It Can’t Be Done: Article 21.55 and the Duty to Defend

Almost two years ago, I wrote a column for “Legal Beat” entitled It Couldn’t Be Done: The Policyholder’s Idea to Reinvigorate Third Party Bad Faith. The article outlined the attempts by a very clever Dallas policyholder attorney and his colleagues to give new life to the moribund, but not dead, cause of action for third-party bad faith in Texas by expanding the scope of articles 21.21 and 21.55 of the Texas Insurance Code. On one hand, policyholder counsel were attempting to broaden the scope of article 21.21, which was designed to prohibit fraud and unfair settlement practices by carriers, by expanding the misrepresentation provisions to apply to any innocent mistake in claims handling. To a very limited extent, policyholders accomplished this in the Texas Supreme Court decision of Rocor International, Inc. v. National Union Fire Ins. Co., 77 S.W.3d 253 (Tex. 2002).

Similarly, policyholder counsel sought to expand article 21.55 far beyond its intended scope. Article 21.55 is a provision requiring the prompt payment of first party claims—imposing an 18 percent penalty for delays beyond the statutory guidelines. However, the article is expressly restricted to first party claims. Therefore, liability policies were not subject to Article 21.55. However, policyholder counsel argue that the duty to defend in a general liability policy is a first party obligation (even though the payments go to defense attorneys). Here too, policyholders were partially successful—until last week.

Recent history of 21.55.

Over the last two years there have been several rulings by federal and intermediate Texas appellate courts, mostly unpublished, that split on whether article 21.55 applies to a general liability policy’s duty to defend. One of those cases, Northern County Mutual Ins. Co. v. Davalos, 84 S.W.3d 314 (Tex. App.-Corpus Christi 2002, pet. granted), has been briefed and argued to the Texas Supreme Court on the 21.55 issue (though the issue is secondary in that case and the Court may or may not address the issue). In addition to Davalos, there have been several other cases, including Luxury Living Inc. v. Mid-Continent Casualty Company, 2003 WL 22116202 (S.D. Tex. Sept. 10, 2003) that have ruled on the issue, but almost without exception these cases have offered no analysis or reasoning to support their rulings.

Until now.

Just days ago, on February 11, 2004, the Dallas Court of Appeals not only issued an opinion finding, quite reasonably, that article 21.55 does not apply to a liability policy’s duty to defend, but it also, wonder of wonders, actually outlined its reasoning. The decision, which has not yet been released for publication, is TIG Ins. Co. v. Dallas Basketball Ltd., No. 05-03-00134 (Tex. App.-Dallas Feb. 11, 2004, no pet. hist.). It is the first Texas appellate court decision that has critically analyzed the contention that reimbursement of attorney’s fees after an insured is sued by a third party constitutes a first party claim under article 21.55. Even better, TIG is the best-reasoned and most persuasive analysis of the article 21.55 issue to date.

The court begins by noting, after a “close examination of the language and purpose of article 21.55,” that an insured’s “request for a defense was not a first-party claim for money to be paid directly to the insured” and that such a claim is therefore outside of the reach of article 21.55. In a well-constructed passage, the Court reasoned that:

“The entire structure of article 21.55 presumes a tangible, measurable loss suffered by the insured for which he seeks payment from the insurance company. Any attempt to apply the statute’s structure to a claim for a defense is unworkable and, based on the language of the statute, clearly unintended by the legislature. …

“A demand for a defense under a liability policy is not a claim for payment. It is a demand that the insurance company provide a legal defense to the insured as required by the policy. The insurance company is not required to send a payment to the insured, prompt or otherwise, in response to a claim for defense. …

“Next, article 21.55’s definition of the term ‘claim’ requires that the claim be a ‘first party claim … that must be paid by the insurer directly to the insured or beneficiary.’ When an insurance company provides its insured with a defense, the company then controls the defense and pays the attorneys’ fees associated with the case to the attorney engaged to represent the insured. … The insured does not receive any direct payment as required by article 21.55.” Slip Op. at 4-5 (citations omitted).

That analysis alone should be sufficient to resolve the issue, and indeed would be going into more detail than most other courts. Yet the court was just getting started and found additional support for its conclusion from § 3 of article 21.55, which establishes that the time period for payment runs from the date the insurer receives all information necessary to secure proof of the insured’s loss. At the time the insured makes his claim for a defense, he has not necessarily incurred any legal expenses or suffered any actual loss. “To equate being made the subject of a lawsuit with suffering a compensable loss would contort the statute’s plain and common meaning.” Slip Op. at 5.
Now on a roll, the court recognized that the penalty imposed on insurers who fail to comply with article 21.55 “has no meaning when applied to claims for a defense.” Section 6 of article 21.55 imposes a penalty based on “the amount of the claim.” A claim for a defense, however, has no “amount” to which the § 6 penalty can be applied “because the claim is not for payment of money but for services to be rendered.” Slip Op. at 5.

Unlike most of its predecessors, the TIG court even recognizes that while its decision is contrary to other decisions: “Few of these cases, however, provide any analysis. And those that do discuss the issue only cursorily.” Slip Op. at 6. For example, the court noted that Northern County Mut. Ins. Co. v. Davalos, 84 S.W.3d 314 (Tex. App.-Corpus Christi 2002, pet. granted), “assumes without discussion” that article 21.55 applies to an insured’s claim for a defense. “The court then goes on to affirm the trial court’s award of damages based on this assumption. Absent any reasoning to support the application of 21.55, Davalos is not persuasive.” Slip Op. at 6.

The TIG court continued on and considered that the federal decisions that have made an Erie guess as to Texas law have all relied on faulty reasoning: that because a claim for defense is made by the insured, it constitutes a first-party claim under article 21.55. “The fact that a claim is a first-party claim is not, however, sufficient in and of itself to place it within the scope of claims to which article 21.55 applies. The claim must also be one for payment to be made directly to the insured or beneficiary. As discussed above, neither of these two factors is present in claims for a defense.” Slip Op. at 6 (emphasis in the original). Exactly!

The court then concluded:

“Based on the foregoing, it is apparent that the legislature did not intend the deadlines and penalties of article 21.55 to apply to claims for a defense. Claims for a defense are fundamentally different than first-party claims for payment based on a loss suffered by the insured. The language of 21.55 cannot be applied to claims for a defense in any meaningful way. Accordingly, TIG’s actions in this case are not subject to the eighteen percent penalty imposed by article 21.55.” Slip Op. at 6-7.

Better luck next time.
TIG is the first decision to make a clear and rational examination of the application of Article 21.55. The reasoning in TIG is rational and compelling, and the decision is the most persuasive authority on the issue.
Okay, the issue is not finally decided, and the Texas Supreme Court may rule differently in Davalos, if it reaches the issue at all. But, at least for now, one court has finally got it right—and even explained why!

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston office of Thompson, Coe, Cousins & Irons, L.L.P. He has extensive experience in insurance coverage and defense matters, specializing in environmental, toxic tort and products cases. Martin is a frequent author and CLE speaker on insurance topics, including coverage and bad faith issues.>

Topics Carriers Texas Claims