The Requirement of a Fully Adversarial Proceeding to Enforce a Judgment Against an Insurer Who Wrongfully Refuses to Defend

The Requirement of a Fully Adversarial Proceeding to Enforce a Judgment Against an Insurer Who Wrongfully Refuses to Defend

What happens when an insurer wrongfully refuses to defend its insured, and the insured assigns its claims against its insurer to the plaintiff? Here’s one possibility: “when an insured and tort claimant enter into an agreed judgment accompanied by a covenant not to execute the judgment, that judgment can be enforceable [against the insurer] if coverage exists.” Ayers v. CD General Contractors, 269 F. Supp. 2d 911, 915 (W.D. Ky. 2003). The Kentucky district court then notes, id., at 915 n.5, that “[t]he Supreme Court of Texas appears to be the only court not following this rule.”) (citing State Farm Fire and Cas. Co. v. Gandy, 25 S.W.2d 696 (Tex. 1996)).

So what rule does Texas follow? In the seminal case of State Farm Fire Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996), the Texas Supreme Court invalidated, as against public policy, an insured’s prejudgment assignment of claims against the liability insurer to the tort victim. Such prejudgment assignments, the high court concluded. tend to encourage collusion. While it may be difficult to understand such solicitude for an insurer who wrongfully refuses to defend its insured (we don’t typically think of contract-breaching insurance companies as needing special protection from courts), the resistance to enforcing collusive judgments against insurers is a very real feature of Texas law, as reinforced last month in Great American Insurance Co. v. Hamel, No. 14-1007, — S.W.3d — (Tex. June 16, 2017).

Hamel is significant for several reasons, including (1) reinforcing the rule that a judgment against an insured cannot be enforced against an insurer unless the judgment was the result of a “fully adversarial trial“; (2) using a much simpler test for determining whether a proceeding was a “fully adversarial trial”; and (3) holding that when liability issues are not the result of a “fully adversarial trial,” the liability issues may be litigated in a subsequent coverage suit.

The Supreme Court contributed enormous clarity on the potentially knotty requirement to prove a “fully adversarial trial.” Rather than force a fact-sensitive inquiry into “collusiveness” or an equally excruciating evaluation of adversarial “effectiveness” (the court of appeals approach), the Court adopted a straightforward skin-in-the-game test: “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 *7. In other words, “proceedings lose their adversarial nature when, by agreement, one party has no stake in the outcome and thus no meaningful incentive to defend itself.” Id. at *8.

The Court then concluded that even though there was no prejudgment assignment of claims (as in Gandy), there had been a pretrial agreement by the Hamels not to enforce any resulting judgment against the insured’s personal assets (other than the insurance policy), or certain named work-related assets, which the insured later testified constituted his only assets. Thus did the insured lose that sword of Damocles that incentivizes robustly adversarial proceedings. He literally had nothing to lose.

The straightforward skin-in-the-game test does not, however, altogether eliminate factual inquiries into the issue. The test creates “a strong presumption,” id. at *9, not a categorical rule. Indeed, the Court held open the possibility that either party could overcome the presumption attaching to the existence, or absence, of “a formal, written pretrial agreement that eliminates the insured’s financial risk.” Id. First, the insurer could show “that, even though the plaintiff and insured defendant did not enter into any formal, written agreement, the evidence nonetheless establishes that the defendant had no meaningful stake in the outcome of the underlying litigation.” Id. Second, “the plaintiff (acting as the defendant’s assignee) may overcome the presumption by submitting evidence demonstrating that the defendant retained a meaningful incentive to defend the underlying suit despite an agreement that eliminated the defendant’s financial risk.” Id.

It is not yet clear what form these attempts at rebutting the “strong presumption” could take. For example, could a reputational risk suffice in the absence of a financial risk?

Importantly, the Supreme Court did not simply let the insurer off the hook upon concluding that the proceeding below had not been fully adversarial. Instead, the Court made it clear that liability issues could be litigated in a subsequent coverage lawsuit, and that, even though the subsequent lawsuit against the insurer by the insured’s assignee had failed to cure the absence of an adversarial proceeding originally, the insured’s assignee should get another bite at that apple, given the confusion on these issues preceding this opinion. The insurer was, after all, accountable for much this messiness in failing initially to honor its contractual duty to defend.

Categories: Insurance Coverage

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