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Dec 10, 2018

The Enforceability of Exclusions Amidst Defects in the Issuance of Surplus Lines Insurance Policies

By: Elliott Cooper

With its ruling in Seger v. Yorkshire Insurance Co., Ltd.,[1] the Texas Supreme Court provided clarity for parties litigating certain coverage disputes involving surplus lines insurance policies.  Prior to Seger, plaintiffs frequently attempted to construe provisions of the Texas Insurance Code applicable to the procurement of surplus lines policies to prevent such carriers from enforcing their policies’ exclusions. 

The plaintiffs in Seger argued that there were defects in the issuance of the surplus lines policies at issue.  While the insurers successfully demonstrated that they were eligible surplus lines carriers in Texas, and that the policies had been procured by a licensed surplus lines agent, the plaintiffs established the following deficiencies: (1) the premium tax had not been paid on the policies; (2) the agent did not complete a diligent search for authorized insurance; (3) the policies did not contain requisite informational language; (4) the policies did not contain the address of each insurer; (5) the agent did not make a reasonable effort to determine the financial condition of each insurer; and, (6) the agent did not verify that all of the insurers were eligible to write in Texas. 

The plaintiffs argued that, as a result of these defects, the carriers were precluded from asserting policy exclusions under section 981.005(a) of the Texas Insurance Code.  This section provides that an eligible surplus lines policy is valid and enforceable unless a material and intentional violation of Chapter 981 exists.  The plaintiffs further argued that these defects made the surplus lines insurers “unauthorized insurers” under Texas Insurance Code section 101.201(a), which would render the policy unenforceable by the insurer.  Thus, as unauthorized insurers of a policy with material violations of the Texas Insurance Code, plaintiffs claimed that the carriers could not rely on any coverage exclusions in the applicable policies.

The Texas Supreme Court analyzed what “unenforceable” means in the context of these statutes and noted that both of these Texas Insurance Code sections provide the insured the option of enforcing the contract to obtain the amount of their claim or loss.  As such, while the policy is unenforceable as to the insurer, the insured retains the right to enforce the contract.  The Court concluded that this makes the policy voidable, which describes an agreement that can be affirmed or rejected at the option of one of the parties. 

As a result, the plaintiffs were presented with two options: (1) enforce their rights under the contract; or, (2) rescind the contract.  If the plaintiffs elected to rescind the contract, they would be entitled to a refund of the premiums paid for the policy.  However, if the plaintiffs sought to enforce the policy, they would be bound by all of the policy’s terms, including any exclusions:

Despite the fact that the burden to prove policy exclusions rests on the Stowers Insurers, the exclusions are provisions that ultimately determine coverage, and the Segers must accept those terms if they want to enforce the policy itself. See Tex. Ins. Code § 981.005(b) (“A material and intentional violation of this chapter ... does not preclude the insured from enforcing the insured's rights under the contract.” (emphasis added)); Tex. Ins. Code § 101.201(a) (recognizing that an insured can recover “the full amount of a claim or loss under the terms of the contract ” from a person who assists in the procurement of an insurance contract from an unauthorized insurer (emphasis added)).[2]

The Texas Supreme Court, therefore, rejected the plaintiffs’ arguments that sections 101.201 and 981.005 of the Texas Insurance Code precluded the surplus lines insurer from asserting policy exclusions when the plaintiffs are relying on the policy to present their case.  Instead, the plaintiffs must accept all of the policy’s terms and conditions—including unfavorable ones—and the insurers are free to plead and prove that policy exclusions bar coverage.

[1] Seger v. Yorkshire Insurance Co., Ltd., 503 S.W.3d 388 (Tex. 2016).

[2] Id. at 406.