The Road to Texas Supreme Court’s Heart: Through the Fifth Circuit

2007 was a year in transition for Texas insurance law

Omar Bradley often said, “Set your course by the stars and not by the light of every passing ship.” In 2007, the Texas Supreme Court failed to heed this advice, following an inconsistent course unbounded by fixed principle. In fact, the Court allowed the Fifth Circuit Court of Appeals to dictate the shaping issues in Texas insurance law by addressing certified questions rather than resolving long-pending insurance cases from Texas courts.

For example, the Court again failed to decide Excess Underwriters at Lloyd’s v. Frank’s Casing Crew. In 2005, after years of delay, the Court ruled that under certain circumstances, an insurer has a right to seek reimbursement from its insured for any payments made to settle uncovered claims. The insured filed a motion for rehearing. It was granted, the case was reargued in February 2006 and still it sits.

The fact that three new justices will participate in the rehearing — Justices Willett, Brister and Johnson — has led to speculation that the Court will vacate or restrict its original decision. This speculation is based on the fact that Justice Johnson was in the majority in the recent Lamar Homes decision (a pro-policyholder opinion on construction defect claims). However, Justices Brister and Willett dissented, and the facts suggest the justices do not have a pro-insured or pro-insurer bent. Rather, their issue specific approach fails to take into consideration the full ramifications of their decisions.

Calling on the Fifth Circuit

This year, the Texas Supreme Court accepted certified questions from the Fifth Circuit Court of Appeals on three key insurance cases — Lamar Homes v. Mid-Continent Insurance Company, Mid-Continent Insurance Company v. Liberty Mutual Insurance Company, and One Beacon v. Don’s Building Supply Inc. Two have been decided and one remains pending.

Lamar Homes is a construction defect case. The coverage case that followed was appealed to the Fifth Circuit, which certified three questions to the Supreme Court. The Court answered “yes” (in favor of the policyholder) to all three questions, but the its handling of the third question best illustrates the Court’s lack of direction. The question was simply whether Tex. Ins. Code §542.060 applies to a CGL insurer’s breach of the duty to defend.

The Court held §542, the prompt-payment statute limited by its own language to first-party claims, applies to liability claims for damages the insured allegedly caused to a third-party. Unlike traditional first-party claims, there is nothing to pay under a liability policy’s duty to defend until the underlying defense counsel submits a bill. The Court then asked whether the insured would have to submit its legal bills to ripen its claim. The Court answered its own question, “[the] statute’s apparent answer is, yes.” Given the burden being placed on adjusters with this decision, it is sobering to get an “apparent” ruling.

One could argue after Lamar Homes that the Court had developed a pro-insured bent, but then it issued the Mid-Continent v. Liberty Mutual decision. This case is not pro-insured or pro-carrier; it is not good for anyone.

In Mid-Continent, the Court held that there is no direct duty of reimbursement between co-primary insurers. According to the Court, although both policies at issue had limits of $1,000,000, there was no duty owed (directly or by subrogation to the insured’s rights) to the insurer paying $1,350,000 (Liberty Mutual) by the underpaying insurer (Mid-Continent) to reimburse the former for payment of more than its proportionate share of the settlement. In reaching its decision, the Court analyzed whether Texas law supported a duty of reallocation under two potential recovery mechanisms: contribution and subrogation.

Because the policies at issue contained pro rata clauses, the co-insurers contractually agreed in their respective policies to pay a proportionate share of the insured’s covered loss up to $1,000,000. The Court concluded the co-insurers did not create obligations between themselves by virtue of these clauses or agree to pay each others proportionate share of the insured’s loss. Therefore, it held that there was no contractual right of contribution between them, and the presence of the pro rata clauses in the policies precluded an equitable contribution claim. The Court further held that a fully indemnified insured has no right to recover an additional pro rata portion of settlement from an insurer, regardless of that insurer’s contribution to the settlement. Thus, having fully recovered its loss, an insured has no contractual rights that a co-insurer may assert against another co-insurer in subrogation.

Liberty Mutual had argued that it was subrogated to its insured’s common-law right to enforce Mid-Continent’s duty to act reasonably when handling an insured’s defense, including reasonable negotiation and participation in settlement. However, an insurer’s common-law duty in Texas in the third-party context is limited to the Stowers duty to protect the insured by accepting a reasonable settlement offer within policy limits. Mid-Continent did not breach a Stowers duty to the insured because the underling plaintiffs never made a settlement offer within Mid-Continent’s policy limits. Additionally, the Court noted that Liberty Mutual paid a debt for which it was primarily liable, thereby defeating the traditional subrogation requirement that the subrogee pay a debt for which another was primarily liable.

One glaring problem with this decision is its potential to undermine more than a decade of allocation law created by American Physicians Insurance Exchange v. Garcia, which is primarily a Stowers case with an interesting “stacking” issue. It is routinely cited (correctly or not) for the proposition that a policyholder can pick any insurer on the risk at a point in time and vertically exhaust the chosen policy. Garcia suggested this was an equitable result because carriers are protected from being burdened with an unfair share by an insured’s choice of one policy over another by allocating among themselves according to their subrogation rights:

“If a single occurrence triggers more than one policy, covering different policy periods, then different limits may have applied at different times. In such a case, the insured’s indemnity limit should be whatever limits applied at the single point in time during the coverage periods of the triggered policies when the insured’s limit was the highest. The insured is generally in the best position to identify the policy or policies that would maximize coverage. Once the applicable limit is identified, all insurers whose policies are triggered must allocate funding of the indemnity limit among themselves according to their subrogation rights.” 876 S.W.2d 842, 855 (Tex. 1994).

The Mid-Continent opinion denied Liberty Mutual both the ability to recover its loss the Garcia way (through subrogation) and went a step further to deny contribution rights as well. By precluding the Garcia route to equity, insurance carriers must take additional steps to protect themselves against overpaying a claim, and insureds could potentially be the ones to suffer.

The Lamar Homes and Mid-Continent decisions illustrate the Court’s lack of foresight with regard to insurance cases. The Court failed to recognize in considering these complex coverage issues that the unrecognized, unintended consequences often dwarf the intended outcome of their opinions.

Topics Carriers Texas