Insurance Law for Agents

A REVIEW OF RECENT TEXAS INSURANCE DECISIONS

by David W. Dodge [1]

I.          SCOPE OF ARTICLE

This paper is designed to provide insurance agents basic information regarding recent Texas insurance coverage and bad faith decisions between 2003 and October 2005.  Particular attention is given to areas in which the law is unsettled, as they reflect potential changes in policy interpretation and legal precedents of which agents should be aware.  The paper also focuses on the aspects of certain cases that are of most interest to Texas agents.  The objective of the article is to provide agents useful information regarding recent coverage interpretations, and to make agents aware of the types of errors and omissions commonly reflected in recent case law.[1]  Although some personal lines cases are discussed, the primary emphasis of the article is on commercial lines.

II.        UPDATE ON RECENT INSURANCE DECISIONS

 Several interesting insurance opinions have been handed down by courts in Texas during the last few years. However, the issues definitively resolved by these decisions remain overshadowed by the questions yet to be answered.  This paper discusses unresolved coverage questions ranging from the insurability of punitive damages to whether negligent construction defects constitute an “occurrence” sufficient to trigger the carrier’s duty to defend under a CGL policy.  This article also discusses recent homeowners, workers’ compensation and automobile insurance decisions, as well as the conflicting decisions on the scope of Article 21.55 of the Texas Insurance Code.  The paper concludes with examples of recent cases in which agents have been sued for errors and omissions, and a sampling of recent bad faith cases.

            A.        Are Punitive Damages Covered Under Texas Law?

An issue that has received a great deal of attention over the past few years is whether punitive damage awards are covered under Texas law.  Recently the Texas Supreme Court has been asked to address this issue in two cases:  Fairfield Ins. Co. v. Stephens Martin Paving, LP, 381 F.3d 435 (5^th Cir. 2004), and Westchester Fire Insurance Company v. Admiral Insurance Co., 152 S.W.3d 172 (Tex. App.—Fort Worth 2004, pet. filed).  In both cases, the decision being appealed held that coverage for punitive damages was provided by the policy and was not contrary to the public policy of Texas.  Although the Texas Supreme Court has not yet accepted the appeal in Westchester Fire, the certified question in Stevens Martin Paving has been fully briefed and is awaiting decision by the court.  We are monitoring these cases and will provide a synopsis of the Texas Supreme Court’s decision in Stephens Martin Paving on our website (www.texasatty.com), once the opinion is handed down. Stephens Martin Paving is a “certified question” from the United States Court of Appeals for the Fifth Circuit.  Through the use of certified questions, federal courts may request that the highest court in a state provide guidance on a dispositive, but unsettled, issue of state law.  The specific question posed to the Texas Supreme Court in Stevens Martin Paving is:  “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 presenting this question to the Texas Supreme Court, the Fifth Circuit set forth the relevant factual and procedural background of the case.  In the underlying action, the survivors of the deceased employee filed suit against Stevens Martin Paving for gross negligence, seeking only punitive damages.  Stevens Martin Paving sought a defense and indemnification under the employers’ liability portion of its workers’ compensation policy.  Fairfield initially defended under a reservation of rights, but then filed a declaratory judgment action arguing that public policy in Texas precludes coverage for punitive damages and as a result, the carrier had no duty to defend or indemnify the insured.  The trial court found that a duty to defend and indemnify existed and the appeal to the Fifth Circuit followed.

 In addition to setting out the factual and procedural history, the Fifth Circuit cited recent decisions leading to its uncertainty regarding the insurability of punitive damages under Texas law.  First, the Fifth Circuit reviewed its own 1978 ruling that Texas public policy did not bar coverage for punitive damages, but observed that more recently, Texas intermediate appellate courts have questioned that holding in light of the Texas Supreme Court’s decision in Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 16-17 (Tex. 1994) (stating that "the legal justification for punitive damages is similar to that for criminal punishment" and that "punitive damages are levied for the public purpose of punishment and deterrence.").  The Fifth Circuit also noted that decisions from the Texas intermediate courts have reached differing conclusions, and that the Texas Supreme Court has not provided any definitive guidance on the issue.  As noted above, the certified question in Stephens Martin Paving is currently under consideration by the Texas Supreme Court.   

Later in 2004, the Fort Worth Court of Appeals similarly determined punitive damages are covered under a professional medical liability policy in Westchester Fire Insurance Company v. Admiral Insurance Company, 152 S.W.3d 172 (Tex. App.—Fort Worth 2004, pet. filed).  That case involved a Stowers action by Westchester—the excess carrier and insured's equitable subrogee—against Admiral, the insured's primary carrier, for Admiral’s allegedly negligent failure to settle an insurance claim within its policy limits.  The trial court granted partial summary judgment for Admiral, limiting the amount of damages Westchester could recover to compensatory damages. Westchester appealed, contending punitive damages were covered under Admiral's policy at the time the underlying lawsuit was settled.  

The Court of Appeals agreed with the trial court’s conclusion that punitive damages were covered and not excluded by the language of the Admiral policy.  However, the appeals court held the conclusion that coverage for punitive damages was against Texas public policy at the time the underlying lawsuit was settled was error.  The court provided a thorough historical analysis of the coverage of punitive damages in Texas, paying particular attention to the state of the law at the time the underlying lawsuit was settled.  Although the court held that coverage for punitive damages was not against public policy at that time, it expressly refused to determine whether insurance coverage for punitive damages violates Texas’ current public policy.  Admiral has asked the Texas Supreme Court to review this case.            

Other recent Texas cases have reached varying results as to the insurability of punitive damages.  For example, in The Philadelphia Indemnity Insurance Company v. Stebbins Five Companies, No. 3:02-CV-1279-M, 2004 U.S. Dist. LEXIS 6374 (N.D. Tex. Jan. 27, 2004), the United States District Court for the Northern District of Texas held that punitive damages are covered under Commercial General Liability (“CGL”) and Professional Liability policies.  The court used a two-prong test to find that punitive damages are covered.  First, the court asked whether the policy’s terms provided for, and failed to exclude coverage of, punitive damages.  Second, the court inquired whether Texas public policy prohibits coverage for punitive damage awards.  As to the first inquiry, the court concluded that because the policy’s terms failed to expressly exclude punitive damages, and the insuring clause provided coverage of “all sums” or “those sums” “that the insured becomes legally obligated to pay,” the liability policy was broad enough to encompass punitive damages.  Similarly, the court held that a finding of malice and a determination of grossly negligent conduct against the insured in the underlying case does not automatically trigger the intentional or expected injury exclusion.  As to the second inquiry, the court determined that insuring punitive damages was not contrary to the public policy of Texas.[2]

 

           

Conversely, in Comsys Information Technology Services, Inc. v. Twin City Fire Insurance Company, 130 S.W.3d 181 (Tex. App. – Houston [14^th Dist.] 2003, pet. denied), the Houston Appeals Court determined that punitive damages were excluded from an Excess Temporary Employment Contractors Errors or Omissions Liability Policy.  The relevant portions of the policy excluded coverage for:

a. Intentional acts, errors or omissions by or at the direction of the insured.
. . .

 b. Any injury or damage arising out of willful, dishonest, fraudulent, criminal or malicious acts, errors or omissions by or at the direction of the insured.

     

The court determined that because the policy excluded intentional acts, damages for actions committed with malice were excluded under section I.2.a of the policy, and that punitive damages supported by a finding of malice were excluded by section I.2.c.   The court also concluded coverage for DTPA violations was similarly excluded as dishonest, fraudulent, or criminal acts under Section I.2.c of the policy.

Although the issue presented to the Texas Supreme Court in Stephens Martin Paving is whether Texas public policy prohibits a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence, the foregoing decisions turn primarily on the language of the particular policy at issue.  Those cases that do address public policy considerations generally attempt to balance the public policies of punishment and deterrence with the principle of freedom of contract.  See, e.g., Westchester Fire Insurance Company v. Admiral Insurance Company, 152 S.W.3d 172 (Tex. App.—Fort Worth 2004, pet. filed).  Given insurers’ ability to exercise that freedom of contract by expressly excluding punitive damages, agents would be well advised to carefully scrutinize liability policies for such exclusions, particularly if their clients have expressed an interest in procuring such coverage, or are in parts of the State where punitive damages are commonly awarded.

B.        Is Your Client Subject to a Post-Settlement Reimbursement Action by the Carrier?

Earlier this year, the Texas Supreme Court decided that an insurer’s right of recovery can arise even absent an insured’s express agreement to reimburse settlement payments made by an insurer, if there is no coverage.  See Excess Underwriters at Lloyd’s, London v. Franks Casing Crew and Rental Tools, Inc., No. 02-0730, 2005 Tex. LEXIS 418 (Tex., May 27, 2005).  In that case, the carrier, Underwriters, was defending its insured, Frank’s Casing, under a reservation of rights.  Frank’s Casing received a Stowers demand from the plaintiffs and urged Underwriters accept the offer and resolve the case.  Underwriters agreed to pay the settlement provided resolution of all coverage issues were reserved for later.  Frank’s Casing refused, but continued to demand that Underwriters accept the settlement offer in an effort to make Underwriters responsible for any judgment in excess of policy limits.  Underwriters subsequently advised Frank’s Casing that it would accept the settlement offer, but intended to seek reimbursement from the insured for the non-covered aspects of the settlement.

The Texas Supreme Court held Frank’s Casing was required to reimburse Underwriters for the settlement payments made for damages not covered by the policy.  In reaching this conclusion, the court determined that when an insured has demanded its liability insurer accept a settlement offer within policy limits, or when an insured expressly agrees that the settlement offer should be accepted, the insurer has a right to be reimbursed if: (1) it has timely reserved its rights; (2) notified the insured it intends to seek reimbursement; and then (3) paid to settle claims that were not covered under the policy.  The court reasoned that when there is a coverage dispute and an insured demands that its insurer accept the settlement offer within policy limits, the insured is deemed to have viewed the settlement offer as a reasonable one.

The Court distinguished Frank’s Casing from Texas Association of Counties County Government Risk Management Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000).  The court concluded that, unlike Underwriters, the insurer in Matagorda County settled without the insured’s consent.  Frank’s Casing expands the holding from Matagorda County—that the only circumstance under which an insurer could obtain reimbursement from an insured for settling non-covered claims is when there is an express agreement permitting a reimbursement action—by holding that an agreement to reimburse an insurer is implied in law when the insureds demands the carrier accept a settlement offer within policy limits.  

C.        Who is Afforded the Protection Provided by the Workers’ Compensation Exclusive Remedy?

In Garza v. Exel Logistics, Inc., 161 S.W.3d 473 (Tex. 2005), the Texas Supreme Court concluded that although an injured worker was an “employee” of a subscribing temporary employment agency, that he was also an employee of its nonsubscribing client company.  As such, although the temporary employment agency was protected by the exclusive remedy of the Texas Workers’ Compensation Act, its nonsubscribing client company was subject to workplace injury negligence lawsuit.       

Garza was hired by Interim, a temporary employment agency.  Interim placed Garza at the worksite of Exel, a client company.  While working at Exel’s site, an Exel employee instructed Garza to cross over a moving conveyor belt to turn off a machine.  In the course of doing so, Garza sustained injuries.  The issue presented to the Texas Supreme Court was whether Exel co-employed Garza, for purposes of the exclusive remedy under the Texas Workers’ Compensation Act.  Reversing the Court of Appeals, the court held that Garza was an employee of both the agency and the client company.            

To determine whether Garza, a general employee of the temporary employment agency, was also an employee of the client company Exel, the court considered traditional indicia of an employer / employee relationship, such as the exercise of actual control over details of the work that gave rise to the injury.  Although the record showed that Garza was supervised by both Interim and Exel supervisors, it was persuaded by the fact that, at the time of injury, Garza was working on Exel’s premises, in furtherance of Exel’s day-to-day business, and that the details of his work that caused his injury were specifically directed by Exel.  The Court held that Garza was also an employee of Exel and could therefore seek remedies from Exel.  Because Exel had not elected to provide workers’ compensation insurance coverage, it was not entitled to Section 406.033 exclusive remedy protection.            

The Garza opinion doesn’t appear to make much sense from an underwriting or business certainty standpoint.  Presumably, the workers’ compensation premiums for a temporary employment firm take into account the varying nature of the covered employees’ duties for multiple clients of the temporary employment company.  Moreover, temporary employment companies routinely market their services, in part, based on the existence of workers’ compensation coverage for the employees they provide.  Forcing companies that utilize the services of temporary employment agencies to obtain duplicative coverage for temporary personnel seems to result only in the payment of double premiums, and the potential for double recovery by the employee.     

If you have nonsubscribing clients that routinely utilize temporary employees, you may want to advise them to attempt to work with their temporary employment companies to devise an arbitration agreement for use with such personnel.  It may also be advisable to explore with any insurer that provides the employer with coverage for workplace injury lawsuits the possibility of obtaining coverage for injuries to such temporary employees.

It is unlikely coverage for injuries to temporary workers would exist under other lines of insurance.  For example, in CX Reinsurance Co. v. Technical Constr. Servs., Inc., Civ. No. H-03-4147 (S.D. Tex. Aug. 18, 2005), the court interpreted the Independent Contractors’ Employees or Leased Workers Exclusion in the standard CGL policy to exclude coverage for temporary workers.  In that case, Technical Construction Services, Inc. (TCSI), a construction company, subcontracted with Quintanilla to perform roofing labor on a construction project.  During the project, Serrano, a worker, fell from the roof and sustained injuries.  Serrano sued TCSI, which sought coverage from its CGL carrier.  The insurance carrier sought declaratory judgment that the incident was not covered under the independent contractor employee exclusion in the policy.  The exclusion provided that the insurance did not apply to injury to “[a]ny employee or leased worker of independent contractors.”  The insurer reasoned that Serrano’s injury was not covered because Serrano was an employee of Quintanilla, a subcontractor for TCSI.  TCSI argued that Serrano was a “temporary worker” rather than an “employee” such that his injury was shielded from the exclusion, because the project was short-term and Serrano was not a permanent employee of Quintanilla.  TCSI also noted that in the definitions section of the policy the term “employee” included the term “leased worker” but did not include the separately-defined term “temporary worker.”           

The Court rejected TCSI’s argument and entered judgment in favor of the carrier. Although the policy expressly provided that words appearing in quotation marks have special meaning, the word “employee” in the independent contractor employee exclusion did not appear in quotation marks.  As such, the court applied the plain and ordinary meaning of the word and concluded that Serrano was clearly an employee of Quintanilla.  Therefore the exclusion applied.

Similarly, it does not appear alternative coverage would be available for nonsubscribers under a business auto policy.  Indeed, in a recent case the Western District of Texas analyzed an insurer’s duty to defend a nonsubscribing employer under just such a policy.  See Illinois National Insurance Co., Inc. v. Hagendorf Const. Co., Inc., 377 F. Supp. 2d 902 (W.D. Tex. 2004).  The underlying lawsuit was brought following the employee’s injury in a single car accident.  After reviewing the allegations in the underlying lawsuit, the court held that the auto policy’s workers’ compensation exclusion applied, even to non-subscribers.

D.        Does a Liability Carrier have the Duty to Defend its Insured from Allegations of Construction Defects under a CGL Policy?

Another area in which Texas law is unsettled is on the issue of whether CGL policies provide coverage for construction defects arising from allegedly negligent design and/or construction, such that an insurance carrier has a duty to defend against such claims.  There are so many conflicting decisions on this issue that the Fifth Circuit Court of Appeals recently certified the following two questions to the Texas Supreme Court: 

1.                  When a homebuyer sues his general contractor for construction defects and alleges only damage to or loss of use of the home itself, do such allegations allege an “accident” or “occurrence” sufficient to trigger the duty to defend or indemnify under a CGL policy. 
    
2.                   When a homebuyer sues his general contractor for construction defects and alleges only damage to or loss of use of the home itself, do such allegations allege “property damage” sufficient to trigger the duty to defend or indemnify under a CGL policy?

 Lamar Homes, Inc. v. Mid Continent Casualty Co., No. 04-51074, 2005 U.S. App. LEXIS 21441 (5^th Cir., Oct. 3, 2005).[3] 

In certifying the foregoing questions to the Texas Supreme Court, the Fifth Circuit also examined the conflict of authority surrounding the economic loss rule as applied to construction defects claims and coverage.  Lamar Homes provides a concise summary of the status of Texas precedent surrounding the “occurrence” and “property damage” coverage arguments attendant to construction defects claims.  Although the following summary of conflicting cases is by no means exhaustive, it amply illustrates the need for guidance from the Texas Supreme Court on these important issues.

In Amerisure Insurance Company v. ML & Associates, Inc., No. 00-37462-SAF-7 (N.D. Tex. Bkrcy. Nov. 26, 2003), the United States Bankruptcy Court for the Northern District of Texas addressed the application of the standard Insurance Services Office CGL policy to a construction defects claim.  ML & Associates, which carried CGL coverage with Amerisure, served as the general contractor for the construction of a municipal complex for the City of Highland Village, Texas.  After completion of construction, Highland Village filed a complaint against ML & Associates and others for physical damage to the building.  Amerisure sought declaratory judgment that it owed no duty to defend or indemnify ML & Associates.            

Amerisure argued that the City of Highland Village’s complaint failed to allege any “property damage” as defined by the policy.  However, the court rejected that based upon the City of Highland Village’s allegations of loss of use of the building caused by the damage to the building.  Amerisure also argued that the Impaired Property Exclusion precluded coverage for such loss. The trial court dismissed the application of the Impaired Property Exclusion by concluding that the building, as constructed by ML & Associates or its subcontractors, constituted “your work” because the policy’s definition of “impaired property” did not include “your work”, but rather, other, tangible property, and the damage to the building which did not fall within “impaired property,” therefore the exclusion did not apply.

The court next addressed Amerisure’s arguments that the City of Highland Village’s pleadings failed to factually allege an “occurrence” as defined by the policy.  However, the court noted the City of Highland Village’s express allegations that ML & Associates negligently performed its own duties and negligently supervised its subcontractors.  Thus, the court determined that the City of Highland Village’s factual claims satisfied the policy definition of “occurrence” triggering the insuring clause.

In Tealwood Construction, Inc. v. Scottsdale Insurance Company, No. 3:02-CV-2159-L, 2003 U.S. Dist. LEXIS 20993 (N.D. Tex. Nov. 19, 2003), the United States District Court for the Northern District of Texas reached the opposite conclusion.  In that case, the court also addressed what allegations constitute an “occurrence” in the construction defects context, but concluded that merely alleging negligence is insufficient to constitute an “occurrence”.  Instead, the court focused on the factual allegations showing the origin of the damages.  Although the court acknowledged the line of cases holding that construction defect claims arising from negligent work allege an “occurrence,” it concluded those cases were distinguishable because, in Tealwood, the petition alleged only “bare bones allegations of negligence”.  Because the petition was devoid of facts which indicated an “occurrence”, and the court was precluded from reading such facts into the pleadings, the factual allegations failed to give rise to the carrier’s duty to defend.

Similarly, the United States District Court for the Southern District of Texas recently concluded the allegation that the insured contractor’s failure to use a ribbed slab design foundation (as recommend by the soil testing and analysis firm) failed to qualify as an “occurrence” and, therefore, failed to trigger the CGL policy’s insuring clause. See Michigan Mutual Insurance Company v. Alliance Construction, Inc., No. H-05-0754 (S.D. Tex. Sept. 21, 2005).  Based on the allegations in the underlying petition, the court determined that the damage to the foundation of the subject structure was the natural and probable consequence of the insured’s intentional breach of the contract.  According to the petition, the insured had received the proper specifications from the soil testing firm yet disregarded the recommendations.  The court found the insured’s failure to heed such recommendations must be considered “volitional” and a “disregard of established standards of construction and design.”  Thus, the court reasoned that the damage to the structure was not an “occurrence” or an “accident,” but rather, the willful failure of the insured to comply with the terms of the contract in designing and constructing the building.

Conversely, in Gehan Homes, Ltd. v. Employers Mutual Casualty Company, 146 S.W.3d 833 (Tex. App.—Dallas 2004, pet. filed), the Dallas Court of Appeals held that a builder’s negligence which results in damage to the house constitutes an “occurrence” because the relevant inquiry is not whether the insured damaged his own work, but whether the resulting damage was unexpected and unintended.  Similarly, in Archon Investments, Inc. v. Great American Lloyds Insurance Company, 2005 Tex. App. LEXIS 6933 (Tex. App.—Houston [1^st Dist.] Aug. 25, 2005), the Houston First Court of Appeals determined allegations that a general contractor and its subcontractors used materials that did not meet industry standards and failed to construct a home in a good and workmanlike manner constituted an “occurrence” under the ISO standard form CGL.  In its analysis, the Court adopted Archon’s argument that a CGL policy provides coverage for “inadvertent construction defects that cause damage after a home has been sold to a buyer when the damages arise from the work of the [general contractor’s] subcontractors.” 

The court observed that damage to real property on which the general contractor/insured or its subcontractors are performing operations at the time of the loss and damage due to the general contractor/insured’s own incorrectly performed work are excluded from coverage:  “However, the policy covers damages arising out of work performed on [the general contractor/insured’s] behalf by a subcontractor if the loss occurred on property not then owned by Archon, i.e., if the loss was a ‘products completed operations hazard.’”  “Because Archon could not have intended that the negligent work of its subcontractors cause physical damage to Braden’s home, damage to Braden’s property due to the negligence of Archon’s subcontractors falls within the scope of an occurrence under the language of the CGL policy . . . .” 

Similarly, in Mid-Continent Casualty Company v. JHP Development, Inc., No. SA-04-CA-192-XR, 2005 U.S. Dist. LEXIS 16212 (W.D. Tex. Apr. 21, 2005), the United States District Court for the Western District of Texas in San Antonio addressed whether negligent construction activities qualified as an “occurrence” under Texas law when dealing with a standard CGL policy.  The court provided a summary of Texas precedent which found construction defects qualify as an “occurrence,” as well as cases holding that construction defects fail to qualify as an “occurrence.”  In finding an “occurrence” in this case, the court observed the lack of factual pleadings alleging that the insured purportedly either knowingly or intentionally damaged the project.  The court noted that factual allegations which alleged damage to “contiguous building materials and interior finishes” adjacent to the insured’s work, as well as allegations that the insured’s defective work allowed water to penetrate through building materials and destroyed the materials and finishes, were sufficient to constitute “property damage” to tangible property.  Finally, the court rejected Mid-Continent’s arguments that the Business Risks Exclusions defeated coverage.

Finally, in Home Owners Management Enterprises, Inc. v. Mid-Continent Casualty Co., No. 3:04-CV-2061-BF(H), 2005 U.S. Dist. LEXIS 22524 (N.D. Tex. Oct. 3, 2005), United States Magistrate Judge Paul D. Stickney recognized the conflict in current Texas law, but concluded that Mid-Continent owed a duty to defend and indemnify its insureds from the claims of the plaintiffs in the underlying arbitration.  Specifically, the court concluded that the facts proven by the plaintiffs in the arbitration proceeding conclusively demonstrated that the acts and omissions giving rise to the homeowner’s claims arose from the builder’s negligence, and therefore constituted an “occurrence” under the policy for the purposes of both Mid-Continent’s duty to defend and its duty to indemnify.  Unlike the other cases discussed above, the underlying proceedings in Home Owners Mangement had been fully adjudicated at the time the coverage dispute was decided, thus allowing the court to adjudicate both the dispute regarding the duty to defend and the duty to indemnify.

Given historically low interest rates and the corresponding boom in new home construction, the issues addressed in the foregoing cases will continue to be litigated unless definitively settled by the Texas Supreme Court.  Even then, individual coverage and duty to defend cases are still likely to turn on the specific factual allegations of the underlying litigation.  Although home builder insureds must fight coverage battles using the allegations of the home owner plaintiffs in the underlying lawsuits, independent defense counsel may be able to persuade plaintiff’s counsel to amend the homeowner’s petition to “plead into coverage,” if the facts support such allegations.  In any event, if you have homebuilder clients that purchase CGL policies from your agency, you should be aware of the possibility that the CGL carrier will take the position construction defect claims are not covered by the policy, or that future endorsements or policy language will seek to exclude coverage for such claims.  

E.         Homeowner’s Insurance:  There’s a Fungus Among Us.

Mold cases continue to present substantial exposure for landlords, home builders, and carriers issuing homeowner’s insurance policies.  Examples of recent cases are set forth below.

In a case dealing with personal injury and property damage allegations by a tenant against a landlord, the Dallas Court of Appeals reversed a summary judgment in favor of the landlord.  In Caldwell v. Curioni, 125 S.W.3d 784 (Tex. App.—Dallas 2004, pet. denied), the Dallas Court of Appeals found issues of material fact as to whether the landlord concealed defects and breached a duty to the tenants which caused them harm.  The appellate court also ruled the “as is” provisions in the lease (regarding the condition in which the tenants leased the property) did not bar the tenants’ action against the landlord.  Accordingly, summary judgment in favor of the landlord was reversed and the case remanded to the trial court for further proceedings.  

In a case of first impression for Texas courts, the Fourteenth Court of Appeals in Houston held that mold does not need to be specifically identified as a named peril in an HOB-T (Tenant) policy in order for coverage to exist.  In de Laurentis v. United Services Automobile Association, 2004 WL 349922 (Tex. App.—Houston [14^th Dist], Feb. 26, 2004), the insured’s apartment sustained water damage in a closet due to an air conditioner overflow, but none of the insured’s personal belongings got wet or came in direct contact with the water.  The insurer denied the claim for mold damage to the contents, finding no named peril covering the loss.  In the tenant’s subsequent lawsuit, the trial court granted summary judgment in favor of the insurer on all claims and the tenant appealed.  Reversing the trial court, the appellate court distinguished between “physical loss” and “direct physical loss” finding that “physical loss” included the “natural consequences of the named peril.” The court therefore extended coverage to mold damage to the apartment contents resulting from a covered peril -- an accidental discharge from an air conditioning system -- because the damage was not specifically excluded.

The Court of Appeals revisited its decision on September 30, 2004, and again on March 31, 2005.  See de Laurentis v. United Services Automobile Association, 162 S.W.3d 714 (Tex. App. – Houston [14th Dist.] 2005, pet. denied).  Although the court concluded its decision regarding coverage was correct, it did re-visit the extra-contractual issues. The insured argued that the trial court erred in granting the carrier’s summary judgment on the extra-contractual claims, including their misrepresentation claims, bad faith claims, and DTPA claims. The court concluded that: “When the alleged misrepresentations concern a party’s failure to fulfill its contractual duties, the alleged failure to later perform the duties does not constitute a misrepresentation under the DTPA.” It further held: “an insurer cannot be liable for bad faith simply because it misinterprets a provision in a policy” and “the fact that there is coverage under a policy does not necessarily mean there is a genuine issue of material fact regarding whether the insurer knew or should have known that the claim was covered.” Thus, the court of appeals concluded the trial court properly granted summary judgment on the insured’s bad faith claims.

The recent hysteria over toxic mold infestations has also spawned litigation over the replacement of HO-B policies with more restrictive HO-A policies.  For example, in Farmers Group Inc. v. Geter, 2004 Tex. App. LEXIS 9364 (Tex. App.—Beaumont 2004), the Beaumont Court of Appeals recently concluded that a class action lawsuit challenging Farmers non-renewal and substitution of HO-B policies with more restrictive HO-A policies could continue.  In doing so, the court examined policy language expressly stating limited reasons for non-renewal and addressed the required elements to certify a class action lawsuit.  Finding that the trial court did not examine “notice,” “opt-out” and cohesiveness issues related to the class certification, the court reversed and remanded the class certification issue back to the trial court for further consideration.

F.         Recent Auto Coverage Decisions.

In Texas Farm Bureau Mutual Insurance Company v. Sturrock, 146 S.W.3d 123 (Tex. 2004), the Texas Supreme Court addressed the breadth of a “motor vehicle accident” relative to PIP coverage.  The court determined that “motor vehicle accident” includes situations where one is injured when his/her foot becomes entangled in a part of the vehicle while exiting the vehicle.  In Sturrock, the Texas Supreme Court clarified that a “motor vehicle accident” occurs when: (1) one or more vehicles are involved with another vehicle, an object, or a person; (2) the vehicle is being used (including efforts to enter or exit) as a motor vehicle; and (3) a causal connection exists between the vehicle’s use and the injury-producing event.  According to the Texas Supreme Court, if a claimant sustains injuries from a slip and fall accident while entering into or exiting from the covered vehicle, and the vehicle provides a causal connection to the injury, PIP coverage applies.  However, PIP coverage will be denied for injuries sustained from slip and fall accidents and collisions occurring prior to the process of entering or exiting a vehicle.  According to the court, if Sturrock had fallen without any involvement of the vehicle, there would be no PIP coverage.  However, because the vehicle’s door was the causative factor in the fall, the Texas Supreme Court held PIP coverage applies.

In another recent decision, the Dallas Court of Appeals addressed how far the “occupying” and “upon” verbiage extends in the UM/UIM context.  McKiddy v. Trinity Lloyd’s Insurance Company, 155 S.W.3d 307 (Tex. App.—Dallas 2004, pet. denied).  McKiddy was a passenger in a car owned by Eddie Deen and Company.  After the Deen car slid off an icy road, McKiddy and the other occupants of the Deen car exited the vehicle.  While McKiddy was outside the Deen car, another vehicle operated by Joe Smith also skidded off the icy road into McKiddy, injuring him.  After recovering Smith’s liability coverage limits, McKiddy sought UIM coverage from Deen’s UIM carrier, Trinity.  Trinity denied UIM coverage on the basis that McKiddy was not “occupying” the Deen vehicle at the time of the incident. 

The Trinity policy’s UM/UIM coverage defined “covered person” as “anyone . . . occupying a covered auto”.  “Occupying” was defined as “in, upon, getting in, on, out or off.”  McKiddy argued that because he was in physical contact with the Deen vehicle, he was “upon” it.  McKiddy could not direct the Court to any evidence that he was in contact with or even next to the Deen vehicle when struck by Smith.  In fact, the only evidence showing McKiddy’s proximity to the covered vehicle was McKiddy’s own deposition testimony that he was ten feet from it.  McKiddy also testified he was walking towards another vehicle when he was struck, not walking back to the covered vehicle in which he had previously been a passenger.  Thus, the court found McKiddy was not “upon” the covered auto.  Also, McKiddy argued that “getting” did not modify the words “on, out, or off.”  The Court disagreed, noting that Texas courts which have considered injuries which occurred outside the covered vehicle looked at whether there was a causal connection between the incident that caused the injury and the covered vehicle.  No such causal connection was demonstrated by McKiddy. 

The Texas Supreme Court has also recently considered who has the authority to reject UIM/UM and PIP coverage.  Old American County Mutual Fire Insurance Company v. Sanchez, 149 S.W.3d 111 (Tex. 2004).  In Sanchez, the court determined that the insured spouse of the person listed as the “named insured” in the policy declarations may properly reject coverage for all “insureds.”  In reaching this conclusion, the court first examined the UM and PIP rejection statutes found at Texas Insurance Code Articles 5.06-1(1) and 5.06-3(a).  After examining Articles 5.06, 5.06-1, 5.06-3, and 5.145, the court also concluded that “any insured named in the policy” is the same as “the named insured.”  Further, the Court considered the statute’s legislative history to ascertain that the Texas Legislature intended to allow any named insured to reject UM and PIP coverage under Articles 5.06-1 and 5.06-3. 

Having determined that the phrase “insured named in the policy” is synonymous with “named insured,” the court then examined the meaning of “named insured” as used in Articles 5.06-1 and 5.06-3 to determine whether the spouse of the named insured can be classified as a “named insured.”  Because Articles 5.06-1 and 5.06-3 referred to the standard personal automobile insurance policy in effect at the time those Articles were adopted, the court analyzed the policy terms at issue therein.  The court concluded that the “named insured” included not only the insured listed by name in the policy’s declarations, but also “that individual’s spouse, if a resident of the same household.”  Accordingly, the spouse of the named insured who resides in the same household falls within that category of persons who may properly reject UM and PIP Coverages.

In another recent case regarding PIP coverage, the Texarkana Court of Appeals ruled that there is no requirement under the PIP provision of the standard Texas auto policy that an insured first demonstrate out-of-pocket expenses or potential future liability in order to demand and recover PIP payments.  Forth v. Allstate Indemnity Company, 151 S.W.3d 732 (Tex. App.—Texarkana Dec. 8, 2004, pet. filed).  In Texas, PIP benefits are recoverable regardless of whether an insured has actually paid for necessary medical services.  According to the court, “incur” simply means “to become liable,” and that an insured who selects a treatment facility “occasioned,” “caused,” or “brought on” the obligation to pay for the services rendered.  The fact the insured did not have any out-of-pocket expenses because of other insurance, i.e., group health, or the fact the insured’s healthcare providers were barred by limitations from collecting from the insured, did not relieve a PIP carrier of its contractual agreement to pay the insured’s reasonable and necessary medical expenses.

G.        Timely Notice of Claims

On occasion, a carrier will attempt to deny coverage based on the allegation that notice of the claim was untimely.  As demonstrated below, whether that argument is successful depends in large part on whether the policy is an “occurrence” or “claims made” policy.

 1.      What Constitutes Adequate Notice of Claims Under Occurrence Policies?

In Ridglea Estate Condominium Association v. Lexington Insurance Company, 309 F. Supp. 851 (N.D. Tex. 2004), the United States District Court for the Northern District of Texas addressed the late notice defense under a commercial property policy.  The court determined that notice given in 2001 of damages from a 1995 hail storm was too late as a matter of law, and therefore precluded coverage under the policy. Ridglea argued that the policy’s notice provision was void as contrary to Tex. Civ. Prac. & Rem. Code §16.071, the policy’s notice requirement was ambiguous and therefore must be interpreted in a manner favorable to Ridglea, and that Lexington waived compliance with the notice provision. Lexington argued that Ridglea could not recover because it failed to comply with the notice requirements, which were conditions precedent to coverage under the policy.

Section 16.071 basically provides that a contract stipulation requiring notice of a claim for damages as a condition precedent to coverage is void to the extent it requires notice within less than 90 days. Although the trial court did not find any Texas Supreme Court decision directly on point, the court’s “Erie guess” relied on Texas Supreme Court precedent which interpreted the phrase “claim for damages.” In so doing, the court determined that insurance policy notice provisions do not pertain to a “claim for damages,” but merely are requirements that insureds give notice of a potentially covered event so the insurance company might be able to promptly conduct an investigation. Thus, the court held Section 16.071 does not apply to an insurance policy’s notice provisions.

The District Court in Ridglea also held the notice provisions in the commercial property policy were unambiguous. Although Texas law does not contemplate that an insured would be required to give notice before it had a reasonable opportunity to ascertain that it had suffered a loss, according to the District Court, the summary judgment record established as a matter of law that Ridglea did, could have, or should have discovered the damage to the roof shortly after the 1995 hail storm had occurred. The court held: “The size of the hailstones, without more, would indicate a need for an immediate inspection of the roofs for damage,” thus placing the insured on notice of the damages.  Significantly, the court also concluded that under Texas law, prejudice was not an element of a late notice defense in the first party context and, as such, Lexington did not have to show prejudice to avail itself of the policy’s late notice defense.

Ridglea appealed to the Fifth Circuit Court of Appeals. Ridglea Estate Condominium Association v. Lexington Insurance Company, No. 04-10447, 2005 U.S. App. 16724 (5^th Cir. Aug. 10, 2005).  The appellate court first observed that an insurer’s total denial of liability on any grounds, after the time for filing a proof of loss had expired, would not constitute a waiver of the defense of late filing of the proof of loss.  According to the court, where the insured provides notice of loss after the period for prompt notice had expired, the insurer’s subsequent general denial of liability likewise comes after the time limit for giving notice and thus does not constitute waiver of the late notice defense.

The court then examined whether prejudice was an element of the late notice defense under Texas law.  The court relied upon the Texas Supreme Court’s decision in Hernandez v. Gulf Group Lloyds, 875 S.W.2d 691 (Tex. 1994), and reasoned that: (1) all insurance policies are contracts; (2) all contracts require a “material breach” to excuse non-performance; and (3) for a breach to be material, it must prejudice the non-breaching party in some way.  As such, the Fifth Circuit determined that prejudice was a requirement which applied equally to all insurance policies issued in Texas, including first-party property policies.  Accordingly, a carrier may only rely upon a policy defense of late notice where it has sustained prejudice from such late notice.

In Clarendon National Insurance Company v. FFE Transportation Services, No. 3:03-CV-1752-BF, 2004 U.S. Dist. LEXIS 23958 (N.D. Tex. Nov. 9, 2004), the United States District Court for the Northern District of Texas addressed late notice and resulting prejudice in the context of an SIR and the MCS-90 endorsement.  Clarendon’s policy with FFE included a $1,000,000 SIR and $1,000,000 policy limit over and above the SIR.  The Clarendon policy also included an endorsement by which FFE was to provide “immediate” notice to Clarendon when there was “any claim in which the requested damage exceeds the” SIR.  The notice endorsement also required that FFE notify Clarendon of an occurrence of any injury, death, or disease paid or reserved for 25% or more of the SIR.  The MCS-90 endorsement provided that “the insured agrees to reimburse the company for any payment made by the company on account of any accident, claim, or suit involving a breach of the terms of the policy, and for any payment that the company would not have been obligated to make under the provisions of the policy except for the agreement contained in this endorsement.” 

One of FFE’s vehicles was involved in an accident and several people brought claims against FFE.  All claimants settled with the exception of Ray Stewart.  The other claimants settled for an aggregate amount of $219,861.99, all within FFE’s SIR.  Stewart brought suit against FFE.  Before trial, Stewart’s settlement demand was $1,000,000.  A jury thereafter awarded Stewart approximately $1.3 Million in damages and interest.  FFE notified Clarendon of the loss more than three months after judgment.  Clarendon acknowledged the claim, and reserved its rights under the policy to disclaim coverage.  Clarendon and FFE subsequently settled Stewart’s claims.

Clarendon thereafter sought recovery from FFE of those sums Clarendon had paid in satisfaction of Stewart’s claims.  The trial court rendered judgment in favor of Clarendon, holding that FFE’s late notice prejudiced Clarendon because it could have accepted a settlement offer for less than the verdict during trial.  The Court also held the MCS-90 endorsement provided Clarendon with the right to settle Stewart’s claim and seek reimbursement from FFE.

Similarly, in Matthew v. Old American County Mutual Fire Insurance Company, No. 05-04-00663-CV, 2005 Tex. App. LEXIS 2951 (Tex. App. – Dallas, Apr. 19, 2005), the Dallas Court of Appeals addressed a liability carrier’s late notice defense.  The Court reiterated and relied upon established Texas principles regarding an insured’s late notice to an insurance carrier and resulting prejudice that is automatically created when the insured permits a default judgment to be taken without sending the suit papers to his liability carrier.  The Court reviewed and rejected each of the insured’s arguments that the carrier could not rely upon the notice provision of the insurance policy and held the carrier was relieved its obligations to defend and indemnify the insured because no notice was given to the carrier before the plaintiff took a default against the insured defendant.

2.         What Constitutes Timely Notice Under Claims Made Policies?

Although late notice of claims under an “occurrence” policy will generally not be sufficient reason for the carrier to deny coverage without showing prejudice, late notice of a claim under a “claims made” policy almost always results in a denial of coverage.  Texas courts reason that the risk insured against on a claims made policy is not that a potentially covered loss will occur, but rather that a claim arising from that loss will be made against the insured during the policy period.  As a result, there is no requirement for the carrier to show prejudice in order to deny a claim for late notice under a claims made policy.  The following recent cases address the effect of late notice under claims made policies.

 In Texas Medical Liability Trust v. Transportation Insurance Company, 143 S.W.3d 335 (Tex. App.—Dallas 2004, pet. denied), the Dallas Court of Appeals decided when notice of a medical malpractice claim is sufficient to constitute notice under a claims-made policy, and whether such notice may inure to the benefit of all potential insured's under the policy as opposed solely to the health care provider to whom the notice is addressed.  The court held that the 4590i notice sent only to an insured doctor employed by the insured clinic did not constitute proper or timely notice for the clinic under a claims-made liability policy.

Similarly, the San Antonio Court of Appeals recently held in First Professional Insurance Company, Inc. v. Heart & Vascular Institute of Texas, No. 04-05-00028-CV, 2005 Tex. App. LEXIS 8192 (Tex. App.—San Antonio Oct. 5, 2005), that notices of claims against two individual physicians were insufficient notice of a claim against the clinic where they practiced.  This result accrued even though: (1) both physicians were named insureds under the policy; (2) the alleged negligence of both physicians and the clinic were based on the same episode of treatment of the same patient; and (3) the insurance carrier did not dispute timely notice of the claims against the physicians.  Notwithstanding these facts, the subsequent claim asserting the clinics’ vicarious liability was found not to have been made during the claims-made policy period, and therefore the insurer had no duty to defend or indemnify the clinic.

Of significance to agents is the fact that First Professional asserted a cross-claim against the agent for failing to purchase a tail policy for Heart & Vascular Institute.  Because of the resolution of the coverage issue, the carrier’s claim against the agent was rendered moot.  However, it appears from the opinion that Heart & Vascular Institute made similar claims against the agent.  Although the disposition of those claims is not addressed by the San Antonio court’s opinion, agents issuing claims-made policies may be well advised to inquire about existing and potential claims, and to counsel their clients, in writing, to purchase tail coverage if potential but unasserted claims may be lurking in the weeds.

As illustrated by Evanston Insurance Company v. Encore Medical Staffing Inc., 2005 WL 2561645 (S.D. Tex. Oct. 12, 2005), it is also important to put new carriers on notice of potential claims.  In Encore Medical Staffing, the United States District Court for the Southern District of Texas held that notice of a “potential claim” reported to the agent during an earlier policy period did not trigger coverage under a claims-made policy when the actual notice of the claim was later made under a new policy, issued by a different insurer.  The court reached this conclusion notwithstanding the fact the retroactive date of the new policy encompassed the earlier notice date.  The court reasoned that notice of intent to file a lawsuit in the future did not meet the definition of a “claim” under the claims-made policy, and therefore, the latter policy was not obligated to defend.

H.        When Does a Carrier Have the Duty to Defend My Client?

The analytical framework for determining when the allegations of a lawsuit trigger an insurance carrier’s duty to defend continue to evolve.  Although the traditional test limits the court’s inquiry to a comparison of the factual allegations in the underlying lawsuit and the provisions of the applicable insurance policy—the “eight corners rule”—some courts continue to look beyond those documents, determining whether the carrier’s duty to defend has been triggered by reference to extrinsic facts.  The following recent cases illustrate different approaches taken by Texas courts, and also discuss the circumstances under which the insured can assume control of its own defense.

 1.         What Can the Court Review in Determining the Duty to Defend my Client?

In an example of the strict application of the “eight corners rule,” the United States Court of Appeals for the Fifth Circuit recently rejected arguments that an exception applies when the “petition labels conduct as negligent, where the true nature of the conduct has been found criminal.”  In Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523 (5^th Cir. 2004), a nanny employed by the insured, Loving Home Care, Inc., was found guilty of the first-degree felony of injury to a child when the baby girl in her care suffered multiple brain hemorrhages and skull fractures resulting in the child’s death.  The criminal conviction required a finding that the nanny acted “intentionally or knowingly”. 

After the conclusion of the criminal trial, the parents filed a civil action against Loving Home Care, who was insured under a commercial professional liability ("CPL") policy issued by Northfield.  Northfield filed a declaratory judgment action seeking a ruling that it had no duty to defend or indemnify based on the policy’s “criminal acts” and “physical/sexual abuse” exclusions.  The trial court applied a traditional “eight corners rule” analysis in determining whether a duty to defend arises under the facts as alleged.  The trial court ruled that the insurer had a duty to defend and Northfield appealed.

On appeal, Northfield argued the petition in the underlying case was drafted to ignore reality and was based on omissions and incomplete characterizations in order to obtain coverage.  Thus, Northfield argued, it should have the right to introduce extrinsic evidence to rebut its alleged duty to defend.  The Fifth Circuit conducted a thorough review of Texas law and examined all of the cases which provide some limited exceptions to the strict application of the eight corners rule.  The court noted that the Texas Supreme Court has never recognized any exception to the strict eight corners analysis that would allow courts to consider extrinsic evidence in addressing the duty to defend, although some lower appellate courts and some federal district courts from Texas have done so.  Generally, limited exceptions have been recognized when essential fact allegations are missing or fundamental policy coverage issues which don’t involve a factual determination of the truth or falsity of the allegations have been raised (e.g., where persons or property have been specifically excluded and whether a policy exists).  Here, the Fifth Circuit made an “Erie guess” that the Texas Supreme Court would not recognize any exception to the strict eight corners analysis and, even if it did recognize some exceptions, the Fifth Circuit believed that those exceptional circumstances did not exist in Loving Home Care. 

Confining it’s analysis to the most recent petition, which had been amended to “remove allegations relating to the nanny’s criminal conviction and the intentional nature of the behavior,”[4] the allegations which claimed that the nanny “negligently dropped the child, and/or negligently shook her, causing severe head injuries that resulted in the infants death,” “if properly assumed to be true, unambiguously stated at least one negligence claim facially within the policy’s coverage.”  Accordingly, the Fifth Circuit affirmed the district court’s coverage decision finding the insurer had a duty to defend. 

In Burlington Ins. Co. v. Texas Krishnas, Inc., 143 S.W.3d 226 (Tex. App.—Eastland 2004, no pet.), the Eastland Court of Appeals similarly applied a strict version of the eight corners rule.  In that case, the court held the insurer owed a duty to defend under Texas law, despite proof that the insured actually knew of past and ongoing losses at the time the policy was purchased.  

Historically, coverage is precluded in Texas in situations that involve a known loss as well as a loss in progress.  In this case, however, the plaintiffs in the underlying lawsuit did not plead when any specific event took place, exactly where it took place, whether Texas Krishnas knew or should have known of the loss, or whether the insured knew of an ongoing progressive loss at the time that the policy was issued.  Looking only to the eight corners of the pleadings and the policy, the appellate court found the trial court properly ruled the insurer owed the Krishnas a defense.  Although proof of the Krishna’s actual knowledge may preclude Burlington’s indemnity obligation, the duty to defend could not be decided on extrinsic evidence of insured’s knowledge or state of mind.

In many instances, plaintiff’s counsel will plead allegations specifically in order to trigger coverage.  For example, in Global Sun Pools, Inc. v The Burlington Insurance Company, No. 05-03-00765-CV, 2004 Tex. App. LEXIS 7552 (Tex. App. – Dallas, Aug. 23, 2004, no pet.), the policy term “its builders” was sufficient to invoke coverage under an additional insured endorsement.  In 2001, Global Sun d/b/a The Pool Depot, built a pool for the Reed family.  The Reeds subsequently sued Global Sun asserting that it sent “its builders to construct the pool and deck,” and that the deck was not constructed in a good and workmanlike manner, resulting in bodily injury to Mrs. Reed.  Global Sun tendered the Reeds’ suit to Burlington as an additional insured under the Burlington policy.  Burlington denied coverage arguing that there were no pleadings showing any connection between the Reeds’ claims and Burlington’s named insured, Paul Simmons.  Paul Simmons, the man who actually constructed the pool, had a policy with Burlington which identified Global Sun as an additional insured “with respect to liability arising out of your [Paul Simmons] operations or premises owned by or rented to you [Paul Simmons].”  The Dallas Court of Appeals determined that the Reeds’ allegation the injury was caused by the faulty workmanship of “its builders” was sufficient to trigger the Burlington additional insured endorsement, regardless of the petition’s failure to specifically identify Paul Simmons.

Perhaps due to the sometimes harsh results of the strict application of the “eight corners rule,” the Texas Supreme Court recently agreed to review the Fort Worth Court of Appeals’ opinion in Fielder Road Baptist Church v. Guideone Elite Insurance Company, 139 S.W.3d 384 (Tex. App.—Fort Worth 2004, pet. granted), 2005 Tex. LEXIS 576 (Tex. June 17, 2005).   In that case, the court of appeals rejected the use of extrinsic evidence demonstrating the loss occurred outside the policy period.  The court observed that “extrinsic evidence is permitted to show no duty to defend only in very limited circumstances” involving “fundamental coverage issues.”   The court also reviewed a Fifth Circuit opinion holding that “extrinsic evidence concerning whether the alleged act actually occurred during the policy period could not be considered because it related to liability, not to a fundamental coverage issue.”  Accordingly, the Fort Worth court concluded that the trial court’s analysis of the insurer’s duties where confined to the eight corners of the pleadings and the policy which were sufficient to support a claim under the policy’s sexual misconduct coverage.[5] 

The Texas Supreme Court’s decision in Fielder may occasion a sea change in the determination of whether carriers have a duty to defend your clients.  We will continue to watch for the court’s opinion in this case.  When issued, it will be posted on our website (www.texasatty.com). 

 2.         Does my Client have the Right to Control its Own Defense if the Carrier Disputes Coverage?

Insured's often wonder whether their insurance carrier and appointed defense counsel have their best interests at heart when the carrier defends the insured under a reservation of rights, while at the same time contesting coverage via a declaratory judgment action or by some other means.  In some cases, such actions on the part of the carrier may result in the loss of the carrier’s right to conduct the insured’s defense.  In the following case, the Texas Supreme Court clarified the types of conflicts that may cause a liability carrier to lose the right to control (but not the obligation to pay for) the defense of its insured.   

In Northern County Mutual Insurance Company v. Davalos, 140 S.W.3d 685 (Tex. 2004), the Texas Supreme Court determined that a disagreement between the insured and its insurer over the venue of a lawsuit against the insured was insufficient to create a conflict requiring the carrier to surrender its contractual right to control the insured’s defense.  Specifically, the court concluded that not every disagreement about how the defense should be conducted amounts to a conflict of interest sufficient to allow the insured to control its own defense. The court reasoned that if such were the case, it would turn the contractual right to control the defense on its head, allowing the insured, not the insurer, to control the defense by merely disagreeing with the insurer’s proposed actions.  However, the court stated that “when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends, the conflict of interest will prevent the insurer from conducting the defense.”  In such cases, the insured should have the right to hire its own counsel, control its own defense, and to recover the costs of that defense from the carrier.

 I.          Does Article 21.55 Apply to Claims Arising from the Denial of the Carrier’s Duty to Defend?

Another significant and unsettled question in Texas insurance jurisprudence is whether Article 21.55 of the Texas Insurance Code[6] -- the “prompt payment” statute -- applies to an insured’s demand for a defense from the claims of a third party under a liability policy.  Article 21.55 creates a cause of action for “claimants”—insureds, policyholders, or named beneficiaries[7]--who make “a first party claim . . . that must be paid by the insurer directly to the insured or beneficiary.”[8]  Although the statute expressly applies only to “first party claims,” courts in Texas have split over whether a claim for a defense under a liability policy is a “first party claim” to which Article 21.55 applies.[9]

Like several other unsettled issues addressed by this article, this issue has also recently been raised in the form of a certified question to the Texas Supreme Court.  In Lamar Homes, Inc. v. Mid Continent Casualty Co., No. 04-51074, 2005 U.S. App. LEXIS 21441 (5^th Cir., Oct. 3, 2005), the Fifth Circuit asked the Texas Supreme Court to answer the following question:  “[D]oes Article 21.55 of the Texas Insurance Code apply to a CGL carrier’s duty to defend?”  As discussed above, in this same case the Fifth Circuit also asked the Texas Supreme Court to determine whether a homeowner’s allegations of negligent construction resulting in damage to the home trigger the CGL carrier’s duty to defend.  Because the certified question regarding the application of Article 21.55 is conditioned on an affirmative answer to the preceding coverage question, if the Texas Supreme Court determines the CGL carrier’s duty to defend is not triggered by such allegations, the Article 21.55 question will be rendered moot.

Notwithstanding certain past statements indicating the denial of a duty to defend could create a cause of action under Article 21.55,[10] recently the Texas Supreme Court has avoided answering the question posed by the Fifth Circuit.  For example, the court denied a petition for review in TIG Insurance Co. v. Dallas Basketball, Ltd., 129 S.W.3d 232, 241-42 (Tex. App.—Dallas 2004, pet. denied).  In that case, the underlying lawsuit arose from claims that the Dallas Mavericks basketball team sent unsolicited facsimile advertisements which violated the Federal Telephone Consumer Protection Act.  In the coverage litigation, the Dallas Court of Appeals held the alleged wrongdoing qualified as an “advertising injury” under commercial general liability insurance policies, and therefore triggered TIG’s duty to defend. 

The Dallas Court of Appeals then addressed the Mavericks’ claim for damages under Texas Insurance Code Article 21.55.  In its analysis of the issue, the court disagreed with Northern Co. Mut. Ins. Co. v. Davalos, 84 S.W.3d 314 (Tex. App.—Corpus Christi, 2002), rev’d on other grounds, 140 S.W.3d 685 (Tex. 2004), and observed that Article 21.55 applies only to “first party claims.” The court concluded that a claim for defense costs “is not a claim under the policies but a common law claim for breach of contract damages.”  Accordingly, the court concluded that the penalty provisions of Article 21.55 do not apply to claims for costs incurred by the insured in defending a third party lawsuit. 

Despite the existence of conflicting state and federal court decisions regarding the application of Article 21.55 to denials of the duty to defend, the Texas Supreme Court denied the petition for review in the Mavericks case, and also failed to reach the issue in Davalos.  Thus, at present, the question remains unresolved.  We will continue to monitor this evolving area of Texas law and supply information on new developments.

Although the Texas Supreme Court has not resolved the outstanding issue addressed above, the court did recently issue an opinion answering another previously unsettled question under Article 21.55:   Whether penalties and interest under Article 21.55 are calculated on the entire amount of the claim, or just the disputed amount.  In Republic Underwriters Ins. Co. v. Mex-Tex, Inc., 150 S.W.3d 423 (Tex. 2004), the insurer tendered payment on the undisputed amount.  Following a bench trial, the trial court determined the partial payment was insufficient and calculated the 18% penalty and interest on the full amount of the claim ($179,000), rather than on the amount that remained in dispute ($33,540).

In addressing the issue, the Supreme Court of Texas analyzed Article 21.55’s definition of “claim” and determined that by including the phrase “that must be paid,” the definition limits the meaning of “claim” to: “the amount ultimately owed, which of course would be net of any partial payments made prior to that determination.”  The court reasoned that such an interpretation would encourage insurers to pay the undisputed portion of a claim early, consistent with the statute’s purpose to obtain prompt payment of claims.  The court also held that the tender of partial payment must be “unconditional,” but placed the burden on the insured to prove the tender was conditioned on a full release.  In Mex-Tex, the court found no such proof, and therefore held the insured was only entitled to the statutory penalty on the disputed amount of $33,540.

J.         Recent Errors & Omissions Cases:  Why are Agents Getting Sued?

One area that gives rise to substantial agent errors and omissions exposure is the agent’s role in providing the carrier with notice of claims.  A recent case illustrating the E&O exposure that can arise from the improper handling of suit papers is Fiske v. Fiske, No. 01-03-00048CV, 2004 Tex. App. LEXIS 7483 (Tex. App.—Houston [1^st Dist.] Aug. 19, 2004, no pet.).  In that case, the insured’s wife was injured while riding as a passenger in the insured vehicle and sued her husband for personal injuries.  Mr. Fiske presented the suit papers to his agent’s office and the agent’s assistant mistakenly believed no suit had been filed.  A $50,000 default judgment was entered, and an unsuccessful effort to set it aside followed.  On appeal, the court noted: “Defendant, Richard Fiske’s actions, by and through his insurance agent, amounted to conscious indifference with respect to answering this lawsuit in a timely and correct manner.”  Thus, the $50,000.00 default judgment was allowed to stand, leaving the agent exposed to the carrier for his negligence in not reporting the claim.

Oral representations regarding the acquisition of coverage are also fertile ground for E&O claims.  For example, the Tyler Court of Appeals recently found that fact issues precluded summary judgment in a case involving an alleged oral contract between the agent and insured to secure the “maximum” amount of uninsured/underinsured motorist (UM/UIM) coverage available.  Critchfield v. Smith, 151 S.W.3d 225 (Tex. App.—Tyler 2004, pet. denied).  In that case, the insured’s son died from injuries sustained in an automobile accident while riding as a passenger in another vehicle.  The insured was paid $100,000 under his UM/UIM policy limit, but later brought suit against the agent asserting that the limit would have been $500,000, but for the agent’s failure to secure the “maximum” limits as allegedly requested by the insured.  Despite the fact that coverage had been in place and renewed with the same limits every year from 1993 until 1999 (when the accident occurred), the court found that fact issues concerning the alleged breach of an oral contract precluded summary judgment, and remanded the case for trial.  To avoid the possibility of a similar scenario, it is best to maintain application or other documentation that clearly presents your clients with the available coverage options, and provides some indicia (preferably the client’s signature or initials) of the coverage options selected.

Agents may also have exposure for placing their client’s insurance with a financially unstable surplus lines carrier.  To make matters worse, your E&O policy may not cover claims arising from such allegations.  Recently the First Court of Appeals in Houston ruled in Greenwood Insurance Group, Inc. v. United States Liability Insurance Company, 157 S.W.3d 444 (Tex. App.—Houston [1^st Dist.] 2004), that the insolvency clause an agent’s E&O policy excluded coverage for the agent’s placement of business with a surplus lines carrier that subsequently became insolvent.

Greenwood was an insurance broker; All-Tex Roofing, Inc. was one of its clients.  Greenwood secured coverage for All-Tex, placing $1 Million of primary coverage with Resure, Inc., a surplus lines carrier with a “B” rating.  Greenwood also obtained for All-Tex a $1 Million excess policy from United National Insurance Company.  While the Resure policy was in place, a third-party liability claim was asserted against All-Tex, which resulted in a judgment of $1.3 Million Dollars.  United National paid a portion of the damages against All-Tex, but Resure had been declared insolvent two years earlier, and provided no primary coverage for All-Tex. 

All-Tex subsequently sued Greenwood based upon Greenwood’s placement of coverage with Resure, and Resure’s failure to provide coverage as a result of Resure’s insolvency.  See All-Tex Roofing, Inc. v. Greenwood Ins. Group, Inc., 73 S.W.3d 412 (Tex. App.—Houston [1^st Dist.] 2002, pet. denied) (reversing summary judgment granted to agent).  Greenwood called upon its own E&O carrier, United States Liability, to defend it in the All-Tex suit.  United States Liability provided Greenwood a qualified defense, and sought declaratory relief, relying upon the United States Liability policy’s insolvency exclusion.  In a case of first impression, the Houston Court of Appeals determined that the insolvency exclusion in Greenwoods’ E&O policy was clear, unambiguous, and enforceable, and therefore Greenwood was not entitled to a defense or indemnity.

 K.        Recent Insurance Code and Bad Faith Cases.

A couple of recent bad faith cases are worth noting.  First, in Dallas Fire Insurance Company v. Texas Contractors Surety and Casualty Agency, 159 S.W.3d 95 (Tex. 2004), the Texas Supreme Court extended its prior opinion in Great American Insurance Company v. North Austin Utility District No. 1, 908 S.W.2d 415 (Tex. 1995), and held that Article 21.21 does not apply to the surety/sales agent relationship.  The rationale for these cases is that surety bonds are not “insurance,” and thus their issuance and sale does not constitute the “business of insurance” under Article 21.21. 

Second is the case of Employers Mutual Casualty Company v. Maya, 3:03-CV-2916-B, 2005 U.S. Dist. LEXIS 7533 (N.D. Tex., Apr. 29, 2005).  In this case the underlying lawsuit was filed by an employee injured by a deep fat fryer explosion at work. The insurers provided defense and reached a settlement with regard to all of the parties sued in the action, except for a second employee. The first employee thereafter obtained a judgment against second employee, who then assigned his claims against the insurers to the first employee, in exchange for the first employee’s agreement not to execute on the judgment.

The insurers filed a declaratory judgment suit against the employees. In response, the employees filed a cross-complaint against the TPA and insurance agent.  The court ruled on summary judgment that the employees had no valid claims against either the agent or the TPA.  Specifically, the court ruled neither the agent nor the TPA could be held liable for alleged breaches of the insurance policies, or for violating any duty of good faith and fair dealing arising from them, because they were not parties to the insurance contracts. The court also determined the employees had no evidence that the agent or the TPA made any false or misleading statements in violation of the Texas Deceptive Trade Practices Act, thus those claims were also dismissed.[11]

III.       CONCLUSION

We hope that this non-exhaustive summary of recent Texas insurance cases will assist you not only in better serving your clients, but also in avoiding potential errors and omissions pitfalls.  Should you have any questions regarding the cases discussed herein, please don’t hesitate to contact David Dodge at the address in the letterhead, via e-mail at davidd@texasatty.com, or via phone at (214) 273-3292.

 DISCLAIMER

Do not use this memo as legal advice or to make legal decisions.  This brief discussion of recent Texas insurance opinions is not meant to be exhaustive.  It is also not intended as legal advice.  Anyone attempting to implement any idea or provision in this memo should first seek advice from competent counsel.  Each insurance-related dispute is different.  Do not attempt to solve individual problems on the basis of the information contained herein alone.  

Attorneys are not certified by the Texas Board of Legal Specialization.

Crown Life Ins. Co. v. Casteel, 22 S.W.3d 378, 385 (Tex. 2000) (holding an agent may be personally liable under Texas Insurance Code Article 21.21 for deceptive acts). 

Nast v. State Farm Fire & Cas. Co., 82 S.W.3d 114, 123-124 (Tex.App.—San Antonio 2002, no pet.) (finding an agent may be held personally liable for misrepresentations concerning insured’s eligibility for flood insurance).