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One of the most important issues in Texas insurance law is center-stage at this moment: whether a liability insurer has a right to recoup from its insured settlement amounts or defense costs paid in connection with a third-party claim when coverage is disputed. Despite opinions by the Supreme Court of Texas in two recent cases, this issue is now anything but settled, especially since the court recently granted rehearing and heard oral argument for a second time in one of those cases. See Excess Underwriters at Lloyd’s London, et al. v. Frank’s Casing Crew & Rental Tools, No. 02-0730, 2005 WL 1252321 (Tex. May 27, 2005)(reh’g granted).

Texas law appeared to take a turn in the insured’s favor on the reimbursement issue in 2000, thanks to the supreme court’s ruling in Texas Association of Counties County Government Risk Management Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000). In Matagorda County, the court held that an insurer could not seek reimbursement from its insured for paying a settlement unless the insured expressly agreed to the settlement and to the insurer’s right to seek reimbursement. The court refused to imply consent based upon the insured’s silence in responding to the insurer’s reservation of rights letter or the insured’s stipulation acknowledging no dispute as to the reasonableness of the settlement.

In May 2005 in Frank’s Casing, however, the Supreme Court of Texas appeared to essentially abandon its holding in Matagorda County, even though they claimed they were not overruling it. The court held that if a liability insurer timely reserves rights, notifies the insured it intends to seek reimbursement, and pays to settle a claim that is not covered, a right of reimbursement will be implied at law in at least two circumstances:

(when an insured has demanded that its insurer accept a settlement offer that is within policy limits, or

when an insured expressly agrees that the settlement offer should be accepted.

The majority opinion was authored by Justice Priscilla Owen, who subsequently left the court to become a judge on the U.S. Court of Appeals for the Fifth Circuit. Additionally, only seven justices participated in the decision because of one vacancy at the court and because one of the justices, Scott Brister, wrote the court of appeals’ opinion before joining the court. Two of the seven participating justices, Justices Harriet O’Neill and Dale Wainwright, agreed that the insurer was entitled to reimbursement under the facts of the case, but wrote separate opinions concurring only in part with the court’s opinion. Finally, although Justice Nathan Hecht fully agreed with the court’s opinion, he wrote a separate concurring opinion to express his belief that Matagorda County was wrongly decided and was effectively overruled by the court’s decision in Frank’s Casing.

The Frank’s Casing decision has sparked much heated debate between the insurance industry and consumers. The industry has welcomed the decision as necessary to prevent insureds from receiving the windfall that results when a liability insurer pays to settle claims which are ultimately proven to be not covered. On the other hand, insureds have criticized the decision on the grounds that it creates an extra-contractual right in favor of insurers and removes the incentive for insurers to decide and litigate coverage issues before the underlying suit is tried. Moreover, insurance defense attorneys have expressed the concern that the decision creates conflicts of interests by potentially embroiling them in disputes between the carrier and insured over settlements.

After Frank’s Casing filed a motion for rehearing, many outside groups filed amicus briefs with the Supreme Court of Texas in response to the May 2005 opinion. The controversy over the opinion and turnover at the court in the interim (Justice Owen has left the court and two new justices have been appointed) set the stage for the court to reconsider its decision.

On January 6, 2006, the Supreme Court granted Frank’s Casing’s motion for rehearing and took the somewhat unusual step of ordering a second oral argument, which was held on February 15, 2006. Eight of the court’s nine justices participated in the oral argument. (Justice Brister did not participate because he wrote the court of appeals’ decision.) The justices questioned the insurer’s counsel about the possibility of including a right to reimbursement provision in policies and charging lower premiums because of the provision. They also asked whether a right to reimbursement removes the incentive for early settlement.

The justices also questioned Frank’s Casing’s counsel as to why the insured should be able to receive a windfall in the form of the insurer’s settlement of a non-covered claim. Perhaps the most intriguing question posed to the insured’s counsel was whether the liability determination in the underlying suit against the insured should be postponed until the coverage is determined.

At oral argument, the insurer’s counsel argued as follows: Reimbursement is a remedy, and no new right to reimbursement is being created. Rather, an insurer has a right under Texas law to litigate whether coverage exists, even if a coverage determination cannot be made prior to the resolution of the underlying suit. Simply put, the insurer has no duty to settle non-covered claims. Insureds benefit from the reasonable early settlement of a claim, which limits any potential for further liability and defense costs. Under the court’s decision, insurers are still required to act in good faith and timely reserve rights.

In response, Frank’s Casing’s counsel vigorously argued that: An insurer should not be allowed to put off its coverage decision, pay to settle a claim to avoid bad faith liability, and then sue the insured for reimbursement. In settling a non-covered claim, the insurer did something that is not contemplated by the policy, and is now seeking something (reimbursement) that is not mentioned in the policy. A demand by the insured to settle a claim within policy limits should not give rise to a reimbursement claim because of the resulting conflict between the insured and its defense counsel.

Frank’s Casing also contended that an implied right to reimbursement would arguably create additional leverage for the insurer to put pressure on insureds at a critical time to either contribute to settlements or face a reimbursement claim, along with the attorney’s fees required to defend. Finally, Frank’s Casing argued that a coverage determination must be made early in the process or it is waived, as a claimant’s settlement offer necessarily reflects availability of insurance, which can be implied when no coverage determination has been made.

The decision to grant rehearing in Frank’s Casing and the questions and comments of the justices at the oral argument suggest that the court intends to alter its original opinion. But it remains to be seen whether the court’s opinion on rehearing will substantially limit or even eliminate the right of reimbursement, or simply rewrite the May 2005 opinion to address some of the concerns raised by the amicus briefs while still preserving some form of reimbursement right. Whatever the court does, one thing is certain: Not everyone will be happy.

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