Does a “follow-form” excess insurance policy mean that it must follow the form of the underlying, primary insurance policy? According to the Texas Supreme Court, not necessarily.

In The Ohio Casualty Insurance Company v. Patterson-UTI Energy, Inc. et al., the Texas Supreme Court examined whether a follow-form excess insurance policy must cover a policyholder’s defense costs after the primary insurance policies had exhausted. The coverage dispute arose from a drilling-rig incident that led to multiple lawsuits which the policyholder, Patterson, and its insurers settled after extensive litigation. Patterson, through its broker, Marsh, had built an insurance tower consisting of a primary policy—the underlying policy—and various additional excess policies, including a “follow-form” excess policy from Ohio Casualty. The settlements and the litigation’s defense expenses triggered Ohio Casualty’s excess policy after exhausting the coverage limits of all lower-level policies. Ohio Casualty funded portions of the settlements with the injured claimants, but refused to cover any of Patterson’s defense expenses. Patterson then sued Ohio Casualty and Marsh.

At the trial court level, Patterson and Ohio Casualty filed competing motions for summary judgment. The trial court granted Patterson’s motion, finding that the defense expenses were covered under the Ohio Casualty policy because that policy “did not clearly and unambiguously exclude the coverage for defense costs provided by the underlying primary policy.” On appeal, the appellate court affirmed the summary judgment, noting that the Ohio Casualty “follow form” policy did not “unambiguously exclude defense expenses”.

The Texas Supreme Court disagreed, finding that the trial and appellate courts performed their analyses backwards. Rather than looking at the primary, underlying policy to determine the grant of coverage, the Court instead stated that the courts should have examined the grant of coverage in the excess policy first. Providing a qualified definition of “follow-form”, the Court rationalized as follows.

[I]t is expected that a contractual dispute about a follow-form excess policy will implicate the underlying policy. The extent of that implication, however, is not a binary choice but one that presents an array of options. The excess policy could adopt the underlying policy in its entirety; it could do so except for various express exclusions; or it could substantially change the scope of initial coverage by providing its own terms. Characterizing an excess policy as a “follow-form” policy, in other words, confirms only that the excess policy will to some degree incorporate the provisions of the underlying policy—the degree of incorporation is determined by the excess policy’s text. At all times, the excess policy itself remains the contract that governs a dispute about its coverage.

What did the Ohio Casualty provide with regard to defense expenses? The excess policy provided as follows.

We will pay on behalf of [Patterson] the amount of “loss” covered by this insurance in excess of the “Underlying Limits of Insurance[.]” . . . Except for the terms, conditions, definitions and exclusions of this policy, the coverage provided by this policy will follow the [underlying policy].

The excess policy defined “loss” as:

those sums actually paid in the settlement or satisfaction of a claim which [Patterson is] legally obligated to pay as damages after making proper deductions for all recoveries and salvage.

The Texas Supreme Court held that Patterson’s own legal expenses did not qualify as “loss” because they did not constitute “damages.” Citing to decade-old precedent, the Court reiterated that “a party’s own attorney’s fees are not, and have never been, damages.”  For Patterson’s legal expenses to qualify as a “loss,” Ohio Casualty would have had to have agreed in the insurance policy to define the term “damages” with a specialized meaning. The policy, however, did not provide any such special definition—it did not even define “damages” at all.

Patterson advanced two primary arguments to the Texas Supreme Court. First, since “damages” was not defined, the Court should start its evaluation with the underlying policy, the one Ohio Casualty was to follow. Second, because the Ohio Casualty policy contained specific exclusions for defense expenses related to asbestos and pollution claims, the policy covered defense expenses for all other types of claims. The Court rejected both arguments.

In holding that defining the term “damages” requires looking at the excess policy first and then underlying one, rather than the other way around, the Court explained as follows.

According to Patterson, the excess policy is bound by the underlying policy’s coverage choice unless the excess policy repudiates that choice rather than simply providing a different kind of coverage. This argument’s essence amounts to the approach we emphatically reject: starting with the underlying rather than the excess policy.

In dicta, the Court noted that even if the term “damages” in the Ohio Casualty policy included defense expenses, the coverage only extended to sums paid to an adverse party, like the personal-injury claimants who sued Patterson after the drilling-rig incident. As defense expenses are not sums paid to an adverse party, Ohio Casualty had no coverage for those expenses under the policy.

Next, the Court rejected Patterson’s argument that the specific exclusion of defense expenses for asbestos and pollution claims provided a grant of coverage for all other claims, including the personal injury claims at issue. The Court rationalized as follows.

[T]he excess policy’s specific references to attorney’s fees in the asbestos and pollution exclusions were understandable redundancies designed to eliminate any conceivable doubt—not surplusage that would alter our interpretation of the rest of the policy. The language of the two exclusions suggests a belt-and-suspenders approach…. [T]he care with which the asbestos and pollution exclusions were drafted should not have the perverse effect of subjecting Ohio Casualty to liability for all other defense expenses, even though the excess policy in no way undertakes to cover them.

As to Marsh, the broker that put together the insurance tower for Patterson, the Court remanded Patterson’s claims, allowing Patterson to pursue its claims against Marsh for failing to procure excess policies that covered defense expenses.

The Patterson case underscores the need for policyholders and brokers alike to disregard the labels affixed to policies and engage in an in-depth review of the coverages granted and excluded at each layer of an insurance tower. Blind reliance on a statement that an excess policy is “follow-form” is simply insufficient.

The attorneys in our Austin and Dallas office are available to answer any questions you may have. Please contact us at info@gstexlaw.com.

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