This story is reprinted with permission from FC&&S Legal, the industry’s onlycomprehensive digital resource designed for insurance coveragelaw professionals. Visit the website to subscribe.

Although the U.S. has a reputation as a litigious society, inreality judges often encourage parties to a lawsuit to settle. Andwhen insurers defend their insureds, settling a case is areasonable trial strategy to limit court costs and attorney fees.What happens when the plaintiffs reach an agreement with thedefendant before trial not to pursue all available assets if theywin? Then, when a judgment is rendered against the insured in thetrial in which the insurer doesn’t participate, must the insurerprovide coverage?

Case of construction defects

Glen and Marsha Hamel hired Terry Mitchell Builders, Inc., tofinish building a single family home in Flower Mound, Texas, whichit did in October 1995. In August 2000, the Hamels said theynoticed signs of water damage in the home. They sued the builder inApril 2002 for breach of implied warranty, negligence, DeceptiveTrade Practices Act violations and Residential ConstructionLiability Act violations, alleging that the builder had failed toperform its services in a good and workmanlike manner. The Hamelsalso alleged that the water damage had resulted from the home’simproper construction or, alternatively, from the improper use orinstallation of a certain exterior stucco finish.

Great American Insurance Company insured the builder underseveral commercial general liability insurance policies, one ofwhich excluded property damage “arising out of” the stucco product.The builder notified Great American of the Hamels’ suit, but GreatAmerican declined to defend the builder, citing the policy’sexterior stucco exclusion because the Hamels’ August 2000 discoveryof the damage fell within that period.

Great American subsequently conceded that this position waserroneous and that, in light of the Hamels’ allegations, theinsurer had wrongfully refused to defend the builder.

Related: Protecting homeowners

Settlement terms

A week before trial, the Hamels reached an agreement with thebuilder providing that, if they obtained a judgment against thecompany, they would only go after the assets in the company’s name,excepting any “personal tools of the trade and truck,” which theHamels agreed not to pursue “even if in [the company’s] name.” Atthe time the agreement had been executed, the company had no assetsbeyond the excepted “tools of the trade and truck.”

The trial court rendered judgment in the Hamels’ favor, awardingthem $365,089 in damages, including $50,000 in mental anguishdamages, plus prejudgment interest and court costs.

The builder subsequently assigned most of its rights againstGreat American to the Hamels. The Hamels, as the builder’sassignees and judgment creditors, sued Great American for breach ofcontract and declaratory relief, seeking to recover the judgmentfrom their suit against the builder under the builder’s insurancepolicy.

Related: Builders risk insurance: 8 things you need toknow

Ruling against insurer

The trial court rendered judgment for the Hamels, finding thefollowing:

• The builder had been negligent.
• Great American had waived its right to control the builder’sdefense.
• The builder had defended itself at the Hamels’ trial in goodfaith. The builder’s and the Hamels’ trial strategies and actionshad been reasonable and not collusive or fraudulent. The trial hadbeen “a genuine contest of issues resulting in an adversarialproceeding.”
• The damage judgment and findings were supported by the evidenceadduced at trial and were binding on Great American. Great Americanhad breached its duties to defend the builder in the Hamels’ suitand to indemnify the builder from the judgment.

The trial court awarded judgment to the Hamels for $355,838,plus interest, court costs, and attorneys’ fees.

Great American appealed, arguing that the judgment was notbinding on Great American because it had not been rendered in afully adversarial trial.

Related: No. 1 coverage case of 2017: When a reservation ofrights letter is not

Great American loses appeal

The court of appeals affirmed the trial court’s judgment in mostrespects, holding that Great American had breached its duty todefend the builder from the Hamels’ suit, the damage judgment hadbeen the result of a fully adversarial trial, and the builder’sassignment of its claims against Great American to the Hamels wasvalid. The court of appeals reversed the portion of the judgmentawarding mental anguish damages, holding they were not compensableas a matter of law.

The dispute reached the Texas Supreme Court, where GreatAmerican contended that the Hamels’ judgment had not beenthe product of a fully adversarial trial and, therefore, it couldnot be enforced against Great American by the Hamels as thebuilder’s assignees. Specifically, Great American argued that thepretrial agreement and stipulations entered into by the Hamels andthe builder — which had not been presented to the trial court inthe Hamels’ suit against the builder — ensured that the builder hadno real stake in the trial’s outcome. According to Great American,this resulted in a sham trial shaped entirely by the Hamels anddesigned to aid in the prosecution of the subsequent insurancelitigation.

The Hamels responded that no evidence of fraud or collusionexisted with respect to their trial against the builder.

Related: Insuring against design failures and professionalrisks

The Texas Supreme Court’s decision

The Texas Supreme Court reversed the court of appeals’ judgmentand remanded the case for a new trial.

In its decision, the court first noted that the enforceabilityof the damage judgment against Great American was valid, giventhat:

• The builder had assigned its claims following, not preceding, atrial and judgment;
• Great American had breached its duty to defend; and
• Great American had neither accepted coverage nor made a goodfaith effort to adjudicate coverage before the Hamels’ claimsagainst the builder had been resolved.

Then, the court summarized Texas law, observing that although aninsurer’s breach of its duty to defend rendered any coveredjudgment binding on the breaching insurer, a plaintiff could notenforce an underlying judgment against the defendant’s insurerabsent a “fully adversarial trial,” in which the underlyingjudgment accurately reflected the plaintiff’s damages and, thus,the insured’s covered loss.

The court noted that one way to ensure that a judgmentaccurately reflected the plaintiff’s damages was to require thatthe loss be determined through a proceeding in which the parties“fully” — “or at least actually and effectively” — opposed andcontested each other’s positions. The court held that the“controlling factor” was:

whether, at the time of the underlyingtrial or settlement, the insured bore an actual risk of liabilityfor the damages awarded or agreed upon, or had some othermeaningful incentive to ensure that the judgment or settlementaccurately reflect[ed] the plaintiff’s damages and thus thedefendant-insured’s covered liability loss.

The court then ruled that, in this case, the pretrial agreementbetween the Hamels and the builder had “eliminated any meaningfulincentive” the builder had to contest the judgment. Specifically,the court pointed out, before trial, the Hamels had agreed not toenforce any resulting judgment against Mitchell’s personal assetsor his truck or “personal tools of the trade ... even if in thename of [the company].” The court added that although the agreementtechnically had not foreclosed the Hamels from pursuing otherassets of the builder, Mitchell himself had testified that thecompany had no other assets except the insurance policy.

Proceedings lost their adversarial nature when, “by agreement,”one party had “no stake in the outcome and thus no meaningfulincentive to defend itself,” the court explained. When a plaintiffagreed “to forgo execution of a judgment against a defendant’sassets, whether in conjunction with a settlement or before trial,”the defendant no longer had “a financial stake in the outcome” andthus likely had “no interest in either avoiding liabilityaltogether or minimizing the amount of damages.” Adversity turnedon “the insured defendant’s incentive to defend (or lack thereof),”and an “after-the-fact evaluation of the parties’ trial strategies”had “no place in the analysis.”

Applying that standard to this case, the court held that thepretrial agreement had “effectively removed any financial stake”the builder had in the outcome of the Hamels’ suit against thebuilder, thereby eliminating any incentive the builder had tooppose the Hamels’ claims. This turned their suit “into a mereformality — a pass-through trial aimed not at obtaining a judgmentreflective of the Hamels’ loss, but instead at obtaining apotentially inflated judgment to enforce against GreatAmerican.”

Accordingly, it ruled, the Hamels’ judgment was not bindingagainst Great American in the lawsuit brought by the Hamels asjudgment creditors and assignees.

Related: Are courts narrowing access to coverage in theconstruction industry?

|

Formal agreement not always required

Significantly, the court added that although a formal, writtenpretrial agreement that eliminated the insured’s financial risk wasnot always necessary or sufficient to disprove adversity, thepresence of such an agreement created “a strong presumption thatthe judgment did not result from an adversarial proceeding,” whilethe absence of such an agreement created “a strong presumption thatit did.” An insurer could overcome the presumption by demonstratingthat, even though the plaintiff and insured defendant had notentered into any formal, written agreement, the evidencenonetheless established that the defendant had no meaningful stakein the outcome of the underlying litigation.

Finally, the court declared that a lack of adversity in adamages trial against an insured could be cured in a subsequentcoverage lawsuit against the insurer — if the parties “properly”litigated the underlying liability issues in the coverage suit.

That had not happened in this case, the court concluded, becausethe parties had not “thoroughly relitigate[d] all aspects of theHamels’ claimed damages.” The Texas Supreme Court then remanded thecase for a new trial.

The case is Great American Ins. Co. v. Hamel (Tex. June16, 2017).

Related: Construction activity is creating opportunity forcarriers and brokers

Steven A. Meyerowitz, Esq., isthe director of FC&S Legal, the editor-in-chief of theInsurance Coverage Law Report, and the founder and president ofMeyerowitz Communications Inc. Email him at [email protected].

Save

Save

Save

Save

Save