Earlier, the insured had written to the carriers stating that the proposed settlement was reasonable in the circumstances (holding aside coverage issues) in an effort to set up the carriers for a third-party bad-faith claim, that is, a claim that the insurers unreasonably failed to settle within policy limits (which in Texas is known as a “Stowers” claim). The policy contained standard boilerplate language saying the insurer couldn’t be sued until a final judgment was entered against the insured or unless a tripartite deal was reached among the claimant, the insured, and the insurer, which the Texas Supreme Court’s lead opinion characterized as vesting in the insured a right to consent to settlements.

The majority opinion in Frank’s Casing announces the rule that an insurer has a right to be reimbursed by its insured if: (i) it timely asserted a reservation of rights; (ii) it notified the insured it intends to seek reimbursement of settlement amounts; (iii) it pays to settle claims that are not covered; and (iv) the insured confirms that the settlement offer is a reasonable one that should be accepted. Slip op. at 8.

The majority reasoned that if the insured confirms that the settlement offer is reasonable – in the context of sending a letter to the carrier setting it up for an excess-of-policy-limits excess-verdict third-party bad-faith claim – it may not contend that settling with only its own money was inappropriate (even though had a settlement not been reached the carrier would have been required to pay for the continued defense of the case). As the majority reasons, “[i]f the offer is one that a reasonable insurer should accept, it is one that a reasonable insured should accept if there is no coverage.” (Slip op. at 10) In a strange twist, the court reasons that by settling with the plaintiff the insurer effectively only is continuing to prosecute the plaintiff’s claim against the policyholder, so the policyholder should [sic?] be in a position of indifference. (Id.) (Of course, the court does not mention that in the tort case the insurer pays for the defense but does not in the coverage case.)

In reaching its holding, the majority evinces great concern that the insurer otherwise would be forced into an uncomfortable position:

1. “It could refuse to settle and face a bad faith claim if it is later determined there was coverage.”

2. “Or it could settle the third-party claim with no right of recourse against the insured if it is determined there was no coverage, which effective creates coverage where there was none.”

Slip op. at 11. The majority does not consider that insurers will not lose the bad-faith case if the failure to settle was reasonable, and no doubt the insured’s not agreeing to fair terms of the settlement would be powerful evidence that the insurers’ failure to settle was not unreasonable or in bad faith. Moreover, the Texas court never considers that insurers are in a position to protect themselves against this risk by, as it had explained in Matgorda County, “drafting policies to specifically provide for reimbursement or by accounting for the possibility that they may occasionally pay uncovered claims in their rate structure.” 52 S.W.3d at 136. Were there an express policy provision on this point, then policyholders could elect not to purchase insurance from carriers that demand reimbursement provisions, and at all events insurance commissioners could scrutinize the terms of any such reimbursement provisions to ensure fundamental fairness.

The Texas majority deems an essential element of a reimbursement claim to be that the carrier reserve its rights to deny coverage, but then does not complete its implicit legal analysis of saying that the insured agreed to a new reimbursement contract with the carrier by accepting the defense on those terms. (As noted below, one of the concurring justices points outs this analytic hole in the majority’s analysis.) Instead, the majority hides behind the judicial fiction of “quasi contract” and finds that “an agreement to reimburse an insurer is implied in law.” Slip op. at 13. Thus, whether or not an insured agrees to a side deal with its carrier by which the insured agrees to reimburse the carrier in exchange for the carrier’s agreement to fund a settlement, the insurer will have a right to reimbursement if it says so before writing the check and the insured makes some acknowledgment that settlement is (in general) a good idea.

Many aspects of the majority opinion come under sharp attack by the concurring justices, and indeed each part of the intellectual edifice created by the majority more or less is decimated by the concurring justices who search for a better rationale for the result.

For example, Justice Hecht’s concurrence asks rhetorically, “Why an insured should assume an obligation to reimburse an insurer’s settlement of a non-covered claim when the insured has the right to consent to settlement and does so, but not when he consents though he has no right to do so, is baffling.” (Hecht, concurring, slip op at 5). Justice Hecht would simply overrule Matagorda County and find that a carrier can always obtain reimbursement for reasonable settlements. (Id.) As he elaborates, “no one suggests that an insurer may unilaterally settle a claim for an unreasonable amount, or in circumstances that actually (rather than hypothetically) prejudice the insured, and then force reimbursement from the insured.” (Id. at 6.) On the other hand, the exposure of the carrier to “severe consequences” and “stiff statutory liabilities” from unreasonably failing to settle a claim powers the insurer’s right to obtain reimbursement where there is no coverage and the settlement is reasonable. (Id. at 3, 7).

Justice O’Neill in her concurring opinion first objected to the majority’s weighing so heavily the insured’s effort to Stower-ize the insurers; as she points out, an insurer only has an obligation to settle if there is coverage. Accordingly, if by hypothesis there is no coverage, then the effort to set up a bad-faith claim is irrelevant as far as strict contractual obligations. See Slip op. at 3 (O’Neill, J., concurring). Justice O’Neill furthermore found salient that the insured had a contractual right to consent to settle; in the absence of such a right, Justice O’Neill implies that a reimbursement right would exist if the carrier offered the insured the ability to continue with the defense (though the concurrence does not address whether the insured must fund that defense alone or whether it may take the amount of money the carrier would have otherwise devoted to settlement and then continue with the defense, with no further recourse against the carrier). Justice O’Neill finds on the facts an agreement by the insured to reimburse because it consented to the settlement and it was clear the insurers would not have settled without that consent. But Justice O’Neill does not find an implied in fact agreement by the insured; instead, like the majority, she finds an implied in law obligation to reimburse. Id. at 5.

Justice Wainright adopts a different tack in his concurring opinion. Like Justice O’Neill he finds Stowers not to be relevant to the contract question presented; instead, he looks to whether a new contract was created in connection with the settlement of the underlying case – in other words, he looks to an implied in fact, separate agreement to reimburse. Justice O’Neill is not concerned as such with the idea that one side or the other obtained advantage through the settlement:

Did Frank’s Casing obtain a windfall – i.e., payment by its insurer of millions of dollars to settle claims against it for which there was no coverage? Or did Excess Underwriters voluntarily pay a settlement to obtain the benefits of saving itself potentially millions of dollars from the expected verdict and millions more from a possible bad faith verdict in a subsequent lawsuit? Two sophisticated entities carefully exercised their rights and obligations in light of their potential exposure.

Slip op. at 6 (Wainright, J., concurring). And he concludes that “[a]bsent the parties entering into a [new] legally enforceable agreement, I do not believe that the equities of the parties’ respective circumstances alone supports allowing a right to recoup the settlement payment.” Id. at 7. On the facts, Justice Wainright finds that “Frank’s Casing, by its acquiescence in the settlement, bound itself under principles of contract law to the condition that Excess Underwriters would be able to seek reimbursement. . . . Frank’s Casing has never disputed that Excess Underwriters’ settlement offer was conditioned on a right to seek reimbursement” Id. at 7, 9.

Justice Wainright further reasoned that:

[T]he weight and potential severity of a Stowers or bad faith insurance verdict can[not] serve as a basis to alter the agreement of the parties [in the insurance policy]. Insurance is a consensual arrangement not subject to change by the threat of a lawsuit. . . . In summary, I would hold that absent a provision in the insurance policy providing for the insured to reimburse the insurer for paying to settle a claim that is later held not to be covered, there is no right to reimbursement of the settlement payment. However, an insurer should be allowed the opportunity to prove a right to recoupment of a reasonable settlement under contract law, including under the theories of implied-in-fact contracts and quasi-contracts, if the insurer gives notice of its intention to recoup the payment in a timely reservation of rights letter or makes reimbursement a term or condition of a subsequent agreement.

Id. at 13. Justice Wainright defends his approach as “straightforward and predictable.” Id. at 14.

Illinois confronted similar issues in finding that insurers could not obtain reimbursement of defense costs through the expedience of “reserving” a right to reimbursement and the insured’s acceptance of the defense. As the General Agents court reasoned:

As a matter of public policy, we cannot condone an arrangement where an insurer can unilaterally modify its contract, through a reservation of rights, to allow for reimbursement of defense costs in the event a court later finds that the insurer owes no duty to defend. We recognize that courts have found an implied agreement where the insured accepts the insurer's payment of defense costs despite the insurer's reservation of a right to reimbursement of defense costs. However, . . . recognizing such an implied agreement effectively places the insured in the position of making a Hobson's choice between accepting the insurer's additional conditions on its defense or losing its right to a defense from the insurer.

828 N.E.2d at 1102. Rather, the better approach is to require insurers to make provision in their insurance policies for the not-infrequent circumstance of settling uncovered claims. The Massachusetts Supreme Court, in addressing the identical issue presented in Frank’s Casing, in part relied on the absence of such a contractual provision in rejecting the right of reimbursement – and cited a nearly 60+ years’ old case where such language was used. Goldberg, 680 N.E.2d at 1128, citing Service Mut. Liab. Ins. Co. v. Aronofsky, 308 Mass. 249, 251, 31 N.E.2d 837 (1941).

At least in Texas, one can expect insurers now routinely to state in the reservation-of-rights letter that they reserve the right to reimbursement; given there is no downside for the carrier in doing this, insureds should expect to be greeted with reimbursement language whenever a claim is submitted if there is any possibility of no coverage, in whole or in part. See generally Northern County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685 (Tex. 2004) (discussing need for independent counsel for insureds). Rather than to deal with these issues at the point of claim, however, insurers should be required to (i) adopt policy language subject to insurance commissioner approval or (ii) enter into separate, valid (interest-free) “loan” arrangements with their insureds at the point of claim where they advance funds subject to reimbursement. This would make clear to all involved what the rules of the road will be. But a splintering of decisions and rationales as displayed by the Texas Supreme Court in Frank’s Casing – resulting in four separate opinions totaling 47 pages – hardly contributes to legal certainty, especially in an area of contract law where parties are searching for certainty, risk transfer, and peace of mind.

Note: A version of this commentary was published in 4 Insurance Coverage Law Bulletin 1 (October 2005) and in the ABA's Insurance Coverage Litigation Committee newsletter (Fall 2006) at 1.