The Texas Eight Corners Rule Won’t Help Suit Against Insurer

Claims Made Policy Will not Respond to Wrongful Acts that are Before Inception of Policy

Aug 18, 2021

The Policy

Cincinnati Insurance Company issued a claims-made liability insurance policy to the directors and officers of Ability Holdings, Inc., ATI Enterprises, Inc., and ATI Acquisition Company (collectively, “ATI”). The policy included up to $10 million in liability coverage for claims “first made” during the “policy period” against ATI’s directors and officers for a “wrongful act.” The relevant policy period was December 30, 2010 to December 30, 2011.

The policy also contains, like all policies, exclusions. One is an exclusion for prior notice of a claim that applies when a new claim is “[b]ased upon, arising out of, or in consequence of, or in any way involving” any wrongful act, interrelated wrongful act, or other fact that was the subject of notice prior to the policy period. Another is the prior/pending litigation exclusion, which applies when a claim is “[b]ased upon, arising out of, or in consequence of, or in any way involving any prior and/or pending litigation as of [December 30, 2010] or any fact, circumstance, situation, transaction or event underlying or alleged in such litigation, regardless of the legal theory asserted in such ‘claim’.”

FACTUAL BACKGROUND

A company with trade schools in several Texas counties has been the subject of multiple similar lawsuits brought by former students who have claimed the schools were a failure in various ways. If any of the prior suits are based on the same wrongful acts as the later one, then a policy limitation that denies coverage when the relevant claims are not first made against the insured during the policy period applies.

ATI operated trade schools across Texas from 2009 to 2011. On February 8, 2010, former students sued ATI in Dallas County, Texas. On October 14, 2011, 107 former students (including the 6 former students who are appellants now) sued ATI.

Cincinnati denied all coverage for the Bartlett lawsuit and explained Cincinnati had concluded: (1) that the Nelson lawsuit and the Bartlett lawsuit were “based upon the same Wrongful Acts and/or Interrelated Wrongful Acts,” meaning that the two lawsuits constituted a single claim first made against ATI prior to the period of policy coverage; (2) that the prior/pending litigation exclusion precluded coverage; and (3) that the prior notice exclusion also precluded coverage.

DISCUSSION

Was Cincinnati entitled to summary judgment?

The district court granted summary judgment to Cincinnati since it determined that the Bartlett lawsuit fell outside the scope of ATI’s insurance coverage.

Can the Plaintiffs maintain a direct action against Cincinnati?

The answer to this question lies at the intersection of two lines of Texas Supreme Court cases. In one, the court has enforced a rule that an injured party cannot sue the defendant’s insurer directly until the defendant’s liability has been finally determined by agreement or judgment. This is an application of the “no direct action” rule. To bind an insurer, a judgment against a defendant it insured must result from a “fully adversarial” proceeding.

An important insurance-law treatise analyzed case law involving policies that prohibit direct actions until an actual trial has been held and concluded that such language should be applied literally.

Did the underlying lawsuit fall outside the scope of coverage?

The district court determined, in the alternative, that Cincinnati was entitled to summary judgment because the Bartlett lawsuit was not within the insurance policy’s scope of coverage.

Under Texas’s well-established eight-corners rule, an insurer’s duty to defend is determined by the claims alleged in the petition and the coverage provided in the policy. If the insured carries its initial burden of showing that a claim is potentially within the scope of coverage, then the burden shifts to the insurer to show that a limitation or exclusion precludes coverage of all claims, also within the confines of the eight corners rule. Extrinsic evidence is generally irrelevant for the duty-to-defend question.

ATI’s insurance policy covers any “claim” that is “first made” against ATI during the “policy period” (basically, all of 2011) for a “wrongful act.” A claim is considered “first made” at the moment “notice of the earliest ‘claim’ arising out of such ‘wrongful act’ or ‘interrelated wrongful acts’ is received in writing by a ‘policy insured’ or by [Cincinnati], whichever comes first.”

The district court determined that the Bartlett lawsuit, i.e., the underlying lawsuit, fell outside of the scope of coverage because it was “sufficiently related” to the Nelson lawsuit, which was filed before the policy period.

Since the Cincinnati policy provides that “all ‘claims’ based upon or arising out of the same ‘wrongful act’ or any ‘interrelated wrongful acts’ shall be considered a single ‘claim’.” Multiple acts constitute “interrelated wrongful acts” if they “have as a common nexus any fact, circumstance, situation, event, transaction or series of facts, circumstances, situations, events, or transactions.”

The plaintiffs in both lawsuits were students of ATI trade schools, albeit at separate campuses. Both lawsuits alleged that “ATI intentionally create[d] and maintain[ed] a high pressure sales culture that constantly pushe[d] admissions representatives and managers to increase enrollment through aggressive and misleading sales techniques and tactics.”

The virtually identical suits alleged a fact common to both lawsuits and integral to the claims presented in both. As a result, the Fifth Circuit concluded that the Bartlett lawsuit and the Nelson lawsuit were based on at least one common “wrongful act” or “interrelated wrongful act” and therefore constitute a single claim under the insurance policy and were clearly and unambiguously excluded.

ZALMA OPINION

Claims Made policies are different than “occurrence” based policies because they limit their coverage to acts that happen and claims that are made during a policy period. Because ATI was the subject of multiple lawsuits when they sought coverage from Cincinnati the claims made policy was issued to limit coverage to new problems not the old ones that eventually drove ATI to bankruptcy.

© 2021 – Barry Zalma Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders.

He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business.

He is available at

http://www.zalma.com

and zalma@zalma.com. Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award. Over the last 53 years Barry Zalma has dedicated his life to insurance, insurance claims and the need to defeat insurance fraud. He has created the following library of books and other materials to make it possible for insurers and their claims staff to become insurance claims professionals.

Go to the podcast Zalma On Insurance at https://anchor.fm/barry-zalma; Follow Mr. Zalma on Twitter at https://twitter.com/bzalma; Go to Barry Zalma videos at Rumble.com at https://rumble.com/c/c-262921; Go to Barry Zalma on YouTube- https://www.youtube.com/channel/UCysiZklEtxZsSF9DfC0Expg; Go to the Insurance Claims Library – https://zalma.com/blog/insurance-claims-library/ The last two issues of ZIFL are available at https://zalma.com/zalmas-insurance-fraud-letter-2/ podcast now available at https://podcasts.apple.com/us/podcast/zalma-on-insurance/id1509583809?uo=4