LEGAL TRENDS

Frank’s Casing About-Face:
Court Denies Settling Insurer’s Reimbursement Claim

By Reagan D. Pratt And James L. Cornell

In a significant victory for policyholders, the Texas Supreme Court has held that an excess insurer does not have an implied right to reimbursement from its insured after it pays to settle an uncovered claim. Excess Underwriters v. Frank’s Casing Crew & Rental Tools, Inc., 2008 WL 274878 (Tex. Feb. 1, 2008). The court’s long-awaited opinion on rehearing reverses its previous unanimous judgment creating a right of reimbursement in favor of insurance carriers. See Excess Underwriters v. Frank’s Casing Crew & Rental Tools, Inc., 2005 Tex. LEXIS 418; 48 Tex. Sup. J. 735 (May 27, 2005).

Frank’s Casing addressed a dilemma frequently faced when an insurer contests coverage for a pending claim. The insured, Frank’s Casing, was the target defendant in a lawsuit arising from the collapse of a drilling platform built by Frank’s Casing. Although Frank’s Casing had excess insurance with a $10 million policy limit, the insurer contested coverage for the claims. During trial, at the suggestion of counsel for Frank’s Casing, the plaintiff offered to settle for $7.5 million, well within the limits of Frank’s Casing’s excess coverage. Frank’s Casing, deeming the offer reasonable, asked the insurer to accept the settlement demand, and refused to agree to reimburse the carrier, reserve the coverage issues, or pay any portion of the settlement.

The carrier faced the typical Stower’s decision. If the insurer rejects a reasonable settlement offer within policy limits, and coverage is later determined to exist, under the Stower’s doctrine, the insurer is liable for the entire judgment, even the amounts in excess of the policy limits. If the insurer pays the settlement, the lack of a reimbursement right effectively creates coverage for the claim even if the courts might ultimately determine that no coverage existed under the policy. This common situation places the risk on the carrier, under the theory that the carrier is in the business of calculating and allocating risk, and is in the best position to absorb and spread a loss, or re-draft its policies to include a right of reimbursement in its policies.

Conversely, a reimbursement right would place the insured in an untenable position if the insurer settles the underlying claim while contesting coverage. The settlement would foreclose the insured’s ability to contest liability on the claim, while exposing it to a liability in a coverage action which may be far beyond its means to pay. A reimbursement right would therefore shift to the insured the risk of evaluating coverage, and require it to evaluate settlement offers in light of its own financial condition rather than based on the amount of insurance protection it has secured. A reimbursement right would also provide the carrier with additional leverage to influence the insured to contribute to settlements when coverage is uncertain.

In Texas Ass’n of Counties County Gov’t Risk Management Pool v. Matagorda County, 52 S.W. 3d 128 (Tex. 2000), the court had resolved this dilemma in favor of insureds, holding that a carrier could only seek reimbursement after obtaining the policyholder’s clear and unequivocal consent to both the settlement and the right to seek reimbursement. But in its original Frank’s Casing opinion, the court distinguished Matagorda County, holding that the insurance company had retained the right to seek reimbursement because it paid the uncovered claims with the insured’s consent, after notifying the insured that it contested coverage and intended to seek reimbursement. The Court found that when Frank’s Casing demanded that the carrier accept the within-policy-limits offer, Frank’s Casing was deemed to have agreed that the offer was reasonable, and was estopped from arguing that it was unreasonable.

After hearing a second oral argument, however, a 5-3 court withdrew its earlier decision and reaffirmed its 2000 holding in Matagorda County. The court left the risk of loss with the insurer, reasoning that the insurer “is in the business of analyzing and allocating risk and is in the best position to assess the viability of its coverage dispute.” It further held that the insured’s encouragement of the settlement, while knowing the insurer intended to seek reimbursement, did not imply an agreement to allow such reimbursement. Since the insured had consistently contested the insurer’s coverage position, the Court found only that the parties had “agreed to disagree.”

In their dissent, Justices Hecht, joined by Justice Green, argued that the law of restitution recognized a right under unjust enrichment for the carrier to reserve its rights, settle the claim, and then seek reimbursement. In a separate dissent, Justice Wainwright argued that the insured’s encouragement of the settlement sufficiently implied its agreement to allow litigation of the claim for reimbursement.

No Harm, No Foul: Late Notice to Insurer Does Not Bar Coverage Absent Prejudice

An insured’s failure to timely notify its insurer of a claim does not defeat coverage under an occurrence-based policy, if the insurer suffers no harm from the delay, under the Supreme Court’s recent holding in PAJ, Inc. v. The Hanover Ins. Co., No. 05-0849, 2008 WL 109071 (Tex. Jan. 11, 2008, rhrng. filed). The 5-4 court ruled that an insured’s breach of a policy provision requiring timely notice of claims, if not material, does not deprive the insurer of the benefit of the bargain and thus cannot relieve the insurer of its contractual coverage obligation. The court drew upon basic contract principles to hold that while a material breach of a contract may deprive a party of the benefit of the contract, an immaterial breach does not. In PAJ, the parties had stipulated that the late notice did not prejudice the carrier, and so, by definition, it was an immaterial breach.

While there was a split of authority regarding whether Texas law required a showing of harm before late notice would defeat coverage, PAJ appears to indicate that the prejudice showing will be required without regard to whether the notice provision is found in the coverage description or in an exclusion, and without regard to whether the provision is characterized as a condition precedent or a mere covenant. The court reasoned that the timely notice provision is “not an essential part of the bargained-for exchange” under an occurrence-based policy, and that automatic forfeitures under such policies would unreasonably allow draconian results from even de minimus delays in notice or other violations of so-called “conditions” in the policy.

The court suggested that it could reach a different result in the case of a “claims-made” policy. Under a claims-made policy, liability coverage is provided for claims made during the policy period, without regard to the date of the underlying occurrence. Some courts have interpreted Texas law to provide for strict enforcement of notice provisions in such policies, based on the greater significance of notice in such policies. The PAJ court observed that, in determining whether prejudice is required, the different function of notice provided a “critical distinction” between claims-made and occurrence-based policies. On the same day that it decided PAJ, the court agreed to review two cases which pose the question of whether that distinction is determinative. SeeXL Specialty Ins. Co. v. Financial Indus. Corp., 2007 WL 4461190 (5th Cir. Dec. 19, 2007) (certified question accepted); Prodigy Comm. Corp. v. Agricultural Excess & Surplus Ins. Co., 195 S.W.3d 764 (Tex. App.—Dallas 2006, pet. granted).

Supreme Court Rewards “Objectively Unreasonable” Carrier For Its Obstinance

In Mid Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W. 3d 765 (Tex. 2007), two primary carriers paid disparate amounts to settle a claim against their common insured. The Texas Supreme Court held that the carrier that paid the bulk of the settlement, Liberty Mutual, cannot recover against the underpaying primary carrier, Mid Continent, under either contribution or equitable subrogation theories.

The insured was covered by its own primary and excess policies through Liberty Mutual, as well as its subcontractor’s Mid Continent primary policy as an additional insured. Both Liberty Mutual and Mid Continent evaluated the potential exposure to all defendants in the underlying action, including the insured, at $2 to $3 million. The case against the insured was settled in mediation. Liberty Mutual paid the entire $1.5 million settlement, and Mid Continent later contributed $150,000, its half of $300,000, representing the amount that it evaluated as the settlement value of the claims against the insured.

Liberty Mutual sued Mid Continent to recover half of the $1.5 million settlement. The trial court held that Mid Continent was “objectively unreasonable” in its analysis and actions. On appeal, the Supreme Court reversed. The Supreme Court held that the excess “other insurance” clauses in the two primary policies created separate and independent obligations between the carriers, and as a result, Liberty Mutual had no right of contribution against Mid Continent. Consequently, when Liberty Mutual paid the settlement, it did so as a “volunteer.” The Supreme Court further held that, since insured did not have a Stowers’ claim against Mid Continent (because no demand had been made within the primary policy limits), there were no rights for Liberty Mutual to assume from the insured under a theory of equitable subrogation. Therefore, when Liberty Mutual “stepped into the shoes” of the insured, there were no claims to assert.

This holding represents a radical departure in insurance jurisprudence. Normally, in this situation, the primary carriers settle the underlying claim and then litigate the allocation of the settlement through equitable subrogation or settlement. This customary approach which has been employed for decades has been eradicated by the Supreme Court. The result is that the carrier that undervalues and underpays the claim will be rewarded for its recalcitrance. As an unintended consequence, this holding is sure to preclude future settlements of underlying claims because the carrier which accurately evaluates the claim will have no avenue of recovery from the carrier that is “objectively unreasonable,” and will no longer be able to settle the claim and then seek redress through a contribution and/or equitable subrogation claim.

Reagan D. Pratt is a partner at Howrey LLP. His practice focuses on the trial and appeal of complex business disputes, including insurance coverage disputes.

James L. Cornell practices law at Cornell & Pardue. His practice includes advising and representing corporate policyholders in their negotiations with and claims against insurance carriers, complex commercial litigation and construction litigation, among other areas. He is a co-founder and former Chair of the Insurance Law Section of the State Bar and co-author of Cornell & Martin’s Texas Insurance Law Digest.

By Tracy Penn

In a unanimous decision, the Texas Supreme Court held that premises owners that “undertake to procure” work fall within the Texas Labor Code’s definition of a general contractor and may be shielded from tort liability. By allowing a premises owner to assume a dual role – that of premise owner and general contractor – the Supreme Court in Entergy Gulf States, Inc. v. Summers, 50 Tex. Sup. Ct. J. 1140 (Tex. Jan. 24, 2007), enlarged the scope of protection for a premises owner under Texas workers’ compensation laws.

In Entergy, John Summers sued Entergy for negligence after he was injured at Entergy’s Sabine Station plant. Summers was employed by a subcontractor, International Maintenance Corp. (IMC), which Entergy had contracted with to perform work on its Sabine Plant. To shield itself from tort liability under Louisiana law, Entergy added an addendum to the contract recognizing it as the “statutory employer” of both IMC and its employees (IMC remained the “direct employer”). Entergy also agreed to provide workers’ compensation insurance for IMC’s employees in exchange for a lower contract price. While this policy was in effect, Summers was injured, applied for, and received benefits under Entergy’s workers’ compensation policy. He then sued Entergy for negligence. Entergy moved for summary judgment asserting that it was a general contractor and, thus, shielded from Summers’ suit.

The district court granted summary judgment to Entergy; but the Ninth Court of Appeals reversed, reasoning that Entergy was not a general contractor because it did not first undertake to procure work and then subcontract it out. The Texas Supreme Court reversed the court of appeals and affirmed the trial court’s finding that Entergy was a general contractor.

The Labor Code provides that workers’ compensation is the “exclusive remedy” for injured employees. A general contractor may, in writing, agree to provide workers’ compensation coverage to the subcontractor and the subcontractor’s employees. Such an agreement makes the general contractor the employer of both the subcontractor and the subcontractor’s employees for purposes of workers’ compensation laws. This arrangement allows the general contractor to avail itself of the exclusive remedy defense of Texas workers’ compensation laws when an employee is injured on the job.

The Texas Supreme Court limited the issue in this case to whether Entergy, as a premises owner, could also be considered a general contractor within the meaning of the Labor Code. It looked to the plain meaning of the definition of general contractor, which is “a person who undertakes to procure the performance of work or a service, either separately or through the use of subcontractors.” The court of appeals had ruled that Entergy was not a general contractor because it did not contract with the owner but was the owner. The Texas Supreme Court rejected this ruling as being based on pre-1993 definitions of “general contractor” and “subcontractor” which defined a general contractor as a person who contracts directly with the owner, and a subcontractor as a person who contracts to perform work or services which a prime contractor has contracted with another party to perform. Case law applying these definitions prohibited a premises owner from being a general contractor, because it could not contract with itself.

The Texas Supreme Court stated that today’s plain meaning of “general contractor” does not preclude a premises owner from also being a general contractor if he “undertakes to procure the performance of work or a service.” It also rejected the court of appeals’ holding that a premises owner was not a statutory employer because it also was based on pre-1993 definitions in the Labor Code. The Court reiterated that the current definitions do not preclude a premises owner from being its own general contractor. In the end, the Court concluded that because Entergy “procured” the subcontractor’s work, it met the definition of “general contractor.”

Through this decision, the Texas Supreme Court is providing premise owners with an opportunity to increase their protection against tort liability by allowing them to assume dual roles: that of premise owner and general contractor. A premises owner who subsequently contracts with a subcontractor can minimize its liability by purchasing workers’ compensation insurance and availing itself of the exclusive remedy defense of Texas workers’ compensation laws. However, questions still remain. As noted in this case, Entergy contracted to provide workers’ compensation insurance to IMC and IMC’s employees in exchange for a lower contract price. This begs question of whether it is enough that the general contractor provide workers’ compensation insurance or is it also required that the general contractor pay for the workers’ insurance? Another issue is whether all parties – owners, general contractors and subcontractors – are entitled to immunity from suit when workers’ compensation coverage is provided. These are issues raised in the case of Rice v. HCBeck Ltd., 2006 WL 908761 (Tex. App.–Fort Worth April 6, 2006), which is currently pending before the Texas Supreme Court.

Tracy Penn is a litigation associate in the Houston office of Gardere Wynne Sewell LLP. She received her J.D. from the Thurgood Marshall School of Law.

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