LIABILITY INSURANCE: SCHOOL DISTRICTS HAVE IT, BUT ARE THEY COVERED?

By James M. Whitton and Elaine S. Morris

Brackett & Ellis, a Professional Corporation

(formerly McLean & Sanders)

Introduction.

It’s Friday afternoon. As you gaze out the window at the beautiful Spring weather and wonder if anyone will notice an early departure, one of your superintendents calls. "What we feared might happen has happened," she says. And without having to ask, you know immediately what she means. Last fall, a freshman told her counselor that she had been "dating" one of the school’s newest teachers. All of the proper steps were taken, the necessary reports were made and the subsequent investigation revealed that the allegations were true. The teacher resigned before he could be fired and he even surrendered his teaching certificate. You hoped that would be the end of it, but you doubted that your client would be that lucky. Your superintendent now tells you that the constable just left her office. The parents of the student have sued the teacher for his conduct, and the teacher’s principal, the superintendent and the school for their negligent hiring and supervision of the teacher. "This is awful," she says, "but at least we have insurance to cover us." You agree and remind her to call the school’s insurance agent immediately and to send him a copy of the petition today. You also ask her to send you a copy of the petition. But before you start the weekend early, there are some things you should consider.

Scope and Overview of Article.

Your school district clients routinely buy commercial general liability insurance policies ("CGL Policies") and believe they will be protected whenever they are sued. Unfortunately, your clients may find themselves insured but not covered. Generally, CGL Policies provide liability coverage for bodily injury or property damage to a third party. They do not provide first party coverage, such as property damage coverage for a school’s buildings or bodily injury coverage for a school’s employees. More importantly, CGL Policies provide liability coverage resulting from the insured’s negligent acts; they do not cover intentional acts. Because the Tort Claims Act (Sec. 101 et seq. Civ. Prac. and Rem. Code) provides immunity to school districts from most lawsuits alleging negligent acts, and because CGL Policies do not cover intentional acts, a school can find itself with insurance coverage where it does not need it, and no insurance coverage where it needs it the most. This article discusses some of the often litigated provisions commonly found in a CGL Policy. It is designed to help you advise your clients when they are sued and the claim is turned over to the insurance company. It will also give you some tips on assisting your clients when they purchase insurance and consider whether additional insurance may be necessary to provide coverage for claims not covered by the standard provisions of the CGL Policy. This article also addresses the insurance company’s possible responses to a claim and options for your clients to address those responses. We will begin with some basic insurance principles.

Types of Policies.

Generally, insurance policies are either occurrence policies or claims-made policies. "Occurrence" policies provide coverage for damages that "occur" during the policy period. It is irrelevant when a claim for damages is made. Suppose that a school carries an occurrence policy in effect for the calendar year 1997 and a student is injured on campus on May 1, 1997 but does not file suit until April 1, 1999. Even though the lawsuit was filed almost two years after the incident, the school would submit this claim to the insurance company providing the policy in effect for 1997 because the incident "occurred" while that policy was in effect.

A "claims-made" policy covers claims that are made during the policy period. For these types of policies, coverage is triggered when the claim is made rather than when the incident occurs. If you assume the same facts as discussed above except that the school carried a claims-made policy rather than an occurrence policy, the school would submit the claim to its insurance carrier for the 1999 calendar year because the claim was made in 1999.

Because schools will typically seek bids each year for insurance protection, they will often have a new insurance carrier and policy each year. These annual changes can result in coverage gaps. Suppose a school has a "claims-made" policy in effect for 1998 and then switches to an "occurrence" policy for 1999. If a student is injured on campus in May 1998 but does not file suit until some time in 1999, neither policy will provide coverage. The claim was made after the "claims-made" policy expired so that policy will not provide coverage. And since the accident occurred in 1998, the "occurrence" policy in effect in 1999 will likewise provide no coverage.

On the other hand, a change in the type of policy can result in double coverage. Assume that the school has an occurrence policy in effect during 1998 and a claims-made policy in effect during 1999. If a student is injured in 1998 and files suit in 1999, both policies will provide coverage because the accident occurred while the "occurrence" policy was in effect and the claim was made while the "claims-made" policy is in effect.

The Duty to Defend and the Duty to Indemnify: Distinct and Separate Duties.

Another insurance related issue that your school district clients need to be aware of is the distinction between an insurance company’s duty to defend the school and its duty to indemnify the school, which are distinct and separate duties.1 The duty to defend involves the insurer hiring an attorney to defend its insured when the claimant’s allegations might involve covered claims. The duty to indemnify involves payment by the insurance company for claims actually covered. Because the duty to defend involves potential coverage and the duty to indemnify involves actual coverage, the duty to defend is broader.

Duty to Defend.

The duty to defend is a contractual duty determined by the language of the insurance policy.2 (Tex. App.-- Houston [1st Dist.] 1990 writ denied). The insurer under this duty is responsible for the expense of hiring an attorney to defend the insured in the lawsuit. The duty to defend is generally established in broad language. For example, a typical duty to defend provision reads as follows:

We will pay those sums the insured becomes legally obligated to pay as damages because of "bodily injury" or "property damage" to which this insurance applies. We will have the right and duty to defend any "suit" seeking those damages.

Most policies state that the duty to defend terminates when the policy limits are exhausted by the payment of a settlement or judgment.3

An insurer’s duty to defend is determined by the allegations in the pleadings and the language of the insurance policy.4 This is referred to as the "eight corners" rule or the complaint allegation rule.5 The duty to defend arises when a third party sues the insured on allegations that, if taken as true, potentially state a cause of action within the terms of the policy.6 Courts require that the factual allegations in the petition be taken as true. Consequently, the insurer may have a duty to defend its insured in a lawsuit even if the factual allegations of the petition are groundless, false, or fraudulent.7 The duty to defend is not affected by facts learned before, during or after the suit.8 (Tex. App. -- Houston [1st Dist.] 1998, n.w.h.). This prevents an insurance company from refusing to defend a lawsuit based upon the merits of the case.

Further, the court in determining the duty to defend must focus on the factual allegations which reveal the origin of the damages rather than the legal theories asserted. For example, in Farmers Texas County Mut. Ins. Co. v. Griffin,9 James Royal, III ("Royal") was allegedly driving a vehicle while his two passengers fired gunshots. The gunshots hit and injured Robert Griffin ("Griffin") as he was walking down the street. Griffin sued Royal and the passengers of the automobile for negligence and gross negligence. Royal sought coverage under his personal automobile liability insurance policy issued by Farmers Texas County Mutual Insurance Company ("Farmers"). The policy excluded coverage for any person "who intentionally causes bodily injury or property damage." The petition alleged that "suddenly and without warning, a vehicle driven by Royal approached Griffin. Several rounds of gunfire were discharged from the vehicle in the direction of the plaintiff. . . . This drive-by shooting was a random act of violence which permanently injured and scarred the plaintiff." Although the petition sought relief on legal theories of negligence and gross negligence, Griffin’s petition alleged facts indicating that the origin of the damages was intentional behavior. Therefore, Griffin’s claim fell within the policy exclusion for intentional acts. Farmers had no duty to defend Royal.

In a petition, multiple causes of action may be alleged. Only one cause of action must potentially fall within the insurance policy in order to obligate an insurer to defend its insured.10 358 S.W.2d 243 (Tex. Civ. App. -- Eastland 1962, writ ref’d n.r.e.). In other words, for an insured to deny the defense, there must be no potential for coverage under any of the causes of action alleged.

Each amendment of a petition or pleading must be considered to determine the duty to defend. For example, in American Physicians Ins. Exchange v. Garcia,11 a patient filed a lawsuit against Garcia alleging medical malpractice. APIE insured Garcia for the year of 1983 while ICA insured Garcia for 1980, 1981, and 1982. One of the issues was which policy was required to provide a defense. The original petition and the five amended petitions alleged that Garcia was guilty of malpractice in his treatment of his patient from October 3, 1980, to approximately April 12, 1982. However, on the day of trial, the patient filed a sixth amended petition which alleged for the first time that Garcia’s medical malpractice began in 1980 and continued until 1983. The court found that the first time any pleading was filed against Garcia alleging malpractice during APIE’s policy period was the day of trial, when the patient filed his sixth amended original petition. Therefore, only ICA was under a legal obligation to defend Garcia until the sixth amended petition was filed.

Lastly, petitions or pleadings may be vaguely drafted or otherwise leave the facts unclear. Therefore, any doubt as to the existence of a duty to defend must be resolved in favor of the insured.12 Where the complaint does not state sufficient facts to clearly bring the case within or without the policy coverage, the general rule is that the insurance company is obligated to defend if there is potentially a case under the complaint that falls within the coverage of the policy.13

The duty to defend is a valuable right under the policy. An insurance company can be obligated to defend an entire lawsuit involving multiple and complex issues simply because one claim or cause of action is potentially covered. Therefore, the insurance company pays all legal fees. Further, depending on the merits of the case and the potential defense costs, an insurance company may decide to settle a case and pay the settlement even if coverage questions exist.

Use of Extrinsic Evidence in Determining the Duty to Defend.

The general rule is courts cannot consider extrinsic evidence when considering whether an insurance company has the duty to defend.14 However, courts in limited instances have allowed extrinsic evidence to be used to make this determination. One Texas court has stated the rule as follows:

Where the insurance company refuses to defend its insured on the ground that the insured is not liable to the claimant, the allegations in the claimant’s petition control and facts extrinsic to those alleged in the petition may not be used to controvert those allegations. But where the basis for the refusal to defend is that the events giving rise to the suit are outside the coverage of the insurance policy, facts extrinsic to the claimants petition may be used to determine whether the duty to defend exists.15

Some courts allow the use of extrinsic evidence when the petition omits or misrepresents a material fact that would clearly exclude coverage. In State Farm Fire & Cas. Co. v. Wade,16 the court found that without addressing the truth or falsity of the allegations and construing the alleged facts broadly, it was impossible to determine whether or not there was coverage under the private boat owner’s policy. State Farm insured an outboard boat owned by Williamson. Williamson and a passenger were found drowned after a trip on the boat. The petition did not address how the boat was being used at the time of the accident. The policy contained a business pursuits exclusion which excluded coverage for injuries arising out of the insured’s business. State Farm asserted this exclusion applied. The court reversed and remanded allowing the use of extrinsic evidence to determine the applicability of the business pursuits exclusion. In Western Heritage Ins. Co. v. Ruber Entertainment,17 applicability of pollution exclusion). the complaint omitted reference to the fact that the third party tort-feasor was intoxicated when he left the insured’s establishment to evade the clear exclusion in the policy for bodily injury arising out of the selling and serving of alcoholic beverages. The court stated that when the petition does not contain sufficient facts to enable the court to determine if coverage exists, it is proper to look to extrinsic evidence in order to adequately address the issue.

However, the admission of extrinsic evidence is limited.18 Relying on these cases, your client’s insurance company might attempt to deny or limit coverage based upon extrinsic evidence. If that happens, a closer examination is warranted. The insurance company may be attempting to avoid its duty to defend under the policy by improperly using extrinsic evidence. In such a case, a letter to the insurance company pointing out its error is advisable.

Duty to Indemnify.

Unlike the duty to defend, which is based upon the allegations in the petition, the duty to indemnify or pay is triggered by the actual facts establishing liability in the underlying suit.19 A determination of the duty to indemnify or pay is contingent on an adverse judgment or settlement agreement.20

The Insuring Agreement of the Policy Establishes the General Parameters for Coverage.

Generally, the insurance company agrees to pay those sums that a school becomes legally obligated to pay as damages because of "bodily injury" or "property damage" caused by an "occurrence" that takes place during the policy period. These three terms are used to make the initial determination of whether a claim is covered. Understanding how these three terms are defined and interpreted by Texas courts will aid a school in determining the type of coverage it is buying and whether a claim is covered.

Bodily Injury.

"Bodily injury" is usually defined in CGL Policies as follows:

bodily injury, sickness or disease sustained by a person, including death resulting from any of these at any time.

Until the Supreme Court decided Trinity Universal Co. v. Cowan,21 some insureds argued that "bodily injury" included emotional and mental injuries. In Cowan, Gregory Gage was working at an HEB photo lab as a clerk when a roll of film containing somewhat revealing pictures of Nicole Cowan was delivered for developing. Gage made extra prints of four of the pictures and took them home. He later showed them to his friends and left the pictures with one friend with instructions to throw them away. The friend, however, showed the pictures to someone else who was a friend of Cowan and told her of Gage’s actions. Cowan sued Gage and HEB alleging, among other things, negligence and gross negligence. Cowan alleged that she had suffered severe mental pain, a loss of privacy, humiliation, embarrassment, fear, frustration, mental anguish and would continue to do so in the future. Gage notified his homeowner’s insurance carrier seeking a defense under its policy. The policy defined "bodily injury" as "bodily harm, sickness or disease. This includes required care, loss of services and death that results." The Court held that the definition of "bodily injury" in the policy did not include purely emotional injuries such as those alleged by Cowan. Consequently, the insurance company did not have to defend Gage. Therefore, under Texas law "bodily injury" does not include purely emotional injuries, but requires an injury to the physical structure of the human body.

Property Damage.

"Property damage" is often defined as follows:

(a) physical injury to tangible property, including all resulting loss of use of that property. All such loss of use shall be deemed to occur at the time of the physical injury that caused it; or (b) loss of use of tangible property that is not physically injured. All such loss of use shall be deemed to occur at the time of the ‘occurrence’ that caused it.

"Property damage" does not include purely economic damages. In Houston Petroleum Co. v. Highlands Ins. Co.,22 Houston Petroleum Company and its president were sued based on allegations that due to their wrongful conduct, the plaintiffs had suffered economic loss including loss of capital contributions in a limited partnership venture conducted by Houston Petroleum Company. Houston Petroleum Company sought coverage under its CGL Policy issued by Highlands Insurance Company. The policy provided coverage for "property damage." The court held that the phrase "loss of use of tangible property" did not include economic loss, the loss of initial investments, subscription funds and profits. Therefore, the plaintiff’s lawsuit did not allege property damage and there was no duty to defend..

Occurrence.

"Occurrence" is defined in more recent CGL policies as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." Intentional conduct is not an "occurrence." Litigation in this area often addressed whether the act was intentional or the resulting injury was intended. This issue was also resolved in Trinity Universal Ins. Co. v. Cowan,23 when the Supreme Court held that there was no duty to defend because there was no "occurrence" under the policy. The policy defined an occurrence as "an accident including exposure to conditions which results in bodily injury or property damage during the policy period." The court found that it was undisputed that Gage intentionally made copies of Cowan’s photographs and showed them to his friends although Gage testified he did not intend for Cowan to learn of his actions. The court held that Gage’s conduct was not an "accident." Gage did exactly what he intended to do when he purposely copied the photographs and showed them to his friends. The fact that Gage did not expect or intend Cowan to learn of his actions was of no consequence in determining whether his actions were an "accident." Although a person may not intend the harm caused by his acts, if the harm is a natural or probable result of those intentional acts, they are not caused by an accident. Gage’s conduct was not an accident because the injury to Cowan, the invasion of her privacy, was of the type that ordinary follows from Gage’s conduct and the injuries could be reasonably anticipated.

Even more troubling, the Fifth Circuit has recently held that the intentional conduct of one insured can preclude coverage for other insureds. Seven women filed suit in Texas state court against the Reverend H. Barry Bailey ("Bailey") alleging a variety of tort claims which all stemmed from alleged sexual improprieties by Bailey. Bailey was the pastor in charge of the First United Methodist Church of Fort Worth ("FUMC"). Gaile Cooke and Dorayne Levin also filed separate suits against Bailey, FUMC and four associate ministers of FUMC. A declaratory judgment action was subsequently instituted in federal court to determine whether coverage existed under various insurance policies for Bailey, FUMC and the four associate ministers.24 The claims against FUMC and the four associate ministers included allegations that FUMC and the associate ministers knew or should have known of Bailey’s conduct and should have attempted to stop Bailey or warn the plaintiffs of his behavior. FUMC’s CGL Policy provided coverage for damages resulting from bodily injury caused by an occurrence. "Occurrence" was defined as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." The federal court stated that where the associate ministers’ liability was related to and interdependent on other tortious activities, the ultimate issue was whether the underlying tortious activities were encompassed within the definition of "occurrence." The court concluded that the insurance company had no duty to defend or to indemnify the associate ministers or FUMC against claims that could not be brought absent the underlying and excluded tortious activities of Bailey. The plaintiffs’ claims against FUMC and the four associate ministers either required proof of misconduct by Bailey or were related to and interdependent claims on Bailey’s sexual misconduct. While the alleged failure of FUMC and the four associate ministers to adequately respond to Bailey’s conduct may have exacerbated the injuries, there would have been no injuries absent Bailey’s improper acts. Therefore, if Bailey’s conduct was excluded from coverage, then so were all of the claims against FUMC and the four associate ministers. The court found that the sexual improprieties alleged were not an "occurrence." The court held that all of the claims against FUMC and the four associate ministers were related to and interdependent on Bailey’s sexual actions, which were not "occurrences" as defined by the policy. In short, the court found that the policy provided no coverage to the insured.

As this article goes to press, there is a state court case involving FUMC, other Methodist entities, their respective insurance companies and these same issues pending before the Dallas Court of Appeals. The style and case number are: Central Insurance Co., et al v. Barry Bailey, Central Texas Conference of the United Methodist Church, Inc.,et al; No. 05-98-00007-CV. You should keep a close eye on this case. The Court of Appeals might interpret Texas law differently than the Fifth Circuit has. If it does and if the Texas Supreme Court ultimately decides the issue, its opinion will control.

 So What Does This All Mean?

At this point your eyes have probably glazed over and you are wondering why you and your school clients need to be concerned about these hair-splitting coverage questions and this hyper-technical insurance policy jargon. You and your clients should be concerned because they too may find themselves without insurance coverage when faced with some of today’s most dangerous claims, namely claims by students against a school and its employees alleging molestation or abuse, and claims by school employees against the school and other school employees alleging sexual harassment.

Consider the lawsuit served on your superintendent this beautiful Friday afternoon. Will the school’s CGL Policy provide coverage? Probably not. Relying on the cases cited above, the insurance company will likely say that there is no coverage for the teacher because his alleged actions were intentional and thus there was no "occurrence" as defined under the policy. The insurance company may go further and argue that there is also no coverage for the principal, the superintendent and the school because the negligence claims against them are so interwoven and inter-dependent with the teacher’s intentional acts, the intentional acts are imputed to these other defendants. And since the policy does not cover intentional acts, there is no coverage for the other defendants even though the petition contains no allegation of intentional conduct by them. The insurance company could take the same position when a teacher sues his/her principal alleging sexual harassment, and also sues the superintendent and the school alleging negligent hiring and supervision. The carrier would argue that the principal has no coverage because his/her actions were intentional, and the superintendent and school have no coverage because the principal’s actions were imputed to them.

This does not mean that a school district is incapable of securing insurance coverage for these types of claims. The insurance industry has realized that there is a niche here that needs filling and it has begun issuing insurance policies that will cover claims of molestation, abuse, sexual harassment, etc. Unfortunately, many schools do not have these types of policies either because they do not know they need them or they believe they cannot afford them. Furthermore, many insurance agents do not realize that the CGL Policies they sell to schools may not cover the most threatening claims schools face. On top of that, different insurance companies have interpreted the standard CGL Policy very differently. Some companies have provided coverage while other companies have denied coverage, even though the CGL Policies were basically identical. The fact is that many schools have plenty of insurance coverage for the negligence claims for which they have immunity, and no insurance coverage for the claims for which they have no immunity.

So What Do We Do? Some Practical Tips.

Obtaining Insurance Coverage.

Generally, an insurance agent has no legal duty to advise a school to expand its insurance protection even if the agent has knowledge of the school’s need for additional insurance. An exception to this rule exists when evidence shows that the school and the agent have created a special business relationship through a history of dealing in which the school has an expectation that the agent will satisfy all of its insurance needs without consultation. For example, in Sledge v. Mullin,25 Mullin sold Ruby Sledge an automobile policy providing coverage for four cars. Ruby notified Mullin she was selling her Nova to her son and had acquired a 1986 Chevrolet Citation. Since Ruby could not afford to insure five cars, she requested that Mullin substitute the Citation for the Nova on the policy. Ruby’s son subsequently was involved in a collision in the Nova injuring the occupants. The Sledges sued Mullin, the agent, claiming that if the Nova were not insured, it was due to Mullin’s negligence. Ruby claimed the agent should have told her about a policy provision that provided automatic extended coverage for a newly acquired car for thirty days. The court held that Mullin owed Ruby no duty to make sure the Nova was insured after she requested the substitution or to tell her how the provision for automatic extension for newly acquired vehicles operated.

To avoid this result, when a school requests bids for liability insurance it should include a detailed list of the types of coverages requested. The school may wish to review past claims and lawsuits to determine the types of coverage needed. The school should require its bidders to state in writing whether the requested types of coverage are included and where they are located in the policies they submit. If the agent tells the school that the policy has a particular type of coverage, then the insurance company may be bound by that agent’s representations. The liability of an insurance company for its agent’s representations regarding the scope of coverage was discussed in Celtic Life Ins. Co v. Coats.26 Kenneth Harrell, an agent for Celtic Life Insurance Co., visited Aloha Pools to discuss health insurance for Aloha’s employees and their families. The owner of Aloha Pools, John Coats, told Harrell that he wanted better policy benefits for psychiatric care than the $20,000 coverage provided by Aloha Pool’s current policy. Coats had one child who required psychiatric care. Harrell proposed a policy that contained a psychiatric benefits limit of $10,000. The business manager of Aloha Pools noted the limit and was assured by Harrell that the limit only applied to out-patient psychiatric care. Based on the representation, the business manager recommended the policy proposed by Harrell. Coats’ son was subsequently admitted to a psychiatric hospital. Celtic only paid $10,000 of the expenses. The court held that an insurance company is generally liable for any misconduct by an agent that is within the actual or apparent scope of the agent’s authority. The misrepresentation by Harrell was made in the course of explaining the policy terms, a task the jury found to be within Harrell’s scope of authority. The court held that Celtic was liable for the representations Harrell made in explaining the policy. Therefore, the $10,000 limit did not apply to in-patient psychiatric care. However, a statement by the school district to the agent requesting a type of coverage will not establish a representation about the scope of coverage. The agent must make an affirmative statement (preferably in writing) about the scope of coverage for the insurance company to be bound by the representation. Even if detailed specifications are published, an insurance agent may simply submit his or her standard CGL Policy. In order to get the written representation from the agent that his or her policy complies with the bid specifications, your clients should include a check list in the bid request that must be completed and returned by the agent identifying which part of the policy provides the specific coverages or rights requested. Under the Celtic case, an insurance agent’s representation that a particular coverage is included in the policy may bind the company. In the absence of some specific misrepresentations by the agent about the insurance, a policyholder’s mistaken belief about the scope or availability of coverage is not actionable.

Independent Counsel.

A CGL Policy usually gives the insurance company the right to choose defense counsel. This has the potential to result in serious conflicts. Quite often the defense counsel hired by the insurance company handles many cases for that company. The defense counsel wants to keep the insurance company happy, but the insured (the school) is the client. The defense counsel may be subject to litigation guidelines by the insurance company which limit the defense counsel’s activities. In many cases, the insurance company controls the investigation and defense of the lawsuit. However, the insured’s ideas as to how the suit is to be handled may differ. This can create conflicts between the insured, the defense counsel hired by the insurance company and the insurance company.

Assume during the course of defending a case, the defense counsel discovers that the insured’s conduct was intentional. If all the acts are intentional, then there is no "occurrence," and the insurance company has no coverage or duty to defend the school. Does the defense counsel notify the insurance company of the facts supporting this coverage defense thus defeating coverage for the school? No. The insured is the client.27 The insurance company may be paying defense costs for a claim that is potentially excluded, but the defense counsel cannot collude with the insurance company to defeat coverage. Defense counsel owes absolute loyalty to the insured and not the insurer. The role of defense counsel and its loyalty to the insured was originally set forth in Employees Cas. Co. v. Tilley.28 In Tilley, the attorney conducted an investigation relating to a late notice defense under the policy. The attorney never advised the insured of the purpose of his action. The insurance company subsequently raised the defense of late notice to support a denial of the claim. The court held that under no circumstances could the defense attorney also work on behalf of the insurance company. The court further held that the insurance company had waived or was estopped to assert the defense of late notice due to the attorney’s conduct.29

Even though it is clear to whom the ultimate duty is owed, will the defense counsel’s heart be in his/her job? After all, the defense counsel’s bread and butter is the ongoing business from the insurance company, not this one case. The defense counsel knows that the insurance company will likely be displeased to learn that this longtime recipient of its largess did not let it know there was no coverage.

Another conflict can arise if the insurance company issues a reservation of rights letter. Does the defense counsel have an obligation to explain coverage issues and possibly pursue coverage for the school? If the defense counsel takes that position, the insurance company may never hire that defense counsel again. Typically, the defense counsel will try to avoid coverage issues. Therefore, the school must hire another attorney to address those issues if and when they arise.

These conflicts can be avoided if your clients have the right to choose their own defense counsel (not to mention the fact that you could get some additional business if you, or your firm, are qualified to handle the case). First, the school should request that the insurance company allow it to choose defense counsel in its bid specifications. However, insurance policies are standard contracts and the insured most likely will have little room for negotiation. A second opportunity to select independent counsel may arise if an insurance company defends under a reservation of rights letter. Some courts hold that once the insurer issues a reservation of rights letter, the insured is not required to accept the insurer’s choice of defense but may select independent counsel at the insurer’s expense.30 However, the school must be careful to select an attorney with adequate qualifications. If you feel that you are not up to the task, you probably know someone who is. You and your client could also ask the insurance company for a list of attorneys that it believes are qualified to handle the case.

  Other Types of Coverage to Request.

A school may want to request coverage for certain types of claims that can be added to a CGL Policy by endorsement or provided by a different type of policy. Again, these requirements need to be part of your client’s written bid specifications. For example, your client should request an endorsement providing coverage for corporal punishment. These claims might not constitute an "occurrence" under the standard provisions of a CGL Policy since corporal punishment most likely will be viewed as intentional. Some insurance companies offer sexual misconduct and sexual harassment coverage by endorsement. However, be careful. Some of these endorsements include sub-limits which are a lower limit than the policy limits for claims falling within that endorsement.

The bid requests should include volunteers as additional insureds. Volunteers will not be familiar with the policies and procedures of the school or the law and could be more likely to subject the school district to liability claims.

Your clients should require that defense costs not deplete policy limits as some policies allow. Your client does not want to learn that its $1,000,000 policy will provide only $800,000 to settle a claim or satisfy a judgement because $200,000 have been paid to the defense counsel. Your client should verify that the defense costs are in addition to the policy limits so that the entire policy limits are available for the payment of judgments and settlements.

Your client should inquire about employment practices liability insurance or an endorsement. A CGL Policy may contain an exclusion for damages for claims based upon termination of employment, refusal to employ, employment practices and policies such as evaluation, reassignment, discipline, defamation, harassment, humiliation or discrimination. Employment practices coverage is a new product and is often a claims made policy. It is designed to cover some of these claims. It may also be expensive, but your client should at least have the option of buying it.

And When Your Client Gets a Claim . . .

Report the claim promptly to the school’s agent. Late reporting in some instances can be a basis for denial if, due to the late reporting, witnesses cannot be found, documents are lost, parties have settled, etc., resulting in prejudice to the insurance company. Report the claim to all insurance companies which potentially might provide coverage. It’s not your job or your client’s job to determine whether or not there is coverage. Immediately forward any suit papers or demand letters to the agent or insurance company.

What The Insurance Company Will Do.

Once the insurance company receives the claim, it has four options:

1. Deny the claim,
2. Defend under a reservation of rights letter or a non-waiver agreement,
3. Tender an unqualified defense to the insured, or
4. Seek a declaratory judgment as to its obligations and rights under the policy.31

Denial.

If coverage is clearly precluded under the policy, then the insurance company may deny the claim. You should make sure the denial letter states the grounds for denial. If it does not, request a letter from the insurance company giving an explanation for the denial. Then review the grounds for denial. Remember, if potentially there is coverage for any cause of action, there is a duty to defend. Further, an ambiguity may exist in the policy provision the insurance company is relying on. Any ambiguity will be construed in favor of the insured, your client. Insurance companies often reevaluate their coverage position once they receive a letter from the insured’s attorney. If the denial is later determined to be wrongful, the insurer cannot require compliance with the policy conditions.32

Reservation of Rights Letter or Non-Waiver Agreement.

The insurance company may choose to issue a reservation of rights letter or a non-waiver agreement. An insurance company issues a reservation of rights letter or a non-waiver agreement when coverage questions exist. The purpose is to permit the insurer to provide a defense while it investigates the coverage issues.33 A reservation of rights letter is unilateral and informs the insured of the coverage questions. The non-waiver agreement serves the same purpose, but requests the insured to sign the agreement acknowledging the coverage issues. If a reservation of rights letter or a non-waiver agreement is issued, the insurance company assumes the defense but the defense is subject to the terms of the letter or agreement. The insurer may withdraw the defense if it becomes clear that there is no coverage under the policy.34

Reservation of rights letters and non-waiver agreements must be particularly worded by the insurance company; a general letter may be insufficient. For example, a reservation of rights letter that simply acknowledges the claim and generally states the company reserves all rights under the policy is probably insufficient. The reservation of rights letter should specifically set out the defenses on which the insurer might rely and disclose the potential conflict.35 If it is subject to two or more interpretations, the ambiguity will typically be resolved against the insurer.36 Further, reservation of rights letters and non-waiver agreements are strictly construed against the insurer and will not be extended by implication beyond their exact terms.37 Sometimes, a reservation of rights letter will recite multiple policy provisions, some which appear irrelevant, and provide no explanation. The school should request the insurance company to provide a letter specifying why coverage may be excluded or limited under the policy.

Failure to issue a reservation of rights letter or non-waiver agreement can preclude the insurance company from raising coverage defenses. Generally, the doctrines of waiver and estoppel cannot create insurance coverage where none exists under the terms of the policy.38 However, an exception to this general rule exists when an insurer with knowledge of facts indicating non-coverage assumes the insured’s defense without a reservation of rights.39 This exception will only apply if the insurer has sufficient knowledge of the facts that indicated that the claim was potentially not covered.40 In addition, the insured must be harmed by the insurer’s continued defense without a reservation of rights or non-waiver agreement.41 Such harm might result if the insured refuses to accept a settlement offer and subsequently a judgment in a higher amount is rendered. The insured may have been harmed because if it had been aware of the potential coverage issues, it might have chosen to settle the case.

Declaratory Judgment.

The insurance company may also file a declaratory judgment action. Insurance coverage disputes regarding the duty to defend have long been recognized as presenting justiciable issues ripe for resolution by a declaratory judgment proceeding. In Farmers Texas County Mut. Inc. v. Griffin,42 the supreme court held that a declaratory judgment action can properly be brought to determine not only whether an insurer has the duty to defend, but the duty to indemnify an insured against an underlying claim. Prior to the decision in Griffin, it was unclear whether an insurance company could file a declaratory judgment action to determine the duty to indemnify prior to the resolution of the lawsuit, because the duty to indemnify was based on the merits of the lawsuit, not the allegations of the petition. The supreme court held in Griffin as follows:

The duty to indemnify is justiciable before the insured’s liability is determined in the liability lawsuit when the insurer has no duty to defend and the same reasons that negate the duty to defend likewise negate any possibility the insurer will ever have a duty to indemnify.43

A full discussion of declaratory judgment action is beyond the scope of this article. If a declaratory judgment action is filed, the school should hire coverage counsel.

Conclusion.

The lesson to be learned is buyer beware. A school may think it is buying insurance coverage which will protect it against liability claims. In fact the policy may provide little if any coverage for some of the most dangerous claims facing schools today. A school must be specific with its agent about the type of claims it wants covered and then be shown in the policies where those claims are covered. Further, if coverage is questioned or denied after a claim is submitted, the school must carefully evaluate the coverage defenses asserted by the insurance company. The school may have to threaten or institute a lawsuit against the insurance company to obtain coverage.

Hope we didn’t ruin your Friday.

1. Trinity Universal Ins. Co. v. Cowan, 945 S.W.2d 819, 821-22 (Tex. 1997).

2. Houston Petroleum Co. v. Highlands Ins. Co., 830 S.W.2d 153

3. American States Ins. Co. of Texas v. Arnold, 930 S.W.2d 196 (Tex. App. -- Dallas 1996, writ denied).

4. National Union Fire Ins. Co. of Pittsburgh, Pa. v. Merchants Fast Motor Lines, 939 S.W.2d 139, 141 (Tex. 1997).

5. Cowan, 945 S.W.2d at 821.

6. Houston Petroleum Co. v. Highlands Ins. Co., 830 S.W.2d 153, 155 (Tex. App. -- Houston [1st Dist.] 1990, writ denied).

7. Heyden Newport Chem. Corp. v. Southern General Ins. Co., 87 S.W.2d 22, 25 (Tex. 1965).

8. Tri-Coastal Cont.v. Hartford Underwriters, 981 S.W.2d 861, 863

9. 955 S.W.2d 81 (Tex. 1997). See Also, National Union Fire Ins. Co., 939 S.W.2d at 141.

10. C.O. Morgan Lincoln-Mercury, Inc. v. Vigilant Ins. Co.,521 S.W.2d 318, 321-322 (Tex. Civ. App. -- Fort Worth 1975, no writ); Superior Ins. Co. v. Jenkins, 358 S.W.2d 243 (Tex. Civ. App. -- Eastland 1962, writ ref'd n.r.e.).

11. 876 S.W.2d 842 (Tex. 1994).

12. Heyden, 387 S.W.2d at 22.

13. National Union Fire Ins. Co., 939 S.W.2d at 141.

14. New York Life Ins. Co. v. Travelers Ins. Co., 92 F.3d 336, 338 (5th Cir. 1996)

15. Gonzales v. American States Ins. Co. of Texas 628 S.W.2d 184, 187 (Tex. Civ. App. -- Corpus Christi 1982 no writ)

16. 827 S.W.2d 448, 451 (Tex. App. -- Corpus Christi 1992, writ denied)

17. 998 F.2d 311, 313 (5th Cir. 1993); see also Guaranty Natl’s Ins. Co. v. Vic Mfg. Co.,143 F.3d 192, 195 (5th Cir. 1998) (court allowed use of extrinsic evidence to determine

18. See Tri-Coastal Contractors, Inc. v. Hartford Underwriters Insurance Co.,981 S.W.2d 861, 863 (Tex. App. -- Houston [1st Dist.] 1998 n.w.h.) (court unwilling to adopt the rationale in Wade); LaFarge Corp. v. Hartford Cas. Ins. Co., 61 F.3d 389, 394 (5th Cir. 1995) (court stated that allowing use of extrinsic evidence when the petition does not contain sufficient facts to determine if the duty to defend exists is a "narrow exception" to the eight corners rule).

19. Cowan, 945 S.W.2d at 821.

20. Two Pesos, Inc. v. Gulf Ins. Co., 901 S.W.2d 495, 499 (Tex. App. -- Houston [14th Dist.] 1995, no writ).

21. 945 S.W.2d 819 (Tex. 1997)

22. 830 S.W.2d 153,156 (Tex. App.-- Houston [1st Dist.] 1990, writ denied)

23. 945 S.W.2d 819 (Tex. 1997)

24. American States Ins. Co. v. Bailey, 133 F.2d 363 (5th Cir. 1998)

25. 927 S.W.2d 89 (Tex. App. -- Fort Worth 1996, no writ)

26. 885 S.W.2d 96 (Tex. 1994)

27. Brandt v. West, 892 S.W.2d 56, 77 (Tex. App. -- Houston [1st Dist.] 1994 writ denied)("There is no attorney-client relationship between an insurer and an attorney hired by the insurer just to provide a defense to one of the insurer’s insured").

28. 496 S.W.2d 552 (Tex. 1973)

29. Id. at 558.

30. Britt v. Cambridge Mut. Ins. Co., 717 S.W.2d 476, 481 (Tex. App. -- San Antonio 1986, writ ref’d n.r.e.); see also Rhodes v. Chicago Ins. Co., 719 F.2d 116, 120-21 (5th Cir. 1985).

31. Farmers Texas County Mut. Inc. Co. v. Wilkinson, 601 S.W.2d 520, 522 (Tex. Civ. App. -- Austin 1980, writ ref’d n.r.e.).

32. See Gulf Ins. Co. v. Parker Products, Inc., 498 S.W.2d 676, 679 (Tex. 1973)

33. J.E.M. v. Fidelity & Cas. Co., 928 S.W.2d 668, 673 (Tex. App. -- Houston [1st Dist.] 1996 no writ).

34. American Eagle Ins. Co. v. Nettleton, 932 S.W.2d 169, 174 (Tex. App. -- El Paso 1996, writ denied).

35. YMCA of Metro Fort Worth v. Commissioner State Ins., 552 S.W.2d 497, 499, 502-504 (Tex. Civ. App. -- Fort Worth 1977) writ ref’d per curiam, 563 S.W.2d 246 (Tex. 1978).

36. Western Cas. & Sur. Co. v. Newell Manufacturing Co., 566 S.W.2d 74, 77 (Tex. Civ. App. -- San Antonio 1978, writ ref’d n.r.e.).

37. Millers Mut. Fire Ins. Co. v. Alamo Exploration, Inc., 548 S.W.2d 85 (Tex. Civ. App. -- Houston [1st Dist.] 1977, no writ).

38. Texas Farmers Ins. Co. v. McGuire, 744 S.W.2d 601, 603 (Tex. 1988).

39. Paradigm Ins. Co. v. Texas Richmond Corp., 942 S.W.2d 645, 652 (Tex. App. -- Houston [1st Dist.] 1997, writ denied); see also Wilkinson, 601 S.W.2d at 521-522.

40. State Farm Lloyds, Inc. v. Williams, 791 S.W.2d 542, 552 (Tex. App. -- Dallas 1990, writ denied).

41. Paradigm, 942 S.W.2d at 652-653.

42. Farmers Texas County Mut. Inc. Co. v. Griffin, 955 S.W.2d 81 (Tex. 1997) (per curiam).

43. Id. at 84.