FORT WORTH COURT HOLDS ISSUER’S APPROVAL NOT NEEDED TO MODIFY BUSINESS RELATIONSHIP BETWEEN POLICY SELLER, REINSURER

May 7, 2012

An action in contract between Arch Reinsurance Company and Underwriters Service Agency based on three-party reinsurance agreement between Arch, Underwriters, and State National was resolved in favor of Underwriters because the challenged modification did not shift any of the risk of the agreement to State National.  In Arch Reinsurance Co. v. Underwriters Svc. Agency, Inc., No. 02-10-00365-CV, 2012 WL1556174 (Tex. App.—Fort Worth April 26, 2012), the court of appeals held that even though State National did not agree to the modification, the only risk to State National both before and after the modification was the risk of Arch’s insolvency, and that the modification therefore “did not have a substantial impact on State National.”  (State National was not a party to the appeal.)

In the underlying reinsurance contract, Arch was the reinsurer, Underwriters sold the policies, and State National issued the policies but passed all risk to Arch.  Arch and Underwriters allegedly entered into a modification titled “Addendum No. 11” that increased Underwriters’ commission, among other things. Arch argued that Addendum No. 11 was required by the underlying contract to be agreed to by all three parties.  Importantly, Arch contended, the addendum modified the reinsurance agreement by changing the liability for gross policy losses.  Under the original agreement, Arch was liable for 100% of gross losses; as modified, Arch’s liability was capped, and some of the liability was shifted to Underwriters.  Arch contended that this change constituted a substantial impact on State National for which State National’s consent was required.

The Court of Appeals disagreed.  First, the court found that nothing in the original reinsurance agreement gave State National control over the business relationship between Arch and Underwriters.  Second, the court concluded that even though Addendum No. 11 reallocated the risk of loss, none of the risk was shifted back to State National.  Reviewing the documents as a whole, the Court concluded that the addendum required Underwriters to owe Arch for any amount over the addendum’s liability cap that Arch was required to pay to State National under the reinsurance agreement.  Thus, since State National was protected after the addendum just as it was before, the Addendum had no substantial impact on State National.  The addendum, therefore, was effective without State National’s agreement.

In a separate issue, the court of appeals reversed the trial court’s award of attorney’s fees to Underwriters under the declaratory judgment act.  Because Underwriters’ declaratory judgment counterclaim did not have any effect beyond Arch’s original lawsuit, the counterclaim was improper, and could not support attorney’s fees.