UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
__________________
No. 98-20413
__________________
ST. PAUL FIRE AND MARINE INSURANCE COMPANY;
ST. PAUL MERCURY INSURANCE COMPANY,
Plaintiffs-Appellees,
versus
CONVALESCENT SERVICES, INC. doing business
as BAYOU GLEN NURSING HOME; MARK SCHULTZ,
executor of the estate of Jacob Schultz;
LILLIAN SCHULTZ,
Defendants-Appellants.
______________________________________________
Appeal from the United States District Court for the
Southern District of Texas
______________________________________________
October 19, 1999
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
2
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)
1
CSI and Schultz’s estate are the appellants on this appeal.
For ease of reference, the appellants will be collectively referred
to as CSI.
3
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
4
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
2
Although CSI now asserts that St. Paul’s knowledge of CSI’s
willingness to contribute “triggered the classic Stowers duty,” in
its counterclaim filed in the court below, CSI candidly admitted
that “St. Paul’s breach of duty is not the classic Stowers breach,
[because] the damages to which St. Paul has exposed its
policyholder are not covered, and Stowers is premised upon an
insurer’s duty to settle a covered lawsuit.” Indeed, the district
court, in its opinion granting St. Paul’s motion for judgment on
the pleadings, took note of CSI’s concession “that St. Paul did not
breach its Stowers duty as set out by the three requirements listed
in Garcia.” Nevertheless, CSI did argue in its counterclaim that
the duties set forth in Stowers were not so limited, and that St.
Paul had breached its duty under Stowers “‘to give the rights of
his principal [policyholder] at least as great consideration as he
does his own.’” (quoting Stowers, 15 S.W.2d at 548).
5
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
3
In Maldonado, the Court did not reach the question left
open in Garcia because there was no evidence that the insurer knew
that the insured had made an unconditional offer to pay the amount
of the settlement demand above policy limits. In its counterclaim,
CSI alleged that St. Paul knew it was willing to contribute. As
stated previously, because this case was disposed of on a Rule
12(c) motion, we accept all allegations in the pleadings as true.
6
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
4
We express no opinion regarding how the Texas Supreme Court
would decide the particular type of Stowers claim left open in
Garcia and Maldonado, both of which involved claims that were
covered.
5
CSI argues that both extending policy limits for covered
claims and extending actual coverage of the insurance contract
involve the insurer being held liable for damages that it was not
contractually obligated to pay. Though we understand CSI’s
argument, we simply do not believe that the Texas Supreme Court’s
precedent allows us to accept that argument. See Garcia, 876
S.W.2d at 848. Stowers extends policy limits when an insurer has
negligently refused to settle a covered claim. Stowers does not
extend or create coverage when an insurer negligently handles a
claim against its insured that is not covered in the first
instance.
6
CSI also argues that the $250,000 settlement demand made by
Schultz involved only the actual damages and did not encompass the
punitive damages. Therefore, the first Stowers prerequisite would
7
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 negligent in investigation or trial of the
. . . lawsuit.” Ranger, 723 S.W.2d at 659. Subsequently, in
Garcia, the Texas Supreme Court referred to this language in Ranger
be met; i.e., the claim was a covered one. Even if the demand
could be so construed, and thus, under Stowers, St. Paul
negligently refused to settle the covered claim, CSI suffered no
damages in this regard because the actual damages that corresponded
to the covered claim did not exceed policy limits, and St. Paul
paid the $380,000 in actual damages. Pursuant to Stowers, if the
jury had awarded Schultz actual damages in excess of CSI’s policy
limits, St. Paul would have been liable for the entire amount of
actual damages, including the amount in excess of policy limits.
7
Certainly, where an insurance company makes
such a contract; it, by the very terms of the
contract, assumed the responsibility to act as
the exclusive and absolute agent of the
assured in all matters pertaining to the
questions in litigation, and, as such agent,
it ought to be held to that degree of care and
diligence which an ordinarily prudent person
would exercise in the management of his own
business.
8
as “dictum” and opined that “[i]n the context of a Stowers lawsuit,
evidence concerning claims investigation, trial defense, and
conduct during settlement negotiations is necessarily subsidiary to
the ultimate issue of whether the claimant’s demand was reasonable
under the circumstances, such that an ordinarily prudent insurer
would accept it.” 876 S.W.2d at 849. Tellingly, CSI and the
dissent in Garcia both rely on the same language in Ranger.
Indeed, the dissent in Garcia accuses the majority of
“retroactively” transforming the holding in Ranger “into mere
`dictum.’” 876 S.W.2d at 863 n.7. It is clear to us that, in
Garcia, the Texas Supreme Court drastically curtailed the broad
language of Ranger.8 This is true regardless whether that language
in Ranger is deemed to constitute the holding.
CSI also relies on opinions from the Seventh and Eighth
Circuits and the Northern District of Alabama to support its claim
that St. Paul breached its duty to treat CSI’s interests with equal
consideration as its own.9 Those three cases rely, at least in
8
Notwithstanding Garcia, CSI argues that the Texas Supreme
Court’s affirmance of a portion of the court of appeals’ opinion in
St. Paul Surplus Lines Ins. Co. v. Dal-Worth Tank Co., 917 S.W.2d
29 (Tex.App.-Amarillo 1995), affirmed in part, reversed in part on
other grounds, 974 S.W.2d 51 (Tex. 1998), has reaffirmed the
holding in Ranger that an insurer has a duty of ordinary care in
the handling of a claim, including the investigation and evaluation
of that claim. We are not persuaded because, subsequent to Dal-
Worth, the Texas Supreme Court in State Farm Mut. Auto. Ins. Co. v.
Traver, reiterated that “Ranger’s broad language about the scope of
the insurer’s responsibilities was dicta.” 980 S.W.2d 625, 628
(Tex. 1998).
9
Carpenter v. Auto. Club Interins. Exch., 58 F.3d 1296 (8th
Cir. 1995); Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23
F.3d 1175 (7th Cir. 1994); and Carrier Express, Inc. v. Home Indem.
Co., 860 F.Supp. 1465 (N.D. Ala. 1994).
9
part, on the insurer’s duty of good faith and fair dealing. In
Texas, a Stowers claim is not a bad faith claim. Maryland Ins. Co.
v. Head Indus. Coatings and Serv., Inc., 938 S.W.2d 27, 28 (Tex.
1996). Furthermore, the Texas Supreme Court has expressly held
that an insurer does not owe its insured a duty of good faith and
fair dealing to investigate and defend claims by a third party
against its insured. Id. This Court has recognized that holding
and explained that “[i]n this context, the Stowers duty is the only
tort duty the insurer must comply with; the duty of good faith in
handling insurance claims does not apply.” Travelers Indem. Co. v.
Citgo Petroleum Corp., 166 F.3d 761, 764 (5th Cir. 1999).10
We also rely on the Texas Supreme Court’s decision in Texas
Farmers Ins. Co. v. Soriano, 881 S.W.2d 312 (1994), to assist us in
making our Erie11 guess. In that case the question was whether the
insurer was negligent for failing to settle certain claims that
were filed against its insured as a result of a car accident.12 Two
sets of claimants, the Medinas and the Lopezes, sought recovery
from the insured. The insured had only the minimum insurance
10
This panel is bound by another panel‘s previous
interpretation of state law absent a subsequent state court
decision that renders this Court’s previous decision incorrect.
Batts v. Tow-Motor Forklift Co., 66 F.3d 743, 747 (5th Cir. 1995).
11
Erie R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817 (1938).
12
The insured also claimed that the insurer breached its duty
of good faith and fair dealing in failing to settle certain claims.
Because the insurer did not challenge whether the duty of good
faith and fair dealing applied in the context of third-party
claims, the Texas Supreme Court did not decide that issue.
Subsequently, the Court held that such a duty did not apply in the
context of third-party claims. Head, 938 S.W.2d at 28.
10
coverage of $20,000 per occurrence, and the insurer offered the
full policy limits of $20,000 to the Medinas, but the offer was
refused. Subsequently, the Lopez claim was settled for $5,000.
The insurer then offered the remaining $15,000 to the Medinas, who
demanded the original offer of $20,000. The case went to trial,
and the jury awarded the Medinas $172,187 in damages. Soriano
assigned his rights against the insurer to the Medinas, who sued
the insurer for its negligent handling of the Medinas’ claims. The
jury found that the insurer was negligent for failing to settle and
awarded $520,577.24 in actual damages. The court of appeals
affirmed the award, finding that there was some evidence that the
Lopez settlement was unreasonable and negligent. The Texas Supreme
Court reversed, holding that “an insurer may enter into a
reasonable settlement with one of . . . several claimants even
though such settlement exhausts or diminishes the proceeds
available to satisfy other claims.” 881 S.W.2d at 315. Put
another way, when determining whether to accept a settlement demand
in a case involving multiple claims and inadequate proceeds, an
insurer may consider only the merits of that particular claim and
the corresponding potential liability of its insured. The Court
explained that “[t]his standard is nothing more than what is
required of an insurer under Stowers.” Id.
Thus, because the Texas Supreme Court does not impose a duty
upon insurers to consider other covered claims when faced with a
settlement demand by one claimant, we believe that the Court would
not impose a duty upon insurers to consider claims that are not
covered--here, the punitive damage claims--by its policy during
11
settlement negotiations involving one claimant. While recognizing
the expansive language in Stowers regarding an insurer’s duty to
the insured, we cannot square the Texas Supreme Court’s recent
precedent interpreting Stowers with a holding that the insurer has
a duty to consider claims that are excluded from coverage when
making its determination of whether a settlement is reasonable.
CSI also cites numerous other cases in support of its various
arguments; however, what this Court must do is predict what the
Texas Supreme Court would now hold. When making an “Erie guess, it
is not our role to create or modify state law, rather only to
predict it.” Lawrence v. Virginia Ins. Reciprocal, 979 F.2d 1053,
1055 (1992). In light of its more recent precedent, we feel
constrained to hold that the Texas Supreme Court would conclude
that St. Paul did not breach any tort duty to CSI.13
B. Whether CSI Sufficiently Raised Statutory Claims
In its final argument, CSI asserts that St. Paul is liable
under the Texas Deceptive Trade Practices Act (DTPA), the Texas
Insurance Code, and common law negligence14 for the damages it
caused when it failed to investigate properly the claim and to
communicate to CSI its evaluation that CSI was exposed to a
13
Because we determine that St. Paul did not breach any tort
duty to CSI, we need not reach St. Paul’s argument that Texas
public policy now prohibits insurance companies from paying
punitive damage awards. See Hartford Cas. Ins. Co. v. Powell, 19
F.Supp.2d 678 (N.D. Tx. 1998) (discussing the history of punitive
damages under Texas law and a prior Fifth Circuit holding that
Texas public policy would not prevent liability insurance coverage
of punitive damages; concluding that Texas public policy now
prohibits such a payment).
14
As set forth above, the only tort duty that St. Paul owed
to CSI arises under Stowers.
12
substantial risk of punitive damages. St. Paul responds that these
statutory claims were not plead. We agree. Although in its answer
CSI cursorily mentioned these statutory claims, there is no
reference to either the DTPA or the Insurance Code in CSI’s
counterclaim. CSI failed to raise properly these statutory claims
in the court below, and that is further evidenced by the district
court’s complete omission of any reference to such claims in its
order granting St. Paul’s motion for judgment on the pleadings. We
refuse to consider claims that were not properly raised in the
district court. First United Financial Corp. v. Specialty Oil Co.,
5 F.3d 944, 948 n. 9 (5th Cir. 1993); see also Singleton v. Wulff,
428 U.S. 106, 120, 96 S.Ct. 2868, 2877 (1976) (“It is the general
rule, of course, that a federal appellate court does not consider
an issue not passed upon below.”).
For the above reasons, the district court’s judgment is
AFFIRMED in all respects.
13