Insurance Litigation Lawyer & Attorney : National Insurance Law Forum : Insurance Coverage, Bad Faith Litigation

In what can only be called a significant turn around, the New Mexico high court recently overruled twenty-four years of precedent when it announced that actual notice from any source to a liability insurer of a lawsuit against its insured could trigger the duty to defend, even when the insured failed to provide notice of the suit or ask for a defense.   In proving the old adage "bad facts make bad law," the New Mexico Supreme Court ruled notice of a liability claim against the insured could come from any source and the insured's failure to demand a defense didn't excuse the insurer from defending covered claims.  

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A Federal District Court Judge from the Southern District of Texas’ Galveston Division recently granted summary judgment against an insurer seeking to enforce identical pro rata sharing provisions contained in multiple primary insurance policies.  In doing so, the court highlighted the lack of options primary carriers now face in Texas when co-primary carriers don't contribute to defense or indemnity benefits to the common insured.  In Nautilus Ins. Co. v. Pacific Employers Ins. Co., No. G-04-619 (S.D. Tex.  February 25, 2008), several insurers were called on to defend and indemnify a seismic testing company which allegedly damaged over 200 buildings in Galveston County while conducting seismic testing.  All of the insurers except Pacific Employers contributed to the settlement and Nautilus Insurance then sought to recover the amounts it overpaid to fund the settlement from Pacific by way of subrogation and enforcement of the policies respective pro rata "other insurance" sharing provisions.  The suit among the co-primary carriers resulted in summary judgment motions being filed on the issue of whether a settling co-primary carrier in Texas can sue a recalcitrant co-primary carrier for not paying it's fair share of the defense costs or the settlement.  Relying on the Texas Supreme Court’s recent decision in Mid-Continent Insurance Co. v. Liberty Mutual Insurance Co., 236 S.W.3d 756 (Tex. 2007), the District Court held last week that because the insured had been fully indemnified, the settling insurer had no claim under Texas law against the non-settling insurer because “there is nothing to which Plaintiff can be subrogated.”  This harsh result is the inevitable consequence of the Texas Supreme Court's decision from February in Mid-Continent v. Liberty Mutual. 

Because of the proliferation of suits involving construction defects, intellectual property violations, toxic torts, premise liability and other significant torts, it is now extremely common for insured defendants to have two or more primary liability carriers whom they turn to for defense and indemnity benefits.  The unwillingness of the Texas Supreme Court to allow one carrier to sue another for reimbursement, contribution or subrogation puts Texas in an extreme minority on this issue and forces carriers in that state to become very creative when settling liability suits when one or more other primary carriers have not or will not contribute to defense or settlement costs.  Carriers in such a situation must consider formal assignments from insureds and other creative alternatives before allowing the underlying liability to be settled and dismissed.   Otherwise, they will find themselves in the same position as Nautilus having overpaid a claim they did not fully owe with no avenues for reimbursement against the carrier who refused to pay timely.  

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In Nejati v. Royal Indemnity Co., 2008 WL 483496 (N.D. Tex., February 19, 2008), Royal was sued by Nejati to enforce a $1.4 million default judgment obtained against Royal’s insured under a commercial auto policy.  Nejati obtained a default judgment because the insured failed to forward suit papers to Royal and repeatedly refused to communicate with Royal about the lawsuit.  Royal received actual notice of the suit from Plaintiff's counsel but it did not file an answer on its insured’s behalf because the insured never made a claim, never asked for a defense, and refused to cooperate with his insurer's efforts to try to protect him.  Royal also never issued a reservation of rights or submitted a non-waiver agreement.  It did, however, engage in limited discussions with Nejati’s attorneys once it was notified of the suit including asking for an extension of the answer date to enable to it contact the insured and including trying to settle the lawsuit before a default judgment was entered. On February 19th, Federal District Court Judge Barbara M.G. Lynn from the Northern District of Texas ruled on cross motions for summary judgment filed by Nejati and Royal. 

The court denied summary judgment determining two fact issues existed: (1) whether Royal was prejudiced by its insured’s breach of the cooperation clause; and (2) whether Royal waived the cooperation clause as a condition precedent to coverage through its conduct.  Consistent with the actions of other Texas courts in recent months, this court implicitly rejected the concept of “prejudice as a matter of law” in finding the referenced fact issues despite the insured’s gross failure to cooperate or to even demand defense or indemnity benefits from his liability insurer.  While there is nothing uniquely significant about this decision, it does illustrate an unfortunate trend among Texas courts (both state and federal) in the last 12 months to refuse to recognize "prejudice per se" when an insured refuses to make a claim, refuses to cooperate, and allows a default judgment to be entered.   While these decisions seem superficially beneficial to policyholders, they are actually harmful to policyholders over the long run.  For example, the efforts of the insurer to try to repeatedly contact the insured, to ask for an extension of time to answer, and to ask opposing counsel how much he wanted to settle the case are obviously good things for the insured.  But, as this case illustrates, if such "good efforts" are going to actually increase the insurer's exposure by creating a fact issue as to its actual prejudice, then the obvious lesson is for insurers to not try to help their insureds and simply wait for actual notice from their insured and wait for a demand for a defense before lifting a finger.  That is a very, very dangerous precedent, but it is the unfortunate implication of the refusal of Texas courts' to recognize prejudice per se or prejudice as a matter of law following late notice.   

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Last Friday, the Texas Supreme Court answered “no” to the following certified questions from the Fifth Circuit: 

"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?"  and,

"Does proof of an insurer's actual knowledge of service of process in a suit against its additional insured, when such knowledge is obtained in sufficient time to provide a defense for the insured, establish as a matter of law the absence of prejudice to the insurer from the additional insured's failure to comply with the notice-of-suit provisions of the policy?"

In National Union fire Insurance Co. v. Crocker, 2008 WL 400398 (Tex. February 15, 2008), a nursing home resident sued the insured nursing home and its employee for injuries suffered when hit by a door swung open by the employee. The employee was terminated after the incident but before suit was filed. The insurer defended the nursing home but did not defend the employee even though the claims against him were covered and the insurer knew he had been served. The insurer attempted to contact the employee by phone and mail without success. During the suit, the employee spoke privately with plaintiff’s counsel at a deposition but refused to speak with the nursing home’s defense counsel. At trial, the jury returned a take nothing defense verdict against the nursing home but the court entered a $1,000,000 default judgment against the employee. The injured resident then sought to collect against the liability insurer because of its alleged coverage on the employee. 

The federal district court hearing the coverage case found the insurer breached its duty to defend the employee by failing to notify him of the available coverage. That court also found prejudice had to be shown to establish a coverage defense based on late notice and the insurer’s “actual awareness” of the suit against the employee precluded it’s ability to establish the required prejudice. On appeal, the Fifth Circuit certified the above questions to the Texas Supreme Court. In addressing the notice requirement in last Friday’s decision, the Texas Court observed that a “more basic purpose” of requiring an insured to forward suit papers to the insurer is to advise them that the insured has been served and the insurer is expected to file an answer on their behalf. An insurer’s knowledge that suit has been filed “does not satisfy this ‘more basic purpose’ or require the insurer to “gratuitously subject itself to liability.” The high court noted: “Simply put, there is not duty to provide a defense absent a request for coverage.”

Addressing the prejudice question, the court distinguished its recent decision in PAJ, Inc. v. Hanover Insurance Co. 2008 WL 109071 (Tex. 2008) (See Texas Insurance Law Newsbrief January 14, 2008), by observing in PAJ the notice was actually late in contrast to the present case where there was no notice from the additional insured at all. Because an insured may opt against seeking a defense from an insurer for a number of reasons, the Texas Supreme Court concluded that “insurers owe no duty to provide an unsought, uninvited, unrequested, unsolicited defense.” As such, the insurer had no duty to inform the employee of available coverage or to voluntarily undertake his defense. And, the high court concluded actual knowledge of the suit against him did not establish prejudice as a matter of law.

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Last Friday, the Texas Supreme Court withdrew its 2006 opinion in Evanston Ins. Co. v. Atofina Petrochemicals, Inc., 2006 WL 1195330 (Tex. May 5, 2006) (where the high court found the additional insured provisions of the liability policy were not broad enough to indemnify the third-party's own acts of negligence, but it failed to decide whether the scope of this coverage is limited in any way by the separate indemnity agreement between the third-party and the policy's named insured). Last Friday, the Texas Supreme Court reversed itself and closely examined the interplay between a contractual indemnity agreement and the scope of coverage afforded to additional insureds. In Evanston Ins. Co. v. Atofina Petrochemicals, Inc., 2008 WL 400394 (Tex. February 15, 2008), the court specifically addressed three specific issues: 1) “whether a commercial umbrella insurance policy that was purchased to secure the insured's indemnity obligation in a service contract with a third party also provides direct liability coverage for the third party;” 2) “whether the insurer is bound to pay the amount of an underlying settlement between the additional insured;” and  3) “whether article 21.55 (now Chapter 542) of the Texas Insurance Code, the “Prompt Payment of Claims” statute, authorized the imposition of penalties and attorney's fees for the insurer's failure to pay the claim timely.”

Addressing the first issue involving the breadth of additional insured coverage, the court focused on the policy language defining who is an insured, the provision discussing the named insured’s duty to indemnify the additional insured, and a separate provision defining an insured to include “A person or organization for whom you have agreed to provide insurance as is afforded by this policy; but that person or organization is an insured only with respect to operations performed by you or on your behalf, or facilities owned or used by you.” The court reasoned that each “who-is-an-insured” clause served to grant coverage independently and, therefore, it held the policy provided the broader scope of coverage and did not exclude liabilities arising out of the additional insured’s sole negligence.  

Addressing the second issue of “whether the insurer was bound to pay the amount of an underlying settlement between the additional insured,” the court revisited related decisions and held the insurer’s “denial of coverage barred it from challenging the reasonableness” of the settlement and the insurer was thus bound to pay the $5.75 million settlement. Addressing the third issue of whether article 21.55 of the Texas Insurance Code applied in this context, however, the court observed the claim in this case was a third-party claim involving the insured’s liability to another and not a first-party claim falling within the statute. Accordingly, the court held that the additional insured was not entitled to attorney fees or damages under article 21.55.

The high court’s treatment of the 21.55 penalty provision is interesting in light of the court’s ruling last month in Lamar Homes where it addressed the same statute in a liability claim involving the duty to defend.   Last Friday’s decision in Atofina Petrochemicals properly ruled the penalty provision does not apply to indemnity benefits under a liability policy.   It still leaves claims for previously tendered defense benefits subject to the 18% statutory penalty pursuant to last month’s decision in Lamar Homes, despite the obvious inconsistency between the two decisions.  A majority of the Texas Supreme Court apparently doesn’t have any problems with applying the 18% statutory penalty to defense benefits under a liability policy when coverage is later determined to exist, but it does have problems applying the same penalty provision to the same claim under the same policy as it relates to indemnity benefits. Friday’s decision in Atofina Petrochemicals is simply a good illustration of why the 21.55 holding in Lamar Homes last month was terribly wrong.  

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This past Friday, the Texas Supreme Court issued a important decision on the availability of liability insurance to cover punitive damage awards when it answered the following certified question presented by the Fifth Circuit: “Does Texas public policy prohibit a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence?” In Fairfield Insurance Co. v. Stephens Martin Paving, L.P., 2008 WL 400397 (Tex. February 15, 2008), the Court in a limited holding found “Texas public policy does not prohibit coverage under the type of workers' compensation and employer's liability insurance policy at issue in this case.” In doing so, the Court provided an extensive and thought-provoking discussion of the law from other jurisdictions, Texas statutory and legislative considerations, Texas case law addressing the issue in other contexts and public policy issues including the “freedom of contract” and the underlying purpose of imposing punitive damages.

In this case, an employee died as a result of on the job injuries and the resulting lawsuit alleged the insured employer “failed to follow and enforce OSHA safety rules and regulations.” The policy at issue provided workers’ compensation and employers’ liability insurance that covered “all sums the insured [Stephens Martin Paving] legally must pay as damages because of bodily injury to [its] employees, provided the bodily injury is covered by this Employers Liability Insurance.”  But, it excluded coverage for damages arising from injuries caused by intentional acts and “punitive or exemplary damages because of bodily injury to an employee employed in violation of law.” However, an endorsement provided “[t]his exclusion does not apply unless the violation of law caused or contributed to the bodily injury.” Because the certified question only focused on the public policy considerations, the court did not address the potential coverage issues and presumed the policy covered the punitive damages sought.

In reaching its decision that coverage for punitive damages was not against Texas public policy, the court focused on the statutory workers’ compensation scheme and accompanying insurance regulations.  The court found because the Texas Workers Compensation Act allowed recovery of exemplary damages caused by the employer’s gross negligence and because the Texas Department of Insurance's execution of that scheme and approval of policy forms reveals an “intent to provide coverage for gross-negligence” while excluding intentional acts, the high court of Texas found the “Legislature’s expressed intent is that Texas public policy does not prohibit insurance coverage for claims of gross negligence in this context.”

The decision was one of the oldest cases on the Court's docket probably indicating the intense internal struggle over the important issues raised by this case.   While the holding is troubling to this author at multiple levels, the obvious and easy solution is for liability insurers to craft expansive punitive damage exclusions in their liability policies.  This decision only deals with the public policy implications of extending coverage to punitive damages when the policy is otherwise silent on such coverage. 

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Last Friday, the Texas Supreme Court issued its opinion on rehearing in Excess Underwriters v. Frank’s Casing, __ S.W.3d __ (Tex. 2008).  The Court withdrew its three-year old opinion that initially created a firestorm in the Texas insurance industry (and also lead to great consternation with commercial insureds) regarding the rights of reimbursement that a liability carrier possesses under Texas law when it pays a potentially non-covered claim.  But, after keeping the industry waiting for more than two years for clarification since it granted the rehearing, last Friday a deeply divided Court reversed course by withdrawing and disregarding its earlier decision and refused to recognize an exception to the Texas rule that an insurer is only entitled to reimbursement for settling a claim against its insured if (1) the policy provides for it, or (2) the insured has given “clear and unequivocal consent to the settlement and the insurer’s right’s to reimbursement.”  After stating that liability insurers were better equipped to “carry the risk” associated with a coverage dispute, the majority suggested that insurers facing settlement demands on disputed claims have several options: refuse to settle and pursue a declaratory judgment action, leverage a declaratory judgment action to settle the third-party lawsuit, or rewrite the policy to include reimbursement rights.  The two dissenting opinions recognized the problems with the majority approach - the windfall to insureds for coverage that was not underwritten when the policy was issued, and the burden other insureds must carry in increased premium costs due to the insurers’ increased risks of settling uncovered claims.  The dissent by Justice Hecht correctly observed that liability carriers in Texas will now have little choice but to bring a DJ action every time a liability claim raises potential coverage issues.  

Friday’s decision in Frank’s Casing is one of the most significant decisions issued by the Texas Supreme Court in recent years. It raises a host of new issues for liability carriers facing potential coverage problems on both defense and indemnity claims.  A liability carrier’s ability to wait until the underlying tort case gets closer to trial before seeking to address and resolve the coverage issues seems to have been eliminated by last week’s decision.  The ironic aspect of the majority’s decision (which was clearly intended to help commercial insureds in Texas) is that Friday’s decision will hurt Texas insureds in the long run because they will be subject to more litigation rather than less.  Friday’s decision leaves Texas liability insurers with few options other than bringing DJ actions against their insureds every time an underlying tort suit raises coverage questions.

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