As the song goes, “if you’re gonna play in Texas, you gotta have a fiddle in the band.” For insurance coverage purposes, if you’re gonna deny in Texas, what is it insurers gotta have? Based on recent court rulings applying Texas law, the answer appears to be -- patience. While an insurer’s duty to defend its insured in a third-party liability lawsuit can and should be addressed promptly, the question regarding whether a duty to indemnify exists under Texas law may linger for years, even if there is no duty to defend.

D.R. Horton-Texas, Ltd. v. Markel Intern. Ins. Co., Ltd.

On December 11, 2009, the Texas Supreme Court issued its holding in D.R. Horton-Texas, Ltd. v. Markel Intern. Ins. Co., Ltd., -- S.W.3d ---, 2009 WL 4728008 (Tex. Dec. 11, 2009), reversing a state appellate court’s determination that the absence of a duty to defend automatically rules out any duty to indemnify. In the D.R. Horton case, James and Cicely Holmes noticed mold damage in their new home shortly after they moved in. They sued the builder, D.R. Horton-Texas Ltd., alleging that construction defects caused the mold damage. D.R. Horton theorized that the alleged defects were caused, at least in part, by work performed by a masonry subcontractor, Rosendo Ramirez, but the underlying pleadings mentioned nothing about any masonry work performed by Ramirez that may have contributed to the damage. Nevertheless, D.R. Horton tendered the underlying lawsuit to Ramirez’s commercial general liability carrier, Markel International Insurance Co., for a defense. The Markel policy named D.R. Horton as an additional insured, but only for claims relating to Ramirez’s work. When Markel refused to defend D.R. Horton, D.R. Horton retained its own defense counsel and settled the underlying lawsuit. D.R. Horton then sued Markel in a Texas state court for reimbursement of its defense costs and the settlement payment.

In the coverage action, Markel filed a motion for summary judgment, contending that under the eight-corners rule it had no duty to defend D.R. Horton because the underlying complaint did not allege facts triggering coverage for D.R. Horton as an additional insured under the Markel policy. Markel argued that the Texas eight-corners rule limits the analysis of an insurer’s duty to defend to the four corners of the allegations in the underlying complaint and the four corners of the policy. In response, D.R. Horton attached depositions from the underlying case, inspection reports, Ramirez’s insurance policy and other evidence.

The trial court granted summary judgment, finding that Markel owed D.R. Horton neither a duty to defend nor a duty to indemnify. The Houston Court of Appeals (14th District) affirmed, explaining that Markel had no duty to defend D.R. Horton because the underlying allegations did not implicate Ramirez’s work and, since there was no duty to defend, there could be no duty to indemnify. The Texas Supreme Court overturned the lower courts’ decisions, holding that Markel may still have a duty to indemnify D.R. Horton even if it had no duty to defend. The court reasoned that, while the duty to defend is subject to the eight corners rule, an insurer’s duty to indemnify depends on the actual facts proven at trial. Since D.R. Horton presented evidence in its response to Markel’s summary judgment motion that potentially pointed to coverage under the Markel policy, the Texas Supreme Court found that the trial court wrongfully granted summary judgment in favor of Markel regarding the duty to indemnify and remanded the coverage action back to the trial court to proceed on the duty to indemnify issue.

You should note, however, that the Texas Supreme Court’s holding in D.R. Horton did not establish a bright-line rule regarding whether an insurer’s duty to indemnify can be adjudicated before the underlying lawsuit becomes final, but instead, the court in D.R. Horton indicated that such a determination should be made on a case-by-case basis. Id. at *3. Importantly, the holding in D.R. Horton did not overrule the Texas Supreme Court’s previous holding in Farmers Texas County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 83 (Tex.1997), which stated that the lack of a duty to defend can – in some cases – foreclose the duty to indemnify issue. See Griffin, 955 S.W.2d at 84. In Griffin, the underlying lawsuit related to an alleged drive-by shooting that caused injury to Robert Griffin as he was walking down the street in Beaumont, Texas. Mr. Griffin then sued the driver of the vehicle, James Royal III, who sought coverage under his automobile liability policy issued by Farmers Texas County Mutual Insurance Company. With the underlying lawsuit pending, Farmers filed a declaratory judgment action regarding its defense and indemnity obligations under the auto policy. In finding Farmers had no duty to defend or indemnify James Royal in the underlying lawsuit, the court in Griffin held that a trial court may appropriately decide the rights of the parties before judgment is rendered in the underlying tort suit, reasoning that “no facts can be developed in the underlying tort suit that can transform a drive-by shooting into an ‘auto accident.’” Id. at 84. The Griffin court noted, “the duty to indemnify is justiciable before the insured’s liability is determined in the liability lawsuit when the insurer has no duty to defend and the same reasons that negate the duty to defend will likewise negate any possibility the insurer will ever have a duty to indemnify.” Id. Unfortunately for Markel, the Texas Supreme Court found the facts in D.R. Horton to be distinguishable from the facts in Griffin.

Based on the holding in D.R. Horton, the duty to indemnify may arise even though there is no defense obligation. When the coverage facts and the underlying facts are inextricably intertwined, the question regarding duty to indemnify must wait until these facts are fully developed in the underlying lawsuit.

Mid-Continent Casualty Co. v JHP Development, Inc.

In some instances, a premature denial of the duty to indemnify can cause major problems for insurers. In Mid-Continent Cas. Co. v. JHP Development, Inc., 557 F.3d 207 (5th Cir. 2009), the Fifth Circuit Court of Appeals, applying Texas law, recently held that when an insurer denies coverage outright, refusing to defend its insured in an underlying lawsuit, and should that denial be wrongful, the insurer will be bound by any judgment rendered against the insured. In other words, even if the insured goes belly-up in the underlying lawsuit and allows a default judgment to be entered against it, the carrier has no recourse to challenge the underlying judgment and/or amount of damages awarded.

In JHP, TRC and JHP entered into an agreement on January 27, 1999 for the construction of a four-story condominium project. The structure was divided into five units, with one designated as a model. With the exception of the model, the construction plans called for the units to remain partially unfinished until they were sold, so that the buyer could choose the finish for the unit. Excavation began in July 1999, the foundation was poured and completed in the fall of 1999, and concrete masonry unit (CMU) firewalls were installed in the spring of 2000. The model unit was completed in the spring of 2001. At that time, the remaining units still required painting, flooring, plumbing and electrical fixtures, and the activation of the HVAC system. Id at 210.

Due to JHP’s failure to properly water-seal the exterior finishes and retaining walls, large quantities of water penetrated the interior of the structure through ceilings and walls, under doors, and at other points, damaging contiguous building materials and interior finishes, including interior drywall, stud framing, electrical wiring, and wood flooring, prior to the final completion of the project. The water intrusion problems started some time in the summer or fall of 2001. As a result of the damage and JHP’s refusal to repair the damage and complete the work, TRC terminated its construction agreement with JHP and retained a separate contractor to repair and complete the condominiums. The repair and completion of the project cost $2,255,578.53. The new contractor attributed $438,466.77 of that amount to investigating, demolishing, repairing, and replacing the non-defective interior finishes and wiring that were damaged by the water intrusion.

TRC sued JHP for breach of contract, breach of warranty, negligence, and attorney’s fees. JHP timely submitted the petition to Mid-Continent for coverage. Mid-Continent denied JHP’s request for coverage and refused to provide a defense, citing, among other reasons, various policy exclusions precluding coverage for “property damage” to “your work.” On December 22, 2003, a default judgment in excess of $1.5 million was entered against JHP in the underlying lawsuit. A declaratory judgment action regarding coverage ensued. The Fifth Circuit held that Mid-Continent wrongfully denied a defense to JHP in the underlying lawsuit, and because of this breach of the duty to defend, the court found Mid-Continent was bound by the amount of the judgment in the underlying suit. Id. at 217-18 (distinguishing State Farm Fire and Casualty Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996)).

Conclusion

It will be interesting to see how Texas courts apply the holding in D.R. Horton. Policyholders will no doubt argue that D.R. Horton should be given the broadest effect possible while Griffin be relegated as a very narrow exception to the new rule established by D.R. Horton. Insurers, on the other hand, will surely argue the opposite. Time will tell who is right.

In the meantime, when a determination is made that no defense is owed to an insured (or a party claiming to be an insured) in an underlying lawsuit, rather than denying coverage outright and closing the file, the more prudent course of action might be for insurers to be patient and monitor the underlying lawsuit as the facts develop therein. That way, insurers will be better able to control their own destiny, so to speak. Otherwise, as the holding in JHP illustrates, insurers may be looking down the barrel of a multi-million dollar judgment from the underlying lawsuit, stuck with several unfortunate facts that were established during the underlying trial unbeknownst to the insurer.

To learn more about this topic, contact Alex Shilliday at (214) 749-6531. To learn more about our Insurance Practice contact Veronica Bates at (214) 749-6530, or Anthony Cox at
(214) 749-6545.