Court Considers Decades-Old Wilkinson Exception in Insurance Law

Texas Lawyer
April 16, 2007
Article by Mary Alice Robbins

Arguments before the Texas Supreme Court on April 11 focused on whether an insurance company that mistakenly agreed to pay to defend an insured whose policy had expired is liable for those costs even though the insurer had no say about the defense.

Closely watched by lawyers for insurers and policyholders, Ulico Casualty Co. v. Allied Pilots Association provides the Supreme Court an opportunity to decide whether an exception exists to the general rule that waiver and estoppel cannot be used to create insurance coverage when none exists under the insured's policy. Austin's 3rd Court of Appeals adopted the exception in 1980's Farmers Texas County Mutual Insurance Co. v. Wilkinson, and other state intermediate appeals courts and federal courts in Texas have recognized the so-called Wilkinson exception over the past 26 years. But the Supreme Court has never adopted that doctrine.

The 3rd Court held in Wilkinson that an automobile liability insurance company, which had sufficient facts available to know that the insured was not covered by its policy, waived its defense of noncoverage by agreeing to provide a defense for the insured without providing an effective reservation of its rights. Key to that holding is whether the insurer's conduct harmed the insured.

"Wilkinson, at least as it has been articulated by the lower court of appeals... is not and should not be the law in Texas," Donald Colleluori, Ulico's attorney and partner in Fort Worth's Figari & Davenport, told the high court during arguments.

Colleluori contended that policyholders have other remedies, such as promissory estoppel and negligent misrepresentation, when an insurer reneges on an agreement to pay the insured's defense costs.

Dan Berryman, Allied's attorney, argued that negligent misrepresentation focuses on one or several misrepresentations. "Here we have misrepresentation plus a policy," said Berryman, a partner in Fort Worth's Kirkley & Berryman.

"But the policy had lapsed," Justice David Medina observed.

Berryman said the 141st District Court jury that heard Ulico found that the insurance company had granted its insured an extended reporting period by agreeing to pay the defense costs. In a claims-made policy, at issue here, the insured must report any claims during the policy period. The jury found that the insurance company essentially extended the reporting period past the deadline.

Estoppel and Coverage

Ulico petitioned the Supreme Court to review the case after Fort Worth's 2nd Court of Appeals affirmed the 141st District Court award of more than $600,000 in damages to Allied in a declaratory judgment suit that Ulico brought against Allied.

The 2nd Court's opinion, written by Justice Terrie Livingston, provides the following background on the case: In 1999, a group of pilots sued Allied, the collective bargaining representative for American Airlines pilots, in the U.S. District Court for the District of Nevada. Allied received service in Allen, et al. v. American Airlines, et al. on Oct. 4, 1999, but did not notify Ulico of the suit until after the claims-made policy covering Allied had expired.

Meanwhile, Allied had contracted with another insurer for liability coverage. Ulico stated in two letters to Allied that Ulico would pay Allied's defense costs in Allen. In the letters, Ulico reserved its right to raise certain defenses but did not reserve its right to assert a late-notice defense to contest coverage.

Allied sought reimbursement for its defense costs in Allen, a case that concluded in September 2001 with a summary judgment in Allied's favor.

According to the 2nd Court's opinion, Ulico never informed Allied that the defense costs were not covered but filed a suit against Allied on Nov. 28, 2001, seeking a declaratory judgment that it was not liable for the costs. Allied filed a counterclaim  alleging that Ulico had breached its obligation to pay the defense costs under the policy.

The jury awarded Allied $308,235 in damages after finding that Ulico provided Allied an extended reporting period under the policy; that Ulico had agreed, separate and apart from the policy, to cover Allied's defense costs in Allen; and that waiver and estoppel blocked the insurer from asserting that its policy did not cover those costs.

As noted in the 2nd Court's opinion, Ulico filed a motion asking the trial court to set aside the jury's verdict on liability and damages, and Allied moved for judgment on the verdict.

The 141st District Court granted Ulico's motion with regard to two of the jury's findings but denied Ulico's motion on the finding that waiver and estoppel prevented the insurer from asserting noncoverage as a defense. The trial court vacated the jury's damage award and awarded Allied $616,468 in damages. The trial court also denied Allied's claim that it was entitled to attorneys' fees based on Allied's assertion that it was recovering under the terms of the insurance policy, which is a contract.

Ulico appealed the trial court's judgment on liability and damages. Allied also appealed, contending, among other things, that Texas Civil Practice & Remedies Code 38.001(8) entitled it to recover attorney's fees under the policy.

"Anytime you recover under a contract in Texas, you're supposed to recover your attorneys' fees," Berryman says in an interview.

In 2005, the 2nd Court reversed the 141st District Court's take-nothing judgment favoring Ulico on Allied's 38.001(8) claim and remanded the case to the district court for a disposition of that issue. The 2nd Court affirmed the trial court's judgment as to Ulico's liability and the damage award.

"By its terms, the Wilkinson doctrine is an exception to the general rule that coverage cannot be created by estoppel. ...Thus, if the Wilkinson exception applies, a finding of estoppel creates coverage under the policy where none existed," Livingston wrote for the 2nd Court panel that decided Ulico. Justice Lee Ann Dauphinot and Bob McCoy joined in the decision.

Any Harm?

During the April 11 arguments, several Supreme Court justices raised questions about the prejudice element of the Wilkinson exception - whether the insurer's conduct harmed the insured. One of those questions focused on whether policyholders who choose their own lawyers can satisfy Wilkinson's prejudice requirement.

At one point during Colleluori's argument, median asked whether Allied was able to select its own defense counsel in Allen.

"Yes it was, and it did," Colleluori replied.

Medina questioned whether there might be a scenario in which an insured is prejudiced even if it selected its defense attorney. "How would they be prejudiced in a scenario like that?" he asked.

Colleluori said he had not found any cases in Texas or in any other jurisdiction that have applied Wilkinson-like estoppel to that type of scenario. He said that underlying premise of the Wilkinson exception is that an insurer has a conflict of interest if it retains counsel and controls the defense of the insured, enabling the insurer to manipulate the defense to its own advantage.

"That conflict of interest is obviated when the insured has its own counsel representing it," Colleluori said.

Colleluori said Allied's defense attorney in Allen testified at the trial in the declaratory judgment action that he would not have done anything different even if Ulico had told him the defense costs were not covered.

Berryman argued that Ulico's conduct prejudiced Allied. Because Ulico agreed to pay for Allied's defense, the insurance company received attorney-client privileged information about its insured's defense, he said.

"But how does that prejudice the insured in this case?" Justice Phil Johnson asked.

The providing of confidential information is in itself prejudicial to Allied, Berryman said. According to Allied's brief to the Supreme Court, Allied's defense attorney advised Ulico of the status, strategy and defense in the Allen suit.

Colleluori contended in his argument that most of the information that Ulico received was public information.

Johnson noted during the arguments that the policy in Ulico had lapsed, regardless of whether Ulico received Allied's confidential information. "Whatever information they gave was not going to change the date of the reporting or the date of the termination of the policy," he said.

Berryman said Allied's insurance industry expert testified at trial that insurers often offered extended reporting periods to maintain customer relations with their insured. However, his comment prompted a brief exchange with a skeptical justice.

Justice Scott Brister said the court could "take judicial notice that an insurance company would be foolish to grant an extension for a huge claim" so that the insurer could pay its investors' money on the claim.

"Would you do it with your money?" Brister asked.

"No, your honor, I certainly would not," Berryman replied.

"I wouldn't do it with mine either," Brister said.

In an interview after the arguments, Colleluori says he expects the Supreme Court "to address Wilkinson and how that exception should be articulated." However, he says the court could rule in Ulico's favor without dealing with Wilkinson.

Berryman also says there is a possibility the court could sidestep the Wilkinson issue in its ruling. He contends Ulico failed to preserve its argument for appeal on the Wilkinson exception. The jury instructions that Ulico proposed and that the trial court adopted included the elements of that exception, he says.

James Cornell, who represents corporate policyholders in insurance litigation but who is not involved in Ulico, says the justices' questions indicate they were exploring whether the insurance company's conduct prejudiced the insured in this case.

"If the court found there was no prejudice, then the court could reverse the intermediate appellate decision without having to decide to adopt or reject Wilkinson," says Cornell, a partner in Houston's Cornell & Pardue and a co-founder and former chairman of the State Bar of Texas Insurance Law Section.

Cornell also points out Allied's argument that Ulico had, by its conduct, granted an extension of the reporting period. "If the court agreed with this argument, then this would allow the court to affirm the underlying decision without deciding whether the Wilkinson exception is Texas law," he says.