R

DUTY TO DEFENDAN ANALYSIS OF THE EIGHT CORNERS RULE

Authored and Presented by:

Lee H. ShidlofskyCook, Roach & Lawless, L.L.P.

327 Congress AvenueSuite 490

Austin, TX 78701(512) 472-3067

(512) 472-3068 FAXlshidlof@cookroach.com

9TH ANNUAL ULTIMATE INSURANCE SEMINAR

STATE BAR OF TEXAS

March 30-31, 2000Dallas, Texas

Duty to Defend R - i

TABLE OF CONTENTS

I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

II. OVERVIEW OF THE DUTY TO DEFEND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

III. CONTRACTUAL BASIS FOR THE DUTY TO DEFEND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

IV. THE “EIGHT CORNERS RULE” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

A. General Contours . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

B. The Role of Extrinsic Evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

C. The Role of Drafting History . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

V. APPLICATION OF THE DUTY TO DEFEND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

A. The Duty to Defend Applies to Insureds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

B. The Duty to Defend Begins at Tender . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

C. Excess and Umbrella Insurers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

D. The Duty to Defend Does Not Apply To Affirmative Claims . . . . . . . . . . . . . . . . . . . . . . . . 6

E. Burden of Proof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

VI. TERMINATION OF THE DUTY TO DEFEND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

VII. COMPARISON WITH OTHER POTENTIAL DUTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

A. The Duty to Indemnify . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

B. The Duty to Investigate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

C. The Duty to Appeal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

VIII. AN INSURER’S OPTIONS WHEN FACED WITH A TENDER . . . . . . . . . . . . . . . . . . . . . . . . . . 8

A. Outright Denial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

B. Defend Under Reservation of Rights or Non-Waiver Agreement . . . . . . . . . . . . . . . . . . . . . 9

C. Provide an Unqualified Defense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

IX. USING DECLARATORY JUDGMENTS TO DETERMINE THE DUTY TO DEFEND . . . . . . 10

X. RECOUPMENT OF DEFENSE COSTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

XI. ALLOCATION OF DEFENSE COSTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

A. Covered vs. Non-covered Claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

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B. Consecutive Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

XII. LIABILITY FLOWING FROM A BREACH OF THE DUTY TO DEFEND . . . . . . . . . . . . . . . . 12

XIII. ETHICAL CONSIDERATIONS OF DEFENSE COUNSEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

A. The Tripartite Relationship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

B. The Use of Captive Firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

XIV. CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Duty to Defend R - iii

TABLE OF AUTHORITIES

CASES

Acceptance Ins. Co. v. Hood, 895 F. Supp. 131 (E.D. Tex. 1995). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Alliance Gen. Ins. Co. v. Club Hospitality, Inc., No. 3:97-CV-2448-H, 1999 WL 500229 (N.D. Tex. July 14 1999) . . . . . . . . . . . . . . . . . . . . . . . . 11

American Alliance Ins. Co. v. Frito-Lay, Inc., 788 S.W.2d 152 (Tex. App.—Dallas 1990, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

American Eagle Ins. Co. v. Nettleton, 932 S.W.2d 169 (Tex. App.—El Paso 1996, writ denied) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

American States Ins. Co. v. Arnold, 930 S.W.2d 196 (Tex. App.—Dallas 1996, writ denied) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

American States Ins. Co. v. Bailey, 133 F.3d 363 (5 Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7, 11th

Balandran v. Safeco Ins. Co. of Am., 972 S.W.2d 738 (Tex. 1998). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Buss v. Superior Court, 939 P.2d 755 (Cal. 1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Canutillo Indep. Sch. Dist. v. National Union Fire Ins. Co., 99 F.3d 695 (5 Cir. 1996). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7th

Certain Underwriters at Lloyds v. Oryx Energy Co., 142 F.3d 255 (5 Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10th

Consolidated Underwriters v. Loyd W. Richardson C. Corp., 444 S.W.2d 781 (Tex. Civ. App.—Beaumont 1969, writ ref’d n.r.e.) . . . . . . . . . . . . . . . . . . . . . . . . 7

Cook v. Ohio Cas. Ins. Co., 418 S.W.2d 712 (Tex. App.—Texarkana 1967, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Dairlyland County Mut. Ins. Co. v. Childress, 650 S.W.2d 770 (Tex. 1983) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

E & L Chipping Co. v. Hanover Ins. Co., 962 S.W.2d 272 (Tex. App.—Beaumont 1998, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6, 7

Employers Cas. Co. v. Mireles, 520 S.W.2d 516 (Tex. Civ. App.—San Antonio 1975, writ ref’d n.r.e.) . . . . . . . . . . . . . . . . . . . . . 14

Employers Ins. Cas. Co. v. Tilley, 496 S.W.2d 552 (Tex. 1973). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Enserch Corp. v. Shand Morahan & Co.,

R - iv 9th Annual Ultimate Insurance Seminar

952 F.2d 1485 (5 Cir. 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9th

Farmers Tex. County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81 (Tex. 1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 4, 7, 11

Farmers Tex. County Mut. Ins. Co. v. Wilkinson, 601 S.W.2d 520 (Tex. Civ. App.—Austin 1980, writ ref’d n.r.e.). . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Federated Mut. Ins. Co. v. Grapevine Excavation Inc., 197 F.3d 720 (5 Cir. 1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 7th

Firemen’s Ins. Co. v. Burch, 442 S.W.2d 331 (Tex. 1968). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

First Gen. Realty Corp. v. Maryland Cas. Co., 981 S.W.2d 495 (Tex. App.—Austin 1998, no pet.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Foust v. Ranger Ins. Co., 975 S.W.2d 329 (Tex. App.—San Antonio 1998, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Gonzalez v. American States Ins. Co., 628 S.W.2d (Tex. App.—Corpus Christi 1982, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Guaranty Nat’l Ins. Co. v. Vic Mfg. Co., 143 F.3d 192 (5 Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3, 7th

Gulf Chem. & Metallurgical Corp. v. Associated Metals & Minerals Corp., 1 F.3d 365 (5 Cir. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4, 12th

Gulf Metals Indus. v. Chicago Ins. Co., 993 S.W.2d 800 (Tex. App.—Austin 1999, pet. requested). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 6

Harville v. Twin City Fire Ins. Co., 885 F.2d 276 (5 Cir. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6, 9th

Heyden Newport Chem. Corp. v. Southern Gen. Ins. Co., 387 S.W.2d 22 (Tex. 1965) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Hill & Wilkinson, Inc. v. American Motorists Ins. Co., No. 3:98-CV-1411, 1999 WL 151668 (N.D. Tex. March 15, 1999) . . . . . . . . . . . . . . . . . . . . . . . . . 6

Houston Petroleum v. Highlands Ins. Co., 830 S.W.2d 153, 155 (Tex. App.—Houston [1 Dist.] 1990, writ denied). . . . . . . . . . . . . . . . . . . . 1st

Katerndahl v. State Farm Fire & Cas. Co., 961 S.W.2d 518 (Tex. App.—San Antonio 1997, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8-10

LaFarge Corp. v. Hartford Cas. Ins. Co., 61 F.3d 389 (5 Cir. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12th

Laster v. American Nat’l Fire Ins. Co., 775 F.Supp. 985 (N.D. Tex. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

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Maryland Ins. Co. v. Head Indus. Coatings & Services, Inc., 938 S.W.2d 27 (Tex. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Matagorda County v. Texas Ass’n of Counties County Gov’t Risk Management Pool, 975 S.W.2d 782 (Tex. App.—Corpus Christi 1998, pet. granted) . . . . . . . . . . . . . . . . . . . . . . . 11, 12

Members Ins. Co. v. Branscum, 803 S.W.2d 462 (Tex. App.—Dallas 1991, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Montrose Chem. Corp. v. Superior Court, 861 P.2d 1153 (Cal. 1993). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

National Sav. Ins. Co. v. Gaskins, 572 S.W.2d 573 (Tex. Civ. App.—Fort Worth 1978, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

National Union Fire Ins. Co v. Merchants Fast Motor Lines, 939 S.W.2d 139 (Tex. 1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 4

National Union v. CBI Indus., 907 S.W.2d 517 (Tex. 1995). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Ohio Cas. Ins. Co. v. Cooper Mach. Corp., 817 F. Supp. 45 (N.D. Tex. 1993). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Pennsylvania Nat’l Mut. Cas. Ins. Co. v. Kitty Hawk Airways, 964 F.2d 478 (5 Cir. 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9th

Rhodes v. Chicago Ins. Co., 719 F.2d 116 (5 Cir. 1983). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 14th

Safeway Managing Gen. Agency for State & County Mut. Fire Ins. Co. v. Cooper, 952 S.W.2d 861 (Tex. App.—Amarillo 1997, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Snug Harbor, Ltd. v. Zurich Ins., 968 F.2d 538 (5 Cir. 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13th

Spruiell v. Lincoln Ins. Co., No. 07-97-0336-CV, 1998 WL 174722

(Tex. App.—Amarillo Apr. 13, 1998) (unpublished). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

St. Paul Ins. Co. v. Rahn, 641 S.W.2d 276 (Tex. App.—Corpus Christi 1982, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Standard Fire Ins. v. Sassin, 894 F. Supp. 1023 (N.D. Tex. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9, 11

State Farm Fire & Cas. Co. v. Wade, 827 S.W.2d 448 (Tex. App.—Corpus Christi 1992, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . 3, 4

State Farm Gen. Ins. Co. v. White,

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955 S.W.2d 474 (Tex. App.—Austin 1997, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

State Farm Lloyds, Inc. v. Williams, 791 S.W.2d 542 (Tex. App.—Dallas 1990, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

State Farm Lloyds, Inc. v. Williams, 960 S.W.2d 781 (Tex. App.—Dallas 1997, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625 (Tex. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Taylor Serv. Co. v. Texas Property & Cas. Ins. Guarantee Ass’n, 918 S.W.2d 89 (Tex. App.—Austin 1996, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Taylor v. Travelers Ins. Co., 40 F.3d 79 (5 Cir. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3th

Texas Employers Ins. Ass’n v. Underwriting Members of Lloyd’s, 836 F. Supp. 398 (S.D. Tex. 1993). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Texas Med. Liab. Trust v. Zurich Ins. Co., 945 S.W.2d 839 (Tex. App.—Austin 1997, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Texas Property & Cas. Ins. Guaranty Ass’n v. Southwest Aggregate, Inc., 982 S.W.2d 600 (Tex. App.—Austin 1998, no pet.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Texas United Ins. Co. v. Burt Ford Enters., 703 S.W.2d 828 (Tex. App.—Tyler 1986, no writ). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9, 13

Travelers Ins. Co. v. Newsom, 352 S.W.2d 888 (Tex. Civ. App.—Amarillo 1961, writ ref’d n.r.e.). . . . . . . . . . . . . . . . . . . . . . . 3, 8

Travelers Ins. Co. v. Volentine, 578 S.W.2d 501, 505 (Tex. Civ. App.—Texarkana 1979, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Trinity Universal Ins Co. v. Cowan, 945 S.W.2d 819 (Tex. 1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7, 8

Trinity Universal Ins. Co. v. Bethancourt, 331 S.W.2d 943 (Tex. Civ. App.—Amarillo 1959, no writ) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7, 8

Triton Dev. Corp. v. Commerce & Indus. Ins. Co., No. CIV.A.3:98-CV-1263-B, 1999 WL 293877 (N.D. Tex. May 4, 1999) . . . . . . . . . . . . . . . . . . . 7

Tri-Coastal Contractors, Inc. v. Hartford Underwriters Ins. Co., 981 S.W.2d 861 (Tex. App.—Houston [1 Dist.] 1998, pet. denied) . . . . . . . . . . . . . . . . . . . . . . 3, 4st

United Servs. Auto. Ass’n v. Pennington, 810 S.W.2d 777 (Tex. App.—San Antonio 1991, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Utica Lloyd’s of Tex. v. Mitchell, 138 F.3d 208 (5 Cir. 1998). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11th

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Warren v. American Nat’l Fire Ins. Co., 826 S.W.2d 185 (Tex. App.—Fort Worth 1992, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Western Heritage Ins. Co. v. River Entertainment, 998 F.2d 311 (5th Cir. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Whatley v. City of Dallas, 758 S.W.2d 301 (Tex. App.—Dallas 1988, writ denied). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9, 12

Willcox v. American Home Assur. Co., 900 F. Supp. 850 (S.D. Tex. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9, 13

MISCELLANEOUS

ALLAN D. WINDT, INSURANCE CLAIMS & DISPUTES, § 4.17 (3d ed. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

BARRY S. OSTRAGER & THOMAS R. NEWMAN, HANDBOOK ON INSURANCE COVERAGE DISPUTES,

§5.02[d], at 208-09 (9 ed. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8th

Charles Silver & Michael Quinn, Wrong Turns on the Three-Way Street: Dispelling Nonsense about Insurance Defense Lawyers, COVERAGE, Nov.–Dec. 1995, at 1. . . . 13

Charles Silver, The Professional Responsibilities of Insurance Defense Lawyers, 45 DUKE L.J. 255 (1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Christopher W. Martin, Reservation of Rights In Texas: Why, Why Not, When, and How, in UNIV. HOUS.,

ADVANCED INSURANCE SEMINAR D (1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Dennis J. Wall, Insured’s Reimbursement of Insurer’s Defense Expenses: When to Ask, When to Say “No,” COVERAGE, May–June 1999, at 1. . . . . . . . . . . . . . . . . . . . . . . . 12

Ellen S. Pryor, Mapping the Changing Boundaries of the Duty to Defend in Texas, ___ TEX. TECH L. REV. ____ (forthcoming 2000) . . . . . . . . . . . . . 4, 7, 13

Ellen S. Pryor, The Stories We Tell: Intentional Harm and the Quest for Insurance Funding, 75 TEXAS L. REV. 1721 (1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Michael Huddleston, Buss Arrives in Texas via Matagorda — The Right of Reimbursement, COVERAGE, Sept.–Oct. 1998, at 1. . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Michael S. Quinn, Reserving Rights Rightly: The Romance and the Temptations, COVERAGE , July–Aug. 1997, at 23. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10, 13

Michael S. Quinn, The Duty to Defend: New Texas Developments, 19 INS. LITIG. REP. 193 (1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

R. Brent Cooper, Duty to Defend, in STATE BAR OF TEXAS, ULTIMATE INSURANCE SEMINAR 24 (1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

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ROBERT H. JERRY, II, UNDERSTANDING INSURANCE LAW § 111[c][2] (2d ed. 1996). . . . . . . . . . . . . . . . . . . 3

Duty to Defend R - 1

I. INTRODUCTION

This article addresses the duty to defend under Stories We Tell: Intentional Harm and the QuestTexas law. The main focus of the article is the scope for Insurance Funding, 75 TEXAS L. REV. 1721,of the so-called “eight corners” rule for determining 1725-38 (1997). an insurer’s duty to defend and its application in thelitigation process. Additionally, this articleaddresses the relationship of the duty to defend withother duties potentially imposed by the insurancecontact, such as the duty to indemnify and the duty The duty to defend is a contractual obligation.to investigate. Moreover, although this article See Farmers Tex. County Mut. Ins. Co. v. Griffin,cannot possibly touch on every issue that arises in 955 S.W.2d 81 (Tex. 1997); Houston Petroleum v.the duty to defend context, it does include Highlands Ins. Co., 830 S.W.2d 153, 155 (Tex.discussions of some of the more common issues, App.—Houston [1 Dist.] 1990, writ denied).such as the offering of a qualified defense and the Texas does not recognize a common law or statutoryconsequences for an insurer’s breach of the duty to duty to defend. Thus, absent a provision in thedefend. Finally, this paper addresses some ethical policy, an insurer has no obligation to assume theconsiderations related to the duty to defend (after defense of its insured or to reimburse its insured forall, we do get ethics credit). incurred defense costs. A typical duty to defend

II. OVERVIEW OF THE DUTY TODEFEND

becomes legally obligated to pay asThe duty to defend may be the single most damages because of “bodily injury” or

important aspect of a liability policy. At the very “property damage” to which thisleast, it is on equal footing with the duty to insurance applies. We will have the rightindemnify. The reasons are simple: We live in a and duty to defend any “suit” seekinglitigious society, and lawyers are expensive. In many those damages. cases, defense costs exceed (and sometimes farexceed) the amount of money necessary to pay a * * * judgment or fund a settlement. Many insureds, If a claim is made or a suit is broughtwhether individuals or small corporations, simply against an “insured” for damages becausecannot afford to retain counsel and/or lack the of “bodily injury” or “property damage”sophistication to retain appropriate counsel to staff caused by an “occurrence” to which thisa particular lawsuit. coverage applies, we will:

The duty to defend solves these problems by * * * requiring the insurer to fund the defense and play an 2. provide a defense at our expense byactive role in the litigation process. Moreover, since counsel of our choice, even if the suitan insurer has a duty to defend even if the is groundless, false or fraudulent . . . .allegations against the insured are “groundless,false, or fraudulent,” the duty to defend helps In contrast to the above, some policies provideprevent an insured from being bankrupted by for the reimbursement of defense costs. In thosefrivolous lawsuits. Thus, in a sense, the duty to policies, the insurer has no duty to assume thedefend is litigation insurance. defense of its insured, but rather has a duty to

The importance of the duty to defend and its defense costs. Such provisions are typical in D&Orole in tort litigation cannot be understated. As one policies. Other policy forms provide the insurer ancommentator has noted, an insurer’s defense option—but not a duty—to assume its insured’sobligation can have an influence on every step of the defense. These “voluntary defense” provisions aretort litigation process, including pleading and filing, often found in excess and umbrella policy forms.

case strategy, the jury charge and negotiation andsettlement strategies. See Ellen S. Pryor, The

III. CONTRACTUAL BASIS FOR THE DUTYTO DEFEND

st

provision provides as follows:

We will pay those sums that the insured

reimburse the insured for reasonable and necessary

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IV. THE “EIGHT CORNERS RULE” Texas and the case law (both state and federal) that

A. General Contours

Texas follows a fairly strict version of the so-called “eight corners” rule or “complaint allegation” • An insurer is required to defend its insuredrule. See Federated Mut. Ins. Co. v. Grapevine if the allegations state a potential claim forExcavation Inc., 197 F.3d 720, 723 (5 Cir. 1999); coverage under the policy.th

National Union Fire Ins. Co v. Merchants FastMotor Lines, 939 S.W.2d 139, 141 (Tex. 1997). • The truth or veracity of the allegations areUnder this rule, courts compare the words within the irrelevant—all factual allegations must befour corners of the insurance policy with the taken as true. allegations within the four corners of the “live” pleading. Stated simply, the duty to defend is • The allegations should be interpreteddetermined by two documents: (i) the insurance liberally. Nevertheless, insurers are notpolicy; and (ii) the latest amended pleading. required to read facts into the pleadings

The duty to defend does not depend on what trigger coverage. the facts actually are, but instead depends on whatthe facts are alleged to be. See Merchants, 939 • When a petition alleges multiple orS.W.2d at 141. Moreover, the duty to defend alternative causes of action, the insureranalysis is not affected by facts that may be must examine each separate allegation toascertained before a lawsuit is filed; by facts that determine whether it has a duty to defend.may develop in the process of a lawsuit; or by the If one alternative cause of action orultimate outcome of a lawsuit. See American allegation is within the terms of the policy,Alliance Ins. Co. v. Frito-Lay, Inc., 788 S.W.2d the insurer has a duty to defend. 152, 154 (Tex. App.—Dallas 1990, writ denied).Accordingly, except in the rarest of situations, the • The proper focus is on the factualduty to defend is a question of law. See State Farm allegations that establish the origin of theGen. Ins. Co. v. White, 955 S.W.2d 474, 475 (Tex. damages alleged in the petition rather thanApp.—Austin 1997, no writ). on the legal theories asserted in the petition.

The Supreme Court of Texas has explained the • Any doubts concerning coverage are to be“eight corners” rule in the following way: resolved in favor of the insured.

Where the [petition] does not state facts In short, an insurer has a duty to defend asufficient to clearly bring the case within lawsuit against its insured unless it can establishor without the coverage, the general rule that a comparison of the policy with the complaintis that the insurer is obligated to defend if or petition shows on its face that there is nothere is, potentially, a case under the potential for coverage. Stated in the alternative, ancomplaint within the coverage of the insurer can refuse to provide a defense only wherepolicy. Stated differently, in case of the facts as alleged fall outside of the coverage grantdoubt as to whether or not the allegations or where they fall squarely within policy exclusions.of a complaint against the insured state a The fact that an initial pleading does not trigger acause of action within the coverage of a duty to defend, however, does not foreclose theliability policy sufficient to compel the possibility that an amended pleading may do so. insurer to defend the action, such doubt will be resolved in the insured’s favor.

Merchants, 939 S.W.2d at 141 (quoting Heyden The role of extrinsic evidence in the duty toNewport Chem. Corp. v. Southern Gen. Ins. Co., defend determination continues to be an area of387 S.W.2d 22, 26 (Tex. 1965)). controversy. As a general rule, the use of extrinsic

The above quote from the Supreme Court of

has followed reveal the following importantcontours of the duty to defend:

and/or imagine factual scenarios that might

B. The Role of Extrinsic Evidence

Duty to Defend R - 3

evidence to either create or defeat a duty to defend holdings, to say that extrinsic evidenceviolates the strict eight corners rule. Most should not be admitted to show that anjurisdictions, however, recognize an exception to the instrumentality was being used for aeight corners rule where the insurer knows or purpose explicitly excluded fromreasonably should know facts that would establish coverage particularly, when doing so doescoverage. See ROBERT H. JERRY, II, not question the truth or falsity of anyUNDERSTANDING INSURANCE LAW § 111[c][2] (2d facts alleged in the underlying petitioned. 1996). filed against the insured.

California, for example, permits both the Wade, 827 S.W.2d at 452. Thus, under the Wadeinsured and the insurer to use extrinsic evidence in exception to the eight corners rule, extrinsicdetermining the duty to defend. See Montrose evidence may be admitted in a declaratory judgmentChem. Corp. v. Superior Court, 861 P.2d 1153 proceeding where the petition does not set out facts(Cal. 1993). Texas courts, on the other hand, have sufficient to allow a determination of whether thosenot allowed extrinsic evidence to be admitted to facts—even if true—would state a covered claim.create a duty to defend. See Taylor v. Travelers Ins. Stated differently, under Wade, extrinsic evidenceCo., 40 F.3d 79, 81 n.2 (5 Cir. 1994); Travelers can be admitted where there is a “gap” in theth

Ins. Co. v. Newsom, 352 S.W.2d 888, 890-94 (Tex. pleadings. Civ. App.—Amarillo 1961, writ ref’d n.r.e.). Incontrast, Texas courts have recognized narrow Wade has been cited favorably by severalexceptions whereby an insurer may use extrinsic federal courts. See Guaranty Nat’l Ins. Co., 143evidence to defeat the duty to defend. See Guaranty F.3d at 194-95 (acknowledging a “narrowNat’l Ins. Co. v. Vic Mfg. Co., 143 F.3d 192, 194 exception” to the eight corners rule where a petition(5 Cir. 1998); State Farm Fire & Cas. Co. v. does not contain sufficient facts to enable a court toth

Wade, 827 S.W.2d 448, 452-53 (Tex. determine if the duty to defend exists); WesternApp.—Corpus Christi 1992, writ denied). Heritage Ins. Co. v. River Entertainment, 998 F.2d

Wade is the most widely cited case supporting Co. v. Hood, 895 F. Supp. 131, 134 n.1 (E.D. Tex.the use of extrinsic evidence under Texas law. Thefacts of Wade are as follows. Williamson owned aboat that was insured by State Farm. Williamsonand a passenger set off from Port O’Connor, Texasin Williamson’s boat, but were subsequently founddrowned in the Gulf of Mexico. The passenger’sestate brought suit against Williamson. State Farmtendered a defense under reservation of rights andfiled a declaratory judgment action to determine itsrights. The applicable policy contained a “businesspursuits” exclusion. The problem, according to thecourt, was that the petition did not contain sufficientfactual allegations to determine whether State Farmowed a defense:

Texas courts allow extrinsic evidence tobe admitted to show a lack of a duty todefend. We conclude that the underly-ingpetition, read broadly does not addressthe issue of how the boat was used, whichis an essential fact for determiningcoverage under this private boat owner’spolicy, and whether State Farm has a dutyto defend the wrongful death suit. Itmakes no sense to us, in light of these

311, 313 (5th Cir. 1993) (same); Acceptance Ins.

1995) (same). In contrast, Texas state courts havegenerally rejected the Wade approach to extrinsicevidence. In Tri-Coastal Contractors, Inc. v.Hartford Underwriters Ins. Co., 981 S.W.2d 861(Tex. App.—Houston [1 Dist.] 1998, pet. denied),st

for example, the court noted that “we are unable tofind other Texas appellate courts that have followedthe Wade rationale.” Id. at 863-64.

Although rejecting Wade, the Tri-Coastalcourt did recognize certain instances where extrinsicevidence may be permissible:

In Texas, extrinsic evidence is permittedto show no duty to defend only in verylimited circumstances, for example wherethe evidence is used to disprove thefundamentals of insurance coverage, suchas whether the person sued is excludedfrom the policy, whether a policy contractexists, or whether the property in questionis insured under the policy.

Id. at 863 n.1.

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At least impliedly, the Tri-Coastal court Moreover, even assuming such extrinsic evidence isrecognized that the extrinsic evidence issue may turn admissible, Texas law is unclear as to whether it canon the type of extrinsic evidence being considered. be considered at the outset or whether the insurerGenerally speaking, there are three types of extrinsic must first file a declaratory judgment action. evidence: (i) evidence that relates only to liability;(ii) evidence that relates only to coverage; and (iii)mixed evidence that relates to both liability andcoverage. See Ellen S. Pryor, Mapping theChanging Boundaries of the Duty to Defend inTexas, ___ TEX. TECH L. REV. ____ (forthcoming2000) [hereinafter Pryor, Mapping ChangingBoundaries]. (Tex. 1997). Although the court never mentioned

Texas courts, including federal courts doubt on the future viability (and necessity) of usingconstruing Texas law, have correctly recognized that extrinsic evidence to deny a defense. The court didextrinsic evidence should never be considered so by noting that the plaintiff’s pleadings—althoughwhere it relates strictly to liability. See Gulf Chem. liberally construed—must be specifically pleaded& Metallurgical Corp. v. Associated Metals & from a factual point of view in order to trigger theMinerals Corp., 1 F.3d 365, 371 (5 Cir. 1993); duty to defend. See Merchants, 939 S.W.2d at 141.th

Gonzalez v. American States Ins. Co., 628 S.W.2d Thus, after Merchants and Griffin, insurers can184, 187 (Tex. App.—Corpus Christi 1982, no arguably deny a defense where the petition orwrit). The more difficult issue is where the extrinsic complaint is too gap-filled to raise even “that degreeevidence relates only to coverage or even more so of doubt which requires resolution for the insured.”where the evidence relates to both coverage and See Merchants, 939 S.W.2d at 142. Of course, theliability. issue of what is necessary to raise “that degree of

As noted above, there is limited support for defend battles. admitting extrinsic evidence in “coverage only”situations. Although such a rule technically violatesa strict eight corners rule, the reality is thatconsidering “coverage only” evidence does not Although drafting history could have beenviolate the underpinnings of the duty to defend. included under the extrinsic evidence discussion,Insurers will still have to defend “groundless, false, some courts and commentators have drawn aor fraudulent” claims that otherwise state a potential distinction between drafting history and extrinsicfor coverage. Thus, under the “coverage only” evidence. Regardless of whether such a distinctionexception, insurers will only be able to avoid the has merit, the role of drafting history has been theduty to defend in situations where the insured has subject of several recent judicial opinions and isnot paid for a defense (e.g., where the defendant is thus worthy of separate discussion. not an insured).

To date, Texas courts have not drawn a clear most often been raised in the duty to indemnifydistinction between “coverage only” evidence and context. Nevertheless, drafting history can also be“mixed” evidence. See Pryor, Mapping Changing relevant in the duty to defend analysis. In particular,Boundaries, supra. To the extent a generalization drafting history is a good example of “coveragecan be made, however, Texas courts appear more only” evidence. Thus, to the extent extrinsiclikely to permit extrinsic evidence where the evidence is admissible, drafting history could beevidence falls into the “coverage only” category. See used in determining the duty to defend where theCook v. Ohio Cas. Ins. Co., 418 S.W.2d 712, 715- scope of a particular policy provision is at issue. 16 (Tex. App.—Texarkana 1967, no writ) (noting“a distinction between cases in which the merit of Before addressing the recent case law, it isthe claim is the issue and those where the coverage important to provide a bit of historical perspective.of the insurance policy is in question . . . .”). In 1995, the Supreme Court of Texas held that

Finally, it should be noted that the SupremeCourt of Texas has in recent years reaffirmed thatTexas is a strict eight corners state. See FarmersTex. County Mut. Ins. Co. v. Griffin, 955 S.W.2d81 (Tex. 1997); National Union Fire Ins. Co. v.Merchants Fast Motor Lines, 939 S.W.2d 139

Wade, its holdings in Griffin and Merchants cast

doubt” will no doubt be the subject of many duty to

C. The Role of Drafting History

It should be noted that drafting history has

Duty to Defend R - 5

parol evidence in the form of drafting history is not exclude evidence of drafting history. The courtadmissible for the purpose of creating an ambiguity. sided with the insurer. Citing CBI, the majoritySee National Union v. CBI Indus., 907 S.W.2d 517 noted that the fundamental rule of construction(Tex. 1995). In CBI, the insured had attempted to permits introduction of extrinsic evidence only afterintroduce evidence of industry-wide testimony an ambiguity has been established. See id. at 808.concerning the breadth of the absolute pollution Moreover, the majority held that the only relevantexclusion to demonstrate that the insurers “surrounding circumstances” were those“understood that the pollution exclusions would not circumstances surrounding the creating of theexclude coverage in construction accident specific contract in question rather than thosesituations.” See id. at 520-21. The Supreme Court, circumstances involving a regulatory body and itshowever, held that such extrinsic evidence could not regulations of a type of policy. See id.be used for purposes of creating a latent ambiguity.See id. at 521. After CBI, it was assumed that items Justice Bea Smith, relying on Balandran,such as regulatory history, drafting history, and authored a strong dissent: testimony from the State Board of Insurance wouldlikewise be inadmissable to create an ambiguity Balandran specifically holds thatwhere there was a lack of facial ambiguity. See R. surrounding circumstance evidenceBrent Cooper, Duty to Defend, in STATE BAR OF regarding promulgation of the policyTEXAS, ULTIMATE INSURANCE SEMINAR 24 (1996). form is not “extrinsic evidence” and may

This assumption, however, may be party’s interpretation of the policy isquestionable in light of recent case law. In 1998, reasonable. the Supreme Court of Texas revisited CBI and heldthat the circumstances surrounding the drafting of a * * * policy could in fact be considered. See Balandranv. Safeco Ins. Co. of Am., 972 S.W.2d 738, 741 Can Gulf Metals rely on representations(Tex. 1998). Balandran involved the interpretation allegedly made by the insurance industryof the “settling, cracking, bulging” exclusion [i.e., to the Department that the languageExclusion 1(h)] and whether it excluded foundation “sudden and accidental” in the revisedlosses caused by plumbing leaks. The insurers form would not restrict existing coverageargued that the policy language on its face was of unintentional pollution? I thinkunambiguous and thus no extrinsic evidence could Balandran holds that it may.be considered. The court disagreed: “While parolevidence of the parties’ intent is not admissible to * * * create an ambiguity, the contract may be read in In this regard I think the majority got itlight of the surrounding circumstances to determine backwards when it held that the “thewhether an ambiguity exists.” Id. at 741. The court surrounding circumstances” that may bethen proceeded to consider evidence from the Board considered in determining ambiguity areof Insurance. The dissent, relying on CBI, those surrounding the making of thechallenged the majority for “resort[ing] to contract, not those present when ainadmissible extrinsic evidence to find support for regulatory body promulgates the form ofits construction of the policy.” Id. at 745. the contract.

The drafting history issue, including both CBI Gulf Metals, 993 S.W.2d at 812 (Smith, J.,and Balandran, were recently addressed by the dissenting). Austin Court of Appeals in Gulf Metals Indus. v.Chicago Ins. Co., 993 S.W.2d 800 (Tex. The Supreme Court of Texas has asked for fullApp.—Austin 1999, pet. requested). Gulf Metals briefing in Gulf Metals. Accordingly, should theinvolved an interpretation of the “sudden and Court decide to entertain the issue, Gulf Metals willaccidental” discharge exception to the traditional provide an opportunity for the Court to clarify when,CGL pollution exclusion. The insured, relying on if ever, drafting history and other extrinsic evidenceBalandran, attempted to admit evidence of drafting can be considered. history. The insurer, relying on CBI, attempted to

be considered in determining whether a

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V. APPLICATION OF THE DUTY TODEFEND

A. The Duty to Defend Applies to Insureds

An insurer’s duty to defend extends to all have been exhausted. See Texas Employers Ins.insureds and additional insureds, including those Ass’n v. Underwriting Members of Lloyd’s, 836 F.named specifically by endorsement and omnibus Supp. 398, 404 (S.D. Tex. 1993). insureds. In some cases, an insurer may have a duty Under Texas law, insolvency does not equateto defend both its insured and an additional insured. with exhaustion. Thus, an excess or umbrella insurerSee Hill & Wilkinson, Inc. v. American Motorists has no duty to “drop down” and defend its insuredIns. Co., No. 3:98-CV-1411, 1999 WL 151668 where the primary insurer is declared insolvent,(N.D. Tex. Mar. 15, 1999); Texas Med. Liab. Trust unless of course a “drop down” provision inv. Zurich Ins. Co., 945 S.W.2d 839, 843 (Tex. included within the duty to defend provision. SeeApp.—Austin 1997, writ denied). Harville v. Twin City Fire Ins. Co., 885 F.2d 276,

B. The Duty to Defend Begins at Tender

Under Texas law, an insurer does not have aduty to defend until the lawsuit is “tendered” to the Another issue that may arise in theinsurer for a defense. See E & L Chipping Co. v. excess/umbrella context is whether the duty toHanover Ins. Co., 962 S.W.2d 272, 278 (Tex. defend is triggered where the primary insurer doesApp.—Beaumont 1998, no writ); Members Ins. Co. not have a duty to defend. Again, the resolution ofv. Branscum, 803 S.W.2d 462, 466-67 (Tex. this issue depends on the terms of the insuranceApp.—Dallas 1991, no writ). What is necessary to policy and, in particular, the terms of the duty toconstitute “tender” depends on the terms of the defend provision. If, for example, thepolicy. At the very least, however, an insured must excess/umbrella policy is a “following form” policy,provide the insurer with a copy of the latest then the excess/umbrella policy will most likely notamended pleading. See Branscum, 803 S.W.2d at have a duty to defend in situations where the467. primary policy has not been triggered. If, however,

C. Excess and Umbrella Insurersexcess/umbrella policy may—depending on whether

Whether an excess insurer has a duty to defend the duty to defend is an option or andepends upon the terms of the excess or umbrella obligation—have a duty to defend. policy. Stated simply, the duty to defend iscontractual in nature regardless of the layer.

Some excess or umbrella policies provide theinsurer with the option to assume the defense and/or An issue that may arise in the course ofto participate in the defense of its insured. The defending insureds is whether the duty to defendpurpose of such language is to permit excess extends to the cost of prosecuting affirmativeinsurers to participate in the defense of the insured claims, such as cross-claims or counterclaims.in situations where the insured’s liability exposure Although there is no Texas caselaw on point, thelikely exceeds the primary layer. When an excess answer to this question—at least under typicalinsurer is provided the option to provide a defense, insuring agreements—is “no.” This follows directlyit may decline to do so without breaching its duties from the language of typical insuring agreements,under the insurance contract. See Laster v. which provides for a defense obligation only forAmerican Nat’l Fire Ins. Co., 775 F. Supp. 985, claims brought “against” the insured. As a practical994 (N.D. Tex. 1991); Warren v. American Nat’l matter, however, it may be wise for the insurer toFire Ins. Co., 826 S.W.2d 185, 187 (Tex. finance the insured’s affirmative claims inApp.—Fort Worth 1992, writ denied).

Other excess and umbrella policy forms,however, require the insurer to assume the duty todefend. Typically, in such policy forms, the excessor umbrella insurer’s duty to defend will not betriggered until the limits of the primary insurance

278-79 (5 Cir. 1989); Taylor Serv. Co. v. Texasth

Property & Cas. Ins. Guarantee Ass’n, 918 S.W.2d89, 91 (Tex. App.—Austin 1996, no writ).

the excess/umbrella policy covers a claim that is nototherwise covered by the primary policy, the

D. The Duty to Defend Does Not Apply ToAffirmative Claims

Duty to Defend R - 7

circumstances where they can reduce the insured’sliability.

E. Burden of Proof A. The Duty to Indemnify

The burden of proof for the duty to defend is The duty to indemnify obligates an insurer tothe same as for the duty to indemnify. The burden pay either a judgment or a settlement that is takenis on the insured to show that a claim against it is against its insured. Like the duty to defend, the dutypotentially within the scope of coverage under the to indemnify is a contractual obligation. policy. See Federated Mut. Ins. Co. v. GrapevineExcavation Inc., 197 F.3d 720, 723 (5 Cir. 1999). The duty to defend and the duty to indemnifyth

If, however, the insurer relies on policy exclusions are distinct and separate duties. See Farmers Tex.to defeat the duty to defend, the burden shifts to the County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 82insurer to prove than one or more of the exclusions (Tex. 1997); Trinity Universal Ins Co. v. Cowan,defeat the duty to defend. See Guaranty Nat’l Ins. 945 S.W.2d 819, 821-22 (Tex. 1997). In contrastCo. v. Vic. Mfg. Co., 143 F.3d 192, 193 (5 Cir. to the duty to defend, the duty to indemnify is notth

1998). Once the insurer proves that an exclusion based on the third party’s allegations, but ratherapplies, the burden then shifts back to the insured to upon the actual facts that comprise the third party’sshow that the claim falls within an exception to the claim. See Canutillo Indep. Sch. Dist. v. Nationalexclusion. See id. Union Fire Ins. Co., 99 F.3d 695, 701 (5 Cir.

VI. TERMINATION OF THE DUTY TODEFEND

The duty to defend terminates in one of three Triton Dev. Corp. v. Commerce & Indus. Ins. Co.,ways: (i) the pleadings are amended in such a way as No. CIV.A.3:98-CV-1263-B, 1999 WL 293877to defeat the duty, see Consolidated Underwriters (N.D. Tex. May 4, 1999); E&L Chipping Co. v.v. Loyd W. Richardson C. Corp., 444 S.W.2d 781, Hanover Ins. Co., 962 S.W.2d 272, 274 (Tex.784-85 (Tex. Civ. App.—Beaumont 1969, writ App.—Beaumont 1998, no writ). Accordingly, inref’d n.r.e.); (ii) the covered portion of a petition or some cases, the negation of the duty to defend willcomplaint is dismissed, see Travelers Ins. Co. v. also negate the duty to indemnify. See Griffin, 955Volentine, 578 S.W.2d 501, 505 (Tex. Civ. S.W.2d at 84 (Tex. 1997). App.—Texarkana 1979, no writ); or (iii) dependingon policy language, when the policy limits are The negation of the duty to defend does not,exhausted by payment of a judgment or settlement, however, automatically negate any possibility of asee American States Ins. Co. v. Arnold, 930 S.W.2d duty to indemnify. But see American States Ins. Co.196, 201 (Tex. App.—Dallas 1996, writ denied) v. Bailey, 133 F.3d 363 (5 Cir. 1998) (holding that(construing Texas Personal Automobile Policy). there can logically be no duty to indemnify in the

VII. COMPARISON WITH OTHERPOTENTIAL DUTIES

th

1996).

It has been uniformly accepted that the duty todefend is broader than the duty to indemnify. See

th

absence of a duty to defend). If, for example, aplaintiff brings a lawsuit against the insured allegingonly intentional conduct but is granted a trialamendment alleging non-intentional conduct andobtains a judgment on the alternative grounds, theduty to indemnify should be triggered. See Pryor,Mapping Changing Boundaries, supra.

B. The Duty to Investigate

Some jurisdictions require an insurer toinvestigate potential liability prior to denying theduty to defend. In Trinity Universal Ins. Co. v.Bethancourt, 331 S.W.2d 943 (Tex. Civ.App.—Amarillo 1959, no writ), the Amarillo Court

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of Appeals held that an insurer had an affirmative According to Windt, an insurer should be requiredduty to investigate prior to denying a defense. Id. at to finance an appeal either: “(a) if there are945-946. The case involved an insured who was reasonable grounds to believe that a judgment insued for assault and battery. The insurer denied the excess of the policy limits might be reversed orclaim on the grounds that the pleadings alleged materially reduced; or (b) if there are reasonableintentional conduct. The insured argued, however, grounds to believe that a judgment entered in athe he was owed a defense because an investigation noncovered area might be reversed.” See ALLAN D.of the “true facts” would have proven that his WINDT, INSURANCE CLAIMS & DISPUTES § 4.17, atactions were not intentional. The Amarillo Court of 213-14 (3d ed. 1995). Likewise, Ostrager &Appeals agreed. Newman note that “[m]ost courts hold that an

The holding in Bethancourt, however, was a liability insurance policy obligates the insurer toshort lived. In fact, the very court that decided appeal a judgment against the insured in anBethancourt quickly retreated from its holding. See underlying action where there are reasonableTraveler’s Ins. Co. v. Newsom, 352 S.W.2d 888, grounds for appeal.” See BARRY S. OSTRAGER &894 (Tex. Civ. App.—Amarillo 1961, writ ref’d THOMAS R. NEWMAN, HANDBOOK ON INSURANCE

n.r.e.). More recently, the Supreme Court of Texas COVERAGE DISPUTES §5.02[d], at 208-09 (9 ed.has put any controversy to rest: 1998) (citations omitted).

Finally, Cowan argues that, because The duty to appeal is a logical extension of theTrinity did not investigate whether there duty to defend. See Cooper, supra, at 43.was a reasonable basis for denying Accordingly, once the duty to defend is triggered,coverage after Gage sought coverage, it the insurer should be obligated to see the casecannot complain about subsequent through to the end. Any other result would overlookdevelopments in the Cowan v. Gage suit. the fact that the trial court is only the first step in theTo the contrary, under the “complaint litigation ladder. Of course, the insurer need onlyallegation rule” an insurer is entitled to appeal when the insured’s interests are at stake.rely solely on the factual allegations Thus, if the entire judgment falls within coverage,contained in the petition in conjunction an insurer can forgo any duty to appeal by simplywith the terms of the policy to determine satisfying its duty to indemnify. whether there is a duty to defend. Theduty to defend is not affected by facts As with all aspects of the duty to defend, theascertained before suit, developed in the language of the particular policy is of paramountprocess of litigation, or by the ultimateoutcome of the suit. Thus, there was noduty to investigate coverage under thesefacts.

Trinity Univ. Ins. Co. v. Cowan, 942 S.W.2d 819,829 (Tex. 1997) (citations omitted) (emphasisadded). In short, Texas does not recognize a duty toinvestigate. Thus, if the complaint—in and ofitself—does not create a potential for coverage, theinsurer has no duty to look outside of the pleadingsbefore declining a defense. Such a rule is consistentwith the principles of the eight corners analysis.

under a reservation of rights or a non-waiverC. The Duty to Appeal agreement; or (iv) assume the insured’s unqualified

defense. See Katerndahl v. State Farm Fire & Cas.The duty to appeal is an issue that has yet to be

addressed by a Texas court. It has, however, beenaddressed by some of the leading commentators.

unparticularized ‘right and duty to defend’ clause in

th

importance in the duty to appeal determination.Accordingly, one should always begin the duty toappeal analysis by looking at the terms of theparticular policy.

VIII. AN INSURER’S OPTIONS WHENFACED WITH A TENDER

When an insurer is faced with the dilemma ofwhether to defend or refuse to defend a profferedclaim, it has four options: (i) completely decline toassume the insured’s defense; (ii) seek a declaratoryjudgment as to its obligations and rights; (iii) defend

Co., 961 S.W.2d 518, 521 (Tex. App.—SanAntonio 1997, no writ). Options (i), (iii), and (iv)

Duty to Defend R - 9

will be discussed in this section. Declaratory arrangements, the court’s broad language arguablyjudgments will be addressed in the next section. prevents an insured from binding an insurer that

A. Outright Denial

An insurer can simply respond to a tender with the air.an outright denial. An insurer who properly refusesto assume the duty to defend can still insist oncompliance by the insured with all policy conditions.See Harville, v. Twin City Fire Ins. Co., 885 F.2d276, 279 (5 Cir. 1989). Outright denials, of When faced with a lawsuit that raises goodth

course, should be reserved for those situations faith coverage questions, a prudent insurer will offerwhere the insurer is certain of its “no coverage” a defense subject to a reservation of rights or non-position. waiver agreement (i.e., a qualified defense). The

Wrongfully refusing to provide a defense, waiver agreement is to permit the insurer to complywhether qualified or unqualified, comes with with its contractual obligation to defend whileconsequences: (i) the insurer loses the right to preserving its right to later contest coverage. Seecontrol the defense; (ii) the insurer loses any right to Katerndahl v. State Farm Fire & Cas. Co., 961insist that the insured comply with policy conditions S.W.2d 518, 521 (Tex. App.—San Antonio 1997,(e.g., no action clause); (iii) the insurer will be no writ). bound by those findings of facts that were actuallylitigated in a fully adversarial trial and essential to A reservation of rights is a unilateral actionthe underlying judgment; and (iv) the insurer will be whereby the insurer informs the insured in writing ofliable for foreseeable damages flowing from the the specific coverage issues. A non-waiverinsurer’s breach of the duty to defend. See Willcox agreement differs from a reservation of rights in thatv. American Home Assur. Co., 900 F. Supp. 850, the policyholder contractually stipulates that the855 (S.D. Tex. 1995); Whatley v. City of Dallas, insurer’s conduct following its receipt of notice will758 S.W.2d 301 (Tex. App.—Dallas 1988, writ not waive policy defenses. Because a reservation ofdenied). rights letter is unilateral, it is more commonly used

Despite the multitude of consequences forbreaching the duty to defend, it is important to note Although the general rule is that the doctrinesthat an insurer which breaches its duty to defend of waiver and estoppel cannot be used to createdoes not lose the right to contest coverage. SeeEnserch Corp. v. Shand Morahan & Co., 952 F.2d1485, 1493 (5 Cir. 1992); Texas United Ins. Co.th

v. Burt Ford Enters., 703 S.W.2d 828, 833 (Tex.App.—Tyler 1986, no writ). Accordingly, while aninsurer may be bound by liability facts that wereactually litigated, the insurer remains free to contestcoverage for such liability. See id. Moreover, in thepast few years, the Supreme Court of Texas has(perhaps unknowingly) softened the blow to insurerswho breach their duty to defend. In State Farm Fire& Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996),the court held that a judgment rendered for theplaintiff against the insured without a fullyadversarial trial is not binding on the insurer oradmissible as evidence of damages in an actionagainst the insurer by the plaintiff as the insured’sassignee. Id. at 714. Although the Gandy court wastrying to mitigate the effects of collusive sweetheart

wrongfully refused to defend to a pre-trialsettlement. Whether or not the court would apply itsholding in such a situation, however, remains up in

B. Defend Under Reservation of Rights orNon-Waiver Agreement

purpose of a reservation of rights and/or a non-

than a non-waiver agreement.

coverage, an exception exists when an insurer, withknowledge of facts indicating noncoverage, assumesthe insured’s defense without properly reserving itsrights to later contest coverage. See PennsylvaniaNat.’l Mut. Cas. Ins. Co. v. Kitty Hawk Airways,964 F.2d 478, 481-82 (5 Cir. 1992); State Farmth

Lloyds, Inc. v. Williams, 960 S.W.2d 781, 785-86(Tex. App.—Dallas 1997, no writ). This is knownas the “Wilkinson exception” and is intended toprotect the insured from any conflict of interest thatmight arise between the insurer and the insured. SeeFarmers Tex. County Mut. Ins. Co. v. Wilkinson,601 S.W.2d 520 (Tex. Civ. App.—Austin 1980,writ ref’d n.r.e.).

Even though the threat of waiver and estoppelcan be daunting to an insurer, the doctrines are notautomatically applied when an insurer fails toproperly reserve its rights. Both Texas and federal

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courts construing Texas law have required the in UNIV. HOUS., ADVANCED INSURANCE SEMINAR

insured to show prejudice (a/k/a “clear and D (1996) unmistakable harm”) before invoking waiver and/orestoppel. See Certain Underwriters at Lloyds v.Oryx Energy Co., 142 F.3d 255, 257 n.2 (5 Cir.th

1998); State Farm Lloyds, Inc. v. Williams, 791 An insurer always has the option of offering anS.W.2d 542, 553 (Tex. App.—Dallas 1990, writ unqualified defense. By doing so, the insurer candenied). demand compliance with all policy conditions and

Offering a qualified defense is a proper course defense. This is so because the insurer, by offeringof action only when the insurer has a good faith an unqualified defense, has waived any potentialbelief that the petition alleges conduct that may not coverage defenses. Stated differently, there is nobe covered by the policy. See American Eagle Ins. conflict of interest precluding the insurer’s controlCo. v. Nettleton, 932 S.W.2d 169, 174 (Tex. over the defense. See Katerndahl v. State FarmApp.—El Paso 1996, writ denied); see also Rhodes Fire & Cas. Co., 961 S.W.2d 518, 523 (Tex.v. Chicago Ins. Co., 719 F.2d 116, 120 (5 Cir.th

1983). Absent a good faith belief, an offer of aqualified defense arguably constitutes a breach ofthe duty to defend. Where, however, an insurer hasa good faith belief that the allegations raise coverageissues, it will not breach its duty to defend byoffering a qualified defense. Nettleton, 932 S.W.2dat 174. Moreover, if the insurer properly offers aqualified defense, it can insist on compliance by theinsured of all policy conditions. See id.; State FarmLloyds Ins. Co. v. Maldonado, 963 S.W.2d 38, 40-41 (Tex. 1998); First Gen. Realty Corp. v.Maryland Cas. Co., 981 S.W.2d 495 (Tex.App.—Austin 1998, no pet.). Additionally, as somecourts have recognized, there is no downside to theinsurer in offering a qualified defense as it maywithdraw its defense if it becomes clear that there isno coverage under the applicable policy. SeeKaterndahl, 961 S.W.2d at 522; Nettleton, 932S.W.2d at 174. But see Liberty Mut. Ins. Co. v.Mustang Tractor & Equip. Co., 812 S.W.2d 663,666 (Tex. App.—Houston [14 Dist.] 1991, noth

writ) (affirming a temporary injunction preventingthe insurer from withdrawing its defense where theinsured can show irreparable injury). Of course,absent some exception to the eight corners rule, theinsurer should be able to withdraw only incircumstances where the petition, in and of itself,does not raise the potential for coverage.

For a more in depth analysis of reservation ofrights and non-waiver agreements, see Michael S.Quinn, Reserving Rights Rightly: The Romanceand the Temptations, COVERAGE, July–Aug. 1997,at 23; Christopher W. Martin, Reservation ofRights In Texas: Why, Why Not, When, and How,

C. Provide an Unqualified Defense

may also assert the right of exclusive control of the

App.—San Antonio 1997, no writ).

IX. USING DECLARATORY JUDGMENTSTO DETERMINE THE DUTY TODEFEND

A declaratory judgment is a judicialdetermination of the rights of respective parties, asopposed to coercive relief or damages. The purposeof declaratory judgments is to settle and afford relieffrom uncertainty and insecurity with respect torights, status, and other legal relations. Declaratoryjudgments can be brought in federal court pursuantto 28 U.S.C. § 2201 or in state court under Chapter37 of the Civil Practice and Remedies Code.

Declaratory judgments play a big role indetermining the duty to defend in that insurersfrequently initiate declaratory judgments to resolveduty to defend disputes. Because the duty to defendis a question of law, declaratory judgments aretypically disposed of by summary judgment.

Although Texas courts have had no problementertaining a declaratory judgment on the duty todefend issue, the traditional rule—untilrecently—was that the duty to indemnify issue hadto await resolution of the underlying lawsuit. SeeFiremen’s Ins. Co. v. Burch, 442 S.W.2d 331 (Tex.1968). In 1997, however, the Supreme Court ofTexas held that “the duty to indemnify is justiciablebefore the insured’s liability is determined in theliability lawsuit when the insurer has no duty todefend and the same reasons that negate the duty todefend likewise negate any possibility the insurerwill ever have a duty to indemnify.” See FarmersTex. County Mut. Ins. Co. v. Griffin, 955 S.W.2d

Duty to Defend R - 11

81, 84 (Tex. 1997). Thus, if and only if the court judgment actions involving the duty to defend. Seedeclares that there is no duty to defend, the court State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2dmay also rule (prior to resolution of the underlying 696, 714 (Tex. 1996); Spruiell v. Lincoln Ins. Co.,litigation) that there is also no duty to indemnify. No. 07-97-0336-CV, 1998 WL 174722 (Tex.See Foust v. Ranger Ins. Co., 975 S.W.2d 329, 332 App.—Amarillo Apr. 13, 1998) (unpublished).n.1 (Tex. App.—San Antonio 1998, writ denied) Accordingly, if squarely presented with the issue,(noting that the duty to indemnify is not justiciable the Supreme Court may reassess its prior holding inprior to resolution of the underlying litigation where Dairyland. the insurer’s duty to defend is triggered).Accordingly, in declaratory judgment actionsinvolving duties under the insurance contract, thecourt’s analysis must always begin with the duty to One of the “hottest” issues in insurance law isdefend. the attempted recoupment of defense costs by

Both Texas and federal courts have held that a lead the way with Buss v. Superior Court, 939 P.2dlawsuit filed against an insured creates a justiciable 755 (Cal. 1997). In Buss, the court held that wherecontroversy so as to afford jurisdiction. See Griffin, a liability insurer provides a defense to the entire955 S.W.2d at 82; American States Ins. Co. v. underlying lawsuit, it may seek reimbursement ofBailey, 133 F.3d 363, 368 (5 Cir. 1998). Some defense costs for claims that are clearly not covered.th

differences between the Federal Declaratory See id. at 776-77Judgment Act and the Texas Declaratory JudgmentAct exist, however, that are worthy of discussion. The Buss arrived in Texas in August 1998. InFirst, whereas attorneys’ fees are awardable to the Matagorda County v. Texas Ass’n of Countiesprevailing party under the Texas statute, the federal County Gov’t Risk Management Pool, 975 S.W.2dstatute does not provide for such an award. See 782 (Tex. App.—Corpus Christi 1998, pet.Utica Lloyd’s of Tex. v. Mitchell, 138 F.3d 208, granted), the Corpus Christi Court of Appeals cited210 (5 Cir. 1998). Second, in federal court, tort Buss with approval and held that an insurer mayth

claimants in pending litigation may be joined in the have a right to reimbursement for defense costsdeclaratory judgment action. See Ohio Cas. Ins. incurred in defending clearly noncovered claims. InCo. v. Cooper Mach. Corp., 817 F. Supp. 45 (N.D. so holding, however, the court explicitly noted thatTex. 1993). But see, Standard Fire Ins. v. Sassin, reimbursement of defense costs is available only894 F. Supp. 1023 (N.D. Tex. 1995) (dismissing when the insurer specifically notifies the insured thatthe injured third party). In state courts, on the other reimbursement of defense costs will later be sought.hand, a tort claimant is not a proper party until final Id. at 784. The Corpus Christi Court of Appealsresolution of the liability issues. See Safeway held that the reservation of rights letter in the caseManaging Gen. Agency for State & County Mut. before it was inadequate because it merely statedFire Ins. Co. v. Cooper, 952 S.W.2d 861, 868-69 that the insurer was reserving its right to contest(Tex. App.—Amarillo 1997, no writ). coverage without any mention that the insurer may

The fact that tort claimants cannot be added to “specific reservation” requirement has been strictlydeclaratory judgment proceedings in state court has followed. See Alliance Gen. Ins. Co. v. Clubthe potential for creating duplicative litigation. Hospitality, Inc., No. 3:97-CV-2448-H, 1999 WLTechnically, the non-party tort claimant cannot be 500229 (N.D. Tex. July 14, 1999) (rejecting a claimbound by any issues resolved in the declaratory for reimbursement where the insurer failed tojudgment proceeding and is thus free to relitigate the include specific reimbursement language in itsinsurance issues. See Dairlyland County Mut. Ins. reservation of rights letter).Co. v. Childress, 650 S.W.2d 770, 773-74 (Tex.1983); National Sav. Ins. Co. v. Gaskins, 572 The exact contours of a reimbursement actionS.W.2d 573 (Tex. Civ. App.—Fort Worth 1978, no will hopefully be settled by the Supreme Court ofwrit). Thus, for now, federal courts may provide for Texas, which has already granted a petition formore finality. Nevertheless, the Supreme Court of review and heard oral arguments in Matagorda. ForTexas has (at least impliedly) suggested that tort now, however, an insurer may seek reimbursementclaimants may be proper parties in declaratory of defense costs only where: (i) it specifically

X. RECOUPMENT OF DEFENSE COSTS

liability insurers. The California Supreme Court

seek reimbursement of defense costs. See id. This

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reserves its right to seek reimbursement; (ii) it damages caused by exposure to silica over a periodobtains a judicial declaration of noncoverage; and of many years. (iii) the defense costs are allocable to thenoncovered claims. Alliance, Southwest Aggregate’s liability

For a more detailed discussion of this topic, see allocation of defense costs for the portion of thealso Dennis J. Wall, Insured’s Reimbursement of claim occurring outside of its policy period. MoreInsurer’s Defense Expenses: When to Ask, When to precisely, under Alliance’s theory, when coverageSay “No,” COVERAGE, May–June 1999, at 1; under consecutive, non-overlapping policies issuedMichael Huddleston, Buss Arrives in Texas via by different insurance companies is triggered by aMatagorda—The Right of Reimbursement, claim of injury occurring across all the policyCOVERAGE, Sept.–Oct. 1998, at 1. periods, each insurer’s duty to defend is determined

XI. ALLOCATION OF DEFENSE COSTS

A. Covered vs. Non-covered Claims

One of the core concepts of the eight corners provides for a partial defense as to the insured. rule is that only one claim must potentially fallwithin the ambit of the insurance policy in order to The court agreed with the Guaranty Fund andobligate an insurer to assume the duty to defend. rejected Alliance’s argument. In doing so, the courtNotwithstanding this fact, some courts have held that an insurer’s duty to defend cannot berecognized a right of allocation on the part of reduced pro rata by the insurer’s “time on the risk”insurers between covered and noncovered claims. or by any other formula. Id. at 605. Any otherSee LaFarge Corp. v. Hartford Cas. Ins. Co., 61 result, according to the court, would violate theF.3d 389 (5 Cir. 1995) (recognizing the right of insurer’s contractual obligation to provide a fullth

allocation where there is a clear distinction between defense. See id. covered and non-covered claims).

Although LaFarge recognized the possibility court specifically rejected two opinions from theof apportionment, the court emphasized the fact that Fifth Circuit that predicted Texas courts wouldapportionment may not be feasible. For example, apply a “time on the risk” proration. See LaFargethe court noted that “even though some of the claims Corp. v. Hartford Cas. Ins. Co., 61 F.3d 389 (5were not covered under the policy, apportionment Cir. 1995); Gulf Chem. & Metallurgical Corp. v.would not be feasible in this case because the claims Associated Metals & Minerals Corp., 1 F.3d 365all arose from a single accident.” Id. at 398. It isthe insurer’s burden to prove that allocation ofdefense costs is feasible. See id. In reality, insurerswill find it extremely difficult to ever meet thisburden.

B. Consecutive Policies

In Texas Property & Cas. Ins. Guar. Ass’n v.Southwest Aggregate, Inc., 982 S.W.2d 600 (Tex.App.—Austin 1998, no pet.), the court addressedthe issue of allocation where the alleged damagesoccurred partially within and partially outside of aninsurer’s policy period. The case involved a numberof silicosis lawsuits filed against SouthwestAggregates. In most cases, the plaintiffs alleged

insurer, argued that it was entitled to a pro rata

by a ratio of that insurer’s “time on the risk” overthe total time period for which damage is claimed tohave occurred. The Guaranty Association, on theother hand, responded by arguing that the duty todefend is absolute and that nothing in the policy

In reaching its “no allocation” holding, the

th

(5 Cir. 1993). Accordingly, until the Supremeth

Court of Texas rules on the issue, it is unclear howa federal panel will deal with the allocation issue.

XII. LIABILITY FLOWING FROM ABREACH OF THE DUTY TO DEFEND

An insurer that breaches its duty to defend itsinsured faces liability for breach of contract. SeeWhatley v. City of Dallas, 758 S.W.2d 301, 309(Tex. App.—Dallas 1988, writ denied). Thus, theinsurer is liable for any foreseeable damages thatdirectly result from the insurer’s breach. See id. Ingeneral, such damages include all reasonable andnecessary expenses incurred by the insured inundertaking its own defense, including attorneys’fees, court costs, and other litigation expenses. See

Duty to Defend R - 13

Texas United Ins. Co. v. Burt Ford Enter., Inc., 703 REP. 193, 201 (1997) [hereinafter, Quinn, The DutyS.W.2d 828, 835 (Tex. App.—Tyler 1986, no writ).Moreover, the insurer is liable for the insured’sreasonable and necessary costs and expensesincurred in prosecuting the breach of contract suitagainst the insurer. See id.

Although the Supreme Court of Texas hasnever squarely addressed the issue, numerousappellate courts and federal courts applying Texaslaw have concluded that an insurer which breachesthe duty to defend is not liable for amounts in excessof policy limits—at least absent a showing of badfaith or negligence in failing to settle the claim. SeeWillcox v. American Home Assur. Co., 900 F.Supp. 850, 856 (S.D. Tex. 1995); United Servs.Auto. Ass’n v. Pennington, 810 S.W.2d 777, 784(Tex. App.—San Antonio 1991, writ denied). Thecourts have done so, however, with little discussionof their rationale. Presumably, an insured who canshow a causal connection between an insurer’sbreach of the duty to defend and an excess verdictshould be able to recover the excess verdict in abreach of contract action. See WINDT, supra, §4.36.

The Supreme Court of Texas has addressedwhether a breach of the duty to defend alsoconstitutes a breach of the duty of good faith andfair dealing. In Maryland Ins. Co. v. Head Indus.Coatings & Services, Inc., 938 S.W.2d 27 (Tex.1996), the court rejected an extracontractual causeof action for breach of the duty to defend. Id. at 28(holding that Texas law only recognizes one tortduty—that being a Stowers duty—in the liabilityinsurance context); see also Snug Harbor, Ltd. v.Zurich Ins., 968 F.2d 538, 546 (5 Cir. 1992). Suchth

a rule fails to recognize the importance of the dutyto defend and the devastating effects a breach of theduty can have on an insured. See St. Paul Ins. Co. v.Rahn, 641 S.W.2d 276, 282 (Tex. App.—CorpusChristi 1982, no writ) (noting that an insurer’swrongful refusal to assume its duty to defend is likesending “its insured, standing hat in hand at its door,packing”). Moreover, such a rule fails to recognizethat the Stowers doctrine does not address orremedy situations where the insurer breaches theduty to defend. Finally, by not permitting anextracontractual cause of action for breach of theduty to defend, the court overlooks the fact that theduty to defend is truly a “first-party” duty within athird-party policy. See Michael S. Quinn, The Dutyto Defend: New Texas Developments, 19 INS. LITIG.

to Defend].

In contrast to the duty of good faith and fairdealing, Texas courts have not squarely addressedwhether article 21.21 of the Texas Insurance Codeprovides a statutory remedy for breach of the duty todefend. Some commentators have taken the positionthat article 21.21 applies (at least arguably) to aninsurer’s breach of the duty to defend. See Pryor,Mapping Changing Boundaries, supra; see alsoQuinn, The Duty to Defend, supra at 201(“Policyholders may have statutory bad faith claims. . . .”).

The issues of what damages an insured canrecover and what consequences flow from aninsurer’s breach of the duty to defend are constantlyevolving. Accordingly, the Texas precedent thatexists today may soon change—especially as morejurisdictions expand the remedies afforded toinsureds for breach of the duty to defend.

XIII. ETHICAL CONSIDERATIONS OFDEFENSE COUNSEL

A. The Tripartite Relationship

When an insurer assumes its insured’s defense,it generally has the right to select defense counsel.Moreover, if no conflict of interest exists, theinsurer may have exclusive control over the defense.When a conflict of interest exists (e.g., when theoutcome of a coverage issue can be affected by themanner in which the underlying action is defended),however, one must be cognizant of the relationshipamong the liability insurer, its insured and thedefense counsel selected by the liability insurer todefend the insured. The relationship among theseparties is known as the “tripartite relationship.”

A big debate exists as to whether Texas is a“one client” or “two client” state. Essentially, thedebate focuses on whether the insurer is also theclient of defense counsel hired by the insurer torepresent the insured. See Charles Silver, TheProfessional Responsibilities of Insurance DefenseLawyers, 45 DUKE L.J. 255 (1995); Charles Silver& Michael Quinn, Wrong Turns on the Three-WayStreet: Dispelling Nonsense about InsuranceDefense Lawyers, COVERAGE, Nov.–Dec. 1995, at1. Texas law is far from clear on this point. Texaslaw is clear, however, that defense counsel owes

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“unqualified loyalty” to the insured. See State Farm Another ethical issue that has come to theMut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625, 628 forefront as of late is the use of “captive firms” to(Tex. 1998); Employers Ins. Cas. Co. v. Tilley, 496 defend insureds. A captive firm is a law officeS.W.2d 552, 558 (Tex. 1973). As the Supreme staffed by lawyers who are actually employees ofCourt of Texas pointed out in Traver, “the lawyer the insurance company. The use of captive firmsmust at all times protect the interests of the insured has increased over the past few years as insurers. . . .” Traver, 980 S.W.2d at 628. have searched for ways to be cost-effective. See

Despite the fact that defense counsel S.W.2d 625, 633 (Gonzalez, J., concurring andundeniably owes its unqualified loyalty to the dissenting).insured, the fact remains that the “so-calledtripartite relationship has been well documented as The Unauthorized Practice of Law Committeea source of unending ethical, legal, and economic has waged war against the use of so-called “captivetension.” Traver, 980 S.W.2d at 633 (Gonzalez, J., firms” to defend insureds. According to the UPLC,concurring and dissenting). As Justice Gonzalez the use of captive firms raises serious ethical issues.further noted, In particular, the UPLC questions whether captive

The duty to defend in a liability policy at the insureds. The use of captive firms has alsotimes makes for an uneasy alliance. The caught the attention of the Supreme Court of Texas.insured wants the best defense possible. See Traver, 980 S.W.2d at 633 (Gonzalez, J.,The insurance company, always looking concurring and dissenting) (noting that “it isat the bottom line, wants to provide a probably impossible for an attorney to provide thedefense at the lowest possible cost. The insured the unqualified loyalty that Tilley requires”lawyer the insurer retains to defend the where the insured is being represented by a captiveinsured is caught in the middle. There is a firm). lot of widsom in the old proverb: He who pays the piper calls the tune. The lawyer For now, the future of captive firms is in thewants to provide a competent defense, yet hands of the courts. The UPLC has filed suitknows who pays the bills and who is most against Allstate seeking to prevent it from usinglikely to send new business. captive firms. Moreover, the UPLC is actively

Id. Recently, Nationwide Mutual Insurance Company

The import of Traver and Tilley in the duty to a suit seeking a declaration that the UPLC statute isdefend context is that an insurer should never use unconstitutional. the same counsel to review coverage as it does todefend the insured. See Employers Cas. Co. v.Mireles, 520 S.W.2d 516 (Tex. Civ. App.—SanAntonio 1975, writ ref’d n.r.e.) (holding that the The state of the law with respect to the duty toemployment of separate firms to defend the insured defend is constantly developing. In the near future,and to address coverage issues eliminates conflicts one can certainly expect caselaw discussing hotof interest). Accordingly, where an insurer offers a issues such as recoupment of defense costs,qualified defense and proceeds by hiring defense allocation of defense costs, and recoverablecounsel, the defense counsel should remain damages flowing from an insurer’s breach of the“independent.” More precisely, where a qualified duty to defend. Moreover, as the caselaw developsdefense is provided, defense counsel should never and as states pass and/or amend their insurancecommunicate with the insurer with respect to codes, new issues are likely to come to the forefront.“coverage” issues. See Rhodes v. Chicago Ins.Co., 719 F.2d 116 (5 Cir. 1983). th

B. The Use of Captive Firmsdefend, it has by no means addressed all of the duty

State Farm Mut. Auto. Ins. Co. v. Traver, 980

lawyers will truly look out for the best interests of

investigating other large insurance companies.

has responded to the UPLC investigation by filing

XIV. CONCLUSION

Although this paper has discussed several ofthe more common issues relating to the duty to

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to defend issues that arise everyday in the world ofinsurance law. For a more in-depth discussion ofthe duty to defend and its many facets, please seeProfessor Ellen Pryor’s soon to be published articlein the Texas Tech Law Review.