Insureds Pre"Vail” over the Independent Injury Rule

By Amy Stewart Law

The pendulum seems to always swing to the left and right before it balances somewhere in the middle. For those who are old enough to remember the meteoric rise of insurance bad faith claims in the late 1980s, decisions issued in the latter part of the 1990s and beyond seemed to signal a near-anaphylactic reluctance by Texas courts to hold any insurer responsible for its conduct. The 2014 decision by the Houston Court of Appeals in United National Insurance Company v. AMJ Investments, LLC indicates, however, the pendulum may be settling to the middle. 2014 WL 2895003 (Tex. App.—Houston [14th Dist.], June 26, 2014).

AMJ involves the insured’s right to recover (and treble) damages under the Texas Insurance Code without an independent injury. The “independent injury rule” is not, in fact, a “rule” at all. To the contrary, it is an erroneous conflation of the factual principals underlying an insured’s right to recover on statutory bad faith claims that has somehow morphed into black letter law. It all began when the Texas Supreme Court held that an insurer’s wrongful refusal to pay a covered claim was actionable under the Texas Insurance Code. Vail v. Texas Farm Bureau Mutual Insurance Company, 754 S.W.2d 129 (Tex. 1988). In Vail, the Court held that the insured’s damages (in “at least the amount of the policy benefits wrongfully withheld”) could be trebled under the Insurance Code via the Deceptive Trade Practices Act. 754 S.W.2d at 136.

Thunderstruck, insurers fought back. Emboldened by decisions like Allstate Ins. Co. v. Watson, 876 S.W.2d 145 (Tex. 1994), wherein the Court declined to extend Vail to create a direct third-party cause of action for insurance code claims, insurers pushed even harder. While some ground was gained by the Texas Supreme Court’s decision in Republic Ins. Co. v. Stoker, 903 S.W.2d 338, 341 (Tex. 1995) (holding that the insured cannot recover for statutory bad faith where there is no coverage under the policy, in the absence of extreme conduct that is independently tortious), it was the Court’s decision in Providence American Ins. Co. v. Castaneda, 988 S.W.2d 189 (Tex. 1998) that hammered the proverbial nail in the coffin, and thus, the fabled “independent injury rule” was born.

In Castaneda, the Texas Supreme Court held that where a denial of coverage is “not wrongful,” claims under the Texas Insurance Code may only be asserted where the insured can show a separate harm. However, the Court’s decision was not based upon a finding there was no coverage under the policy, but on a finding there was a bona fide dispute about coverage at the time the denial was issued. Id. at 194. Therefore, the insured’s liability had not become “reasonably clear” for purposes of rendering its conduct actionable. Id.

Conflating the issue of coverage with the propriety of a denial, or presumptively equating the two, lower Texas courts and federal courts in Texas began to hold that an insured may not recover extra-contractual damages at all unless the insurer’s conduct causes damage separate and apart from a breach of contract claim. Laird v. CMI Lloyds, 261 S.W.3d 322 (Tex. App.—Texarkana 2008, pet. dism’d w.o.j.); USAA v. Gordon, 103 S.W3d 436 (Tex. App.—San Antonio 2002, no pet.); Eagle Oil & Gas v. Travelers Prop. & Cas. Co., 2014 WL 3406686 (N.D. Tex., July 14, 2014). Since then, the rule has been applied to first- and third-party liability claims alike. See, e.g., Mid-Continent Cas. Co. v. Eland Energy, Inc., 709 F.3d 515, 522 (5th Cir. 2013) (holding that “no Texas court has yet held that recovery is available for an insurer’s extreme act, causing injury independent of the policy claim, in the first-party claim context, let alone in the third-party claim context”); Powell Electrical Systems, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, 2011 WL 3813278 (S.D. Tex. 2011). The AMJ case however, calls these erroneous holdings into question.

AMJ brought suit against United after a dispute arose as to the amount United was obligated to pay for damage caused to an AMJ-owned building by Hurricane Ike. The jury found United was liable on AMJ’s breach of contract claim, also finding United had violated the Texas Insurance Code by “[a]ttempting to enforce a full and final release of a claim from a policyholder when only a partial payment has been made”… and “failing to attempt in good faith to effectuate a prompt, fair, and equitable settlement of a claim when [its] liability ha[d] become reasonably clear.” Id. at *4. Importantly, although AMJ recovered on both its breach of contract and insurance code claims, AMJ elected to recover on its bad faith claims. Id. at *2. Subsequently, a verdict was entered for $300,000 in compensatory damages, $600,000 for knowing violations of the Texas Insurance Code, and $178,734 in prompt pay penalties, together with interest and attorney’s fees. Id. at *20-21.

United appealed, arguing, among other things, AMJ was not entitled to recover under the Texas Insurance Code because it had failed to show it had sustained an injury independent of its breach of contract claim. Id. at *4. Although the court ultimately modified the judgment and remanded it for a further determination of AMJ’s attorney fee claim, the court rejected United’s argument that AMJ had failed to show it sustained an independent injury required to support its insurance code claims. Id. at *9. Following Vail, the court disagreed, holding: “If a property insurer fails to pay the full amount of the claim as a result of an unfair claim-settlement practice under the Insurance Code, the insured may elect to recover its damages under either a breach-of-contract or a statutory-violation theory.” Id. at *9 (citing Waite Hill Servs., Inc. v. World Class Metal Works, Inc., 959 S.W.2d 182, 184-85 (Tex.1998). Distinguishing Castaneda, the court held that AMJ had “pleaded and proved that its claim was covered and its insurer breached the contract.” Id. “Consequently, and as a matter of law, United's failure to pay when its liability was reasonably clear caused AMJ to be damaged in an amount at least equal to the amount of the insurance proceeds that were wrongfully withheld.” Id. (citing Vail, 754 S.W.2d at 136). Having elected to recover on its statutory claims, damages were appropriately trebled.

United filed a motion for rehearing en banc, which was denied on October 7, 2014. United's petition for review is due to the Texas Supreme Court on December 19, 2014. If the Texas Supreme Court takes the case, it will be the most significant bad faith decision rendered by the Court this century. If it doesn’t, Vail prevails by default. Either way, it’s a hugely important decision for policyholders in Texas.