Settlement Relationships—Insurer, Insured, and Defense Counsel

The opinion in McCain v. Promise House, Inc., No. 05–16–00714–CV, 2018 WL 2042009, 2018 Tex. App. LEXIS 3092 (Tex. App.—Dallas May 2, 2018), provides a roadmap for enforcing settlement agreements under Rule 11 of the Texas Rule of Civil Procedure. Of more interest to insurance professionals and coverage counsel, the opinion raises troubling issues about the relationships among an insured client, its insurer-retained attorney, and the insurer. Most problematic is the court's holding that an appointed counsel is the "sub-agent" of the insured client and is, therefore, authorized to sign a settlement agreement on behalf of the client, as directed by the insurer, without the client's consent.

Facts of the McCain Case

McCain sued Promise House, alleging his son had been physically and sexually abused while a resident there. Promise House had a liability policy with Arch Insurance that included a "sexual or physical abuse" endorsement. That endorsement provided that Arch would have the "right and duty to defend" Promise House against any suit making such allegations. Promise House tendered the McCain claim to Arch, and Arch retained counsel to defend the lawsuit.

As is common in duty-to-defend policies, Promise House's policy authorized Arch to, "at [its] discretion, investigate any act of 'sexual or physical abuse' and settle any claim or 'suit' that may result." Within a month after answering the lawsuit, Promise House's appointed attorney signed a Rule 11 settlement agreement with McCain, securing a full and final release in exchange for a payment of $400,000. About 2 months later, however, Promise House objected to the "proposed settlement" and took the position that its attorney—appointed by Arch—did not have the authority to enter into the settlement agreement on its behalf. That's where things got interesting.

Upon learning of Promise House's position, McCain filed the Rule 11 agreement with the court and amended his petition to assert breach-of-contract claims against both Promise House and Arch. McCain argued, among other things, that the signature of Promise House's attorney alone made the agreement enforceable and that Arch had both a right and a duty to accept the settlement. Promise House argued that its attorney was not authorized to execute the settlement agreement because he did so without Promise House's knowledge, consent, authorization, or approval. Arch agreed that the policy gave it the right to settle and that it had approved the settlement but denied it was a party to any contract with McCain. The parties filed cross-motions for summary judgment, and the trial court entered a take-nothing judgment against McCain.

The Appellate Decision

On appeal, McCain argued that Promise House's policy gave Arch the absolute right to settle all claims, and "Arch, through its assigned defense counsel, authorized and approved the settlement" that bound Arch to pay the $400,000 on behalf of Promise House. The court of appeals agreed, and reversed and rendered judgment against both Promise House and Arch.

The court's analysis has two key components: enforcement of Rule 11 agreements and the relationships among the insurer, insured, and defense counsel. The court confirmed that "a written settlement agreement may be enforced even though one party withdraws consent before judgment is rendered on the agreement." To enforce the agreement in that circumstance, the offended party must, as McCain did here, pursue a separate breach-of-contract claim and establish the elements of such a claim. Although the agreement, in this case, contemplated that the settlement would be "memorialized in a final settlement agreement," the court held that it contained all of the essential terms and was enforceable—provided the defendant's lawyer's signature was binding.

Acting as the client's agent, an attorney may bind the client by executing a Rule 11 agreement. See Green v. Midland Mortgage Co., 342 S.W.3d 686, 691 (Tex. App.—Houston [14th Dist.] 2011, no pet.). Indeed, there is a longstanding presumption that "an attorney retained for litigation [has] authority to enter into a settlement on behalf of a client." See City of Roanoke v. Town of Westlake, 111 S.W.3d 617, 629 (Tex. App.—Fort Worth 2003, pet. denied) (citing Williams v. Nolan, 58 Tex. 708 (1883)). That presumption can be rebutted by evidence that at the time the attorney acted, he or she did so without the client's knowledge or consent. See Karle v. Innovative Direct Media, Ltd., 309 S.W.3d 762, 765 (Tex. App.—Dallas 2010, no pet.). The case law suggests that rebutting the presumption is often a question of fact. It does not appear from the opinion or the party's briefing that McCain had any reason to question the authority of Promise House's attorney of record at the time that the settlement was negotiated.

The court in McCain did not rely on the attorney's presumed authority and did not expressly determine whether Promise House had rebutted the presumption. Instead, the court found that the attorney was given authority to settle by the client's insurance policy under which the lawyer was appointed: "Arch retained counsel to represent Promise House; thus Arch became Promise House's agent, and the attorney became Promise House's sub-agent." To support this holding, the court relied on language in Ranger County Mut. Ins. Co. v. Guin, 723 S.W.2d 656, 659 (Tex. 1987). In Ranger, the Texas Supreme Court said the defending insurer's duty to its insured "extends to the full range of the agency relationship" and approved a jury instruction that an insurer-appointed attorney is "the sub-agent of the insurer," making the insurer "as responsible for the [attorney's] conduct as [it] is for its own conduct." 723 S.W.2d at 658–59.

In later cases, however, the Texas Supreme Court repeatedly characterized Ranger's expansive language as dicta. See State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625, 628 (Tex. 1998); American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 849 (Tex. 1994). In Traver, the Texas Supreme Court reiterated the longstanding principle that a lawyer's sole duty is "unqualified loyalty" to the client even when the lawyer has been appointed and is being paid by an insurer, and the lawyer "may not act contrary to the client's wishes." 980 S.W.2d at 627-28 (citing Employers Cas. Co. v. Tilley, 496 S.W.2d 552, 558 (Tex. 1973)). The court expressly rejected the argument that an insurer can be held vicariously liable for the actions of appointed counsel. See also Taylor v. Allstate Ins. Co., 356 S.W.3d 92, 97 (Tex. App.—Houston [1st Dist.] 2011, pet. denied) (following Traver).

The insurance contract may give the insurer a right to conduct the defense, which, absent a conflict of interest, "includes the right to select the attorney who will defend the claim and to make other decisions that would normally be vested in the insured as the named party." Northern County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685, 688 (Tex. 2004). This contractual relationship, however, does not weaken the appointed lawyer's duty of "unqualified loyalty to the insured" client. Id. at 690 (citing Traver); see also Unauthorized Practice of Law Comm. v. American Home Assur. Co., 261 S.W.3d 24, 41 (Tex. 2008) ("[D]efense counsel, whether private or on staff, owes the insured unqualified loyalty.").

Although the court in McCain did not articulate how Arch became a party to the settlement contract signed only by counsel for Promise House, it apparently presumed that the same counsel represented both Promise House and Arch. Some jurisdictions hold an appointed defense counsel effectively has two clients (the insurer and the insured), although the primary duty is generally owed to the insured if a conflict arises. Texas, however, is generally considered a "one-client" state.

Nevertheless, as the court recognized, the policy granted Arch the right to settle claims in its discretion. (Disputes between Promise House and Arch remain pending in a separate lawsuit.) But, as demonstrated here, exercising this right can be complicated without participation by the insured. An insured may reject the insurer's tendered defense and defend itself but, absent a disqualifying conflict, risks losing the right to be compensated for the defense costs. Davalos, 140 S.W.3d at 690. Similarly, interfering with the insurer's defense or settlement could in some circumstances breach the insured's duty to cooperate and thus potentially undermine coverage under the policy. And, because the Stowers settlement duty is owed only to the insured, the insured's objection to the settlement would negate the insurer's duty to accept a reasonable settlement offer, though not its right to do so. A clear line of communication between the insurer and its policyholder often can address some of these issues before they erupt into serious conflicts.

Conclusion

Disputes between the insurer and the policyholder client can place appointed defense counsel in an untenable position with no easy resolution. The lawyer's duty of "unqualified loyalty" to the client requires, at a minimum, keeping the client informed of material developments, including settlement negotiations. The lawyer can recommend the client consult independent coverage counsel for advice concerning the client's rights and obligations under the policy. And, while the lawyer may not act contrary to the client's wishes, the Traver court noted counsel might be allowed to withdraw from the representation if "he is not permitted to act as he thinks best." 980 S.W.2d at 627–28. Each of these contingencies should generally be addressed in the attorney's engagement letter with the client.

In the end, no one suggests that McCain did not enter into the settlement in good faith, relying on the presumed authority of the defendant's counsel of record. And Arch, from which the attorney received instructions, unquestionably intended to fund the settlement. So, a disinterested observer may conclude that the court reached the right "common sense" result but plowed up some thorny issues in its wake. The moral? Communicate early and often.