Texas Supreme Court reins in agreements between plaintiffs and insureds

On June 16, 2017, the Texas Supreme Court issued its opinion in Great American Insurance Company v. Hamel, holding that an insured’s defense is not “fully adversarial” if a pretrial agreement removed any financial consequences for the insured. Generally speaking, when an insurer breaches its duty to defend, that insurer is barred from collaterally attacking a judgment against the insured. But under a twenty-year-old precedent, even a breaching insurer is not bound by a judgment that did not result from a “fully adversarial” proceeding. The Great American decision clarifies that the fully-adversarial standard is not satisfied if a pretrial agreement or settlement “deprives one of the parties of its incentive to oppose the other.” This holding will likely prevent plaintiffs from entering the type of pretrial agreements with insureds that remove the adversarial nature of the case and transform the trial into a “mere formality.”

Background

The Hamels filed suit over defective construction of their house in Flower Mound, Texas. The thrust of the allegations was that poor materials and workmanship allowed water to collect behind the synthetic stucco facade of the home, rotting portions of the structure. The defendant contractor, Terry Mitchel Builders, submitted the case to its general liability carrier, Great American Insurance. Great American refused to defend the claim arguing, at the time, that the loss was excluded from the relevant policy. After the underlying case was decided, Great American would go on to admit that its refusal to defend was wrongful. Without the benefit of a defense by Great American, Terry Mitchell Builders was barely able to defend the suit, much less to pay a judgment. As a result, the contractor agreed on the eve of trial to stipulations of liability in exchange for a promise that the plaintiffs would not pursue the owner of the business personally. With the contractor lacking any financial incentive to further defend the case, the resulting “trial” consisted of little more than the judge reviewing the stipulations and entering judgment for the plaintiffs.

After trial, the insured assigned his rights against Great American to the plaintiff who filed a suit to collect against the policy. That case, too, had a trial before the bench. Great American argued that it was not liable, despite its failure to properly defend the insured, because the underlying trial was not “fully adversarial.” The focus of the insurance-coverage trial was on whether the parties below were adversarial enough to validate the judgment as against Great American. Based on the trial record in the underlying trial, the court found that the judgment was enforceable against Great American. The appellate court affirmed.

Rule of Law

The Texas Supreme Court held that the parties were not fully adversarial and thus the judgment was subject to collateral attack by Great American. But the court also held that where an insurer wants to make such an attack, a subsequent insurance-coverage trial can relitigate the issues and render the judgment enforceable. Because the focus of the insurance-coverage trial was the extent of adversity, rather than the merits of the dispute, the Supreme Court remanded for a new trial.

State Farm Insurance Co. v. Gandy holds that whereas an insurer normally may not collaterally attack a judgment in which it breached its duty to defend the insured, the insurer is not bound by a judgment that does not arise from a fully adversarial trial. After all, a trial in which the parties are not truly adverse proves little about the merits.  This case clarifies that the trial is not fully adversarial if a pretrial agreement or settlement removes all financial incentive for the insured to defend the case. Moving forward, “the presence of such an agreement creates a strong presumption that the judgment did not result from an adversarial proceeding, while the absence of such an agreement creates a strong presumption that it did.” In holding that the underlying issues can be relitigated in the insurance-coverage case, the Texas Supreme Court stopped short of giving Great American its desired holding. The insurance company argued that a lack of full adversity under Gandy poisoned the proceedings once and for all. To the contrary, the court held that while a lack of adversity prevents the plaintiff from using the findings in that trial against the insurance company, it does not prevent the plaintiff from establishing liability by other means in the subsequent insurance-coverage case.

Likely Impact on Insurance Carriers and Plaintiffs

This case mitigates one risk that insurance carriers face when they refuse to defend a claim. Namely, that the insured will abandon the defense and make admissions that place liability on the insurer. But carriers are now faced with the prospect of relitigating the merits of the insured’s case. Thus, this may incentivize carriers to defend questionable cases in the first instance.

Plaintiffs must now rethink the validity of their pretrial agreements with undefended insureds. Plaintiffs now know that if they remove the insured’s financial incentive to defend the case too early, they will have to prove the merits of the coverage against the insurance carrier in a subsequent action. Thus, instead of releasing the insured in exchange for admissions of liability, plaintiffs may choose to fully litigate the case against the insured who lacks the benefit of a defense by the carrier.

Click here to read the opinion.