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On July 7, 2017, the United States Fifth Circuit Court of Appeal, in Associated International Insurance Company v. Scottsdale Insurance Company, held that, under Texas law, the subrogation clause of an insurance agreement allowed a subrogated insurer to seek reformation of a contract between its insured and a third party.  In that appeal, the defendant’s primary and excess insurer settled a lawsuit.  The excess insurer, Associated International Insurance Co., then sought reimbursement from Scottsdale, an insurer that had also issued a commercial umbrella policy to the insured defendant.  Scottsdale argued Associated could not seek reimbursement because the property that had been at issue in the underlying suit was not listed on Scottsdale’s schedule of covered properties.

After Scottsdale denied its demand, Associated sought reformation of the insured’s contract with Scottsdale.  Associated argued that it was a mutual mistake for the insured and Scottsdale to have omitted the property at issue.  The United States District Court for the Southern District of Texas denied Associated’s claim, holding that Associated, as a subrogated insurer, had no standing to seek reformation because Associated was not in privity with the insured-Scottsdale agreement.  A panel of the United States Fifth Circuit reversed, agreeing with Associated.

The panel held that the district court “erred in reading reformation’s privity requirement to necessitate a specific connection” to the Scottsdale policy.  Here, the subrogation clause in the insured’s policy with Associated provided the connection.  The panel explained that Texas courts “generally treat subrogation as placing an insurer-subrogee in privity with its insured.”  In other words, the insured’s agreement to subrogate Associated to its claim after Associated paid the settlement on the insured’s behalf allowed Associated to stand in the shoes of the insured, including seeking to reform the insured’s policy with Scottsdale.  Scottsdale countered that Texas law, much like the laws of other states, limits a subrogated insurer’s rights.  For example, the subrogee may not “end up better off as a result of paying the insured by obtaining amounts from a third party beyond what is covered.”  The Fifth Circuit dismissed this argument as Associated sought “reformation as an avenue to recover what it paid, not to obtain a windfall from its insured’s filing of a claim.”

The unanimous decision of the panel extends the rights of insurers to recover amounts paid to their insureds.  Insurers should examine additional insurance provided to their insureds to determine if any further rights of recovery exist, and insureds should review not only their insurance policies but also their related contracts to ensure that their business relationships remain protected.

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