Over many years of this author’s 40 years of practicing law and 30 years of teaching judicial advocacy and insurance appeals, the two areas of Texas jurisprudence most interesting to me have been intentional torts and insurance coverage disputes. While there are several points of intersection between those two worlds of intentional torts and insurance, one specific point of intersection has arisen with surprising frequency and success – the tort of bad faith investigations by insurers.
Claims of bad faith investigation by insurers has arisen in many different contexts, and not surprisingly those claims have proved very successful in practice. What has been surprising, however, is that these successful claims have resulted either in the case settling favorably for policyholders or having been decided in the secrecy of coverage arbitrations. As a direct result of the confidentiality of arbitrations and the settlement of these claims prior to appeal, the case law jurisprudence on this type of bad faith has largely gone unreported and undeveloped in appellate opinions. This lack of development and resulting lack of awareness cries out for correction. This paper is an attempt to bring this issue to the considered attention of bench and bar and to start a discussion that leads to judicial development of claimed regarding bad faith insurance claims investigations.
To that end, this paper will first identify the well settled jurisprudential principles outside of insurance that have been developed by the Texas Supreme Court and other appellate opinions. The paper will then identify the relatively limited number of reported coverage cases in which these principles have been applied. Finally, the paper suggests just a few specific examples of the many potential coverage issues to which these principles may be applied.
One obvious caveat needs to made explicit – this paper is not intended to be a neutral, academic law review article merely summarizing existing Texas insurance jurisprudence regarding bad faith investigations by insurers. Instead this is an explicit advocacy piece to bring these issues to the attention of the bench and bar and it should be viewed in that light. The author hopes that the paper will provoke serious discussion between both sides of the coverage bar, and lead to the jurisprudence surrounding bad faith investigations by insurers being further developed by savvy policyholders and litigious insurers in Texas’ appellate courts and Supreme Court.
At the outset, it may be information to consider bad faith investigation allegations based on unreasonable investigations that would satisfy the standards used in all other area of jurisprudence. It is this author’s belief that those cases are being settled, and that is the real reason we don’t have more explicit appellate cases applying these jurisprudential principles in the context of insurance cases. In any event, there is no principled basis that this author knows to say that insurance jurisprudence should be carved out as an exception to all that otherwise broadly and uniformly applied intentional tort jurisprudence.
The contours of the general duty to investigate has long been developed in various areas of Texas jurisprudence. For decades, in the late Nineteenth and early Twentieth Centuries, in ownership disputes involving both real and personal property, Texas courts routinely applied the concept of “inquiry notice.” Inquiry notice is a doctrine that creates a legal duty to make a “further inquiry” when a party who is about to undertake some action learns of relevant suspicious facts that would make a reasonable person investigate further. Flack v. First Nat. Bank of Dalhart, 148 Tex. 495, 500, 226 S.W.2d 628, 632 (1950). Under the doctrine of “inquiry notice,” a buyer is obligated to investigate suspicious facts and red flags that point to the existence of an undisclosed owner. In other words, suspicious facts and red flags create a duty to investigate that did not otherwise exist.
This good faith duty to investigate was explored in depth by the Texas Supreme Court in Janvey v. GMAG, L.L.C., 592 S.W.3d 125 (Tex. 2019). The Court defined “inquiry notice” in the context of an allegedly fraudulent transfer of $88 million in cash as follows:
[A] transferee is on inquiry notice when it “takes property with knowledge of such facts as would excite the suspicions of a person of ordinary prudence” regarding ‘the fraudulent nature of an alleged transfer.”… A transferee on inquiry notice knows facts that are, or should be, suspicious: red flags that a reasonable person would have investigated prior to engaging in the transfer.Janvey, 592 S.W.3d at 130 (quoting Hahn v. Love, 321 S.W.3d 517, 527 (Tex. App. – Houston [1st Dist.] 2009, pet. denied)).
Thus, under Texas jurisprudence, “suspicious” circumstances and “red flags” can trigger a legal duty that may not have otherwise existed. The Janvey court concluded that when Texas courts had found violations of the doctrine of inquiry notice, potential buyers of property were often appropriately charged with the key knowledge – that someone else, besides the seller, had competing claims to own the property being bought and sold.
One recurring theme in the inquiry-notice caselaw, especially in the real estate context, is that basic notions of justice require a party acquiring land or other property to reach out and directly contact whoever might have a claim on the property. This may formally be described as a duty to “investigate,” and it was based on the practical expectation that a potential purchaser should have the common decency to pick up the phone and call the potential owner. This practical expectation of investigation appeared in the caselaw as early as 1904, when the Texas Supreme Court held that it was a “safe and salutary rule” to require a purchaser “to go to the possessor and ascertain the nature and extent of his claim.” Collum v. Sanger Bros., 98 Tex. 162, 165, 82 S.W. 459, 460 (1904). The Court emphasized that “common prudence and common honesty demand this course.” Id. Similarly, in Carter v. Converse, the Tyler Court of Appeals emphasized that the defendant should have just picked up the phone and called the plaintiff: “Certainly an inquiry of appellee would have prevented the forged ratification deed and probably would have discovered the facts surrounding the execution of the power of attorney ….” Carter v. Converse, 550 S.W.2d 322, 331 (Tex. Civ. App. – Tyler 1977, writ ref’d n.r.e.).
A notable federal opinion on on “implied actual notice” (which appears to be the same as inquiry notice), authored by the influential Judge Posner, echoed this same theme – that the party potentially on notice should have picked up the phone and begun to investigate further . See Shacket v. Philko Aviation, Inc., 841 F.2d 166, 170 (7th Cir. 1988) (“Inquiry either of Clark Aviation or of Krueger Aviation would immediately have disclosed Smith’s fraud ….”) (Posner, J.). Importantly, Judge Posner also calibrated just how suspicious the facts needed to be in order to trigger the duty to further investigate, depending on how easily it would be to discover potentially competing ownership claims: “When the burden of inquiry is slight, facts only slightly suspicious are enough to trigger it.” Shacket, 841 F.2d at 171. Even when using more formal descriptions, the inquiry notice doctrine is based on how an objectively “honest and prudent person” would act after learning of the suspicious circumstances and red flags. Flack, 148 Tex. at 500, 226 S.W.2d at 632.
As a result, for well over 100 years, when Texas courts found “inquiry notice,” sales were often invalidated, liens were often lost or subordinated, and damages awarded – all because the buyers had failed to satisfy their duty to investigate further.
In both state and federal jurisprudence, the doctrine of “inquiry notice” is closely aligned with the doctrine of “willful blindness.” The U.S. Supreme Court has explored and applied the doctrine of willful blindness, and the foundational case is its near unanimous opinion in Global-Tech Appliances, Inc. v. SEB S.A., 563 U.S. 754, 769 (2011) . According to Global-Tech, “a willfully blind defendant is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts.” Id. Most importantly, “persons who know enough to blind themselves to direct proof of critical facts in effect have actual knowledge of those facts.” Global-Tech, 563 U.S. at 766. Parties who are willfully blind are “just as culpable as those who have actual knowledge.” Id. Global-Tech cited a secondary source for the proposition that “A court can properly find willful blindness only where it can almost be said that the defendant actually knew.” Id. at 769-70 (describing G. Williams, Criminal Law § 57, p. 159 (2d ed. 1961)).
Willful blindness was best described by the Seventh Circuit – “the form of actual knowledge that consists of closing your eyes because you’re afraid of what you would see if you opened them.” Shacket v. Philko Aviation, Inc., 841 F.2d 166, 171 (7th Cir. 1988) (Posner, J.). Other names for willful blindness include “willful ignorance,” deliberate ignorance,” and “conscious avoidance of the truth.”
Willful blindness is commonly used in federal criminal law, and it importantly attributes the necessary scienter to a defendant whenever the defendant strongly suspects the illegality of his actions – but deliberately refuses to take the obvious steps to find out. A common criminal law example is where the driver of a vehicle carrying contraband deliberately chooses not to look in the trunk. A driver like this takes the attitude: “Don’t tell me, I don’t want to know.” United States v. de Luna, 815 F.2d 301, 302 (5th Cir. 1987). The criminal’s obvious motive is, if caught, to be able to ‘truthfully’ tell the police, “I did not know.” Federal criminal law, jaded to this old trick, instead attributes the necessary actual knowledge to the defendant if the jury finds that the defendant was willfully blind.
One question is when will willful blindness serve as a substitute for actual knowledge. While some intermediate courts have held that willful blindness does not literally constitute “actual” knowledge of the wrongdoing, see Fenner v. Am. Sur. Co. of New York, 156 S.W.2d 279, 283 (Tex. Civ. App. – Waco 1941, writ ref’d w.o.m.), other courts have held that willful blindness does effectively constitute actual knowledge: “The rule that willful blindness is equivalent to knowledge is essential, and is found throughout the criminal law.” United States v. Jewell, 532 F.2d 697, 700 (9th Cir. 1976) (en banc) (citations omitted).
In criminal cases, federal courts have traditionally used “willful blindness” in their jury instructions. These are often called “deliberate ignorance instructions” or “Jewell instructions,” after the seminal U.S. Supreme Court case, United States v. Jewell.
Willful blindness has a lot in common with a violation of inquiry notice (i.e., by a failure to investigate further). In fact, the Texas Supreme Court has expressly linked the concepts. See Janvey, 592 S.W.3d at 133 (“A transferee on inquiry notice of fraud cannot shield itself from TUFTA’s clawback provision without diligently investigating its initial suspicions – irrespective of whether a hypothetical investigation would reveal fraudulent conduct. To hold otherwise rewards willful ignorance ….”). On the other hand, violations of inquiry notice for the mere failure to investigate further can be different from willful blindness. In order for the failure to investigate to become willful blindness the defendant’s decision not to investigate further must be to avoid the truth. The law of defamation provides one example. To prove that a defendant defamed a public official, the law famously requires that the plaintiff prove actual malice. New York Times Co. v. Sullivan, 376 U.S. 254, 279-80 (1964). In applying the “actual malice” standard, the Texas Supreme Court distinguished the mere failure to investigate from willful blindness: “A failure to investigate fully is not evidence of actual malice; a purposeful avoidance of the truth is.” Bentley v. Bunton, 94 S.W.3d 561, 596 (Tex. 2002).
This paper posits that the critical distinction between the violation of inquiry notice and willful blindness is the intent, motivation, or deliberateness underlying the decision to not investigate further. This distinction closely tracts the U.S. Supreme Court’s definition of willful blindness: “a willfully blind defendant is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts.” Global-Tech, 563 U.S. at 769.
The Fifth Circuit has similarly held that “The key aspect of deliberate ignorance is the conscious action of the defendant – the defendant consciously attempted to escape confirmation of conditions or events he strongly suspected to exist.” United States v. Lara-Velasquez, 919 F.2d 946, 951 (5th Cir. 1990) (emphasis in original). The Seventh Circuit adopted a similar view in the Shacket opinion by Judge Posner. In ruling on a federal statute that required “actual notice,” Judge Posner explained that inquiry notice was sufficient to constitute “actual notice” – but that willful blindness went further and constituted a “form of actual knowledge”:
Admittedly, the line between “constructive notice,” which is not within the scope of 49 U.S.C. § 1403(c), and “implied actual notice,” which is, is a fine one. But “constructive notice” often means no notice, while “implied actual notice” requires (1) actual knowledge of (2) highly suspicious circumstances, coupled with (3) an unaccountable failure to react to them. This in turn is a shade short of the form of actual knowledge that consists of closing your eyes because you’re afraid of what you would see if you opened them.
Shacket, 841 F.2d at 171.
There are a variety of ways under the existing common law in which insurers, like any other type of party, could be under a duty to investigate in connection with their own insurance contract.
First, the Texas Supreme Court has long recognized that red flags and suspicious circumstances can create a duty to investigate in certain circumstances, such as when someone is about to purchase real property that might belong to someone else:
The general doctrine is, that whatever puts a party upon an inquiry amounts, in judgment of law, to notice, provided the inquiry becomes a duty, as in the case of purchasers and creditors, and would lead to the knowledge of the requisite fact, by the exercise of ordinary diligence and understanding.
Wethered’s Administrator v. Boon, 17 Tex. 143, 150 (1856) (cited in Janvey).
The decision whether to extend, or deny, insurance coverage or defense can be considered similar to those circumstances. Insurers are the sellers of insurance services, including claims handling services, who are:
The principles used in other areas to establish knowing and actual knowledge should be no less applicable, notwithstanding that the Texas Supreme Court has not yet had the opportunity to address those claims and issues.
Second, inquiry notice has already been applied to insurers – in the context of limitations. United Healthcare Services, Inc. v. First St. Hosp. LP, 570 S.W.3d 323, 336 (Tex. App.—Houston [1st Dist.] 2018, pet. denied).
As background, “[c]ourts use varying terminology to express and apply the discovery rule. At times, as with the cases cited above, the focus is on whether ‘reasonable diligence’ would have discovered the fraud…. At other times, the question is whether the plaintiff had ‘constructive notice’ of the fraud because pertinent information was ‘readily accessible and publicly available’ but ignored….” Id. at 336 (internal citations omitted). “A third expression is in terms of “inquiry notice.” Id. (citing Seureau v. ExxonMobil Corp., 274 S.W.3d 206, 228 (Tex. App. – Houston [14th Dist.] 2008, no pet.) (framing discover rule using “inquiry” standard), and Hoover v. Gregory, 835 S.W.2d 668, 671 (Tex. App.—Dallas 1992, writ denied) (same)).
Under the inquiry notice approach to the discovery rule, “knowledge of facts that could cause a reasonably prudent person to make an inquiry that would lead to discovery of the cause of action is in the law equivalent to knowledge of the cause of action for limitations purposes.” See Town of Dish v. Atmos Energy Corp., 519 S.W.3d 605, 613 (Tex. 2017) (quoting with approval Mitchell Energy Corp. v. Bartlett, 958 S.W.2d 430, 436 (Tex. App. – Fort Worth 1997, pet. denied)). Once a party is on inquiry notice of an alleged fraud, the limitations period begins:
“[W]e conclude that notice of Aetna’s suit placed United on inquiry notice of its fraud claim against First Hospital and its affiliated Off-site ERs, meaning that United’s fraud claim accrued, as a matter of law, on June 2, 2011, when, through the exercise of reasonable diligence, United could have discovered the facts giving rise to its claim.”
United Healthcare Servs., Inc. v. First St. Hosp. LP, 570 S.W.3d 323, 336 & 340 (Tex. App. – Houston [1st Dist.] 2018, pet. denied).
Third, in the real estate context, an inquiry-notice based legal duty to investigate has long been part of Texas law. Most vividly, a duty to inquire can be triggered when someone is in possession of the property: “We think it a safe and salutary rule to require of a prospective purchaser of land to ascertain whether any other be in occupancy of it; and, if there be such possession, to go to the possessor and ascertain the nature and extent of his claim.” Collum, 98 Tex. at 165; 82 S.W. at 460. Texas courts have also cited various different types of red flags that can trigger the doctrine:
Because the inquiry-notice doctrine was developed so extensively in the context of real estate, it might have been tempting to posit that the doctrine is limited to real estate – but that would be wrong. For example, the Texas Supreme Court recently applied the inquiry-notice doctrine to cash transfers – arguably the opposite of real estate, given that cash is typically considered the prototypical fungible asset. See Janvey, 592 S.W.3d at 130-32.
Moreover, historically, the doctrine was never limited to real estate. As another example, one of the Texas Supreme Court’s landmark inquiry-notice cases involved a chattel mortgage on cattle. See Flack, 148 Tex. at 497-98, 226 S.W.2d at 630. In Flack, the Supreme Court found that there was legally sufficient evidence to support a jury finding that a bank was on inquiry notice that the borrower did not own the cattle at issue, when – among other things – the cattle were not branded and the bank officer had testified that “if cattle did not have a man’s brand …, that makes one wonder about it, and that where a man is showing cattle (as collateral to a loan) that he has claimed to own for some time and that are still unbranded, this fact would make one wonder more.” Id., 148 Tex. at 501, 226 S.W.2d at 632-33. The bank officer had also discovered that there was another, joint owner of the cattle and had undertaken to confirm that the borrower owned different cattle – but had not done so for the cattle at issue. Id. Another inquiry-notice case addressed whether an attorney received notice of a judgment. See Welborn Mortg. Corp. v. Knowles, 851 S.W.2d 328, 331 (Tex. App. – Dallas 1993, writ denied) (“Where there is a duty of finding out and knowing, negligent ignorance has the same effect in law as actual knowledge.”).
The Texas Legislature has expressly placed a duty to investigate on insurers – in connection with the adjustment of claims. In particular, “failing to adopt and implement reasonable standards for the prompt investigation of claims arising under the insurer’s policies” is an unfair settlement claim practice. Tex. Ins. Code § 542.003(b)(3). While proceedings to enforce 542 are limited to the TDI, they nevertheless impose a duty on insurers consistent with the propositions in this paper. See, e.g., Terry v. Safeco Ins. Co. of Am., 930 F. Supp. 2d 702, 714 (S.D. Tex. 2013). Additionally, “refusing to pay a claim without conducting a reasonable investigation with respect to the claim” is “an unfair method of competition or an unfair or deceptive act or practice” – i.e., bad faith. Tex. Ins. Code § 541.060(a)(7).
Implicit in the duty to investigate is a requirement that the investigation be legitimate, objectively full and fair, and not a mere pretext. “[A]n insurer cannot insulate itself from bad faith liability by investigating a claim in a manner calculated to construct a pretextual basis for denial.” State Farm Fire & Cas. Co. v. Simmons, 963 S.W.2d 42, 44 (Tex. 1998); see also AIG Aviation, Inc. v. Holt Helicopters, Inc., 198 S.W.3d 276, 288 (Tex. App.—San Antonio 2006, pet. denied) (“Based on the evidence, the jury could have concluded that AIG knowingly conducted an outcome-oriented investigation.”).
Nor can an insurer shirk its duty to investigate by passing the responsibility off to an expert. “Instead, we have repeatedly acknowledged that an insurer’s reliance upon an expert’s report, standing alone, will not necessarily shield the carrier if there is evidence that the report was not objectively prepared or the insurer’s reliance on the report was unreasonable.” State Farm Lloyds v. Nicolau, 951 S.W.2d 444, 448 (Tex. 1997); see also id. (“Courts of appeals have likewise held, in similar circumstances, that evidence casting doubt on the reliability of the insurer’s expert’s opinions may support a bad-faith finding.”).
For example, the following evidence would constitute bad faith by an insurer when settling a claim:
There is evidence that would show Standard Fire’s investigation of Mrs. Stephenson’s claim was not a reasonable one but, instead, was an investigation conducted to disprove the compensability of the claim, in accordance with instructions from the investigator’s supervisors. There was also evidence that Standard Fire basically approached heart attack claims by conducting an investigation that would disprove the claim.
Standard Fire Ins. Co. v. Stephenson, 963 S.W.2d 81, 85 (Tex. App.—Beaumont 1997, no pet.).
A good faith duty to investigate also arises under Texas common law as a result of the special relationship between insurers and their insureds. “The ‘special relationship’ between the insured and insurer imposes on the insurer a duty to investigate claims thoroughly and in good faith, and to deny those claims only after an investigation reveals there is a reasonable basis to do so.” Viles v. Sec. Nat. Ins. Co., 788 S.W.2d 566, 568 (Tex. 1990). The Texas Supreme Court has adopted the same standards discussed above for the common law duty. See Universe Life Ins. Co. v. Giles, 950 S.W.2d 48, 55 (Tex. 1997) (“Although section 4(10)(a)(ii) does not, by its terms, govern common-law bad-faith actions, we believe that the standard it establishes will prove workable in such actions.”).
Because of the special relationship between insurers and insureds, insurers also have special duties under Texas law that reinforce the duty to avoid misleading their insureds. Specifically, insurers owe their insureds a duty that does not exist in contracts generally: an extra duty of good faith and fair dealing. Arnold v. Nat’l Cnty. Mut. Fire Ins. Co., 725 S.W.2d 165, 167 (Tex. 1987). This duty is similarly based on the special relationship between insurance companies and their insureds – a relationship that “arises out of the parties’ unequal bargaining power and the nature of insurance contracts which would allow unscrupulous insurers to take advantage of their insureds’ misfortunes in bargaining for settlement or resolution of claims.” Id.
Accordingly, “[a]n insurer has a duty to deal fairly and in good faith with its insured in the processing and payment of claims.” Republic Ins. Co. v. Stoker, 903 S.W.2d 338, 340 (Tex. 1995); see also Tex. Ins. Code § 542.003(b)(4) (establishing liability for “not attempting in good faith to effect a prompt, fair, and equitable settlement of a claim submitted in which liability has become reasonably clear”). The Texas Supreme Court has also confirmed that a “good faith and fair dealing” claim is in effect “a bad-faith cause of action related to claims processing.” Elephant Ins. Co., LLC v. Kenyon, 644 S.W.3d 137, 143 (Tex. 2022).
While the common law duty of good faith has been referred to as applicable only to first-party insurance, that is a different duty of good faith than this paper is speaking to/relying on. All insurers are under some duty of good faith and fair dealing to their insured, regardless of third party vs. first party contexts, due to the imbalance of power between insurers and their insured that underlie insurance relationships. Although the Texas Supreme Court has specifically 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,” the Court has not ruled out a duty of good faith generally. See Maryland Ins. Co. v. Head Indus. Coatings & Services, Inc., 938 S.W.2d 27 (Tex. 1996).
Moreover, an exception in the third-party policy context is defense obligations, which are considered first-party because the duty is owed by the insurer to the policyholder itself to pay for the policyholder’s own defense, whether directly, or indirectly to policyholder’s attorneys. See Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007) (“[A]n insured’s claim against liability insurer for defense costs is a ‘first party claim’ within the meaning of the prompt payment statute.”). In other words, the duty of an insurer to investigate may be supported or curtailed based on the type of policy and other circumstances, and that presumably would affect any corollary duty of inquiry.
The doctrine of inquiry notice is likely to have the biggest investigation impact in connection with insurers’ duty of good faith and fair dealing. The Texas Supreme Court in Janvey held that a party lacks good faith as a matter of law if that party is on inquiry notice and fails to investigate further – regardless of whether that investigation would have revealed the underlying fraud. See generally Janvey, 592 S.W.3d at 128-33.
The Janvey case arose from the billion-dollar Stanford Ponzi scheme. See Janvey, 592 S.W.3d at 126-28. The Janvey case involved the issue of unwinding “fraudulent transfers” via the Texas Uniform Fraudulent Transfer Act (TUFTA). While TUFTA does not generally address common-law fraud, TUFTA does protect the creditors of insolvent debtors from improper, preferential transfers of the debtor’s assets to select creditors – usually to those creditors who are friends or family members.
In Janvey, one of the biggest victims of the Stanford Ponzi scheme – a person named Magness – withdrew his funds from Stanford before other creditors were able to do the same. TUFTA was designed to claw back that withdrawal for the benefit of all creditors. Under TUFTA, however, Magness could keep his early withdrawal – if among other requirements, he could prove that he acted in good faith. To prove good faith, Magness had to overcome a jury finding that he was on inquiry notice of the Ponzi scheme. Janvey, 592 S.W.3d at 127. Moreover, the Court was required to assume that Magness did nothing to investigate his suspicions. Id. at 128.
The Janvey Court was thus squarely presented with the following question – whether a party on inquiry notice is acting in good faith or not when it fails to conduct a further investigation. The Texas Supreme Court ruled that, by itself, the failure to investigate proved as a matter of law that Magness did not act in good faith: “a transferee seeking to prove good faith must show that it investigated the suspicious facts diligently. A transferee who simply accepts a transfer despite knowledge of facts leading it to suspect fraud does not take in good faith.” Id. at 131.
Interestingly, in an attempt to show his good faith, Magness pointed to another jury finding: that any investigation by Magness would have been futile. The Texas Supreme Court rejected that futility defense: “a transferee on inquiry notice of the debtor’s fraudulent intent cannot prove good faith without conducting a diligent investigation – regardless of what that investigation would reveal.” Id. at 130.
Under Janvey, anyone who fails to investigate suspicions and red flags before undertaking some significant action is not operating in good faith as a matter of law. In fact, under Janvey, the failure to investigate before taking the proposed action inherently shows a lack of honesty: “If the transferee fails to demonstrate its good faith and avoid willful ignorance by conducting a diligent investigation, it cannot be characterized as acting with honesty in fact.” Id. at 131.
Janvey’s holding in this respect is not unique. An older opinion from the Texas Supreme Court made a similar holding under the common law. In 1911, the Texas Supreme Court held that a “flagrant case of bad faith” could be made out when a party attempts to obtain ownership of real estate while he remained “purposely ignorant of facts of which he would have learned, had he been scrupulous about the rights of others ….” Houston Oil Co. of Texas v. Hayden, 104 Tex. 175, 182, 135 S.W. 1149, 1152-53 (1911) (emphasis added).
Importantly, under existing Texas law, the absence of good faith has been held to be the equivalent of acting in bad faith. See Fenner, 156 S.W.2d at 283-84 (holding that there was no need for the jury charge to define the term “good faith” after it had already defined “bad faith” because that additional definition “would have been a mere negative statement of the term ‘bad faith’”).
The failure to investigate may substitute for actual knowledge, an important element of torts such as fraud and defamation. See, e.g., Anderson v. Durant, 550 S.W.3d 605, 614 (Tex. 2018) (“Fraudulent inducement is a species of common-law fraud that shares the same basic elements: (1) a material misrepresentation, (2) made with knowledge of its falsity or asserted without knowledge of its truth, (3) made with the intention that it should be acted on by the other party, (4) which the other party relied on and (5) which caused injury.”); In re Lipsky, 460 S.W.3d 579, 593 (Tex. 2015) (“‘Actual malice’ in this [defamation] context means that the statement was made with knowledge of its falsity or with reckless disregard for its truth.”). In fact, both standards recognize that avoidance of the truth – whether “asserted without knowledge of its truth” or “reckless disregard for its truth” – is no defense.
Consistent with these torts, both violations of inquiry notice and willful blindness have been held to serve as substitutes for actual knowledge. See, e.g., Champlin Oil & Ref. Co. v. Chastain, 403 S.W.2d 376, 388 (Tex. 1965) (addressing inquiry notice); Global-Tech, 563 U.S. at 766 (addressing willful blindness); Jewell, 532 F.2d at 700 (addressing willful blindness).
The practical results of invoking the violation of the inquiry notice doctrine most commonly is to impute knowledge to a party:
The law is that a party who has knowledge of such facts as would cause a fair and prudent man of ordinary caution to make further inquiry, is chargeable with notice of the facts which by ordinary diligence he would have ascertained. He is not warranted in shutting his eyes against the lights before him. Actual notice of facts which would put a prudent man on inquiry is sufficient proof of notice.
Brown v. Hart, 43 S.W.2d 274, 278-79 (Tex. Civ. App. – Amarillo 1931, writ ref’d).
In Texas, being charged with knowledge based on the violation of the inquiry-notice doctrine can carry the same consequences as having actual knowledge: “It has been determined by Texas authority that imputed actual notice carries with it the same legal consequences as conscious knowledge.” Champlin Oil, 403 S.W.2d at 388 (citing Hexter v. Pratt, 10 S.W.2d 692 (Tex. Comm’n App. 1928)); see also id. (“It seems clear that under certain circumstances, one having the means of knowledge may be held to the same standard of responsibility as one possessing conscious knowledge.”). For example, the landmark Flack opinion freely used the term “actual notice” to describe the consequence of being on inquiry notice:
‘Notice, as said above, may be either actual or constructive. ‘Actual notice’ literally means express or positive personal information or knowledge directly communicated to the person to be affected. In a more comprehensive sense, the term also embraces knowledge of all those facts which reasonable inquiry would have disclosed, the duty of inquiry extending only to matters that are fairly suggested by the facts really known. In other words, whatever fairly puts a person upon inquiry is actual notice of the facts which would have been discovered by reasonable use of the means at hand.’ Sec. 3, 31 Tex. Jur., pp. 359-360.
Flack, 148 Tex. at 499-500, 226 S.W.2d at 631-32 (emphasis added).
Other courts have squarely held that any notice obtained through the violation of something similar to the inquiry-notice doctrine is considered actual notice and only a shade short of the actual knowledge that comes from willful blindness – because the suspicions arose from actual knowledge of the suspicious facts and red flags:
But “constructive notice” often means no notice, while “implied actual notice” requires (1) actual knowledge of (2) highly suspicious circumstances, coupled with (3) an unaccountable failure to react to them. This in turn is a shade short of the form of actual knowledge that consists of closing your eyes because you’re afraid of what you would see if you opened them.
Shacket, 841 F.2d at 171.
Importantly, the failure to investigate upon inquiry notice, by itself, may not be sufficient to impute “constructive knowledge” sufficient to prove fraud. See Janvey, 592 S.W.3d at 130-31. The violation of inquiry notice requires one more thing to trigger constructive knowledge in the context of fraud: the means to successfully discover the fraud. Id. at 130 (“There are at least two types of knowledge a transferee has when on inquiry notice: (1) actual knowledge of facts that raise a suspicion of fraud, and (2) constructive knowledge of what the transferee could have uncovered in an investigation.”) (emphasis added).
As discussed above, to prove the intentional tort of fraud, a showing that the defendant acted recklessly can be sufficient to establish liability: “To prevail on its fraud claim, [the plaintiff] must prove that: … (2) [the defendant] knew the representation was false or made it recklessly as a positive assertion without any knowledge of its truth ….” Ernst & Young, L.L.P. v. Pac. Mut. Life Ins. Co., 51 S.W.3d 573, 577 (Tex. 2001) (emphasis added). Thus, blackletter Texas law allows fraud liability for a level of knowledge less than actual knowledge. Another classic formulation of the elements of fraud posits that the knowledge requirement can be even lower: “The elements of fraud are a material misrepresentation, which was false, and which was either known to be false when made or was asserted without knowledge of the truth ….” DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 688 (Tex. 1990) (emphasis added).
There are many cases demonstrating that willful blindness is sufficient to meet the knowledge requirement for fraud. First, most obviously, the Texas Supreme Court has already found willful blindness to be sufficient to support liability for fraud. See Pierce v. Fort, 60 Tex. 464, 470-71 (1883). In Pierce, the Texas Supreme Court applied the concept of willful blindness to extend fraud liability to a defendant even though – interestingly enough – that defendant did not make a fraudulent representation to the fraud victim. Thus, under Pierce, a party is liable for fraud when he knowingly benefits from fraud, even if he did not make the fraudulent statements. Pierce, 60 Tex. at 470-71; see generally In re Arthur Andersen LLP, 121 S.W.3d 471, 481 (Tex. App.—Houston [14th Dist.] 2003, orig. proceeding) (applying this “knowingly benefits from fraud” formula to a high-profile case arising out of the Enron scandal). Even more importantly, the Texas Supreme Court in Pierce further held that a party’s willful blindness was sufficient to support fraud liability:
[I]f the fraud was practiced upon [Mrs. Pierce] her by those whom she trusted, and [Wright] was wilfully blind in order that he might profit by it, he was as guilty as those who perpetrated the fraud.Pierce, 60 Tex. at 470.
Second, even aside from Pierce, the U.S. Supreme Court has noted that most states recognize that proving willful blindness is sufficient to meet the scienter requirements for fraud. See United States ex rel. Schutte v. SuperValu Inc., 598 U.S. 739, 749-50 (2023) (explaining that the scienter requirements for the False Claims Act track the scienter requirements for common-law fraud, including “deliberate ignorance”).
Third, the U.S. Supreme Court has also explained that willful blindness can be considered a form of actual knowledge. See Global-Tech, 563 U.S. at 766 (“It is also said that persons who know enough to blind themselves to direct proof of critical facts in effect have actual knowledge of those facts.”).
Fourth, in federal criminal law, willful blindness is sufficient to establish the required criminal scienter. See generally United States v. Lara-Velasquez, 919 F.2d 946, 950-53 (5th Cir. 1990). This is significant because criminal law is traditionally seen as providing more constitutional and due process safeguards than civil law.
Fifth, according to the US Supreme Court in Global-Tech, willful blindness is much closer to actual knowledge than recklessness:
[W]illful blindness … surpasses recklessness and negligence. Under this formulation, a willfully blind defendant is one who takes deliberate actions to avoid confirming a high probability of wrongdoing and who can almost be said to have actually known the critical facts…. By contrast, a reckless defendant is one who merely knows of a substantial and unjustified risk of such wrongdoing ….Global-Tech, 563 U.S. at 769-70. As mentioned above, under Texas law, recklessness has long been sufficient to support liability for fraud. See Ernst & Young, 51 S.W.3d at 577. Given the above, anything that surpasses recklessness should support liability for the intentional tort of fraud.
Under Texas law, a violation of notice inquiry, standing alone, might be sufficient to support a finding of fraud. The Texas Supreme Court has invoked the concept of inquiry notice in a way that mimicked fraud. See generally Champlin Oil, 403 S.W.2d at 383-88. In Champlin Oil, the Texas Supreme Court first attributed knowledge to the oil producers of an oil processing plant’s (mistaken) payment formula – based on an admittedly ambiguous notice letter that the processing plant had sent to the oil producers. See id. at 386-87. The Champlin Oil Court then held that the oil producers wrongly induced the processing plant to use that mistaken formula by not responding to the letter. See id. at 383-89. As a result, the oil producers were estopped from challenging the mistaken formula. See id. at 387-89.
As pointed out above, the failure to investigate when under a duty to do so can trigger not only bad faith liability but liability for knowing bad faith as well. Texas courts have already done so in the context cited above at pages __-__.
There are additional situations, not yet tested in Texas’ appellate courts, in which the same jurisprudential rules, principles, and outcomes should apply. The following are just a few examples.
In Certain Underwriters at Lloyd’s, London v. Prime Nat. Res., Inc., 634 S.W.3d 54 (Tex. App.—Houston [1st Dist.] 2019, no pet.), the author of this paper was the primary coverage counsel on the trial team, and later the lead appellate lawyer, during the trial for an insured injured by an insurer’s failure to investigate. The Prime case involved a claim for an oil well in the Gulf of America that was lost during Hurricane Rita. Id. at 60. The insurer had paid W&T – the operator of the well – the full amount of its claim. Id. at 62.“Prime likewise submitted its claim using identical costs and supporting documentation, but it was not paid for its costs incurred in repairing and recompleting the damaged H-2 Well at the same time as W&T.” Id.
The case proceeded to trial, and the jury found that “found that Underwriters engaged in various unfair and deceptive practices that resulted in damages to Prime.” Id. at 63. Of particular relevance here, the jury found that although “Underwriters received notice of Prime’s claim on September 29, 2005 and that Underwriters ‘fail[ed] to request from Prime all items, statements, and forms that Underwriters reasonably believed, at that time, would be required from Prime within 60 days of’ September 29, 2005.” Id.
On appeal, the court of appeals upheld the jury verdict of bad faith. The court reiterated the proposition noted above – “an insurer’s reliance on an expert report, standing alone, will not necessarily shield the insurer if there is evidence that the report was not objectively prepared or the insurer’s reliance on the report was unreasonable.” Id. at 75.
It is this author’s view that the liability finding in Prime indicates that insurers do owe an enforceable duty to investigate to their insureds – a duty whose extents should be consistent with the jurisprudence cited in this paper from other areas of Texas law.
The author of this paper was the policyholder’s insurance coverage and bad faith expert witness in a coverage dispute concerning multi-party conflicts of interest among several separate defendants all covered under the same insurance policy. The primary defendant could not get the insurer to recognize that multi-party conflict and appoint separate counsel for the different insureds, so the policyholders assumed their own defense. The crux of my analysis and expert opinion was that the insurer had improperly delegated its responsibility for conducting the further investigation of conflicts to its expert coverage counsel, and after the insured put the insurer on inquiry notice of the conflict the insurer had committed bad faith when it decided not to conduct its own further investigation and thereby knowingly turned away from the truth. After receiving the expert report, the insurer and its counsel, who I have long considered to be among the best, if not the best, carrier side counsel in the country, chose not to depose me on my bad faith opinions and instead settled all bad faith claims on the first day of trial. In my estimation, this example confirms that the best coverage counsel are aware of the serious bad faith exposure that potentially confronts an insurer who knowingly turns away from investigating the truth about a wide variety of coverage decisions.
The author of this paper has been coverage counsel on the trial teams in a number of cases where the insured had one or more towers of excess coverage over its primary insurance and where the policy holder and the insurer with the defense obligation disagreed over the value of the potential trial verdict against the insured. In virtually all of those situations, when the insurer to whom the defense had been tendered refused to tender its limits to the next higher excess insurer, a potential existed for asserting that the insurer(s) had committed a bad faith failure to investigate further after being placed on inquiry notice. In the great majority of those cases, the insurer ultimately settled the underlying liability case. In my estimation, this is just another set of examples where insurers and their expert coverage counsel are secretly aware of the tremendous bad faith exposure that potentially confronts insurers when they knowingly turn away from further investigating the truth in adjusting a claim.
Other examples undoubtedly exist in other fact situations where insurer has a duty to investigate, and if instead of investigating the insurer chooses not to investigate, and can then be liable for bad faith, and if the insurer knowingly chose not to investigate then it can be liable for “knowing” bad faith.
The author of this paper can similarly posit other circumstances, based on real-world experience, where the insurer may be exposed to bad faith, and also knowing bad faith, for failing to further investigate the basis for its coverage denial or other injurious decision after being put on inquiry notice by the policyholder’s coverage counsel. For example, an insurer may owe a duty to investigate further when the insured follows the insurance policy’s provisions for appealing the insurer’s denial of coverage. When the insurer investigates the policyholder’s proffered facts in that appeal, the insurer cannot turn away from the truth by failing to also investigate fully and objectively the facts that are good for the insured and bad for the insurer. Otherwise an investigation in that context performed merely as a pretext to deny coverage can potentially create bad faith liability and even knowing bad faith liability in connection with that decision.
In particular, there is a prospect that under the expansion of the duty to defend beyond an 8-corners rule might that lead to a duty for an insurer to affirmatively investigate extrinsic facts that may require a defense, not simply investigate reasons to decline a defense. See Monroe Guar. Ins. Co. v. BITCO Gen. Ins. Corp., 640 S.W.3d 195, 204 (Tex. 2022). Previously, insurers in were off the hook if the pleading and policy, alone, indicated no duty to defend; they are now arguably required to make an additional investigation beyond the pleading. The possibility would be an extremely timely and far-reaching consequence, and highly useful for insurance practitioners.
An examination of intentional torts in other contexts demonstrates that insurers risk bad faith liability for failing to investigate further because even parties in arm’s-length relationships, as opposed to insurers under the higher duty of good faith to their insureds, have been held liable for intentional tort liability and punitive damage exposure for failing to investigate further. The scope of an insurer’s duty to investigate under current Texas law has not been explored, much less specifically under first-party and third-party situations, if even relevant. It is this author’s theory that insurers are rightfully scared of what will happen when this area of the law is explored in published appellate opinions using these principles that exist in all other areas of jurisprudence. A fear that would suggest a profitable area of inquiry on behalf of insureds.
In Global-Tech, a finding of willful blindness led to liability for induced patent infringement. Global-Tech addressed a tort with an express knowledge requirement: “[W]e now hold that induced infringement under § 271(b) requires knowledge that the induced acts constitute patent infringement.” Global-Tech, 563 U.S. at 766. Global-Tech expressly held that willful blindness satisfied that knowledge requirement:
Returning to Pentalpha’s principal challenge, we agree that deliberate indifference to a known risk that a patent exists is not the appropriate standard under § 271(b). We nevertheless affirm the judgment of the Court of Appeals because the evidence in this case was plainly sufficient to support a finding of Pentalpha’s knowledge under the doctrine of willful blindness.
Global-Tech, 563 U.S. at 766.
Under current Texas law, willful blindness can satisfy the knowledge requirement to recover punitive damages based on gross negligence. Gross negligence is statutorily defined as “actual, subjective awareness” of the risk created by the wrongdoing. Tex. Civ. Prac. & Rem. Code § 41.001(11). For the reasons discussed above regarding fraud and other intentional torts, supra, Section V.C., there are persuasive reasons to believe that “willful blindness/willful ignorance” should satisfy the statutory requirement of “actual, subjective awareness” under Tex. Civ. Prac. & Rem. Code § 41.001(11). Specifically, again, the Texas Supreme Court has already found, under the common law, that willful blindness is sufficient to meet the knowledge requirements for fraud. See Pierce, 60 Tex. at 470. So do most other states, according to the Supreme Court. See Schutte, 598 U.S. at 749-50. Willful blindness is also sufficient to satisfy the particularly strict scienter requirements of criminal law. See generally Lara-Velasquez, 919 F.2d at 950-53.
Further, willful blindness is sometimes considered a “form of actual knowledge.” Shacket, 841 F.2d at 171. At the very least, it is a recognized substitute for actual knowledge. See Global-Tech, 563 U.S. at 766; Jewell, 532 F.2d at 700. Another, more recent, Supreme Court decision provided additional support by specifically acknowledging the possibility that willful blindness may be sufficient to satisfy a strict, statutory, actual-knowledge requirement: “Today’s opinion also does not preclude defendants from contending that evidence of ‘willful blindness’ supports a finding of ‘actual knowledge.’” Intel Corp. Inv. Policy Comm. v. Sulyma, 589 U.S. 178, 190 (2020).
The practical results of applying the inquiry-notice doctrine have been significant. Most commonly, for example, parties have lost ownership claims at issue. In Janvey, as a result of the inquiry-notice, a withdrawal of $88 million in cash from the notorious Stanford bank was declared to be a so-called “fraudulent transfer” – which required the party on inquiry notice to return the money for the benefit of all the creditors. See generally Janvey v. GMAG, L.L.C., 977 F.3d 422, 426 (5th Cir. 2020) (opinion from the Fifth Circuit after the Texas Supreme Court answered its certified question in the opinion discussed above).
In Janvey, the defendant was trying to avoid the fraudulent transfer statute by invoking a statutory, “good faith” defense against clawbacks. See Tex. Bus. & Com. Code § 24.009(a) (“A transfer or obligation is not voidable under Section 24.005(a)(1) of this code against a person who took in good faith and for a reasonably equivalent value or against any subsequent transferee or obligee.”). According to the Supreme Court, by itself, the failure to investigate defeated good faith: “In this circumstance, a transferee seeking to prove good faith must show that it investigated the suspicious facts diligently. A transferee who simply accepts a transfer despite knowledge of facts leading it to suspect fraud does not take in good faith.” Janvey, 592 S.W.3d at 131.
Moreover, there have been cases where a failure to investigate by a party on inquiry notice defeated concrete property rights:
Finally, under appropriate circumstances even a negligent violation of the inquiry-notice doctrine can result in actual knowledge. According to the Texas Supreme Court, the inquiry-notice doctrine can attribute knowledge to a party, even if the failure to investigate is merely negligent: “Where there is a duty of finding out and knowing, negligent ignorance has the same effect in law as actual knowledge.” Flack, 148 Tex. at 500-01, 226 S.W.2d at 632 (quoting Hexter v. Pratt, 10 S.W.2d at 693); see also Welborn, 851 S.W.2d at 331 (likewise using the phrase “negligent ignorance” to describe the doctrine of inquiry notice).
For example, counsel for insureds might use the concepts outlined in this paper to hold insurers accountable in various scenarios such as:
Consistent with the Texas Insurance Code, the existing common law based jurisprudence regarding insurance, as well as common law based jurisprudence in disparate areas of law, insurers may also be subject to a duty to fully and objectively further investigate once it begins to investigate extrinsic facts regarding coverage. The duty to adequately investigate further may have additional particular relevance, as it may impose duties on insurers—and remedies for policyholders where insurers fail to discharge that duty—not otherwise foreseen or appreciated by either party. These issues could have very significant implications for further development of Texas insurance jurisprudence and for significantly effecting the practical results in coverage disputes.
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