USAA Texas Lloyds Company v. Menchaca, 545 S.W.3d 479 (Tex. 2018)

Quinn’s Part Three

This part is a brief exposition and  discussion of part of the Supreme Court’s Opinion Section II entitled “Recovering Policy Limits for Statutory Violations.”* Remember: the Court is discussing (i) the relationship between contracts of insurance (or insurance policies), on the one hand, as sources of liability and (ii) violations of the Texas Insurance Code, on the other. What the Court says is largely a repeat of what it said in Menchaca I, except for the enormous number of scholarly footnotes sketching much recent insurance bad faith judicial history and perhaps from some very subtle distinctions which have–so far, anyway–been lost on me. (*The Opinion of the Court, Justice Boyd’s opinion, is to be classified as a plurality opinion, though the Court unanimously adopts each of the “Five Rules.”) 

Conceptually speaking, when judicial picturing, reasoning, and conclusions as to principle have become confused (e.g., divergent) or confusing, our legal system requires that courts go to legal foundations or legal fundsmentals, to underlying governing principles. To do this is as basic as constitutional principles themselves, says the Texas Supreme Court, and SCOTUS as well. See United States v. New Mexico, 455 U.S. 733 (1982).

According to the Texas Supreme Court, in this case, the place to start is the contract of insurance. After all, insurance policies are contracts of insurance.  Obviously, every insurer-insured relationship hinges on the existence between them of a contract of insurance–a mutual agreement, a set of reciprocal promises generating rights and duties, all based upon consideration. No contract, no such relationship. This is about as fundamental as it can get. 

Given this, at least most of the same rules that apply to any other type of contract, apply to contracts of insurance, as well. There are variations, however. In the insurer-insured relationship, the insurer exclusively controls identifying losses, evaluations of losses, processing, and denial of claims. Given this asymmetry, insurers can easily use their control to take advantage of their insureds. Usually, this results at least in part from “inherently unequal bargaining power.”

For this reason, some years ago, the Court laid down a fundamental principle which it added to the common law of contracts, namely,  that insurers and insureds had a “special relationship” which brought more balance to the relationship. It did this by imposing a common principle ordaining that first-party insurers must deal fairly and in good faith with their insureds when processing claims. The idea of fairness implies that insurers cannot take advantage of their insureds, but must treat them at least equally. The ideas of fairness and good faith contain the ey

The Texas Insurance Code supplemented the common law duty by imposing procedural requirements that govern the manner in which insurers review and resolve an insured’s claim for policy benefits. Section 541.050(a) of TIC prohibits an insurer from any “unfair settlement practices.” And it provides the mistreated insured with a statutorily based, private cause of action for discriminatory, unfair, deceptive, or bad-faith practice to recover actual damages, court costs, attorney fees, plus treble damages if knowingly commits a prohibited act.

Actual damages are what common law would compute as the benefit of the bargain, i.e., the difference between the value represented and the value received. In other words, actual damages are what the insured would have received as contract damages had the insurer not misbehaved itself. TIC does not create new coverages or new benefits not already existing under the policy, i.e., not already existing under the terms of the contract of insurance. An insured’s claim for breach of contract by the insurer is distinct from and independent of claims that involve ex-contractual duties and therefore rights.

A Quinn CommentPerhaps it was to maintain this idea of separateness and distinctness that led this Court, and others around the country, to treat common law bad faith actions as torts, or tort-like, as opposed to implied warranties or promises within the contract of insurance.  Then again, perhaps it had to do with the statute of limitation differences between tort actions and contract actions.

Given this obvious conceptual foundation, does it make sense for an insured to be able to recover damages for bad-faith claims processing under TIC,  not to mention under the common law, if there are no benefits available under the policy? To put the same point slightly differently: Should an insured be able to recover damages from an insured for its violations of TIC in claims handling when there are no relevant policy benefits, i.e., no covered losses? 

Menchaca II Rule 1: The General Rule (R-1)

Here is R-1 as it comes from Menchaca I: “The general rule is that an insured cannot recover policy benefits for an insurer’s statutory violation if insured does not have a right to those benefits under the policy.” (Emphasis added.)

Quinn’s First Comment. This formulation of R-1 is subject to criticism, I think. The presence of the word “if” makes it look like the formulation of a sufficient condition of when an insured may recover from an insurer for its statutory violations. The double negative, however, makes it a necessary condition. Here is another way, it seems to me, to formulate R-1: It is a necessary condition, generally speaking, of an insured’s  having a right to recovery from an insurer for its statutory violations that the insurer has a right to benefits under the policy.” Here is another way to put this point, it looks like to me: An insured can have a right to recovery from an insurer for its statutory violations only if it has a right to benefits under the relevant policy.

Quinn’s Second CommentConsider the question: Can an insured be validly found to have a right to money from an insurer for violating TIC when an insurer if the insured has no right to benefits under the policy itself. The answer to this question, generally speaking, is no. In addition to the fundamental principle just discussed, this answer is also to be found in the language of the statute. It provides for damages when the insurer’s violation of the statute has caused a loss to the insured. If an alleged loss was not covered, then the violation of the statute by the insurer cannot be the cause of the insured’s loss. There isn’t really any “loss” at all arising out of the relevant part of the insurance transaction since there was no coverage.  

Quinn’s Third Comment One way to think about this point is to distinguish between two types of losses. The Menchaca case arose out of a storm, Ike, so let’s use it as an example. Suppose Insured suffered a storm-loss. It came from the storm and what it caused. The next question would be: Did Insured suffer an insurance-loss, an insured loss? The former type of loss can occur without there being the latter type of loss, e.g. if there is no relevant coverage. Whether there is an insured loss depends fundamentally on the terms of the policy–that is, on its language. Insurance disputes can involve both kinds of losses and both kinds of damages or damage.

Quinn’s Fourth Comment. Might this rule, when combined with the other rules, imply that the existence of coverage at some point in time is always “king”? The answer is “Well, yes, but merely ‘almost always’; indeed very, very close to always, though also almost always subject to some narrow exceptions. ” 

Menchaca II Rule 2: Entitled-to-Benefits Rule (R-2)

“[A]n insured who establishes a right to receive benefits under an insurance policy can recover those benefits as ‘actual damages’ under the statute if the insurer’s statutory violation causes the loss of benefits.” (Emphasis added.)

Quinn’s First Comment.  Because of the presence of the word “if” R-2 looks like a sufficient condition. Of course, it is not this at all. It is a necessary condition, and this fact is exposed by the presence of the word “can.” R-2 is really a way of stating a necessary condition for recovery by an insured from an insured for violations of TIC. Moreover, this right is triggered only if (i) the insured has a right to benefits under the policy, but (ii) she proves that she has that right, as well.

Quinn’s Second Comment. What does Rule-2 actually do? Its effect is simply an announcement that if an insured wants to recover “actual damage” for an insurer’s violation of TIC in the claims process, it will need to establish that it had (or has) a right to benefits under the policy. Proof of benefit rights is a necessary condition for IBF recovery. R-2 plays no significant roll in Menchaca II. One might wonder why not.

Quinn’s Third Comment. R-2 says nothing about what an insurer must or must not do in order to violate the relevant sections of TIC. It says nothing about what an insured must prove against an insurance company to prevail. In a way, it’s a “meta-rule.”

Menchaca II Rule 3: Benefit-Lost Rule (R-3)

“An insured can recover benefits as actual damages under the [Texas] Insurance Code [TIC] even if the insured has no right to those benefits under the policy if the insurer’s conduct caused the insured to lose that contractual right.”

R-3 requires insureds who are plaintiffs in IBF cases to prove some things. It does not, however, require her to prove that the insurer has breached the contract of insurance. Breach of contract and injurious statutory violations are distinct and independent.

Quinn’s First Comment on Rule-3As for me, personally, I think the insured-plaintiff must almost always prove that the statute-violating conduct of the insurer caused a breach of the insurance contract or was a breach of that contract. In other words, the insured must have had a relevant hypothetical right under the contract which to insurer undermined or destroyed  Of course, there are unusual exceptions. 

The court draws several examples of the kind of situation out of its relatively recent history.  One of them goes like this. There is a storm. There are many large losses among several insureds. To simply the example, here how it works. Suppose there are two insureds under the same policy, A and B. There is no question about the existence of coverage. The insurer haggles with A about his rights and while it is doing that it is paying B’s claim. Eventually, the insurer exhausts the policy by paying B, and then denies coverage to A since there is nothing left with which to pay. Thus, the insurer caused–or may have caused–A to lose the rights to benefits it had without actually breaching the policy. The insurer might want to claim that it had a right to settle with B and leave A standing in the ditch. However, such conduct is probably inconsistent with the “special relationship” it has with A.

The Court is drawing a distinction between breaches of contract and violations of statutes. They are distinct from one another, says the Court; they are independent of one another emphasized the Court.

Quinn’s Second Comments on Rule-3The Court’s argument clearly underlines the distinctness and independence between recovery for breach of contract and recovery for violation of the statute. To some extent, of course, isn’t this distinctness without a difference? The insured will still, under most circumstances, have to prove what is tantamount to a breach of contract, at least at a simplistic level: “I had a covered loss. You were obligated to pay it. You did not do so. You do not have a good reason for not doing so. I have lost money. Therefore, you breached the contract of insurance.”

The Court’s conclusion, as perfect as its reasoning is, entails several conclusions which are disappointing, in a general way, to plaintiff-insureds and which appear to have some public policy difficulties.  

Consider an adjustment that involves serious and unfair errors, but the no-coverage conclusion of which is correct. Something seems wrong here. Consider the situation in which an insurer erroneously and unfairly denies coverage but then reverses itself and then grants it.  Consider the reverse situation, where the insurer by serious error grants coverage but then correctly reverses itself, with the actual adjuster being motivated in the second, correct decision by forbidden discriminatory reasons. 

Something seems wrong in both these cases.  Isn’t what we have here explicitly forbidden insurer misconduct for which compensation cannot be obtained? But some might ask, “Wasn’t the creation of common law bad faith in part designed to control such misconduct? Wasn’t insurer bad-faith as a cause of action created in the first place to devise a regulatory system over insurers which would be decided by the courts and initiated by citizen insureds?

These are more matters of political debate than they are jurisprudential. Contracts are at the core. They say what they say. The contracts are mostly wrapped up on a statutory regime that rests on several concepts, one of which is causation of loss. From the point of view of the law, as it is thought to be, the Court seems right. At the same time, it must be remembered that the law is almost always more complex than it appears to be on the surface.

Menchaca II Rule 3 (R-3)–Alternative Formulation

Menchaca’s Third Rule can be read this way: Even if the insured cannot establish a present contractual right to policy benefits, the insured can recover benefits as actual damages under the Insurance Code, if the insurer’s statutory violation causes the loss of benefits–it caused a right which could have been asserted to evaporate, or–poof!–disappear. 

Quinn Comment. The basic idea here is that even if the insured does not have coverage, i.e., a right to benefits under the contract, at the temporal moment of the insurer’s denial, the insured may recover if the insurer somehow caused him not to have that right a right he previously had.

The following might be an example of that sort of situation. The insured makes a claim. The adjuster gives the insured poor instructions as to how to establish a right to recovery but misleads the insurer so that the claim ends up being denied because of what the adjuster said. 

So might this: The insured calls in and indicates that he has a claim but doesn’t want to file it immediately because he has a two-week vacation planned with his wife for their 20th wedding anniversary. The adjuster says “OK. Have a good time.” But when the insured returns and files, the insurer denies the claim., e.g., for late notice or untimely filing. 

Of course, there are many, many examples of these sorts of situations. 

 Menchaca II Rule 4: Independent-Injury Rule

“[A]n insurer’s statutory violation causes an injury independent of the loss of policy benefits, the insured may recovery damages for that injury, even if the policy does not grant the insured a right to benefits.”

Quinn’s Comment. The Court is here laying out a conceivable scenario. The Court’s opinion explicitly states that it has never seen a case like this. 

Quinn’s CommentGiven the wording of R-4 perhaps it might work as follows, keeping in mind that the plaintiff in the IBF case must actually be an insured of that company, and presumably under the very policy at issue.  (Otherwise, why would she be called an “insured.” Thus, we already have a “special relationship” between the insurance company and the insured.) Now suppose the adjuster despises the insured for some reason, and for this reason, misleads the insured into believing that there might be coverage though he knows immediately that there is none with respect to this particular loss*. The adjuster then pushes the insured through a group of expensive claims maneuvers and then mocks and sneers at the insured as he denies coverage, thereby causing the insured physical and emotional pain. The insured is thereby brought within the purview of R-4, though someone who was not actually an insured would not be, although s/he might have a different sort of cause of action.  

A Springtime, 2020 Hypothetical. In insured owns a bar that has a first-party policy which includes a business interruption clause, but also knows that the cause excludes coverage resulting from governmental shutdown orders bases on the presence of a virus. In the context of discussing how to proceed with the claim, the adjuster recommends to the insured that he should drink as much Jack Daniels as possible since it will kill the virus and keep him safe. Unfortunately, as the adjuster knows, the insured is an alcoholic who also suffers from severe clinical depression. You can pretty much guess the rest.

Menchaca II Rule 5: No-Recovery Rule

The last rule is simple. If a plaintiff has no right to benefits and has not suffered an independent injury at the hands of the injurer, he cannot recover from the insurer for its violations of TIC provisions. 

Quinn’s Last Comments. If a plaintiff is not an insured at all of that company, then it cannot (or could not) at any time legally speaking recover under the provisions of the Insurance Code for any violation of that Code by that insurer. This sounds a little like the rules of attorney malpractice: Only a client can recover from a lawyer for legal malpractice. No injustice there. If you think you are an insured, but you’re not, then you lose the lawsuit unless the insurer injures you by some other tort entirely, one not connected to statutory bad faith and probably one not connected to common law bad faith either.  Again, no injustice, and still lots of opportunities. 

There is another more interesting problem. Under R-3, if an insurer screws, A,  its policyholder, out of coverage by causing it not to have a right to policy benefits although those rights are built into the policy, A’s actual damages are restricted to what A should have been paid as policy benefits were it not for the insurer’s misconduct, setting aside the attorney fees and costs of court to which A may be entitled under the statute and setting aside the treble damages which might be won by A if the insurer’s conduct is sufficiently outrageous. 

But what about all the extra costs A might have incurred as the result of the insurer’s violation of the statute. Suppose A has to do a lot of unnecessary investigation as a result of the fact that the insurer did not do its duty–a duty that exists as the result of the contract of insurance having created a “special relationship,” if nothing else.  The extra investigative costs are not part of the policy benefits, so A is “SOL,” as they say. Is that justice? Many policyholders their lawyers might see things differently. 

An insurer might response, “Nonsense. Those can be recovered under a breach of contract action. All insurers, including me, have a contractual duty to perform satisfactory investigations and make rational decisions. You are saying that my misconduct removed you from coverage, i.e., caused you not be entitled to payment under the policy, so now–under the law–you can recover by means of the statute’s formula damages, but nothing more. So what? If you want to recover further expenses you had to put out because of my errors, sue me under the contract. After all, you can get attorney fees that way too.”

I suspect that, insofar as industries can thing, this is what the insurance industry wanted all along, and, in theory at least, there is nothing wrong with that philosophy. Insurance, after all, is a contract relationship, and insurance policies create a special relationship. It certainly won’t hurt larger business insurers since they and their lawyers are used to contract lawsuits. But what about individual policyholders. They often don’t have the money to pursue things like the further investigations needed to overcome the insurer’s errors. In addition, individual policyholders are often represented by personal injury counsel who are often much more comfortable with tort and tort-like lawsuit or so some believe–than they are with contract cases, or so it is thought.

After all, I’ve heard one say, “Contract cases involve a plethora of technicalities and defenses that a hard to deal with when what is at issue is not all that much money anyway. Is this really justice? Isn’t the law being restructured to favor insurers substantially, as against individuals,  where there is not really outrageous conduct?”

What might be the response? Might it be this? “Bad faith happens only when there is outrageous conduct. Mere mistakes do not constitute bad faith. Thus the insured should always be reaching for the treble damages set forth in the statute.” And what’s the response to that? Well, . . . .” And so on. 

Michael Sean Quinn, Ph.D., J.D., C.P.C.U, Etc
2112 Hartford Rd.
Austin, Texas 78703
(512) 656-0503