Texas Association of Counties County Government Risk Management Pool, Petitioner

Matagorda County and Keith Kilgore, Respondents

Justice Owen, joined by Justice Hecht, dissenting.

Matagorda County has been unjustly enriched in this case. It acknowledges that the amount that the Texas Association of Counties paid to settle serious claims against it was reasonable. And Matagorda County must now concede that those claims were not covered by its agreement with the Association. The County should be required to bear responsibility for its own liabilities. Because the Court does not require it to do so, I dissent.

I would hold that when an insurer reserves its right to contest coverage and there has been a settlement demand within policy limits that the insured agrees is reasonable, the insurer may settle the claim and recover settlement costs based on an obligation that is implied in law. In order to prevent unjust enrichment, obligations are implied in law even when there is no agreement, either express or implied.

The most cogent discussion of an insurer's reimbursement rights when a third party's claims against an insured are not covered appears in a decision of the California Supreme Court. Buss v. Superior Court of Los Angeles County, 939 P.2d 766 (Cal. 1997). That court held that a right of reimbursement for defense costs should be implied in law. Id. at 776-77. "The insurer therefore has a right of reimbursement that is implied in law as quasi-contractual, whether or not it has one that is implied in fact in the policy as contractual." Id. at 776.

The reimbursement issue in Buss arose in a case that the court called a "mixed" action, that is, some of the claims were covered by the insured's policy and some were not. Under California law, an insurer has a duty to defend all claims in a mixed action, including claims that are not even arguably covered. Id. at 775. But the question in Buss was whether the insured could nevertheless seek reimbursement for the costs of defending claims that were "not even potentially covered" when they were joined with claims that were covered. Id. at 776. The California Supreme Court first explained that the duty to defend non-covered claims in a mixed action was not a contractual obligation. "We cannot justify the insurer's duty to defend the entire 'mixed' action contractually, as an obligation arising out of the policy, and have never even attempted to do so." Id. at 775. Instead, the court has imposed the duty to defend as an obligation of law. "[W]e can, and do, justify the insurer's duty to defend the entire 'mixed' action prophylactically, as an obligation imposed by law in support of the policy." Id.

But is does not follow, the California court reasoned, that the insured is entitled to benefit from a bargain that it did not make with the insurer. The court concluded that it "would not upset the [insurance] arrangement" to shift the defense costs of claims that are not covered to the insured. Id. at 776. One of the compelling reasons the court gave is that the insureds do not pay premiums for a defense of claims that are not covered:

Under the policy, the insurer does not have a duty to defend the insured as to the claims that are not even potentially covered. With regard to defense costs for these claims, the insurer has not been paid premiums by the insured. It did not bargain to bear these costs.

Id.

The court then held that a right of reimbursement is implied in law based on principles of restitution. Id. at 776-77. "[U]nder the law of restitution such a right runs against the person who benefits from 'unjust enrichment' and in favor of the person who suffers loss thereby." Id. at 777. The court further explained that "[e]ven if the policy's language were unclear, the hypothetical insured could not have an objectively reasonable expectation that it was entitled to what would in fact be a windfall." Id. In support of this conclusion, the court cited one of its earlier decisions in which it had said that if an insurer reserves the right to assert coverage issues, then it may seek reimbursement from its insured for a reasonable settlement payment. Id. (citing Johansen v. California State Auto. Ass'n Inter-Ins. Bureau, 538 P.2d 744, 750 (Cal. 1975)).

In another decision, Maryland Casualty Co. v. Imperial Contracting Co., 260 Cal. Rptr. 797, 803 (Cal. Ct. App. 1989), a California court had held that an insurance company was entitled to reimbursement of settlement costs over the objection of the insured once a court had determined that the settlement amount was reasonable. In the case before us today, there is no need for a court determination of the reasonableness of the settlement. Matagorda County has always conceded that the amount paid to settle the Coseboon litigation was reasonable.

Other decisions have held that an insurer may settle a claim without the consent of the insured and then seek reimbursement for the portion of the settlement funds that are the insured's sole obligation. In Arkwright-Boston Manufacturers Mutual Insurance Co. v. Aries Marine Corp., 932 F.2d 442 (5^th Cir. 1991), an insured was effectively self-insured for the first $500,000 of liability after its primary carrier became insolvent. In the underlying suit against the insured, the plaintiff's settlement demand was $1,745,000. The insured's excess carrier, Arkwright, undertook to settle the case for that amount, but the insured refused to tender its $500,000. Arkwright sent a letter to the insured before disbursing the settlement funds advising that it intended to seek reimbursement of the $500,000 that represented the insured's obligation. Id. at 444. The insured did not object to the settlement or claim that it was unreasonable. The Fifth Circuit held that the insured was obligated to reimburse its insurer and that its obligation stemmed from its "duty to contribute its retained limit to what it admits was a reasonable settlement." Id. at 447. See also Certain Underwriters at Lloyd's London v. Oryx Energy Co., 142 F.3d 255, 260 (5^th Cir. 1998) (holding that the insurer was entitled to reimbursement from the insured for amounts paid to settle punitive damage claims that were not covered by the policy).

Here, Matagorda County is contractually responsible not just for a portion of the damages, but for all damages that it owed to the Coseboon plaintiffs. By definition, claims that are not covered under a policy of insurance are the responsibility of the insured. The insured should be required to contribute its full share of liability for amounts paid to settle contractually excluded claims.

Implying an obligation as a matter of law is far from unprecedented in this state's jurisprudence. This Court has implied at least two obligations in contracts of insurance. First was the Stowers obligation, which is a duty imposed on an insurer to accept a settlement demand within policy limits if the claim is covered and an ordinarily prudent person would accept it, considering the likelihood and degree of the insured's potential exposure to an excess judgment. See American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 849 (Tex. 1994) (defining the duty imposed in G.A. Stowers Furniture Co. v. American Indem. Co., 15 S.W.2d 544 (Tex. 1929)). The Stowers obligation is not to be found within the four corners of an insurance policy. It has been imposed by the Court "as a matter of law." Stowers, 15 S.W.2d at 547. Second, this Court has imposed as a matter of law a duty of good faith and fair dealing in contracts of insurance. See Arnold v. National County Mut. Fire Ins. Co., 725 S.W.2d 165, 167 (Tex. 1987).

An obligation of reimbursement should be imposed when an insured pays an amount that the insured agrees is reasonable to settle a claim that is not covered. This rule of law would preserve the respective rights and obligations of parties to an insurance contract. An insured would be responsible for liabilities it incurs that are not covered by the policy of insurance. In this case, there is no principled basis for requiring the Association rather than Matagorda County to bear the cost of settling the Coseboon litigation. There is no dispute that the amount the Association paid to settle the matter was reasonable. Matagorda County is receiving a benefit for which it did not bargain--payment of a claim that was not covered under its agreement with the Association. Matagorda County has been unjustly enriched because it paid nothing to settle a serious claim against it. The Association has paid an obligation that was Matagorda County's alone.

The Court says that an insured should not be required "to choose between rejecting a settlement within policy limits or accepting a possible financial obligation to pay an amount that may be beyond its means, at a time when the insured is most vulnerable." __ S.W.3d at __. Certainly, an insured who has no coverage for claims brought against it may be in a "vulnerable" position. But that is not due to anything that the insurance carrier has done. It is a consequence of the insured's choice not to obtain full coverage. The Court's statement is also irrational. A reasonable settlement offer is one that the insured, acting as a person of ordinary care and prudence, would accept. In situations like the one before us, when there was a coverage dispute, an insured's knowledge that it ultimately may have to fund a settlement offer will cause the insured to make a fair evaluation of whether the settlement offer is in fact a reasonable one. But regardless of the size of a claim that is not covered, the financial obligation to pay that claim remains with the insured. An insured's lack of financial resources does not change that fact.

I agree with the Court that in this case, there was no implied-in-fact agreement between the Association and Matagorda County. The letter that the Association sent to the County reserving the right to contest coverage and to seek reimbursement recognizes that the County had expressly declined to contribute to funding the settlement. The letter did not say that the Association would proceed with the settlement unless Matagorda County objected, nor did the County demand that the Association settle or do anything to affirmatively accept the settlement.

But the Court's opinion unnecessarily forecloses all implied-in-fact agreements between an insured and its insurer with regard to reimbursement for settlement payments. The Court says, "the insurer may fund the settlement and seek reimbursement only if it obtains the insured's clear and unequivocal consent to the settlement and the insurer's right to seek reimbursement." __ S.W.3d at __. The Court does not provide any rationale for such a sweeping ruling.

Implied-in-fact contracts are a species of contract. Unless there are strong public policy reasons for holding otherwise, the law of contracts applies to the relationship between an insured and its insurer. See generally State Farm Life Ins. Co. v. Beaston, 907 S.W.2d 430, 433 (Tex. 1995) (holding that "the interpretation of insurance contracts is governed by the same rules of construction applicable to other contracts") (citing Forbau v. Aetna Life Ins. Co., 876 S.W.2d 132, 133 (Tex. 1994)). If an insured tacitly accepts the benefits of an offer made by its insured, then an agreement is formed. See generally Jerry, The Insurer's Right to Reimbursement of Defense Costs, 42 Ariz. L. Rev. 13, 71 (2000). This is so even if the insured rejects a condition the insurer attached to the offer if the insured nevertheless accepts performance by the insurer. Id. at 71-72. Agreements of this nature frequently arise when an insurance company sends a reservation-of-rights letter, and the insured accepts its benefits. Id.

In Walbrook Insurance Co. v. Goshgarian & Goshgarian, 726 F. Supp. 777 (C.D. Cal. 1989), the insurance company sent a reservation-of-rights letter in which it stated that it intended to seek reimbursement of defense costs if it was determined that there was no duty to defend. Id. at 784. The insureds objected to this reservation, but they accepted $500,000 in defense costs. Id. The court concluded that even though the insureds "specifically objected" to the reservation of the right to seek reimbursement, that objection was inconsistent with the insureds' acceptance of the fruits of the insurance carrier's tender. Id. The court properly held that "acceptance of the monies constitutes an implied agreement to the reservation." Id.

Other courts have held that an insured's silence in response to an insurer's reservation of the right to seek reimbursement of defense costs coupled with an acceptance of the defense results in an implied agreement. See Knapp v. Commonwealth Land Title Ins. Co., 932 F. Supp. 1169, 1172 (D. Minn. 1996); North Atl. Cas. & Sur. Ins. Co. v. Dodson, 743 F. Supp. 1361, 1367 (N.D. Cal. 1990); Omaha Indem. Ins. Co. v. Cardon Oil Co., 687 F. Supp. 502, 505 (N.D. Cal. 1988); Gossard v. Ohio Cas. Group of Ins. Cos., 35 Cal. Rptr. 2d 190 (Cal. Ct. App. 1994); see also Jerry, 42 Ariz. L. Rev. at 73 (concluding that under the law of contracts or the law of restitution, "the insurer has a right to reimbursement for costs incurred in defending noncovered claims" if the insurer reserves its right to seek reimbursement).

At least one court has held that there is a right of reimbursement for defense costs under a reservation-of-rights letter without discussing the legal theory for that holding. In Resure, Inc. v. Chemical Distributors, Inc., 927 F. Supp. 190, 194 (M.D. La. 1996) (applying New Mexico law), the court held that because the reservation-of-rights letter specifically referred to reimbursement for defense costs, the insurer was entitled to reimbursement.

Depending on what a particular reservation-of-rights letter says, I can perceive that there may be valid distinctions between reservation-of-rights letters that address reimbursement for settlement payments and those that address defense costs. If an insured accepts a defense or payment for defense costs after receiving a reservation-of-rights letter, that acceptance should be deemed an acceptance of the insurer's right to reimbursement if it turns out that the claim was not covered. But silence or acquiescence to a settlement may or may not be deemed acceptance of an obligation to reimburse, depending on what the reservation-of-rights letter provided or on the parties' conduct. If in the case before us, the County had demanded that the Association settle the Coseboon litigation after receiving the reservation-of-rights letter, I would hold that an implied-in-fact agreement arose, even if the County maintained that there was no obligation to reimburse. A demand for settlement by the County would have constituted an acceptance of the Association's offer to settle the case with the right to seek reimbursement. See, e.g., Walbrook, 726 F. Supp. at 784. Or if the Association's letter had said it intended to proceed with the settlement ten days from the date of the letter unless the County advised it not to, I would likewise hold that there was an implied-in-fact agreement.

It would be more judicious for the Court to decide whether an implied-in-fact contract has arisen between an insured and its insurer on a case-by-case basis. Instead, the Court has entirely precluded the application of this aspect of contract law to insurers. The Court offers no compelling reason for that edict.

The Court does not address defense costs in today's decision. However, the Court says at one point in its opinion that "a unilateral reservation-of-rights letter cannot create rights not contained in the insurance policy." __ S.W.3d at __. The decision that the Court cites for that proposition, Shoshone First Bank v. Pacific Employers Insurance Co., 2 P.3d 510 (Wyo. 2000), dealt with defense costs, but it did not address the situation in which there is no duty to defend.

In Shoshone, some of the claims against the insured were covered and some were not. The insurance company sent a reservation-of-rights letter in which it said that it intended to allocate the costs of defending the non-covered claims to the insured. The Supreme Court of Wyoming held, unremarkably, that it would not allow allocation of costs. Id. at 514. It concluded that it should follow the minority view, which is that an insurance company's duty to defend includes the obligation to defend non-covered claims when they are asserted together with covered claims. Id. at 515. The reservation-of-rights letter was ineffective to alter the contractual duty to defend. Id.

The Court's statement that a "unilateral reservation-of-rights letter cannot create rights not contained in the insurance policy is not only overly broad, it is a misstatement. For example, an insurance company can bind itself in a reservation-of-rights letter to pay defense costs even if none of the claims against the insured are covered. An insurance company that tenders a defense but reserves only the right to assert that it has no indemnity obligation cannot seek to recover defense costs when it is subsequently determined that there was no coverage and no duty to defend. Dohoney, The Liability Insurer's Duty to Defend, 33 Baylor L. Rev. 451, 478 (1981); see also Employers Cas. Co. v. Tilley, 496 S.W.2d 552, 559 (Tex. 1973).

Under Texas law, if an insurance company tenders a defense with a reservation of rights, the insured may either accept that defense with the reservation of rights, or it may refuse the tendered defense and defend the suit itself. Rhodes v. Chicago Ins. Co., 719 F.2d 116, 120 (5^th Cir. 1983); American Eagle Ins. Co. v. Nettleton, 932 S.W.2d 169, 174 (Tex. App.--El Paso 1996, writ denied). If the insured decides to defend itself, it must bear the cost of that defense if the claims against it are not covered by insurance.

It would seem that an insured should have to pay defense costs for excluded claims regardless of whether it defends itself or allows its insurance company to assume the defense with a reservation of rights. The Court does not offer any reason why, on public policy or other grounds, an insurer should be foreclosed from recovering defense costs if the insured accepts a defense that is tendered with a reservation of rights. Nevertheless, insurers should be on notice that today's decision may foreshadow how the Court will decide the issue if it is presented.

I would hold that when an insurer pays an amount that the insured agrees is reasonable to settle a claim, and a court later determines that the claim was not covered, the law imposes an obligation on the insured to reimburse the insurer. Because I would render judgment for the Texas Association of Counties on this basis, I respectfully dissent. I also take issue with the Court's categorical holding that the law of implied contracts does not apply to the relationship between insurers and their insured.

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Priscilla R. Owen

Justice

OPINION DELIVERED: December 21, 2000