Texas, once a jurisdiction feared by insurers potentially liable for first-party bad faith claims, appears to have lightened up a bit. In 1997, the Texas Supreme Court in The Universe Life Ins. Co. v. Giles, 950 S.W.2d 48 (Texas 1997), carved out a more reasonable standard for determining whether an insurer had breached its duty of good faith and fair dealing.
Formerly, under Texas law, an insurer violated its duty of good faith and fair dealing when "the insurer had no reasonable basis for denying or delaying the payment of a claim, and the insurer knew or should have known that fact." Aranda v. Ins. Co. of N. Am., 748 S.W.2d 210, 213 (Tex. 1988). The Texas Supreme Court in The Universe Life Ins. Co. v. Giles, 950 S.W.2d 48 (Texas 1997), recognized that despite the relatively straightforward nature of the standard of proof for a bad faith claim, courts were having a difficult time applying the standard. The problem was that an insured was required to prove the absence of a reasonable basis to deny a claim, yet under the "no evidence" standard of review applicable in Texas, an appellate court was required to resolve all conflicts in the evidence and draw all inferences in favor of a bad-faith finding. Applying the "no evidence" standard of review, the appellate court could not give weight to an insurer's evidence of a reasonable basis for the denial or delay, and no judgment could ever be reversed for want of evidence because there could never be any evidence of a reasonable basis for denial or delay presented on appeal. See Lyons v. Millers Cas. Ins. Co., 866 S.W.2d 597, 600 (Tex. 1993).
Thus, the Court in Universe Life chose to articulate a standard for recovery that avoided the complexities of employing the "no-evidence" standard of review with respect to bad faith claims. Upon reviewing the Texas Legislature's 1995 amendment to Article 21.1, section 4 of the Insurance Code (the definition of unfair settlement practices), the court decided to adapt the Legislature's definition to fashion a bad faith standard in positive terms. The new standard requires an insured to demonstrate that the insurer failed to attempt in good faith to effectuate a prompt, fair, and equitable settlement of a claim with respect to which the insurer's liability has become reasonably clear. Id. at 55. Thus, the claimant has the burden of proving that "the insurer knew or should have known that it was reasonably clear that the claim was covered." Id. This standard eliminates the conflict with the no-evidence standard of review, as well as unifies the common law and statutory standards for bad faith.
Texas also has recently clarified and narrowed the conditions under which an insured may recover the two primary forms of extra contractual damages, punitives and mental anguish. With regard to punitive damages, an insured can recover only when the bad faith is "accompanied by malicious, intentional, fraudulent, or grossly negligent conduct." Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 18 (Tex. 1994). Similarly, the courts will closely scrutinize mental anguish claims. A plaintiff cannot recover unless he or she demonstrates "direct evidence of the nature, duration, and severity of the mental anguish, thus establishing a substantial disruption in the plaintiff's daily routine." Parkway Co. v. Woodruff, 901 S.W.2d 424, 444 (Tex. 1995).
Several recent decisions highlight the Universe Life decision's value to insurers faced with defending bad faith claims. One such decision is Lawson v. Potomac Ins. Co. v. Illinois, Civil No. 3:98-CV-0692-H.
On August 14, 1998, Judge Barefoot Sanders, a U.S. District Judge for the Northern District of Texas, granted summary judgment in favor of Potomac Insurance Company on claims of bad faith and Insurance Code and Deceptive Trade Practices Act violations. 12 Mealey's Litigation Reports No. 41 at D-8 (September 9, 1998).
Patricia Lawson filed a claim with Potomac, her homeowners insurers, for foundation damage and plumbing repairs that she alleged were causally related. Potomac denied the claim. After extensive litigation between Lawson and the plumber retained to make repairs, Potomac agreed to pay for the plumbing costs. Potomac refused to reimburse Lawson for the foundation damage, however, asserting that the damage was not causally related to the plumbing leaks, and that even if it was causally related, the damage was excluded under the terms of the policy.
Lawson brought an action in Texas state court asserting, inter alia, breach of contract for failure to pay that portion of the claim related to the foundation repairs, breach of the duty of good faith and fair dealing, violation of several sections of the Texas Insurance Code and Deceptive Trade Practices Act ("DTPA"), and mental anguish.1 Potomac moved for summary judgment on the grounds that the policy excluded coverage for foundation damage and the extra-contractual claims lacked merit.
In its well-reasoned opinion, the court cited several recent cases in which Texas courts held that where coverage was questionable the insurer has a reasonable basis to deny or delay claims without threat of bad faith. See e.g. Higginbotham v. State Farm Mut. Ins. Co., 103 F.3d 456, 459 (5th Cir. 1997) and U.S. Fire Ins. Co. v. Williams, 955 S.W.2d 267, 268 (Tex. 1997). In fact, one court held that bad faith is not established where the jury determines that the insurer denied coverage because it was simply wrong about the proper construction of a policy term. See Pioneer Chlor. Alkali v. Royal Indemn. Co., 879 S.W.2d 920, 939 (Tex. App. 1994). Relying on these decisions, Judge Sanders accepted Potomac's argument that it denied coverage for the foundation damage because, relying on its engineer's report, it believed the damage was caused by soil movement. The court noted that Lawson provided no evidence to the contrary.2
The court also pointed out that under Texas law the same burden must be met for extra-contractual tort claims under the Texas Insurance Code and the DTPA. Thus, the court concluded that because Lawson could not establish that Potomac had acted in bad faith, she could not prevail on her extra-contractual tort claims under the Insurance Code and DPTA.
Additionally, the court noted that Lawson could not recover for mental anguish because she had failed to provide any direct evidence of the nature, duration, and severity of her alleged anguish, nor had she presented evidence of a substantial disruption of her daily routine.
Although there are a few proponents of complete abolition of the bad faith tort, at this point insurers doing business in Texas must be satisfied with the fact that the changes reflected in the Insurance Code and the Universe Life decision go far towards eliminating past excesses that adversely affected the insurance industry.
1 The action was later removed to federal court upon the motion of Potomac.
2 Note that while an insurer can refute claims of bad faith by showing there was a reasonable basis for denying coverage, the question of an insurer's liability is usually a question for the jury. It is only where there is no conflict in the evidence that a court can decide whether there is bad faith as a matter of law. Universe Life v. Giles, 950 S.W.2d at 56.