Texas Supreme Court Places a Constraint on Deals between Claimants and Insureds

When an insurance carrier refuses to provide a defense to an insured, based on its opinion that there is no coverage for the claim asserted against its insured, it is not uncommon for the insured and the claimant to reach an agreement whereby the insured assigns its rights against the insurance carrier to the claimant. The Texas Supreme Court dealt with this situation in State Farm Fire & Casualty Co. v. Gandy, 925 S.W.2d 696 (Tex.1996). After outlining the factors to be considered in determining whether an assignment from an insured to a claimant is binding, the Court independently concluded:

“In no event, however, is a judgment for plaintiff against defendant, rendered without a fully adversarial trial, binding on the defendant’s insurer or admissible as evidence of damages in an action against defendant’s insurer by plaintiff as defendant’s assignee.”

The Gandy opinion did not explain how a court should go about determining whether a trial is “fully adversarial.” Consequently, parties and the lower courts have struggled with what “fully adversarial” means during the two decades since the opinion was published. In Great American Insurance Company v. Hamel, 2017 WL 2623067 (Tex. June 16, 2017), the Court provides an explanation.

The Court begins by commenting that parties and the lower courts have understandably, albeit mistakenly, focused on how the trial between the claimant and the insured was conducted–attempting to ascertain whether it was fully adversarial. The Court explains that sorting out the details of how a trial was conducted is not workable approach. 

The correct focus is on whether the arrangement between the claimant and the insured—resulting in either an agreed settlement amount or a trial court judgment—relieves the insured of all risk.  If the structure of the arrangement is such that amount of the settlement or judgment is of no concern to the insured, then the insured has no incentive to ensure that the settlement or judgment accurately reflects claimant’s damages. Similarly, if the amount of the settlement or judgment is of no consequence to the insured, then there is no adversity between the claimant and the insured as to the amount of the settlement or judgment.    

The Court describes the correct focus as follows:

“Today we clarify that the controlling factor is whether, at the time of the underlying trial or settlement, the insured bore an actual risk of liability for the damages awarded or agreed upon, or had some other meaningful incentive to ensure that the judgment or settlement accurately reflects the plaintiff’s damages and the defendant-insured’s covered liability loss.”

The take-away point is that when an insurance carrier refuses to defend its insured, a settlement between a claimant and an insured, or a judgement taken by the claimant against an insured, is not binding on the insurance carrier unless the insured remains at risk despite the settlement or judgment. It is clear that the “at risk” test is satisfied if the insured may have to pay the settlement or judgment amount if the insurance carrier establishes that there is no coverage for the claim.  On the other hand, the phrase “or some other meaningful incentive” will undoubtedly give rise to creative arrangements and interesting arguments going forward. Like most judicial clarifications, this one leaves plenty of room for creative arguments in the future.

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