By Rachelle (“Shelley”) H. Glazer, Thompson & Knight LLP, and John P. Atkins, Thompson Coburn
Have we mentioned that USAA Texas Lloyds Co. v. Menchaca, 545 S.W.3d 479 (Tex. April 13, 2018) has changed things? Lyda Swinerton is another example.
Lyda Swinerton Builders (“LSB”) was hired as general contractor to build an office building in 2003. In conjunction with this project, LSB hired a subcontractor, A.D. Willis Company, Inc. (“Willis”), to perform primarily roofing-related work. The subcontract required Willis to obtain general liability insurance and to designate LSB as an additional insured for liabilities relating to Willis’ work for LSB under the subcontract.
To comply with this requirement, Willis obtained a policy from Oklahoma Surety Company (“OSC”) containing the required additional insured endorsement through an “insured contract” mechanism, which provided that the endorsement applied after Willis agreed by a written “insured contract” to designate LSB as an additional insured. The term “insured contract” is defined “to include ‘[t]hat part of any other contract or agreement pertaining to [Willis’] business . . . under which [Willis] assume[s] the tort liability of another party to pay for ‘bodily injury’ or ‘property damage.’”
In 2005, Adam Development Properties (“ADP”) was assigned the interest of the original project owners in the original contract between LSB and the project owner. At some point, ADP became unsatisfied with LSB’s performance of the contract, and in 2008 ADP sued LSB for breach of contract. LSB later filed a third-party petition against Willis. The litigation became progressively more complex as it went on.
With each petition in this litigation, LSB requested OSC defend it as an additional insured under Willis’s CGL policy. OSC refused all such requests. A federal lawsuit by and against many insurers ensued, but in the end, the only claims that did not settle were those by LSB against OSC. LSB sought damages for breach of contract due to OSC’s refusal to defend LSB in the state court lawsuit.
On summary judgment, the trial court found that OSC had (and breached) a duty to defend, and further found that OSC had violated Texas’s prompt pay law. After a bench trial, the district court ruled against LSB on its remaining claims for unfair claims handling under Chapter 541 of the Texas Insurance Code, holding that LSB had failed to show any injury independent of the loss of policy benefits.
On appeal, OSC had three arguments: (1) that it did not have a duty to defend because the alleged insured contract was not signed by LSB; (2) that it was not liable under the prompt pay law; and (3) that under Texas’s “anti-stacking” rule, it should not have been found liable to LSB.
First, the Fifth Circuit addressed OSC’s duty to defend. The first hurdle was determining whether LSB was actually an additional insured under Willis’s policy. OSC argued that the subcontract between LSB and Willis did not qualify as a “written insured contract” because LSB failed to countersign. Because no countersignature requirement was imposed by the policy, the court rejected this argument.
The court then turned to the traditional eight-corners rule to decide whether what was alleged in the underlying action fell within the scope of coverage. As long-time Texas insurance practitioners will know, this rule requires the court to look at the facts alleged in the petition and measure them against the insurance policy’s language “and determine if the facts alleged present a matter that could potentially be covered by the insurance policy.” Basically, if the petition alleges anything potentially within the scope of coverage, the insurer must defend the whole case.
OSC argued that additional insured coverage was limited to “‘liability directly attributable’ to Willis’ performance of its work for LSB,” but the petition was not specific as to which subcontractor caused the property damage. Although the petition did not explicitly refer to Willis or its work, it indicated that the property damage was caused by subcontractors and specifically referenced roofing deficiencies (which were the area of Willis’s work). In turn, the policy identified Willis as a “commercial roofing contractor.” Consequently, the court found the petition contained claims that potentially fell within the scope of coverage under Willis’s policy, under which LSB was an additional insured.
The court also briefly addressed the anti-stacking rule but found that it was not applicable to this particular situation. The anti-stacking rule exists to prevent insureds from attempting to obtain coverage for the same event from multiple non-overlapping policies covering different policy years. OSC argued that LSB had selected another insurer covering a different year to provide a complete defense, and so could not stack OSC’s insurance on top of that. But the court found that this argument lacked certain key facts to support it: In particular, OSC did not show that LSB had “selected” defense coverage from the other insurer before OSC denied its claim. The court pointed out that if LSB had only turned to another insurer after OSC rejected its claim, the application of the anti-stacking rule would reward LSB for denying a claim it should have defended. The Fifth Circuit thus rejected the anti-stacking argument and affirmed the breach of contract judgment.
The court then turned to the prompt payment claim. Texas’s prompt payment law provides that an insurer who is liable for a claim under a policy and fails to promptly pay it is subject to penalty interest in addition to its liability for the claim. Defense costs incurred as a result of the insurer’s failure to defend are a “claim” under Texas’s prompt payment law. Because OSC only challenged its prompt payment liability on the basis of its other arguments regarding its lack of a duty to defend, the court affirmed the prompt payment judgment as well.
The court then moved to LSB’s cross-appeal, which sought reversal of the district court’s judgment against its unfair claims handling claim under the independent injury rule. According to LSB, OSC violated the code by knowingly misrepresenting the policy coverage in order to not have to defend it. At the time of its decision, the district court felt bound by the Fifth Circuit’s decision in Great American Insurance Co. v. AFS/IBEX Financial Services Inc. In Great American, the court had held that extracontractual claims like those under Chapter 541 could only be sought if there was some injury other than the denial of policy benefits.
Then, Menchaca changed everything. In particular, Menchaca’s articulation of what the Texas Supreme Court called the “entitled to benefits rule” caused the Fifth Circuit to rethink its holding in Great American. This rule establishes that insureds who prove a right to benefits under a policy can recover those benefits as “‘actual damages’ under the [Insurance Code] if the insurer’s statutory violation causes the loss of the benefits.” Essentially this rule permits an election of remedies on the part of the insured if the insured was (1) denied policy benefits and (2) a statutory violation is part of the reason the insured was denied those benefits. The insured can decide to seek its policy benefit under a contract theory or as “actual damages” under the Insurance Code.
Menchaca had not overruled the “independent injury rule” on which Great American and the district court decision had relied. That rule holds in relevant part that “an insurer’s statutory violation does not permit the insured to recover any damages beyond policy benefits unless the violation causes an injury that is independent from the loss of benefits.” The Fifth Circuit highlighted the phrase “beyond policy benefits” and noted that this implied that under the “entitled to benefits rule” policy benefits could still be sought as actual damages under the unfair claims practices statute. Essentially, the “independent injury rule” simply means that a statutory violation that neither causes a measurable independent injury nor deprives the insured of her policy benefit is not an injury for which recovery is possible under the Insurance Code. Here, policy benefits were denied, and the “entitled to benefits rule” permits recovery of policy benefits via statutory means.
Consequently, LSB might be entitled to significant damages it was denied by the district court’s incorrect (but understandable) application of Great American. For instance, LSB had alleged that OSC’s misrepresentation of the policy had been knowing. Under Chapter 541 of the Insurance Code, a knowing violation could entitle the insured to treble actual damages. Whether the statutory violation had been knowing was never decided, requiring a remand on that specific issue.
OSC also challenged the time frame during which the trial court had determined penalty interest under the prompt payment law had applied. The district court had ordered the 18% rate to be calculated “until the date of payment of this judgment.” But Texas’s prompt payment law actually does not specify when the rate stops accruing. While the court noted there were some persuasive arguments for upholding the district court’s approach, the court ultimately found itself bound by previous Fifth Circuit precedent holding the penalty interest “only accrues until the date judgment is rendered in the trial court.” Thus, for “LSB’s claims for breach of duty to defend and violation of prompt payment law, that date was February 23, 2016, when the trial court entered the amended final judgment.”
That is, of course, until a new judgment would be entered in the case. Because the Fifth Circuit reversed the district court’s ruling on LSB’s Chapter 541 claim, there was still an outstanding claim without any judgment, and LSB could, on remand, prevail and elect to recover its defense costs as actual damages under the Insurance Code instead of as breach of contract damages. If successful, the terminating date for accrual of penalty interest on that claim would be the date of entry of the new final judgment.
Not all is confusion post-Menchaca. Here, the Fifth Circuit made good use of the Supreme Court’s careful setting out of the various rules for extracontractual damages to ultimately change its mind on when extracontractual damages are appropriate. While Menchaca has resulted in many questions, in this case it also provided needed answers.
 Lyda Swinerton Builders, Inc. v. Oklahoma Surety Co., 903 F. 3d 435, 440 (5th Cir. August 29, 2018).
 Id. at 441–42.
 Id. at 442–43.
 Id. at 443–44.
 Id. at 444.
 Id. at 444–45.
 Id. at 446 (quoting Ewing Constr. Co. v. Amerisure Ins. Co., 420 S.W.3d 30, 33 (Tex. 2014)) (emphasis added by court).
 Id. at 446–47.
 Id. at 448.
 Id. at 447–48.
 Id. at 449.
 Id. at 450.
 Id. at 452 (citing Great American Insurance Co. v. AFS/IBEX Financial Services Inc., 612 F. 3d 800 (5th Cir. 2010)).
 Id. (quoting USAA Texas Lloyds Co. v. Menchaca, 545 S.W.3d 479, 495 (2018)).
 Id. (quoting Menchaca, 545 S.W.3d at 500) (emphasis in original).
 Id. at 453.
 Id. at 454–55 (quoting and following Great Am. Ins. Co. v. AFS/IBEX Fin. Servs., Inc., 612 F.3d 800, 809 (5th Cir. 2010))
 Id. at 455.