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Liability insurer not vicariously liable for malpractice committed by insurer retained to defend policyholder against third party claim.

State Farm Mutual Automobile Insurance Company v. Traver, 980 S.W.2d 625, 1998 Tex. LEXIS 158 (Texas Supreme Court; December 31, 1998).

Under the usual terms an automobile liability policy, the insurer has a duty to defend and also the right to control the defense and possible settlement of any claims against the policyholder brought by third parties. This usually includes the insurer's right to select and supervise defense counsel at least to some extent along with the insurer's responsibility to pay defense counsel. But under the rules of legal ethics, the lawyer's client is the policyholder. It is to the policyholder to whom the lawyer owes duties of loyalty, zealous representation, and the avoidance of conflict of interest or other factors that might undermine the lawyer's professional judgment about how best to defend the case. This tension in the "tripartite" relationship among insurer, counsel, and policyholder has long been problematic and the source of considerable academic commentary and bad faith litigation.

Where an insurer fails to settle a claim within the policy limits and the third party obtains a judgment against the policyholder in excess of the limits, the liability insurer is frequently sued for bad faith refusal to settle. Recently, a policyholder in this situation not only sued the insurer for bad faith but also sought to hold the insurer liable for the alleged legal malpractice of the defense lawyer selected by the insurer. The Texas Supreme Court rejected this attempt in State Farm v. Traver, 980 S.2.2d 625 (1998). Specifically, the Court held that an insurer "is not vicariously liable for the malpractice of an independent attorney it selects to defend an insured". See 1998 Tex. LEXIS 158 at (*)2.

Mary Davidson, a State Farm policyholder, collided with Calvin Klause, also a State Farm policyholder, in an automobile accident. Mary Jordan, a passenger in the Klause car, was severely injured and brought suit. She obtained a $375,000 award plus $100,000 in prejudgment interest, an amount well in excess of the $25,000 per person liability limits in both the Davidson and Klause automobile insurance policies issued by State Farm. Davidson died shortly after trial but her estate (administered by Traver) pressed her claim alleging that State Farm had committed bad faith in spuming a settlement demand within policy limits made by Jordan. Davidson also alleged that State Farm was liable for the conduct of the defense attorney who failed to adequately defend Davidson while vigorously defending Klause. Davidson also alleged that her second-class defense had been a deliberate attempt by State Farm to cover itself from liability that might befall it for failing to agree to a settlement that paid the full Klause policy limits to the third party claimant and victim of the accident (Jordan).

Jordan initially made a joint settlement demand to both defendants for their combined policy liability limits ($50,000) plus Klause's underinsured motorist coverage ($20,000). State Farm refused, offering instead Davidson's policy liability limit ($25,000), Klause's underinsured motorist coverage ($20,000), but only $5,000 of Klause's liability coverage. Jordan refused this counteroffer. Although State Farm later increased its offer to include Klause's full liability coverage (thus meeting Jordan's original demand), Jordan also refused this offer.

See 1998 Tex. LEXIS 158 at (*)4, n. 2.

In Texas as in other states, the insurer is ordinarily liable for the amount of any excess judgment against the policyholder where the plaintiff made a demand for settlement at or below the policy limits and where there was no reasonable basis for rejecting the settlement offer. Davidson alleged that the seriousness of the Jordan injuries and the degree of fault likely to be attributed to Klause or Davidson had made it imperative that State Farm accept the settlement under Stowers Furniture Co. v. American Indem. Co., 15 S.W.2d 544 (Tex. Comm. app. 1929), the venerable Texas precedent permitting a policyholder's cause of action against the insurer for negligently refusing a settlement offer within policy limits. By counteroffering in the face of Jordan's policy limits settlement demand rather than settling, State Farm was liable under Stowers according to Davidson. Although Stowers and its progeny in Texas are often discussed as "negligent" failure to settle cases, the Stowers doctrine in Texas functions like the law of other states permitting a claim of "bad faith" by the policyholder where there is a failure to settle within policy limits.

In addition, Davidson argued that State Farm should also be vicariously liable for the attorney's lackluster defense of Davidson, which allegedly included "failing to attend several key depositions and failing to offer a meaningful defense at trial." Davidson also alleged that State Farm was actively liable for bad faith in that it had "orchestrated this malpractice to avoid potential Stowers liability to Klause arising from the settlement negotiations." The Traver Court permitted the bad faith claim to be further prosecuted on remand but specifically rejected any vicarious liability for insurers due to attorney malpractice. To be liable for attorney mishandling of the case, the liability insurer must have in some way contributed to the malpractice. In Texas after Traver, mere vicarious liability is not enough.

The Traver Court based its decision on the status of the allegedly malpracticing attorney as an independent contractor. He apparently was neither in-house counsel to State Farm nor an employee of a "captive" law firm that does business exclusively as a representative of a particular insurer. Treating the matter as one of agency, the Court stated that a principal (in this case State Farm) can be liable for an agent's conduct only when it has a right to control the agent (in this case the lawyer). Although State Farm did have control over whether the attorney accepted settlement offers and presumably could have replace him with new counsel under the terms of a typical auto liability policy, State Farm did not have a right to micromanage the attorney's litigation conduct, according to the Court.

Although the Texas Supreme Court did not decide more than it had to decide in the Traver case, the decision does suggest that insurers may be liable for attorney miscues where the insurer does closely control counsel's handling of the matter. This aspect of Traver could take on additional importance in light of recent insurer efforts to establish strict case management guidelines for retained counsel. These guidelines often establish presumptive restrictions of counsel regarding discovery, legal research, and other pretrial activities and trial preparation. Retained counsel are usually required to obtain insurer approval in order to deviate from the guidelines. In such cases, substandard attorney defense of a liability claim could be laid at the feet of the micromanaging insurer and create liability under a theory of active control rather than vicarious liability.
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Title Annotation:State Farm Mutual Automobile Insurance Co. v. Traver
Author:Stempel, Jeffrey W.
Publication:Journal of Risk and Insurance
Date:Jun 1, 1999
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