The package of cover provided by an insurer to its insured is ordinarily substantively defined by the maximum level of indemnity or applicable policy limit. The insured will have made a decision as to the extent of insurance it requires, and the insurer how much it is willing to offer, with the level of premium paid and received being assessed against the risk which is being insured. The insurer determines its premium income as against a business model which (across many different policies and risks) allows it to work towards securing a profit. That business model relies upon certainty as to maximum exposure, and hence will not address the potential risk of the policy limit being determined inapplicable, so that the insurance provided is effectively unlimited. However, the Texas courts have developed a tort law doctrine that serves as an overlay to the policy and makes the potential shift of "uninsured" exposure from insured to insurer a very definite reality.

The Stowers doctrine

The so-called Stowers doctrine provides that if an insurer unreasonably fails to accept a demand made by a claimant for payment of "policy limits", the insurer may be liable under tort law for the amount of any subsequent judgment against the insured, even if in excess of the contractual policy limits. Punitive damages are available since the cause of action is a tort. The Texas legislature has incorporated, and in effect duplicated, this doctrine into its Unfair Claims Practices Act, thus allowing for recovery of treble damages for a "knowing" failure to settle when liability is reasonably clear. Attorneys' fees are also recoverable under the statutory version of this extracontractual cause of action.

The Stowers doctrine derives from the 1929 case of GA Stowers Furniture Company v American Indemnity Company, in which the Texas Supreme Court established a duty on insurers to "exercise that degree of care that a person of ordinary care and prudence would exercise under the same or similar circumstances", noting that "a failure to exercise such care and prudence would be negligence on the part of the [insurer]". Any failure to exercise reasonable care in resolving the claim within policy limits can shift the risk of any excess judgment from the insured to the insurer, thereby rendering the policy unlimited in nature.

Application of the doctrine

The Stowers duty is based upon the fact that the insurer retains control of both defence and settlement pursuant to the terms of its insurance policy. As the Judge noted in the 1990 decision in Foremost County Mutual Insurance Company v Home Indemnity Company, "the raison d'être for the Stowers Doctrine is that the insurer, when in control of the litigation, might refuse a settlement offer that its client, the insured, would want to accept if it had the option".

In American Physicians Ins. Exch. v Garcia, the Texas Supreme Court summarised the Stowers elements as follows:

  • [T]he claim against the insured is within the scope of coverage [at the time the offer is made]
  • the demand is within policy limits
  • the terms of the demand are such that an ordinary prudent insurer would accept it, considering the likelihood and degree of the insured's potential exposure to an excess judgment

While a formal written demand by the claimant has not yet been required by the Texas courts, the settlement offer's scope and terms must be clear and not the subject of dispute. Although the courts have not required that the insured actually demand acceptance of the settlement, this is the typical practice. Thus, even if the insured agrees that the case should not be settled, this is not necessarily a defence to the claim that the failure to settle was unreasonable.

A bona fide dispute regarding coverage has also not been found to be an absolute defence to a Stowers claim - see the 2010 decision in LSG Technologies, Inc. v. U.S. Fire Ins. Co., holding that Stowers does not involve questions of bad faith and thus a bona fide coverage dispute is not a defence to such claims. Moreover, legal advice regarding coverage is not a complete defence, and even claiming it would potentially waive the attorney client privilege. The duty to indemnify must usually wait for conclusion of the underlying suit in order for a court to determine coverage. Thus, insurers must often make an educated guess as to whether there is coverage or not. If insurers guess there is no coverage and it is later found that there is, the insurers are still liable for amounts awarded in the underlying judgment in excess of limits, even if a reasonable insurer would have contested coverage.

Recommendations

When a Stowers compliant demand is received, therefore, it is recommended that the insured be engaged urgently as to its position in respect of such demand. A Stowers letter or demand must fulfill certain requirements in order to be deemed valid. Importantly, such demand must be "unconditional" and must be clear and beyond dispute. A full and complete release must be offered to the insured, including a release from any collateral or related interests such as those of a lienholder.

The difficulty faced by insurers is that in a situation where a Texas court assumes jurisdiction over a claim (even if such jurisdiction may be open to justifiable challenge), and a Stowers demand is made before any jurisdictional challenge is heard, it must be responded to or a catastrophe may ensue. The timing of the demand is subject to a reasonableness test, but that is an issue to be decided by a jury, not as a matter of law. This can lead to a complex risk analysis, particularly in the case of relatively low policy limits, as contrasted with a high value claim. The greater the differential between the limit and the claim, the more likely it is that if Texas courts were to retain jurisdiction, a jury would find an insurer's "refusal" to settle the claim to be unreasonable.

The entry of a judgment in excess of limits creates great difficulty from an appellate standpoint. A supersedeas bond must be filed to prevent execution against the insured during the course of any appeal of the underlying suit. Attempts can be made to modify the amount of the bond, but this is a difficult task fraught with danger and uncertainty. The cost of the bond must typically be paid as a supplementary payment or defence cost in addition to the limits. The bond must be fully collateralized in some form. Thus, to prevent execution and/or an assignment by an insured of its rights against the insurer, the insurer must agree to a bond in excess of its limits. If there is a coverage issue, agreeing to bond even a judgment within limits waives the coverage defence because the money is already committed contractually through the bond.

The failure to bond will result in a voluntary assignment of rights against the insurer from the insured to the claimants or an involuntary turnover of the causes of action against the insurer to the claimants. As the Stowers duty is owed only to the insured, claimants may only sue for amounts up to the policy limits as a judgment creditor and in their own name. Any extra-contractual amounts would require an assignment or turnover.

Conclusion

The application of the Stowers doctrine through the Texas courts is a real issue, and from our experience increasingly common. Although developed as a means of protecting an insured from possible abuse by its insurer, with the requirement of Texas law for disclosure of policy documentation (and hence limits) significant scope exists for plaintiff attorneys to exploit the doctrine in the hope of greater financial gain. From a plaintiff attorney's perspective, the best possible outcome in respect of a Stowers demand is the refusal of the insurer to settle at policy limits, as this may serve to increase the potential financial recovery from the claim.

Whilst arguably the doctrine is a concern in relation to any loss globally where a Texas involvement could be contended by a plaintiff's attorney, from our experience it is particularly relevant to countries in Central and South America where Texas is geographically one of the closest US states, and hence more likely to have a direct link with an insured's operations or the passengers utilising their services. Insurers should consider carefully the possible impact of Texas law upon the risks they insure, and be alive to the risk of an unlimited policy ruling against them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.