the court certified the question to the Texas Supreme Court as follows:

Where an additional insured does not and cannot be presumed to know of coverage under an insurer's liability policy, does an insurer that has knowledge that a suit implicating policy coverage has been filed against its additional insured have a duty to inform the additional insured of the available coverage?

The 5th Circuit also asked if the insurer's actual knowledge of these circumstances establishes lack of prejudice as a matter of law. 

The Texas Supreme Court answered No to both questions.  "[A]n insurer that has not been notified that a defense is expected bears no extra-contractual duty to provide notice that a defense is available to an additional insured who has not requested one."  On the question of whether or not the insurer was prejudiced, the Court distinguished this case from PAJ, Inc. v. Hanover (see my discussion at CGL Insurers Must Prove Prejudice), in which the insured sent late notice to the insurer.  In this case, the Court stated, "[N]otice was not merely late; it was wholly lacking."

Bottom line: "Insurers owe no duty to provide an unsought, uninvited, unrequested, unsolicited defense."

But the facts in Crocker are extreme.  National Union bent over backward to contact the employee.  A jury determined that neither the facility nor its agents (including employees) were negligent before the plaintiff obtained a $1 million default judgment.  By contrast, in most additional-insured late-notice cases, the equities are more balanced or favor the additional-insured.  For example, should the insurer avoid coverage when an additional insured requests coverage during the investigation phase before a lawsuit is actually filed but after the plaintiff has demanded relief?  There may even be extensive pre-suit communications between the additional insured and the insurer in which the former's intent to seek coverage is clear.  As the Crocker Court observed, the insurer's duty to defend is not actually triggered until the lawsuit is filed and conveyed to the insurer.  Yet, if the additional insured fails to forward the lawsuit but continues to correspond about the claim, would the Crocker Court excuse the insurer or call it an unsought, uninvited, unrequested, unsolicited defense?

It appears likely that the PAJ decision will require the insurer to show prejudice before avoiding this type of coverage, which means that, as long as the additional insured sends a complaint (or amended complaint) to the insurer and requests a defense within a reasonable time before trial (some decisions have held that a month or two is reasonable), the duty to defend will be triggered. 

But it is clear that ignorance of one's additional-insured status is no excuse.  That is bad news for so-called "omnibus" insureds, like employees of a named insured company, who do not contract for their additional-insured status and so probably have no idea of their rights to coverage.  For those who become additional insureds by contract with the named insured, simply because the named insured is being defended in a lawsuit, does not mean that the insurer has any obligation to cover additional insureds until they send a copy of the complaint and demand defense and indemnity in their own right.

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.

Additional Insureds' Rights Expanded In Significant Texas Decision

Evanston Ins. Co. v. ATOFINA Petrochem. Inc., # 03-0647 (Tex. February 15, 2008) (See ATOFINA Decision)

Today, the Texas Supreme Court cleared three significant insurance cases, each of which deserves attention.  I think the most significant of the three is the ATOFINA ("Atofina") case.  I will address the other two in subsequent postings.

This case substantially expands the rights of additional insureds under liability policies.  An "additional insured" is typically added to a named insured's policy by virtue of the parties' contract in which the named insured, for example a contractor or commercial tenant, agrees to procure liability insurance and add the general contractor or landlord as an additional insured to the policy for claims that arise from or relate to the contract operations or premises.  If the policy contains a provision, usually an "additional-insured endorsement," that adds such contract parties to the policy, then they become "additional insureds" under the policy. (See discussion, Additional-Insured Coverage)

Atofina expands coverage for additional insureds in at least three important respects:

1. The additional insured is entitled to insured status under the policy even if the accident or injury was caused by the additional insured itself or some agent other than the named insured;
2. "Sole-negligence" exclusions in the additional-insured endorsement will not excuse the insurer from defending additional insureds (even if the additional insured is the only defendant in the lawsuit) if the additional insured alleges that the plaintiff or someone else may also be negligent (this, I think, may have the greatest impact for future cases, as discussed below);
3. Insurers, including excess insurers, that wrongfully refuse to defend an insured (including an additional insured) may not dispute the reasonableness of a settlement amount, if the insured was offered an opportunity to defend or participate in settlement negotiations.

Here are the facts:  Atofina hired a contractor to perform some construction at Atofina's refinery.  The contract required the contractor to indemnify and hold Atofina harmless from claims "except to the extent any loss is attributable to the concurrent or sole negligence . . . of [Atofina]."  The contractor also agreed to procure a primary liability insurance policy with certain minimum limits and an excess policy "following form" (having the same terms) to the primary policy.  The contractor procured this insurance.  The primary policy contained an additional-insured endorsement that excluded the sole negligence of the additional insured.

Contractor's employee fell through a rusted tank and drowned in the fuel oil below. The decedent's family sued the contractor and Atofina for wrongful death (but soon dismissed the contractor leaving Atofina as the sole defendant).  The primary insurer tendered its limits, but Evanston, the excess insurer, denied coverage to Atofina primarily on the basis that the policy did not cover additional insureds for their own negligence (i.e., coverage applied only if the contractor caused the accident at least in part).  Atofina answered the lawsuit and alleged that the decedent was contributorily negligent.  Atofina also sued Evanston for coverage and settled the underlying lawsuit for $6.75 million (all but one million of which it claimed from Evanston).

The trial court granted summary judgment to Evanston, but the intermediate court of appeals reversed in favor of Atofina.  The Supreme Court reviewed the case (twice -- it issued an initial decision in May 2006, which it now withdraws).  Evanston first argued that the underlying policy covers Atofina "only for liability arising out of [the contractor's] ongoing operations [for Atofina] . . ."  The contractor was not hired, argued Evanston, to work on the storage tanks.  Therefore, the liability was not sufficiently connected to the insured operations.

On this issue, the high court recognized a split among Texas cases.  One case, Granite Contr. Co. v. Bituminous Ins. Co., 832 S.W.2d 427 (Tex. App. - Beaumont 2003) imposed a "fault-based" interpretation that bars coverage for an additional insured unless the named insured's conduct caused the accident.  Two other appellate cases, Admiral Ins. Co. v. Trident NGL, Inc., 988 S.W.2d 451 (Tex. App. Houston [1st Dist.] 1999) and McCarthy Bro. Co. v. Continental Lloyds Ins Co., 7 S.W.3d 725 (Tex. App.- Austin 1999) applied a broader theory of causation that allowed coverage for the additional insured as long as the accident occurred more or less within the contract works.  For example, if the named insured is a painting contractor whose employee is injured on the work site by a stray truck driven by, say, a plumbing contractor, the injury bears a close enough connection to the painting contractor's operations to trigger coverage.  It was on the work site and the employee was within the scope of the contract works.  "We do not require proximate cause or legal causation," said the Atofina Court.

This is a significant clarification of Texas law on this point.  Many insurers routinely challenge additional-insured coverage because the accident was not caused by the named insured's operations.  No more.

Second, and most significant.  Evanston argued that the underlying policy excluded the sole negligence of the additional insured, and the Evanston policy, following form, contained the same exclusion.  Since Atofina was the only defendant in the underlying suit, only sole-negligent liability was being alleged.  The high court disagreed, reasoning:

On the record before us, we are unable to determine as a matter of law whether the accident was the product of Atofina's sole negligence.  The Jones family originally sued both Atofina and [the contractor], alleging both parties were negligent.  There were allegations in Atofina's pleadings that Jones himself was contributorily negligent.  [Emphasis added]

The Court held that, without a determination of liability, it was impossible to say whether the exclusion should apply.

The significance of this reasoning is that arguably an insurer's duty to defend must now be determined not simply by an "8 corner" rule (reading the policy and complaint), but also by reading the defendant's answer and perhaps other pleadings.  Courts are not supposed to look at extrinsic evidence (i.e., anything except the 8 corners of the policy and the complaint)  See discussion of this rule, 8 Corner Rule in Texas).  Up until now, if the complaint fails to allege some fact necessary to trigger coverage, then the insured may be denied an otherwise merited defense.  Now it seems the insured is master of its own fate.  By answering that the plaintiff contributed to his own death, Atofina provides the allegation necessary to avoid the sole-negligence exclusion.  Insureds and additional insureds may provide missing allegations in their answers and expand the strict 8 corner to 12 or more corners, so to speak.  The expansion is potentially very significant.

Third, the Atofina Court appears to reaffirm its earlier holding in Employers Cas. Co. v. Block, 744 S.W.2d 940 Tex. 1988), that an insurer that wrongfully refuses to defend may not challenge a subsequent settlement as unreasonable.  This is the only portion of the opinion that drew a strong dissent.  Justice Hecht agreed that Evanston was obligated to cover the additional insured but would have remanded the case to allow Evanston to challenge the amount of the settlement.  The problem that the dissent finds is that Block involved a primary insurer that breached its duty to defend.  Evanston, as an excess insurer, had no duty to defend, at least until the primary policy was exhausted.  Justice Hecht criticized the majority for applying the Block rule when an excess insurer refuses to accept a demand to participate in settlement negotiations.

However, in this case, the primary insurer had already tendered its policy limits, apparently from the very beginning.  While it may be technically true that Evanston's duty to defend was not yet triggered, it may be that both Atofina and the primary insurer were asking Evanston to take over the defense.  The facts are not clear.  Still, the lesson here for policyholders is to invite excess carriers to the negotiation table.  After this decision, they probably will be hard put to refuse, knowing that they may be stuck with whatever settlement is reached in their absence.

"Tension in the Duty To Defend" By Scott Stolley

In a recent article, referenced above, published in Headnotes, a publication of the Dallas Bar Association, (see Tension), Thompson & Knight Partner Scott Stolley identifies four unsettled areas in Texas law governing an insurer's duty to defend.  These include:

• Extrinsic Evidence
• Selection of counsel
• Recoupment of Costs
• Prompt Payment

The Texas Supreme Court recently addressed two of the areas of concern (See Frank's Casing and PAJ Inc.).  Nonetheless, many of the details, raised in Stolley's article, remain to be worked out in subsequent cases.  Worth the read. 

Additional-Insured May Not Access Liability Policy Proceeds For Its Own Damages, Court Finds

Ohio Cas. Ins. Co. v. Time Warner Entertainment Co., # 05-06-01437 (Tex. App.--Dallas, Feb. 6, 2008) Court Opinion

After a string of policyholder victories in the Texas Supreme Court (see Texas Supreme Court About Face), Time Warner appears to be testing the waters with this case.  Time Warner (TW) hired a contractor to install fiber-optic cable around the City of Plano.  In addition to requiring the contractor to carry specified types and amounts of liability insurance, TW's contract also required it to be added as an additional insured to the contractor's CGL policy, a very common arrangement.  TW later sued the sub for negligently causing damage to the work and surrounding property.  Again, not an uncommon development.

TW then sued the contractor's CGL carrier seeking $1.5 million for property damages.  The trial court, for reasons not explained in the decision, granted summary judgment to TW.  On appeal, the court readily agreed with the insurer that TW, as the tort plaintiff, had no right to bring a direct action against the defendant's CGL insurer until it obtained a judgment or a settlement agreed to by the insurer.  Texas, unlike Louisiana, is not a "direct action" state.  Plaintiffs may not skip over defendants and directly sue their liability insurers.

TW then boldly demanded coverage for its damages by virtue of its status as an addition insured under the policy, relying on the recent Lamar Homes decision (see Lamar Homes Decision, holding that defective workmanship may constitute a covered occurrence and cause property damage under a CGL policy -- not a contested issue in the TW suit). 

To its credit, the court patiently analyzed the policy language and concluded that TW could not show any claim alleging TW's legal liability for covered damages.  Quoting Allan Windt's respected treatise, Insurance Claims & Disputes, the court observed, "Third-party liability policies require, as a condition precedent to the insurer's liability, that the insured be liable to a third person, by means of either a judgment or a settlement."

What was TW thinking?  Additional-insured status does not convert a third-party liability policy into a first-party property policy or a construction bond.  However, the court refused to render judgment in favor of the insurer and instead remanded the case to the trial court because the insurance claims were not ripe.  In other words, TW might be sued by Plano or adjacent landowners and so might be entitled to liability coverage at that time.  An adverse judgment now might unfairly impair TW's rights to such coverage.