Reprinted with permission from the July 28, 2014 edition of Texas Lawyer. © 2014 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited.
In June 2014, the U.S. Court of Appeals for the Fifth Circuit in Graper v. Mid-Continent Cas. Co. affirmed summary judgment in favor of an insurer that had fulfilled its duty to defend its insureds by tendering its chosen attorney, rather than reimbursing the fees charged by the attorney chosen by the insureds. The Fifth Circuit found that, under Texas law, no conflict of interest exists between an insurer and its insured when the insurer defends a claim subject to a reservation of rights, if the issues to be litigated in the underlying action are separate and distinct from issues that determine insurance coverage.
According to the court’s opinion, Mid-Continent issued successive general liability policies to Hallmark Design Homes, a Texas homebuilder, and Hallmark Collection of Homes, its general partner, covering the time period from May 2004 to January 2009. In March 2009, Kipp Flores Architects sued Hallmark and Joe Partain, as principal of the company, alleging that Hallmark had violated several of its copyrights in its architectural designs. Laura and William Graper, also principals of Hallmark, were later added to the suit. The complaint alleged that Hallmark had used the architects’ copyrighted designs when constructing homes and used those same designs in the homebuilder’s advertising material.
As explained by the court, the insureds requested a defense from Mid-Continent, which agreed to defend subject to a reservation of rights. The reservation of rights listed several policy provisions that may have precluded coverage, including: 1. that the injury may not have occurred during the coverage period of the policies; and 2. that the infringing conduct may have been intentional or willful and, therefore, excluded.
In light of the reservations, the insureds notified Mid-Continent that they would select their own counsel because a conflict of interest existed between them and any potential counsel Mid-Continent chose to represent them. Mid-Continent refused to fund the insureds’ defense unless they used its chosen counsel. Refusing to comply, the insureds proceeded to defend the suit against them with their chosen counsel.
The insureds later filed a declaratory judgment action in state court, seeking a determination of their rights under the Mid-Continent policies. The lawsuit was removed to the Southern District of Texas, where Mid-Continent filed a motion to dismiss and a motion for summary judgment, which the district court, finding that Mid-Continent had fulfilled its duty to defend its insureds when it tendered its chosen counsel to represent them. On appeal to the Fifth Circuit, the only issue to decide was whether Mid-Continent was obligated to pay for the insureds’ personal counsel.
Ultimately, the focus of the court’s opinion was as to whether a true conflict existed between Mid-Continent and its insureds. On that, the court turned to Northern County Mutual Insurance Co. v. Davalos from 2004, in which the Supreme Court of Texas recognized that an issuance of a reservation of rights does not create a conflict of interest alone, but can potentially create such conflict. Whether a conflict existed depended on whether the facts the court would determine in the underlying lawsuit were the same facts upon which coverage depended.
Applying that standard, the Fifth Circuit looked first to the “timing of infringement” issue. In the underlying action, the insureds defended against the copyright claims on the grounds that the claims accrued such that the statute of limitations had run. In the coverage action, they argued that the timing of the occurrence and the accrual of the copyright infringement claims “run on the same factual track,” creating a conflict because adjudication of many of the same facts would determine both the insureds’ liability and their coverage.
Rejecting this argument, the Fifth Circuit determined that, in litigating the statute of limitations defense, the insureds only would need to determine when the claim for infringement accrued, not necessarily when the acts of infringement occurred. Because the occurrence of the infringement may have taken place before its discovery by plaintiffs and before the claim accrued, no disqualifying conflict existed under the “same facts” test.
In addition to the issue of timing, the insureds also argued that a conflict existed because the plaintiffs had pleaded for heightened statutory damages based on an argument that they were willful in nature and the Mid-Continent policies contained an exclusion for the knowing violation of the rights of others. The Fifth Circuit explained, however, that a finding of a willful infringement under the Copyright Act does not require proof of knowing conduct. Therefore, a willful infringement would not necessarily trigger the exclusion pertaining to the knowing violation of rights of another. Accordingly, having found no actual conflict under the same facts test, the court upheld the district court’s ruling and Mid-Continent had no obligation to reimburse the insured’s defense costs.
The Fifth Circuit’s holding in this case further narrows the ability of an insured to claim the right to independent counsel under Texas law and falls in line with other recent authority from the federal courts in Texas, including the Fifth Circuit’s 2012 decision in Downhole Navigator, LLC v. Nautilus Ins. Co. and the Northern District of Texas’s 2011 decision in Coats, Rose, Yale, Ryman & Lee, P.C. v. Navigators Specialty Ins. Co., which was affirmed by the Fifth Circuit in 2012. The court’s ultimate holding in Graper is clear—insureds beware and utilize independent counsel with caution, especially when doing so without an insurer’s consent. Until such time as the Supreme Court of Texas weighs in on the independent counsel issue, it appears the right to independent counsel will be governed by these decisions.
Sincerely,
Lee Shidlofsky
Founding Member of Shidlofsky Law Firm
Douglas P. Skelley
Member of Shidlofsky Law Firm
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