(Article from Insurance Law Alert, March 2024)
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Holding
Granting conditional mandamus relief, the Texas Supreme Court ruled that a policyholder suffered a covered “loss” because an underlying settlement rendered it “legally obligated to pay,” but that the settlement was neither binding nor admissible in related coverage litigation. In re Illinois National Ins. Co., 2024 Tex. LEXIS 158 (Tex. Feb. 23, 2024).
Background
Cobalt, an energy company, was named as a defendant in a federal securities action. A court appointed a collection of investment funds that held Cobalt shares (“GAMCO”) as lead plaintiff in the suit. Cobalt’s insurers denied coverage for the claims and refused to advance defense costs. Cobalt subsequently filed for bankruptcy and settled with GAMCO. The settlement agreement provided for a “Settlement Amount” of $220 million and included an “obligation to satisfy” the amount by Cobalt. However, the parties agreed that it would be “payable exclusively” from any insurance recoveries and that GAMCO would pursue all of Cobalt’s claims against its insurers on Cobalt’s behalf. The agreement released all claims against Cobalt and its executives, regardless of whether GAMCO was able to recover any insurance proceeds, and required that Cobalt deposit $4.2 million that it had previously received from certain insurers into an escrow account and cooperate with GAMCO in its efforts to obtain insurance coverage.
After a court approved the settlement, GAMCO intervened in a coverage suit between Cobalt and its insurers. The parties cross-moved for summary judgment on three issues: (1) whether Cobalt suffered a covered “loss”; (2) whether GAMCO had standing to sue the insurers; and (3) whether the settlement was binding on the insurers or admissible to establish coverage.
A Texas trial court ruled in GAMCO’s favor and the Texas Supreme Court accepted the insurer’s petition for mandamus relief.
Decision
The Texas Supreme Court explained that the first two issues turned on resolution of the same question: whether Cobalt had a “legal obligation to pay” any sums to any party. As the court noted, the relevant policies required a legal obligation to pay in order to establish a covered “loss” and under Texas’s “no-direct-action” rule, an injured party may only sue the wrongdoer’s insurer after it has established that the insured was legally obligated to pay damages.
The insurers argued that Cobalt was not financially liable to pay GAMCO because the settlement agreement released Cobalt from any liability and required GAMCO to look solely to the insurers for recovery. Further, the settlement agreement allowed Cobalt to recover up to $28.5 million it had spent in defense costs if GAMCO was successful in obtaining insurance proceeds.
The court rejected these arguments and held that Cobalt was “legally obligated to pay.” The court noted that Cobalt had already deposited $4.2 million in insurance benefits into an escrow account and remained “legally obligated” to pay any additional benefits it might receive. Further, the court emphasized that Cobalt was obligated to fully cooperate in GAMCO’s litigation against the insurers, at its own expense. The court deemed it irrelevant that Cobalt denied liability or wrongdoing in the settlement, reasoning that a legal obligation to pay does not depend on an admission of liability. Similarly, the court held that a legal obligation to pay can exist even if Cobalt is not required to pay “from its own pockets.”
The court acknowledged that Cobalt’s release from any liability “require[d] a slightly more complicated analysis,” but concluded that the settlement ultimately rendered Cobalt “legally obligated to pay” GAMCO—through both the prior payment and any future payments to the escrow account. In this context, the court emphasized that if Cobalt failed to fulfill its obligations to deliver any future recoverable benefits, the release would be ineffective.
With respect to the third issue, whether the settlement agreement was binding on the insurers or admissible in a coverage action, the Texas Supreme Court held that the trial court abused its discretion and granted conditional mandamus relief. The Texas Supreme Court ruled that the settlement agreement was not binding against the insurers or admissible to establish coverage for the amount of loss because it did not result from a “fully adversarial trial.” The court based this holding on its finding that Cobalt lacked the necessary “meaningful incentive” to ensure that the settlement accurately reflected GAMCO’s damages. The court explained: “the settlement agreement here ‘eliminated any meaningful incentive’ because GAMCO ‘agreed not to enforce any resulting judgment’ and ‘not to pursue’ Cobalt’s non-insurance assets, leaving only the insurance policies ‘as a potential source to satisfy any judgment obtained.’”
Comments
One important element in the court’s decision was the fact that the policies at issue were “liability” policies rather than “true ‘indemnity’ policies.” A liability policy obligates an insurer to pay “on behalf of” the insured the amounts that the insured is legally obligated to pay. In contrast, under an indemnity policy the insurer agrees to reimburse the insured for the amounts the insured “has actually paid” to fulfill a legal obligation. The court deemed this distinction critical in finding that Cobalt was legally obligated to pay, regardless of whether it “ever actually pays out of its own coffers first.”