St. Paul Fire & Marine v. Convalescent Serv., 98-20413

• Decision Date: 19 October 1999
• Docket Number: No. 98-20413,98-20413
• Citation: 193 F.3d 340
• Parties: (5th Cir. 1999) ST. PAUL FIRE AND MARINE INSURANCE COMPANY; ST. PAUL MERCURY INSURANCE COMPANY, Plaintiffs-Appellees, v. CONVALESCENT SERVICES, INC. doing business as BAYOU GLEN NURSING HOME; MARK SCHULTZ, executor of the estate of Jacob Schultz; LILLIAN SCHULTZ, Defendants-Appellants
• Court: U.S. Court of Appeals — Fifth Circuit

Page 340

193 F.3d 340 (5th Cir. 1999)

ST. PAUL FIRE AND MARINE INSURANCE COMPANY; ST. PAUL MERCURY INSURANCE COMPANY, Plaintiffs-Appellees, v. CONVALESCENT SERVICES, INC. doing business as BAYOU GLEN NURSING HOME; MARK SCHULTZ, executor of the estate of Jacob Schultz; LILLIAN SCHULTZ, Defendants-Appellants.

No. 98-20413

UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

October 19, 1999

Appeal from the United States District Court for the Southern District of Texas

Before POLITZ, DeMOSS, and BENAVIDES, Circuit Judges.

BENAVIDES, Circuit Judge:

This appeal involves the scope of an insurer's duty to its insured in the context of settlement negotiations under Texas law. Concluding that the Texas Supreme Court would not impose a duty upon an insurer to take into consideration a claim specifically excluded from coverage, we affirm.

I.BACKGROUND

St. Paul Fire and Marine Insurance Company (St. Paul) filed a complaint for declaratory relief pursuant to 28 U.S.C. 2201 in federal district court, seeking a determination that it was not liable for payment of a punitive damages award entered against its insured, Convalescent Services, Inc. (CSI), in a state court action in Harris County, Texas. The following events gave rise to the underlying state court action. Jacob Schultz was a patient at a nursing home owned by CSI called Bayou Glen Nursing Home. Schultz developed decubitus ulcers, which involved complete loss of skin and tissue and exposed bone structure. Recovery from the ulcers required hospitalization, surgery, and skin grafts. Schultz brought suit against CSI in Texas state court, alleging a variety of negligent acts and omissions that resulted in serious personal injury and near death. Schultz sought actual and punitive damages.

Although St. Paul insured CSI against damages arising from its negligence, the policy specifically excluded coverage for punitive damages. Pursuant to that policy, St. Paul defended CSI in the underlying state lawsuit. Prior to trial, Schultz made a settlement demand of $250,000, well within CSI's policy limits. At that time, Schultz's medical damages alone were $80,000. St. Paul rejected the demand and made a counteroffer of $35,000. The case proceeded to trial, and ultimately, finding CSI liable for negligence and gross negligence, the jury awarded Schultz $380,000 in actual damages and $850,000 in punitive damages. Although St. Paul paid the actual damages award on behalf of CSI, it refused to pay the punitive damages award based on an exclusion in the policy.

Thereafter, CSI executed an assignment of its rights against St. Paul to Schultz's estate in exchange for a covenant to delay execution of the underlying state court judgment. ¹ CSI filed suit against St. Paul in the district court of Harris County, Texas, alleging that St. Paul had negligently handled the investigation and settlement negotiations in regard to Schultz's claim against CSI. St. Paul then removed the suit to federal district court and filed the aforementioned complaint seeking a declaratory judgment that it did not breach any duties owed to CSI in connection with the defense and settlement of the underlying state court proceedings.

CSI counterclaimed, asserting that St. Paul breached its duty to exercise ordinary care in the defense, evaluation, and settlement of the lawsuit against CSI in violation of the doctrine set forth in G.A. Stowers Furniture Co. v. American Indemnity Co., 15 S.W.2d 544 (Tex. Comm'n App. 1929, holding approved). St. Paul filed a motion for judgment on the pleadings, arguing that it had not violated its Stowers duty. The district court agreed and granted St. Paul's motion for judgment on the pleadings. The court entered final judgment declaring that St. Paul had no liability for payment of the punitive damages award. CSI now appeals.

II.ANALYSIS

A.Negligent Failure to Settle under Texas Law

CSI contends that the district court erred in granting St. Paul's motion for judgment on the pleadings with respect to its counterclaim. A judgment on the pleadings pursuant to Rule 12(c) of the Federal Rules of Civil Procedure is reviewed de novo. St. Paul Ins. of Bellaire v. AFIA Worldwide Ins., 937 F.2d 274, 279 (5th Cir. 1991). This Court must look only to the pleadings and accept all allegations in them as true. Id.

Specifically, CSI argues that St. Paul unreasonably refused to accept a $250,000 settlement demand in the underlying state court suit, thereby violating its duty under Texas law. To determine a state law question, federal courts must look to decisions of the highest state court. Transcontinental Gas v. Transportation Ins. Co., 953 F.2d 985, 988 (5th Cir. 1992). If the state's highest court has not spoken on a particular issue, "it is the duty of the federal court to determine as best it can, what the highest court of the state would decide." Id.

In Texas, an insurer must exercise the degree of care and diligence when responding to settlement demands within policy limits that "an ordinarily prudent person would exercise in the management of his own business." Stowers, 15 S.W.2d at 547. A failure to exercise such care constitutes negligence on the part of the insurance company. Id. This well-recognized duty arises from the obligations to defend and indemnify pursuant to the insurance contract and the control the policy grants to the insurer over the insured's defense. American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 846 (Tex. 1994).

The Texas Supreme Court has explained that an insurer's duty to settle under Stowers is not activated unless the following three requirements are met:

(1) the claim against the insured is within the scope of coverage, (2) the demand is within the policy limits, and (3) the terms of the demand are such that an ordinarily prudent insurer would accept it, considering the likelihood and degree of the insured's potential exposure to an excess judgment.

Garcia, 876 S.W.2d at 849.

CSI admits, as it must, that punitive damages are specifically excluded under its insurance policy issued by St. Paul. CSI maintains, however, that it has never asserted that St. Paul had a duty to settle a claim not covered under its policy. Instead, CSI argues that the Stowers duty to settle within policy limits was triggered because St. Paul knew that CSI was willing to pay its share of any demand for non-covered damages in order to avoid exposure to a large award of punitive damages. ² In other words, if St. Paul had made CSI aware of its internal evaluation that the exposure to a punitive damages award was great, then CSI would have contributed toward a settlement based upon such exposure. CSI asserts that St. Paul knew or had reason to know that CSI would have been willing to contribute toward a settlement because, within the preceding year, at St. Paul's request, CSI had paid $100,000 of its own money toward settlement of an apparently unrelated action that presented a substantial risk of punitive damages.

CSI asserts that although the Texas Supreme Court has not addressed the merits of this particular type of Stowers claim, it specifically mentioned such a potential liability in Garcia, and State Farm Lloyds Ins. Co. v. Maldonado, 963 S.W.2d 38, 41 n.6 (Tex. 1998). We disagree. In both of those cases, the question the Supreme Court expressly left open was "when, if ever, a Stowers duty may be triggered if an insured provides notice of his or her willingness to accept a reasonable demand above the policy limits, and to fund the settlement, such that the insurer's share of the settlement would remain within the policy limits." 876 S.W.2d at 849 n.13. Unlike those cases, in the case at bar, Schultz's settlement demand was not above CSI's policy limits. More importantly, in contrast to the case at bar, both Garcia and Maldonado involved claims--and damages corresponding to those claims--that were covered by the insurance policy. ³

As the Texas Supreme Court stated in Garcia, "[w]e start with the proposition that an insurer has no duty to settle a claim that is not covered under its policy." 876 S.W.2d at 848. This language indicates that St. Paul had no duty to take into consideration CSI's potential exposure to punitive damages during settlement negotiations regarding covered claims. Therefore, we do not believe that the Texas Supreme Court would find that St. Paul's alleged knowledge of CSI's willingness to pay for the punitive portion of the settlement triggered the traditional duty to settle under Stowers.⁴

In short, Stowers holds insurers liable for damages on covered claims above policy limits to ensure that insurers accept reasonable settlement offers (especially ones close to policy limits) that an ordinarily prudent insured would have accepted. Stowers therefore extends the policy limits for covered claims; however, CSI's interpretation would, in effect, extend the actual coverage of the insurance contract. ⁵ CSI's argument wholly ignores the most basic proposition that an insurer has no duty to settle a non-covered claim. Given these circumstances, CSI has failed to establish that St. Paul had a duty under Stowers to accept the $250,000 settlement demand.⁶

Nevertheless, CSI argues that, independent of the duty in Stowers to accept reasonable settlement demands, St. Paul had a larger duty to handle the claims against CSI in a non-negligent manner. CSI relies on, inter alia, the standard of care language in Stowers, 15 S.W.2d at 547, ⁷ and the Texas Supreme Court's "holding" in Ranger County Mut. Ins. Co. v. Guin, 723 S.W.2d 656, 659 (Tex. 1987), that an insurer's duty extends to the full range of the agency relationship which includes investigation, preparation for defense of the lawsuit, trial of the case, and reasonable attempts to settle. Although Ranger does contain broad language regarding an insurer's duty to the insured, that language certainly is not the holding inasmuch as there was "no contention that [the insurer] was...