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From Tilley to Gandy-Working in Shades of Gray

On Behalf of | Apr 1, 2024 | Firm News |

From Tilley to Gandy – Working in Shades of Gray

Authored and Presented By:
David D. Disiere
Martin, Disiere, Jefferson & Wisdom, L.L.P.
808 Travis, Suite 1800
Houston, Texas 77002
Facsimile: 214-219-4218
E-Mail: [email protected]

Co-Authored and Presented By:
Michael Huddleston
Shannon, Gracey, Ratliff & Miller, L.L.P.
500 North Akard Street, Suite 2575
Dallas, Texas 75201
Telephone: 214-245-3075
Facsimile: 214-219-4218
E-Mail: [email protected]

Also Presented By:
Mark A. Ticer
Law Office of Mark A. Ticer
3300 Oak Lawn, Suite 700
Dallas, Texas 75219
Telephone: 214-215-0666
Facsimile: 214-219-4218
E-Mail: [email protected]

Texas Institute of CLE 2004
June 10 – 11, 2004

From Tilley to Gandy – Working in Shades of Gray
The Lawyer, who has made not only the scales of right but also the sword of justice his symbol, generally uses the latter not merely to keep back all foreign influences from the former, but, if the scale does not sink the way he wishes, he also throws his sword into it, a practice to which he often has the greatest temptation because he is not also a philosopher, even in morality.

Immanuel Kant, Perpetual Peace (1795)

I. Introduction

This paper is intended to provide resource material upon which to begin and give framework to your assessment and research in ethical dilemmas in the tripartite relationship. By no means do we provide answers to your specific issues, as Texas precedent provides no such clearly articulated answers, merely oars to row your vessel. As you will see, practitioners navigating these waters will frequently find themselves in the fog and working in shades of gray.

We begin with an historical evolution of Tilley and its progeny to a practical application in the insurer/insured/defense attorney context. We also address issues of insurer control versus defense attorney control devices.

II. Tilley and its Progeny: Evolution in Progress

A. Tilley’

In Tilley, Douglas Starky, an employee of Prudential Drilling Company was working on a Prudential well site when he sustained an injury on or about November 25, 1967. Tilley, as an independent contractor to Prudential Drilling Company, was furnishing tools and employees for the lifting of casing pipe off a Prudential platform. Tilley’s equipment and crew were lifting casing pipe, which slipped and fell upon Starky. Although Tilley’s job foreman, Grady Fore, knew of the incident, it was disputed whether Fore or anyone else advised Tilley of the November 25, 1967 incident or whether Tilley had actual notice of the incident prior to Starky filing suit against Tilley on September 19, 1969.

Employers secured a standard non-waiver agreement from Tilley and engaged counsel to represent Tilley in the Starky litigation. Simultaneous with defense counsel’s representation of Tilley in the Starky litigation, defense counsel also performed services for Employers which were adverse to Tilley on coverage issues. Specifically, defense counsel failed to advise Tilley of the conflict of interest while actively developing the late notice policy defense and evidence. Such evidence developed by Tilley’s defense counsel served as the predicate for Employer’s declaratory judgment action against Tilley, seeking to deny coverage on the grounds of late notice. Tilley countered that Employer’s conduct and breach of duties served as a waiver of policy defenses and was so contrary to public policy that Employers was estopped, as a matter of law, from denying responsibility for the defense of the Starky

In addressing defense counsel’s conduct, the Texas Supreme Court made evident that “custom, reputation, and honesty of intention and motive are not the tests for determining the guidelines which an attorney must follow when confronted with a conflict between an insurer who pays his fee and the insured who is entitled to his undivided loyalty as his attorney of record.” 2Instead, the Court examined the policy in question, which provided that the insurance company’s obligation to defend the insured included providing an attorney to represent the insured which is selected, employed and paid by the insurance company. Nevertheless, such attorney becomes the attorney of record and the legal representative of the insured, and, as such owes the insured that unqualified loyalty as if he had been originally employed by the insured. “If a conflict arises between the interests of the insurer and the insured, the attorney owes a duty to the insured to immediately advise him of the conflict”

The Court observed that the American Bar Association National Conference of Lawyers and Liability Insurers made a study of the recurring tripartite problem and issued a list of “Guiding Principles” for the guidance of liability insurers furnishing legal counsel for their insureds. Two of the Principles, which the Tilley Court approved of, include:

? IV. Conflicts of Interest Generally – Duties of Attorney. In any claim or in any suit where the attorney selected by the company to defend the claim or action becomes aware of facts or information which indicate to him a question of coverage in the matter being defended or any other conflict of interest between the company and the insured with respect to the defense of the matter, the attorney should promptly inform both the company and the insured, preferably in writing, of the nature and extent of the conflicting interest. . . .

? V. Continuation By Attorney Even Though There is a Conflict of Interests. Where there is a question of coverage or other conflict of interest, the company and the attorney selected by the company to defend the claim or suit should not thereafter continue to defend the insured in the matter in question unless, after a full explanation of the coverage question, the insured acquiesces in the continuation of such defense. .

These Guiding Principles are “not diluted or nullified” by a general non-waiver agreement.

Thus, acts not coming with the plain import of the non-waiver agreements, i.e., the carrier using the same attorney to represent the insured in the underlying liability action and to actively work against the insured on coverage of such claim or loss, may operate as a waiver of such non-waiver agreement and policy defenses. Thus, Employers’ conduct served as a waiver of policy impediments.

Interestingly, Tilley has oft-been cited for the proposition that, in the tripartite relationship, the defense counsel has but one true client, the insured. However, a literal reading of Tilley imports no such rule; instead, Tilley provides that the insured is owed the same duties of loyalty and confidentiality as the insurer, and that in the event of a conflict, the defense counsel’s duties flow to the insured as opposed to the carrier.

v Tilley provides instruction in the handling of conflicts situations. Also, Tilley provides that, “[I]f a conflict arises between the interests of the insurer and the insured, . . .”, implying that there may be cases and circumstances which do not result in a conflict between the insurer and the insured. However, such proviso fails to consider the inherent struggle and conflict between the insurer and the insured regarding the control and handling of the defense of a particular matter.

B. Gandy 3

The Texas Supreme Court in Gandy made a number of rulings that have significantly affected Texas insurance law and practice and will continue to do so for the foreseeable future. First,

the Court eliminated the use of traditional “sweetheart deals” as a method for resolving tort claims and creating the damage basis for extra-contractual claims against the defendant’s liability carrier. Second, the Court altered the rules relating to collateral estoppel and the binding effect of agreements or agreed judgments on carriers. Third, the Court held that declaratory actions may be brought prior to resolution of the underlying tort suit. Fourth, the Court, albeit in dicta, suggested that article 21.55 of the Texas Insurance Code applies to third-party liability carriers. Fifth, the Court’s finding that certain agreements may so affect the judicial system that they are unenforceable has been used by some to assail a number of different types of agreements as contrary to public policy. Finally, the Court appears to have at least in part allowed to stand liability findings outside of the Stowers elements where the carrier assumed the defense of a suit that it in fact had no duty to defend.

I. History and Background

The case begins with a tragedy. The claimant, Julie Kathleen Gandy, was sexually molested by her stepfather, a service station operator named Ted Pearce, over a lengthy period of time. Gandy subsequently sued both the stepfather and her mother. Gandy alleged that her mother failed to warn her of her father’s propensity to engage in such behavior. Pearce hired a local attorney, E. Ray Andrews, who was well known to Pearce. Andrews was hired to defend the civil suit filed in Dallas County, a related criminal action, and a divorce action.

Pearce asked his homeowners carrier, State Farm, to provide a defense and indemnity for the molestation claims against him. Pearce’s attorney handled the defense during the time State Farm evaluated coverage. Eventually, State Farm told Pearce that it would defend him subject to a detailed reservation of rights, indicating the numerous reasons molestation was unlikely to be covered. In a separate letter, State Farm informed Andrews that it would allow him to continue to defend the case and that it would pay his fees. Thus, State Farm voluntarily agreed to provide independent counsel based on the circumstances of the case. State Farm provided a separate defense, subject to a reservation of rights to the estranged spouse of Pearce.

A month before State Farm had communicated with the insured about the defense subject to reservation, Andrews had already failed to properly answer discovery on behalf of Pearce. Unbeknownst to State Farm, Andrews continued to fail to properly answer the discovery, ultimately resulting in an award of monetary sanctions against Pearce and an order to produce adequate discovery answers.

State Farm was provided no information about this discovery dispute. State Farm later filed a declaratory action in federal court to determine whether there was a duty to defend and/or indemnify.

To avoid the coverage problems, the claimant’s counsel pushed for death penalty sanctions for discovery abuse to establish an inadequate defense theory of recovery. Pearce convinced another local attorney with whom he had other business dealings to become involved in the case. Pattison arrived late, out-of-breath, and severely overheated at the courthouse for the sanctions hearing. He was given a reprieve by the judge on the evidentiary sanctions hearing and quickly began discussions with the claimant’s counsel about doing a “sweetheart” deal, involving an assignment of Pearce’s rights against State Farm in exchange for a covenant not to execute.

Pattison and Pearce indicated to the claimant that State Farm had wrongfully refused to defend. The attorneys then began the preparation and exchange of documents, which several months later culminated in an agreed judgment for $6,000,000. The agreed judgment was peppered with recitals intended to affect coverage, to falsely suggest the trial court had determined the agreement was not fraudulent and collusive, and to falsely suggest an actual hearing was held to bless this instrument. Pattison and Pearce continued to keep State Farm in the dark until the last day before the judgment became final. Pattison had been asked about the status of the case previously and feigned ignorance, stating he needed to review the file.

Upon learning of the judgment, State Farm’s counsel sent a strongly worded letter to Pattison stating that an independent counsel defense had been offered subject to reservation of rights and that any failure to properly defend would be the responsibility of the insured. Behind the scenes, the claimant sent agitated correspondence to Pattison asking for confirmation that in fact there had been a wrongful refusal to defend, eventually asking for an affidavit to that effect that was never provided.

A bad faith suit was then brought by the claimant in Marshall, Texas, a city which had no ties to the underlying suit (which was brought in Dallas County) or the underlying facts (which occurred in yet another, different county). The suit was not only against State Farm, but also against E. Ray Andrews, the original trial counsel.’

(a) Trial Court’s Coverage Ruling

Judge Bonnie Leggat granted State Farm’s motion for summary judgment, holding that there was no duty to defend and no coverage for the underlying sexual molestation claims as a matter of law. Judge Leggat, a former prosecutor, made clear to the claimant’s Dallas attorneys that they might that intent was inferred as a matter of law in a molestation claim such as that presented. Notably, the underlying pleadings included virtually every known theory for trying to invoke coverage in molestation cases, such as allegations of mental deficiency based on impulsive behavior, invasion of privacy and negligence in failing to seek treatment and warn others of his propensity to molest.

The case went to trial on the theory that E. Ray Andrews, the independent counsel hired by Pearce, was the agent of State Farm and that in any event State Farm had misled Pearce into believing that he was stuck with Andrews and could hire no one else as his counsel, though he did hire Pattison without consultation or notice to State Farm. The damage theory asserted was that if Pearce had in his words “constructive counsel,” then he either would have been found innocent or at least would not have had a judgment against him for an amount as great as the $6,000,000 he agreed to have entered against him.

At trial, the jury was presented with the spectacle of a victim saying that her step-father molested her, her step-father saying that he did not molest her though he had plea bargained the criminal charges and agreed to a massive civil judgment against him, and then the victim’s attorneys saying that the step-father was damaged by State Farm because he very well might have won the civil suit or at least better controlled the damages. Clearly, consistency was a hobgoblin in this case.

The trial became even more convoluted as Andrews, who had carefully eschewed showing up for the first two days of his own malpractice trial, suddenly appeared as a witness for the claimant. Andrews promptly recanted much of his prior deposition testimony to the effect that he was competent to handle civil cases and that he was not an agent of State Farm. On cross-examination, it was quickly learned that the claimant had dropped her suit against Andrews

less than two minutes before he took the stand. Andrews vigorously asserted that despite these damning circumstances, “like George Washington, I cannot tell a lie.”

The jury awarded $200,000 in damages to the claimant based on alternative theories of liability such as negligence, agency, and violations of the Texas Deceptive Trade Practices Act (DTPA) and the Texas Insurance Code. The trial court rejected numerous strong challenges made by State Farm to the assignment/covenant fiction. The trial court followed the first opinion of the Texas Supreme Court issued in American Physicians Ins. Exchange v. Garcia, 36 TEX. SUP. CT. J. 406 (Dec. 31. 1996).

(b) Court of Appeals’ Decision

The Texarkana Court of Appeals found that there was legally sufficient evidence to support the liability findings based on the notion that State Farm voluntarily assumed a duty to defend that it did not have contractually and that it had a duty to carry out this assumed duty with reasonable care. The court stated that State Farm did not “explicitly set out the extent of its responsibility, its relationship with Andrews, or Pearce’s options to select counsel of his own” would support liability under each of the alternative theories of liability.

The court of appeals reluctantly held that the agreed judgment was some evidence of damages and thus ignored the fact that the covenant not to execute was the legal equivalent of a release and thus extinguished the harm from the judgment if any. The court vigorously criticized the use of such “sweetheart” deals because they perpetrate a fraud on the court and perpetuate an untruth -­that the insured may have to pay the agreed judgment. The court stated that the judgment in Gandy was a “sham.”

The court also criticized the decision of the Texas Supreme Court in its initial opinion in American Physicians Ins. Exchange v. Garcia, supra. 2“Despite our protestations noted above, it appears that our Supreme Court is of the opinion that, even when there is a covenant not to execute, the amount of the judgment can be evidence of some damage to the one who suffered the judgment.” 880 S.W.2d at 138. The court stated that this approach was inconsistent with the decision of the Texas Supreme Court in Elbaor v. Smith, 845 S.W.2d 240 (Tex. 1992), in which the court had found Mary Carter agreements to be contrary to public policy because they “skew the trial process, mislead the jury, promote unethical collusion between nominal adversaries, and create the likelihood that a less culpable defendant will be hit with the full judgment.”

2. The End of Sweetheart Deals

Gandy did not present a classic “sweetheart deal.” The classic approach had been to agree to an assignment and have either a form of “prove-up” “trial” or enter an agreed judgment. The carrier was, pre-Gandy, not clearly permitted to attack the reasonableness of the damages findings, thus allowing the insured and the claimant to set the amount of extra-contractual damages without any real limits other than their own imagination. The reasoning of prior cases was that to challenge the award would be an impermissible “collateral” attack on the underlying judgment. Employers

Cas. Co. v. Block, 744 S.W.2d 940, 943 (Tex. 1988). The classic “sweetheart” scenario occurred where there had been a Stowers demand that was no accepted by the carrier.

In Gandy, the carrier did not deny coverage, defended subject to a reservation of rights, and did not receive a Stowers demand prior to entry of an agreed judgment. Instead, the insured claimed that the defense counsel he had selected became a State Farm attorney and thus under Ranger Ins. Co. v. Guin, the carrier was responsible for the malpractice of this attorney. In short, rather than looking to the judgment as proof of damages in excess of policy limits as a matter of law, the damages question in the bad faith cases turned on whether a different result as to liability or damages would have been achieved if “proper” defense counsel had been selected and/or monitored. Thus, again in contract to the typical “sweetheart scenario,” the damages in Gandy were not established as a matter of law to be the amount agreed to in connection with the agreed judgment.

As to whether the insured could lawfully assign his cause of action to the claimant, the Court held:

[A] defendant’s assignment of his claims against his insurer to a plaintiff is invalid if (1) it is made before an adjudication of plaintiff’s claim against defendant in a fully adversarial trial, (2) defendant’s insurer has tendered a defense, and (3) either (a) defendant’s insurer has accepted coverage, or (b) defendant’s insurer has made a good faith effort to adjudicate coverage issues prior to the adjudication of plaintiffs claim.

Id. (emphasis added). The Court made clear that this list of factors in combination or otherwise was not immutable and would have to be examined in each case. the assignability of choses in action as a matter of equity, the common law has always recognized serious concerns about the fairness of trials resulting from such transactions and the fact that such agreements exponentially increase and stir-up litigation in a champertous fashion. Id. citing RESTATEMENT (SECOND) OF CONTRACTS § 317(2)(b) (1981) and numerous other authorities. The court then analyzed four prior decisions in which it had found assignments to be contrary to public policy, including decisions relating to non-assignability of legal malpractice claims, unenforceability of Mary Carter agreements, non-assignability of direct claims to a settling co­defendant, and non-assignability of interests in estates. Id. The court concluded that it had never “upheld assignments in the face of concerns that such agreements might increase and/or distort litigation.

The court then turned to the specific situation presented in Gandy. First, the court stated that the point of the assignment/covenant in that case “was not to end the litigation but to prolong it.” Second, the court went to great lengths to point out how the litigation against State Farm had been “distorted” by the arrangement. The court noted that Gandy and her counsel had taken widely varying positions regarding damages, asking for $1 million in pleadings, testifying to $50,000 per occurrence, deciding to enter a judgment for $12,500 per occurrence because any greater sum would not be reasonable, and then urging in the bad faith case that even the $12,500 per occurrence awarded by the agreed judgment was not fair because Pearce would have had a lesser amount awarded if competent counsel had been provided. The court also noted that Pearce denied guilt, pleaded nolo contendere to abuse charges, admitted and agreed to abusing Gandy, and then at trial again denied abusing her.

The court strongly discouraged such facile and convenient position shifting:

Parties often take inconsistent positions in lawsuits. Generally the law permits this. Here the parties took positions that appeared contrary to their natural interests for no other reason than to obtain a judgment against State Farm. . .The court of appeals did not exaggerate when it called Gandy’s agreed judgment against Pearce “a sham”, or when it stated that the judgment “perpetuates a fraud” and “an untruth.”

The court then discussed several different problem situations that involved similar problems.

The court noted that a common characteristic of the problems with assignments and covenants is that the claimant will want such an agreement if either his claim against the insured is weak or his chance of recovery against the insured is small. Once the agreement is made, the insured no longer has an incentive to oppose the claimant, thus either agreeing to a judgment or laying down at a brief evidentiary hearing in which the insured’s defense and participation are “minimal.” The court noted that where the judgment is not the result of a fully adversarial trial, it is difficult, if not impossible, to determine what a real litigated recovery would have been, particularly without the assistance and cooperation of the insured. Under such circumstances, the fact that such agreements encourage settlement does not obviate the fact that they distort the trial and end in results that are worse than if there had been no settlement.

3. Collateral Estoppel and Collateral Attack

The Gandy Court overruled the holding in Block, supra, that a challenge to the amount of an agreed judgment was an improper “collateral attack” on the judgment. The Court stated:

In no event, however, is a judgment for plaintiff against defendant, rendered without a fully adversarial trial, binding on defendant’s insurer by plaintiff as defendant’s assignee.

The court expressly disapproved of language in its own opinion in and that of the Fifth Circuit in United States Aviation Underwriters, Inc. v. Olympia Wings, 896 F.2d 949, 954 (5th Cir. 1990), to the contrary. Thus, a carrier may always contest the amount of the so-called judgment where it is not the result of a fully adversarial proceeding and not face the challenge that such an attack is an impermissible collateral attack. Thus, even a carrier which has wrongfully refused to defend may still challenge a set-up or non-adversarial judgment.

The court, in reviewing the approaches taken by a number of other jurisdictions, firmly rejected any rule for future, different cases that would rely upon a retrial of the underlying case or an attempt to determine the reasonableness of any settlement entered without the carrier’s consent. The court concluded that once the parties changed positions, “their views are altered, and it is very difficult to determine what might have been.” Thus, the court concluded that this type of hindsight inquiry should be avoided absent “compelling reasons” to the contrary. The court reasoned that pre­judgment coverage adjudication eliminates the need for such agreements or such inquiries. The court reiterated its warning:

In no event should a judgment agreed to between plaintiff and defendant be binding on defendant’s insurer. If an insurer’s liability is to be litigated in an action by a plaintiff as a[n] [insured’s] assignee after such a judgment is rendered, it should be done on the strength of the plaintiffs claims rather than the generosity of defendant’s concessions.


This aspect of the decision in Gandy leaves unclear the extent to which the Court will find certain types of settlement arrangements and procedural methods of resolving the underlying

suit binding on the carrier. For example, the Texas courts have not clearly addressed whether a default judgment rendered because the insured was too impecunious to defend itself is one that is fully adversarial or whether it need not meet the fully adversarial test. Additionally, the courts have not explained to any significant degree what is entailed in “fully adversarial,” what are the markers.

The recent decision of the Dallas Court of Appeals in Stroop v. Northern County Mut. Ins. Co., 2004 WL 817461 (Tex. App.-Dallas, April 16, 2004), answers at least the question of whether a trial of the merits of the underlying suit and the pertinent coverage issues in a later coverage suit can satisfy the adversarial requirement. In that case, the parties entered into an agreed judgment as the method for settlement. The agreement included an assignment of rights against the carrier in return for a covenant not to execute against the personal, non-insurance assets of the insured. Id. at * 1-2. Subsequently, and as an alternative method of recovery/protection against Gandy, the claimants obtained a turnover of rights against the carrier. Id. at *2.

The court held that Gandy’s requirement of a fully adversarial trial could not be met by a coverage trial of he liability and damages facts from the underlying suit because once the defendant made the assignment, the adversarial process was adversely affected because the defendant of necessity had no stake or a drastically different stake or incentive in fighting the findings. Id. at *3. In short, reconstructing a defense does not amount to a fully adversarial trial.

The court also rejected arguments that the turnover order, involuntary as it was purported to be, somehow called for a different rule to apply. The court held that regardless of whether under a turnover order or otherwise, “the Gandy principle applies.” Id. at *4.

The future of Gandy will ultimately be decided to a large degree in bankruptcy courts. Special settlement arrangements negotiated and approved by the bankruptcy court could in effect result in bankruptcy law supplanting or being “supreme” to Texas substantive law. One of the more interesting areas for Gandy to be considered is the “pre-pack” bankruptcies being used in many mass toxic tort settings. A reorganization plan is voted on and approved with the persuasive influence of the claimants; the bankrupt insured has little or no reason to challenge valuations made by the claimants and memorialized in the final approval of the plan. The approved plan is then treated as a “judgment” to be executed on against the carriers. No trial is held; at best, some minimal proof of the qualifying type of injury is submitted under the scrutiny of a “futures” representative appointed by the court, but typically suggested by the claimants and perhaps the insured. No trial; no fully adversarial trial; no recovery under Gandy or is Gandy superseded by federal bankruptcy law?

4. Pre-Tort Resolution Declaratory Actions

The Gandy Court noted that the need for the insured to protect itself against personal liability does not exist where it can obtain a determination of whether there is coverage or not before the entry of an adverse judgment against it. 3(Query whether this means that the rules are different where an declaratory action is unavailable?) The court did not discuss the fact that before Gandy there had been a strict bar to the litigation of the duty to indemnify before resolution of the underlying case. 4 The court appeared to find that such actions are not only permissible but are also encouraged because they remove uncertainty that vexes all concerned with the underlying case and the coverage issues.

Many refused to find that Gandy changed the long-standing prior law holding that pre-judgment adjudication of indemnity was constitutionally improper. Indeed, most thought it very curious that a long-standing rule of constitutional dimension would be altered by a passing comment without any real discussion of the issue or the prior case-law such as Burch.

The Supreme Court revealed another wrinkle on this issue in Farmers Tex. County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 84 (Tex. 1997). In that case, the court held that in the factual circumstances presented hi that case, the insured’s right to indemnity could be determined prior to resolution of the underlying suit. The court in Griffin reasoned that the controlling constitutional provision at issue in Burch was Article V, section 8, of the Texas Constitution, which required a determination that the amount in controversy had to be valued at or amount to five hundred dollars. The court noted that until the underlying case went to judgment, no one could be sure of whether the amount in controversy requirement was met. One wonders why this requirement would not also present a problem in duty to defend cases as well. Also, it is indeed strange that this particular “amount in controversy” point was not discussed at all in Burch.

The Griffin court held that Section 8 has now been amended. The court held that the language was sufficiently broadened to permit a court to resolve jurisdiction issues pertaining to pre­judgment declaratory actions regarding indemnity prior to resolution of the underlying suit. The court also noted that it had “hinted” at this change in the law in Gandy when it observed that indemnity issues are not always “non-justiciable before liability is resolved.” Id. at 83.

The court held that only some indemnity issues are justiciable. In this respect, the court made two critical points. First, the court warned:

It may sometimes be necessary to defer resolution of indemnity issues until the liability litigation is resolved. In some cases, coverage may turn on facts actually proven in the underlying lawsuit. For example, the plaintiff may allege both negligent conduct and intentional conduct; a judgment based on the former type of conduct often triggers the duty to indemnify, while a judgment based on the latter usually established the lack of a duty. In many cases, however, the court may appropriately decide the rights of the parties before the judgment is rendered in the underlying tort suit.

Id. (emphasis added). Of course, the example given is erroneous and contrary to prior Texas law. A mere finding that the insured is negligent does not submit and will not bind the carrier as to whether the intended harm exclusion or the accident requirement of the policy is met.

Second, the court in Griffin expressly limited its holding to the situation where the insured has no duty to defend and the same reasons that would negate the duty to defend negate any possibility the insurer would ever have a duty to indemnify. Thus, while “actual facts” are typically used to determine the duty to indemnify, the court held in Griffin that a court could hold that there was no duty to indemnify if there was no duty to defend under the pleaded facts. This court based its decision on the notion that the duty to defend is broader than the duty to indemnify, and if there was no duty to defend, there logically could be no duty to indemnify. Thus, Griffin is not an unlimited holding that declaratory actions will work in every case for determining whether there is a duty to indemnify, indemnity prior to resolution of the underlying suit.

The courts of appeal generally adopted a narrow reading of Griffin. In Calderon v. Mid-Century Ins. Co. of Texas, 1998 WL 898471, *4 (Tex. App.-Austin 1998, no writ), the court held that there was a duty to defend and thus it could not determine indemnity prior to resolution of the underlying suit. The court held that the underlying suit would determine whether there was a duty to indemnify and that to act prior to resolution of that suit would be “premature.”

The San Antonio Court of Appeals reached the same result in Foust v. Ranger Ins. Co., 975 S.W.2d 329, 331 (Tex. App.-San Antonio 1998, writ denied). The court held there was a duty to defend and thus Griffin did not apply to allow indemnity to be determined. The court emphasized that Griffin did not profess to overrule the Burch rule against providing advisory pinions regarding indemnity. Id. at 332 n. 1.

In Matagorda County v. Texas Ass ‘n of Counties Govt. Risk Mgmt. Pool, 52 S.W.3d 128 (Tex. 2000), the court held that a carrier was not entitled to unilaterally reserve the right to and then sue the insured for reimbursement of amounts tendered towards settlement of the underlying case against the insured based on the fact that there is no coverage. Insurers have repeatedly urged that unilateral reimbursement is a critical protective device to avoid Stowers exposure. The court in Matagorda did permit the use of an agreement between the insured and the insurer to allow reimbursement, bilateral reimbursement.

The court in Matagorda reasoned that there was no great need for unilateral reimbursement in light of the availability of an early declaratory action brought prior to resolution of the underlying suit. The court stated that if the insured will not consent or agree to allow reimbursement, the carrier can always “seek prompt resolution of the coverage dispute in a declaratory action.” The court broadly suggested that declaratory actions are readily available on questions of indemnity prior to resolution of the underlying suit. Id. at 135. The court added:

In Gandy, we required insurers either to accept coverage or make a good-faith effort to resolve coverage before resolving the underlying claim . TAC’s position undermines Gandy by reducing insurers’ incentive to seek early resolution of coverage disputes.

Id. The effect of this court’s ruling will clearly be to encourage the filing of a declaratory action on coverage in every action involving coverage issues. This ruling will lead to great confusion and debilitating delay. The caseloads of the courts will double for every case with a coverage issue. Unless the court’s statements in the Matagorda opinion regarding Griffin were intended to indicate that Griffin is being expanded, then declaratory actions are absolutely not available to resolve whether there is a duty to indemnify in most cases. They are certainly not available where there is a duty to defend, the opposite situation from that presented in Griffin. Declaratory actions would also not appear to be available where only some claims or damages may be covered.

The Griffin exception has now been followed in at least one federal declaratory action. In Southwest Tank and Treater v. Mid-ContinentCas. Co., 2003 WL 223445, *6 (E.D. Tex. 2003)(Davis, J.). In that case, the court broadly held that if there is no duty to defend, then there will not be a duty to indemnity. The court held that there was no duty to defend and thus no duty to indemnify based on the exclusion for the repair <!– [if gte vml 1]>


<![endif]–>or replacement of property because the insured’s work was performed on it.

Recently, in Westport Ins. Co. v. Atchley, Russell, Waldrop & Hlavinka, 267 F. Supp.2d 601, 626 (E.D. Tex. 2003), the court held that the general rule in Texas is that indemnity cannot be determined until resolution of the underlying suit. The only exception, the court noted, is when the court determines that there is no duty to defend and no set of facts alleged would invoke coverage, citing Griffin. The court also refused to resort to extrinsic evidence to determine the duty to defend and thus also the duty to indemnify. In Utica Nat’l Ins. Co. v. American IndemnityCo., 2003 WL 21468776, *6 (Tex., June 26,2003), the Supreme Court gave slightly more insight into when indemnity can or cannot be determined as a matter of law based on the pleadings. The degree of insight is muddied by the fact this is a plurality opinion. Interestingly, the court made these comments in a case in which the parties agreed that the duty to defend could be determined as a matter of law and in which the underlying suit had already been settled and the coverage litigation filed afterward. One of the issues presented in the case was whether the injection of patients with an infected hypodermic needle was a cause of the insured’s liability. In other words, the court concluded that the policy in question, which excluded coverage for claims “due to” professional services, required proof that the professional act was a liability-causing act and not an innocent act that was a part of the chain of causation. Id. at *4-5. The Supreme Court noted that in Griffin, supra, it had held that indemnity often turns on the resolution of factual issues. The court, quoting Griffin, stated:

“It may be sometimes necessary to defer resolution of indemnity issues until the liability litigation is resolved. In some cases, coverage may turn on facts actually proven in the underlying lawsuit. For example, the plaintiff may allege both negligent conduct and intentional conduct; a judgment based upon the former type of conduct often triggers the duty to indemnify, while a judgment based on the latter usually establishes a lack of a duty.”

Utica, supra, at *6 (quoting Griffin, 955 S.W.2d at 84). The court applied this rule to the case before it, reasoning:

The injured patients alleged both professional and general liability. A determination by the finder of fact that the infection was caused by the breach of a professional standard of care-for example, a finding that the infection was caused by the doctor’s negligent administration of the anesthetic-would negate [the carrier’s] duty to indemnify [under the professional services exclusion]. If, however, the professional services were rendered with due care, then the exclusion would not apply.

Id. Thus, it would appear that the fact of the settlement does not foreclose in any way the ability to resolve true coverage-related factual issues. Is the court suggesting that since the case basically came to it based on facts alleged and limited by agreement of the parties to those plead somehow makes Griffin relevant?

It is important to note that the opinion suggests that in appropriate cases the Griffin exception can still be used to determine the duty to indemnify, even if the underlying suit has settled and the duty to defend is moot. Thus, the court could resolve a moot issue to resolve a live indemnity controversy.

Of course, the reasoning in Utica is bewildering. Normally, the duty to indemnify is determined by the actual facts upon which “liability” is based. Here, there was a settlement and thus the determination of “liability” was not contained in a verdict and/or judgment. The court appears to be suggesting that because of the “due to” language, the parties will actually litigate for the first time whether the injection itself was done negligently and thus could have created a liability “due to” professional services. The court does not appear to answer whether more than the “injection” itself could be considered. The insureds were also alleged to have been negligent in maintaining the medicine box where anesthetic vials were kept. The opinion certainly does not appear to foreclose the use of this “professional act” as a theory. A footnote to the opinion states that the parties agreed that this theory would involve general as opposed to professional conduct. Id. at 7 n.2. This agreement was only “for purposes of this appeal.” One would expect that the gloves will be off at the new trial on this issue. Nevertheless, the dissenting opinion of Justice Enoch suggests that the court has indeed cut off any theory that the administration of the medicine lock-box as a basis of professional liability subject to exclusion. Id. at *7. The court also does not answer the question of what happens if there are mixed findings, in other words some liability “due to” professional services and some not. The court clearly rejected the notion that the injection was professional and served as the hub of the wheel of all liability, thus invoking the concurrent cause doctrine or related and interdependent doctrine to cut-off all liability, discussed in the briefs but not explained by name in the opinion.

Utica is still pending. Both sides have filed motions for rehearing, and the case has been reargued to the Court. These motions raise a number of issues, including whether the concurrent cause and/or related and interdependent rules till exist after the plurality decision.

5. Applicability of 21.55 to Third-Party
Liability Carriers

Admitting that declaratory actions may be a burden to the insured, the court noted that attorney’s fees can be recovered by the insured and that an interest penalty may be awarded under TEX. INS. CODE art. 21.55, sec. 6 (Vernon’s Supp. 1996). Since Gandy, the courts applying Texas law on this issue have been badly split. The most recent decision is that of the Dallas Court of Appeals in TIG Ins. Co. v. Dallas Basketball, Ltd., 2004 WL 352079, slip op. at *6­7 (Tex. App.-Dallas, Feb. 25, 2004, reh’g overruled), which held that the statements regarding 21.55 in Gandy were dicta and that the better view was that the statute had no application to third-party liability carriers. This issue is also before the Supreme Court in Northern County Mutual Insurance Company v. Davalos, 84 S.W.3d 314 (Tex. App. – Corpus Christi 2002, pet. granted/pending).

6. Impact on Other Agreements

Gandy does not appear to have had any significant impact regarding the challenging of other types of agreements as against public policy. The prior decisions of the Supreme Court, such as Elboar v. Smith, 845 S.W.2d 240 (Tex. 1992)(Mary Carter agreements), seem to provide more real guidance and instruction than Gandy itself. The Court certainly shows no desire in Gandy to greatly expand the categories of agreements contrary to public policy, which could obviously have a deleterious effect itself.

7. Other Torts-Assumed Duty

The elements of Stowers simply could not and were not satisfied under the facts in Gandy. The court of appeals rejected arguments that the lack of any duty to defend and/or indemnify prevented any extra-contractual liability under either the DTPA/Insurance Code or under common law negligence. The theory was simply that State Farm failed to inform the insured that he could change attorneys and State Farm would still agree to pay for the defense. The insured claimed that even though he picked the lawyer who mishandled discovery and got him sanctioned, he thought, based on the carrier’s communications, that he had to proceed with this lawyer and this lawyer only. The court of appeals thus in effect sanctioned a claim against the carrier for in effect derivative liability for the malpractice of the defense attorney based upon inadequate or misleading communications with the insured about the defense being provided. The negligence count was more obtuse, being based primarily on the assumption of duty concept. It is unclear whether the court of appeals would have reached the same result in Gandy after State Farm Mutual Automobile Insurance Company v. Traver, 980 S.W.2d 625 (Tex. 1998)(holding that carrier cannot be held vicariously liable for the acts of the insurance defense attorney).

C. Maryland Insurance Company

In Maryland Insurance Company, Don Nelson, an employee of Head Industrial Coatings & Services, Inc., sued Texas Utilities Electric Company and others for personal injuries he sustained while working on TU’s premises. TU cross-claimed against Head Industrial for contractual indemnity (the “PI Suit”). Head Industrial, in turn, sought coverage and defense from its CGL insurer, Maryland Insurance Company. Prior to Nelson’s injury, Head Industrial had been assured by Maryland’s local recording agent, Gans & Smith Insurance Agency, that Head Industrial had $500,000 coverage for claims such as Nelson’s. However, in fact, Gans & Smith had failed to procure the coverage because of a clerical error. Thus, when presented with the PI Suit, Maryland Insurance, relying upon the policy language and unaware of Gans & Smith’s actions, denied coverage and refused to defend Head Industrial in the PI Suit. Head Industrial then sued Maryland Insurance and Gans & Smith.

Thereafter, in the PI Suit, TU and Head Industrial each assigned to Nelson their claims against Maryland Insurance, and Nelson agreed to prosecute the claims and attempt to recover TU’s and Head Industrial’s defense costs in the PI Suit. Head Industrial and Gans & Smith guaranteed Nelson a recovery of $500,000 and Nelson promised not to enforce any judgment against their assets. The parties released their claims against each other except as provided in the settlement. Head Industrial also dismissed its action against Maryland Insurance and Gans & Smith. Nelson obtained a judgment against TU and Head Industrial for $1.8 Million, after a brief, non jury trial.

Nelson subsequently sued Maryland Insurance in Head Industrial’s name seeking policy benefits and damages due to the denial of defense and coverage of Head Industrial in the PI Suit. Nelson also alleged that Maryland Casualty breached its duties of good faith and fair dealing, Insurance Code and DTPA duties owed to Head Industrial. Shortly before trial, Maryland Insurance learned of Gans & Smith’s mistake, and offered the policy limits of $500,000, which Nelson/Head Industrial refused. The matter proceeded to trial, wherein the court rendered judgment against Maryland Insurance, compensating Nelson/Head Industrial for the sum of the judgment in the PI Suit, defendants’ costs and attorneys’ fees in the PI Suit, statutory penalties under Tex. Insur. Code Art. 21.55, prejudgment interest and attorneys’ fees.

A divided court of appeals modified the judgment to limit actual damages to the $500,000 policy limits, defense costs in the PI Suit, and eliminate the Art. 21.55 damages, instead trebling the actuals.

In its summary analysis, the Texas Supreme Court refused to recognize a cause of action for breach of the duty of good faith and fair dealing in the third-party context. “Texas law recognizes only one tort duty in this [third-party claim] context, that being the duty stated in Stowers Furniture Company v. American Indemnity Company, 15 S.W.2d 544 (Tex. Comm’n App. 1929, holding approved). The Court determined that an insured is fully protected against his insurer’s refusal to defend or mishandling of a third-party claim by his contractual and Stowers rights. “Imposing an additional duty on insurers handling third-party claims is unnecessary and therefore inappropriate.” The Court also determined that the “damages are not trebled” and a third-party claim was not subject to penalty under Art. 21.55 “for the reasons explained by the court of appeals.”

• We observe that Head Industrial involved common law claims for breach of the duty of good faith and fair dealing, not statutory violations of Tex. Insur. Code Ann. Art. 21.21. Since the rendition of Head Industrial, the Dallas Court of Appeals has issued Chickasha Cotton Oil Company v. Houston General Insurance Company 5 which noted that the Insurance Code was modified in 1995, after suit was filed in Head Industrial, by adding § 4(10) which permits an insured to sue its insurer for unfair settlement practices as a statutory claim under Art. 21.21, including claims in the third-party context.

• Art. 21.55 was held not to apply to this third-party liability claim and claim for defense because the claim was filed and presented to the carrier and the carrier denied defense and coverage all almost one full year prior to the enactment of Art. 21.55. It appears that the parties did not address or argue the distinction between a first-party claim under Art. 21.55 and a third-party claim and demand for defense under Art. 21.55

• Subsequently, TIG Insurance Company v. Dallas Basketball, Ltd., 129 S.W.3d 232 (Tex. App. – Dallas 2004, rehrg overruled April 05, 2004) has determined that Art. 21.55 is not applicable to an insured’s claim for a defense of a third-party liability action. This issue remains unresolved, however, as indicated in the Davalos decision discussed below.

D. Davalos6

Timoteo Davalos was injured in an automobile accident in Dallas County, Texas in October, 1995. Davalos sued the driver of the other vehicle in Matagorda County, Texas and a North Carolina insurer. The driver and his wife sued Davalos in Dallas County, Texas. Davalos hired is own counsel who filed an answer and motion to transfer venue of the Dallas County case to Matagorda County.

Davalos’ attorney promptly sent the petition for the Dallas County case to Northern County and requested that it provide a defense to Davalos. Northern County responded by requesting that Davalos withdraw his motion to transfer venue and then allow Northern County’s selected counsel substitute in. Davalos refused to withdraw his motion to transfer venue, and maintained his selected counsel.

Subsequently, Davalos sued Northern County in Matagorda County alleging that Northern County breached its duty to defend Davalos in the Dallas County action, engaged in unfair methods of competition and unfair or deceptive acts or practices under Tex. Insur. Code Ann. Art. 21.21, and violated Tex. Insur. Code Art. 21.55 by failing to undertake Davalos defense.

The trial court found for Davalos on cross motions for summary judgment. Judgment was entered for Davalos for $15,000 for breach of contract and an additional monetary award for Davalos’ claim under Art. 21.55. Northern County appealed such judgment.

In his first point of error, Davalos argued that Northern County breached its contract by failing to defend Davalos in the Dallas County action. The Court of Appeals stated the general proposition that:

When an insurer is faced with the dilemma of whether to defend or refuse to defend a proffered claim, it has four options: (1) completely decline to assume the insured’s defense; (2) seek a declaratory judgment as to its obligations and rights; (3) defend under a reservation of rights or a non-waiver agreement; or (4) assume the insured’s unqualified defense.

The Court then observed that Northern County did not decline to assume Davalos’ defense. Also, Northern County did not seek a declaratory judgment as to its rights and obligations under the policy, nor did Northern County defend under a reservation of rights or a non-waiver agreement. Instead, Northern County objected to the retention of Davalos’ chosen counsel, insisted upon substituting in Northern County’s counsel of choice, and insisted upon Davalos’ withdrawal of motion to transfer venue.

In determining that Northern County breached its contractual duty to defend Davalos in the Dallas County action, the Court noted that, consistent with Traver, the insurer’s control of the defense is limited such that “the insurer’s control of the insured’s defense under this policy includes authority to … and, where no conflict of interest exists, to make other decisions that would normally be vested in the client, here the insured.” 7

Davalos’ desire to move the case to Matagorda County as opposed to the carrier’s desire to leave the matter in Dallas County is an “obvious conflict of interest.” Such conflict of interest “forfeited [the carrier’s] control of the defense . . .”. Thus, Northern County breached its contractual obligation to defend Davalos.

Next, the Court addressed Davalos’ argument that Art. 21.55 applies to the determination of the duty to defend a third-party liability claim. Further, Davalos argued that Northern County is liable to Davalos for an Art. 21.55 violation because Northern County failed to timely respond to the demand for defense. Northern County countered that it did not violate Art. 21.55 because the time deadlines were met. Notably, Northern County did not argue the distinctions between a first versus third-party claim and such application to Art. 21.55.

The Court of Appeals determined that since Northern County did not explicitly accept or reject Davalos’ claim, it failed to meet the time deadlines to accept or reject the claim, and subjected itself to attendant Art. 21.55 liability. The Court did not address which of Davalos’ claims subjected Northern County to liability, the claim for defense or the claim for coverage under the policy. The Court did not address the technical or practical implications of applying Art. 21.55 to a third-party claim for liability coverage.

Davalos appears to recognize the inherent conflict of who controls the defense, the insurer or the insured. Notably, the Davalos Court looked at the insured’s initial control over venue selection, which was the precipitating fact creating the conflict – not that the conflict then vests control in the insured. This dichotomy is slightly askew to Tilley.

E. Traver 8

In Traver, Mary Davidson collided with Calvin Klause in an automobile collision in January, 1989. Mary Jordan, a passenger in Klause’s car, was severely injured. Both Davidson and Klause were insured with State Farm Mutual Automobile Insurance Company. Each had an auto liability policy with a per person limit of $25,000.

Jordan sued both Davidson and Klause. State Farm retained two separate attorneys to represent Davidson and Klause. The jury found Davidson 100 % responsible for the accident and awarded Jordan $375,000 plus approximately another $100,000 in prejudgment interest.

Davidson died shortly after trial. Her executor, Ronald Traver, brought suit against State Farm contending that State Farm was negligent, breached its duty to defend Davidson in the Jordan lawsuit, breached its Stowers duty, breached the duty of good faith and fair dealing and Tex. Insur. Code Ann. Art. 21.21 as well as DTPA. Specifically, Traver alleged that the defense attorney retained by State Farm to represent Davidson in the Jordan litigation committed malpractice by failing to attend several key depositions and by failing to offer a meaningful defense at trial. Traver also alleged that State Farm orchestrated such malpractice to avoid Stowers exposure to Klause.

The trial court rendered summary judgment in favor of State Farm on all claims. The court of appeals reversed in part and affirmed in part. The court of appeals held that, under Ranger County Mutual Insurance Company v. Guin, 723 S.W.2d 656, 659 (Tex. 1987), State Farm was responsible for any injury caused by the malpractice of the attorney it retained for Davidson. Because State Farm had not negated the existence of such alleged malpractice, the court of appeals remanded Traver’s negligence claim for trial, along with any claims under the DTPA or Insurance Code relating to such negligence. The court of appeals held further that State Farm had conclusively negated Traver’s Stowers claim and that the State Farm owe no duty of good faith to its insured in the third-party context.

The Texas Supreme Court, in determining that an insurance company is not liable for the malpractice of the independent attorneys the insurer retains to represent its insureds, relied upon traditional concepts of principle/agent black letter law. Specifically, the Court examined whether the insurer acted as principal with the right to control the details of the agent/attorney’s conduct.

The Court recognized that, although the standard personal auto policy vests the insurer with the right to control the defense, including the authority to accept or reject settlement offers, and, absent any conflict of interest, the right to make other decisions that would normally be vested in the insured client, such control does not meet the requisite control for vicarious liability. 9 Further, the defense attorney, as an independent contractor, has discretion in the handling of the day to day details of conducting the defense. Also, as the attorney “owes unqualified loyalty to the insured,. . . the lawyer must at all times protect the interests of the insured if those interest would be compromised by the insurer’s instructions .” 1° Accordingly, under such circumstances of control, the carrier cannot be vicariously responsible for the attorneys’ conduct.

However, the Supreme Court rejected State Farm’s contention that Head Industrial necessarily limited Traver’s damages to the policy limits and defense costs. The Court clarified its position in Head Industrial that it was unnecessary to recognize a duty of good faith and fair dealing in the context of third-party liability insurance because the duty of reasonable care adopted in Stowers already protected the insured. The Court reiterated Industrial Head such that the rights granted under Stowers together with rights under the contract of insurance fully protect an insured against an insurance company’s erroneous refusal to defend a third-party liability claim. However, the Supreme Court distinguished Traver, asserting that Traver’s claims were not that the insurer merely refused a defense to the third-party liability action, but that the insurer “consciously undermined the insured’s defense”. The Supreme Court remanded the matter to the trial court to allow Traver to pursue “any remaining claims that he pled or might plead” against State Farm.

41 . The Court rendered judgment for State Farm on all claims based upon allegations of vicarious liability. Traver did not challenge the court of appeals’ judgment on the Stowers duty, the duty of good faith and fair dealing, or any statutory claim relating to those duties. Thus, all of Traver’s claims had been disposed of by either the Texas Supreme Court or the court of appeals; there were no claims surviving to remand. The Supreme Court’s remand of claims which “might” be pled may demonstrate the Court’s willingness to entertain Tilley type arguments and the recognition of a common law tort claim in circumstances where the carrier’s conduct “consciously undermines” the insured’s defense.

F. Tex. Comm. On Professional Ethics, Op. 533, V. 63 Tex. B. J. 806 (Sept. 2000)

Tex. Ethics Opinion 533 pertains to an insurance company’s litigation and billing guidelines. Specifically, the issue confronting the Ethics Commission was:

May a lawyer, who is retained by an insurance company to defend its insured, ethically comply with litigation/billing guidelines which place certain restrictions on how the lawyer should conduct the defense of the insured?

In addressing this issue, the Ethics Commission first observed that insurance policies between an insurer and insured customarily define the insurance company’s obligations to defend the insured with an attorney selected and paid for by the insurer. Various insurers may promulgate guidelines which place restrictions on how retained counsel can conduct the defense of the insured, including whether to retain an expert or conduct legal research or investigate the claims made against the insured.

The Ethics Commission then relied upon Tilley and its progeny for the rule of law that an attorney/client relationship exists between an insured and the lawyer retained by the insured’s insurer. Also, the Ethics Commission recognized that loyalty is an essential element in the lawyer’s relationship to a client, including the client/insured. Relying upon the Texas Disciplinary Rules of Professional Conduct (“D.R.”) 2.01, the Ethics Commission noted that, “in advising or otherwise representing a client, a lawyer shall exercise independent professional judgment and render candid advice.” D.R. 5.04 also supports the Ethics Commission in stating, “a lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering such legal services.”

All such disciplinary rules concentrate on the Traver issues of control and use of independent judgment. To the extent litigation or billing guidelines or instructions from a carrier interfere with the lawyer’s professional judgment, such guideline or instruction violate D.R. 1.01, 1.08, 2.01, and 5.04. Regardless of an insurer’s agreement with an attorney regarding the attorney’s fee and services to be rendered, the “lawyer must at all times be free to exercise his or her independent professional judgment in rendering legal services to the client.” “No restriction or requirement by the third-party insurer can direct or regulate the lawyer’s professional judgment in rendering such legal services or affect the lawyer’s responsibility to the insured/client.”

•Ethics Opinion 533 supports the Tilley duties flowing from the defense counsel directly to an insured/client. Also, Ethics Opinion 533 may provide authority for the defense counsel to decline a carrier’s request or instruction which may (i) place defense counsel in a conflict situation and/or (ii) fail to further the liability defense of the insured/client in contravention of defense counsel’s professional judgment.

G. American Home”

American Home Assurance Company, Inc. and The Travelers Indemnity Company sought a declaratory judgment against the Unauthorized Practice of Law Committee that using lawyers who are employees of an insurance company (in-house or staff counsel) to defend insureds under liability policies was not the unauthorized practice of law by the insurers. The UPLC counter-claimed for a declaratory judgment and for an injunction enjoining American Home and Travelers from the continued use of their staff attorneys to represent their insureds.

The trial court, on cross-motions for summary judgment, held that the insurance companies were indeed engaged in the unauthorized practice of law. American Home and Travelers appealed.

The Court observed that:

Insureds purchase liability insurance to protect against the risk of defending a lawsuit and to protect against the risk of having to pay a money judgment as a result of that lawsuit. The defense of a lawsuit covered by liability insurance involves the “tripartite” relationship consisting of the insured, the insurer, and the defense counsel. Because this tripartite relationship may involve conflicts, there has been an ongoing national debate concerning the ethical obligations of defense counsel and the role of the insurer in providing defense counsel. Use of staff counsel by insurance companies has raised the issue of whether such use constitutes the unauthorized practice of law by corporations.

Also, the Court recognized that the typical liability policy vests the right to take complete and exclusive control of the insured’s defense unto the insurer. The Texas Supreme Court has also recognized that a liability policy may grant to the insurer the right to take such control of the insured’s defense.

The Court then conducted a historical review of staff counsel and the ethical implications. In 2001, two bills were introduced to the Texas House of Representatives which would have had the effect of vitiating staff counsel from representing insureds. Insurance companies responded with testimony to the House regarding the economic benefits to the insurers and insureds from the use of staff counsel. The UPLC argued various ethical considerations, including the use of staff counsel violates the Texas Disciplinary Rules of Professional Conduct.

The UPLC argued that employers, including insurance companies, have the right to direct the details of the work of their employees. UPLS then concluded that the insurance company’s right to control the details of the work of staff attorneys creates an irreconcilable conflict with the interests of the insured because insurance companies will interfere with their staff attorneys’ exercise of professional judgment.

The Court disagreed, opining that the UPLC began with a faulty premise. Instead, the Court observed that an employee attorney does not owe an absolute duty of loyalty to his or her employer. Instead, the attorney’s ethical duty to the client outweighed the firm’s interest in demanding loyalty from its attorney employees.

Further, the Court provided:

The insurance staff attorney, like the outside attorney, may face conflicts; however, his status as an employee is not an irreconcilable conflict. . . . Potential conflicts are inherent in the tripartite relationship, and those ethical concerns are properly addressed by the Texas grievance system.

UPLC also argued that the use of staff counsel implicates violations of Professional Ethics rules. Specifically, UPLC argued that use of staff counsel violates Texas. D. R. 1.05 (confidentiality of information); 1.06 (conflict of 19 interest: general rule); 2.02 (evaluation for use by third persons); 5.04 (c) and (d) (professional independence of a lawyer); 5.05 (unauthorized practice of law); 7.06 (prohibited employment); 8.03 (reporting professional misconduct); and 8.04 (misconduct). The Court rejected such argument, stating, instead, that the Court had reviewed the Texas Disciplinary Rules and the ABA Model Rules, and determined that noting in the Texas Rules supports the conclusion that it is unethical for insurance staff counsel to represent insured. Instead, the Court relied upon ABA Formal Opinion 282, which was re-affirmed by ABA Formal Opinion 03-430, which determined that “there is nothing basically unethical in a lawyer, who is employed and compensated by a collision insurance company, defending a person in an action based upon damage to person and property brought by a third party.” ABA Formal Opinion 282 was relied upon and forms the basis of Texas Committee on Professional Ethics Opinion 260 (1963).

Next, the UPLC argued that Texas is a “one-client” state, meaning that the insured is the only client. However, the Court rejected such premise, noting that the Texas Supreme Court “has not expressly held that Texas is a one-client state.” Instead, Texas Committee on Professional Ethics Op. 260 recognized that the defense attorney in the tripartite relationship had two clients. Also, the Court reconciled Tilley such that Tilley

. . . also viewed the outside attorney as having two clients, the insurer and the insured. The Tilley court’s analysis was in terms of a lawyer representing two or more clients with differing interests. The concurring opinion faulted the majority for not finding that the lawyer’s duties ran only to the insured.

The Court continued that “reality and common sense dictate that the insurance company is also a client.”

The insurance company retains the attorney, controls the legal defense, decides if the case should be settled, and pays any judgment or settlement amount up to policy limits. It is a fiction to say that the insured is the only client in view of the contractual relationships. We agree that the insured is the primary client and that ethical choices must be resolved in favor of the insured. But under contract law, the attorney can have two clients. [Footnote omitted.] The “one-client, two-client” argument speaks to ethical conflicts, not to whether an insurance company is engaged in the unauthorized practice of law.

Notably, the Unauthorized Practice of Law Committee filed its petition for review to the Texas Supreme Court on April 05, 2004.

Although American Home does address the fallacy of the one-client rule, it fails to address the inherent conflicts attendant to the control of the defense of the insured, and as exemplified in Davalos.

H. Duddlesten12

In 1991, Duddlesten obtained workers’ compensation insurance from Highlands for the policy term July 01, 1991 through July 01, 1992. The next two years, Duddlesten obtained workers’ compensation insurance from Aberdeen, a subsidiary of Highlands, with the policy effective terms 1992/1993 and 1993/1994. As part of the 1991/1992 policy, Duddlesten agreed to a retrospective premium payment plan. Under this retrospective premium payment plan, a standard annual premium amount would be adjusted according to factors based on the amounts that Highlands had to pay on claims made under the policy.

Highlands timely filed the requisite notice of election with the State Board of Insurance and indicated on the notice of election form that the retrospective rating plan was for a term of three years. The notice of election form also indicated that the retrospective rating plan would apply to the 1991/1992 policy, but there was no reference to the 1992/1993 or the 1993/1994 policies. The 1992/1993 and 1993/1994 policies issued by Aberdeen incorporated the premium payment plan from the 1991/1992 policy by reference. None of the applications for the three policies indicated that there would be a retrospective premium payment plan in effect.

In March, 2000, Duddlesten sued Highlands for “inappropriately” settling and paying several claims that had been asserted against Duddlesten by Duddlesten’s employees. Duddlesten asserted claims predicated upon Art. 21.21, negligence, DTPA, fraudulent inducement, breach of fiduciary duty, breach of the duty of good faith and fair dealing, breach of contract and for declaratory relief.

The trial court granted summary judgment against Duddlesten on its claims for breach of contract, DTPA and Insurance Code claims. Highlands was granted summary judgment as to Duddlesten’s claims of breach of fiduciary duty. Finally, the trial court granted summary judgment in favor of Duddlesten on its claims for fraud in the inducement, breach of express warranty, and estoppel claims. properly investigate and adjust the various claims. Duddlesten relied upon policy language which provided, in pertinent part,:

We will pay promptly when due the benefits required of you by the Worker’s Compensation law.

Specifically, Duddlesten argued that such policy verbiage imposed upon Highlands the duty to pay only those claims against Duddlesten that were valid. Also, Duddlesten relied upon policy language which stated, “We have no duty to defend a claim, proceeding or suit that is not covered by this insurance.” Duddlesten argued that such defense obligation was violated when Highlands settled claims that should not have been covered by the policy.

The Court disagreed, and held that the policy vested Highlands with the right to investigate and settle all claims, proceedings or suits. Further, Highlands’ results of investigation would determine its obligation to pay benefits consistent with the policy’s terms. There is no requirement in the policy that Highlands obtain Duddlesten’s consent when settling a claim or investigating the merits of such claim, and the Court declined to write such clause into the policy.

Duddlesten also asserted claims under the Tex. Insur. Code Ann. Art. 21.21 and Texas DTPA. Essentially, Duddlesten’s Insurance Code and DTPA claims encompass the argument that Highlands misrepresented the policy’s terms and benefits by knowingly misrepresenting that only legitimate claims would be paid. The Court dismissed such argument, relying upon evidence that Duddlesten had no personal knowledge and was not aware of anyone with Duddlesten’s company who knew of any alleged misrepresentation

Also, Duddlesten asserted as evidence of misrepresentation that letter from an independent insurance agent which stated that the insurance agent believed that Highlands’ adjustment 21

calculations were correct and Duddlesten’s experts’ affidavits which contradicted such adjustment calculations. The Court observed that, as a matter of law, Highlands had the right to settle claims under the policy and such right was not contractually limited. Any alleged or implied misrepresentation stemmed from an alleged failure to comply with the terms of the contract, which provides the basis for a breach of contract claim. Such conduct cannot be used to support an action under the Insurance Code or DTPA.

Duddlesten also alleged that Highlands owed a fiduciary duty to Duddlesten, which Highlands breached. The Court, instead, found that no such fiduciary relationship existed between insured and insurer. The Court observed that:

Fiduciary relationships can be created by formal, or technical relationships, such as attorney-client relationships, or from informal relationships where the existence of confidence and trust imposes greater duties as a matter of law.

The Court noted that “there is no general fiduciary duty between and insurer and its insured.”

To impose an informal fiduciary relationship in a business transaction, the requisite special relationship of trust and confidence must exist prior to, and apart from the agreement made the basis of the suit. . . .

Insofar as Duddlesten’s negligence claim, Duddlesten did not assert a traditional Stowers claim; instead, Duddlesten alleged that Highlands negligently settled and paid invalid workers’ compensation claims that had been asserted against Duddlesten. According to Duddlesten, because Highlands would be reimbursed by Duddlesten pursuant to the retrospective premium payment plan, Highlands had less incentive to dispute invalid claims and were allegedly

negligent in settling several of the claims asserted against Duddlesten. Duddlesten argued that Ranger County Mutual Insurance Company v. Guin, 723 S.W.2d 656 (Tex. 1987) expanded the Stowers duties to cover a claim for negligent claims handling.

The Court rejected Duddlesten’s argument, citing American Physicians Insurance Exchange v. Garcia, 876 S.W.2d 842, 849 (Tex. 1994) wherein the Texas Supreme Court referred to the Ranger Court’s language about the duty of an insurer as “dictum”. Also, this Duddlesten Court noted that the Supreme Court has expressly recognized only one tort duty in the third-party liability context, that being a Stowers duty. Being “unwilling to expand the scope of an insurer’s duties to the insured,” the Duddlesten Court rejected the insured’s argument for the creation of a negligent claims handling tort duty.

L Stroop13

In 1992, Sunset Transportation, Inc. carried a commercial insurance policy issued by Northern for a one-year policy term. After finding cheaper coverage, Sunset purchased a policy from Underwriters Lloyds Insurance Company which went into effect on April 01, 1992.

On April 07, 1992, Ray Dillen and his passenger, Deniese Stroop, were in an accident with a Sunset truck. In 1994, Dillen and Stroop filed suit against Sunset seeking recovery for damages and injuries allegedly resulting from the accident. Because Lloyds was designated an impaired insurer, the Texas Property & Guaranty Association assumed Sunset’s defense. Texas Property urged Northern that it was obligated to defend and indemnify Sunset under the Northern policy. Northern took the position that its policy had been cancelled effective April 01, 1992, which was several days prior to the collision.

In 1996, the parties settled, with Texas Property, on behalf of Sunset, agreeing to pay Dillen and Stroop $52,500 each (plus court costs). Also, Sunset agreed to a judgment in the amounts of $750,000 and $500,000 in favor of Dillen and Stroop, respectively. Sunset also assigned its rights under the Northern policy to Dillen and Stroop. In exchange, Dillen and Stroop agreed not to execute personally against Sunset on the agreed judgments. In addition, the settlement agreements provided that Texas Property would receive twenty-five percent (25%) of any proceeds that Dillen and Stroop recovered from Northern.

Dillen and Stroop subsequently sued Northern. They asserted, among other things, that Northern breached the insurance contract by failing to defend Sunset and sought recovery from Northern on the agreed judgments. The trial court entered summary judgment in favor of Northern, and Dillen and Stroop appealed to the Dallas Court of Appeals. Initially, the Dallas Court affirmed the summary judgment, holding that Northern had proved as a matter of law that the assignment was void consistent with State Farm Fire and Casualty Company v. Gandy, 925 S.W.2d 696 (Tex. 1996). Dillen and Stroop filed for rehearing.

Faced with an assignment which had been declared invalid, Dillen and Stroop returned to court and obtained a turnover order. The order required Sunset to turn over its rights against Northern to Dillen and Stroop. Dillen and Stroop then filed a second suit against Northern (the “Second Suit”).

Meanwhile, the Court granted Dillen’s and Stroop’s rehearing, withdrew the initial opinion declaring the assignment invalid, and substituted a new opinion in which the Court determined that Sunset and Northern had not effectively cancelled the Northern policy before the date of the accident. Thus, the court did not reach the issue of whether the assignment was void under Gandy.

Thereafter, in the Second Suit, a jury trial was held to determine Sunset’s liability and damages from the collision. The jury rendered a verdict attributing 55% of the negligence to the Sunset driver and 45% of the negligence to Dillen. The jury awarded damages to Dillen in the sum of $140,500 and damages to Stroop in the sum of $360,000. Nevertheless, the trial court rendered summary judgment as well as JNOV in favor of Northern.

Dillen and Stroop returned to the remanded initial suit and sought recovery on the jury verdict from the Second Suit. The court in the initial suit granted summary judgment in favor of Northern, which Dillen and Stroop appealed.

Essentially, in both cases, Dillen and Stoop ultimately sought recovery against Northern based on the jury verdict in the Second Suit. Dillen and Stroop argued that Sunset’s liability and damages were determined in the “fully adversarial” trial of the Second Suit. The Dallas Court of Appeals summarized the issue as whether the jury trial in the Second Suit was a “fully adversarial trial” consistent with Gandy.

The Dallas Court observed that the purpose of the Second Suit was to find facts concerning Sunset’s fault and Dillen’s and Stroop’s damages from the collision. However, Sunset was not a named defendant to the Second Suit, was not served with citation, and did not make an appearance in the Second Suit. Thus, the jury’s “verdict” purported to determine hypothetically disputed fact issues between a party and a non-party. Moreover, the Court noted the procedural history that Dillen and Stroop had sued Sunset in the underlying action, which had settled with Dillen and Stroop accepting $52,500 each and releasing Sunset from further liability on account of the collision. Accordingly, any fact issues addressed in the Second Suit had previously been resolved in a final, then-unappealable decision in the underlying suit.

Additionally, the Dallas Court relied upon Gandy in its assessment that the proceedings of the Second Suit do not qualify as a “fully adversarial trial”.

Gandy discusses the distortions that can occur once the defendant, assured of no personal liability, agrees to a judgment and assigns its claims against its insurer to plaintiff. The “principal problem” with the arrangement is that, once made, the defendant no longer has any incentive to oppose the plaintiff: [Citations omitted.]In the subsequent action by plaintiff against insurer, the proper inquiry for the court is this: “What result would plaintiff and defendant have reached had they remained fully adversarial to the end?” [Citations omitted.] Gandy questions whether that inquiry is even answerable once the plaintiff and defendant have settled and the defendant is assured of no further personal liability.

The trial here illustrates some of the difficulties in attempting to reconstruct an adversarial posture between defendant and plaintiff Northern attempted to defend the actions of Sunset’s driver. When Dillen and Stroop offered the driver’s testimony, through deposition testimony taken eight years earlier in the initial lawsuit, Northern objected Northern’s attorney represented to the trial court that the drier was not Northern’s client, that he was beyond the reach of a subpoena, and thus Northern had no control over the witness. Ultimately no live witnesses were called on Sunset’s behalf: In these circumstances, Northern’s attempt to reconstruct a defense of Sunset cannot be deemed ally adversarial” trial.

Thus, the Dallas Court ” determined that the assignment was invalid as failing to encompass a “fully adversarial trial” in contravention of Gandy.

Also, the Court held that the turnover order added nothing to Dillen’s and Stroop’s ability to recover from Northern. The • turnover statute aids a judgment creditor in reaching property to satisfy a judgment. Under the statute, a trial court may order a judgment debtor to turn over non-exempt property for the purpose of executing a judgment. The statute is purely procedural in nature and does not provide for the determination of the substantive rights of the parties. Whether Dillen and Stroop pursue Northern as assignees under a consensual agreement or as transferees under a turnover order, Gandy principles apply; a judgment for plaintiff against defendant, rendered without a fully adversarial trial, is in no event binding on defendant’s insurer in an action against the insurer by the plaintiff.

III. Application to Practical Tripartite Issues

A. Reservation of Rights Assessed Against the Pleadings

Often-times, a liability carrier may issue a reservation of rights and proffer a qualified defense to its insured. During the course of the defense of those claims against the insured, a claimant may amend or supplement its pleadings or file a motion for summary judgment asserting facts which support or evidence the application of 24 a policy exclusion. Defense counsel, consistent with the majority of carriers’ litigation guidelines, must report such pleadings to the carrier. In consideration of Tilley, Traver, and Duddlesten, to what extent does defense counsel report? What should be reported to the insured? Should defense counsel provide any instruction or direction to the insured relative to coverage handling?

B. Ethics Opinion 533 versus Litigation Guidelines and Issues of Control

As noted in Davalos, there exists an inherent conflict between the insurer and insured relative to control of the defense of the matter. Although the standard liability policy and case law vests control of the defense unto the insurer, does not the insured actually drive the bus? The insured may well initiate an actual conflict by instructing defense counsel to engage in discovery which a carrier’s litigation guidelines or claims supervisor does not authorize. Ethics Opinion 533 and Travers rely upon the Disciplinary Rules and the “sanctity” of the attorney’s professional judgment to afford defense counsel more autonomy from its referring insurance company “client”. So, where does the “control” rest?

C. Coverage Under More than One Policy

Next, we examine the hypothetical where the pleadings invoke a qualified defense under Policy I , i.e. a business auto or professional liability policy. Plaintiff’s counsel and defense counsel, retained by the Policy I ‘s insurer, confer and collaborate on amended pleadings in an effort to trigger a defense under another policy, Policy 2, i.e., CGL. Multiple issues may be implicated.

Defense counsel retained by Policy 1 ‘s insurer may argue that defense counsel acted properly on behalf of the mutual insured in merely trying to obtain the most possible coverage for the mutual insured. However, Tilley nor its progeny provide such basis; in fact, Tilley, its progeny, and the standard liability policy, itself, address the defense of the case against the insured. Matters of insurance coverage are not encompassed by the policy and are governed by the standard policies’ Other Insurance clauses through which carriers may pursue one another for contribution towards defense and/or indemnity.

Further, extending this hypothetical, what transpires where the factual allegations crafted, in part, by defense counsel help create pleadings and exposure which Policy 2 does not cover; has defense counsel enhanced the overall and uncovered exposure to the insured?

Also, what about circumstances where Policy 1 instructs defense counsel to refrain from communication or reporting to Policy 2 unless or until some event or action occurs? Tilley, Gandy, Maryland Casualty, Travers and the Texas Disciplinary Rules may afford some guidance, but not definitive response.

D. Staff Counsel Defending Under ROR

American Home addressed the use of staff counsel. Questions arise over American Home’s disposition in the circumstance where an insurer utilizes staff counsel to defend an insured pursuant to reservation of rights. American Home’s position regarding the “two-client” rule may be further complicated by a “three-client” rule where the defense counsel must also adhere to his employer’s guidelines, instructions and potential restrictions relative to discovery and the handling of the defense of a case.

IV. Conclusion

There is no definitive resolution of these myriad of issues confronting an insurer-retained/insured­client defense counsel. The most prudent course of conduct remains for defense counsel to refrain from any involvement in coverage matters – if questioned by a carrier on an issue which may impact coverage, to refer the carrier to its outside coverage counsel. Also, to the extent the insured seeks guidance on coverage matter, defense counsel is best served by advising the insured/client that, due to potential conflicts, defense counsel must refer the insured/client to its own, personally retained coverage counsel. As far as issues of control are concerned, defense counsel is best served by Ethics Opinion 533, to manage the defense consistent with counsel’s best professional judgment, irrespective from whence any instruction or direction derived, insurer or insured.

As can be seen from the cases above, defense counsel protecting the interests of an insured must frequently navigate in the fog. Focusing on their duties to the insured combined with prompt, full, and complete disclosure of the potential conflict to the insured and insurer will serve as a lighthouse and help lighten or darken these shades of gray.

‘ Employers Casualty Company v. Tilley, 496 S.W.2d 552 (Tex. 1973).
2Id. at 558.
2The initial decision of the court of appeals in Gandy was issued the day after the Texas Supreme Court vacated its initial opinion in Garcia, 876 S.W.2d 842 (Tex. 1994). The second opinion in Garcia went to great lengths to On rehearing, the court of appeals ignored this significant change in the Supreme Court’s position.
3State Farm Fire and Casualty Company v. Gandy, 925 S.W.2d 696 (Tex. 1996).
3 An approach similar to that recognized in Gandy was suggested in Buitron v. Vanguard Underwriters Ins. Co., No. 13-93-644-CV (Tex. App.–Corpus Christi, June 6, 1996) (unpublished).
4See, e.g., Fireman’s Ins. Co. v. Burch, 442 S.W.2d 331, 332 (Tex. 1968).
4 Maryland Insurance Company v. Head Industrial Coatings and Services, Inc., 938 S.W.2d 27 (Tex. 1996).
5 Chickasha Cotton Oil Company v. Houston General Insurance Company, 2002 WL 1792467, No. 05-00-01789-CV (Tex. App. Dallas 2002, no pet.). Northern County Mutual Insurance Company v. Davalos, 84 S.W.3d 314 (Tex. App. Corpus Christi 2002, pet. granted/pndg.).
7Davalos, 84 S.W.3d at 318.
8State Farm Mutual Automobile Insurance Company v.Traver, 980 S.W.2d 625 (Tex. 1998).
9Traver, 980 S.W.2d at 627
10Id. at 628. .
LiAmerican Home Assurance Company, Inc. v. Unauthorized Practice of Law Committee, 121 S.W.3d 831 (Tex. App. — Eastland 2004, pet. filed).
12Inc. v. Highland Insurance (Tex. App. — Houston [1s` Dist.]
13Stroop v. Northern County Mutual Insurance Company, WL 817461 (Tex. App.—Dallas, April 16, 2004.