Texas Supreme Court Continues Onslaught of Coverage Decisions

Since last August, the Texas Supreme Court has issued a half dozen major insurance cases, many on issues pending for years. The Court recently heard argument in key cases involving the insurability of punitive damages in general liability policies and on trigger of coverage in the property damage context. The deluge of insurance opinions continued in February with important decisions in three new cases. Let’s take a brief look at two of them, with at look at the third in the next issue.

National Union v. Crocker — Duty to Inform, Duty to Insure

In National Union Fire Insurance Company of Pittsburgh, P.A. v. Beatrice Crocker, on Feb. 15, 2008, the Texas Supreme Court held that that (1) a carrier owes no extra-contractual duty to inform an insured (here an additional/omnibus insured) that the insured entitled to a defense under a liability policy and (2) even when the carrier has actual notice of the suit, it has no duty to defend an insured until the insured makes a demand for coverage on the carrier.

Crocker involved lawsuit filed by Beatrice Crocker against a nursing home seeking damages for injuries she sustained when she was hit by a door that was swung open by a nursing home employee. Crocker filed the lawsuit against the owner of the nursing home, Emeritus Corp., and its employee who swung the door, Richard Morris. Morris was covered as an additional insured under a commercial general liability policy issued to Emeritus by National Union. National Union defended Emeritus, but Morris never forwarded the suit papers to National Union, nor did he inform National Union that he had been sued. National Union did not defend Morris, even though it knew of the suit, knew the claims were covered by the policy, and knew Morris was an additional insured under the policy.

Three Certified Questions

The Crocker case came to the Texas Supreme Court on three questions certified by the United States Court of Appeals for the Fifth Circuit:

First, where an additional insured does not and cannot be presumed to know of coverage under an insurer’s liability policy, does an insurer that has knowledge that a suit implicating policy coverage has been filed against its additional insured have a duty to inform the additional insured of the available coverage?

Second, if the above question is answered in the affirmative, what is the extent or proper measure of the insurer’s duty to inform the additional insured, and what is the extent or measure of any duty on the part of the additional insured to cooperate with the insurer up to the point he is informed of the policy provisions?

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

The Court answered the first and third questions in the negative, but did not reach the second question, as it was conditioned on an affirmative answer to the first question.

Relying on Weaver and Harwell

The Texas Supreme Court relied heavily on the 1978 high court ruling Weaver v. Hartford Accident & Indemnity Co., 570 S.W.2d 367 (Tex. 1978) holding that an insurer is not liable to an additional insured’s judgment creditor when the additional insured failed to notify the insurer that he had been served with process, even though the insurer knew about the suit, and the additional insured knew nothing about the policy. The holding in Weaver was unanimously reaffirmed several years later in Harwell v. State Farm Mutual Automobile Insurance Co., 896 S.W.2d 170 (Tex. 1995) where the Court provided that an insurer did not have to “gratuitously subject [] itself to liability” until the insured fulfilled the duty to notify the insurer of service of the suit against it.

The Court noted that both Weaver and Harwell turned on the recognition that notice and delivery-of-suit-papers provisions in insurance policies serve two essential purposes:

1. They facilitate a timely and effective defense of the claim against the insured, and more fundamentally; and
2. They trigger the insurer’s duty to defend by notifying the insurer that a defense is expected.

The Crocker case confirmed these prior decisions and went further to provide there is no unilateral duty on the insurer to act unless and until the additional insured first requests a defense by notifying the insurer that the insured has been served with process and the insurer is expected to answer on its behalf. However, the Crocker opinion also notes, in dicta, that “an insurer that is aware an additional insured has been sued may, and perhaps should, choose to inform the insured that a defense is available …”

On the third certified question, dealing with the issue of knowledge, the Texas Supreme Court recognized that the Fifth Circuit was concerned about “changes in Texas insurance law” over the years, including the mandatory endorsement issued by the Texas Board of Insurance which required a showing of prejudice in certain suits before an insurer may use “late notice” to deny coverage. The Court specifically referred to its own recent opinion in PAJ, Inc. v. Hanover Insurance Co., 2008 WL 109071 (Tex. 2007), where the Court had held that late notice of a covered claim will not defeat coverage unless the insurer was actually prejudiced by the delay. The Court concluded that PAJ was not applicable to the facts of Crocker because PAJ involved late notice while Crocker involved no notice at all. In addition, it does not appear that the insurer in PAJ had actual notice of the suit against the insured before notice of the claim was given by the insured.

At the beginning of the Crocker opinion, the Court stated that it was holding that an insurer’s actual notice that an additional insured has been served with process does not establish as a matter of law that the insurer has not been prejudiced by the insured’s failure to notify the insurer of the suit. In the analysis of the prejudice issue, however, the Court does not reach this conclusion and seems to hold instead that prejudice is not at issue in Crocker because no notice was ever given. Because of this inconsistency, it is not exactly clear how the Court might rule if it is now presented with a case in which an insurer has actual notice that its insured has been sued but the insured delays in making a demand for coverage. What Crocker does make clear, however, is that in the absence of a demand by the insured, an insurer has no duty to act to protect the insured.

Fairfield v. Stephens Martin — Recovery of Exemplary Damages

Fairfield Insurance Co. v. Stephens Martin Paving LP also came before the Texas Supreme Court on a certified question from the Fifth Circuit: “Does Texas public policy prohibit a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence?”

The Court ruled on Feb. 15 that Texas public policy does not prohibit coverage under the type of workers’ compensation and employer’s liability insurance policy at issue in this case.

Stephens Martin Paving (SMP), a highway paving company, employed Roy Bennett as a brooming machine operator; Bennett died as a result of injuries sustained when a brooming machine rolled over him. SMP carried a workers’ compensation and an employer’s liability insurance policy, issued by Fairfield Insurance Company. Fairfield paid workers’ compensation benefits to Bennett’s wife and children under the policy.

Bennett’s survivors sued SMP for gross negligence, seeking exemplary damages because SMP allegedly failed to provide a safe place to work, failed to follow and enforce OSHA safety rules and regulations, and failed to properly train and supervise its employees. Having received workers’ compensation benefits, Bennett’s survivors were barred by statute from recovering actual damages and sought only exemplary damages in the suit.

Fairfield sued SMP and Bennett’s survivors in federal district court, seeking a declaratory judgment that Fairfield owed no duty to defend or indemnify SMP in the suit for exemplary damages. The federal district court concluded that the language in Fairfield’s policy covered exemplary damages and that Texas public policy did not prohibit insurance coverage of those damages. The court entered a judgment declaring that Fairfield had a duty to defend SMP and a duty to indemnify SMP if SMP was adjudicated responsible for the damages sought in the underlying suit. Fairfield appealed, and the Fifth Circuit certified the question.

A Two-Step Analysis

The Court determined that a two-step analysis was required to ascertain whether exemplary damages for gross negligence are insurable. First, the plain language of the policy must cover the exemplary damages sought in the underlying suit against the insured. Second, the public policy of Texas must allow coverage in the circumstances of the underlying suit.

Under the employer’s liability part of the policy, Fairfield agreed to pay “all sums [SMP] legally must pay as damages because of bodily injury to [its] employees, provided the bodily injury is covered by this Employers Liability Insurance” and other specific costs. It excludes coverage of “punitive or exemplary damages because of bodily injury to an employee employed in violation of law.” An endorsement to the policy added that “[t]his exclusion does not apply unless the violation of law caused or contributed to the bodily injury.” The policy also excluded damages arising from injuries caused by intentional acts. However, because the Fifth Circuit’s question was directed only at the public policy of Texas, the Court limited their discussion to the public policy issue of the analysis and presumed that the policy language covered the exemplary damages sought.

Because this case arose from a claim for exemplary damages under the Texas Workers’ Compensation Act, the Court reviewed the applicable statutory scheme and accompanying insurance regulation of that field. The Court found that, while workers’ compensation insurance provides the exclusive remedy for the injury or death of a participating employee in most cases, this exclusive remedy does not prohibit recovery of exemplary damages if the employee’s death is caused by the employer’s gross negligence.

Based upon the “all sums” language in the employer’s liability part of the Texas Department of Insurance-approved, dual coverage policy which covers some of the common law claims excluded from the workers’ compensation part of the policy, a participating employer would have coverage for workers’ compensation claims and claims based on gross negligence (although no coverage would exist for intentional acts). The Court held that the Legislature’s expressed intent is that Texas public policy does not prohibit insurance coverage for claims of gross negligence in the context of this type of insurance.

Without clear legislative intent to generally prohibit or allow the insurance of exemplary damages arising from gross negligence, the Court declined to make a broad proclamation of public policy. The Court did, however, offer some considerations applicable to the analysis in other cases.

Enforcement Versus Public Policy

In the absence of expressed direction from the Legislature, whether a promise or agreement will be unenforceable on public policy grounds should be determined by weighing the interest in enforcing agreements versus the public policy interest against such enforcement. Courts weighing this interest should consider the reasonable expectations of the parties and the value of certainty in enforcement of contracts generally. On the other side of the scale is the extent to which the agreement frustrates important public policy. Also to be considered, the Court said, is the purpose of exemplary damages, which, according to 150 years of Texas jurisprudence, is to punish the wrongdoer and set “a public example to prevent repetition of the act.” The Court acknowledged that there is some inherent tension between the policies recognized by freedom of contract and the policy behind awarding exemplary damages.

The Court went on to discuss the considerations involved in various hypothetical situations.

First, the Court noted that Texas appellate courts have uniformly rejected as against public policy coverage under uninsured or underinsured motorist policies when the insured seeks to recover from his own insurer exemplary damages assessed against a third-party tortfeasor, because, in that situation, the burden of the exemplary damages would fall entirely on the insurer and its policyholders, not on the tortfeasor, thereby entirely defeating the purpose of such damages.

Next, it observed that Texas courts of appeals have also noted that the policy considerations regarding exemplary damages coverage depend on whether the basis for the damages is the conduct of the insured’s employees or agents. In this situation, disallowing coverage for a large corporation means that exemplary damages for the misconduct of perhaps one or only a few employees will “inevitably be passed on to the consumers of its products — who are also innocent.”

Thus, the Court highlighted the general considerations that are important when determining whether the policy behind exemplary damages should limit parties’ ability to contract for coverage of those damages.

Landmark Decisions

The breadth and scope of these recent decisions is astonishing, especially when years passed between important discovery decisions in the past. Now it seems that the court is issuing landmark decisions almost every month. What is just as amazing is that key issues, such as trigger of coverage, that were avoided by the Court for decades are now routinely accepted by the Court on certified question. The Court has created volatility by its recent decisions and it looks as if this trend of actively engaging big insurance issues will continue for the foreseeable future. We are living, as the Chinese curse goes, in interesting times.

Topics Lawsuits Carriers Texas Legislation Claims Workers' Compensation