Insurer Not Liable Under Texas Law After Judge Requires Strict Compliance With Notice Requirement

A Texas magistrate judge, applying Texas law, found Hallmark Collection of Homes, LLC (“Hallmark Collection”), a bankrupt homebuilder, did not provide its insurer, Mid-Continent Casualty Co. (“Mid-Continent), adequate notice of a lawsuit and, therefore, Mid-Continent did not have to pay its share of a $63 million judgment against the insured.

The underlying suit stemmed from the alleged breach of a licensing agreement between Hallmark Collection and Kipp Flores Architects, LLC (KFA). Mid-Continent issued a series of commercial general liability policies to Hallmark Collection with an additional named insured of Hallmark Design. The policies provided in part: “If a claim is made or ‘suit’ is brought against any insured, you must … see to it that we receive written notice … as soon as practicable … You and any other involved insured must … [i]immediately send us copies of any demands, notices, summonses or legal papers received in connection with the claim or ‘suit.’” It is undisputed that Mid-Continent did not receive any notice of the underlying lawsuit until over nine months after the suit began. Mid-Continent then received notice letters on behalf of additional defendants to the suit. The notice letters did not make any mention of Hallmark Collection or reference to Hallmark Collection’s bankruptcy proceeding, but did include the underlying complaint and amended complaint. Mid-Continent responded to both notices with reservation of rights letters, which also did not mention Hallmark Collection, and identified Hallmark Design as the insured.

After the bankruptcy court determined that Hallmark Collection did not have any assets to satisfy its creditors, KFA sent Mid-Continent a presentment letter reporting the $63,471,000 final judgment against Hallmark Collection based on the allegedly breached licensing agreement and demanded payment of $6,000,000 as obligated under the terms of the insurance policies. Mid-Continent denied KFA’s request. KFA then filed an action against Mid-Continent as a judgment creditor of Hallmark Collection and a third-party beneficiary under the Mid-Continent Policies.

Under Texas law, “[t]o recover under an insurance policy as a third-party judgment creditor, a plaintiff must show that the insured complied with all conditions and terms of the policy.”  The magistrate found that based on the plain meaning of the notice provision, each “involved insured” must promptly send Mid-Continent copies of the legal papers filed in a suit. The judge then found that because Hallmark Collection failed to comply with the policy notice of suit provision, Mid-Continent’s duty to defend was never triggered and therefore the insurer had no liability. KFA argued that based on policy language and Texas law, Mid-Continent could only invoke lack of notice as an affirmative defense by proving prejudice. Under Texas law “the crucial inquiry is whether the insurer’s ability to defend against the claim has been irreparably impaired by an insured’s failure to comply with a notice-of-suit provision.” Texas law also provides that “[m]ere awareness of a claim or suit does not impose a duty on the insurer to defend under the policy.” The magistrate judge found that Hallmark Collection’s notice was not only late, but altogether absent and that in failing to comply with the notice provision and requesting a defense, the Hallmark Collection “deprived Mid-Continent of its ability to answer and to defend against KFA’s claims in the Underlying Action; to conduct discovery; and to fully litigate the merits of KFA’s bankruptcy proof of claim.”

KFA also argued that full compliance with the notice provision was not required because Mid-Continent accepted and assumed a duty to defend all named insureds in its reservation of rights letters. The magistrate again disagreed and stated that “even if Mid-Continent did offer to defend Hallmark Collection subject to a reservation of rights, the insurer did not thereby waive its right to insist on full compliance with all of the policy terms.” The magistrate judge noted that in the reservation of rights letters Mid-Continent reserved its right to deny coverage, based on the insured’s failure to comply with “any policy condition, limitation or term” and therefore Mid-Continent could argue that it had no duty to defend Hallmark Collection.  Kipp Flores Architects LLC v. Mid-Continent Cas. Co., 4:14-cv-02702 (S.D. Tex. Jan. 9, 2015).