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By Jennifer L. Gibbs
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2017 was a busy year for insurance practitioners, legislators and jurists. The year brought a number of long-awaited Texas Supreme Court opinions, ranging from a case of simple contract construction to a lengthy opinion addressing the high-stakes question regarding the circumstances under which a policyholder is permitted to recover benefits under the Insurance Code. The Fifth Circuit also issued a few notable insurance-related opinions in 2017, including the resolution of a split as to whether asbestos is a “pollutant” for purposes of the pollution exclusion. The year also saw the introduction and passage of legislation aimed at minimizing abuses in weather-related claim and litigation matters.[1] The legislation became effective just days after Hurricane Harvey struck the Texas coast, causing estimated losses reaching $200 billion and also likely ensuring several more years of active property insurance litigation in Texas.

As 2017 draws to a close, we summarize the cases that made this year memorable and will influence coverage decisions and disputes in 2018.

Texas Supreme Court Opinions

The Big Kahuna — USAA Texas Lloyds Co. v. Menchaca

The most notable insurance opinion of the year was issued by the Texas Supreme Court on April 7, 2017 in USAA Texas Lloyds Co. v. Menchaca, a case involving storm damage to residential property sustained during Hurricane Ike.

After a jury found that USAA did not breach the contract, the trial court still entered an order allowing Menchaca to recover damages in the absence of a breach of contract. The Court of Appeals affirmed. The Texas Supreme Court was then asked to decide “whether an insured can recover policy benefits as actual damages caused by an insurer’s statutory violation absent a finding that the insured had a contractual right to the benefits under the insurance policy. Stating that “[g]enerally, the answer to this question is ‘no’, but the issue is complicated and involves several related questions. In an effort to clarify these issues, we distill from our decisions five distinct but interrelated rules that govern the relationship between contractual and extracontractual claims in the insurance context.”[2]

The Texas Supreme Court then laid out the following five rules:

1. The General Rule: An insured cannot recover policy benefits as damages for an insurer’s statutory violation if the policy does not provide the insured a right to receive those benefits.[3]
2. The Entitled to Benefits Rule: An insured who establishes a right to receive benefits under the insurance policy can recover those benefits as actual damages under the Insurance Code if the insurer’s statutory violation causes the loss of benefits.[4]
3. The Benefits-Lost Rule: Even if the insured cannot establish a present contractual right to policy benefits, the insured can recover benefits as actual damages under the Insurance Code if the insurer’s statutory violation caused the insured to lose that contractual right.[5]
4. The Independent Injury Rule: If an insurer’s statutory violation causes an injury independent of the loss of policy benefits, the insured may recover damages for that injury even if the policy does not grant the insured a right to benefits.[6]
5. The No-Recovery Rule: An insured cannot recover any damages based on an insurer’s statutory violation if the insured had no right to receive benefits under the policy and sustained no injury independent of an alleged right to benefits.[7]

The fourth stated rule has caused the most confusion. This rule requires the insured to assert damages that are truly independent of any policy benefits in that they may not “flow” or “stem” from denial of policy benefits.[8] Notably, mental anguish damages were the only type of damages identified by the court as possible “independent injury” damages. The court further noted that the application of this rule “would be rare, and we in fact have yet to encounter one.”[9]

Because of the “confusion that our precedent caused in the litigation and appeal of this case,”[10] the court reversed the court of appeals’ judgment and remanded the case for a new trial. Notably, USAA filed a motion for rehearing, arguing the court’s opinion needs to be revised due to substantial confusion regarding the interpretation of the opinion and how it should be applied by the courts.

UPDATE: On Friday, Dec. 15, the Texas Supreme Court granted USAA’s motion for rehearing.

The Ongoing Fully Adversarial Trial Debate — Great American Insurance Company v. Hamel

In Great American Insurance Company v. Hamel,[11] the Texas Supreme Court clarified its prior decision in State Farm Fire & Casualty Co. v. Gandy,[12] and held that when the parties reach an agreement before trial or a settlement that deprives one of the parties of its incentive to oppose the other, the proceeding is no longer adversarial.

The case involved an underlying lawsuit brought by the Hamels against their home builder for failing to construct the home in a good and workmanlike manner. The builder’s general liability insurer, Great American, refused to defend the builder and the Hamels obtained a judgment against the builder. The builder then assigned most of its claims against Great American to the Hamels. The Hamels subsequently sought to recover the judgment from Great American.

Notably, the week before trial, the parties entered into a Rule 11 agreement by which the Hamels agreed not to enforce a favorable judgment against any of the builder’s assets (except the insurance policy) in exchange for the builder’s agreement to appear at trial without seeking a continuance.

The court of appeals affirmed most of the trial court’s judgment, “holding that Great American breached its duty to defend the Builder from the Hamels’ suit, the Damage Judgment was the result of a fully adversarial trial, and the Builder’s assignment of its claims against Great American to the Hamels was valid.”[13]

The Texas Supreme Court clarified 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 thus the defendant-insured’s covered liability loss.”[14] Stated differently, “proceedings lose their adversarial nature when, by agreement, one party has no stake in the outcome and thus no meaningful incentive to defend itself.”[15]

The court then concluded that “the pretrial agreement effectively removed any financial stake the builder had in the outcome of the Damage Suit, thereby eliminating any meaningful incentive the builder had to oppose the Hamels’ claims.[16] Under those circumstances, the Court reasoned that the Damage Judgment was not binding under Gandy. The Court held that “the Damage Trial was not fully adversarial and [therefore] the resulting judgment is not binding on Great American.”[17]

A Fence is a “Dwelling”— Nassar v. Liberty Mut. Fire Insurance Co.

In Nassar v. Liberty Mut. Fire Insurance Co.,[18] the Texas Supreme Court found that fencing attached to the insureds' house by bolts or cement was unambiguously covered under the policy's “dwelling” provision, rather than under the “other structures” provision.

The claim involved damage sustained during Hurricane Ike to the insured’s rural property in Richmond, Texas. The applicable policy issued by Liberty Mutual provided coverage under the policy’s “dwelling” provision and additional coverage under the policy’s “other structures” provision.

The Nassars disputed Liberty’s coverage position that the fencing did not qualify as a “dwelling.” The applicable policy provision stated that coverage was afforded for “the dwelling on the residence premises shown on the declarations page including structures attached to the dwelling.”[19] Residence premises was defined to include “the one or two-family dwelling, including other structures, and grounds where an insured resides or intends to reside within 60 days of the effective date of this policy.”[20]

The Texas Supreme Court looked to the dictionary, which defines “structure” as “any construction, production, or piece of work artificially built up or composed of parts purposefully joined together” and defines “attach” as “to annex, bind, or fasten.” [21] The court then found that the fencing around the Nassars’ property was artificially constructed and “composed of parts purposefully joined together” and was fastened to the dwelling; and therefore, the Nassars’ policy interpretation was reasonable and the applicable policy language was unambiguous. The court then reversed and remanded the case to the trial court.

This case is notable because the provision at issue is likely found in thousands of similar homeowners’ policies.

The Attorney-Client Privilege Alive and Well — In re Nat'l Lloyds Insurance Co.

In keeping with the historically strong protection of the attorney-client privilege, the Texas Supreme Court recently held that nonprivileged information pertaining to attorneys’ fees, such as a request for hourly rates, total amount billed and total reimbursable expenses, was not relevant, and thus not discoverable.

In re Nat'l Lloyds Insurance Co. involved four multidistrict litigation cases in which homeowners sued National Lloyds Insurance Company, Wardlaw Claims Service Inc., and Ideal Adjusting Inc. asserting breach of contract, statutory and extracontractual causes of action.[22] During the pending litigation, National Lloyds asserted that the homeowners’ attorney’s fees claims were excessive. Two months before trial, the insureds issued discovery requests regarding the insurer’s hourly rates, expenses, billing invoices and indicia of payment. The insureds asserted that the opposing party’s attorney’s fees could be considered as a factor in determining a reasonable fee recovery.[23]

In a split decision, the majority of the Texas Supreme Court held that even if the factual information about hourly rates and aggregate attorney fees was not privileged, that information was generally irrelevant and thus not discoverable because it does not establish or tend to establish the reasonableness or necessity of the attorney fees an opposing party has incurred. The court found that “Absent a fee-shifting claim, a party's attorney-fee expenditures need not be reasonable or necessary for the particular case.”[24] The court further stated that “[b]arring unusual circumstances, allowing discovery of such information would spawn unnecessary case-within-a-case litigation devoted to determining the reasonableness and necessity of attorney-fee expenditures that are not at issue in the litigation. This is not a proper discovery objective.”[25] Notably, the court cautioned that “[a]ttorney-billing information may be discoverable by virtue of the opposing party designating its counsel as a testifying expert.”[26]

Fifth Circuit Opinions

Asbestos is a “Pollutant”— Longhorn Gasket and Supply v. Trinity Lloyd’s Insurance Co.

Deciding an issue that has divided courts across the country, the U.S. Court of Appeals for the Fifth Circuit, applying Texas law, ruled that asbestos is a “pollutant” for purposes of an insurance policy’s pollution exclusion. The case involved a dispute over whether a gasket manufacturer’s liability policies provided coverage for lawsuits due to alleged exposure to asbestos-containing gaskets manufactured by the insured.

Recognizing that the case law is varied on this issue and because the pollution exclusion in the policy listed “irritant, contaminant, or pollutant,” the Fifth Circuit looked at the definitions of all three terms, and found that asbestos is both an irritant and a pollutant.

The court thus held that the underlying claims fell within the pollution exclusion because they claimed bodily injury arising out of the discharge, dispersal, release or escape into the atmosphere and originated with an irritant and pollutant (asbestos). Notably, the court did not decide whether the “sudden and accidental” exception to the pollution exception applied and remanded the case to the district court to determine whether that exception applied.

Prompt Payment of Appraisal Award Precludes Extracontractual Claims —Mainali Corp. v. Covington Specialty Insurance Co.

In Mainali Corp. v. Covington Specialty Insurance Co., the Fifth Circuit Court of Appeals confirmed that, under Texas law, an insurer’s prompt payment of an appraisal award precludes recovery for alleged violations of the Texas’ Prompt Payment of Claims Act.[27]

The appraisal panel issued an award on an actual cash value basis. Although the appraisal award totaled less than the prior payments by Covington, an additional payment was issued to the insured due to an allocation by the appraisal panel for building damage.[28]

Covington then sought summary judgment on the claims in the pending litigation. Mainali argued that Covington’s post appraisal payment was subject to the Prompt Payment of Claims Act in Chapter 542 of the Texas Insurance Code.[29] The district court granted Covington’s motion. On appeal, the Fifth Circuit Court of Appeals was asked to decide whether a payment made to comply with an appraisal award, which in most cases is going to be paid after the 60-day window, is subject to this penalty. Noting that “no reported Texas case has ever subjected such a payment to the statute” — the court held that prompt payment of an appraisal award under the policy precludes an award of penalties under the Insurance Code’s prompt payment provisions.[30]

The Mainali case is important because it was decided after the Texas Supreme Court’s opinion in Menchaca.

Both the 5th Circuit and Texas state courts continue to hold that prompt payment of an appraisal award precludes claims for both breach of contract and prompt payment statutory violations and that nothing in Menchaca changes that analysis.[31]

Other Notable Cases — Waiver Regarding Right to Appraisal

In two separate cases, the 14th District Court of Appeals in Houston held that denial of an insured's claim does not always constitute waiver of the right to appraisal.

In In re State Farm Lloyds,[32] State Farm admitted that the policy covered part of the loss, but did not pay because the amount of the loss fell below the policy's deductible. State Farm denied coverage for other damage. After the insured filed suit, State Farm answered, demanded a jury and then invoked the appraisal provision in the applicable policy.

The insureds argued that State Farm waived the appraisal provision. Recognizing that State Farm did not deny the claim in its entirety, and noting that the insured provided no evidence that State Farm waived the appraisal provision in writing, as required by the policy, the court refused to find waiver of the right to demand appraisal.

Similarly, in Pounds v. Liberty Lloyds of Texas Insurance Co.,[33] another panel of the Houston 14th District Court of Appeals found that the insured had not proven that its insurer waived the right to invoke appraisal. In that case, the denial letter from the insurer invited the insured to contact the claims representative if he had any questions or concerns about his claim. The court found that this language indicated that an impasse had not yet been reached.[34] The court also noted that the applicable policy also required that “a waiver or change of a provision of this policy must be in writing by [Liberty Lloyds] to be valid.”[35]

For the above reasons, and the lack of any evidence regarding prejudice to establish waiver, the court held that the trial court did not abuse its discretion when it compelled appraisal under the homeowners' policy and the insured did not demonstrate that insurer waived its right to invoke appraisal under the policy.

Other Notable Cases — Duty to Allocate/Segregate and Late Notice

Certain Underwriters at Lloyd's of London v. Lowen Valley View LLC[36] presents many of the key issues facing the commercial property insurance industry such as multiple dates of loss, pre-existing damage, late reporting and allocation/segregation. The insurance coverage dispute involved hail damage to the insured’s hotel in Irving, Texas, potentially caused by a number of hail events occurring between 2006 and 2014. The claim was first reported to the insurer on Dec. 29, 2014, identifying a June 13, 2012, date of loss.[37]

The insurer denied coverage on the basis that the insured failed to give notice until over two and a half years after the alleged hailstorm and the late notice prejudiced the insurer’s ability to properly investigate the claim.[38] The insurer then filed a declaratory judgment action, asking the court to declare that there was no coverage under the policy due to late notice and prejudice. The insurer sought summary judgment, attaching to its motion for summary judgment an affidavit from the adjuster describing how the late notice impacted his investigation of the claim. The insurer argued that the insured failed to provide any evidence either that the present damage was solely due to the June 12, 2012, storm or upon which a jury could reasonably allocate the present damage between the June 2012 storm and several documented hail events occurring outside the coverage period. In support of this position, the insurer pointed to the insured’s own weather history reports showing eight hail events occurred outside the policy period that could have caused the damage and also noted that the insured did not select the date of the loss; but rather the insurance agent selected the date after reviewing the weather reports and noticing that one hail event occurred during the policy period.[39]

Emphasizing the insured’s burden to establish evidence to allow the jury to segregate covered losses from noncovered losses, the court found that the insured failed to raise a genuine issue of fact on this point, and granted summary judgment in favor of the insurer.

The court also ruled as a matter of law that the insured’s notice of claim given over 30 months after the damage allegedly occurred was not prompt. As for the prejudice requirement, the court noted that “even if the Court were to disregard Phipps's sworn testimony as to how his inspection was impacted by the delay, the Court would still find as a matter of law that the late notice resulted in tangible prejudice to Underwriters because the evidence shows that the cost to repair the damage increased by $47,802.67, or roughly ten percent, between June 2012 and January 2015.”[40] The court, therefore, held that the insurer was entitled to summary judgment on late notice grounds, as well.[41]

This opinion follows the Fifth Circuit’s holding in Hamilton Properties [42] and reaffirms the principle that a significant delay in reporting a claim constitutes late notice and, if the insurer’s investigation was impacted as a result, prejudice can be proven as a matter of law. Once the insurer proves prejudice, the insured’s breach of contract and extracontractual causes of action fail as a matter of law. 

Jennifer L. Gibbs is a partner with Zelle LLP in Dallas.

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] Insurance Takeaways from Texas’ New Hailstorm Bill at http://www.zellelaw.com/assets/htmldocuments/Insurance%20Takeaways%20From%20Texas%20New%20Hailstorm%20Bill%20%20%20.pdf

[2] Id. at *4.

[3] Id. at *8. (This rule derives from the fact that the Insurance Code only allows an insured to recover actual damages “caused by” the insurer’s statutory violation. See Tex. Ins. Code §541.151.)

[4] Id. at *9. (This is based on the general rule that an insured cannot recover policy benefits from an insurer’s extra-contractual violation if the policy does not provide the insured a right to those benefits.)

[5] Id. at *9-10. (This rule can apply in the context of claims alleging that an insurer misrepresented a policy’s coverage, waived its right to deny coverage or is estopped from doing so, or committed a violation that caused the insured to lose a contractual right to benefits that it otherwise would have had.)

[6] Id. at *11. (There are two separate aspects of this independent injury rule. The first is that if an insurer’s statutory violation causes an injury independent of the insured’s right to recover policy benefits, the insured may recover damages for that injury even if the policy does not entitle the insured to receive benefits. The second aspect of the independent-injury rule is that an insurer’s statutory violation does not permit the insured to recover any damages beyond policy benefits unless the violation causes an injury that is independent from the loss of the benefits.)

[7] Id. at *12. (The fifth and final rule is simply the natural corollary to the first four rules.)

[8] Menchaca at *12.

[9] Id.

[10] Id. at *15.

[11] 525 S.W.3d 655 (Tex. 2017).

[12] 965 S.W.2d 696 (Tex. 1996).

[13] Hamel, at 662.

[14] Id. at 666.

[15] Id.

[16] Id. at 671.

[17] Id.

[18] 508 S.W.3d 254 (Tex. 2017).

[19] Id. at 256.

[20] Id.

[21] Id. at 258.

[22] Id. at *1.

[23] Id. at *2.

[24] Id. at *1. [26] Id. at

[25] Id. The dissent opined that the attorney-expert witness would be subject to cross-examination and possible impeachment by his own billing records. Id. at *17.

[26] Id. at *14.

[27] 872 F.2d 255, 257 (5th Cir. 2017).

[28] Id.

[29] Id.

[30] Id. at 259.

[31] See, e.g., Nat'l Sec. Fire & Cas. Co. v. Hurst, 523 S.W.3d 840 (Tex. App.—Houston [14th Dist.] 2017) (no pet.) (holding insurer's tender of payment following appraisal estopped insured from recovering for breach of contract, and insurer was not liable for claims of bad faith and unfair settlement practices); Ortiz v. State Farm Lloyds, No. 04-17-00252-CV, 2017 WL 5162315 (Tex. App. —San Antonio, Nov. 8, 2017) (Court granted summary judgment in favor of insurer after prompt payment of appraisal award); Cano v. State Farm Lloyds, No. 3:14-CV-2720-L, 2017 WL 3279139 (N.D. Tex. Aug. 2, 2017) (finding appraisal award that was greater than initial estimate payment could not be used as evidence of breach of contract, especially where underlying contract provided for resolution through appraisal; insureds did not suffer independent injury from insurer's delay in payment between initial payment and its timely payment of appraisal award; insured could not seek damages for any delay in payment between initial payment and insurer's timely payment of appraisal award; and insureds abandoned or waived their fraud and conspiracy-to-commit-fraud claims).

[32] 514 S.W.3d 789, 794–95 (Tex. App. – Houston [14th Dist.] 2017) (orig. proceeding).

[33] 528 S.W.3d 222 (Tex. App.—Houston [14th Dist.] 2017) (no pet. hist.).

[34] Id. at 227.

[35] Id. at 226.

[37] Id. at *2.

[38] Id.

[39] Id. at *9.

[40] Id. at *15.

[41] The case is currently on appeal to the 5th Circuit.

[42] No. 3:12-CV-5046-B, 2014 WL 3055801 (N.D. Tex. July 7, 2014).