LIABILITY INSURANCE - DUTY TO DEFEND - HISTORICAL DEVELOPMENT

LIABILITY INSURANCE AND THE DUTY TO DEFEND: SOME HISTORICAL DEVELOPMENTS?

Michael Sean Quinn, Ph.D. & J.D.

This is an anecdotal and, to some extent, conjectural, even speculative, introductory history of the development of a crucial part of liability insurance. Reliable literature on the origins and development of liability insurance is impossible to find.  Thus, one must begin with guesses, to some degree. 

It is important to remember that liability insurance is a latecomer to the insurance industry. Many types of insurance existed long before it. Even if one's observations are restricted to modern times, a significant number of so-called first-party insurance coverages existed before it, for example, fire, marine, and life insurance. 

In the English speaking world, for example, fire insurance originated late in the Seventeenth Century, after the "Great Fire" in London in 1666.  In America, fire insurance seems to have originated in 1754, more or less, a "gift" of Benjamin Frankin. Probably he got the idea from his life in England. At that time, most forms of insurance were "societies," meaning that they were mutual poolings.

Obviously, liability insurance originated as what its name describes: insurance providing indemnity for those found to be liable to others for injuries of various injuries the insured caused. It should be immediately obvious that this sort of insurance is tied to the existence of an active court system, to the industrial revolution of mostly the 19th Century, to a commercialized economic system, and to the kind of reasoning and theory for legal thinking characteristic of the Enlightenment and post-Enlightenment periods.  Underwriting requires extensive fact-gathering and sophisticated fact gathering. 

Often liability insurance is called third-party insurance, referring to the fact that, quite literally, the insurance provided insureds with indemnity for amounts paid to others because of injuries the insured had caused. It should be remembered that originally "indemnity" means a payment to the insured for amounts the insured has paid. That technical meaning of "indemnity" changed over time so that the insurer might pay amounts the insured owed for injuries it sustained, e.g., fire, and not wait for the insured to pay and then reimburse him. 

A great many things can be called "injuries." For example, if someone fails to carry out a business arrangement this can be considered an injury. One early form of liability insurance would look like this: A and B enter into an agreement to perform a certain mercantile task. In an agreement, A and B promise to do x for C. A and B fail to perform, so C suffers a loss. A and B would be liable to sue for damages their failure caused C. But, while A and B have agreed to pay the whole debt to C, they have agreed that A will indemnify B for what he had paid pays. 

This would be a form of liability insurance. One should notice that the arrangement between A and B has nothing to do with what is owed C. It should also be recognized that this arrangement is a substitute or replacement of A lending B money to pay C, though A might have to borrow money to indemnify B or pay B's portion of the debt to C. 

An insured's obligation to pay for an "injury" he (or it) caused  might be the result of a court finding, or–more likely–it might be the result of something like what we now call an "arbitration."  It might, for example, be something decided by an informal group of "elders" in a given industry, say, at a coffee shop, with both A and B agreeing to be found by what the "elders" find.  Before that, it might begin by dealing with reputational dangers.  

Industries where this form of liability insurance is to be found, maybe, is portrayed in the business sections of Charles Rappleye, Robert Morris: Financier of the American Revolution (2010). Morris was a big-time merchant, importer, exporter, with a syndicate of agents all over Europe, the West Indies, and some cities in America. He was also one of the founding fathers, though not usually recognized as such, perhaps because there are so many controversies about his financial conduct as a government official.  He was a "big player," but also a big spender, a was his wife. He, close to, ended his days in debtor prison. It is not being suggested here that Morris had actual deals involving financial liability insurance, but it would be found, if at all, in his kind of business. 

There is sparse, if any, real evidence that these sorts of business dealings and resolutions were widely practiced. However, import and export merchants had large organizations with agents in many places, there would have to be an arrangement of the sort I have just outlined. 

Obviously, insurance of this sort is not for individuals living ordinary lives, but for those active in large, complex businesses, that might, for example, default in a  business dealing. Of course, then, as today, such liability might be dealt with through a loan or some sort. Thus,  liability insurance began as something closely connected to the financial industry.  

It is also important to remember that liability insurance started or developed as an attachment to other sorts of insurance, as is still sometimes true. Marine liability insurance is a good example of this idea. Liability insurance did not begin as a separate, distinct, and stand-alone type of insurance contract, although it certainly began as a type of contract, or part of a type of contract. 

It is hard to imagine liability insurance without industry, heavy equipment, a good deal of commercial transportation,  railroads, for example, as well as ships, highly active markets, and an elaborate banking system. Thus, liability insurance did not originate or develop early-on from problems arising out of the causation of bodily injury.  In fact, virtually the opposite is true. 

It appears that liability insurance in America at least began in a serious way after the Civil War and toward the end of the Nineteenth Century, at the earliest. Some have suggested that it really got started in connection with railroads. Others suggest that its true origin comes with the development of the use of motor vehicles.  This would place its development within the Twentieth Century. I suspect that the latter position is more correct, although it is possible that railroads sold forms of accident insurance along with some tickets. (A dime for a regular ticket and $0.13 for one with accident insurance.) When I was a kid, one could buy this sort of insurance with airline tickets.

Then, as now, accident insurance is a form of first-party insurance–a sort of specialized health insurance. Perhaps the sort of insurance one can buy when renting a car is like that.  In its history of itself as a business, it brags that it originated in 1864 to sell accident insurance. Apparently one of the founders of the Travelers got this idea while traveling in Europe.  The name of the company suggests that accident insurance was originally conceived as something for those traveling.

In any case, I speculate that liability insurance really began with motor vehicles. If so then auto insurance was, at least at a massive level, the first form of liability insurance. One would bet that both first-party and third-party insurance were sold bundles together, ab initio, or very soon thereafter, at least as an available option. 

If liability insurance did not really start as a significant component of the industry until the Twentieth Century, and if the duty to defend did not arise until that time, or thereafter, then no wonder there is virtually no historical literature about it. 

It is important in tracing the duty to defend to keep in mind that often the price of defending a lawsuit is substantial, and often it exceeds the amount of the loss.  Thus, the insurer's duty to defend is a central part of a liability policy.  These days all sorts of policies are mixed between first-party coverage, such as homeowners' policies, and even title insurance policies. 

 

                                                       mquinn@msqlaw.com.                                                            (512) 656-0503 

  

INSURER'S DUTY TO DEFEND, EIGHT (8) CORNERS RULE, COLLUSIVE FRAUD, PROVING COLLUSIVE FRAUD CONCLUSIVELY BY INSURER A NEW EXCEPTION

LIABILITY INSURER'S DUTY DEFEND SACROSANCT IN INSURANCE CONTRACT SUBJECT TO RARE EXCEPTION, HOLDS TEXAS SUPREME COURT

Loya Ins.  Co. v. Hurtado

Michael Sean Quinn, Ph.D., J.D., C.P.C.U.  Etc.*

The duty of a liability insurer to defend its insured is a central part of the liability insurance contract. It may be found there either by the explicit language of the policy or as an implied term.  Exposure to paying legal fees in defending against a lawsuit is one of the losses liability insurance is there to cover. This is a crucial part of liability insurance policies. That exposure can often be larger than the amount recoverable; they would be incurred far more frequently than judgments holding liability, and they would provide huge areas for blackmail. 

To have an insured almost automatically protected, whether an insurer has a duty to defend is decided by simple, mechanical means that favor the insured. The principle is this: if the plaintiff's pleading against the insured defendant asserts, describes, or sketches (even poorly) an act, omission, event, or state of affairs and an alleged resulting injury, then the insurer has a duty to defend the insured, judging all this by (1) what is to be found within the petition or complaint itself, i.e., within its four corners of the pages of the pleading and not by facts found outside it, and (2) by what is to be found in the insurance policy, that is, within its four corners. This is called the "Eight Corners Rule." Obviously, this phrase is a metaphor since petitions and insurance policy invariably have multiple pages. 

Virtually all policies of liability insurance involve a provision that the insurer has a legal obligation to defend an insured if the insured is sued for recovery by means of a pleading, usually a Petition or Complaint which describes or asserts, even cursorily, confusedly, or falsely, a covered type of event or state of affairs.  The pleadings themselves may involve some types of fraud, e.g., if the plaintiff is trying to defraud the defendant, i.e., the insured, and thereby the insurer. The duty to defend is a very broad one–much broader than the duty to pay the insured's insured losses.

This duty on the part of an insurer is a central part of the contract. It may be found there either by the explicit language of the policy or as an implied term.  Exposure to paying legal fees in defending against a lawsuit is one of the losses liability insurance is there to cover. This is a crucial part of liability insurance policies. That exposure can often be larger than the amount recoverable; they would be incurred far more frequently than judgments holding liability, and they would provide huge areas for blackmail. 

To have an insured almost automatically protected, whether an insurer has a duty to defend is decided by simple, mechanical means that favor the insured. The principle is this: if the plaintiff's pleading against the insured defendant asserts, describes, or sketches (even poorly) an act, omission, event, or state of affairs and an alleged resulting injury, then the insurer has a duty to defend the insured, judging all this by (1) what is to be found within the petition or complaint itself, i.e., within its four corners of the pages of the pleading and not by facts found outside it, and (2) by what is to be found in the insurance policy, that is, within its four corners. This is called the "Eight Corners Rule." Obviously, this phrase is a metaphor since petitions and insurance policy invariably have multiple pages. 

The language of the pleading is construed in ways favorable to the insured. Vague pleadings favor the insured's right to a defense, as does the language of the policy.

Now you know, if you didn't already, why this is called the "Eight Corners Rule," four come from the pleading, and four come from the policy. The actual length of the pleading and the policy are irrelevant. 

All U.S. states and the entirety of federal courts have this rule or something so close to it that only learned insiders could recognize any differences. Not all states have the same rule as to how much of the case the insurer must defend. In Texas, the rule is that if a lawsuit brought against an insured contains one claim which requires a defense, then the insurer must defend the entire case as part of its contractual obligation, and it has to pay for the whole defense. California has a different rule.

On May 1, 2020, the Texas Supreme Court ruled unanimously that there was an exception. This exception arises when the plaintiff in the case under consideration as to coverage and the insured who (or which) is a defendant in that case together decide to cooperate in deceiving the insurer as to facts crucial to coverage. The court called this "conclusive fraud," and no description of any kind or quality as to the conspiratorial arrangement was to be found anywhere within the relevant eight corners.

Tests of and challenges to the Eight Corners Rule occur in courts from time to time. That is what is at issue in this case.

The number of this case in the Supreme Court of Texas records is 18-0837, and the full list of parties to the case (aka the "style" of the case—or part of it anyway) is Loya Insurance Company, Petitioner v. Osbaldo Hurtado Avalos and Antonio Hurtado as Assignees of Karla Guevara, Respondents. The case is coming to the Supreme Court from the San Antonio Court of Appeals, aka the Court of Appeals for the Fourth District of Texas. 592 S.W.3d 138. The whole list of parties is too long for most people, so it will be shortened for most citations and other purposes. It will probably be referenced as Loya Ins. Co. v. Avaldos, although there will be a temptation for some to cite the case as Loya Ins. Co. v. Hurtado. The former of these two is the correct one and is the one to be used. 

Here is the background. The insurance company, Loya had sold an auto liability insurance policy to Karla Guevara. Karla's husband, Rodolfo Flores was explicitly excluded from the policy's coverage.

There was a car accident. Rudolfo Flores, the husband of Karla Guevara, driving (or "moving") Karla's car, ran into a different car occupied by Osboldo Avalos and Antonio Hurtado, then apparently a couple. The two couples agreed to falsely state to the responding police officer and to the insurer that Karla Guevara was driving.

The Hurtado couple (Osbaldo and Antonio) sued Karla and sought coverage from Loya. It provided her a defense. Karla disclosed the lie to the lawyer appointed to defend her attorney and identified Rodolfo as the actual driver. Defense counsel disclosed the lie to the insurer. It canceled Karla's deposition and denied her both coverage and a defense. The Hurtados moved for summary judgment; they prevailed and were granted judgment against Karla for $450.343.34. (Suit #1)

Karla assigned her rights against Loya to the Hurtado couple. They filed suit against it for recovery for breach of contract, negligence, insurance bad faith, and violation of the Deceptive Trade Practices-Consumer Protection Act (DTPA). The insurer brought counterclaims for breach of contract, fraud, and a declaratory judgment that it provided no coverage for what happened and no duty to defend. (Suit #2).

In Suit #2, the trial court granted summary judgment to Loya on the grounds that the Hurtadoses were "asking this Court to ignore every rule of justice and help [them] perpetuate a fraud." The Hurtadoses appealed arguing that the district court had acted contrary to the Eight Corners Rule. The Court of Appeals reversed the decision of the trial court, granting that its opinion appeared seemingly "logically contrary," but upholding the ironclad, expansively understood duty to defend. One of the justices concurred asking the Supreme Court to review that case and create a narrow exception to take this kind of case out from under the Eight Corners Rule. 

The case went up to the Supreme Court. It wrote a masterful opinion including a discussion of the history of the duty to defend, why it had not created this exception before, how declaratory judgments worked, and why Loya did not have to have such judgment before it cut off providing a defense. All of these passages are well worth reading. 

The Court's decision is crystal clear. It upheld or reinstated the trial court and reversed the judgment of the court of appeals. "In determining an insurer's duty to defend, a court may consider extrinsic evidence regarding whether the insured and a third party [to the contract of insurance] suing the insured colluded to make false representations of fact in that suit for the purpose of securing a defense and coverage where they would not otherwise exist."

Some people will worry that this new rule will make it possible for unscrupulous insurers to invoke this exception and seek to avoid paying claims or to prolong the litigation process. The Court dealt with this problem. "If the insurer conclusively proves such conclusive fraud, it owes no duty to defend. An insurer confronted with undisputed evidence of collusive fraud may choose to withdraw its defense without first seeking a declaratory judgment, though it risks substantial liability if its view of the duty to defend proves to be wrong." Obviously, the Court has created a huge burden of proof for the insurer, and an even more rigorous burden if the insurer lacks an undisputed proof of collusive fraud.

It should be kept in mind that this sort of situation is rare, so the situation is unlikely to occur, even in auto cases where it is most likely to come up. Keep in mind, "most likely" is still restricted to rarity. 

*See Quinn's Resumes--"Long Resume" and "Short Resume are on the Internet

This essay is my work and no one else's and so I alone bear responsibility for it
quinn@QClaw.com