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

 

Are attorney’s fees awarded in a class action settlement “damages” covered by a general liability policy?   Are they covered as “costs” under the “Supplementary Payments” Provision of a CGL policy?  Not according to the Eleventh Circuit in Alea London Limited v. American Home Services, Inc., 638 F.3d 768 (11th Cir. 2011). In that case, the Court of Appeals held that attorney fees awardable in a TCPA class action suit are not “damages” because of “personal and advertising injury” nor do they constitute costs payable under the Supplementary Payments provision of a CGL policy. Indeed, at the outset, the Court recognized that the ordinary and legal meaning of "costs" under Georgia law does not include attorneys' fees.   

 

 

The TCPA does not contain any provision that allows the court to award attorneys fees.   Most TCPA actions, however, are brought as class actions. Thus, Plaintiffs often invoke the provisions of FRCP Rule 23 to obtain attorney fees. That rule states, in pertinent part:

(h) Attorney Fees Awards. In an action certified as a class action, the court may award reasonable attorney fees and non-taxable costs authorized by law or by agreement of the parties.

 

That provision is different from other statutory bases for attorney fees where attorney fees are expressly referred to as “part of costs.”     For example, in federal civil rights suits,  plaintiffs request attorney fees pursuant to the Civil Rights Attorney's Fees Awards Act of 1976 (42 U.S.C. § 1988).   That statute permits the court, in its discretion, to award the prevailing party "a reasonable attorney's fee as part of the costs."   In Sullivan County, Tenn. v. Home Indem. Co., 925 F.2d 152 (6th Cir.1991), the court found such attorney fees were not "damages.” The Court viewed 42 USC § 1988 as reflecting an unambiguous intent to treat attorney fees as costs in order to ensure that the fees could be assessed against a state agency notwithstanding the bar to such awards presented by the Eleventh Amendment to the federal Constitution. The court found the supplementary payment provision of the policies, which made the insurer responsible for all costs taxed against the insured in a suit for damages, demonstrated "very persuasively" that the policy meant to refer to "damages" only in the conventional sense of the term, for if the word "had been used originally in a sense that already included costs, the quoted portion of the Supplementary Payments provision would have been totally unnecessary...."

In Alea, the Court held that under the insuring agreement, the insurer agreed only to: (1) pay damages the insured was legally obligated to pay; (2) defend lawsuits against the insured; and (3) investigate and settle claims. It observed that at the end of the insuring agreement, the policy expressly states: “No other obligation or liability to pay sums or perform acts or services is covered unless explicitly provided for under Supplementary Payments – Coverages A and B.”

The Court noted that the Supplemental Payment obligations are expressly limited to: (1) expenses incurred by the insurer in defending the insured; (2) cost of certain bonds; (3) reasonable expenses the insured incurs at the insurer’s request in investigating or defending the lawsuit; (4) all costs taxed against the insured in the law suit; (5) pre judgment interest and (6) post judgment interest. “Notably absent is any supplementary payment for attorneys' fees for claimants against the insured.”   The Court concluded that there was no language in the policy that leads to the conclusion that the insurance contract contemplated that the insurer would indemnify the insured for its opponents’ attorneys’ fees. Accordingly the 11^th Circuit affirmed the District Court’s ruling that the fees awarded to the underlying plaintiffs in the TCPA class action suit and assessed against the insured were not covered by the policy. 

Notably, the typical “Supplementary Payments” provision in a CGL ISO policy form issued prior to 2006 states, in pertinent part:

We will pay, with respect to any claim we investigate or settle, or any “suit” against an insured we defend… (e) all court costs taxed against the insured in the “suit.”

In the CG 00 01 12 07 ISO form,  the following language was added to par. e: “However these payments do not include attorneys’ fees or attorneys’ expenses taxed against the insured.”  The addition of that language should remove any argument that an opponent’s attorney fees are covered as costs under the Supplemental Payments provision.

There may still be a debate as to whether an award of attorney fees constitute “damages” as there is some conflicting case law on that subject. For example, in Hyatt Corp. v. Occidental Fire & Cas. Co. of N.C., 801 S.W. 2d 382 (Mo. App. 1991), the Missouri Court of Appeals found that attorney fees paid as part of a settlement of a class action suit are covered as damages. Hyatt involved an underlying class action personal injury suit where multiple persons were killed or injured when two skywalks at the Kansas City Hyatt Regency collapsed. That suit settled. The underlying plaintiffs’ counsel was awarded attorney fees as part of the settlement. One of the insurers refused to pay the attorneys fees, arguing that they were not “damages” within the meaning of its general liability policy. The Missouri appellate court disagreed. The court held that the “principal amounts at issue with respect to the federal class action are not the settlements paid to plaintiffs but [the insurer’s] share of attorney’s fees awarded in the federal class action as part of the settlement of the case. Such an award of attorney’s fees is indistinguishable from a damages award for coverage purposes.” Id. at 393-394.  

The Hyatt court relied on City of Ypsilanti v. Appalachian Ins. Co., 547 F. Supp. 823 (E.D. Mich. 1982) aff’d. mem. 725 F.2d 682 (6^th Cir. 1983), a civil rights case. In that case, the district court held that attorney fees do not constitute "costs" under the insurance policy because the definition of "costs" refers only to the expense of carrying on the defense of a lawsuit. It does not refer to sums for which the insured is found liable, such as an award of attorney fees.  Id. at 827.  It found, however, “that a reasonable person in the position of the insured would believe that the words ‘all sums which the Insured shall become legally obligated to pay as damages would provide coverage for all forms of civil liability, including attorneys’ fees.”  Contra, Cutler-Orosi Unified School Dist. v. Tulare County School Districts Liability/Property Self-Insurance Authortiy, 31 Cal. App. 4^th 617 (5^th Dist. 1994)(“We agree with the Sullivan County court that to treat attorney fees as damages in such circumstances would ignore the evident intent of the policies to differentiate between costs and damages and would render the supplementary payment provisions superfluous).

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In Travelers Property v. Centex Homes, No. C 10-02757 CRB (N. D. Cal. April 1, 2011), Centex, a general contractor, was sued in certain construction defect litigation. Pursuant to a reservation of rights, Travelers agreed to defend Centex, an additional insured under its policy. Centex refused to allow counsel retained by Travelers to defend it or to associate in its defense. The court held that under the policies, Travelers had the “right and duty to defend” suits seeking damages to which the policies apply. Upon being provided a defense, Centex had no right to interfere with Travelers’ right to control the defense. 

 

The court agreed that for an insurer to be excused from its duty to defend and indemnify after an insured’s breach of the cooperation clause, the insurer must show that it suffered substantial prejudice from the insured’s breach. It recognized, however, that the California Supreme Court had held that prejudice may be presumed where it “naturally, inherently and necessarily exists.” It also noted Ninth Circuit authority holding that when an insured refuses an insurer’s choice of counsel, the insured not only violates the duty to cooperate, but also interferes with the insurer’s right to conduct a defense. This breach provides sufficient grounds to deny the insured’s claims for defense costs and indemnification. 

Centex asserted that Travelers had a conflict in controlling its defense as Travelers insured both Centex and its named insured subcontractors in the construction defect actions, and Centex had filed cross-complaints against the subcontractors. The court rejected this argument on the ground that Centex’s cross-complaints against the subcontractors were for indemnification. Centex’s liability in the actions would be derivative of the liability of the subcontractors who performed the work. The court recognized that Travelers would have the same interest in defending both its named insured subcontractors and Centex against the plaintiffs’ claims in both lawsuits.    Centex also argued that Travelers’ reservation of rights to deny an indemnity obligation for property damage occurring outside of the Travelers’ policy periods created a conflict of interest. The court rejected that argument, noting that a conflict exists only “when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel… retained by the insurer for the defense of the claim.”    The court found that independent counsel was not required under California Civil Code Section 2860 as Travelers’ reservation  did not give rise to a conflict of interest because the timing of the property damage was a factual issue outside of defense counsel’s control.

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The Court of Appeals of Indiana recently addressed the “Montrose“  language added to the CGL ISO form in 2001 in the context of a construction defect claim where a fractured storm drain caused significant flooding a year after the drain was damaged.  The insuring agreement requires that “bodily injury” or “property damage” be caused by an “occurrence” and that the “bodily injury” or “property damage” occur during the policy period. The Montrose language adds that the insurance applies only if, prior to the policy period, no insured knew that the “bodily injury” or “property damage” had occurred in whole or in part.   Significantly, it also states that any “bodily injury“ or “property damage” which occurs during the policy period and was not, prior to the policy period known to have occurred, includes a continuation, change or resumption of that “bodily injury” or “property damage”  after the end of the policy period.  

 In Grange Mutual Cas. Co. v. West Bend Mut. Ins. Co., No. 29D04-0706-PL-1112 (Ct. App. IN March 15, 2011), http://www.ai.org/judiciary/opinions/pdf/03151109ehf.pdf, Sullivan was the General Contractor for a school construction project. Its subcontractor, McCurdy, installed the storm drain pipes.   One of the storm pipes was fractured in 2005 while McCurdy was doing its installation work. More than a year later, the school experienced significant water damage due to flooding. It was later discovered that the flooding was due to the fractured storm drain. Sullivan’s insurer paid $146,403 for the water damage.   That insurer brought a subrogation claim against McCurdy and its two insurers:  West Bend and Grange.  West Bend had issued CGL coverage to McCurdy while the construction was ongoing , including the date in which the storm pipe was fractured.    Grange issued CGL coverage to McCurdy at the time of the flooding. Those two carriers jointly settled the subrogation claim and then litigated which insurer actually owed coverage for the loss.   Significantly, the loss that was paid included only damages from the flooding, not any damages for the cost of repairing the pipe.

Grange argued that the negligent fracturing of the storm drain pipes determines coverage and that West Bend should pay all of the damages resulting from the flood as the fracturing of the pipe took place in West Bend’s policy period.   West Bend argued that the policy implicated is the policy in effect when the claimant was actually damaged, and not when the negligence of the insured took place. 

The Court of Appeals held that the timing of the “occurrence” is irrelevant to the coverage determination.   It found that the Grange policy was triggered because significant property damage actually occurred during its policy period as a result of the flooding and there was no suggestion that McGurdy was aware of the damage to the storm drain prior to the inception of the Grange policy.  

It also found that West Bend’s policy was triggered as the storm drain pipe was damaged by McCurdy during the West Best policy period.   It noted: “West Bend’s policy provides that this initial property damage includes any continuation, change or resumption of that ‘property damage’ after the end of the policy period.”   It held that because the West Bend policy was triggered at the time McGurdy negligently fractured the drain pipe, the policy covered all damages that flowed from the original damage, including the extensive flood damage.    It concluded that the loss should be allocated between Grange and West Bend pursuant to the “other insurance” provisions in the policies, which both provide for equal shares.   

 

Comments:   The loss for which the insurers paid the Sullivan’s subrogated insurer was limited to the flood damage. No payment was made for the cost of repairing the damaged pipe – which is the only “property damage” that took place in the West Bend policy.  The damaged pipe, in many jurisdictions, would not be considered “property damage” caused by an “occurrence,” in the first instance as the property damage was limited to the insured’s own product.   See, e.g.,  Stoneridge Dev. Co. v. Essex Ins. Co., 888 N.E.2d 633 (Ill. App. 2d Dist. 2008)(cracking in the walls caused by the construction of the residence near soil which was not properly compacted by the developer’s subcontractor was not “property damage” caused by an "occurrence" as the cracks were the natural and ordinary consequences of defective workmanship). Under that rationale, it is only when “property damage” causes injury or damage to third party property (e.g, the flooding), that it is considered “property damage” caused by an occurrence.”   That would result in only Grange’s policy being implicated for the damages resulting from the flood, not West Bend’s policy.   Indiana courts, however, have taken a different position on whether defective workmanship constitutes an “occurrence.”    In Sheehan Const. Co., Inc. v. Continental Cas. Co., 935 N.E.2d 160 (Ind. 2010), the Indiana Supreme Court adopted the view that improper or faulty workmanship does constitute an accident [or "occurence"] so long as the resulting damage to the building is an event that occurs without expectation or foresight. Id. at 169.   Under that rationale, it is possible a court could view the initial property damage, albeit restricted to the pipe itself, as being caused by an “occurrence.”  That still begs the question as to whether the later flooding damage is a continuation, change or resumption of that “property damage” (i.e., the fractured pipe).    One might argue that the  flooding is a consequence of the initial “property damage.” It could be viewed as having been proximately caused by the fractured pipe. But is the flooding damage a “continuation, change or resumption” of the fractured pipe?     

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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.  

In Garcia v. Underwriters at Lloyd’s, London, --- P.3d ----, 2008 WL 943502 (N.M. 2008), the counsel for the plaintiffs, wrongful-death beneficiaries, provided the insurer with a copy of the filings in a related probate proceedings. The insurer issued a reservation of rights letter and Lloyd’s New York counsel responded to the probate administrator and provided guidance to Lloyd’s as to how to proceed under New Mexico law. Despite the probate administrator’s request to participate in the probate proceeding, Lloyd’s followed its New York counsel’s advice and did not participate. The court entered a $3 million judgment for plaintiffs and the probate administrator assigned all claims against Lloyd’s to the plaintiffs. The plaintiffs then sued Lloyd’s for breach of contract, bad faith, and violations of the New Mexico Insurance Code and Unfair Practices Act.

Lloyd’s won a summary judgment at the trial court based on the existing rule (at the time) that an actual demand for a defense must be made by the insured to his liability insurer in order to trigger the duty to defend. On appeal, the New Mexico high court found the “interests of fairness” favored placing the burden on the insurer once it had actual notice to inquire if its insured desired a defense. While the New Mexico court noted their was a split among the states as to whether notice must come from the insured, it found that Lloyd’s offered no compelling reason that it should not allow actual notice “from any source” to suffice. The New Mexico court thus reversed the summary judgment for Lloyd’s and held the new rule applied because Lloyd’s did not affirmatively rely on the lack of a demand when it made its decision not to defend its insured. It determined that Lloyd’s instead relied on incorrect advice from its New York counsel that Lloyds did not need to participate in the probate proceeding. The court pointed out Lloyd’s use of New York counsel seven times in its opinion raising questions as to whether the court was motivated more by "fairness" or it's apparently dislike of New York lawyers giving bad advice as to New Mexico law. 

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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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