On December 20, 2024, the Texas Supreme Court issued an interesting decision addressing whether an insured was entitled to coverage under its excess liability policy for legal expenses it incurred in defending an underlying suit. Ohio Casualty Insurance Company v. Patterson-UTI Energy, Inc.
BACKGROUND
The coverage dispute arose from a drilling rig incident that resulted in multiple lawsuits against the insured. The amounts paid for the defense and settlement of the lawsuits exhausted the limits of the insured's primary policy and lower-level excess policies. The insured then sought coverage under its higher-level excess policy. The excess insurer paid portions of the settlement amounts, but declined coverage for the defense amounts. Coverage litigation ensued.
The trial court granted summary judgment for the insured, finding coverage because the excess policy did not clearly and unambiguously exclude coverage for defense expenses. The intermediate court of appeals affirmed. In doing so, the intermediate appellate court reasoned that because the underlying policy covered defense expenses and the excess policy was a "follow form" policy that did not unambiguously exclude defense expenses, the excess policy necessarily provided coverage.
TEXAS SUPREME COURT ANALYSIS AND DECISION
The Texas Supreme Court began its analysis with what it characterized as a "cardinal principle" of insurance law dating back to 1886, which holds that the policy is the contract, and outside papers can be imported only if done "in so clear a manner as to leave no doubt of the intention of the parties." Pursuant to this authority, the supreme court instructed that the proper framework is to start with the text of the policy at issue, to refer to extrinsic documents only if the policy at issue clearly requires doing so, and then to refer to such extrinsic documents only to the extent of incorporation.
The supreme court emphasized that this same framework applies when addressing coverage under a follow-form excess policy and that the court of appeals improperly inverted this framework by starting with the underlying policy:
True ... it is expected that a contractual dispute about a follow-form excess policy will implicate the underlying policy. The extent of that implication, however, is not a binary choice but one that presents an array of options. The excess policy could adopt the underlying policy in its entirety; it could do so except for various express exclusions; or it could substantially change the scope of initial coverage by providing its own terms. Characterizing an excess policy as a "follow-form" policy, in other words, confirms only that the excess policy will to some degree incorporate the provisions of the underlying policy—the degree of incorporation is determined by the excess policy's text. At all times, the excess policy itself remains the contract that governs a dispute about its coverage. The court of appeals should have first "look[ed] to the excess policy to determine coverage" rather than "first examining the terms of the [underlying] policy." (alterations and emphasis in original).
While the insured indicated that it agreed with this framework, it argued that because the underlying policy covered the defense expenses, the follow-form excess policy necessarily did as well. The underlying policy obligated the insurer to pay "ultimate net loss," which was defined to include defense expenses. Relying on this definition, the insured asserted that a follow-form excess policy is bound by the underlying policy's coverage choice unless it expressly repudiates that choice. The supreme court disagreed, reasoning that the insured's argument "amounts to the approach we emphatically reject: starting with the underlying rather than the excess policy."
Instead, starting with the excess policy, the supreme court explained that the excess policy's insuring agreement did not use the term "ultimate net loss" from the underlying policy. Rather, the insuring agreement obligated the insurer to pay the amount of "loss" in excess of the "Underlying Limits of Insurance." Thus, the excess policy covered the defense expenses only if those expenses constituted "loss," which term was defined as sums actually paid in the settlement or satisfaction of a claim that the insured is legally obligated to pay as damages.
It was undisputed that the defense expenses were "actually paid" and that the insured was legally obligated to pay them via the engagement letter with its attorneys. However, the supreme court emphasized that "a party's own attorney's fees 'are not, and have never been, damages.'" Recognizing that contracting parties may give "bespoke definitions to ordinary terms," the supreme court explained that for the defense expenses to qualify as "loss," the parties must have agreed by contract to give the term "damages" a specialized meaning. The court noted that the excess policy did not include any special definition of "damages" and that the context surrounding the use of the term "damages" suggested the usual definition, not one that included defense expenses. The supreme court reasoned that "because a party paying its own defense expenses would not do so 'in the settlement or satisfaction of a claim'" (emphasis in original), this language must refer to sums that insured was obligated to pay to an adverse party such as the third-party claimant who was injured in the incident. The supreme court further explained that if the insured became obligated to pay the claimant's attorney's fees, those fees could be covered. However, the excess policy did not cover the fees that the insured paid to its own attorneys.
The supreme court concluded that the insured could not sustain its burden to establish coverage for the defense expenses and, therefore, reversed the judgment of the court of appeals and rendered judgment for the insurer.
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