FULL POLICY COVERAGE MAY BE LIMITED AFTER A DEFENSE WITHOUT RESERVATION

Rather than merely assuming full policy coverage is available in Texas, insureds may be required to prove not only prejudice, but the extent of any damages resulting from a prejudicial defense without reservation of rights.

That’s the signal sent by the Texas Supreme Court in late August in Ulico Casualty Co. v. Allied Pilots Assoc., Case No. 06-0247, which addressed the long-standing “Wilkinson exception” to the rule that coverage cannot be created by waiver or estoppel.

For years, insureds, insurers and their attorneys have operated under the presumption that Farmers Texas County Mutual Insurance Co. v. Wilkinson, 601 S.W.2d 520 (Tex. Civ. App. – Austin 1980, writ ref’d n.r.e.), correctly stated an exception to the Craddock rule established in 1937.

In Washington Nat. Ins. Co. v. Craddock, 130 Tex. 251, 109 S.W.2d 165 (1937), the Supreme Court held that the doctrine of estoppel cannot be used to create insurance coverage when none exists by the terms of the policy. But Wilkinson added the caveat that “if an insurer assumes the insured’s defense without obtaining a reservation of rights or a non-waiver agreement and with knowledge of facts indicating non-coverage, all policy defenses, including those of non-coverage, are waived or the insurer may be estopped from raising them.” 601 S.W.2d at 521. The rule has traditionally been viewed as based on the notion that there is at least an appearance of a conflict of interest where an insurer represents the insured while potentially developing a coverage defense against it.

In 1988, the Supreme Court reaffirmed the Craddock rule in Texas Farmers Insurance Co. v. McGuire, 744S.W.2d 601 (Tex. 1988), a case which did not involve a defense without reservation of rights. In that opinion, the Court noted the Wilkinson exception, but declined to address it because it was not relevant to the issues in McGuire.

In the Ulico Casualty case, the Supreme Court, for the first time, examines the Wilkinson exception. In our view, the Court rejected the “form” of the Wilkinson exception, but adopted its “substance.”

Ulico Casualty involved a claims-made policy. It required that the insured, as a condition to coverage, give written notice of any claim within either the policy period or any extended reporting period. Although APA was served with a suit 21 days prior to the end of the policy period, Ulico was not notified of the suit until five days after its expiration. Ulico initially reserved all rights under the policy, but later expressly agreed to reimburse APA’s attorney’s fees.

When presented with billings of more than $600,000, Ulico filed a declaratory judgment action seeking to avoid liability for defense costs. At trial the jury (among other things) found that Ulico waived, or was estopped from asserting, the defense that the policy did not cover the underlying suit because notice was not timely provided. The trial court entered judgment solely on the waiver and estoppel findings of the jury, and awarded APA’s full defense costs, less an applicable deductible. The court of appeals affirmed based upon the Wilkinson exception.

The Supreme Court began its opinion with this difficult-to interpret summary:

“We hold that if an insurer’s actions prejudice its insured, the insurer may be stopped from denying benefits that would be payable under its policy as if the risk had been covered, but the doctrines of waiver and estoppel cannot be used to re-write the contract of insurance and provide contractual coverage for risks not insured.”

After an exhaustive discussion of the history of Craddock, Ferris v. Southern Underwriters, 109 S.W.2d 223 (Tex. Civ. App. – Austin 1937, writ ref’d), Wilkinson, and other cases touching on these issues, the Court concluded that Wilkinson’s holding was too broad, in that it implies that waiver and estoppel can be used (in the situation where a defense without reservation is provided) to actually create coverage where none would otherwise exist. Rather, the Court makes it clear that the policy is in no way “expanded” by such conduct. However, a similar result can be reached where an insured is prejudiced by the insurer’s actions, because the insured can assert an estoppel theory to recover any damages its sustains because of the insurer’s actions. Based upon this understanding of the law, the Court held that the jury’s findings that insurance coverage was created by estoppel or waiver, were “immaterial” and could not support a judgment against Ulico.

The Court specifically noted that there was no evidence presented that APA sustained any prejudice because of Ulico’s actions.

In a concurring opinion, Chief Justice Jefferson, joined by Justice O’Neill, commented that if the insured is prejudiced by the insurer’s defense without reservation, “it matters little whether a court says coverage was created or that the benefits are those that would have been payable had there been coverage; a rose by any other name would smell as sweet.”

We agree that the point made in the majority opinion is a subtle one, going more to the form of the action rather than the substance. However, the Court’s holding that prejudice is required before an insurer is liable for damages as a result of a defense without reservation is important to note.

By Sid Davis

Sidney H. Davis, Jr. passed away on October 26, 2009. If you are seeking legal help, or have a question about this article or a pending legal matter, please contact Dawn Woelfel Hansen at (214) 741-1166.

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