Applying Texas law, the United States Court of Appeals for the Seventh Circuit has held that public policy prohibits enforcement of a settlement arrangement in which an insurer with no duty to defend played no role in the settlement, the plaintiff promised to seek damages only from the insurer, and the insured defendant admits liability, stipulates to damages, and assigns its claim against the insurer to the plaintiff.  Hendricks v. Novae Corporate Underwriting, Ltd., 2017 WL 3573390 (7th Cir. Aug. 18, 2017).

The insured entered into a contract with another company, but one of the company’s shareholders later sued the insured for alleged misrepresentations and negligent claims-handling.  The insurer denied coverage for the lawsuit and remained uninvolved because it did not owe a duty to defend under the policy.  The insured and the shareholder ultimately resolved the litigation by entering into a settlement agreement.  Under the terms of the settlement agreement, the insured agreed to stipulate to the entry of judgment in the amount of $5.12 million in favor of the shareholder, an assignment to the shareholder of the insured’s right to recover from the insurer, and a covenant by the shareholder not to execute the judgment against the insured.  The shareholder then sued the insurer to recover the stipulated judgment.  The district court determined that the insurer owed no duty to indemnify because the judgment was not binding under Texas law.  The shareholder appealed.

On appeal, the Seventh Circuit affirmed and held that the settlement agreement and subsequent assignment of rights under the policy were unenforceable as contrary to Texas public policy.  The court first determined that Texas law as opposed to Illinois law applied because the location of the subject matter of the settlement agreement focused on resolving a Texas state litigation.  The court then noted that Texas law has a history of disallowing assignments in order to avoid the multiplication of suits and to uphold the idea that rights at common law are to be determined by the identity of the particular individuals involved and their circumstances.  The court also highlighted that the Texas Supreme Court has previously prohibited assignments of this nature on the grounds that pre-trial settlements and assignments are collusive.  The court rejected the shareholder’s argument that the settlement and assignment were lawful because the insurer failed to tender a defense.  In so holding, the court explained that the insurer had no contractual duty to defend the insured under the terms of the policy.  The court thus held that the settlement and assignment were collusive and impermissibly distorted, complicated, and prolonged the litigation by engaging an insurer that otherwise had no obligation to be involved, and as such were unenforceable.