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Long after oral argument and in the midst of continuous debate, the Texas Supreme Court continues to mull over whether an insurer who wrongfully refuses to defend a third-party claim or pay defense costs can be held liable for statutory penalties under the Insurance Code’s prompt payment of claims provisions (TEX. INS. CODE ANN. §§ 542.051-.061; formerly TEX. INS. CODE ANN. art. 21.55). See Lamar Homes, Inc. v. Mid-Continent Cas. Co., 428 F.3d 193 (5th Cir. 2005)(certified question of applicability of 21.55 to Texas Supreme Court). Despite the fact that the question looms in the chambers of Texas’ highest court, a few courts have recently issued rulings in opposite directions, while at least one federal court has openly refused to rule on the issue, pending word from the Supreme Court. The split in authority is centered on the application of key terms in the prompt payment statute, such as “claim.”

Texas appellate courts, for the most part, have consistently held that article 21.55 does not apply to third-party liability claims. On July 6, 2006, the Houston Court of Appeals joined the Dallas Court of Appeals and other Texas appellate courts in holding that a demand for a defense under a liability policy is not a first-party claim, refusing to apply the prompt payment statute. See Pine Oak Builders, Inc. v. Great American Lloyds Insurance Co., No. 14-05-00487-CV, __ S.W.3d __, 2006 WL 1892669 (Tex. App. – Houston [14th Dist.] July 6, 2006, no pet.). The Houston court adopted the reasoning of the Dallas court in TIG Insurance Co. v. Dallas Basketball, Ltd., 129 S.W.3d 232 (Tex. App. – Dallas 2004, pet. denied), and held that the structure of article 21.55 presumes a tangible loss has been suffered by the insured for which it seeks payment from its insurer. The Houston court further stated that attempting to apply the statute to a claim for a defense is unworkable and goes against the legislative intent. The court concluded that when an insurer refuses to provide a defense, the insured’s claim for reimbursement is not a claim under the insurance policy, but is a common law claim for breach of the policy; thus the prompt payment statute does not apply.

On the other end of the pendulum, a Houston magistrate judge presiding over a case in the Southern District followed the direction of several federal district courts in Texas that have departed from the Texas state courts and generally held that a failure to promptly pay defense costs can trigger statutory penalties. See HCC Employer Serv., Inc. v. Westchester County Surplus Lines Ins. Co., 2006 WL 1663343 (S.D. Tex. June 5, 2006). In HCC, the insurer refused to indemnify its insured for defense costs incurred and other amounts paid in connection with a previous settlement agreement. In a Memorandum Opinion dated June 5, 2006, Magistrate Judge Nancy Johnson held that where the policy itself does not obligate the insurer to provide a defense, the prompt payment of claims statute applies to claims for reimbursement of defense costs which fall within the policy’s definition of “Loss.” The court analyzed the facts of the case and the policy, and expressly stated that the case presented distinct issues from those certified to the Supreme Court in Lamar Homes. The court concluded that based on the policy language and facts, the statutory prompt payment penalties attached both to the insured’s indemnity claims for defense costs and amounts paid by the insured to resolve the third-party claim.

In the wake of these two holdings, a magistrate from the Western District of Texas issued a Memorandum Order and Opinion on July 18, 2006 in a coverage action as to all issues, but abstained from ruling on the issue of whether the insurer violated article 21.55 by failing to tender a defense or settle the underlying suit. See Federal Ins. Co. v. Infoglide Corp., 2006 WL 2050694 (W.D. Tex. July 18, 2006). The court held that, although some of the claims at issue are best characterized as first-party claims, other courts have treated a claim for reimbursement of defense and settlement costs as a third-party claim for which no relief is available under article 21.55. Because the issue is still in dispute, and is pending before the Supreme Court, the court refused to try to predict the outcome of that case and refused to resolve the 21.55 claim on this ground. The court left open the issue, “in the hopes that a definitive answer will be forthcoming from the Texas Supreme Court.”

Clearly, these cases add more fuel to the fire. The recent decisions continue to cause further confusion to insureds, insurers and commentators, and heighten emotions and economic concerns. How do we evaluate and calculate the potential exposure in a case when the penalty is possibly 18% interest? Is interest still accruing if the judge puts off a ruling in hopes of guidance from the Supreme Court? If the statute ultimately applies to third-party claims, will it apply to claims for indemnity or reimbursement of defense costs, or both? These are all logical questions which the Supreme Court may or may not answer in Lamar Homes.

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