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February 24, 2017

Construction Lawyers: Be Aware: The “Duty to Cooperate” May Apply to an Insured’s Affirmative Claims

Sam Laurin

The opinion in Mid-Continent Casualty v. Petroleum Solutions, Inc .begins with the following statement:  "This insurance coverage case raises legal issues suitable for a law school examination." It is true the facts of Mid-Continent would unquestionably make a challenging law school exam question.  The opinion in Mid-Continent is 44 pages and a significant portion of the opinion is devoted to an analysis of the Texas Product Liability Act (the "Act') and whether the insurance policy at issue covered attorney's fees and costs claimed under the Act.  The focus of this article is the federal district court's holding that an insured's refusal to dismiss an affirmative claim/counterclaim may breach an insured's duty in the policy to cooperate with an insurer in defense of a claim. In order to understand this holding, a brief overview of the facts is necessary.

The facts of Mid-Continent began when Bill Head ("Head") contracted with PSI to construct and install an underground fuel tank for a truck stop.  PSI in turn purchased a component part (flex connector) for the fuel tank from Titeflex.  The fuel tank leaked and spilled 20,000 gallons of fuel.  Head then brought a lawsuit against PSI alleging that PSI was at fault because the flex connector was defective, among other theories.  PSI tendered the defense of Head's claim to Mid-Continent, which has issued a commercial general liability (CGL) policy to PSI.  Mid-Continent accepted the defense under a reservation of rights.  PSI in turn joined Titeflex under the Act and alleged that PSI was entitled to contribution and indemnity.  Head later filed a direct claim against Titeflex on the basis of strict liability but later dismissed Titeflex.

After Head dismissed its claim against Titeflex, counsel for PSI advised PSI to dismiss its claim against Titeflex without prejudice because Titeflex was "vigorously defending itself" and that vigorous defense was undercutting PSI's position in defending against Head's claim. Titeflex also filed a counterclaim against PSI for indemnification and fees under the Act after Head dismissed its claims against Titeflex.  Titeflex then offered to dismiss its counterclaim against PSI, if PSI dismissed its affirmative claims against Titeflex.  PSI then dismissed its affirmative claims without prejudice and Titeflex responded by saying it would only dismiss its counterclaim if PSI dismissed its claim with prejudice.  Titeflex gave PSI 48 hours to accept this offer.  Despite the recommendations of its counsel to accept the offer, PSI did not accept the offer in part because it wanted to reserve its right to pursue Titeflex because of Mid-Continent's reservation of rights.

Court Held that the Duty to Cooperate Applied to PSI's Rejection of the Settlement Offer

The case proceeded to trial and Titeflex was awarded a judgment against PSI for attorney's fees, costs, and expenses.  After several appellate decisions, Titeflex's judgment was affirmed by the Texas Supreme Court. After the decision by the Texas Supreme Court, Mid-Continent denied coverage for Titeflex.  One of the reasons cited by Mid-Continent was that PSI breached the duty to cooperate when it failed to accept Titeflex's settlement offer.   The district court in Mid-Continent held that the duty to cooperate applied to PSI's rejection of the settlement offer.  While the district court also found that there was a genuine issue of material fact as to whether PSI had breached its duty to cooperate by not accepting the settlement offer, the mere possibility that an insured can violate the duty to cooperate under these facts should be of concern to construction lawyers.  The balance of this article analyzes the basis for the court's decision and why this decision is concerning. 

The policy at issue provided that PSI was to cooperate with Mid-Continent relative to the investigation or settlement of the "claim," or defense against the "suit."  PSI argued, correctly in the author's opinion, that the cooperation clause only applied to responding to Titeflex's affirmative claims.  The district court rejected this argument based on the definition of "suit" in the Policy. The district court found that the Policy defined "suit" as a civil proceeding in which damages because of bodily injury or property damage to which this insurance applies are alleged.  Because the definition of suit included the entire civil proceeding and PSI's affirmative claims were part of the suit, the court reached/jumped to the conclusion that PSI's affirmative claims were therefore subject to the cooperation clause.

Policy Language Cited by the Court Doesn't Support Conclusion Reached

The Policy language cited by the district court does not support the conclusion it reaches.  A common sense definition of "defense against the suit" would be the facts and law that an insured utilizes to defend against the lawsuit (or a claim for that matter).  Black's Law Dictionary supports this conclusion as it defines "defense" in part as the defendant's stated reason why the plaintiff has no valid case. While a counterclaim may arise out of the same operative facts, and may practically reduce the amount of a plaintiff's claim, it is not a defense on the merits of a plaintiff's claims. The Court's conclusion in Mid-Continent that the cooperation clause applied to PSI's affirmative claims ignores the common sense meaning of defense in the context of a civil lawsuit and in the context of a CGL policy.

The court's conclusion also ignores the fact that the "suit" definition is limited to a civil proceeding in which damages to which this insurance applies are alleged.  CGL insurance only applies to claims against an insured; it does not apply to affirmative claims which the insured has.  Thus, the more reasonable reading of definition of the "suit" and its relationship to the cooperation clause in Mid-Continent is as follows:  (a) if there is a lawsuit filed for which the insurance provides coverage for damages, then (b) the insured must cooperate with the insurer with respect to the defense of any claim which triggered coverage. 

Consider the potential application of Mid-Continent to the following hypothetical.  An owner sues a general contractor for damages based on a partial collapse of a project during construction. The general contractor argues that the collapse was caused by bad design. The owner withholds $500,000 in payments otherwise owed to the general contractor to cover the costs of paying the damages for the collapse.  On the whole the general contractor has the much better case.  Under the theory expressed in Mid-Continent the insurer could attempt to pressure the general contractor to reduce its contract balance claim in order to settled the owner's property damage claim, or face a claim for breach of the duty to cooperate.  That would be inappropriate because the insured has paid a premium for defense and indemnity and the insurer should be limited to defending the case based on an analysis of the merits of the defense, defense costs, etc.  The general contractor is owed the $500,000 and if the insurer pressures the general contractor to reduce its claim, that is tantamount to asking the insured to pay at least a portion of the indemnity even though the general contractor already paid a premium to the insurer for indemnity.  An insurer's evaluation and defense of a claim should not and cannot be in any way influenced by whether the insured has affirmative claims.

The decision in Mid-Continent arose out of some complex and unique facts and appears to be one of the first cases to hold that the duty to cooperate applies to an insured's affirmative claims. Nonetheless, the case is out there and construction lawyers need to be aware of its potential powerful impact.

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Sam Laurin

Bose McKinney & Evans LLP, Indianapolis, Indiana, Division 7 (Insurance, Surety & Liens)