INSURANCE LITIGATION: INCLUDING BAD FAITH AND EXTRA CONTRACTUAL DAMAGES

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1 INSURANCE LITIGATION: INCLUDING BAD FAITH AND EXTRA CONTRACTUAL DAMAGES Presenter: MARK L. KINCAID Kincaid & Horton, L.L.P. 114 West 7th Street, Suite 1100 Austin, Texas / / fax Co-Authors: SUZETTE E. SELDEN Kincaid & Horton, L.L.P. 114 West 7th Street, Suite 1100 Austin, Texas / / fax ZACH WOLFE Fleckman & McGlynn, P.L.L.C. Bank of America Center 515 Congress Avenue, Suite 1800 Austin, Texas State Bar of Texas 32 nd ANNUAL ADVANCED CIVIL TRIAL COURSE July 29-31, 2009 San Antonio CHAPTER 29

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3 MARK L. KINCAID KINCAID & HORTON, L.L.P. 114 West 7th Street, Suite 1000 Austin, Texas / / fax Mark Kincaid is a partner in Kincaid & Horton, L.L.P. He graduated from the University of Texas with B.B.A. and J.D. degrees with honors. He is board-certified in Civil Trial Law, Consumer & Commercial Law, and Civil Appellate Law by the Texas Board of Legal Specialization. Mr. Kincaid represents consumers and businesses in insurance litigation, deceptive trade practice litigation, and business disputes. Mr. Kincaid teaches Insurance Litigation as an Adjunct Professor at the University of Texas School of Law. In 1994, Mr. Kincaid was appointed by Governor Ann Richards to head the Office of Public Insurance Counsel, a state agency that advocated for insurance consumers, where he served before returning to private practice. Mr. Kincaid is a former member and past chair of the State Bar of Texas Consumer Law Council. He is chair of the State Bar Pattern Jury Charge committee on Business, Consumer, Insurance, and Employment. Mark Kincaid was managing editor of Texas Consumer Law Reporter from , and he has directed numerous programs on consumer and insurance law and has authored and presented many articles on these subjects. He is co-author of the Texas Practice Guide: Insurance Litigation (West 2009). Mark s colleagues have given him an AV rating in the Martindale-Hubbell Law Directory, and designated him a Super Lawyer in the 2003 through 2009 surveys of Texas lawyers published by Law & Politics Media and the publishers of Texas Monthly magazine.

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5 SUZETTE E. SELDEN KINCAID & HORTON, L.L.P. 114 West 7th Street, Ste Austin, Texas / / fax Suzette Selden is an associate at Kincaid & Horton, L.L.P. She graduated magna cum laude from Brigham Young University with a B.A. degree and cum laude from the University of Houston Law Center with a J.D. degree. She was a visiting student at the University of Texas School of Law during her third year of law school. Mrs. Selden represents consumers and businesses in insurance litigation, deceptive trade practice litigation, and business disputes. Suzette Selden served as legal editorial assistant at Jones McClure Publishing the publisher of the O Connor s litigation manuals, where she worked on O Connor s Texas Causes of Action and several other legal manuals. Additionally, she was head notes and comments editor of the Houston Journal of International Law from Before attending law school, Mrs. Selden worked as a television news producer for an ABC affiliate station in Washington state and interned for the Dateline NBC news magazine program in New York City.

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7 Zach Wolfe Fleckman & McGlynn, PLLC 515 Congress Avenue, Suite 1800 Austin, Texas Phone: Fax: Zach Wolfe is a member of the law firm Fleckman & McGlynn, PLLC. He has over 11 years of experience in a wide variety of business litigation matters, including trials, arbitrations, and appeals. His extensive experience in commercial litigation includes insurance coverage, securities fraud, embezzlement, partnership disputes, intellectual property, trade secrets, commercial lease disputes, and business torts. He received his undergraduate degree magna cum laude from Harvard in 1994 and graduated from the University of Texas School of Law with honors in He has written a number of articles on insurance litigation topics.

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9 TABLE OF CONTENTS 1. The Plaintiff is considering filing suit The Defendant sent the pleadings from the Plaintiff s suit to the Insurer The Plaintiff has decided on a strategy of trying to plead into coverage The Defendant sent the pleadings from the Plaintiff s suit to the Insurer, The Defendant sent the pleadings from the Plaintiff s suit to the Insurer, The insurer agreed to defend and has been paying for a defense lawyer, Suit has been filed, and the Plaintiff s ability to collect will depend on the existence of insurance coverage A lawyer selected by the Defendant has been defending the lawsuit for months Two Plaintiffs sue the Defendant The Insurer hired a lawyer to defend, but the Insurer keeps messing with the defense The defense lawyer hired by the insurer is doing a great job of defending An Insurer that has been defending a Defendant under a reservation of rights letter settles the claim The Plaintiff feels her case is strong and well-developed, so she is ready to make a settlement demand The Defendant is very worried about liability and the toll the ongoing suit is taking Choice of Law Principles Choice of Law Cases The Plaintiff has a very large damage claim, After the Plaintiff filed suit, The Plaintiff just got a huge verdict against the Defendant Power Point: Insurance Issues for Trial Lawyers i

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11 INSURANCE LITIGATION, INCLUDING BAD FAITH AND EXTRA CONTRACTUAL DAMAGES Mark L. Kincaid, * Suzette E. Selden,¹ & Zach Wolfe As every experienced trial lawyer knows, and as new lawyers soon find out, insurance issues can substantially impact, and even dominate, trials from before suit is filed, up to when (and whether) the judgment is paid. The problem is that trial lawyers like to think about trials, not insurance. So what happens when insurance issues intrude? What do you do? What do you need to know? What should you be thinking about? These are the questions this paper will address. The hope is that you will get enough information to become conversant with the important insurance issues you are likely to encounter. For more experienced lawyers, this will be more of a review; for the less experienced, more of a heads-up. You won t learn enough insurance law to be in danger of becoming an insurance nerd. The examples will follow the normal sequence of a trial from pre-suit to post-verdict. 1. The Plaintiff is considering filing suit. There may be claims against several parties, and the facts may justify alleging intentional and accidental conduct. What should the Plaintiff think about insurance coverage? One of the first insurance issues the Plaintiff s lawyer will confront is whether to plead into coverage, although the very idea is something of a * Mark L. Kincaid is a partner with Kincaid & Horton, L.L.P. in Austin. He graduated with honors from the University of Texas Law School and teaches Texas Insurance Litigation there as an adjunct professor. He is board-certified in Consumer Law, Civil Trial Law, and Civil Appellate Law. He is co-author of West s Texas Practice Guide on Insurance Litigation, and has written and spoken frequently on insurance and consumer issues. ¹ Suzette E. Selden is an associate with Kincaid & Horton, L.L.P. She graduated with honors from Brigham Young University with a B.A. (2002), and the University of Houston Law Center (2006). Zach Wolfe is a partner with Fleckman & McGlynn, P.L.L.C. in Austin. He has diverse experience in a variety of business litigation matters, including representation of businesses in disputes with their insurers. He graduated with honors from the University of Texas School of Law in 1997, where he learned most of what he knows about insurance law from Mark Kincaid s Insurance Litigation course. misnomer. All a plaintiff can do is plead the case in a manner that gives rise to the insurer s duty to defend its insured. But that doesn t mean the insurer has to pay the claim. The duty to pay depends on the proof at trial, and proof on coverage issues (in a subsequent trial) that were not decided in the underlying suit. a. Why plead into coverage? It seems counterintuitive that a plaintiff would intentionally plead in a way that provoked an insurer to fund the opposition. Nevertheless, there are significant reasons why this is precisely what the plaintiff wants to do. The most obvious reason to plead into coverage is to try to prove a claim that is covered so the insurer will have to pay it. This rationale exists when the defendant does not have the resources to pay. In a thorough paper on the subject, Professor Ellen Pryor identifies several other reasons why a plaintiff might plead into coverage: If an insurer finds itself obligated to defend, the insurer may take into account defense costs, even of a non-covered claim, which may give the claim settlement value. (1) If a claim is covered, the insurer has a duty to settle and may be liable for an excess judgment if it breaches that duty. An insurer defending a potentially covered claim may determine that the risk of failing to settle is too high, so the insurer may be willing to pay. (2) The insurer could erroneously fail to defend, which in some jurisdictions (but not Texas) will estop the insurer from contesting its duty to pay. (3) In some jurisdictions, if the insurer wrongfully denies a defense, it may be liable for extracontractual damages, which may give the claim value. (4) If the insurer defends, but does not properly reserve its right later to contest coverage, the insurer may have waived coverage defenses and be required to pay the claim. Ellen S. Pryor, The Stories We Tell: Intentional Harm & The Quest For Insurance Funding, 75 Tex. L. Rev. 1721, 1734 (1997). b. Why not? There may be valid reasons not to plead into coverage, if the facts support a claim that is not necessarily covered. For example, if the defendant has sufficient resources to pay the resulting judgment, requiring the defendant to defend a claim that is not covered by insurance may create economic incentives to settle. Aside from economic considerations, a plaintiff may want to avoid triggering coverage, as a matter of 1

12 principle. For example, a victim of abuse may want to sue the abuser for intentional conduct, seeking vindication and to punish the wrongdoer. Other strategic factors may favor not pleading into coverage. If the plaintiff wants quick injunctive relief, then triggering a defense by an insurer may hamper the process, without providing any benefit. See Beth D. Bradley, Pleading Traps & Tricks: Pleading In & Out of Coverage, in State Bar of Texas Insurance Law Section, Insurance, Litigation and You: The Impact of Insurance In Litigation, tab 3, p. 11 (2004). Unnecessarily pleading multiple years, or invoking multiple lines of coverage, may simply complicate negotiations because of issues between and among the various insurers. Id. 2. The Defendant sent the pleadings from the Plaintiff s suit to the Insurer, asking it to defend and pay if necessary. The suit alleges various claims. Some appear to be covered; some may not be. Is the Defendant entitled to a defense? Under Texas law, the Defendant would be entitled to a defense as long as at least one of the claims is covered. If the petition potentially states any covered claim, the insurer must defend the entire suit. The courts reason that the insurance contract obligates the insurer to defend its insured, not to provide a partial defense. See St. Paul Ins. Co. v. Tex. Dept. of Transp., 999 S.W.2d 881, 884 (Tex. App. Austin 1999, pet. denied); Landmark Chevrolet Corp. v. Universal Underwriters Ins. Co., 121 S.W.3d 886, 890 (Tex. App. Houston [1st Dist.] 2003, no pet.); Rhodes v. Chicago Ins. Co., 719 F.2d 116, 119 (5th Cir. 1983). This is also an important principle for the Plaintiff to recognize when attempting to plead into coverage (see section 3 below). This is just one of the many rules governing the insurance company s duty to defend. Under Texas law, the following general principles will determine whether the Defendant will be entitled to a defense from its insurer: The duty to pay and the duty to defend are distinct, separate duties. King v. Dallas Fire Ins. Co., 85 S.W.3d 185, 187 (Tex. 2002); Trinity Universal Ins. Co. v. Cowan, 945 S.W.2d 819, (Tex. 1997). An insurer s duty to defend is determined solely by the allegations in the pleadings and the language of the insurance policy. This is the eight-corners or complaint allegation rule. Lamar Homes, Inc. v. Mid-Continent Cas. Co., No , 2007 WL , at *8 (Tex. Aug. 31, 2007); King, 85 S.W.3d at 187; Trinity, 945 S.W.2d at 821; National Union Fire Ins. Co. v. Merchants Fast Motor Lines, Inc., 939 S.W.2d 139, 141 (Tex. 1997). The allegations of the complaint should be considered in light of the policy provisions, without reference to the truth or falsity of the allegations, and without reference to what the parties know or believe the true facts to be. Guideone Elite Ins. Co. v. Fielder Road Baptist Church, 197 S.W.3d 305, 308 (Tex. 2006); Argonaut Southwest Ins. Co. v. Maupin, 500 S.W.2d 633, 635 (Tex. 1973); Colony Ins. Co. v. H.R.K., Inc., 728 S.W.2d 848, 850 (Tex. App. Dallas 1987, no writ); Gulf Chem. & Metallurgical Corp. v. Associated Metals & Minerals Corp., 1 F.3d 365, 369 (5th Cir. 1993). A court resolves all doubts regarding the duty to defend in favor of finding the duty. King, 85 S.W.3d at 187; Merchants, 939 S.W.2d at 141; Heyden Newport Chem. Corp. v. Southern Gen. Ins. Co., 387 S.W.2d 22, 26 (Tex. 1965). Where the complaint does not state facts sufficient to clearly bring the case within or without the coverage, the general rule is that the insurer is obligated to defend if there is, potentially, a case under the complaint within the coverage of the policy. Stated differently, in case of doubt as to whether or not the allegations of a complaint against the insured state a cause of action within the coverage of a liability policy sufficient to compel the insurer to defend the action, such doubt will be resolved in the insured s favor. Heyden Newport v. Southern Gen., 387 S.W.2d at 26 (quoted in Nat l Union v. Merchants, 939 S.W.2d at 141). A court must focus on the factual allegations rather than the legal theories asserted. Lamar Homes, 2007 WL , at *10; Farmers Texas County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 82 (Tex. 1997); Nat l Union v. Merchants, 939 S.W.2d at 141. If the petition does not allege facts within the scope of coverage, an insurer is not legally required to defend a suit against its insured. King, 85 S.W.3d at 187; Trinity, 945 S.W.2d at 821. A court will not look outside the pleadings or imagine factual scenarios that might trigger coverage. National Union v. Merchants, 939 S.W.2d at The Plaintiff has decided on a strategy of trying to plead into coverage. How should the Plaintiff plead the case? If the Plaintiff decides to try to plead into coverage, the following strategies should be considered. 2

13 a. Plead other theories Parties seeking to plead into coverage have an incentive to allege alternate theories, even though some theories may be excluded. For example, in St. Paul Ins. Co. v. Texas Department of Transportation, the plaintiffs allegation that the insured was negligent in its supervision of highway construction was sufficient to trigger the insurer s duty to defend, even though the plaintiffs allegations of gross negligence and intentional torts would be excluded by the intentional injury exclusion. 999 S.W.2d at 887. In Westchester Fire Ins. Co. v. Gulf Coast Rod, Reel & Gun Club, 64 S.W.3d 609 (Tex. App. Houston [1st Dist.] 2001, no pet.), the insureds were covered for claims that they intentionally dredged a waterway, where the resulting damage was not expected or intended. In Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523, (5th Cir. 2004), the court found a duty to defend based on pleadings that the defendant acted negligently, even though extrinsic evidence showed the injuries to the child were intentional. The plaintiffs had amended the petition to remove all allegations relating to the intentional nature of the behavior. Id. Repleading to recharacterize conduct as negligent instead of intentional will not work in cases where the conduct is inherently intentional. For example, sexual molestation of a minor is inherently intentional, no matter how it is pleaded. See, e.g., Maayeh v. Trinity Lloyds Ins. Co., 850 S.W.2d 193, (Tex. App. Dallas 1992, no pet.). Even if the intentional act exclusion does not apply, sexual assault is not an occurrence within the scope of coverage because it is not accidental. See State Farm Fire & Cas. Co. v. Brooks, 483 F. Supp. 2d 695, 702 (E.D. Tex. 1998). Similarly, pleading that the defendant was drunk will not make an intentional assault unintentional. Id. at ; see also Wessinger v. Fire Ins. Exch., 949 S.W.2d 834, 840 (Tex. App. Dallas 1997, no pet.). b. Plead broadly and generally The general rule is that if the pleadings are too vague or general, the court may find they lack sufficient facts to state a claim potentially within coverage, and the court will not read facts into the pleadings. See, e.g., Trinity Universal Ins. Co. v. Cowan, 945 S.W.2d at 825. On the other hand, clarity in pleadings may not be helpful when trying to plead into coverage. As noted above, courts generally hold that uncertainties are resolved in favor of finding a duty to defend. In Burlington Ins. Co. v. Texas Krishnas, Inc., 143 S.W.3d 226 (Tex. App. Eastland 2004, no pet.), the court found a duty to defend where several different theories were alleged against several different parties all arising out of abuse. Characterizing the pleadings as vague, broadly worded, and containing a mishmash of legal theories and factual allegations, the court noted that that the pleadings might well be the result of very careful, as opposed to very careless, pleading practice. 143 S.W.3d at 232. c. Plead other insureds or actors Another strategy for pleading into coverage is to consider whether the facts support liability for more than one person on more than one theory. For example, in King v. Dallas Fire Ins. Co., 85 S.W.3d 185, 186 (Tex. 2002), the insurer had a duty to defend an insured employer against claims that it negligently hired, trained, and supervised an employee who committed an intentional assault, even though the assault itself was not a covered occurrence. See also Burlington Ins. Co. v. Texas Krishnas, Inc., 143 S.W.3d 226, (Tex. App. Eastland 2004, no pet.) (insurer had duty to defend allegations of negligently hiring, training, and supervising individuals who committed abuse); State Farm Gen. Ins. Co. v. White, 955 S.W.2d 474, 477 (Tex. App. Austin 1997, no pet.) (insurer had duty to defend bystanders sued for negligently failing to report intentional abuse by another). Thus, even where one actor commits an intentional tort, there may be legitimate grounds to allege that another actor was negligent, and the negligence claim is more likely to be covered. Alleging that an individual acted as the agent for a defendant can also help plead into coverage. In Heyden Newport, the plaintiffs alleged that Pickering was an agent for the insured, Newport Industries, at the time of the collision. The court held this allegation sufficient to invoke the duty to defend, regardless of the defendant s extrinsic allegation that Pickering was not its agent at the time. 387 S.W.2d at 26. d. Plead again The duty to defend is determined based on the most recent pleading. See Fielder Road Baptist Church v. Guide One Elite Ins. Co., 139 S.W.3d 384, 390 (Tex. App. Fort Worth 2004, no pet.), aff d, 197 S.W.3d 305 (Tex. 2006); Royal Ins. Co. v. Hartford Underwriters Ins. Co., 391 F.3d 639, 644 (5th Cir. 2004). If an initial pleading does not trigger coverage, the party trying to plead into coverage should consider an appropriate amendment that will invoke the duty. e. Plead different dates Several cases find a duty to defend where the petition alleges conduct occurring during the period of the insurer s coverage, even though extrinsic evidence shows the conduct did not occur during the policy period. In Guideone Elite Ins. Co. v. Fielder Road Baptist Church, the plaintiffs alleged the church s 3

14 youth pastor was employed from 1992 to 1994 and committed sexual abuse during that time. 197 S.W.3d at 308. The insurer s policy was effective from 1993 to Id. The Texas Supreme Court held that the court of appeals properly refused to consider extrinsic evidence that the youth pastor left employment with the church in 1992, before the insurance policy took effect, because that was extrinsic evidence that would contradict the facts alleged in the petition. Id. at 307, 311; see also Gulf Chemical, 1 F.3d at The Defendant sent the pleadings from the Plaintiff s suit to the Insurer, asking it to defend and pay if necessary. The pleadings state a claim within coverage and entitle the Defendant to a defense. If the Insurer wrongfully delays or denies a defense, what can the Defendant do? Under the recent Texas Supreme Court case Lamar Homes, Inc. v. Mid-Continent Casualty Co., one option a Defendant has is to sue the Insurer under the Prompt Payment of Claims statute. 242 S.W.3d 1, at *16-17 (Tex. 2007). The prompt payment statute, formerly codified as article of the Texas Insurance Code and now recodifed as sections , provides for additional damages when an insurer wrongfully refuses to pay or delays payment of a claim. Specifically, if an insurer fails to promptly respond to or pay a claim as required, the prompt payment statute makes the insurer liable to the insured for both the amount of the claim and interest on the amount of the claim at the rate of eighteen percent a year as damages, together with reasonable attorney s fees. Tex. Ins. Code (a). This remedy is now available to a defendant when its insurer wrongfully refuses to defend a case. For example, in Lamar Homes, the insured, a construction builder, sold a new home that developed problems due to defects in the foundation. 242 S.W.3d, at *5. The buyers sued the builder, which forwarded the lawsuit to its insurance company seeking a defense and indemnification under a commercial general liability (CGL) insurance policy. The insurer denied coverage and refused to defend. Consequently, the builder sought a declaration of its rights under the CGL policy and sought recovery under the prompt payment statute. Upon finding that the claims asserted against the builder were covered by the CGL policy and that the insurer had breached its duty to defend, the Texas Supreme Court held that the prompt payment statute applied and that the builder was entitled to the costs of its defense as well as eighteen percent interest and attorney s fees. Id., at *19. The prompt payment statute requires that the insurer follow certain procedures and meet certain deadlines in responding to and paying claims. To trigger the insurer s duties, the defendant must supply the insurer with certain information. First, the defendant must submit a written notice of claim. Tex. Ins. Code (4), After receiving the notice, the insurer has fifteen days to acknowledge receipt, commence its investigation, and request from the claimant all items, statements and forms that the insurer reasonably believes, at that time, will be required from the claimant. Id But the statutory deadlines for accepting and paying the claim will not begin to run until the insurer receive[s] all items, statements, and forms required by the insurer to secure final proof of loss. Id , According to Lamar Homes, in a duty to defend situation, the statutory deadlines will not begin to run until the defendant provides the insurer with statements or invoices for legal services: [t]hese statements or invoices are the last piece of information needed to put a value on the insured s loss. 242 S.W.3d, at *19. Therefore, a defendant must be sure to submit his bills for legal services to the insurer in order to trigger his rights under the prompt payment statute. Id. 5. The Defendant sent the pleadings from the Plaintiff s suit to the Insurer, asking it to defend and pay if necessary. The Insurer sent back a letter citing many definitions and exclusions from the policy and explaining many reasons the Insurer asserts for never paying the claim. Nonetheless, the letter concludes with an offer to defend, and even pay for a lawyer to be chosen by the Insurer. The Defendant likes the idea of a free lawyer, but is leery of one chosen by the Insurer, especially considering the letter took pains to list all those reasons the Insurer has for never paying the claim. What should the Defendant do? The insurer has sent what is known as a reservation of rights letter that is, it is agreeing to provide a defense, but is reserving the right to later deny payment of the claim. When an insurer decides to defend under a reservation of rights, the insured has the right to reject this qualified defense and hire his own defense lawyer. The insurer must pay for this lawyer. Britt v. Cambridge Mutual Fire Ins. Co., 717 S.W.2d 476, 481 (Tex. App. San Antonio 1986, writ ref d n.r.e.); Rhodes v. Chicago Ins. Co., 719 F.2d 116, (5th Cir. 1983). When presented with a qualified defense, the insured can choose to accept the qualified defense, knowing the insurer may pay for the defense but later deny coverage. Alternatively, the insured can reject the qualified defense and insist that the insurer tender an unqualified defense that is agreed to provide coverage to pay the claim, in addition to 4

15 providing a defense or the insured may seek his own counsel, at the insurer s expense. None of these answers will always be preferable. There are several factors that should be considered. If coverage is doubtful, a defense under a reservation of rights may be a good thing. Often an insurer will have to defend a claim based on the allegations in the petition, but the proof at trial may negate coverage. In that event, the insured loses nothing by accepting the qualified defense, because that is all he would be entitled to anyway. In addition to getting a free defense, the insured may receive other benefits. First, the defense may be effective to win the claim, so coverage does not matter. Second, the cost of defending the claim may create settlement value sufficient to get the claim resolved. Third, the circumstances of the case, or sometimes just the momentum of the litigation, may induce the insurer to tender some amount in settlement, based on its perception that there is a risk of coverage. On the negative side, when an insurer defends under a reservation of rights there is an inherent conflict. One of the key benefits of a good defense is often to position the case for a favorable settlement. It may be very undesirable to reach a critical juncture where the case could be settled only to have the insurer insist that it will not settle because there is no coverage. In that situation, the insured could benefit from a lawyer willing to aggressively argue coverage issues with the insurer. An independent lawyer may be more effective in making those arguments than a lawyer chosen by the insurer who may be reluctant to jeopardize other relations with the insurer. It may be in the insured s interest to insist that the insurer embrace coverage. Failing that, it may be in the insured s interest to have his own attorney, being paid by the insurer. Sometimes having an attorney chosen by the insured may create more uncertainty on a part of the insurer, which can create settlement pressure, if that is desired. There are reasons it might not be a good idea to insist that the insurer pay for an attorney selected by the insured. When the insurer chooses the lawyers, under certain circumstances the insurer may be to blame and held responsible for conduct of that lawyer. A mistake in the defense of the case might be attributable to the insurer and thus create a basis to collect from the insurer. On the other hand, if the insured chooses a lawyer, the insurer may have a more plausible argument that it did not control the conduct of the lawyer and cannot be blamed for any mistakes. Although the reasoning is questionable, one court held that the insured could be guilty of contributory negligence based on his selection of, and failure to replace, his chosen defense counsel who the court said was incapable of properly handling the civil case in the professional manner. State Farm Fire & Cas. Co. v. Gandy, 880 S.W.2d 129, 137 (Tex. App. Texarkana 1994). rev d on other grounds, 925 S.W.2d 696 (Tex. 1996). Another factor to consider is the attorney s fees. Insurance defense lawyers often agree to work for lower hourly rates, presumably in return for getting repeat business from the insurer. Hiring a person of similar experience in the free market may require higher hourly fees, and the insurer may balk at paying those fees. This creates the prospect of having to fight over the proper amount of fees at the very beginning of the case. Still another factor to consider is that in many cases insurance defense lawyers work under litigation guidelines imposed by insurers. These guidelines may limit what work is done by the lawyer and may dictate that certain tasks be performed by paralegals. A free market lawyer without an ongoing relationship with the insurer may be less likely to be influenced by such guidelines. 6. The insurer agreed to defend and has been paying for a defense lawyer. Unlike the preceding example, the insurer did not send a letter reserving a right later to deny coverage. Nevertheless, the insurer changes its mind and does try to raise a coverage defense. The general rule is that waiver and estoppel cannot be used to create insurance coverage. Texas Farmers Ins. Co. v. McGuire, 744 S.W.2d 601, 603 & n.1 (Tex. 1988). A significant exception to this rule until recently was the Wilkinson exception. In Farmers Texas County Mutual Ins. Co. v. Wilkinson the court recognized this general rule but held, However, it follows from these general principles that, if an insurer assumes the insured s defense without obtaining a reservation of rights or a nonwaiver agreement and with knowledge of the facts indicating non-coverage, all policy defenses, including those of non-coverage, are waived, or the insurer may be estopped from raising them. 601 S.W.2d 520, (Tex. App. Austin, 1980, writ ref d, n.r.e.). However, the Texas Supreme Court rejected the Wilkinson exception in Ulico Casualty Company v. Allied Pilots Association, 262 S.W.3d 773 (Tex. 2008). The court held that an insurer was not estopped to assert lack of coverage, and did not waive the argument that a claim made outside the coverage period was not covered. Ulico provided liability insurance to APA under a claims made policy. APA submitted a claim after the coverage period expired, but Ulico agreed to reimburse APA for defense costs. When the insurer later denied coverage and asserted it did not owe defense costs, APA asserted and obtained jury findings 5

16 that Ulico was estopped to deny coverage or had waived the argument that the claim was not covered. The supreme court reiterated the rule that the doctrines of waiver and estoppel cannot be used to expand coverage under a policy. See Washington Nat l Ins. Co. v. Craddock, 130 Tex. 251, 109 S.W.2d 165 (1937) (no waiver); Texas Farmers Ins. Co. v. McGuire, 774 S.W.2d 601 (Tex. 1988) (no estoppel). The court recognized that waiver and estoppel may operate to avoid a forfeiture such as by preventing the insurer from arguing late notice, but the doctrines could not be used to extend coverage to a risk that was not covered. The court disagreed with the holding in Wilkinson that an insurer that assumes the insured s defense without obtaining a reservation of rights and with knowledge of facts indicating noncoverage waives all policy defenses, including the defense of noncoverage, and is estopped from raising the defense. The court held that, for estoppel to prevent the assertion of a defense of noncoverage, there must be a showing of prejudice. The court specifically disagreed with Wilkinson s statement that non-coverage of a risk is the type of right an insurer can waive and thereby effect coverage for a risk that was not covered by the contract. The court also seemed to disagree with Wilkinson s assumption that defending without an effective reservation of rights necessarily created prejudice. The court contrasted the decision in Tilley where the insured suffered actual prejudice from the insurer asserting a coverage defense of late notice that was developed by the defense attorney hired by the insurer. See Employers Cas. Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973). Because the court found no evidence that APA was prejudiced, and because it was undisputed that the claim was made outside the coverage period, the court reversed and rendered judgment that APA take nothing. The Fifth Circuit has restated the elements as requiring proof: (1) that the insurer had sufficient knowledge of the facts or circumstances indicating non-coverage but (2) assumed or continued to defend its insured without obtaining an effective reservation of rights or non-waiver agreement and, as a result, (3) the insured suffered some type of harm. Pennsylvania Nat l Mut. Cas. Ins. Co. v. Kitty Hawk Airways, Inc., 964 F.2d 478, 481 (5th Cir. 1992). The courts have held that for estoppel to prevent the assertion of a defense of non-coverage, there must be a showing of prejudice. Pacific Indem. Co. v. Acel Delivery Serv., Inc., 485 F.2d 1169, 1173, 1175 (5th Cir. 1973); State Farm Lloyds, Inc. v. Williams, 960 S.W.2d 781, 785 (Tex. App. Dallas, 1997, writ dism d by agreement); Kitty Hawk, 964 F.2d at 481 n. 11. The holding in Ulico does not allow for the previous Wilkinson assumption that defending without an effective reservation of rights necessarily creates prejudice. More will have to be shown to meet the prejudice element. 7. Suit has been filed, and the Plaintiff s ability to collect will depend on the existence of insurance coverage. What information should the Plaintiff get regarding coverage? What can the Plaintiff do about coverage issues at this point? In state court, the simplest way to obtain information about the Defendant s insurance coverage is to serve a standard Request for Disclosure. Rule 194.2(g) of the Texas Rules of Civil Procedure requires the Defendant to disclose any indemnity and insuring agreements described in Rule 192.3(f). Rule 192.3(f) provides: Except as otherwise provided by law, a party may obtain discovery of the existence and contents of any indemnity or insurance agreement under which any person may be liable to satisfy part or all of a judgment rendered in the action or to indemnify or reimburse for payments made to satisfy the judgment. Information concerning the indemnity or insurance agreement is not by reason of disclosure admissible in evidence at trial. Similarly, Rule 26(a)(1)(D) of the Federal Rules of Civil Procedure requires disclosure of any insurance agreement under which any person carrying on an insurance business may be liable to satisfy part or all of a judgment which may be entered in the action or to indemnify or reimburse for payments made to satisfy the judgment. Note that these rules do not say that discovery is limited to insurance policies that cover the alleged loss. The language may be liable, although somewhat vague, acknowledges the practical reality that whether a policy covers an alleged loss is often highly uncertain. Does this mean the Defendant must produce every insurance policy in its files? In In re Dana Corp., 138 S.W.3d 298, 301 (Tex. 2004), a toxic tort case involving multiple plaintiffs, the defendant argued that it should not be required to mass-produce insurance policies until each plaintiff established which of the company s products was allegedly at fault and for what time periods the exposure allegedly occurred. The supreme court refused to go that far, but it agreed that a threshold showing of applicability must be made before a party can be ordered to produce multiple 6

17 decades of insurance policies. Id. Insurance policies need not be produced until they are shown to be applicable to a potential judgment. Id. Thus, the Plaintiff should be prepared to take reasonable steps to limit the requested policies to those that may apply to a potential judgment, especially in cases implicating multiple policies and policy periods. Of course, the insurance-savvy Plaintiff will often want to obtain more than the insurance policy alone. For example, the Plaintiff may want to serve an interrogatory asking what position the insurer has taken on coverage, or serve a request for production asking for a copy of the insurer s reservation of rights letter and any similar correspondence. The reservation of rights letter provides especially valuable information. First, it will alert the Plaintiff to the coverage issues in dispute, allowing the Plaintiff to shape its pleadings and proof to try to maximize coverage (see the discussion of pleading into coverage in section 3 above). Second, the reservation of rights letter is important because if the insurer is defending without an effective reservation of rights, with knowledge of the facts indicating non-coverage, and there is a showing of prejudice, the insurer will be held to have waived any defense of non-coverage. See Ulico Cas. Co. v. Allied Pilots Ass n, 262 S.W.3d 773, 785 (Tex. 2008). It may also be important for the Plaintiff to know whether the limits of the Defendant s policy have been exhausted or diminished by other claims. The Plaintiff may want to depose a representative of a corporate Defendant with knowledge about the Defendant s insurance coverage. The Plaintiff may even want to investigate what extra-contractual claims the Defendant has against its insurer because these issues affect collectability and, hence, settlement value. Does Rule 192.3(f) authorize additional discovery concerning insurance coverage, beyond merely obtaining a copy of the applicable insurance policies? In Dana Corp., the Texas Supreme Court said no. 138 S.W.3d at The plaintiffs in that case sought to compel the defendant to produce a witness for deposition to testify regarding insurance policies. Id. Specifically, the plaintiffs wanted to find out what policies existed and whether their limits were exhausted or about to be exhausted. Id. The court acknowledged that the purpose of Rule 192.3(f) is to facilitate settlement discussions, but it refused to read the Rule broadly as authorizing discovery of more than the insurance agreement s existence and contents. Id. at However, the court left open the possibility that discovery of additional information concerning insurance coverage could be obtained under the general relevance standard for the scope of discovery stated in Rule 192.3(a). Id. at 304. That Rule provides, in general, that a party may obtain discovery regarding any non-privileged matter that is relevant to the subject matter of the pending action. Tex. R. Civ. P (a). Based on Rule 192.3(a), the court in Dana Corp. found that the trial court did not abuse its discretion in ordering the defendant to produce a witness for deposition on insurance coverage. However, the court hinted that the scope of that deposition might be limited to proving up the contents of the policies. Dana Corp., 138 S.W.3d at 304. The court provided little guidance to the parties concerning the proper scope of questioning, if any, concerning erosion of the insurance policy limits. Id. So how much discovery of additional insurance information does Rule 192.3(a) allow? The easy part of the answer is that the Plaintiff can obtain as much discovery as the Defendant is willing to provide. If the parties are engaged in serious settlement discussions, it may be in the Defendant s own interest to provide additional information about its insurance coverage. For example, if the Plaintiff has made a settlement demand that exceeds policy limits, the Defendant may want to give the Plaintiff information about the limits to encourage the Plaintiff to make a lower demand. On the other hand, if the Defendant will not cooperate and the issue must be presented to the trial court, the question will be whether the discovery is relevant to the subject matter of the pending action under Rule 192.3(a). 8. A lawyer selected by the Defendant has been defending the lawsuit for months. After taking discovery, filing and responding to various motions, and engaging in settlement discussions, the Defendant s lawyer learns for the first time that the Defendant has an insurance policy that might provide coverage for the Plaintiff s claims. What should the Defendant do? Typically, the insurance policy will require the insured to give prompt notice of a claim or suit to the insurer. However, the Defendant should not assume that coverage is lost when timely notice is not given. To preserve the Defendant s rights, defense counsel should immediately send written notice to the insurance company. See Sparks v. Aetna Life & Cas. Co., 554 S.W.2d 228, 230 (Tex. Civ. App. Dallas 1977, no writ) (oral notice was insufficient where policy required written notice). Next, the Defendant should avoid taking any action that might prejudice the insurer. Although the issue is unsettled, the insurance company may be required to prove that it was prejudiced by the failure to give timely notice. 7

18 Several factors may come into play in determining whether the insurer is required to show that it was prejudiced by the delay in providing notice. a. Is the notice requirement a covenant, or a condition precedent? In Hernandez v. Gulf Group Lloyds, 875 S.W.2d 691 (Tex. 1994), the Texas Supreme Court held that an insured s violation of a settlement-without-consent exclusion does not negate coverage where the insurer fails to show actual prejudice. Id. at 693. The exclusion in Hernandez stated that coverage did not apply to bodily injury or property damage with respect to which the insured made any settlement without the insurance company s written consent. Id. at 692 n. 1. However, the court reasoned that insurance policies are contracts subject to rules applicable to contracts generally, including the principle that only a material breach by one party will excuse the other party from performing. Id. at When the insurer is not prejudiced by the insured s breach, the breach is not material, and coverage is not affected. Id. at 693. Does the prejudice requirement of Hernandez apply to an insured s failure to give timely notice of suit? In Hanson Production Co. v. Americas Insurance Co., 108 F.3d 627 (5th Cir. 1997), the Fifth Circuit said yes. The insurer in Hanson argued that the prejudice requirement is limited to those policies that are subject to a mandatory endorsement required by the State Board of Insurance (see below). The Fifth Circuit disagreed, stating that it believed the Texas Supreme Court would opt for a uniform rule of construction requiring the insurer to show prejudice. Id. at 630. Applying Hernandez, the court held that the insurer must show prejudice to avoid coverage based on insured s failure to provide prompt notice of a claim. The court reasoned that [t]he fundamental principle of contract law recognized in Hernandez that a material breach by one contracting party excuses performance by the other party, and an immaterial breach does not is equally applicable to notice cases. Id. at 631. The Fifth Circuit followed the same reasoning in Ridglea Estate Condominium Ass n v. Lexington Insurance Co., 415 F.3d 474, 480 (5th Cir. 2005), holding that the prejudice requirement applied to a property insurance policy. The court based its decision on the the method of the Texas Supreme Court s reasoning in Hernandez, and the general principle underlying that reasoning. Id. Coastal Refining is another case rejecting a narrow interpretation of Hernandez. In that case, the Houston Court of Appeals rejected the insurer s argument that the reasoning of Hernandez is limited to uninsured/underinsured motorist claims, stating that Hernandez was expressly decided on the fundamental principle of contract law that a material breach by one contracting party excuses performance by the other party, and an immaterial breach does not. Coastal Refining & Mktg., Inc. v. U.S. Fid. & Guar. Co., No CV, 2006 WL , at *5 (Tex. App. Houston [14th Dist.] May 30, 2006, no pet. h.) (not yet published). In contrast, the Dallas Court of Appeals has adopted a narrow interpretation of Hernandez, holding that the insurer is not required to prove prejudice where the policy states the notice requirement as a condition precedent to coverage. PAJ, Inc. v. Hanover Ins. Co., 170 S.W.3d 258, 261 (Tex. App. Dallas 2005, pet. granted); accord Prodigy Communications Corp. v. Agric. Excess & Surplus Ins. Co., 195 S.W.3d 764, (Tex. App. Dallas 2006, pet. filed) (applying PAJ). In PAJ, the court acknowledged Hernandez s principle that only a material breach excuses performance by the other party. Id. at 260. However, the court distinguished Hernandez as dealing with a mere contractual covenant, as opposed to a contractual condition. Id. at 263. Noting that the clause at issue in Hernandez was contained within a policy exclusion, the court stated, We see a significant difference between a policy condition (performance of which is necessary to trigger any obligation for coverage) and a policy exclusion (which operates only after the obligation for coverage is in place). Accordingly, the PAJ court declined to follow federal cases requiring the insurer to show prejudice. Id. The Texas Supreme Court granted a petition for review in PAJ but has not yet issued a decision. The court may use PAJ as an opportunity to clarify how far the reasoning of Hernandez reaches. b. Does the Texas Department of Insurance s mandatory endorsement apply? The Texas Department of Insurance requires general liability policies issued in Texas to include an endorsement stating that the insured s failure to comply with a notice requirement will not bar coverage for bodily injury or property damage unless the insurance company is prejudiced. Chiles v. Chubb Lloyds Ins. Co., 858 S.W.2d 633, 635 (Tex. App. Houston [1st Dist.] 1993, writ denied). If the policy is subject to this requirement, and if the claim is for bodily injury or property damage, the insurer will be required to show prejudice. Coastal Refining, 2006 WL , at *3. However, even if the policy is subject to this mandatory endorsement, the prejudice requirement may not apply if the claim is for personal injury or advertising injury rather than bodily injury or property damage. See PAJ, 170 S.W.3d at 263 (mandatory endorsement did not apply to advertising 8

19 injury coverage); Gemmy Indus. Corp. v. Alliance Gen. Ins. Co., 190 F. Supp. 2d 915, (N.D. Tex. 1998) (same), aff d 200 F.3d 816 (5th Cir. 1999), opinion at 1999 WL c. Claims-made or occurrence policy? Generally, an occurrence policy provides coverage for claims arising out of an occurrence that takes place during the policy period, while a claimsmade policy provides coverage for claims that are made during the policy period. In late notice situations, this distinction can affect whether the insurer is required to show prejudice. Several decisions have held that claims-made policies, unlike occurrence policies, are not subject to a prejudice requirement. Ridglea, 415 F.3d at 480 n.4; Fed. Ins. Co. v. CompUSA, Inc., 319 F.3d (5th Cir. 2003); Matador Petroleum Corp. v. St. Paul Surplus Lines Ins. Co., 174 F.3d 653, 658 (5th Cir. 1999). Compare St. Paul Guardian Ins. Co. v. Centrum G.S. Ltd., 383 F. Supp. 2d 891, (N.D. Tex. 2003) (prejudice requirement does apply to all occurrence-based policies regardless of the type of coverage at issue). The rationale is that coverage does not even arise under a claims-made policy until the claim is reported during the policy period. See, e.g., Hirsch v. Texas Lawyers Ins. Exch., 808 S.W.2d 561, 565 (Tex. App. El Paso 1991, writ denied) ( To require a showing of prejudice for late notice would defeat the purpose of claims-made policies, and in effect, change such a policy into an occurrence policy. ). A further distinction can be drawn between a claims-made policy, which requires that the claim be made during the policy period, and a claims-made and reported policy, which requires the claim to be made and reported to the insurer during the policy period. The insured might argue that the prejudice requirement should apply where the policy is merely claims-made but not where the policy is claims-made and reported. However, at least one court has rejected this argument. Chicago Ins. Co. v. Western World Ins. Co., 1998 WL 51363, at *3 (N.D. Tex. 1998) (not designated for publication). d. Dealing with unclear case law As illustrated by the case law discussed above, it is not entirely clear under Texas law whether an insurer must demonstrate prejudice before it can avoid its obligations under a policy where the insured breaches a prompt-notice provision or a consent-to-settle provision. Motiva Enterprises, LLC v. St. Paul Fire & Marine Ins. Co., 445 F.3d 381, 386 (5th Cir. 2006). What is clear is that the defendant who gives late notice of a claim or suit should do as much as it can to make a factual record that demonstrates a lack of prejudice to the insurer. Whether the insurer is prejudiced by lack of notice is generally a question of fact. Struna v. Concord Ins. Services, Inc., 11 S.W.3d 355, (Tex. App. Houston [1st Dist.] 2000, no pet.). The defendant should avoid entering into a settlement without the insurer s consent, trying the case without the insurance company s involvement, relinquishing rights the insurance company might want to preserve, etc. If prejudice is avoided, the defendant will at least preserve the ability to argue that the failure to give timely notice does not excuse the insurer from providing coverage. 9. Two Plaintiffs sue the Defendant. One Plaintiff s injuries are grievous; the other s less so. Either claim would exceed the policy limits. The Insurer pays the policy limits to settle the smaller claim, leaving Defendant exposed on the larger claim. What do the remaining Plaintiff and the Defendant do? Unfortunately for the Plaintiff and the remaining Defendant, the Defendant probably has no claim against the Insurer for violating its Stowers duty to accept a reasonable settlement offer within policy limits. Under Texas Farmers Insurance Co. v. Soriano, 881 S.W.2d 312, 315 (Tex. 1994), an insurer cannot be held liable for negligence where it enters into a reasonable settlement with one claimant, even where the settlement exhausts or diminishes the proceeds available to satisfy other more serious claims. Soriano offers a cautionary tale for Plaintiffs who wait too long to make a Stowers demand. In the underlying suit, two groups of Plaintiffs, the Medinas and the Lopezes, sued Soriano for wrongful death arising from a car accident. Soriano s policy limits were $20,000. Texas Farmers Insurance offered $20,000 to the Medinas, but the Medinas rejected this offer. Farmers later settled the Lopez claim for $5,000 and offered the remaining $15,000 to the Medinas. The Medinas rejected this offer, but later demanded $20,000. Id. at 313. Farmers would not pay $20,000, and the Medinas took their claims to trial, obtaining a judgment exceeding $172,000. Id. Soriano subsequently sued Farmers for negligence and obtained a judgment including over $520,000 in actual damages. Id. at 314. On appeal, Farmers argued that there was no evidence that it violated its Stowers duty by settling the Lopez claim for $5,000 and subsequently refusing to settle the Medina claims for $20,000. Soriano, on the other hand, argued the Lopez settlement was unreasonable when viewed in comparison to the more serious Medina claims. When faced with multiple claims with inadequate proceeds, Soriano argued, an insurer should weigh the seriousness of the claims and attempt to settle those 9

20 claims within policy limits that pose the greatest threat of liability for an excess judgment. Id. The Supreme Court rejected Soriano s argument, holding that when faced with a settlement demand arising out of multiple claims and inadequate proceeds, an insurer may enter into a reasonable settlement with one of the several claimants even though such settlement exhausts or diminishes the proceeds available to satisfy other claims. Id. at 315. The Court believed this approach promotes settlement and encourages claimants to make claims promptly. Id. The Supreme Court reasoned that Farmers could not be held liable for violating its Stowers duty because one of the elements of a Stowers claim is a settlement demand within policy limits. A demand above policy limits, no matter how reasonable, does not trigger the Stowers duty to settle. Id. at (citing Am. Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, (Tex. 1994)). Although the Medinas eventually made a $20,000 settlement offer, that offer did not come until after the policy limits had been reduced to $15,000 by the Lopez settlement. Therefore, there was no evidence of a settlement demand within policy limits. Id. at The Court also found that Farmers did not violate any duty to its insured by entering into the Lopez settlement and leaving less money available to settle the more serious Medina claims. The fact that the Medinas claims may be more serious is not evidence that the Lopez claim was unreasonable when viewed in comparison to the more serious Medina claims, the Court stated. To be unreasonable, the Court held, Soriano must show that a reasonably prudent insurer would not have settled the Lopez claim when considering solely the merits of the Lopez claim and the potential liability of its insured on the claim. Id. at 316. For trial lawyers, the key point from Soriano is that the Insurer is free to evaluate the reasonableness of each claim independently from the other. In a lawsuit with multiple Plaintiffs, each Plaintiff therefore has a powerful incentive to be the first to make a Stowers demand within the policy limits. This means that Plaintiffs must evaluate the settlement value of the case as early as possible. Of course, this may be difficult when the net worth of the Defendant is unknown. Notably, the Soriano opinion states that the Medinas rejected the Insurer s original $20,000 offer because they wished to investigate Soriano s personal assets. Soriano teaches trial lawyers that they may not have that luxury if they want to preserve a Stowers claim against the Insurer. What options, then, do the Plaintiff and the nonsettling Defendant have when the Insurer pays the policy limits to settle one claim, leaving the nonsettling Defendant exposed? In light of Soriano, the Plaintiff and the non-settling Defendant may want to consider choice-of-law principles as an escape hatch (see discussion of choice of law in section 12). Another state s law may recognize a broader duty of the insurer to act reasonably in settlement negotiations when faced with multiple claimants. 10. The Insurer hired a lawyer to defend, but the Insurer keeps messing with the defense. The Insurer won t pay the defense lawyer to do certain tasks, contending that they can be done by a paralegal. The Insurer won t pay for an expert the defense lawyer thinks is needed. The Insurer quibbles over venue choices and such. What should the defense lawyer do? What can the Defendant do? The defense lawyer owes her unqualified loyalty to the insured. Employer s Casualty Co. v. Tilley, 496 S.W.2d 552, 558 (1973). In State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998), the court extended that view and held that the attorney is the sole agent of the insured. The court also pointed out that ethical rules prohibit the attorney letting any outside influences impair the insured s defense. Id. at 628. Thus, the defense lawyer is an independent contractor. The court held that these factors prevent the insurer from exercising the control over the attorney that would lead to vicarious liability. Id. This just means that if the lawyer mishandles the case, the insurer cannot be held vicariously liable for the malpractice of the defense lawyer it has chosen. On the other hand, the insurer can be directly liable for its own conduct that limited the lawyer s decisions or caused the mishandling of the case. In Traver, the court remanded for consideration of any remaining claims based on the insurer s own misconduct. Id. at 629. If the insurer takes steps, or insists on a course adverse to the insured, the insurer may lose the right to control the defense, if there is a conflict of interests. The insurer may incur liability to the insured if it interferes with the lawyer s efforts on the client s behalf. In Northern County Mutual Insurance Co. v. Davalos, 140 S.W.3d 685, (Tex. 2004), the court held the insurer did not breach its duty to defend, because the conditions the insurer tried to impose did not create a sufficient conflict of interest. The insurer did not breach its duty to defend by conditioning its offer of a defense on the insured agreeing to waive his motion to transfer venue filed by attorneys who were already representing him. Id. The court recognized that under certain circumstances there will be a conflict of interests that prevents the insurer from conducting the defense; however, the court found this was not such a case. The 10

21 court reasoned that Davalos could have accepted the defense and then submitted the issue of venue to the defense counsel for an independent examination. The court suggested that the defense lawyer then could have rejected the insurer s request to transfer venue if the insured s interests would be compromised by the insurer s instructions. Id. at 690. Nevertheless, there is much in the court s opinion that may offer protection to insureds in other cases. The court recognized a number of circumstances where a conflict of interests may prevent the insurer from controlling the defense. The court cited authority for the proposition that defending under a reservation of rights letter will create a conflict of interests, and when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends, that conflict will prevent the insurer from conducting the defense. Id. at 689. The court also listed four other circumstances when the insured may rightfully refuse the insurer s defense: (1) when the tendered defense is not a complete defense under circumstances in which it should have been; (2) when the attorney hired by the carrier acts unethically, and at the insurer s direction advances the insurer s interests at the expense of the insured s; (3) when the defense would not, under the governing law, satisfy the insurer s duty to defend; and (4) when, although the defense is otherwise proper, the insurer attempts to obtain some type of concession from the insured before it will defend. Id. Citing other authorities, the Davalos court noted that a party paying for another s legal services such as an insurer must allow for reasonable representation, and any directives must be reasonable in scope and character. The defense lawyer owes unqualified loyalty to the insured and must at all times protect the interests of the insured if those interests would be compromised by the insurer s instructions. Id. at The defense lawyer hired by the insurer is doing a great job of defending, but the Insurer has made clear that it is reserving the right to deny coverage. The defense lawyer says she can t advise the Defendant on coverage questions but will vigorously defend him. The Defendant is worried and wants advice. Many fine defense lawyers believe that they have an ethical duty to stay away from coverage issues when an insurer hires them to defend an insured. However, the principles of Tilley and Traver make plain the opposite is true. Not only is it permissible for the defense lawyer to advise her client on coverage issues, she is risking a malpractice suit if she defends the suit without paying attention to coverage issues. Burying one s head in the sand on coverage questions is asking for trouble. If coverage issues did not affect how a case is defended, the Defendant s attorney might safely avoid dealing with coverage questions. But coverage questions very often have a significant impact on how a case should be handled. A few examples illustrate the point: (a) Some of the Plaintiff s claims are covered and others are not. The insured has limited resources to fund the defense, but the insurer is paying for the defense under a reservation of rights. The defense lawyer has solid grounds for disposing of the covered claims through a motion to dismiss or motion for summary judgment. Instinctively, the defense lawyer wants to knock out as many claims as possible before trial. What should the defense lawyer do? If it is important to the insured for the insurance company to continue paying for the defense and it almost always is then the last thing the Defendant s attorney should do is get rid of the claims that have triggered the insurer s duty to defend. (b) The Plaintiff alleges the insured defendant negligently inflicted emotional distress (back when that was a viable theory). The Defendant s lawyer wants to argue that the only valid theory is intentional infliction of emotional distress. However, the insurance policy has an intentional injury exclusion. Clearly, if the defense lawyer is concerned with maximizing coverage, she may want to rethink whether to make this argument. See Boyles v. Kerr, 855 S.W.2d 593, (Tex. 1993) (Gonzalez, J., concurring). (c) The Plaintiff s pleading lays out the Plaintiff s allegations in meticulous factual detail, and the allegations make it crystal clear that an exclusion in the Defendant s insurance policy applies. The Insurer has sent the Defendant a letter denying coverage. If the Plaintiff would just delete some of the factual details from its petition, leaving the same causes of action, the pleading would be sufficient to trigger the duty to defend. Ordinarily, the defense lawyer might like having a pleading that spells out the details of the Plaintiff s case. But in this case, the Defendant s lawyer is thinking about calling up the Plaintiff s lawyer to suggest amending the pleading to remove the specific allegations that are allowing the insurance company to deny coverage. In each of these situations, a defense lawyer who pays attention to coverage issues and seeks to 11

22 maximize her client s insurance coverage will defend the case differently than the lawyer who tries to ignore coverage questions. Indeed, in the first example above, the coverage issue would cause the defense lawyer to do the opposite of what she would ordinarily do. It therefore seems reasonably clear that, generally, the defense lawyer should give the client guidance on insurance coverage issues and to avoid handling the case in a way that jeopardizes the client s coverage. Of course, there may be situations where the Defendant and his lawyer will make a strategic decision to take some action that is helpful to the defense of the case notwithstanding the negative effect on insurance coverage. But the point is that the defense lawyer should at least take the coverage issues into account and advise the client about how litigation decisions will affect coverage. Should the result be any different when the insurance company is paying the lawyer s bills? Before saying yes, remember Tilley and Traver. In Tilley, the Supreme Court held that an attorney selected, employed, and paid by the insurance company owes the insured the same type of unqualified loyalty as if he had been originally employed by the insured. 496 S.W.2d at 558. In Traver, the Supreme Court said that the lawyer hired by the insurance company to represent the insured must at all times protect the interests of the insured if those interests would be compromised by the insurer s instructions. 980 S.W.2d at 628. If the Defendant s attorney takes these statements seriously, it will be difficult to defend the position that she cannot advise her client on coverage questions. Of course, the Defendant s attorney should be careful not to take any action that would violate any clause in the insurance policy requiring the insured to cooperate with the insurer in the defense of the underlying suit. Moreover, shaping the defense of the suit to maximize the client s insurance coverage should not go as far as doing any kind of sweetheart deal that would run afoul of the principles of State Farm Fire & Casualty Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996) (see section 14 below). But if the Defendant s counsel defends the suit in a way that jeopardizes the Defendant s insurance coverage, she may find herself named as a defendant in a malpractice action. 12. An Insurer that has been defending a Defendant under a reservation of rights letter settles the claim. Is the Insurer then entitled to seek reimbursement from the Defendant since coverage was disputed? No. The Texas Supreme Court decided in Excess Underwriters at Lloyd s v. Frank s Casing Crew & Rental Tools, Inc., 246 S.W.3d 42 (Tex. 2008), that a liability insurer that settles a claim on which coverage is disputed has no right of reimbursement. The court held that the risk of coverage is best placed with the insurer. The majority further held that there was no implied agreement by Frank s Casing to allow the insurer to settle and seek reimbursement. The court rejected the argument that the insurer created such an obligation by making it a condition of the settlement. The court found no implied agreement to reimburse the insurer, in light of Frank s Casing s consistent position that the insurer was responsible for the claim. The majority also refused to recognize any equitable right of reimbursement, because doing so would rewrite the contract. The court emphasized that an insurer may avoid this dilemma by seeking a prompt resolution of disputed coverage issues. This continues to be a point the supreme court has made many times, urging insurers to resolve disputed coverage issues before the underlying liability is established. However, clear holdings from the supreme court severely limit the circumstances under which coverage can be litigated before the underlying suit. See Farmers Texas County Mutual Ins. Co. v. Griffin, 955 S.W.2d 81, 84 (Tex. 1997). The court has not yet resolved this conflict. 13. The Plaintiff feels her case is strong and welldeveloped, so she is ready to make a settlement demand. How does she make an offer the Insurer can t (or shouldn t) refuse? To make an offer that the Insurer will have to think twice about refusing, the Plaintiff will want to consider how to make an offer that will expose the Insurer to a potential Stowers claim if the offer is rejected and the Plaintiff later obtains a judgment exceeding the Defendant s policy limits. Under Stowers, the insurer has a duty to accept a reasonable settlement demand within policy limits. G.A. Stowers Furniture Co. v. Am. Indem. Co., 15 S.W.2d 544, (Tex. Comm n App. 1929, holding approved). How far does the Stowers duty reach? In Ranger County Mutual Insurance Co. v. Guin, 723 S.W.2d 656, 659 (Tex. 1987), the supreme court stated the insurer s Stowers duty broadly as including investigation, preparation for defense of the lawsuit, trial of the case and reasonable attempts to settle. However, the supreme court significantly narrowed the scope of an insurer s Stowers liability in American Physicians Insurance Exchange v. Garcia, 876 S.W.2d 842 (Tex. 1994). Garcia is the starting point for any trial lawyer who wants to understand how to Stowerize an insurance company. Under Garcia, the elements of a Stowers claim are: (1) the underlying claim against the insured is within the scope of coverage; (2) the plaintiff in the underlying suit makes a settlement demand that is 12

23 within the policy limits; (3) the settlement demand proposes to release the insured fully; and (4) the terms of the demand are such that an ordinarily prudent insurer would accept it, considering the likelihood and degree of the insured s potential exposure to an excess judgment. Id. at The Garcia court rejected the notion that the insurer has a broader duty to make reasonable efforts to settle a case. Id. at The Plaintiff should also be aware that Stowers now has a statutory counterpart. In Rocor International, Inc. v. National Union Fire Insurance Co., 77 S.W.3d 253, 261 (Tex. 2003), the court held that a liability insurer can be liable under article of the Insurance Code for delaying settlement. To establish the insurer s statutory liability for failure to reasonably attempt settlement, the insured must show: (1) the policy covers the claim; (2) the insured s liability is reasonably clear; (3) the claimant has made a proper settlement demand within policy limits; and (4) the demand s terms are such that an ordinarily prudent insurer would accept it. Id. at 262. The elements stated in Garcia seem simple enough, but there are many pitfalls for the lawyer who wants to make an effective Stowers demand. Here are some potential mistakes to avoid: a. Offering an amount that is not within policy limits. This is the key point. A demand above policy limits, even though reasonable, does not trigger the Stowers duty to settle. Id. at 849. Although one could argue for a broader duty to engage in reasonable settlement negotiations, the Garcia court instead chose a strict rule requiring a settlement offer within policy limits. b. Failing to consider whether the policy limits have been diminished by other claims. Suppose the Plaintiff obtains a copy of the insurance policy in discovery, and it says the limits are $20,000. But what if the insurance company has already paid $5,000 to settle another claim? In that situation, a $20,000 settlement demand would not support a Stowers claim. See Tex. Farmers Ins. Co. v. Soriano, 881 S.W.2d 312, 315 (Tex. 1994). Before making an offer, the Plaintiff should try to determine the current available policy limits. If there is uncertainty, the Plaintiff may want to demand the policy limits rather than a stated sum of money. See Garcia, 876 S.W.2d at c. Failing to make an express settlement offer. Although a formal demand is not an absolute prerequisite for Stowers liability, Id. at 849, the offer should be direct and unequivocal. Making an offer that is implicit or vague is dangerous, especially considering that the Garcia court expressly declined to shift the burden of making settlement offers onto insurers. Id. at 851. A communication from the Plaintiff that merely invites the Insurer to make an offer within policy limits is unlikely to support a Stowers claim. d. Failing to make the settlement offer in writing. Garcia does not say that an offer must be in writing to trigger the Stowers duty. But why risk a subsequent factual dispute about the offer? If there is any dispute or confusion about the specific terms of the offer, it may not satisfy the elements of a valid Stowers claim. See Rocor, 77 S.W.3d at 263. The insured in Rocor sought to rely on an oral offer made by the plaintiff s counsel at a meeting with defense counsel, but the record revealed great confusion about the offer s terms. The Supreme Court held that the oral offer was insufficient, reasoning that at a minimum the settlement s terms must be clear and undisputed. Id. e. Offering only a partial release of the insured. Generally, an effective Stowers demand must propose to release the insured fully. Garcia, 876 S.W.2d at In many settlement negotiations, a full release of the defendant is an unspoken part of the deal, but a Plaintiff seeking to Stowerize an insurance company should make this point explicit. Furthermore, the Plaintiff should be careful not to offer merely a partial release of the Defendant. f. Failing to address hospital liens. This is a corollary of the requirement of offering a full release. If there is a statutory hospital lien on the Plaintiff s cause of action, the Plaintiff cannot release the cause of action without addressing the lien. See TEX. PROP. CODE (a). Thus, a settlement demand that does not include a release of hospital liens is not an effective Stowers demand. Trinity Universal Ins. Co. v. Bleeker, 966 S.W.2d 489, 491 (Tex. 1998). g. Not allowing a reasonable time to respond. If the plaintiff makes a Stowers demand but does not give the defendant and its insurer a reasonable time to respond, a court may find the offer ineffective to trigger the insurer s duty to settle. See State Farm Lloyds Ins. Co. v. Maldonado, 963 S.W.2d 38, 41 (Tex. 1998) (finding there was no evidence that insurer knew at a point when it had a reasonable amount of time to respond that an unconditional offer had been made). 13

24 14. The Defendant is very worried about liability and the toll the ongoing suit is taking, but the Plaintiff hasn t made a demand, and the Insurer won t make the first offer. What can the Defendant do to make the Insurer move? The Defendant s major problem in this situation is that the Insurer s duty to settle is very narrowly defined under Texas law. The Insurer does have a duty under Stowers to accept a reasonable settlement offer within policy limits, assuming all of the elements of a Stowers claim are satisfied (see section 11 above). However, the Texas Supreme Court has held that Stowers does not impose a general duty to make reasonable efforts to settle the case within policy limits, and that it does not require the Insurer to initiate settlement discussions. See Soriano, 881 S.W.2d at ; Garcia, 876 S.W.2d at The Insurer s statutory Stowers duty has similar limitations. Rocor, 77 S.W.3d at Furthermore, under Texas law an insurer does not have a common law duty of good faith and fair dealing with respect to a third-party liability policy. Maryland Ins. Co. v. Head Indus. Coatings & Services, Inc., 938 S.W.2d 27, 28 (Tex. 1996). In the third-party liability context, the Stowers duty is the only common law tort duty recognized by Texas law. Id. at Choice of Law Principles So how can the Defendant pressure the Insurer to make a move? One potential strategy is to investigate (1) whether some other state s law may apply and (2) whether that state s law defines the Insurer s duty to settle more broadly. For example, under New York law, a liability insurer has an implied duty of good faith to settle. See Pavia v. State Farm Mut. Auto. Ins. Co., 626 N.E.2d 24, (N.Y. 1993). If another state s law is more favorable than Texas law and would potentially apply to a suit against the Insurer, the Defendant might be able to apply greater pressure to the Insurer to get the case settled. The Defendant s attorney will need to do some research and draw up a detailed roadmap to get to another state s more favorable law: First, the Defendant should gather sufficient facts to determine the other states whose laws may potentially apply. This should include where the policy is issued, where the insured is located, where the insurer is located, where the settlement negotiations take place, etc. Second, once the Defendant has identified each state whose law could potentially apply, the Defendant should research the substantive law of each state on the insurer s duty to settle. The Defendant can then determine whether any of those states define the insurer s duty more broadly than Texas law. Third, the Defendant should identify the states where a suit against the insurer could be filed and identify the choice of law rules applied in those states. The Defendant can then strategize about where a suit against the Insurer could be filed so that the right state s law is most likely to be applied. How do Texas courts deal with choice of law in insurance cases? Absent a valid choice of law clause, Texas courts apply the substantive law of the state with the most significant relationship to the particular issue. Duncan v. Cessna Aircraft Co., 665 S.W.2d 414, 421 (Tex. 1984). When insurance policies are involved, there is also a Texas statute to consider. Article of the Insurance Code provides: Any contract of insurance payable to any citizen or inhabitant of this state by any insurance company or corporation doing business within this state shall be held to be a contract made and entered into under and by virtue of the laws of this state relating to insurance, and governed thereby, notwithstanding such policy or contract of insurance may provide that the contract was executed and the premiums and policy (in case it becomes a demand) should be payable without this State, or at the home office of the company or corporation issuing the same. Tex. Ins. Code Ann. art For this statute to apply, courts have identified three requirements: (1) the insurance proceeds are payable to a citizen or inhabitant of Texas; (2) the policy is issued by an insurer doing business in Texas; and (3) the policy must be issued in the course of the insurance company s Texas business. Reddy Ice Corp. v. Travelers Lloyds Ins. Co., 145 S.W.3d 337, 341 (Tex. App. Houston [14th Dist.] 2004, pet. denied). Courts construe article narrowly to avoid giving it extraterritorial effect. Id. at 341. A corporation is an inhabitant only of a state where it is incorporated, and doing business in other states is not enough. See id. at Also, this statute applies only when the Texas citizen is the insured that is subject to the suit. The fact that other insureds might be Texas residents does not suffice. Id. at 341 & n.6. If a Defendant seeking to avoid application of Texas law can show that article does not apply, it can then argue that another state has the most significant relationship. The substantive issues in the dispute with the insurer will determine which factors a court considers in determining the most significant relationship. See, e.g., W.R. Grace & Co. v. Continental Cas. Co., 896 F.2d 865, 873 (5th Cir. 1990); Snydergeneral Corp. v. Great American Ins. Co., 928 F. Supp. 674, 677 (N.D. Tex. 1996). The lawyer seeking to apply another state s law should also review several provisions of the Restatement (Second) of Conflict of Laws (1971). 14

25 Section 6 has the general principles, section 188 has general principles regarding contract rights, section 193 relates to contracts of casualty insurance, and section 145 has the general principle for torts. While courts discuss the general principles in section 6, the other sections usually decide the outcome. Choice of Law Cases The following cases illustrate how Texas courts have applied choice of law principles in the insurance context: In Seguros Tepeyac, S.A. Compania Mexicana de Seguros Generales v. Bostrom, 347 F.2d 168 (5th Cir. 1965), the Texas insured bought an auto policy to provide coverage while driving in Mexico, where a serious accident occurred. The court applied Mexican law to issues relating to breach of contract, because the contract was executed in Mexico, there was a Mexican insurer, and the policy was expected to cover liability in Mexico. Id. at 172. However, the court applied Texas law to the tort issues relating to the breach of the Stowers duty. The court first noted that the place of injury, Mexico, was not relevant to the insurer s liability. The court found Texas law applied to the Stowers claim because: (1) there was a Texas insured, (2) the offer to settle was made in Texas, (3) the suit was filed in Texas against a Texas defendant, (4) the insurer s misconduct in failing to settle and defend took place in Texas, (5) the insurer was qualified to do business in Texas, and (6) Texas had an interest in protecting its citizens when there was a breach of the insurer s duty to an insured Texan. 347 F.2d at The court in Snydergeneral Corp. v. Great American Ins. Co. 928 F. Supp. 674 (N.D. Tex. 1996), applied Minnesota law to breach of contract claims because the relationship with the insurer was centered in Minnesota, the policy was negotiated and bought in Minnesota, the defendant was incorporated and based in Minnesota, and the insurer transacted business in Minnesota. The defendant in Snydergeneral bought the liability policy long before it was acquired by a Texas entity, so the parties had no reason to believe that Texas law would apply. The court found that Minnesota had the most significant relationship to the contract claims. Id. at 678. However, the Snydergeneral court held that Texas law applied to the claims for unfair claims settlement practices and breach of the duty of good faith and fair dealing. The court reasoned that these causes of action accrued when the insurer failed to respond to a demand for coverage and defense. At that time, the Texasbased defendant was the insured, and the Texas defendant communicated with the insurer from its principal place of business in Texas. The court found that the damages from the conduct occurred in Texas and that Texas had a significant interest in matters regarding violations of its insurance laws. Id. In W.R. Grace & Co. v. Continental Casualty Co., the underlying tort suit was filed in Texas. The defendant joined its insurers as third-party defendants and asserted claims for coverage against them. 896 F.2d at 867. The Fifth Circuit found that New York had the most significant relationship to the issues in the case. Id. at The insured and three of the eleven excess insurers had their principal places of business in New York, and the insurance broker was in New York. Most of the policies were solicited, negotiated, and delivered in New York, and the premiums were paid in New York. The insured gave notice of the claims in New York. Id. at 873. The court concluded that New York was the center of the relationship between the insured and insurers and that New York had a strong and overriding interest in the outcome of the insurance coverage disputes that involved a New York insured and contractual relations with insurers doing business in New York. Id. The W.R. Grace court rejected the insured s argument that Texas law should apply because it would determine the source of funds for settlement. Id. The court pointed out that school districts were already paid. The coverage lawsuit would only determine the insured s recovery from its insurers. Id. Texas had an interest in the plaintiffs recovery in the underlying suit, but that interest ended with the settlement. New York had an interest in the remaining insurance disputes. Id. at The insurer in Reddy Ice filed suit in Texas seeking a declaratory judgment that it did not have a duty to defend or indemnify the insured in personal injury suits filed in Louisiana. 145 S.W.3d at 339. The court held that Texas law applied to the coverage issue. Id. at 346. The court noted that if the issue is the duty to defend or indemnify, and the issues require construction and application of the insurance policies, the relevant inquiry is what state has contacts with the insurance dispute, not with the underlying suit. Id. at 345. The court went further and said that for a nationwide liability policy, the place of the contract, negotiations, and domicile are the primary factors. Id. at 346. The courts also have applied Restatement 193 by noting that the location of the risk and subject matter of the contract are not significant or 15

26 determinative in deciding choice of law for a multi-risk insurance contract. Id. at 345. In St. Paul Mercury Ins. Co. v. Lexington Ins. Co., 78 F.3d 202, 205 (5th Cir. 1996), Louisiana had the most contacts with the underlying tort suit, but Texas had more contacts with the insurance dispute. Since the issues in the suit concerned construction of the insurance policies, the court held that Texas law applied. We have held that when the issues of a case require the construction and application of insurance policies, the court explained, the relevant inquiry is what contacts the state has with the insurance dispute, and not with an underlying lawsuit. Id. After reviewing these choices of law principles, the Defendant s lawyer may be able to construct an argument that another state s law would apply to tort claims against the insurer. If so, the Defendant may be able to take advantage of another state s more favorable law on the insurer s duty to settle. 15. The Plaintiff has a very large damage claim, which exceeds the Defendant s first layer of coverage. Fortunately, the Defendant also has an excess policy. The problem is that the Plaintiff can t reasonably settle for just the underlying limit. But if she makes a demand that exceeds the underlying limits, the underlying insurer can refuse to do anything. The excess insurer also says it doesn t have to do anything until the underlying insurer pays. How can the Plaintiff and Defendant break this gridlock? Unfortunately for the Plaintiff and Defendant, Texas law is undeveloped and generally bad for the insured on triggering a duty to settle when there are multiple layers of coverage. Thus, the best option in this situation may be to argue that Texas law does not apply (see discussion of choice of law in section 12 above). Some states have more favorable law on the duties of the primary and excess insurers in this situation. For example, under New York law, a primary insurer has a good faith duty to engage the Plaintiff s counsel in settlement negotiations even if the Plaintiff s offer exceeds the policy limits. See Young v. Am. Cas. Co., 416 F.2d 906, 910 (2 nd Cir. 1969). New York law also recognizes a duty of good faith owed by the primary insurer to the excess insurer. See Pavia v. State Farm Mut. Auto. Ins. Co., 626 N.E.2d 24, 27 (N.Y. 1993). Furthermore, under New York law an excess insurer has a duty to negotiate in good faith and consider settlement offers after the primary insurer tenders its limits. See Yonkers Contracting Co. v. Gen. Star Nat l Ins. Co., 14 F. Supp. 2d 365, (S.D.N.Y. 1998). If another state has more favorable law on the insurers duty to settle, and if there is a good argument that the other state s law applies, the insured may be able to obtain more leverage in settlement negotiations. However, if the facts of the case do not support the choice of law strategy, the Plaintiff and Defendant will have to do the best they can under Texas law. The problem is the Texas Supreme Court s formulation of the elements of a Stowers claim. As the Supreme Court explained in Garcia, a demand above policy limits, even though reasonable, does not trigger the Stowers duty to settle. 876 S.W.2d at 849. If the plaintiff demands a reasonable amount that exceeds the primary limits, arguably the primary insurer has no duty to respond. Under other cases, the excess insurers have no duty to respond until the primary tenders its limits. See, e.g., Keck, Mahin & Cate v. Nat l Union Fire Ins. Co., 20 S.W.3d 692, 701 (Tex. 2000). Thus, a plaintiff trying to trigger multiple layers of coverage faces gridlock. The primary does not have to respond to an excess demand, and the excess insurers do not have to respond until the primary does. The court s decision in Garcia contains what may be a very important qualification. The court recognized other cases where there may be excess demands. The court dropped a footnote stating: A liability policy requires an insurance company to indemnify an insured only up to the insured s contractual limits with that company. Thus, insurers have no duty to accept over-the-limit demands. We do not reach the question of when, if ever, a Stowers duty may be triggered if an insured provides notice of his or her willingness to accept a reasonable demand above the policy limits, and to fund the settlement, such that the insurer s share of the settlement would remain within the policy limits. Nor do we address the Stowers duty when a settlement requires funding from multiple insurers and no single insurer can fund the settlement within the limits that apply under its particular policy. 876 S.W.2d at 849 n.13. The Supreme Court has not addressed this question in subsequent cases. This gives room to argue that when there is a demand within the combined limits perhaps the Stowers duty is modified to require a response by all of the insurers. This is still an open question, but one explicitly left open by the Supreme Court. One lower court has held that a primary insurer owed no duty to the excess insurer to settle a claim where the demand, although reasonable, exceeded the primary limits. The court reached this conclusion despite noting this language from the footnote in Garcia. See Westchester Fire Ins. Co. v. Am. Contractors Ins. Co. Risk Retention Group, 1 S.W.3d 16

27 872, 874 (Tex. App. Houston [1st Dist.] 1999, no pet.). Another court has held that a demand that the primary insurer tender its limits did not trigger the Stowers duty to settle. Birmingham Fire Ins. Co. v. Am. Nat l Fire Ins. Co., 947 S.W.2d 592, (Tex. App. Texarkana 1997, writ denied). The court in Garcia also left open another possibility. The court suggested that affirmative misconduct by the primary insurer that subverted or terminated settlement negotiations might support liability for failure to settle, despite an excess demand. 876 S.W.2d at 850 n. 17. However, the decision in Birmingham Fire noted that this exception has never been recognized since Garcia. 974 S.W.2d at Based on the possibilities of openings in Texas law or the application of another state s more favorable law, here are some suggestions that might help impose liability on the insurers or at least apply settlement pressure by causing the insurers to fear excess exposure: (1) Make sure all the insurers are put on notice. (2) Make sure all the insurers are kept informed of settlements demands and offers, and the information needed to evaluate them. (3) Insist that the primary insurer must tender so that the excess insurers will be obliged to act. (4) If the primary tenders, insist that the next layer has a duty to tender to trigger the next layer. (5) Make an excess demand on all insurers for their combined limits, and insist that they cooperate in settling. (6) Consider a combined policy limits demand to all the insurers. Insist they cooperate to protect their insured. (7) If, for example, you intend to argue that New York law applies, make sure that the demands are all made to the insurers in their New York offices and, if possible, that the settlement decisions come from the New York offices. This will support the New York choice of law argument. (8) Look for any conduct by any of the insurers that interferes with settlement, and document it. 16. After the Plaintiff filed suit, the Insurer refused to defend and made clear it won t pay any resulting judgment. The Plaintiff and Defendant think the claim should be covered. The Defendant wants to avoid the expense of a trial and the risk of having to pay, so she has offered the Plaintiff an agreed judgment that will admit liability, and an assignment of any claims she might have against the Insurer. The Defendant, in return, wants an agreement that the Plaintiff won t execute against the Defendant and will look solely to the Insurer. The Plaintiff is tempted. Is this a good idea? 17. The Plaintiff just got a huge verdict against the Defendant. The Plaintiff had offered to settle within the Defendant s insurance limits, but the Insurer refused to settle. The Insurer now wants to pay the policy limits, but the Plaintiff now wants to collect the entire judgment. What options do the Plaintiff and Defendant have? a. The need for an agreement In these scenarios, the interests of the parties shift. The plaintiff wants recovery, and the only source may be the insurance company. The insured/defendant wants financial protection from personal liability. Defeating the plaintiff would be great, but if the plaintiff wins, the defendant wants the insurer to pay. The insurer is in lockstep with the defendant on defeating the plaintiff, but if it goes badly, the insurer would like to avoid paying. The plaintiff is adverse to the defendant and the insurer on liability. The plaintiff is aligned with the defendant on coverage, and adverse to the insurer. Can the plaintiff and the defendant reach some sort of agreement that gets compensation to the plaintiff and protects the defendant from personal liability? (By the way, these are two of the goals of liability insurance in the first place.) No one yet knows the right answer, but we do know some wrong answers. b. A brief history of certain agreements Historically, parties would enter into what came to be called by some the sweetheart deal. After the insurer abandoned the defense, failed to settle, denied coverage, or did something else that made the defendant feel vulnerable, the defendant and plaintiff would reach an agreement. The defendant would agree to a judgment, or at least would not oppose it. The defendant would assign to the plaintiff all, or part, of his rights against the insurer. In return, the plaintiff would agree not to collect the judgment from the defendant and would only look to the insurance proceeds. Defendants liked this, because it gave them what they had bargained for under the insurance policy protection from personal liability. Plaintiffs liked this, because it gave them what they hoped for from the insurance policy a source of recovery for the defendant s liability. Insurers hated this, because they found themselves facing the asserted binding effect of a judgment in the 17

28 underlying case, for huge damages, based on an agreement between parties who did not have the same interests as the insurer, or based on an uncontested, lay down trial. c. The background of Gandy In State Farm Fire & Casualty Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996), the court told us what not to do. Understanding how the issues arose sheds some light on the court s holdings. Julie Gandy sued Pearce, her step-father, alleging that he had repeatedly abused her sexually. Pearce requested that State Farm defend him. State Farm provided homeowner s insurance to Pearce, and Gandy alleged that some of the sexual abuse occurred at his home. Pearce hired Andrews to act as his attorney in the civil suit. Andrews specialized in criminal law and was defending Pearce in the criminal prosecution that had been filed because of Gandy s allegations. State Farm was notified of the suit about six months after Gandy s suit was filed, State Farm advised Pearce that it had decided to defend him, but reserved its right to deny coverage based on the policy exclusion for intentional conduct. State Farm later sent Andrews a letter directing him to send his bills to it and to keep it advised of the progress of the lawsuit. Id. at Andrews, who clearly was incapable of handling the civil case, continued to represent Pearce. Id. at 137. Andrews later filed a motion to withdraw as Pearce s attorney after he improperly answered interrogatories and failed to appear at a hearing on a motion to compel. The new attorney persuaded the trial court not to sanction Pearce, and thereafter Pearce, who had by that time concluded that State Farm had refused to do anything except pay Andrews bill, decided to settle the case. Id. at 700. Pearce and Gandy then entered into an agreed judgment awarding her actual and punitive damages of over $6 million. At the same time, Pearce assigned Gandy all of his rights and causes of action that he had against State Farm or any other insurer. Gandy, in turn, executed a covenant to limit execution on the judgment in return for Pearce s assignment of his rights to her. State Farm was not a party to the settlement discussions and was completely unaware of the agreed judgment until a copy of it arrived in the mail. Id. at Gandy filed suit against State Farm as assignee of Pearce on the basis that State Farm had failed to provide Pearce an adequate defense. Although the trial court rendered summary judgment that State Farm s policy did not cover Gandy s injuries from Pearce s intentional acts, the jury found that State Farm was negligent in handling Pearce s defense and that State Farm violated the DTPA. The jury found Pearce s actual damages to be $200,000 and set attorney s fees at 15% of that amount. Id. at The trial court rendered the judgment based on the verdict in favor of Gandy, and the court of appeals affirmed. Id. at 704. The supreme court reversed and rendered a take-nothing judgment. Id. at 720. d. The decision in Gandy The basis for the court s decision was its conclusion that Pearce s assignment to Gandy of his rights against State Farm was invalid, and thus Gandy had no right to recover from State Farm. Id. at 705. After expounding on the history of law relating to the assignability of causes of action, the court noted that, although the law originally prohibited such assignments, the modern rule is that, generally, the assignment of a cause of action is permissible. Id. at However, according to the court, there are exceptions to the general rule when the assignment tends to increase and distort litigation. The court gave four examples of impermissible assignments: (1) causes of action for legal malpractice arising out of litigation (Zuniga v. Groce, Locke & Hebdon, 878 S.W.2d 313 (Tex. App. San Antonio 1994, writ ref d)); (2) Mary Carter agreements (Elbaor v. Smith, 845 S.W.2d 240 (Tex. 1992)); (3) the assignment of a tort claim to one tortfeasor so that tortfeasor can prosecute the claim against another tortfeasor (International Proteins Corp. v. Ralston- Purina Co., 744 S.W.2d 932 (Tex. 1988)); and (4) the assignment of an interest in an estate (Trevino v. Turcotte, 564 S.W.2d 682 (Tex. 1978)). Id. at According to the court, Pearce s settlement with Gandy did not terminate the litigation but prolonged it because Gandy wanted to recover against State Farm rather than Pearce. Id. at The court also found that the settlement greatly distorted the litigation against State Farm. Id. at 712. As an example, the court noted that in her lawsuit against Pearce, Gandy had claimed that she suffered $50,000 in damages each time Pearce abused her (325 times). However, at the time of settlement, Gandy s lawyer claimed that $12,500 per incident fairly compensated for Gandy s injuries. In the lawsuit against State Farm, Gandy took the position that her damages were actually far less than the judgment amount in order to establish that Pearce was damaged by State Farm s negligent handling of his defense. The court explained that this last change in position was necessary in order to create damages for Pearce because, if the damages were as those in the agreed judgment, then Pearce would not have been damaged by State Farm s mishandling of his defense. Id. The court also mentioned the change in Pearce s position. Pearce, when Gandy s suit was first filed, denied ever abusing her. Then he agreed to a $6 18

29 million judgment that stated he abused her 325 times in two years. Later, in the lawsuit against State Farm, Pearce again denied that he abused Gandy at all and claimed that he could have proven his innocence if State Farm had provided him with competent counsel. Id. While taking inconsistent positions is not generally prohibited, the court found the change suspect because both Gandy and Pearce took positions contrary to their natural interests so that a judgment might be secured against State Farm. Thus, the court found the agreed judgment was a sham and held the assignment invalid. Id. at The court, however, did not conclude that all settlements involving an assignment of rights in exchange for a covenant not to execute are invalid. Rather, the court held that an assignment of an insured s claim against his or her insurer to the plaintiff is invalid if: (1) it is made prior to an adjudication of plaintiff s claim against defendant in a fully adversarial trial, (2) defendant s insurer has tendered a defense, and (3) either: (a) defendant s insurer has accepted coverage, or (b) defendant s insurer has made a good faith effort to adjudicate coverage issues prior to the adjudication of plaintiff s claim. Id. at 714. The fully adversarial trial requirement is very important. The court stated, In no event, however, is a judgment for plaintiff against defendant, rendered without a fully adversarial trial, binding on defendant s insurer or admissible as evidence of damages in an action against defendant s insurer by plaintiff as defendant s assignee. Id. The court disapproved any contrary language in Employers Casualty Co. v. Block, 744 S.W.2d 940, 943 (Tex. 1988), and United States Aviation Underwriters, Inc. v. Olympia Wings, Inc., 896 F.2d 949, 954 (5th Cir. 1990). Id. The court felt that requiring an adjudication of the plaintiff s claim in a fully adversarial trial would insure a fair determination of the value of such a claim rather than allowing the parties to place a value on the claim and thereby forcing the possibility of having to take positions inconsistent with their interests. Id. at The court did say that if the plaintiff and insured settle after a fully adversarial trial, the value of the [plaintiff s] claim can be taken to be the amount of the judgment obtained. Id. at 713. What if these elements are not all present? We do not know. The court said, We do not address whether an assignment is also invalid if one or more of these elements is lacking. Id. at 714. While the court did not give guidance on what type of agreement would be valid, the court did not say that all similar agreements would be bad. The court noted that these types of settlements frequently arise in situations where the defendant has asked the insurer to provide a defense and the insurer has refused or has provided a qualified defense. In those cases, the settlement is designed to protect the defendant from personal liability, which the court recognized as a legitimate concern. However, the court felt that this concern could be better addressed by resolving the issue of the insurer s obligation to defend before the plaintiff s claim is adjudicated, such as by a declaratory judgment action. Thus, the court s requirement that the insurer make a good faith effort to adjudicate coverage issues prior to the resolution of the plaintiff s claim. A non-insurance decision by the supreme court may foreshadow how the court will decide whether, and to what extent, an insured may assign to a thirdparty claimant the insured s claims against an insurer. In PPG Industries, Inc. v. JMB/Houston Centers Partners Ltd., 146 S.W.3d 79 (Tex. 2004), a buyer of a commercial building sued the manufacturer of defective windows under the DTPA for breach of warranty. The buyer asserted its right to sue based on a general assignment by the original owner of all warranties. The court held that the DTPA claim was not assignable. Relying on the decision in State Farm v. Gandy, 925 S.W.2d 696 (Tex. 1996), the court held that a more important reason not to allow assignment of the DTPA claim was because an assignment might increase or distort litigation. The court stated that it had prohibited assignments that may skew the trial process, confuse or mislead the jury, promote collusion among nominal adversaries, or misdirect damages from more culpable to less culpable defendants. The court reasoned that juries would be confused by assessing the mental anguish suffered by the consumer and the punitive damages based on the situation and sensibilities of the parties, only to have that money go to an assignee. The court also feared that an assignment would give the seller and purchaser a strong incentive to direct the suit elsewhere for relief and would cause the litigation to continue with the parties in different roles precisely the results that have led us to prohibit assignments in other contexts. Assignability, the court opined, may encourage some buyers to cooperate if not collude with a seller who may have been the one that actually misled them. The four dissenting justices would have held the DTPA claim was assignable, for the most part, because the assignment did not present the concerns that led to 19

30 voiding assignments in other cases. The dissenters distilled these concerns as: first, prolonging the suit rather than resolving the litigation; and, second, distorting the litigation by causing the parties to take positions that appeared contrary to their natural interests. While this was not an insurance case, the analysis of both the majority and the dissenters appears certain to fuel arguments in future insurance cases about whether, and to what extent, an insured defendant can assign to a plaintiff his claims under Texas Insurance Code article (a companion to the DTPA) and other claims against his insurer. Gandy voided the assignment based on the circumstances in that case. The PPG case broadly prohibits assignment of DTPA claims. Nevertheless, claims generally are assignable, so unless the court is in full retreat from this position, there must be circumstances where assignments that carefully navigate the court s evolving policy concerns are valid. So what do we conclude from all of this? e. Considerations from Gandy Here are some of the considerations can be distilled from Gandy: 1. Does the agreement prolong the litigation instead of terminating it? This seems to be a red herring. In ordinary cases, settlements usually do terminate the suit. In insurance cases, there customarily is the underlying suit where the insurer cannot be a party and the coverage suit where the insurer can be. An agreement to assign a claim to the plaintiff neither prolongs nor terminates the coverage suit; it just changes who is seeking the relief. It is also hard to see how an assignment to the plaintiff would prolong the litigation, considering that the plaintiff may already have standing to sue as a judgment creditor or may acquire the defendant s rights by a turnover order. 2. Does the agreement distort the litigation by causing the parties to change their positions? 3. Was the agreement made prior to an adjudication of plaintiff s claim against defendant in a fully adversarial trial? It seems this factor does not go so much to the validity of the agreement as it goes to the effect. The agreement may be valid but will not bind the insurer to liability and damages that were not adjudicated. If the issues were adjudicated, they should be binding on the insurer. 4. Did the insurer tender a defense? If not, it is more justifiable that the insured had to make a deal to protect himself. By analogy, if the insurer mishandled the defense for example, by failing to accept a reasonable settlement demand the insured also may be justified in seeking protection by an agreement with the plaintiff. 5. Did the insurer accept coverage? If not, the insured may be more reasonable in seeking protection by an agreement. 6. Did the insurer make a good faith effort to adjudicate coverage issues prior to the adjudication of the plaintiff s claim? This factor is of questionable use. There are limited instances when an insurer can get a determination of the duty to pay a claim before the underlying liability is resolved. 7. Does the agreement protect the defendant from personal liability after the insurer has breached an obligation? This is similar to 4. The court suggested that an agreement in this context may be legitimate. The Gandy decision left plaintiffs, defendants, and insurers with uncertainty about what options are available to a defendant that is denied, or loses confidence in, the insurer s protection. f. The decision in ATOFINA After a decade of uncertainty, the supreme court decided Evanston Insurance Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660 (Tex. 2008), and clarified the limits of Gandy and the options available to defendant/insureds to protect themselves from insurers breaches. ATOFINA was sued over the death of a worker who was employed by another company. ATOFINA contended that it was an additional insured under an excess policy issued by Evanston. Evanston refused to provide coverage, contending that ATOFINA s sole negligence was the cause of the loss and was excluded. ATOFINA then settled with the plaintiffs and sought to collect from Evanston. The court first found that ATOFINA was covered by the Evanston policy as an additional insured. The court then considered the insurer s argument that it was not bound by the settlement because ATOFINA failed to show the settlement was reasonable. ATOFINA responded that the insurer s wrongful denial of coverage barred it from challenging the reasonableness of the settlement. The court reached back to and revived its decision in Employers Casualty Co. v. Block, 744 S.W.2d 940 (Tex. 1988), to hold that the insurer s 20

31 denial of coverage barred it from challenging the reasonableness of the settlement. The ATOFINA court reaffirmed the holding in Block that the insurer was barred from collaterally attacking the agreed judgment by litigating the reasonableness of the damages recited therein [.] The Block decision bound the insurer to an amount set by an agreed judgment, which was not the result of a fully adversarial trial. The ATOFINA court extended this reasoning to include a settlement agreement between the plaintiffs and the defendant/insured [ATOFINA]. The ATOFINA court held that the equitable principles of estoppel and waiver found in Block were triggered by the insurer s denial of coverage by letter and by its assertion of no coverage in its pleadings throughout the coverage suit. The ATOFINA court further held that an insurer would be estopped to challenge the settlement whether it attempted to rely on a policy provision or to assert that the amount was unreasonable. In Block, the insurer was estopped to challenge the judgment, because the insurer had violated its duty to defend. In ATOFINA, the excess insurer had no duty to defend, but had wrongfully denied coverage. The ATOFINA court held this distinction was unimportant. What was important, and justified barring the insurer s ability to challenge the settlement, was that the insurer had notice and an opportunity to participate in the settlement discussion. The court cited with approval the court of appeals decision in Ranger Insurance Co. v. Rogers, 530 S.W.2d 162, 167 (Tex. Civ. App. Austin 1975, writ ref d n.r.e.), for the proposition that [h]ad [the insurer] accepted the defense, it would have had, of course, the opportunity to conduct the defense in a manner most likely to have defeated the plaintiff s claim or at least to have reduced the amount of damages. The ATOFINA court reasoned that if the insurer, Evanston, had not denied coverage it would have been able to influence the amount of the settlement. The ATOFINA court also reaffirmed the decision in United States Aviation Underwriters, Inc. v. Olympia Wings, Inc., 896 F.2d 949 (5th Cir. 1990), which it cited for the proposition that an insurer that flatly refuses to defend cannot contest the reasonableness of a consent judgment agreed to between the defendant/insured and the plaintiff, while an insurer that offers a defense under a reservation of rights can contest the reasonableness of a settlement. The court in ATOFINA found that Gandy was not controlling. The ATOFINA court found that Gandy s holding was explicit and narrow, applying only to a specific set of assignments with special attributes and that Gandy s invalidation applies only to cases that present its five unique elements. First, this case did not fall within Gandy s holdings, because the key factual predicate of an assignment was missing. This removed the case from the formal bounds of Gandy. Second, the court reasoned that Gandy was concerned about assignments that made evaluating the merits of the plaintiff s claim difficult by prolonging disputes and distorting trial litigation motives, but not all cases implicate those concerns. Invoking Gandy s own language, the ATOFINA court noted, We should not invalidate a settlement that is free from this difficulty [of fairly evaluating a plaintiff s claims] simply because it is structured like one that is not. The ATOFINA court found that barring the insurer from challenging the settlement shortened litigation, instead of prolonging it. Further, the settlement did not distort the litigation. Because ATOFINA settled without knowing if the claim was covered, it had an incentive to minimize the settlement in case it had to pay. The court concluded that the insurer was liable for the settlement amount. It appears that Gandy is limited to cases where the insurer has tendered a defense, while ATOFINA and the revived Block will control whenever the insurer breaches its duty to defend or duty to pay. Logically, the court might also extend the reasoning of ATOFINA to other breaches by an insurer, such as breach of duty to settle. g. Other considerations The plaintiff must have a fully adversarial trial. If the plaintiff has it against the defendant that will bind the insurer in the later coverage suit. If the defendant is just a speed bump on the road to that second lawsuit, so that the plaintiff takes a default judgment or negotiates an agreed judgment, the plaintiff will need to have a fully adversarial trial against the insurer. The bottom line is that the plaintiff has to try his case once, either against the defendant or against the insurer. The cases hurt by the requirement are the ones so weak they can only be won if the defendant lays down. And those are claims the insurer should not have to pay. The fully adversarial trial requirement does not so much impose a burden as it takes away an advantage the court thought was unfair. A covenant not to execute is bad for the plaintiff. Obviously, it takes away one source of recovery the defendant. It also lets the insurer argue that the defendant is not really damaged, because he faces no liability, so the insurer has nothing to indemnify. See State Farm Lloyds, Inc. v. Williams, 960 S.W.2d 781, 789 nn (Tex. App. Dallas 1997, writ dism d by agr.). Leaving aside the dubious merit of this argument, why give the insurer this attack? 21

32 In the Williams case, the court rejected the argument that the covenant negated damages, but the court did find that the damages were not necessarily equal to the amount of the judgment, because the defendant s personal liability was limited. From the plaintiff s side, why make an agreement that reduces the value of the claim? In the pre-suit example, a plaintiff may be tempted to offer a covenant not to execute as an inducement for the defendant to agree to a judgment. This seems to go to the heart of what the Gandy court found repugnant. If the plaintiff s claim is so weak that these enticements have to be exchanged, maybe that is the kind of agreement that ought to be void. On the other hand, if the claim has merit, it should be triable without the defendant s induced acquiescence. In the post-verdict example, it is not clear why the plaintiff would ever agree to a covenant not to execute against the defendant. The plaintiff doesn t need the defendant to agree to liability; the defendant s liability has been established. The plaintiff shouldn t need to offer the covenant to acquire the defendant s rights against the insurer. The plaintiff already has standing to sue as a judgment creditor on contract claims. Seaton v. Pickens, 126 Tex. 271, 87 S.W.2d 709, 710 (1935). The plaintiff may be able to get a turnover order to obtain the right to sue on the defendant s extracontractual claims. See 9 William V. Dorsaneo, Texas Litigation Guide (2002). Moreover, being on the losing end of the verdict, the defendant has little leverage. If the plaintiff just won a fully adversarial trial, the defendant has little room to bargain. His best shot is to assign everything to the plaintiff and hope the plaintiff gets paid by the insurer. If the plaintiff gets paid, the defendant benefits to that extent, which beats immediate proceedings to collect on the judgment. One gray area is the plaintiff s right as judgment creditor to pursue extracontractual claims, such as those under former article 21.21, now recodified under Chapter 541. See Allstate Inc. Co. v. Watson, 876 S.W.2d 145, (Tex. 1994) (Spector, J., concurring)(would grant standing to judgment creditor). To that extent, it may be necessary, or at least wise, to get an assignment. But for the reasons stated, the defendant still isn t in a position to demand a covenant not to execute. Another thing to consider is who should pursue the litigation against the insurer the plaintiff, the defendant, or both? If the defendant has resources to fund the litigation it may make sense for the plaintiff to let the defendant do more of the work. If the defendant has limited resources, it may be necessary for the plaintiff s attorney to take the lead because, otherwise, neither the lawyer or client will get paid. Consideration should be given to the dual roles the attorneys in the underlying case have as witnesses and advocates. While it may be permissible, and cost effective, for the same lawyers to continue representing their respective clients, at some point they likely will be material witnesses. For example, both lawyers may need to testify about settlement opportunities missed by the insurer. It makes sense to plan ahead for this transition. The attorneys also should consider their ability to fairly advise the client regarding events where the attorneys were key participants and will be key witnesses. 22

33 Insurance Issues for Trial Lawyers Mark L. Kincaid & Zach Wolfe 1. Pleading into coverage Why plead into coverage? Why not? 2. Duty to defend rules for determining duty to defend 23

34 3. Pleading into coverage -- tips other theories broad and general other insureds/actors re-plead alternate dates 4. Qualified defense/reservation of rights insurer s options defendant/insured s options 5. Defending without reservation of rights Wilkinson exception estoppel elements 24

35 6. Discovery of insurance policies coverage letters absence of coverage letters other claims against limits 7. Late notice of claims 8. Multiple claims/inadequate limits Texas law -- Soriano 25

36 9. Interference with defense general principles vicarious liability direct liability 10. Coverage issues for defendants Tilley tri-partite relationship undivided loyalty 11. Effective settlement demands 26

37 12. Initiating settlement talks 13. Excess claims/multiple limits 14. Agreements between plaintiff and defendant need for an agreement old practice current considerations 27

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