Texas Courts Dice and Slice Through Duty to Defend Issues and Evaluate the Mix of the (Ham)el Adversarial Proceeding Requirement and Texas No-Direct-Action Rule

September 21, 2021

Well, summer 2021 has come and (almost) gone. As we move into the fall, considerable uncertainty still exists as to the effects of and how to manage the issues presented by the COVID-19 pandemic. From an insurance coverage perspective, insurers continue to dominate in litigation. As of September 14, 2021, insurers have secured wins in almost 93% of the reported cases. While many of these decisions have not yet exhausted the appellate process, it goes without saying that it has been an uphill battle all the way for insureds. Without legislative intervention, most businesses likely will not be able to recover COVID-19 losses from their insurers absent specific pandemic-type coverage.

There have been more positive happenings for insureds in the non-COVID, third-party liability side of things, with several recent opinions going in favor of the duty-to-defend. In one case, Crum & Forster Specialty Insurance Co. v. Chemicals, Inc., Judge Lee Rosenthal, Chief United States District Judge for the Southern District of Texas, issued an opinion holding that Crum & Forster Specialty Insurance Company (“Crum & Forster”) owes a duty to defend under the commercial general liability policies it issued to Chemicals, Inc. (“Chemicals”), for underlying lawsuits alleging personal injuries from chemical exposures.[1] The complaints contained allegations that the plaintiffs sustained injuries from exposures to toxic substances in aqueous film-forming foams that were designed, manufactured, and marketed by several defendants, including Chemicals. These complaints also included allegations that the exposures to these substances occurred during the plaintiffs’ employment as military or civilian firefighters. The complaints did not, however, contain allegations regarding dates as to when the plaintiffs were exposed or when their symptoms first manifested.

The Crum & Forster policy required that “bodily injury” first occur during the “policy period.” The policy also had a “Continuous or Progressive Damage or Injury” condition added by endorsement, which stated: “If the date cannot be determined upon which such ‘bodily injury’ . . . first occurred[,] . . . then . . . such ‘bodily injury’ . . . will be deemed to have occurred or existed . . . before the ‘policy period’.”[2] Based on this, the issue was whether this additional condition to coverage was met by the allegations in the complaints and, if so, whether the allegations triggered Crum & Forster’s duty to defend.

The court recognized that the “default” rule in Texas is that an insurer owes a duty to defend when the dates of loss are not alleged in a pleading but could, potentially, fall within the policy period and be determined in future proceedings.[3] Crum & Forster argued that the plain language of the policy superseded the “default” rule, asserting that, “An injury will be deemed to fall outside the policy ‘[i]f the date cannot be determined upon which such “bodily injury” . . . first occurred or existed.’”[4] The court disagreed:

Because Crum & Forster did not unambiguously reserve the right to unilaterally determine whether a date of loss can be determined, the Texas default rule applies. The policy stated only that the date can “be determined,” not who must make the determination, or that it must be made with no evidence or opportunity to present it.[5]

Based on the allegations that the underlying plaintiffs were exposed to and potentially injured during the applicable policy periods, Crum & Forster could not meet its burden to show that the dates of damage could not be determined or that the allegations in the underlying pleadings were not within the scope of the policy.[6] Rather, the court found that the underlying complaints supported the potential for coverage, as the allegations created a reasonable inference that injury could have first occurred during the policy period.[7]

In another case, Landry’s, Inc. v. Ins. Co. of the State of Pennsylvania, the Fifth Circuit determined that the Insurance Company of the State of Pennsylvania (“ICSOP”) had a duty to defend Landry’s in an underlying data-breach lawsuit.[8] In the opinion, the Fifth Circuit addressed a developing area of law regarding insurance claims for data breach and cyber liability, finding coverage for the insured while also providing a rather memorable (and quotable) line in reaching its holding.

Landry’s faced a lawsuit from its credit card processing company for losses arising out of a data breach that occurred at multiple Landry’s-owned restaurants. Landry’s sought coverage under its commercial general liability policies issued by ICSOP and subsequently sued ICSOP after it refused to defend. The policy broadly obligated ICSOP to “pay those sums that [Landry’s] becomes legally obligated to pay as damages because of ‘personal and advertising injury’” and stated that ICSOP “will have the right and duty to defend [Landry’s] against any ‘suit’ seeking those damages.” The policy defined “[p]ersonal and advertising injury” as “injury . . . arising out of” several offenses, including “[o]ral or written publication, in any manner, of material that violates a person's right of privacy.”[9]

The district court found that “[n]one of the . . . ‘personal and advertising injury’ triggers were implicated by the allegations” because there were no allegations of a “publication” as contemplated by the policy.[10] Rather, because the underlying plaintiff asserted only that “[a] third party hacked into [the] credit card processing system and stole customers’ credit card information,” there was no allegation of “violat[ion] [of] a person’s right of privacy” because the lawsuit involved the payment processor’s contract claims, not the cardholders’ privacy claims.[11]

In reversing, the Fifth Circuit rejected this narrow interpretation, explaining that “[t]he contractual text and structure suggest the parties intended the broadest possible definition of ‘[o]ral or written publication.’”[12] This, according to the court, means that “even merely ‘exposing or presenting [information] to view’” will meet the “publication” requirement for coverage.[13] This is consistent with how courts have viewed the meaning of “publication” in the context of evaluating coverage for defamation claims.[14]

Turning to the next issue of whether the second component, “violat[ion] [of] a person’s right of privacy,” was satisfied, the court noted as follows:

ICSOP urges us not to follow the plain text of the Policy and instead to alter it. In ICSOP’s view, the Policy covers only tort damages “arising out of . . . the violation of a person’s right of privacy.” Thus, ICSOP suggests, it might defend Landry’s if it were sued in tort by the individual customers who had their credit-card data hacked and fraudulently used. But ICSOP thinks it bears no obligation to defend Landry’s in a breach-of-contract action brought by [the credit card processing company]. Of course, the Policy contains none of these salami-slicing distinctions.[15]

Relying on Lamar Homes, Inc. v. Mid-Continent Casualty Co., the Fifth Circuit reiterated that, under Texas law, the proper inquiry of whether a duty to defend exists focuses on the facts alleged as opposed to the labels attached to the claims in the underlying suit.[16] As a result, the Fifth Circuit held that ICSOP had a duty to defend Landry’s in the underlying lawsuit.

Finally, in Turner v. Cincinnati Insurance Co.,[17] the Fifth Circuit evaluated the interplay between the Supreme Court of Texas’ 2017 decision in Great American Insurance Co. v. Hamel[18] and the Texas’ no-direct-action rule. In Hamel, the Court clarified that any judgment rendered against a defendant insured without a fully adversarial trial will not be binding on the insurance company for the defendant insured.[19] In particular, the Court explained that a judgment does not bind an insurer unless, “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.”[20]

In Turner, six plaintiffs obtained a default judgment against an insured and subsequently filed a coverage action to collect on that judgment from the insurer.[21] The district court found that the plaintiffs lacked standing under Texas’ “no-direct-action” rule to sue the insurer without either an adversarial judgment against the insured or a valid assignment from the insured.[22] In evaluating whether the default judgment against the insured satisfied the no-direct-action rule that would allow the plaintiffs to maintain their coverage suit directly against Cincinnati, the court focused on Hamel.[23]

The court explained that, from Hamel and cases that came before it, a general principle exists under Texas law that “an insurer that wrongfully refuses to defend its insured is barred from collaterally attacking a judgment or settlement between the insured and the plaintiff.”[24] The Fifth Circuit postured the issues as follows:

From the Texas Supreme Court’s no-direct-action rule decisions, we know that “the general rule is that an injured party cannot sue the [insured–defendant’s] insurer directly until the [insured–defendant’s] liability has been finally determined by agreement or judgment.” See In re Essex[Ins. Co., 450 S.W.3d 524, 525 (Tex. 2014)] (ellipses omitted). Texas’s highest court, though, has not decided a case involving the no-direct-action rule in the context of plaintiffs obtaining a judgment that is potentially insufficient. At the same time, the court decided each of the cases in the Hamel line — including Hamel, Gandy, ATOFINA, and Block — without any reference to the no-direct-action rule. We must determine whether there is any overlap.[25]

In Landmark American Insurance Co. v. Eagle Supply & Manufacturing, L.P., a Texas court of appeals applied the no-direct-action rule and Hamel together, holding that two non-adversarial judgments did not satisfy the no-direct-action rule.[26] In that case, a third-party plaintiff sought to enforce two non-adversarial judgments against the insured–defendant’s insurer. The court found that the policy’s “no direct action” provision in the policy itself precluded the third-party plaintiff from pursuing the insurer directly.[27]

The Landmark court held that, “without a sufficient judgment against [the insured–defendant], [the third-party plaintiff] does not have a ripe claim under the no-direct-action rule to pursue a breach of contract claim as a judgment creditor against [the insurer].”[28] Thus, the Landmark court held that the judgments against the insured–defendant did not satisfy the no-direct-action rule because neither was “the result of a fully adversarial trial under Hamel and Gandy.”[29]

The Fifth Circuit, however, declined to follow Landmark, explaining that Cincinnati’s policy provision did not include language requiring an actual trial, but rather an “adjudication”:

No action shall be taken against us unless, as a condition precedent thereto, there shall have been full compliance with all of the terms of this policy and until the obligation of the “policy insureds” to pay shall have been finally determined, either by an adjudication against them or by written agreement of the “policy insureds,” the claimant and us. Any person or organization or the legal representative thereof who has secured such judgment or written agreement shall thereafter be entitled to recover under this policy to the extent of the insurance afforded by this policy. Bankruptcy or insolvency of a “policy insured” or of a “policy insured’s” estate shall not relieve us of any of our obligations hereunder.[30]

In reaching this decision, the Fifth Circuit explained that it was required to take the language of the “no-direct-action” provision literally. Thus, the court determined that the Supreme Court of Texas would hold as follows:

First, the “general rule” applies, i.e., a third-party plaintiff is barred from suing the defendant’s insurer, when the third-party plaintiff has obtained neither a judgment nor agreement of any kind establishing the insured–defendant’s liability.

Second, if the third-party plaintiffs obtain a judgment, then the court must look to the language of the no-action clause to determine whether it is the sort of judgment that satisfies the no-direct-action rule. For example, if the no-action clause contains an “actual trial” requirement, then the judgment must be sufficiently adversarial under Hamel . . . .[31]

The court held that the clause in Cincinnati’s policy did not require an actual trial; rather, the plaintiffs must have obtained “an adjudication against” the insured before bringing an action directly against Cincinnati. Based on this, the court held that the default judgment was, under the circumstances before the court, sufficient to overcome the no-direct-action rule, but the default judgment was not sufficient to bind Cincinnati to the judgment under Hamel.[32] In fact, the court determined that the Cincinnati policy did not provide coverage.[33]

COMMENTARY

Whew! That was a long read. We apologize for the length and that we have not communicated more frequently . . . . But, major props if you are still paying attention!

Both Chemicals and Landry’s reiterate that, when evaluating the duty to defend, insurers should be cognizant that courts will broadly interpret the policy in favor of coverage. As evidenced by the policy language in Chemicals, insurers have introduced (and will continue to introduce) manuscript language trying to shift the burden of proof to the insured. Hopefully, courts will continue to see through this tactic and continue to place the burden of establishing whether a limitation on coverage exists on the insurer—as required by Texas statute and extensive case law. Turner adds another complex and esoteric rule when evaluating whether judgments against an insured bind an insurer. The court did, however, make sure to point out that, when in doubt, focus on the plain language of the policy.

If you have been a loyal follower of our blogs, you know that the Supreme Court of Texas is likely to soon address whether a major exception to the eight-corners rule applies. For those that may have missed out on the developments, read up here. We will be sure to keep you apprised of the results of that decision and any other cases that include references to deli meats.

Stay tuned . . .

Sincerely,

Lee Shidlofsky
Member

Douglas P. Skelley
Member

Rebecca DiMasi
Member

Blake Crawford
Senior Counsel

[1] No. CV H-20-3493, 2021 WL 3423111, at *1 (S.D. Tex. Aug. 5, 2021).

[2] Id. at *1.

[3] Id. (citing See Lyda Swinerton Builders, Inc. v. Okla. Sur. Co., 903 F.3d 435, 447 (5th Cir. 2018); Indian Harbor Ins. Co. v. KB Lone Star, Inc., No. H-11-CV-1846, 2012 WL 3866858, at *14 (S.D. Tex. Sept. 5, 2012) (“Texas courts have held that a carrier is obligated to defend when the underlying petitions are silent about the time of the damage.”) (citing Gehan Homes, Ltd. v. Employers Mut. Cas. Co., 146 S.W.3d 833, 845–46 (Tex. App.—Dallas 2004, pet. denied))).

[4] Id.

[5] Id. (citing Pendergest-Holt v. Certain Underwriters at Lloyd’s London, 600 F.3d 562, 571 (5th Cir. 2010) (“[I]f an insurer ‘wants the unilateral right to refuse a payment called for in the policy, the policy should clearly state that right.’”).

[6] Id. at *2 (citing Allied Prop. & Cas. Ins. Co. v. Clean N Go, LLC, 290 F. Supp. 3d 619, 623 (E.D. Tex. 2017); Indian Harbor Ins. Co. v. KB Lone Star, Inc., 2012 WL 3866858, at *14 (S.D. Tex. Sept. 5, 2012) (finding a duty to defend when the insurer “ha[d] not met its burden to establish as a matter of law that the property damage did not happen during the policy period”)).

[7] Id.

[8] Landry’s, Inc. v. Ins. Co. of the State of Pa., 4 F.4th 366 (5th Cir. 2021).

[9] Id. at 368.

[10] Id.

[11] Id.

[12] Id. at 369.

[13] Id.

[14] See id. at 370 (citing Exxon Mobil Corp. v. Rincones, 520 S.W.3d 572, 579 (Tex. 2017)).

[15] Id. at 371.

[16] Id. (citing Lamar Homes, Inc. v. Mid-Continent Cas Co., 242 S.W.3d 1, 15–16 (Tex. 2007)).

[17] 9 F.4th 300 (5th Cir. 2021).

[18] 525 S.W.3d 655 (Tex. 2017).

[19] Id. at 663, 666.

[20] Id. at 666.

[21] 9 F.4th at 304.

[22] Id.

[23] Id. at 309–10.

[24] Id. at 310 (citing Hamel, 525 S.W.3d at 662–63; Evanston Ins. Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660, 671 (Tex. 2008), Employers Cas. Co. v. Block, 744 S.W.2d 940, 943 (Tex. 1988)).

[25] Id. at 311.

[26] 530 S.W.3d 761, 770–72 (Tex. App.—Eastland 2017, no pet.).

[27] Id. at 770. The provision at issue stated:

No action will be taken against [Landmark] unless, as a condition precedent, the Insured is in full compliance with all of the terms of this policy and until the amount of the insured’s obligations to pay shall have been finally determined, either by judgment against the insured after actual trial, or by written agreement of the insured, the claimant and the Company.

Id. It is also of note that, unlike in Hamel, the insurers in Landmark did not breach the duty to defend. See id. at 771 n.3.

[28] Id. at 772.

[29] Id.

[30] 9 F.4th at 311–12.

[31] Id. at 312.

[32] Id. at 313.

[33] Id. at 317.