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By Shannon M. O'Malley
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Insurance practice in Texas has become somewhat rote. Typically, a petition is filed against both an insurance company (that is often not based or incorporated in Texas) and a local adjuster. In addition to a breach of contract claim, the lawsuits always allege boilerplate allegations including the breach of the common law duty of good faith and fair dealing and violations of Sections 541 and 542 of the Texas Insurance Code.

Insured plaintiffs invoke these provisions strategically in order to (1) avoid federal jurisdiction and (2) pressure the insurance company to settle quickly to avoid statutory penalties. For example, under Section 541, which prohibits misrepresentation regarding a policy or an insurer, the legislature essentially codified the common law “bad faith” cause of action against the insurance company and the individual adjuster, thereby permitting a local Texas defendant to be added to the litigation. Of course, under well-established Texas law, the insured plaintiff must allege an independent injury against the adjuster, including damages that are separate and apart from the amount due under the policy. This statutory bad faith cause of action is also still subject to the defenses available under the common law duty of good faith and fair dealing requirements. Namely, when there is a bona fide dispute among the parties, a court typically will not find an insurer liable under the common law or Section 541. To the extent a fact finder determines the existence of an independent injury and that the insurer violated Section 541, a plaintiff may recover his or her actual damages, plus court costs and reasonable attorney fees. If the fact finder determines the insurer knowingly committed the act complained of, those damages may be trebled.

Section 542 is more commonly known as the “prompt payment statute.” Its provisions apply only to the insurance company (not the individual adjuster) and require the company to respond to claims and make payments due within certain delineated time frames. Arguably problematic about the prompt payment statute is that even if there is a bona fide coverage or measurement dispute, if a court finds that an insurer’s coverage interpretation (though reasonable) is wrong, the insurer is likely subject to Section 542 penalties. And those penalties can be steep — in addition to the amount of the unpaid claim, the insurer must pay 18 percent per year as damages, together with attorneys’ fees.

Accordingly, an insurance company that legitimately disputes an insured’s claim is often subject to potentially severe penalties regardless of its good faith adjustment of the claim. This is especially true when an insured presents a claim months or even years after a loss, thereby hindering an insurer’s ability to promptly investigate a claim, particularly in the situations where the claim bears evidence of both covered and uncovered causes of loss, and where an insured files suit without notice to the insurer that a dispute even exists between the parties.

And while there certainly may be instances where insurance companies appropriately face the penalties imposed by the Texas Insurance Code, the reality is that most insurance companies attempt to settle claims fairly, promptly and in good faith. When there is a bona fide dispute (or when the insured submits a late or supplemental claim unsupported by any evidence of additional damage) and the parties’ differences are demonstrable, the appraisal provision included in most policies may be invoked to assist in the resolution of the dispute. And Texas courts — both federal and state — definitively recognize that the prompt payment of an appraisal award ends an insurer’s exposure for breach of contract, breach of the duty of good faith and fair dealing, and Sections 541 and 542 of the Texas Insurance Code, thereby providing the insurer with a safe haven from the common boilerplate allegations of statutory violations now included in every Texas lawsuit.

Prompt Payment of an Appraisal Award Precludes Breach of Contract

Typically, insurance policies contain the following (or similarly worded) appraisal provision:

B. Appraisal. If we and you disagree on the value of the property, the amount of loss or the net income and operating expenses, either may make a written demand for an appraisal of the loss. In this event, each party will select a competent and impartial appraiser. The two appraisers will select an umpire. If they cannot agree, either may request that selection be made by a judge of a court having jurisdiction. The appraisers will state separately the value of the property, the amount of loss or the net income and operating expenses. If they fail to agree, they will submit their differences to the umpire. A decision agreed to by any two will be binding. Each party will:

1. Pay its chosen appraiser; and

2. Bear the other expenses of the appraisal and umpire equally.

If there is an appraisal, we will still retain our right to deny the claim.

The threshold for invoking this provision requires that the parties actually disagree on the amount of loss at issue. In fact, some courts in Texas have prohibited an insured from invoking this provision unless the insured can provide some support for the amount of loss claimed.

If an appraisal is properly invoked, however, under Texas law, “an insurer’s timely payment of a binding and enforceable appraisal award, and the insured’s acceptance of payment, estops the insured from maintaining a breach of contract claim against the insurer.” Therefore, if an insurer promptly pays that portion of the award due under the policy, the insured’s breach of contract claim is no longer viable. This is true even if the award is greater than that amount previously paid or measured by the insurer.

If the Insured Cannot Maintain a Breach of Contract Claim, the Insured is also Precluded from Bringing a Common Law or Section 541 Bad Faith Claim

Courts further recognize that an insured’s bad faith claim — under either the common law or Section 541 of the Texas Insurance Code — is also precluded if an insurer promptly pays an appraisal award. The Houston Court of Appeals discussed this in detail recently in Anderson v. American Risk Insurance Company Inc. After discussing Texas courts’ approval of appraisal provisions and their effective use to “provide a means to resolve disputes about the amount of loss for a covered claim,” the court reiterated Texas law that “absent a breach of contract, the insured cannot maintain a common law bad faith claim in Texas unless the insurer ‘committed some act, so extreme, that would cause injury independent of the policy claim’ or fails to timely investigate the insured’s claim.” The “independent injury” exception was discussed in the Texas Supreme Court’s opinion in Republic Insurance Co. v. Stoker, but the Anderson court noted that in the 21 years since that opinion, no Texas court has yet held that recovery is available based upon an insurer’s extreme act.

The Anderson court further extrapolated that because a common law bad faith could not be maintained in the absence of a breach of contract claim (when an appraisal award is promptly paid), an insured is also precluded from bringing statutory bad faith claims under Section 541 of the Texas Insurance Code. The court noted that “Texas law holds that extra-contractual tort claims pursuant to the Texas Insurance Code and DTPA require the same predicate for recovery as a bad faith claim under a good faith and fair dealing violation.” Accordingly, the court determined that when there is no merit for a common law bad faith claim, there is similarly no merit under the Texas Insurance Code.

Other courts have recognized this harmony. For example, recently, the Fifth Circuit in Quibodeaux determined an insured “must first show that the insurer breached the contract” in order to prevail on a common law bad faith claim. The court further recognized that the same requirement for a valid breach of contract claim “applies to claims for statutory bad faith under Chapter 541 of the Insurance Code and Trade Practices Act.” Because the insured could not demonstrate breach of contract after the insurer promptly paid the appraisal award, the court affirmed dismissal of the insured’s bad faith claims.

Similarly, in Reyna, the court recognized the derivative nature of an insured’s bad faith claims with a breach of contract claim and found timely payment estopped an insured from bringing a bad faith claim.

Prompt Payment Claims Under Section 542 Are also Precluded When an Insurer Promptly Pays an Appraisal Award.

Finally, courts also find that liability under Section 542 of the Texas Insurance Code is precluded when an insurer promptly pays an appraisal award. In Quibodeaux, the Fifth Circuit recognized that under Texas law, “a plaintiff may not seek Chapter 542 damages for any delay in payment between an initial payment and the insurer’s timely payment of an appraisal award.”

Similarly, the Anderson court reiterated Texas law that “full and timely payment of an appraisal award under the policy precludes an insured from recovery of penalties under section 542.058 as a matter of law.”

Therefore, when an insurer promptly pays an appraisal award, it may avoid the 18 percent per annum penalty under Section 542 and attorneys’ fees.

Conclusion

The Anderson, Reyna and Quibodeaux cases are discussed above in detail because they represent the most recent (in the last 60 days) recognition by courts that prompt appraisal award payments essentially end an insurer’s exposure for breach of contract and extracontractual claims. By no means are these cases outliers, however.

The advent of parties’ increased use of the appraisal provision since the Texas Supreme Court’s decision in State Farm Lloyds v. Johnson, created an influx of case law addressing the effect of prompt payment of an appraisal award. And courts in addition to the three discussed above almost universally have recognized the benefits of prompt payment to both parties.

Essentially, by properly invoking an appraisal provision, and promptly paying any award due under that provision, insurers can be assured that their liability for claims will be resolved once and for all and the benefits of the policy’s alternative dispute resolution process are met. And the insurer need not be concerned about the boilerplate statutory bad faith allegations now included in every lawsuit.

—By Shannon M. O'Malley

Shannon O'Malley is a partner at Zelle LLP's Dallas office. She focuses her practice on analyzing complex and novel property insurance coverage issues.

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.