Associated International Insurance Co. v. Scottsdale Insurance Co.

Case: 16-20465 Document: 00514064111 Page: 1 Date Filed: 07/07/2017
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
July 7, 2017
No. 16-20465
Lyle W. Cayce
Clerk
ASSOCIATED INTERNATIONAL INSURANCE COMPANY, Individually
and as subrogee of Alpha Barnes Real Estate Services, L.L.C.,
Plaintiff - Appellant
v.
SCOTTSDALE INSURANCE COMPANY,
Defendant - Appellee
Appeal from the United States District Court
for the Southern District of Texas
Before REAVLEY, HAYNES, and COSTA, Circuit Judges.
GREGG COSTA, Circuit Judge:
Subrogation clauses are common in insurance policies. They transfer
rights from the insured to the insurer, allowing the latter to recover funds it
paid to cover the former’s loss. We decide whether the rights that flow through
a subrogation clause allow an insurer to seek reformation of a contract between
its insured and a third party.
I.
This Texas insurance case arose from an assault in an apartment
complex owned by VDC-Matthew Ridge, Ltd. The plaintiff in that lawsuit
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sought recovery from Matthew Ridge and the property manager of the complex,
Alpha-Barnes Real Estate Services, LLC. The lawsuit settled.
Matthew Ridge had an insurance policy issued by Westfield Insurance
Company that extended to Alpha Barnes through its role as Matthew Ridge’s
property manager. Westfield exhausted that policy in defending and settling
the lawsuit for both the apartment complex and property manager. Matthew
Ridge’s commercial umbrella insurer, Associated International Insurance
Company, paid the portion of the settlement that was in excess of the Westfield
policy. Associated now seeks reimbursement from Scottsdale Insurance
Company, an insurer that issued a commercial umbrella policy to Alpha. It
does so despite that policy not listing the complex on the schedule of covered
properties.
Associated asserts it can seek reimbursement from Scottsdale on Alpha’s
behalf through a subrogation clause in the policy it issued to Alpha. That
clause states that “if [Alpha] has rights to recover all or part of any payment
[Associated has] made under [the] policy, those rights are transferred to
[Associated].” But how can Associated seek reimbursement from Scottsdale
when the umbrella policy does not list the property at issue? Associated
contends that it can reform the Alpha-Scottsdale agreement to include the
apartment complex because it was omitted due to a mutual mistake between
those contracting parties.
The district court rejected this argument, first in an unexplained order
dismissing Associated’s claim at the pleading stage under Rules 12(b)(1) and
12(b)(6), and later in a brief opinion denying Associated’s motion for
reconsideration. The district court concluded that Associated had no standing
to seek reformation because it was not in privity with the Alpha-Scottsdale
“agreement.” Associated appeals, arguing that it has standing as a subrogee
to seek reformation on its insured’s behalf.
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II.
Despite the ubiquity of subrogation clauses, Texas law has not addressed
whether a subrogation clause allows a subrogee to assert a reformation claim
on a contract between its subrogor and a third party. As we answer it in the
first instance, we keep in mind the longstanding principle of Texas courts to
“recognize the [subrogation] doctrine . . . to its fullest extent.” Frymire Eng’g
Co. ex rel. Liberty Mut. Ins. v. Jomar Int’l., Ltd., 259 S.W.3d 140, 141 (Tex.
2008) (quoting Faires v. Cockrill, 31 S.W. 190, 194 (1895) (noting that “the
courts of no state have gone further” than Texas “in applying the doctrine of
subrogation”)).
“Subrogation is the substitution of one party for another such that the
new party may assert the rights of the substituted party.” Cont’l Cas. Co. v.
N. Am. Capacity Ins. Co., 683 F.3d 79, 85 (5th Cir. 2012). Without subrogation,
the only ways to prevent an insured from obtaining a double recovery would be
to delay the insurer’s payment until recovery from a third party could be had
or to disallow an insured from recovering from a third party once the insurer
paid out the claim. The former could cause delay in insurance companies
paying claims to make injured parties whole; the latter could allow tortfeasors
to escape liability. LEE R. RUSS & THOMAS F. SEGALLA, COUCH ON INSURANCE
§ 222:4 (3d ed. 2005). Subrogation avoids these unfavorable outcomes by
permitting an insurer to “stand in the shoes of the insured,” allowing the
insurer to assert any claims or rights held by the insured against a third party.
Mid-Continent Ins. v. Liberty Mut. Ins., 236 S.W.3d 765, 774 (Tex. 2007); see
also Am. Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 484 (Tex. 1992)
(allowing a subrogee to assert a legal malpractice claim against the subrogor’s
defense attorney).
Do those rights that pass to the subrogee include the right to reform a
contract? Reformation allows parties to correct a mutual mistake made in
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drafting a contract, “so that the instrument truly reflects the original
agreement of the parties.” Simpson v. Curtis, 351 S.W.3d 374, 378 (Tex. App.—
Tyler 2010, no pet.) (citing Cherokee Water Co. v. Forderhause, 741 S.W.2d 377,
379 (Tex. 1987)). Reformation may be sought by either the parties to the
original contract or those standing in privity with them. Merrimack Mut. Fire
Ins. Co. v. Allied Fairbanks Bank, 678 S.W.2d 574, 577 (Tex. App.—Houston
[14th Dist.] 1984, writ ref’d n.r.e.).
The district court erred in reading reformation’s privity requirement to
necessitate a specific connection to the Alpha-Scottsdale insurance policy.
Privity in Texas instead focuses on the relationship to a party. See id.
(“Reformation is an action on a written contract and may be had only by the
immediate parties thereto and by those standing in privity with them.”); First-
Citizens Bank & Trust Co. v. Greater Austin Area Telecomm. Network, 318
S.W.3d 560, 566 (Tex. App.—Austin 2010, no pet.) (“[P]rivity is established by
proving that the defendant was a party to an enforceable contract with either
the plaintiff or a party who assigned its cause of action to the plaintiff.”); see
also PRIVITY, BLACK’S LAW DICTIONARY 1320 (9th ed. 2009) (“The connection or
relationship between two parties, each having a legally recognized interest in
the same subject matter.”).
So the standing question turns on whether Associated is in privity with
Alpha. The subrogation clause in the Associated-Alpha policy provides that
connection. Courts generally treat subrogation as placing an insurer-subrogee
in privity with its insured. See, e.g., St. Paul Fire & Marine Ins. v. State
Volunteer Mut. Ins. Co., 212 F.3d 595 (5th Cir. 2000) (unpublished table
decision) (holding, under Mississippi law, that a subrogee is in privity with a
subrogor, allowing the subrogee to challenge a contract between the subrogor
and a third party); D’Arata v. New York Cent. Mut. Fire Ins. Co., 564 N.E.2d
634, 665 (N.Y. 1990) (noting that a subrogee is in privity with an insured as it
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“stands in the shoes” of the insured for preclusion purposes); DeCare v.
American Fidelity Fire Ins. Co., 360 N.W.2d 872, 876 (Mich. Ct. App. 1984)
(applying res judicata because the subrogee “stood in [the subrogor’s] shoes”
and thus was in privity); Ohio Dept. of Human Serv. v. Kozar, 651 N.E.2d 1039,
1041 (Ohio Ct. App. 1995) (same). This makes sense as subrogation works
much like an assignment; both transfer rights from the assignor to the
assignee. See Hamilton v. United Healthcare of La., Inc., 310 F.3d 385, 397
(5th Cir. 2002) (Garza, J., concurring) (“[I]n essence, subrogation is an
assignment.”); COUCH ON INSURANCE § 222:54 (noting that the distinction
between assignment and subrogation may be “academic and not a substantive
matter”). And it is well accepted that an assignment creates privity. First-
Citizens Bank & Trust Co., 318 S.W.3d at 566. As subrogees stand in the shoes
of their insureds just like assignees “stand[ ] in the shoes of [ ] assignor[s],”
Gulf Ins. Co. v. Burns Motors, Inc., 22 S.W.3d 417, 420 (Tex. 2000), the privity
necessary for reformation logically extends to the subrogation context. 1
Despite the broad rights Texas grants subrogees, Scottsdale tries to find
a limit in cases preventing subrogees from recovering certain types of damages.
They may not, for example, seek statutory or punitive damages. Nat’l Union
Fire Ins. Co. of Pittsburgh, Pa. v. Ins. Co. of N. Am., 955 S.W.2d 120, 133 (Tex.
App.—Houston [14th Dist.] 1997), aff’d sub nom. Keck, Mahin & Cate v. Nat’l
Union Fire Ins. Co. of Pittsburgh, Pa., 20 S.W.3d 692 (Tex. 2000). Those rules
1 Scottsdale asserts that New Jersey has held that subrogation does not create privity.
Kolker Chem. Corp. v. Lumbermens Mut. Cas. Co., 196 A.2d 266 (1963). Kolker held that a
subrogee has standing to seek reformation of a contract if it has a substantial interest in that
contract. Id. at 268–69. Scottsdale reads this to mean that subrogation does not create
privity. But Kolker made no such finding, as it only held that a substantial interest was
enough without opining on what role privity plays. Even if New Jersey law did reject privity
in this situation, more persuasive is the Texas jurisprudence repeatedly stating that a
subrogee “stands in the shoes” of the insured and the prevailing view that subrogation creates
privity.
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follow from the equitable purpose of subrogation which is to allow the subrogee
to seek recovery of amounts it paid to the insured. Id. Texas does not allow
the subrogee to end up better off as a result of paying the insured by obtaining
amounts from a third party beyond what it covered. But that is not what
Associated is seeking through its reformation claim. It seeks reformation as
an avenue to recover what it paid, not to obtain a windfall from its insured’s
filing of a claim.
Scottsdale also points out that it may not always be in the insured’s
interest for a subrogee to seek reformation of the contract. Perhaps the
contracting parties’ mistake provided an overall benefit to the insured, as a
successful reformation claim could result in a higher premium or a different
list of covered properties. But an insured’s displeasure with its insurer’s
litigation decisions is a not infrequent consequence of the subrogee getting to
step into its shoes. An insurer may, for example, pursue a subrogation claim
against a business with whom the insured wants to maintain cordial relations,
or against a doctor with whom the insured has a close relationship. In those
cases, the insured gets no say in the subrogee’s decision to bring suit. Cf.
Prudential Prop. & Cas. Co. v. Dow Chevrolet-Olds, Inc., 10 S.W.3d 97, 100
(Tex. App.—Texarkana 1999, pet. dism’d) (explaining that an insurer “can
assert its subrogation claim independently of the insured” in reversing
dismissal against insurance company because its insured refused to appear for
deposition). The same is true here. And the reformation claim, if successful,
would only return the insured to the agreement it intended to make in the first
place. It would not impose obligations on the insured to which it never agreed.
Cherokee Water Co., 741 S.W.2d at 379 (“The underlying objective of
reformation is to correct a mutual mistake . . . so that the instrument truly
reflects the original agreement of the parties.”).
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We have no basis for considering the merits of that reformation claim as
the case was dismissed on standing grounds at the pleading stage. That
judgment of the district court is REVERSED and we REMAND for further
proceedings during which the merits of reformation can be considered.
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