In a recent decision, a U.S. District Court held a primary insurer could not assert an equitable unclean hands defense against the excess insurer in response to an equitable subrogation claim in a Stowers case. Westport Ins. Corp. v. Pennsylvania Nat’l Mut. Cas. Ins. Co., No. 4:16-CV-01947, 2023 WL 2574982, at *1 (S.D. Tex. Mar. 17, 2023). A marina in north Texas was damaged in a storm after it contracted with Insurance Alliance (IA) to procure full insurance coverage . After the storm, gaps in the coverage were discovered and the marina sued IA. IA was insured by a $5 million primary policy issued by Westport and an umbrella policy issued by Penn National with a $15 million limit. Westport defended the marina but Penn National was not notified of the suit immediately, and Westport participated in settlement discussions, which were unsuccessful. At trial a jury awarded over $8.7 million in damages to the marina. Id. at 1-2.

Westport agreed to supersede the judgment but only to the extent of its remaining policy limits ($3.3 million), Penn National declined to supersede the remainder, and IA had to file the supersedeas bond in the full amount to avoid forfeiture of its assets. Subsequently, IA asked Westport and Penn National to reimburse it for the bond and Westport agreed if Penn National would agree to fund any final judgment above the remaining Westport limits. Id. at 2. Penn National merely agreed to “honor its obligations” to IA under its policy and IA filed a substitute bond with NASIC as surety. The underlying judgment was affirmed on appeal and the marina demanded IA immediately pay the judgment. IA, Westport and NASIC entered into negotiations to resolve the judgment, but Penn National refused to participate. An agreement was reached in which NASIC paid Highport the undisputed amount and Westport reimbursed NASIC. Westport then notified Penn National that the primary policy was exhausted and demanded Penn National pay the “ultimate net loss” in excess of the Westport limits. Id.

In the suit between the two insurers, Penn National argued Westport violated its Stowers duties in failing to settle within its limits on four separate occasions. Ultimately, the jury found Westport failed to act prudently as to all four settlement offers. Id. at 3. Westport argued Penn National could not enforce the Stowers duties by equitable subrogation because Penn had “unclean hands” and that defense, among others, was submitted to the trial judge after the jury verdict. See Hand v. State, 335 S.W.2d 410, 419 (Tex.Civ.App.—Houston 1960, writ ref’d. n.r.e.) (determination of whether a party has unclean hands is left to the discretion of the trial court). Generally, equitable relief is not warranted “when a plaintiff has engaged in unjust, unconscionable, or inequitable conduct with regard to the issue in dispute.” 2023 WL 2574982, at 5 (citing In re Francis, 186 S.W.3d 534, 551 (Tex.2006)). Westport argued that, in numerous ways, Penn breached its duties to defend and indemnify the marina when its policy was triggered, and therefore came to its equitable subrogation claims with “unclean hands.” Id. at 6-7.

The court first held that Penn’s conduct did not constitute “unclean hands” but, in the alternative, found that the defense was legally invalid because Westport had breached its Stowers duties in connection with two settlement demands, well before Penn National’s policy obligations were triggered.  Id. at 7-8. Thus, Penn National’s breaches were “collateral to” the Stowers violations and were “’unrelated misconduct’ that ha[d] no bearing on Westport’s Stowers violations.” Id. at 5, 8 (citing Grohn v. Marquardt, 657 S.W.2d 851, 855 (Tex. App.—San Antonio 1983, writ ref’d)). The court thus held that “Penn National’s breach of its duties to defend and indemnify, even if such conduct qualified as unclean hands, was merely collateral to Penn Nationals Stowers claims.” Id. at 8.  The holding, in essence, is that the subrogee’s “unclean hands” must have some role in causing the underlying damage before it can preclude the subrogation action.