TEXAS: An Introduction to Insurance

Responding to Time Limit Demands in Texas in the Age of Nuclear Verdicts and Settlement

The proliferation of “nuclear verdicts” has resulted in increasingly larger settlement demands during litigation. The demands seek to expose insurers to judgments in excess of policy limits. Texas recognizes a negligence-based action for failure to settle based on G.A. Stowers Furniture Co. v American Indemnity Co., 15 S.W.2d 544, 547 (Tex. Comm'n App. 1929, holding approved). In Stowers, the court established an insurer’s duty to settle based on the "control" exercised by the insurer under a policy. The Stowers elements are (i) the claim against the insured is within the scope of coverage at the time the offer is made, (ii) the demand is within policy limits, and (iii) the terms of the demand are such that an ordinary prudent insurer would accept it, considering the likelihood and degree of the insured's potential exposure to an excess judgment. If these conditions are met, and a judgment or settlement is entered in excess of the policy limits, a non-settling insurer may be liable in excess of its limits.

Nuclear verdicts have made evaluating settlement demands significantly more difficult. It is important for an insurer evaluating a settlement demand to consider the following issues.

First, the demand and the insurer’s response will be highlighted in the coverage litigation. The insurer’s conduct during settlement negotiations will also be considered. Recent case law has confirmed that each demand is evaluated in the context of the case, at that juncture.

Second, the insurer’s investigation will be considered by the jury in any subsequent litigation. Issues that will be considered include whether the insurer conducted its own verdict search, evaluated the verdicts and settlements presented by the claimant as support and conducted a mock jury exercise or similar process.

Third, a suit for excess liability is a fact issue that is adjudicated after a judgment against the insured, and the insured is potentially faced with economic catastrophe. The insurer will be judged by a jury of “Monday morning quarterbacks” who are aware of the demand and the end result.

Nuclear verdicts complicate predicting what a jury will do on a particular case, which makes it difficult to prove after a verdict what a “reasonable” insurer would have done at the time. Although nuclear verdicts are unreasonably high, the increasing likelihood of such verdicts will bear upon the determination of whether the insurer acted reasonably in refusing to settle.

Can You Incorporate Extrinsic Contracts into Policies? Yes, But Beware

In complex litigation, how an insurance policy interacts with underlying contractual obligations can have a significant impact. In Texas, especially after In re Deepwater Horizon, 470 S.W.3d 452 (Tex. 2015), when analyzing coverage under a policy, courts will look to extrinsic contracts if the policy specifically calls for it.

ExxonMobil Corp. v Nat'l Union Fire Ins. Co., 672 S.W.3d 415 (Tex. 2023) emphasized the significance of policy language. In Exxon, a key issue was whether the required insurance limits in an underlying contract were incorporated into an umbrella policy. The case arose out of an injury claim. Exxon’s contract with Savage Refinery Services required Savage to carry at least USD2 million in coverage and name Exxon as an additional insured. Savage obtained a primary liability policy and an umbrella policy from National Union.

The injury claim settled for USD24 million, and USD5 million of the settlement was paid out of Savage’s primary policies, including the National Union primary policy. The remaining USD19 million was paid by Exxon because National Union denied coverage under the umbrella policy, arguing that the underlying contract required only USD2 million in coverage and that its policies incorporated by reference the insurance provision – which effectively reduced the insurance limits to USD2 million.

The court reviewed Texas law on whether extrinsic contractual provisions can be incorporated into insurance policies, including the Deepwater Horizon case. In that case, the court clarified that “we determine the scope of coverage from the language employed in the insurance policy, and if the policy directs us elsewhere, we will refer to an incorporated document to the extent required by the policy”. However, courts will not consider coverage limitations in underlying documents “unless obligated to do so by the terms of the policy”.

In Exxon, the court concluded that Exxon was an additional insured under the umbrella policy, which provided coverage to any additional insured under the primary policy. And the primary policy contained a blanket additional insured provision that covered any entity that Savage had agreed in a written contract to name as an additional insured. The court found that, for purposes of determining who is an additional insured, the policy incorporated the underlying contract.

The bigger question – what limit applied – came next. National Union focused on the umbrella provision specifying that it does not provide “broader coverage” than the primary. Because the umbrella policy followed form, and the primary policy incorporated by reference the USD2 million minimum, the umbrella had no obligation to pay any excess amount. The court rejected this argument holding that the term “broader coverage” referred to the type of coverage, not how much was available.

The court found that the umbrella policy did not refer to the limits of insurance at all, much less specifically incorporating the terms of an extrinsic contract. Further, the court noted that the contract required only a minimum amount of insurance; it did not set a limit on the amount of insurance that could be procured. Finally, the Court noted that National Union’s interpretation of the policies and contract would defeat the general purpose of an umbrella policy, which is to provide additional insurance if a primary policy is exhausted.

Thus, insurers and insureds are free to incorporate the terms of an extrinsic contract, such as a service contract with insurance requirements, into an insurance policy. However, the policy should clearly specify the exact terms of the extrinsic contract to be incorporated.

Adversarial Trials and Enforceability of Agreed Judgments

When liability insurers refuse to defend an insured in a lawsuit, insureds sometimes settle the claims by assigning their claims against the insurer in exchange for a covenant not to seek recovery from the insured’s assets, but only from the insurance policy.

In State Farm Fire & Cas. Co. v Gandy, 925 S.W.2d 696, 714 (Tex. 1996), the court refused to enforce an agreed judgment against an insurer stating that a judgment “rendered without a fully adversarial trial” is not binding on an insurer or admissible as evidence of damages in an action against the insurer. Id. The court was concerned about collusion, the integrity of the litigation process and whether such judgments are an accurate reflection of the insured’s liability and the plaintiff’s damages. Gandy was limited to agreed judgments and Texas courts continued to enforce settlements against insurers that denied coverage where there was no collusion. In the absence of collusion or distortion of the litigation process, courts also enforced against insurers’ judgments entered after underlying proceedings that were essentially prove-ups or default hearings where the insured put on no defense.

In Great Amer. Ins. Co. v Hamel, 525 S.W.3d 655 (Tex. 2017), the court examined what constitutes an adversarial trial for the purpose of rendering a judgment enforceable against an insurer. The court found 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 ensure that the judgment or settlement accurately reflects the plaintiff’s damages and thus the defendant – insured’s covered liability loss”. Id. at 666. It declined to enforce an underlying judgment against the insurer because the insured had received a covenant not to execute against its assets prior to the judgment.

In In Re Illinois Nat’l. Ins. Co., No. 22-0872, the court revisited the non-enforceability of judgments or settlements against an insurer. The underlying settlement and judgment provided that the judgment debtor and defendants would prosecute coverage litigation against the insurers to recover the settlement amount and that the recovery would be paid to the underlying plaintiffs. This prosecution and payment obligation was the consideration for a prospective release of the underlying claims against the judgment debtor and related parties.

The court held that an insured suffers a “loss” – and a claimant can sue the insurers directly – when the claimant and insured settle, and the claimant agrees to look solely to an insurance policy for recovery. However, the court held that, in the subsequent litigation against the insurer, a settlement that protects the insured against any “actual risk of liability” beyond its obligation to pay insurance benefits is neither binding nor admissible because it did not “result from a fully adversarial proceeding”. Therefore, where an insured does not face liability beyond the insurance proceeds, an insurer is not bound by the settlement agreement during the subsequent coverage litigation.