Texas High Court Establishes Clear Rules for Breach of Contract, Bad Faith Suits Against Insurers

In an effort to clear up confusion as a result of past decisions, the Texas Supreme Court announced five rules that “address the relationship between contract claims under an insurance policy and tort claims under the Insurance Code.”

The clarification was part of an opinion issued earlier this month in the matter of USAA Texas Lloyd’s Company v. Gail Menchaca.

According to the opinion, the issue in the case is whether Menchaca can recover policy benefits based on jury findings that the insurer violated the Texas Insurance Code and the violation resulted in the insured’s loss of benefits the insurer should have paid under the policy.

Gail Menchaca contacted USAA Texas Lloyds after Hurricane Ike caused damaged to her home in September 2008. An adjuster that came out to examine the damage to her Galveston Island home found minimal damage and the insurer determined the repair costs did not exceed her policy’s deductible. Five months later, Menchaca requested a re-inspection of the property so USAA sent another adjuster to re-inspect the home. The second adjuster confirmed the first adjuster’s findings and USAA declined to pay under her policy. USAA’s refusal to pay anything under her homeowner policy led Menchaca to sue the insurer claiming breach of contract and unfair settlement practices in violation of the Texas Insurance Code. She sought the insurance benefits under her policy, court costs and attorneys’ fees.

The case was tried and the jury found the insurer did not breach its contract with Menchaca, but did engage in unfair and deceptive practices by not conducting a reasonable investigation when it refused to pay her claim and awarded her $11,350 in damages. The court of appeals affirmed the lower court’s decision in granting judgment in favor of the plaintiff.

The high court stated that in an effort to provide clarity on whether an insured can recover policy benefits as actual damages caused by an insurer’s statutory violation absent a finding that the insured had a contractual right to the benefits under the insurance policy, it established five rules that govern the relationship between contractual and extra-contractual claims in insurance. The rules came about from prior decisions on similar Texas cases:

1. The General Rule – An insured can’t recovery policy benefits as damages for an insurer’s statutory violation if the policy doesn’t provide the insured the right to receive the benefits. According to the opinion, the Insurance Code only allows an insured to recover actual damaged caused by an insurer’s statutory violation.
2. The Entitled-to-Benefits Rule – An insured who establishes a right to receive benefits under the insurance policy can recover benefits as actual damages under the Insurance Code if the insurer’s statutory violation causes the loss of benefits.
3. The Benefits-Loss Rule – Even if the insured can’t establish a present contractual right to policy benefits, the insured can recover benefits as actual damages under the Insurance Code if the insurer’s statutory violation causes an injury independent of the loss of policy benefits, the insured may recover damages for that injury even if the policy doesn’t grant the insured a right to benefits. According to the opinion, this rule applies to “claims alleging an insurer misrepresented a policy’s coverage, waived its right to deny coverage or is estopped from doing so, or committed a violation that caused the insured to lose a contractual right to benefits that it otherwise would have had.”
4. The Independent-Injury Rule– If an insurer’s statutory violation causes an injury independent of the loss of policy benefits, the insured may recover damages for that injury even if the policy doesn’t grant the insured a right to benefits.
5. The No-Recovery Rule: An insured cannot recover any damages based on an insurer’s statutory violation if the insured had no right to receive benefits under the policy and sustained no injury independent of a right to benefits.

As a result of an error made by both the trial court and court of appeals in disregarding the jury’s response to one of the questions, as well as the establishment of the new rules, the court decided to reverse the appeals court decision and judgment and remand the case back to the trial court for a new trial.

According to an insurance bulletin summarizing the decision, Cozen O’Connor attorneys Alicia Curran and Ronald Tigner noted that the opinion is important because it summarized 30 years of bad faith decisions.