The Texas Supreme Court is grappling with conflicting principles from its prior decisions in a case that may affect how insurers approach the duty to defend in Texas.

In Seger v. Yorkshire Ins. Co., Ltd., (Case No. 13-0673), the carriers denied coverage on a wrongful death claim against a company called Diatom.  Claiming an inability to pay for counsel, Diatom defaulted post-answer and made no attempt to defend the claims at trial.  It did not make an opening statement or a closing argument, did not cross-examine any of plaintiffs’ witnesses, and presented no evidence of its own.  The trial resulted in a $27MM judgment against Diatom (compared to a pre-trial demand within policy limits of $250,000).  Shortly after trial, Diatom assigned to the plaintiffs a wrongful denial of coverage claims against its carriers.

For the next decade, the wrongful death plaintiffs pursued Diatom’s carriers, and eventually prevailed at the trial court level.  By that time, interest and costs had swelled the amount of the underlying judgment to over $70MM.  On appeal, the Seventh Court of Appeals reversed, holding that because Diatom had essentially laid down at trial, the $27MM damages award was not the result of a true adversarial proceeding.  The Court of Appeals therefore held that the award was not conclusive of plaintiffs’ actual damages and was “inadmissible as evidence of damages in the present action” against the insurers.

On appeal to the Texas Supreme Court, the wrongful death plaintiffs contend that Diatom was unable to present any defense at trial precisely because the insurers wrongfully denied coverage, and that under existing Texas law an insurer who wrongfully refuses to defend a claim cannot later challenge the reasonableness of a settlement made by its insured.  Evanston Ins. Co. v. Atofina PetroChemicals, Inc., 256 S.W.3d 660 (Tex. 2008). A contrary ruling, plaintiffs argue, would provide an incentive for insurers to refuse to defend financially unstable or insolvent insureds.

On the other hand, the carriers argue that the$26MM trial judgment against Diatom and subsequent assignment was a sham – the result of collusion between Diatom and plaintiffs.  The carriers point to prior Texas Supreme Court case law expressly intended to prevent such collusion, which holds that “in no event . . . is a judgment for plaintiff against defendant, rendered without a fully adversarial trial, binding on a defendants insurer or admissible as evidence of damages in an action against defendant’s insurer by plaintiff as defendant’s assignee.” State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d 696, 714 (Tex. 1996) (emphasis added).

Interestingly, both sides argue against adoption of a potential compromise position: California’s Pruyn approach.  Under Pruyn, a settlement following a wrongful denial of coverage creates an evidentiary presumption of the value of the underlying claim. The burden of proof shifts to the insurer to prove that the settlement was the product of fraud or collusion at a second trial. Pruyn v. Agricultural Ins. Co., 42 Cal.Rptr. 2d 295 (1995).  While the Texas Supreme Court has previously expressed serious doubts about the wisdom and practicality of the Pruyn approach, the difficult facts presented in Seger may prompt it to reconsider those concerns.

Seger v. Yorkshire Ins. Co. is set for oral argument before the Texas Supreme Court on September 3, 2015.