Limiting the Damage: Fifth Circuit Pares Down Mid-Continent v. Liberty Mutual

A little over two years ago, the Texas Supreme Court issued the landmark decision of Mid-Continent v. Liberty Mutual. In that case, the Court up-ended the traditional relationship of co-insurers by changing the nature of other insurance clauses and stripping away the contribution and subrogation rights of paying carriers against non-paying carriers such that any carrier that pays more than it’s “pro-rata” share of a loss is prevented from asserting a claim against the non-paying carrier.

Not surprisingly, the Mid-Continent decision has made settlement negotiations in multi-carrier cases much more difficult. In many cases, if one or more carriers refuse to participate, or limit their participation, settlement talks stall since any overpayment by another carrier is in essence a voluntary payment without recourse against the non-paying carrier. Many negotiations and attempts at settlement have died because of this seemingly insoluble dilemma.

The Expanded Problem

While the decision has caused many problems, it was at least generally understood that it was limited to the duty to indemnify. One reason is that the duty to defend has never been pro-ratable in Texas — if you have a duty to defend, it is a complete duty, so the “several and independent” language used in Mid-Continent regarding other insurance clauses made no sense in to the duty to defend context.

However, in the months following the issuance of Mid-Continent, several attempts were made to extend the application of Mid-Continent to the duty to defend to avoid paying defense costs being fronted by other carriers, even though several carriers shared the duty.

One such case was Trinity Universal Ins. Co., Utica National Ins. and National American Ins. Co., v. Employers Mutual Cas. Co., 2008 WL 2078202 (S.D. Tex. 2008). In that case, the Federal Court for the Southern District of Texas held that Mid-Continent applied to preclude a right of contribution or subrogation for defense costs.

In Trinity, the insured, Lacy Masonry, was hired to install all of the masonry work and façade items for the construction of a hospital. Unfortunately, the plans called for the installation of a synthetic “exterior insulation and finish system” (EIFS). The system failed, Lacy Masonry was sued, and four insurers were requested to defend and indemnify Lacy Masonry. All but one insurer agreed.

The non-paying carrier denied that it had a duty to defend or indemnify based upon an EIFS exclusion in its policy. All of the policies contained substantially similar “other insurance” clauses, so the three defending carriers brought suit against the non-paying carrier while the underlying lawsuit was pending.

Because the lawsuit alleged faulty workmanship both inside the building and on the façade, the trial court determined that the non-paying carrier had a duty to defend, which it had breached. Nonetheless, that Court, relying on Mid-Continent, held that because all of the policies contained “other insurance” clauses, the defending insurers lost their common law right of contribution from the other co-insurers, and their contractual rights were “several and independent of each other, not joint.”

Simply put, the insurers could not enforce any contractual rights against other insurers with whom they had no contractual relationship. Although Lacy Masonry would be entitled to enforce its contractual rights against the non-paying carrier, Lacy Masonry had no real damages to assert because the other insurers were paying for its defense. The non-paying carrier was rewarded for its incorrect decision to deny payment.

Additionally, the Court determined that the paying insurers had no subrogation rights against it because, by definition, subrogation entails stepping into the insured’s shoes and asserting whatever rights are available to the insured to recover from third parties.

However, Lacy Masonry never had any loss, since the other insurers covered the defense from the beginning. Also, the Court reiterated that a defending insurer owes a complete defense and may not pay the insured only its pro rata share of defense costs. This case was appealed to the Fifth Circuit.

The Fifth Circuit Decision

The Fifth Circuit ruled that Mid-Continent does not extend to the duty to defend an insured. [__ F.3d. __, No. 08-20532, 2010 WL 6903 (5th Cir. Jan. 4, 2010)] The Fifth Circuit agreed with the lower court that the non-paying carrier had a duty to defend its insured in the underlying suit, but it disagreed with the lower court’s decision to apply Mid-Continent‘s holding — if relevant insurance policies to a dispute contain pro rata or “other insurance” clauses, and a co-primary insurer pays more than its pro rata portion of a settlement to indemnify an insured and another co-primary insurer underpays, then the overpaying insurer cannot seek reimbursement from the underpaying insurer under theories of contribution or subrogation — to the duty to defend.

Rather, the Fifth Circuit concluded that Mid-Continent only deals with the issue of indemnity for a common insured and “leaves open the separate question of whether a co-insurer that pays more than its share of defense costs may recover such costs from a co-insurer who violates its duty to defend a common insured.”

The Fifth Circuit noted that Texas courts have repeatedly held that an insurer’s duty to defend is separate from and broader than its duty to indemnify, and the policy language confirmed that duty in its “other insurance” provision, which speaks only to an insured’s “loss.” The “other insurance” provision does not indicate a similar proration of costs incurred with regard to the separate and distinct duty to defend. Thus, the Fifth Circuit concluded that the “other insurance” clause applies only to the duty to indemnify, not the duty to defend.

The Fifth Circuit reasoned that in Mid-Continent the duty to indemnify is several and independent and therefore Liberty Mutual could not meet the common obligation requirement of a contribution claim, but the same is not true for the non-paying carrier’s duty to defend Lacy Masonry. In other words, though the carrier may only owe one one-fifth of the duty to indemnify along with the other co-insurers, it has a complete duty to defend. Because all co-primary insurers have a complete duty to defend, the “common obligation” requirement for a contribution claim is satisfied.

Looking Ahead

While no direct challenges to Mid-Continent appear likely in the near future, the Trinity case sets a reasonable limit on its application. The remaining concern is figuring out methods and strategies to engage non-paying carriers (where coverage applies) in settlements, or finding ways to craft settlements that allow paying carriers to resolve cases without forfeiting contract rights.

Stay tuned for future updates!