By: Doug Rees
The existence of insurance coverage drives a lot of claims and often determines a claimant’s level of interest in pursuing their claim. These dynamics are often at play in construction claims, particularly in the residential context. Homebuilders and other residential contractors often do not have much in the way of assets and the only means for satisfying any potential judgment is often an insurance policy.
The existence of an insurance policy or policies of course does not necessarily mean there is coverage for the claim. This is certainly true for a construction defect claim under a general liability policy. Insurance carriers often contest and deny coverage for such claims, leaving their insured to fend for themselves in defending against the litigation. While this leaves the insured strapped and having to fund their own defense, it also creates a bit of a quandary for the claimant, who has to determine whether the claim is worth pursuing, given the potential that any ultimate recovery may be limited or non-existent.
Having a claimant pursue only the insurance policy proceeds is an attractive option to both the claimant and the insured defendant. Assignments of an insured’s claims against its insurance carrier are therefore often considered when an insurance carrier has contested coverage. The extent to which any such assignment will be recognized as legitimate and enforceable has long been and continues to be a hotly debated topic. The Texas Supreme Court has held that set up or sham assignments will not be recognized because they violate public policy. The difficulty comes in determining what constitutes a sham or set up judgment. What does it take for an assignment to be legitimate? Further complicating matters is the fact that most assignments involve a situation where the insurance carrier has denied coverage. An insurer’s breach of its duty to defend generally strips the carrier of its ability to challenge any covered judgment and makes any covered judgment binding on the insurer. So what happens when an insurer wrongfully denies coverage and the claimant and the insured reach an agreement to assign the insured’s claims to the claimant and work together to obtain a judgment so that the claimant can pursue the claims against the carrier? The Texas Supreme Court was recently presented with such a situation and basically held that you simply litigate the case again between the claimant and the insurance carrier.
Great American Insurance Co. v. Hamels was decided by the Texas Supreme Court on June 30, 2017. The case involved a residential construction claim against a builder who had been hired by the Hamels to build a home for them. The builder was actually the second builder hired by the Hamels, as the original builder had abandoned the project before completion. The builder was insured by Great American who had issued general liability policies to the builder insured over five consecutive policy periods during the late 1990’s. The house was constructed with an Exterior Insulation and Finish System (EIFS). The last two Great American policies contained an EIFS exclusion and Great American denied the claim, taking the position that the damages manifested themselves during the last policy period, when they were discovered, triggering the EIFS exclusion in their final policy period. Great American’s position, however, turned out to be wrong, as the Texas Supreme Court later clarified that Texas would follow the “injury in fact” rule and not the “manifestation rule,” triggering the earlier policies without the EIFS exclusion. Great American later conceded that it had wrongfully refused to defend the insured.
The builder did hire a lawyer to represent it in the underlying action but had limited assets to fund its defense. The case went to trial, resulting in a judgment that was entered following a bench trial and the issuance of findings of fact and conclusions of law by the trial court. The insured assigned its claims against Great American to the Hamels following the conclusion of the trial and the entry of the judgment. The Hamels then filed suit against Great American as the assignee and judgment creditor of the insured builder asserting a claim for breach of contract and for declaratory relief seeking to recover on the judgment. Great American contested the assignment and contested the Hamels’ claim, challenging the assignment and claiming that the trial was conducted and the judgment was issued under highly suspicious circumstances and that the assignment was therefore void as against public policy. Great American essentially claimed that the judgment was issued without a fully adversarial trial and was therefore void as against public policy, citing to the Supreme Court’s 20 year old decision of State Farm v. Gandy.
This case presented an interesting issue for the Supreme Court because it was different than the Gandy case. In Gandy, State Farm was actually defending the case and the insured went around the carrier and entered into a settlement with the claimant without notice to State Farm. As part of its ruling in Gandy, the Court held that in no event will a judgment rendered without a fully adversarial trial be binding on the defendant’s insurer or admissible as evidence of damages in an action against the defendant’s insurer by a plaintiff as the insured’s assignee. The question was therefore what constitutes a “fully adversarial trial?”
The Court first noted that the validity of the assignment itself was not at issue. It was issued after and not before the trial and before judgment was entered and the carrier breached its duty to defend and did not even make a good faith effort to adjudicate any coverage issues prior to a resolution of the claims against its insured by filing a declaratory judgment action. A valid assignment is not enforceable, however, unless there is a fully adversarial trial and so the Supreme Court still had to address that issue.
The builder actually had counsel and participated in the trial of the Hamels’ claim. The question was how much of a fight did they actually put up. The Supreme Court noted how difficult it is to evaluate and determine the level of effectiveness of a party’s trial performance. The Court of Appeals actually determined that the insured’s performance at the trial was sufficient to constitute a fully adversarial trial. The Supreme Court held that it is not possible to accurately evaluate an insured’s performance at the trial to determine its “adversarial” nature. Instead, the Supreme Court held “that the controlling factor is whether, 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 insure that the judgment or settlement accurately reflects the plaintiff’s damages and thus the defendant-insured’s covered liability loss.” The insured builder had reached a pre-trial agreement with the Hamels that they would not seek to pierce the corporate veil or to enforce the judgment against the builder’s owner individually so long as the builder would appear at trial and not seek a continuance. The parties also executed stipulations of fact in lieu of responding to the Hamels’ outstanding requests for admissions that steered the claims and damages toward coverage. The stipulations were not actually introduced at trial but the builder testified consistent with those stipulations. The Supreme Court held that this pre-trial agreement eliminated any meaningful incentive for the builder to contest the judgment, making the proceeding no longer adversarial. The pre-trial agreement effectively removed any financial stake that the builder had in the outcome of the litigation.
Having determined that the judgment against the builder was not binding on the builder’s insurer, the Court was faced with the issue of what happens with the insurance claim. Great American, of course, argued that the unenforceable assigned judgment ended the inquiry and it should have no responsibility for the claim. Citing to the Court’s language from its earlier Gandy opinion, Great American argued that “it is very difficult to determine what might have been” once the parties have changed positions after a settlement. The Supreme Court acknowledged that such an inquiry should ordinarily be avoided absent compelling reasons, but found that the insurer’s wrongful refusal to defend presents a compelling reason to engage in such an endeavor. According to the Court, “[t]he insurer should not benefit from the problem it helped create, as Great American’s proposed solution-rendition of judgment in its favor-would allow.” The Court held that the parties could simply re-litigate the insured’s underlying liability in the coverage action. The Court found that the Hamels and Great American had been focused primarily on coverage issues in the litigation of the coverage action and not the insured’s liability on the underlying claim and therefore remanded the case for a new, more comprehensive trial on the claims in the coverage litigation.
The Court was obviously trying to strike a balance. It was not going to reward a carrier for refusing to provide coverage when it should have, but was also seeking to prevent claimants and insureds from being able to manipulate what is supposed to be an adversarial system resulting in an enforceable judgment. Claimants and insureds will no longer be able to reach an agreement prior to an actual trial on the merits, even if they go through the motions of a trial, no matter how much they dress it up. Efforts will likely be made to have a “fully adversarial trial” based on a wink and a nod without an actual agreement or assignment until after a judgment has been entered but that is a case for a later day. On the other hand, carriers will not be able avoid their coverage obligations simply because a sham judgment has been entered against their insured and will have to address the merits of the claim following an assignment. One issue that will be interesting to watch is whether it will now matter when the assignment is issued when a carrier wrongfully denies coverage. If the liability of the insured can be litigated in the coverage action, a claimant and an insured may very well be tempted to assign the insured’s claims to the claimant after the carrier initially denies coverage and let the claimant try to pursue the claim and the coverage action against the carrier.