It Couldn’t Be Done: A Policyholder’s Idea To Reinvigorate Third Party Bad Faith

The Setting
Throughout the 1980’s and early 1990’s, the risk of bad faith liability was a major factor in evaluating third party claims for coverage. Ever increasing jury verdicts led to many inflated settlements of marginal claims. Indeed, the fear of bad faith was often a greater factor in settlements than the magnitude or risk of actual damages.

With breathtaking speed, however, the Texas Supreme Court changed the direction of Texas bad faith and extra contractual law in a series of decisions beginning with Lyons v. Millers Cas. Ins. Co., 866 S.W.2d 597 (Tex. 1993). The Supreme Court quickly followed up with the decisions in Transportation Ins. Co. v. Moriel, 879 S.W.2d 10 (Tex. 1994) and Republic Ins. Co. v. Stoker, 903 S.W.2d 338 (Tex. 1995). The trend away from bad faith liability culminated in the finding in Maryland Cas. Ins. Co. v. Head, 938 S.W.2d 27 (Tex. 1996), that there is no duty of good faith and fair dealing in the third party context.

As a practical matter, bad faith risks in third party cases had shrunk drastically. For some time Texas retained its reputation as a risky forum for bad faith claims, but slowly the changed reality was recognized. Carriers then began to evaluate claims more in line with their actual liability exposure. With the recognition that there was no burden of a duty of good faith, the primary area of concern became the risk of undue delays in the payment of covered claims under Article 21.55 (which is limited to the first party context), and violations of Article 21.21. The exception, first party claims, are subject to a duty of good faith as enunciated in State Farm Fire & Cas. Co. v. Simmons, 963 S.W.2d 42 (Tex. 1998), and has expanded to post-litigation conduct recently in Mid-Century Ins. Co. of Texas v. Boyte, 49 S.W.3d 408 (Tex. App. – Fort Worth 2001, petition for review pending).

The Challenge
Inventive policyholder lawyers have struggled for years now to find a wedge to create a viable, serious risk of third party bad faith—preferably one strong enough to create a fear (or reality) of large adverse extra contractual damages. Where actual damages are weak, this is often the plaintiff’s only leverage. Where a claim is strong, its value would be considerably greater. Emboldened by many successes in recent years, the usually sober defense bar has said “it couldn’t be done.” Third party bad faith is dead. The case law leaves few holes and the Texas Supreme Court is largely conservative and respectful of contract language. The Court has been quick to apply contracts as written, and has not sought to find hidden ambiguities that exist only in the vagaries of the policyholder’s wishful thinking. In essence, the challenge confronting policyholder counsel is reminiscent of a poem written by Edgar Guest:

Somebody said that it couldn’t be done,
But he with a chuckle replied
That “maybe it couldn’t,” but he would be one
Who wouldn’t say so till he’d tried.
So he buckled right in with the trace of a grin
On his face. If he worried he hid it.
He started to sing as he tackled the thing
That couldn’t be done, and he did it.

Edgar A. Guest, “It Couldn’t Be Done,” stanza 1, Collected Verse of Edgar A. Guest, p. 285 (1934).

The response
Alas, faced with this challenge, there are always creative policyholder counsel working diligently to give new life to the moribund, but not dead, bad faith beast. Some of their ideas may resonate with some courts. For instance, one recent tactic is attempting to broaden the scope of Tex. Ins. Code Art. 21.55, which is restricted solely to first party claims, to extend to the duty to defend in general liability (that is, third party liability) contracts. Policyholders maintain that the duty to defend is a first party obligation because it provides a benefit to the policyholder, not to the third party. To the contrary, carrier counsel have long maintained that the duty to defend is an obligation stemming from a liability contract relating to third party claims. The “benefit” aims to prevent third party liability and is closely woven together with it. At least one court in Dallas County, in an unpublished ruling, has applied the provision to the duty to defend. Thus, while the argument has only begun to be tested, it has already had limited, though not precedential, success.

Another interesting gambit is one sprung from the fertile mind of Ernest Martin, a respected Dallas policyholder counsel. In his search for an opening in the Code, he has come to believe that Article 21.21, Section 4 (11), entitled “Misrepresentation of Insurance Policy” is an open door to expanding extracontractual liability to a myriad of potential oversights and miscues. This provision defines an “unfair and deceptive acts or practice” to include a laundry list of potential acts that could cover many common events in the handling of liability claims.

During a mostly friendly discussion with Ernest, I realized that the provision—meant to punish actual fraud or deceptive actions by the insurer which are designed to confound or confuse the less-sophisticated insured—could potentially be misconstrued by a court.

Beguiled by the dulcet tones of a valiant knight of the downtrodden, a court may be swayed to apply this provision to an inadvertent failure to disclose policy information (“failing to state a material fact that is necessary to make other statements made not misleading”); to reservation of rights letters which include mistakes of fact (“making an untrue statement of material fact”); or simply taking a position on the meaning of a policy provision where the case law is undecided (“making a statement in such a manner as to mislead a reasonably prudent person to a false conclusion of material fact”).

Think about it: if I write a denial letter that is not absolutely taut in its reasoning, have I potentially violated Article 21.21 by making a misleading statement? Is a failure to explain the legal arguments about the temporal aspect of the “sudden and accidental” pollution exclusion a “failure to make necessary statement so as not to be misleading”? Is a denial of coverage that is later found to be inaccurate an “untrue statement”?

Of course not! No rational court could stretch this language to such a breaking point. Where the carrier has a rational basis for its coverage position and actions, case law such as Stoker and Head protect it from bad faith liability. The courts have long recognized that human beings adjust claims and that perfection is beyond reach.

Still, I keep seeing Ernest buckling “right in with the trace of a grin ….”

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases. Martin is the former chairman of the Reinsurance Committee, Insurance Section of the State Bar of Texas, and was appointed to the Chair of the Environmental Coverage Committee. He is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.”