The Texas Supreme Court has ruled that the “fully adversarial trial” requirement under which an assigned judgment against an insured is binding on its insurer only if the judgment is the product of an adversarial trial could apply to: (1) an insurer which had improperly denied a defense to its insured and (2) an underlying judgment in which the insured entered into agreements concerning the evidence but did not assign its rights until after the judgment was entered. Great American Insurance Company, et al. v. Glen Hamel, et al., 2017 WL 2623067 (Tex. June 16, 2017).

Homeowners sued a home builder after they discovered water intrusion damage in their house allegedly attributed to the builder’s defective work. The builder tendered the suit to its insurer which declined to defend. Before trial, the builder and the homeowners entered into an agreement under which the builder’s principal agreed to testify in exchange for a promise that the homeowners would not execute a judgment against him or try to pierce the corporate veil. The builder stipulated that it was responsible for the defects in the home. During a bench trial, the builder called no witnesses, although it did cross-examine the homeowners’ witnesses. The judge entered judgment against the builder, which then assigned to the homeowners its right to pursue claims against its insurer.

The insurer relied on a 1996 Texas Supreme Court case to argue that the homeowners could not recover on the assigned judgment based on collusion between them and their builder. The Texas Supreme Court held in that case that an insured’s assignment of claims against his insurer to an underlying plaintiff is invalid if: (1) it is made prior to an adjudication of the underlying plaintiff’s claim against the defendant in a fully adversarial trial; (2) the insurer offered a defense; and (3) either (a) the insurer accepted coverage, or (b) the insurer made a good faith effort to adjudicate coverage issues prior to the adjudication of plaintiff's claim. It further held that in no event, however, is a judgment rendered without a fully adversarial trial binding on a defendant’s insurer or admissible as damages in an action against the insurer by the plaintiff as defendant’s assignee. Both the trial court and appellate court distinguished the prior Supreme Court case on the basis that in Hamel the insurer had not defended the builder and there was no pre-trial assignment of rights. Both found that the judgment was the product of a fully adversarial trial.

The Texas Supreme Court reversed. It did not invalidate the assignment because it found that the insurer had wrongfully failed to defend its insured. However, it held that the underlying judgment was not binding on the insurer, and that the insurer was therefore able to attack the reasonableness of the judgment, because the underlying judgment was not the result of a fully adversarial trial. It held that the “controlling factor” is “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 and thus the defendant-insured’s covered liability loss.” The Supreme Court held that the parties’ pre-trial agreement eliminated any meaningful incentive the builder had to contest the judgment because it removed any financial stake the builder had in the outcome.