Last week, the United States District Court for the Western District of Texas addressed the binding nature against an insurer of a less than fully adversarial proceeding against its insured in CBX Resources, LLC v. Ace American Insurance Company and Ace Property and Casualty Insurance Company, No. 5:17-CV-17-DAE, 2018 WL 3203153 (W.D. Tex. Jun. 28, 2018). The original state suit stemmed from an oil and gas operation in Zavala County, Texas in 2011. CBX leased the mineral tract and hired Espada Operating, LLC for drilling and operation. Espada drilled and installed a fracking system into the production casing, however months later when Espada tried to pull the production casing out, it discovered a fracture of 3,400 feet in the well and determined that the production casing below the fracture could not be recovered. As a result, the well was plugged and abandoned. Espada was insured under a policy issued by Ace American and an umbrella policy issued by Ace Property.

In February 2013, CBX sued several defendants (not including Espada) for damages arising from the total loss of the use of the well in the 293rd Judicial District Court of Zavala County, Texas. CBX later added Espada as a defendant who was represented by counsel retained by Ace American. In August 2013 Espada filed a third-party petition alleging that a catastrophic failure in the casing occurred down the well hole and the well could not be repaired. In September 2015, CBX served a Stowers demand on Espada seeking a full and unconditional release of its claims in exchange for an amount within the limits of the policies issued by Ace American and Ace Property. Less than a month later however, Ace American pulled Espada’s defense and the state court granted withdrawal of Espada’s counsel approximately 71 days before trial. Espada failed to appear at a pre-trial hearing and the court ordered judgment to be entered in favor of CBX. Just over a week later, the court held a hearing addressing damages where CBX put forth witnesses and evidence. The court entered a judgment finding Espada was negligent and awarded CBX damages and post-judgment interest. The court thereafter entered an Order for Turnover Relief transferring ownership of Espada’s causes of actions against its insurers, Ace American and Ace Property, to CBX.

In January 2017, CBX sued Ace American and Ace Property (together “Ace”) in Federal court asserting causes of action for breach of Ace’s Stowers duty to reasonably settle, bad faith, breach of contract, deceptive insurance practices, and declaratory judgment regarding Ace’s duty to defend and indemnify Espada in the state court matter. Both CBX and Ace filed cross motions for partial summary judgment on Ace’s duty to defend and the Court granted Ace’s motion and denied CBX’s, the Court found the underlying insurance policy did not apply to the type of property damage alleged by CBX. Accordingly, Ace did not have a duty to defend.

In this matter, Ace proceeded to file a declaratory judgment seeking declaration that the underlying judgment CBX obtained against Espada is not binding against Ace or admissible in the instant suit as evidence of damages.

The primary issue the Court considered was whether the underlying judgment against Espada was the result of a fully adversarial proceeding. The Court looked to the recent Texas Supreme Court opinion in Great American Insurance Co. v. Hamel issued in 2017 for guidance on the issue of whether an insurer can be bound or damages be admitted against an insurer without a fully adversarial trial. The Hamel court interpreted the phrase “fully adversarial” as “whether at the time of the underlying trial or settlement, the insured bore an actual risk of liability for the damages awarded or agreed upon, or had some other meaningful incentive to ensure that the judgment or settlement accurately reflects the plaintiff’s damages…” Accordingly, the measurement against Espada was whether Espada breached any actual risk of liability for damages at the time of judgment or whether Espada had some other meaningful incentive to ensure the judgment accurately represented CBX’s damages in the state court case.

Although the Texas Supreme Court in Hamel noted that a court should normally apply the presumption that the lack of any pretrial agreement suggests that at the underlying judgment was the result of a fully adversarial proceeding, the court here distinguished Hamel in several respects. Unlike the present case, the defendant in Hamel attended the damages hearing where here, after Espada’s counsel withdrew, Espada did not appear at trial. The court took the facts that Espada wholly failed to appear at docket call and the damages hearing, that only CBX appeared at the damage hearing, and Ace’s evidence that Espada was financially unstable and unable to hire counsel, among others, indicated that the trial and the underlying judgment were not fully adversarial and therefore cannot be used as evidence against Ace.

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