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By Shannon M. O'Malley
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In Gotham Insurance Co. v. Warren E&P Inc.,[1] the Texas Supreme Court recently addressed an age-old and often-asked question: Can an insurer recoup money paid to its insured when it later learns it overpaid? The answer: Insurers can only look to the terms of their policies and cannot rely upon claims in equity.

This thorny issue arose out of an oil well explosion and fire that occurred in 1997. The insured, Warren E&P Inc. (Pedeco), entered into a joint venture with two other companies, Warren Resources Inc. (WRI) and Oil Technology Fund (Fund), to drill a series of wells, including the well that blew out in 1997. The parties also entered into a joint operating agreement that covered the blowout well and designated Pedeco as the operator. The agreement determined that Pedeco possessed 12.5 percent cost-bearing working interests, while the WRI and the Fund possessed the remaining interests.

Gotham Insurance Co. insured Pedeco, but not WRI or the Fund. The policy provided coverage for expenses incurred to regain or attempt to regain control of a blown-out well, to the extent of the insured’s working interest. At the time of the loss, Pedeco notified Gotham of the blowout and represented that it was the sole operator and held a 100 percent working interest in the well. This representation was repeated by Pedeco’s insuring agent and on its sworn proof of loss. Based on these representations, Gotham paid claims totaling over $1.8 million to Pedeco.

After it issued payment, Gotham acquired the joint operating agreement through other sources, thereby discovering that Pedeco’s interest in the well was limited. Gotham then inquired of Pedeco whether it had a 100 percent working interest in the well, as previously reported, in light of the joint operating agreement. Pedeco responded that it held 100 percent of the equitable title to the well under a farmout agreement; was the sole performing party under turnkey drilling agreements; would have full liability in the event of a blowout; and paid a premium for its full interest in the well.

In response to this statement, Gotham ceased any further payments under the claim and intervened in an ongoing lawsuit between Pedeco and its subcontractors. Gotham alleged that Pedeco breached the policy by misrepresenting its interest and sought reimbursement of its prior payments under the alternative theories of restitution and unjust enrichment. Gotham also sued WRI and the Fund under equitable recovery theories, alleging that those parties were contractually responsible to pay for the repair costs. Pedeco counterclaimed for breach of the policy.

The claims were addressed on summary judgment and appealed three times. In the first two appeals, the courts concluded that Gotham should prevail on its restitution and unjust enrichment claims because Pedeco had been reimbursed by WRI, and therefore had not suffered a recoverable loss. On remand, the trial court awarded Gotham judgment for over $1.8 million against Pedeco, WRI and the Fund on the basis of Gotham’s equitable claims for restitution and unjust enrichment.

The third appeal was transferred under docket equalization procedures and the court reversed, holding that Gotham was not entitled to equitable rights of reimbursement under Texas law because those rights did not exist under the terms of the policy. The Texas Supreme Court granted a petition for review to resolve the conflict.

The court determined that, under Fortis Benefits v. Cantu,[2] Gotham could not recover its overpayment under theories of equitable recovery if the insurance policy provided a remedy. In Fortis Benefits, the Texas Supreme Court recognized that “‘equity follows the law,’ … [w]here a valid contract prescribes particular remedies or imposes particular obligations, equity generally must yield unless the contract violates public policy.”[3] Here, the court found that the policy provided Gotham with some form of recovery against Pedeco under the due diligence and misrepresentation clauses.

The court specifically found that the due diligence clause required Pedeco “to comply with regulations and industry standards.”[4] Therefore, to the extent that Gotham could show that Pedeco did not use a blowout preventer in accordance with the Texas Railroad Commissions’ regulations of oil well blowout preventers, it could, for example, recover for breach of the policy under the due diligence provision.

The court also found that Gotham could void the policy under the misrepresentation clause if Gotham could prove that Pedeco made a fraudulent or material misrepresentation that misled Gotham into waiving defenses. The court found both clauses were enforceable and not against public policy. Therefore, the court concluded that the policy “addresses the matters at issue, [and] Gotham may not proceed on its equity claim against Pedeco.”[5]

Similarly, the court determined that Gotham’s equitable claims against the co-venturers WRI and the Fund were also barred. Gotham claimed that its payments to Pedeco discharged the co-venturer’s obligations under the joint operating agreement to share in the repair costs for the well. But because the policy “addresses the matter of Gotham seeking a return of payments that benefitted others,”[6] the court determined the policy’s “salvage and recoveries clause and subrogation clause address Gotham’s ability to recover an overpayment that discharged [the co-venturer’s] obligations.”[7] Therefore, the court found that even equitable claims against third-parties may be governed by an insurance policy.[8]

The moral of the Gotham story is that insurers’ claims for overpayment or repayment are limited to the terms of the insurance policy. Therefore, carriers must ensure that their policies are clearly written to address situations where they are entitled to reimbursement.

For example, the Gotham court recognized that some policies in fact have reimbursement clauses, noting “a reimbursement clause may operate to allow an insurer to recover payments previously made even if the insured did not breach the policy. But the absence of a reimbursement clause does not necessarily foreclose an insurer’s ability to recover if the insured has breached the policy. The insurer may still pursue a claim that the insured’s breach proximately caused its damages, which is subject to any applicable defenses and affirmative defenses.”[9]

The court’s implicit result is that unless an insured is found to have breached some other provision of the policy, such as the due diligence or misrepresentation clause, without a reimbursement clause or another clearly written provision, an insurer is now precluded from recovery for a mistaken overpayment under theories of equity. Alternatively, if an insurance policy does not give an insurer any method of recovery by contract against the insured (for reimbursement, breach, or otherwise), an insurer may then use equitable recovery theories.

—By Shannon M. O'Malley, Zelle Hofmann Voelbel & Mason LLP

Shannon O'Malley is a partner in Zelle Hofmann's Dallas office.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] Gotham Insurance Co. v. Warren E&P. Inc., 57 Tex. Sup. Ct. J. 336, 2014 WL 1190049 (Tex. 2014).

[2] Fortis Benefits v. Cantu, 234 S.W.3d 642 (Tex. 2007).

[3] Gotham, 2014 WL 1190049 at *3, citing Fortis Benefits, 234 S.W.3d at 648-49.

[4] Id. at *4.

[5] Id. at *5.

[6] Id.

[7] Id.

[8] Notably, the Court did not dismiss Gotham’s ability to recover outright. Instead, it remanded the contract claims, noting: “[b]ecause several clauses in the policy address these matters, Gotham must proceed on its contract claim and may only rely on its equity claims if it prevails on its misrepresentation theory and elects the remedy of voiding the policy.” Id. at * 8.

[9] Id. at *6 (emphasis added). The Court recognized, “[b” Id.