Insurance law - Frank's Casing's effect on reimbursement of settlement and defense costs in Texas.

• Author: Tang, Rosalyn

IMAGINE that you are a business owner. One of your employees badly injures himself while on your premises. He sues you for hundreds of thousands of dollars. Both parties enter into settlement negotiations. You thank your lucky stars that you have insurance that might cover this claim, but you and your insurer dispute over whether this claim is covered under your insurance policy. If the claim is covered, your insurer must pay the settlement amount. If the claim is not covered, you must pay the settlement amount. The insurance policy does not allow you to consent to settlement, which means that the insurer has control of approving the settlement amount. The injured employee offers to settle for an amount within your policy's limit. Even though you have no right to consent to the settlement amount, you agree that this amount is reasonable. Before the coverage dispute is determined, your insurer settles the case. Your insurer unilaterally reserves its right to seek reimbursement from you if a court later determines that coverage does not exist, even though your insurance policy says nothing about reimbursing your insurer for settling non-covered claims. After your insurer pays the settlement, a court later determines that the claim is not covered.

Now your insurer wants you to reimburse it for the settlement amount it paid on your behalf. Prior to the summer of 2005, you would not have to reimburse your insurer. (1) You paid a premium to pass certain risks to your insurer, and you had absolutely no control over settlement negotiations. It would be unfair to be forced to reimburse your insurer for a settlement amount to which you could not consent.

Before May 2005, the insurer would not be entitled to reimbursement of settlement costs, but today, the outcome is less clear because of a recently decided Texas Supreme Court case. In May 2005, the Texas Supreme Court in Excess Underwriters at Lloyd's, London v. Frank's Casing Crew & Rental Tools ("Frank's Casing") ruled that an insurer is entitled to reimbursement of settlement costs in certain circumstances. (2) This decision caused significant concern among insurers, insureds, and defense attorneys regarding the settlement-reimbursement question.

The purpose of this comment is to discuss the settlement-reimbursement question in light of Frank's Casing and address its effect on an insurer's ability to recoup defense costs expended on its insured for a non-covered claim. Section I discusses the settlement-reimbursement question in Texas. It begins by examining the supreme court's treatment of the settlement-reimbursement question before Frank's Casing. Next, it discusses the supreme court's decision in Frank's Casing and its reliance on the majority view in recognizing an implied right to reimbursement in insurance contracts. This section also provides an overview of criticisms and reactions arising from the Frank's Casing decision and general guidance to a practicing attorney in analyzing the settlement-reimbursement question in light of Frank's Casing.

Section II discusses Frank's Casing's effect on the defense-reimbursement question, which the supreme court has not addressed. The issue raised after Frank's Casing is whether the insurer is entitled to reimbursement of defense costs if a court later finds no coverage. This section examines the majority and minority views in other jurisdictions, concluding that the Texas Supreme Court will likely adopt the majority view and entitle an insurer reimbursement of defense costs for a non-covered claim in the same way it adopted the majority view on the settlement-reimbursement question.

1. Frank's Casing's Effect on Reimbursement of Settlement Costs

   1. Pre-Frank's Casing: No Implied Right to Reimbursement

      Prior to Frank's Casing, no implied right to reimbursement existed in Texas. (3) The Texas Supreme Court established this proposition in Texas Association of Counties County Government Risk Management Pool v. Matagorda County, a case in which inmates sued Matagorda County ("County") after other inmates physically and sexually assaulted them at the County jail. The County demanded that its insurer, TAC, defend and indemnify them under its law enforcement insurance policy. TAC disputed coverage but continued to defend the County. The victim inmates offered to settle the lawsuit for $300,000, which was within policy limits. The County stipulated that the amount was reasonable. TAC issued a reservation-of-rights letter to the County, reserving its rights to continue to deny coverage and to seek reimbursement of the settlement funds from the County if the court found that the claim was not covered under the policy. The insurance policy did not state that TAC could seek reimbursement for those settlement funds if it was later determined that the policy did not provide coverage. More significantly, the insurance policy allowed TAC to settle any claim at its own discretion, and without the County's consent. The trial court held that the claim was not covered.

      The Texas Supreme Court in Matagorda County held that the insurer may not obtain reimbursement from its insured for an amount that the insurer paid to settle a claim that was later determined to be excluded from coverage. The court provided a general and sweeping rule regarding reimbursement of settlement costs: "when coverage is disputed and the insurer is presented with a reasonable settlement demand within policy limits, the insurer may fund the settlement and seek reimbursement only if it obtains the insured's clear and unequivocal consent to the settlement and the insurer's right to seek reimbursement." (4) The court explained that an insurer cannot imply a right to reimbursement when the insurance policy does not mention such a right, just as the insurance policy in Matagorda County did not. Additionally, a unilateral reservation-of-rights letter, such as the one TAC issued, cannot create rights not contained in the insurance policy. TAC argued it was entitled to reimbursement because the County failed to dispute the settlement's reasonableness. The court disagreed and stated that "the mere fact that the County did not dispute the settlement' s reasonableness does not imply that it agreed to reimburse TAC should TAC decide to accept the settlement and then later prevail on its coverage defense." (5)

      Important to the court's holding is the County's inability to consent to settlement by its own policy's terms. The County's inability to consent to the settlement amount meant that it did not have any control over settlement. The Matagorda County court wanted to prevent an insurer, who had a unilateral right to settle, from accepting a settlement amount beyond its insured's financial reach and then seek reimbursement from its insured when the insured could not consent to the settlement amount in the first place. Thus the court held that the insurer (TAC) was not entitled to reimbursement of the settlement amount it paid for a non-covered claim. (6)

   2. Post-Frank's Casing: Implied Right to Reimbursement Exists

      Five years later, the Texas Supreme Court addressed the same issue under different facts. (7) Frank's Casing fabricated an offshore drilling platform for ARCO that collapsed in the Gulf of Mexico. Frank's Casing had excess insurance coverage from its insurer, Excess Underwriters, in the amount of $10 million. Unlike the Matagorda County policy, the insurance policy in this case required Frank's Casing's approval of any settlement. (8) Like the Matagorda County policy, the Frank's Casing policy did not contain any reservation-of-rights clause, which would allow its insurer, Excess Underwriters, to seek reimbursement from Frank's Casing for settling claims that were not covered. ARCO agreed to settle for $7.5 million and "stowerized" the offer. (9) Frank's Casing demanded that Excess Underwriters settle the case for this amount. Excess Underwriters offered to pay, conditioned on its intent to seek reimbursement if the court found that the claim was not covered, and Frank's Casing agreed. Later, the trial court found that the policy did not cover Frank's Casing's claim and required Frank's Casing to reimburse Excess Underwriters. Shortly thereafter, the trial court withdrew its order due to the then-newly issued Texas Supreme Court decision in Matagorda County and signed a take-nothing judgment against Excess Underwriters. The court of appeals reluctantly affirmed. (10)

      On petition for review, the Texas Supreme Court held that an insurer is entitled to reimbursement from its insured in at least two circumstances: (1) when an insured has demanded that its insurer accept a settlement offer that is within policy limits; or (2) when an insured expressly agrees that the settlement offer should be accepted. (11) Distinguishing its prior decision in Matagorda County, the Texas Supreme Court reversed the appellate court's holding and held that Excess Underwriters (insurer) was entitled to reimbursement from Frank's Casing (insured). (12)

      Under the first circumstance, the court held that when an insured demands that its insurer accept a settlement offer that is within policy limits, it triggers a reimbursement obligation. The court presumed that if an insured makes a demand on its insurer to pay the settlement offer that is within policy limits, the insured believes the demand is reasonable and thus, is willing and able to pay if a court finds coverage. "If the offer is one that a reasonable insurer should accept, it is one that a reasonable insured should accept if there is no coverage." (13)

      Under the second circumstance, the Frank's Casing court reasoned that reimbursement is appropriate because the insured has some control over settlement, unlike the Matagorda County insured. The Frank's Casing insured had the right to consent and in fact did consent to the settlement amount. Frank's Casing had the option of continuing the litigation, but it made an informed...