Malpractice Insurer Not Liable for Bad Faith for Rejecting Settlement Demand Within Limits

The United States District Court for the Western District of Texas, applying Texas law, has held that a legal malpractice insurer was not liable for a statutory bad faith claim by the insured law firm because the evidence presented a bona fide coverage dispute, not a bad faith denial of the request for a defense.  Ryan Law Firm v. New York Marine & Gen. Ins. Co., 2020 WL 5820531 (W.D. Tex. Sept. 30, 2020).

The insured law firm was sued for malpractice, and the insurer defended the lawsuit under a reservation of rights.  After losing on a motion for summary judgment, the insured engaged in settlement negotiations without authorization from the insurer.  The insurer did not consent to the resulting proposed settlement because the amount exceeded defense counsel’s claim evaluation.  The insurer instead offered a smaller amount it would be willing to contribute toward the proposed settlement.  The insured subsequently settled the underlying lawsuit without the insurer’s consent for an amount within policy limits, and coverage litigation followed.  The insured alleged breach of contract and violations of Chapter 541 of the Texas Insurance Code, seeking to recover the amount it paid to settle the underlying lawsuit.

The insurer moved for summary judgment on the basis that it had no indemnification obligation because the insured materially breached the policy by failing to obtain the insurer’s consent.  The court denied the motion, finding that the insurer failed to present evidence that it was prejudiced from the insured’s breach of the consent-to-settle provision of the policy.  In the insurer’s second motion for summary judgment, it argued that the insured’s Chapter 541 claim failed because the insured’s sole remedy under Texas law was limited to a Stowers claim and further, that the insured had presented no evidence that the insurer acted or failed to act in a way that it knew to be false, unfair or deceptive.

Under the Stowers doctrine, “insurers must exercise ‘that degree of care and diligence which an ordinarily prudent person would exercise in the management of his own business’ in responding to settlement demands within policy limits.”  The magistrate judge recommended that the court grant the insurer’s motion and dismiss the insured’s Chapter 541 bad faith claim.  The Texas Supreme Court has held that “a Stowers cause of action does not accrue until the judgment in the underlying case becomes final.”  Accordingly, the magistrate judge concluded, the insured’s statutory bad faith claim under Chapter 541 failed as a matter of law; the insurer’s duty under the Texas Stowers doctrine never ripened because the underlying lawsuit settled before the case was tried and a final judgment entered.  The magistrate also concluded that the Chapter 541 claim failed because there was a bona fide coverage dispute, not a bad faith denial of defense.  Further, the law firm had not pled any damages independent from the benefits to which it was allegedly entitled under the Policy, and thus it could not recover damages under Chapter 541.