Breach Duty to Defend and Lose Right to Attack the Settlement
Two insurance carriers that provided consecutive coverage to a mutual insured asked the Texas Court of Appeal whether Audubon Insurance Company (Audubon) should receive contribution and reimbursement from Great American Lloyds Insurance Company (GALIC) for defense and settlement costs Audubon incurred as the result of GALIC’s breach of its duty to defend and indemnify their mutual insured. In Great American Lloyds Insurance Company v. Audubon Insurance Company, No. 05-11-00021-CV (Tex.App. Dist.5 08/06/2012) the Texas Court of Appeal resolved the dispute.
Holigan Family Investment, Inc., a homebuilder, purchased two policies of commercial general liability insurance from GALIC providing coverage from July 1, 1995, through July 1, 1996, and from July 1, 1996, through July 1, 1997. Audubon and other insurance companies provided consecutive commercial general liability coverage to the homebuilder from July 1, 1997, through April 1, 2002.
In December 2001, David and Marilyn DeShields (the homeowners) sued the homebuilder in Harris County alleging that the homebuilder negligently constructed their home. They also sued their own homeowners insurance carrier, Prudential Property and Casualty, alleging negligent claims handling. The homeowners alleged that the exterior balcony of their home was constructed in a defective manner and allowed water to enter the home. They also alleged that although the homebuilder attempted to make repairs, it did so in a negligent manner. Additionally, the homeowners alleged that the HVAC system was negligently installed and resulted in intermittent condensation that dripped outside the pan onto the attic floor. And they alleged that as a result of the negligence of the homebuilder, its employees, and its contractors, toxic mold grew in the walls of the home, potentially exposing the homeowners and their child to biohazardous organisms.
GALIC, Audubon, and the other insurers agreed to defend the homebuilder against the homeowners’ claims. GALIC agreed to pay one-third of the defense costs. About a year later, however, GALIC withdrew its agreement to contribute to the homebuilder’s defense costs. It concluded that, based on discovery in the lawsuit, the earliest date any damage occurred was around March 30, 1998, which was outside its policy period, and that it did not have a duty to defend or indemnify the homebuilder. Audubon and the other insurers continued to defend the homebuilder. Prudential settled the homeowners’ claims against it, and the homeowners nonsuited the Harris County lawsuit.
The homeowners re-filed their lawsuit against the homebuilder in Dallas County; Prudential intervened. Audubon and the other insurers continued to represent the homebuilder and ultimately settled the case with the homeowners and Prudential. Audubon then sued GALIC for contribution and reimbursement of defense and settlement costs. Audubon contended that GALIC breached its contract with the homebuilder by withdrawing its defense and refusing to indemnify the homebuilder.
GALIC’s Motion for Summary Judgment
GALIC contends it did not have a duty to defend the homebuilder. An insurer’s duty to defend arises when a third party sues the insured on allegations that potentially state a cause of action within the terms of the policy, without regard to the truth or falsity of the allegations. The duty to defend in Texas is determined under the “eight corners rule” – that is, by examining the allegations in the underlying pleadings and the language of the insurance policy.
Injury or Damage During the Policy Period
The petition in the underlying lawsuit alleged that the balcony was negligently constructed and allowed water to penetrate the home, and that the HVAC system was negligently installed and allowed water to drip onto the attic floor. The petition did not allege when the home was built, when the homebuilder attempted to make repairs, or when the damage occurred. The petition alleged that the homebuilder and its employees and contractors were negligent.
GALIC argued that the issue is not whether the homeowners alleged a specific date the property damage or bodily injury occurred, “but whether under the ‘eight corners’ rule, a duty to defend is triggered where the underlying pleadings contain absolutely no allegations regarding the timing or dates of anything, including construction, repairs, or when the alleged damage or injuries occurred.” Audubon responded that GALIC owed a duty to defend because the allegations in the petition did not show that the claim clearly was not covered.
The homeowners here filed the underlying lawsuit in 2001 and alleged bodily injuries and property damages in the “past.” Construing the allegations liberally in favor of the insured, the Court of Appeal concluded that GALIC owed a duty to defend the homebuilder and the trial court did not err by denying GALIC’s traditional motion for summary judgment on that basis. See Nat’l Union Fire Ins. Co. v. Merchants Fast Motor Lines, Inc., 939 S.W.2d 139, 141 (Tex. 1997) (per curiam) (stating “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 insured’s favor”) (quoting Heyden Newport Chem., 387 S.W.2d at 26); Gehan Homes, 146 S.W.3d at 846. Policy Exclusion for “Damage to Your Work”
GALIC also argues that it did not have a duty to defend because the homeowners’ allegations against the homebuilder for faulty workmanship fall within the exclusion for “damage to your work.” Additionally, the homeowners amended their petition in the Dallas County lawsuit to included the HVAC contractor as a defendant. Construing the petition liberally in favor of the insured, we conclude that the allegations were sufficient to claim that subcontractors may have performed the work and, as a result, the exclusion for “damage to your work” did not apply to preclude GALIC’s duty to defend.
GALIC’s policies covered the policy periods from 1995 to 1997, and Audubon’s policies covered the policy periods from 1997 to 1998. Although the “other insurance” provisions of GALIC’s and Audubon’s policies their respective insuring agreements state that they cover only “bodily injury” and “property damage” that occurs during the policy period. Because the policies are for different policy periods, by necessity the policies do not cover the same injury or damage and there is no other valid and collectible insurance that is available to the insured. GALIC and Audubon are, therefore, not co-primary insurers.
When an insurer breaches its duties to defend and indemnify its insured, however, the insurer may not collaterally attack the settlement by litigating the reasonableness of the agreement.
The evidence here showed that property damage occurred during the insurers’ respective policy periods and that the insurers, except GALIC, agreed to defend and indemnify their mutual insured against the homeowners’ claims. Because GALIC wrongfully refused to defend and indemnify its mutual insured, The Court of Appeal concluded that GA;OC is precluded from litigating whether Audubon allocated the loss among the policies.
This is a warning to all insurers faced with a claim for defense in a four-corners or eight-corners state like Texas. If an insurer refuses to defend and the court later finds it was wrong it will not only be required to pay its obligation but it will be unable to argue about any settlements reached by the insured or the insured’s other insurers. It seems best, where there is any question of the need to defend is to do so under a full reservation of rights and if, after the case is over, to seek reimbursement from the insured. Otherwise the insurer is gambling that it will have no control over the defense, the cost of defense, or any settlement made by the insured with the third party.
© 2012 – Barry Zalma
Barry Zalma, Esq., CFE, has practiced law in California for more than 40 years as an insurance coverage and claims handling lawyer. He also serves as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud. Mr. Zalma serves as a consultant and expert, almost equally, for insurers and policyholders.
He founded Zalma Insurance Consultants in 2001 and serves as its senior consultant.
Mr. Zalma recently published the e-books, “Zalma on Insurance Fraud – 2012″; “Zalma on Diminution in Value Damages – 2012,”“Zalma on Insurance,” “Heads I Win, Tails You Lose — 2011,” “Zalma on Rescission in California,” “Arson for Profit” and others that are available at www.zalma.com/zalmabooks.htm.