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(Article from Insurance Law Alert, July/August 2017)

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The Texas Supreme Court ruled that a judgment against a builder was not enforceable against the builder’s insurer (notwithstanding the insurer’s wrongful refusal to defend) because the judgment was not the product of a “fully adversarial proceeding.”  Great American Ins. Co. v. Hamel, 2017 WL 2623067 (Tex. June 16, 2017).

The Hamels sued their home builder after discovering water damage.  The builder was insured under five consecutive one-year policies issued by Great American.  Great American refused to defend based on a stucco exclusion in the last policy, which was in effect when the damage was discovered.  Great American later conceded that its refusal to defend was wrongful under Texas’ “injury in fact” trigger rule.  Prior to trial in the underlying case, the Hamels and the builder agreed that the Hamels would not attempt to enforce any judgment against the builder.  In addition, the builder executed stipulations that admitted negligence in the construction of the home.  Thereafter, a trial resulted in a judgment in the Hamels’ favor.  The Hamels, as assignees of the builder’s claims, sued Great American, seeking to recover for the underlying judgment.  A trial court ruled in the Hamels’ favor, finding that because Great American had waived its right to control the defense, it was bound by the judgment.  An appellate court largely affirmed the decision.  The Texas Supreme Court reversed and remanded the matter for a new trial.

Under Texas law, an insurer that breaches the duty to defend is bound by any covered judgment, but only if that judgment results from a “fully adversarial trial.”  The court explained that a fully adversarial trial occurs when the parties actually and effectively oppose and contest each other’s positions.  The controlling factor is whether “the insured bore an actual risk of liability for the damages awarded . . . or had some other meaningful incentive to ensure that the judgment or settlement accurately reflects” the damages.  The court concluded that this standard was not met because the pretrial agreement had effectively removed the builder’s financial stake to contest liability.  Although the court declined to issue a bright-line rule, it noted that a pretrial agreement that eliminates the insured’s financial risk creates “a strong presumption” that the judgment did not result from an adversarial proceeding.