| Dear Colleague,
The Supreme Court of Texas issued a significant opinion last week. In USAA Texas Lloyd’s Co. v. Menchaca, 14-0721, 2017 WL 1311752 (Tex. Apr. 7, 2017), the Court stated that, “In light of the parties’ obvious and understandable confusion over our relevant precedent and the effect of that confusion on their arguments in this case, we conclude that a remand is necessary here in the interest of justice.” The Court seemingly recognized a new appellate point—confusion! Practice tip: This new appellate point likely applies only in insurance cases, so proceed with caution.
Oh, and the Court ruled on an important insurance issue as well. If you’re like Lee and have been thinking about first-party bad faith claims for the last twenty years (Seriously! See Lee H. Shidlofsky, The Changing Face of First-Party Bad Faith Claims in Texas, 50 S.M.U. L. Rev. 867 (1997)), then you spent last weekend happily curled up with a glass of pinot and a copy of the Menchaca opinion. But you haven’t thought about first-party bad faith claims for twenty years and you didn’t spend the weekend reading Menchaca because, well, you’re sane.
In all seriousness, Menchaca presented the Court with an opportunity to “provide clarity regarding the relationship between claims for an insurance policy breach and Insurance Code violations.” A tension had developed in Texas law between the Court’s rulings in Vail v. Texas Farm Bureau Mutual Insurance Co., 754 S.W.2d 129, 136 (Tex. 1988), on the one hand, and Provident American Insurance Co. v. Castañeda, 988 S.W.2d 189 (Tex. 1998), on the other.
The Vail court held that an insured who is wrongfully denied policy benefits need not show any injury independent from the denied policy benefits. The Vails purchased fire insurance from Texas Farm Bureau Mutual Insurance Company, and subsequently a fire destroyed their home and its contents. Texas Farm Bureau’s agent told the Vails the company would not willingly pay the claim, and Texas Farm Bureau, living up to that prediction, denied the claim. The Vails sued Texas Farm Bureau, and the case proceeded to trial on the Vails’ statutory and breach of the common law duty of good faith and fair dealing claims. The Court concluded as follows:
We hold that an insurer’s unfair refusal to pay the insured’s claim causes damages as a matter of law in at least the amount of the policy benefits wrongfully withheld.
Vail established that an insured can recover policy benefits as damages for an unfair settlement practices claim, without any requirement of an independent injury. That holding was uncontroversial until the Supreme Court of Texas’ decision in Castañeda ten years later.
In Castañeda, the insured purchased a health insurance policy from Provident American Insurance Company. The policy did not cover expenses resulting from sicknesses manifesting within thirty days of the policy’s effective date or disorders of internal organs, including the gallbladder, within six months of the effective date. The insured’s two children (also insured under the policy) were diagnosed with hemolytic spherocytosis (HS) thirty-three days after the effective date of the policy; however, they had exhibited symptoms of HS all of their lives. Provident denied coverage for the splenectomy and gallbladder removal for the insured’s daughter. She sued Provident, alleging violations of the Texas Deceptive Trade Practices Act and Article 21.21 of the Texas Insurance Code. The jury awarded $50,000 in damages and the trial court trebled those damages. The Supreme Court of Texas reversed the award, holding that “none of the actions or inactions of Provident American was the producing cause of any damage separate and apart from those that would have resulted from a wrongful denial of the claim.” In particular, the Court agreed with Provident “that its conduct in handling the claim did not cause any injury independent of the denial of policy benefits.” The Court seemed to require an injury independent of the contractual damages for a bad faith claim to exist.
Courts latched on to that language and routinely stated that the Supreme Court of Texas had implicitly overturned Vail. Most notably, the Fifth Circuit, in Parkans International, LLC v. Zurich Insurance Co. 299 F.3d 514 (5th Cir. 2002), and Great American Insurance Co. v. AFS/IBEX Financial Services, 612 F.3d 800 (5th Cir. 2010), limited the damages available to an insured for a first-party bad faith claim to independent injuries, not policy benefits. In Parkans, the insurer had not breached the contract, and the Fifth Circuit held that, there “can be no recovery for extra-contractual damages for mishandling claims unless the complained of actions or omissions caused injury independent of those that would have resulted from a wrongful denial of policy benefits.” In AFS/IBEX Financial Services, the claim was covered by the policy, and the Fifth Circuit reaffirmed its holding in Parkans. Countless federal district court opinions did the same. And, Texas intermediate courts of appeals got into that act as well and for nearly twenty years an insured had to establish an independent injury to successfully prosecute an extra-contractual claim in many, if not most, courts in Texas.
The Supreme Court of Texas had an opportunity to right the ship in In re Deepwater Horizon, 807 F.3d 689, 698 (5th Cir. 2015), on certified questions from the Fifth Circuit, but that case settled before the Court could address the question of whether an insured must allege and prove an injury independent from the denied policy benefits to maintain an extra-contractual claim. The issue came up again in Menchaca, and nearly twenty years after Castañeda, the Supreme Court had its opportunity to clarify the law on the issue.
The factual background in Menchaca is relatively straightforward—Gail Menchaca’s home was damaged by Hurricane Ike, she made a claim on her homeowner’s policy issued by USAA, and the claims adjuster determined that, although there were damages to the home, the estimated amount of the costs of repair were less than the deductible. Five months later, at Menchaca’s request, USAA sent another adjuster to re-inspect the home, that adjuster reached the same conclusion, and USAA again denied the claim. Menchaca sued USAA for breach of the insurance policy and for unfair settlement practices in violation of the Texas Insurance Code. The jury found that USAA had not breached the policy; however, it also found that USAA had engaged in various unfair or deceptive practices resulting in $11,350 in damages—the difference between what should have been paid under the policy and what was actually paid. Thus, the applicability of the independent injury rule was set for review. The Supreme Court of Texas framed the issue before it as follows:
The primary issue is whether the insured can recover policy benefits based on jury findings that the insurer violated the Texas Insurance Code and that the violation resulted in the insured’s loss of benefits the insurer “should have paid” under the policy, even though the jury also failed to find that the insurer failed to comply with its obligations under the policy.
Recognizing the “substantial confusion” among courts and the parties regarding the issue and taking into account William Blackstone’s observation that “seldom will it happen that any one rule will exactly suit with many cases,” the Supreme Court set out “five distinct but interrelated rules that govern the relationship between contractual and extra-contractual claims” in the first-party context.
The General Rule—“[A]an insured cannot recover policy benefits for an insurer’s statutory violation if the insured does not have a right to those benefits under the policy.” The General Rule is a restatement of the Supreme Court’s ruling in Republic Ins. Co. v. Stoker, 903 S.W.2d 338, 341 (Tex. 1995). In Stoker, the insurer initially denied the claim based on an improper reason, then issued a subsequent, valid denial. The trial court granted the insurer’s motion for summary judgment against the insured’s breach of contract claim; however, the case proceeded to trial on the bad faith claims, and the jury found the insurer liable on the extra-contractual claim and awarded policy benefits, the only damages alleged and proved at trial. The court of appeals affirmed, but the Supreme Court held that as “a general rule there can be no claim for bad faith when an insurer has promptly denied a claim that is in fact not covered.” Id. at 341. The Menchaca Court stated that “a more accurate statement of the rule we announced in Stoker is that ‘there can be no claim for bad faith [denial of an insured’s claim for policy benefits] when an insurer has promptly denied a claim that is in fact not covered.’” The Court in Menchaca expressly disagreed with USAA’s argument, which carriers have been making for years, that “an insured can never recover policy benefits as damages for a statutory violation.”
The Entitled-to-Benefits Rule—“[A]n insured who establishes a right to receive benefits under an insurance policy can recover those benefits as ‘actual damages’ under the statute if the insurer’s statutory violation causes the loss of the benefits.” The Court called the Entitled-to-Benefits Rule “a logical corollary to the general rule,” first recognized in Vail. The Court cleared up the longstanding confusion between Vail, Stoker, and Castañeda—“We did not reject the Vail rule in Stoker or in Castañeda.” To be absolutely clear, the Court explained the interplay between the General Rule and the Entitled-to-Benefits Rule as follows:
In short, Stoker and Castañeda stand for the general rule that an insured cannot recover policy benefits as damages for an insurer’s extra-contractual violation if the policy does not provide the insured a right to those benefits. Vail announced a corollary rule: an insured who establishes a right to benefits under the policy can recover those benefits as actual damages resulting from a statutory violation. We clarify and affirm both of these rules today.
Under this corollary rule, it is clear that an insured my seek policy benefits for a statutory violation without alleging or proving an independent injury, so long as the insured is entitled to those policy benefits.
The Benefits-Lost Rule—“[A]n insured can recover benefits as actual damages under the Insurance Code even if the insured has no right to those benefits under the policy, if the insurer’s conduct caused the insured to lose that contractual right.” The Benefits-Lost Rule appears to have limited application. As the Court stated, it has “recognized this principle 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.” In other words, if the insurer’s statutory violation causes the loss of benefits, then the insured again may seek policy benefits as damages for extra-contractual claims without alleging or proving an independent injury.
The Independent-Injury Rule—“[A]n insurer’s extra-contractual liability is ‘distinct’ from its liability for benefits under the insurance policy.” The Court explained that there are two “aspects” of this rule: First, “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 “actual damages” recoverable under this scenario, however, must be “truly independent of the insured’s right to receive policy benefits.” The “second aspect” of the rule states 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.” The Court recognized that a recoverable independent injury would be rare and refused to speculate regarding possible examples.
The No-Recovery Rule—“[A]n insured cannot recover any damages based on an insurer’s statutory violation unless the insured establishes a right to receive benefits under the policy or an injury independent of a right to benefits.” The last rule, a “natural corollary to the first four rules,” appears uncontroversial—an insured cannot recover if they cannot establish damages, either in the form of policy benefits or an independent injury.
In short, the Supreme Court made clear that no independent injury is required to support an extra-contractual claim in a first-party case if the insured is entitled to policy benefits or if the insurer’s actions caused the insured to lose policy benefits. The Court’s summary sets out the standards in their logical order:
We clarify today that 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. An insured who establishes a right to receive benefits under the policy can recover those benefits as actual damages under the Insurance Code if the insurer’s statutory violation causes the loss of the benefits. And an insured can recover benefits as actual damages under the Insurance Code even if the insured has no contractual right to those benefits if the insurer’s conduct caused the insured to lose that right. 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 insured is not entitled to receive benefits under the policy. But if the policy does entitle the insured to benefits, the insurer’s statutory violation does not permit the insured to recover any actual damages beyond those policy benefits unless the violation causes an injury that is independent from the loss of the benefits. Finally, 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 a right to benefits.
Having recognized the confusion in the law and having set out these clarifying rules, the Court remanded Menchaca’s case for a new trial in the interest of justice.
Commentary
Vindication! Lee has been saying for years that Castañeda did not overturn Vail and that the Supreme Court of Texas did not require an independent injury for extra-contractual claims if the insurer wrongfully denied policy benefits. He claims to have predicted the other rules announced in Menchaca, but we think that’s the pinot talking. How many insureds over the last twenty years were told by their lawyers and the courts that their extra-contractual claims had little or no merit because they could not prove any damages beyond the loss of policy benefits? Or if they could prove an independent damage, how many insureds did not pursue their valid claims because those damages, even when trebled, were insubstantial compared to the contractual damages? Menchaca represents a “reset” for policyholders and corrects the course of developments in this area of the law over the last couple of decades. Some commentators are already saying Menchaca is unwieldy or will present challenges in its application. Others are saying the ruling muddies the waters more than clarifies the issues and rules. The Supreme Court of Texas, however, has gone a long way in Menchaca toward clearing up this area of the law after twenty years of policyholders’ claims being dismissed or never being made because of a misinterpretation of the law.
Sincerely,
Lee Shidlofsky
Member
Douglas P. Skelley
Member
Rebecca DiMasi
Member
Henri Nicolas
Senior Counsel
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