Property Casualty Focus

In In re Illinois National Insurance Co., the Texas Supreme Court held that disclaiming insurers were not bound by any underlying settlement agreement, entered into without the insurers’ consent, where the claimants promised not to pursue the insured’s non-insurance assets.

The underlying claimants were investment funds that filed suit in 2014 against Cobalt International Energy and its officers and directors. The claimants asserted securities fraud in connection with an SEC investigation of Cobalt’s alleged illegal payments to Angolan government officials and misrepresentations as to the oil content of its exploratory wells, which caused Cobalt’s stock price to decline drastically.

Cobalt notified its liability insurance tower of the SEC investigation, the oil allegations, and the investors’ suit. The insurers denied coverage due to untimely notice and the applicability of policy exclusions and refused to advance defense costs. Cobalt self-funded its defense and filed a coverage action against the insurers.

After four years of litigation and Cobalt’s entry into bankruptcy, the underlying claimants and Cobalt agreed to a $220 million settlement, which represented the total policy limits available under Cobalt’s liability insurance tower. Under the settlement agreement, Cobalt agreed to an “obligation to satisfy” the settlement amount “payable exclusively” from any insurance proceeds, and the claimants agreed not to pursue any non-insurance assets. The parties further agreed that the claimants would “pursue and prosecute on [Cobalt’s] behalf” all of Cobalt’s rights, interests, claims, and coverage under the insurers’ policies, allowing the claimants to control the coverage action but expressly not assigning Cobalt’s insurance policies or coverage claims to the claimants. Cobalt would also receive up to $28.5 million of any recovery the claimants recovered from the insurers to reimburse its defense costs plus interest.

The bankruptcy court and underlying court approved the settlement agreement. Although Cobalt had notified the insurers of the settlement agreement and bankruptcy approval proceedings, the insurers did not participate. Upon settlement approval, the claimants intervened in the coverage action. After the trial court denied the insurers’ jurisdictional pleas and summary judgment motions contesting the claimants’ standing and the binding power of the settlement agreement, the insurers sought mandamus relief with the Texas Supreme Court.

The Texas Supreme Court identified three considerations that arise when an insured settles with an underlying claimant without the insurer’s consent or participation: (1) whether the insured has suffered a “loss” if the settlement limits the claimant’s recovery to coverage available under the insured’s policy; (2) whether the claimant can file a direct action against the insurer to recover the insurance proceeds; and (3) assuming the insured suffered a loss, whether the settlement is binding against the insurer, or admissible evidence as to coverage and a claimant’s damages. Regarding the first two issues identified, the Texas Supreme Court concluded that (1) the insured suffered a “loss” under the policies and (2) the claimants could file a direct action against the insurers because Cobalt had a legal obligation to pay under the settlement and was liable for any recoverable insurance proceeds. The insurers contended that there was no insurable “loss” because Cobalt was not obligated to pay via its own funds and because the claimants agreed not to enforce any obligation to pay under the settlement or judgment. However, the court found that the settlement created a legal obligation to pay from Cobalt’s own assets, i.e., its insurance policies, regardless of whether Cobalt admitted liability. The court further determined that the insurers’ obligation arose when Cobalt became legally obligated to pay, regardless of whether Cobalt has actually paid.

On the third issue, however, the Texas Supreme Court held that the settlement was not binding or admissible in the coverage action because it did not arise out of a “fully adversarial trial.” The court cited the principle that the indemnitor should not be obligated to pay more than what is actually lost and noted that the controlling factor as to whether a settlement arose from a fully adversarial proceeding is whether the insured bore an actual risk of liability for the damages awarded or agreed upon. Importantly, the court ruled that the requirement for a fully adversarial proceeding applies even when the insurer neither accepts coverage nor adjudicates coverage.

Though the court did not question the good faith negotiations or absence of collusion in the settlement, it emphasized that the settlement terms protected Cobalt against any “actual risk of liability” beyond its obligation to pay insurance benefits it may or may not receive. Consequently, because the claimants agreed not to pursue Cobalt’s non-insurance assets, the court determined that Cobalt had no “meaningful incentive” to defend itself or minimize damages, as evidenced by the settlement amount being tied to the value of the policies rather than the claimants’ losses. Accordingly, the Texas Supreme Court granted the insurers’ mandamus relief in part and ordered the trial court to vacate its prior orders.