United States: Fifth Circuit Makes Numerous Rulings Regarding Coverage For Insureds Defense Costs And Denies Insurers Reliance On Billing Guidelines

Case:  Aldous v. Darwin Nat'l Assurance Co.,
           U.S. Fifth Circuit Court of Appeals
           851 F.3d 473 (5th Cir. 2017)

In Aldous v. Darwin Nat'l Assurance Co., he plaintiffs, Charla Aldous and her law firm Charla G. Aldous, P.C. d/b/a Aldous Law Firm, sued their professional liability insurer, Darwin National Assurance Company, regarding defense costs Darwin owed, where plaintiffs' attorney in the underlying malpractice suit also pursued claims for the insured and against the former client. The district court dismissed certain claims on a 12(b)(6) motion and decided the remainder of the case on summary judgment. The U.S. Fifth Circuit Court of Appeals reversed and remanded for further proceedings.

The litigation arose out of the Aldous plaintiffs' representation of Albert Hill, III, in trust litigation as an heir to the Hunt Petroleum Corp. fortune. Aldous, along with two other attorneys, Lisa Blue and Steve Malouf, secured a $114.7 million judgment on a contingency basis, but Hill refused to pay the fee. Aldous, et al. retained Alan Loewinsohn to sue to recover their fee, and Hill counterclaimed for breach of fiduciary duty, duress, breach of contract, fraud and professional negligence. The counterclaims triggered Darwin's policy with regard to Aldous. (The other attorneys had separate policies with a different insurer). Darwin agreed to pay Loweinsohn to defend Aldous along with Blue and Malouf, agreeing to split Loewinsohn's costs three ways with the other malpractice insurers. The court ruled in favor of Aldous, Blue and Malouf, awarding $21.9 million for the earned contingency fee in the trust litigation, $479,595 in costs in the trust litigation, and costs and fees of $2,586.560.11 in defending Hill's counterclaims.

Darwin then contended that the total amount of defense costs payable to Loewinsohn was only $668,068.38, with Darwin owing only $222,689.44, which was its one-third share. Darwin further claimed that Aldous should reimburse the $279,676 extra it had advanced during the underlying litigation. Aldous thus filed suit in Texas state court for breach of contract, breach of the duty of good faith and fair dealing, and violations of the Texas Insurance Code and Texas Deceptive Trade Practices Act. Darwin removed the case to federal court and counterclaimed for breach of contract and unjust enrichment.

The federal district court granted summary judgment in favor of Darwin, holding that Aldous was judicially estopped from claiming more than $668,068.38 in defense costs, based on affidavits submitted in the underlying litigation against Hill. The court also concluded that Aldous could not recover fees incurred in prosecuting her claims against Hill, even if it was inextricably intertwined with her defense, because of the judicial estoppel. As a further result, the district court ruled that Darwin could recover the overpayment but it could not assert breach of contract claims, as contrary to the anti-subrogation rule.

The U.S. Fifth Circuit Court of Appeals first addressed the issue of judicial estoppel, since that ruling precluded Aldous from establishing a breach of contract against Darwin and underpinned Darwin's claim for equitable relief on the overpayment. The Court first noted that in cases of diversity jurisdiction, federal courts are bound to apply federal principles of judicial estoppel (not state rules). To prevail, Darwin had to establish that Aldous's position was "clearly inconsistent with its previous one" and that Aldous had convinced that court to accept that previous position. After reviewing the evidence provided in the underlying litigation with Hill, the Fifth Circuit concluded that Aldous had never taken the position that defense costs were limited to $668,068, but rather simply presented fees that were solely related to defense, while there were additional fees of over $2 million that were incurred for both defensive and affirmative claims. Since there was no judicial estoppel, Aldous' claims for breach of contract were viable. Further, the precise amount of defense costs remained a disputed issue of fact.

The Fifth Circuit further addressed Darwin's contention that it did not breach the insurance contract in failing to pay the additional amounts of defense costs, because the policy gave Darwin discretion to determine what constituted "reasonable claim expenses," which Darwin contended include only charges covered by the policy. The Court refused to determine if this policy provision was generally enforceable, because it concluded that Darwin had in fact failed to make any determination about the reasonableness of the claim expenses before refusing to pay them. The Court did note that if the policy gave Darwin an "unquestionable right to pay only to the extent it pleases," then coverage would be illusory. The Fifth Circuit also stated that the insurer's Billing Guidelines could not bind Aldous, because they were not part of the insurance contract.

In light of the erroneous judicial estoppel, the district court had refused to consider Aldous' claim for a declaratory judgment that Darwin had to pay all of the attorneys' fees and costs that were "inextricably intertwined" with the defense and pursuit of affirmative claims. The Court of Appeals quickly disposed of those claims, holding that no Texas court had ever held that the duty to defend included payment of legal fees for prosecuting affirmative claims. Thus, the Court rejected those claims.

Likewise, the appellate court addressed Aldous' claims for breach of the common law duty of good faith and fair dealing, which had been dismissed on Darwin's motion to dismiss for failure to state a claim. The Court noted that under Texas law, an insurer has a duty of good faith and fair dealing in handling its own insured's claims, but it has no similar duty to its insured to investigate and defend claims by a third party. The federal court concluded that the loss for which Aldous made a claim was Hill's, a third-party, so Darwin owed no duty of good faith or fair dealing. The Fifth Circuit also upheld the dismissal of Aldous' claims under the Texas Insurance Code and the Texas Deceptive Trade Practices Act, because Aldous had no independent injury for the mishandling of the claims, following its prior decision in Parkans Int'l, LLC v. Zurich Ins. Co., 299 F.3d 514 (5th Cir. 2002).

Next, the Court of Appeals addressed Darwin's claims to recover the amount it had overpaid for Aldous' defense. First, the Court concluded that Darwin had no claim for equitable reimbursement under Texas law, citing to Excess Underwriters at Lloyd's, London v. Frank's Casing Crew & Rental Tools, Inc., 246 S.W.3d 42, 45 (Tex. 2008) and Miga v. Jensen, 299 S.W.3d 98, 103 (Tex. 2009). Rather, the insurer's remedy is to include a right of reimbursement in the insurance contract or to obtain a clear and unequivocal consent from the insured to the payment in light of disputed coverage along with consent to a right to seek reimbursement.

Finally, the Fifth Circuit determined that Aldous' recovery of legal fees from Hill, which Darwin had already paid, was not a breach of the insurance contract. Rather, Darwin could have and should have asserted its subrogation rights in the underlying lawsuit against Hill. Since it failed to do so, it could not recover those amounts through a breach of contract claim.

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