Home Indemnity Company ("Home") appeals from a summary judgment in a declaratory action brought by Foremost County Mutual Insurance Company ("Foremost"). The district court held that Foremost's insured was also covered by Home's policy and that as a consequence Foremost was entitled to subrogation against Home for half of the $3,200,000 Foremost paid in settlement of claims related to, or arising under, the liability insurance policy covering Foremost's insured. We reverse and render.

Facts.

Eli J. Butler and his company, Paradise Investment Corporation, held a general liability policy issued by Home and an automobile liability and physical damage policy issued by Foremost, each with a $250,000 limit. The estate of Mario Porcayo sued Butler after Porcayo was killed when struck by a motorhome which Butler was driving. Foremost refused to defend Butler, claiming non-coverage (Later Foremost admitted coverage.). Home tendered a defense to Butler under its workers' compensation policy but did not indicate to Butler that there might be liability coverage under its general policy. Both Home and Foremost refused settlement offers within their policy limits.

Immediately prior to trial, a covenant not to execute (drafted by Home's lawyers) was signed; the Porcayos agreed not to execute against Butler, and Butler assigned to the Porcayos any rights he might have against Foremost (including his claim for wrongful refusal to defend). At trial, Home did not question the Porcayos' witnesses. Final judgment was rendered against Butler by the court (Home did not request a jury trial.) in the amount of $3,797,000.

Shortly thereafter, Foremost settled its claims with the Porcayos for $3,200,000. Foremost then sought, in a declaratory judgment action, subrogation or contribution from Home. That claim was based upon the fact that Home was a co-insurer, since Butler was a named insured on Home's policy even if the motorhome he was driving at the time of the accident was not on Home's schedule of automobiles under the policy.

The insurers filed cross-motions for summary judgment; the district court granted Foremost's and denied Home's. The court found that Butler was covered under Home's policy, and thus Home was liable as a co-insurer. The district court then ordered that Home pay half of Foremost's $3,200,000 settlement, reasoning that Home could be held liable for amounts in excess of its policy limits based upon its earlier refusal of the settlement offer within policy limits.

Discussion.

We first address the question of whether Home's policy covered Butler for his liability arising from the automobile accident in which, while driving his vehicle, Butler accidentally killed Porcayo. Butler was a named insured on the policy, but his vehicle was not listed under the "schedule of automobiles" in Home's policy. Home's general liability policy includes the explicit statement, "The company will pay on behalf of the insured all sums which the insured should become legally obligated to pay as damages because of (c) bodily injury or (d) property damage to which this insurance applies, caused by an occurrence and arising out of the ownership, maintenance or use ... of any automobile..." (emphasis added). Home's policy also defines "persons insured," stating, "Each of the following is an insured under this insurance to the extent set forth below: a) the named insured; b) any partner...." Butler was listed by endorsement as a named insured under the policy.

Notwithstanding these seemingly unambiguous statements indicating that Home would pay any liability of Butler's arising from his use of any automobile, Home argues that the policy, when read as a whole, suggests that only those automobiles listed under the schedule of automobiles are covered. To the extent that Home did determine its rates as indicated in the schedules, examination of the schedules confirms Home's statement that a separate premium was paid for each automobile listed under the schedule of Paradise's automobiles. Therefore, it is indeed possible that Butler and Paradise were not paying the premium which Home would have demanded had it intended to cover the vehicle at issue.1

Under Texas law, which governs this diversity action, it "is a fundamental rule that the writing will be construed most strictly against the party who drafted it." Ellis v. Mortgage & Trust, Inc., 751 S.W.2d 721, 723 (Tex.App.--Fort Worth 1988, no writ). Home, of course, is the drafter of the policy here. Also in general under Texas law, where language in an insurance policy is susceptible of more than one construction, such policies must be construed strictly against the insurer and liberally in favor of the insured. Barnett v. Aetna Life Ins. Co., 723 S.W.2d 663, 666 (Tex.1987). Therefore, "any automobile" should be interpreted literally; if Home wanted to limit coverage to owned automobiles that were listed on the schedule, it could have included this provision simply by saying, "any scheduled automobile, hired automobile, or non-owned automobile, as defined in the policy" instead of "any automobile."

Furthermore, Home's premium schedules would suggest, at most, that an automobile must be listed on the schedule in order to be classified as an "owned automobile,"2 not that automobiles must be listed on the schedule as an absolute prerequisite to any coverage for that automobile's driver. Indeed, coverage for many of the insureds under the policy is qualified by the type of automobile being used, limited in some cases to "owned automobiles" and in other cases extending to "hired automobiles" or "non-owned automobiles." Coverage to the named insured, on the other hand, is unqualified. Butler, as a named insured, is thus afforded coverage as to all automobiles. Hence, we conclude that the district court did not err in finding coverage for Butler under Home's policy.

Foremost claims that as a co-insurer Home is liable for half of the $3,200,000 Foremost paid in settlement to the Porcayos. However, the limit of both the Foremost policy and the Home policy was only $250,000. Foremost argues, and the district court held, that Home can be liable for amounts in excess of its policy limit based upon the "Stowers doctrine" of Texas insurance law, which arises from G.A. Stowers Furniture Co. v. American Indem. Co., 15 S.W.2d 544 (Tex. Comm'n App.1929, holding approved).

In Conoco, Inc. v. Republic Ins. Co., 819 F.2d 120, 123 n. 4 (5th Cir.1987), we described the Stowers doctrine as allowing

an insured to recover damages from his insurer for the insurer's failure to settle a claim against the insured within the policy limits. Where the insurance policy gives the insurer complete control of the litigation, the Stowers Doctrine protects the insured in certain circumstances from having to pay a judgment greater than the policy amount if the insurance company previously spurned a settlement offer for less than or equal to the policy amount. The insured's cause of action, however, did not arise under the original doctrine until he had actually paid part of the judgment in excess of the policy limits.

In the instant case Foremost and Home did each refuse a settlement offer within its policy limits prior to the agreement on the covenant not to execute and prior to trial. However, the Stowers doctrine applies only "in certain circumstances." Id. Stowers itself suggests, and subsequent cases have held, that among the conditions necessary for application of the doctrine should be negligent or bad-faith conduct by the insurer. See Stowers, 15 S.W.2d at 545; Highway Ins. Underwriters v. Lufkin-Beaumont Motor Coaches, 215 S.W.2d 904, 927-28 (Tex.Civ.App.--Beaumont 1948, no writ); Whatley v. City of Dallas, 758 S.W.2d 301, 308-09 (Tex.App.--Dallas 1988, writ denied). It is doubtful that negligence or bad faith was established in the instant case, but we need not consider this matter further, as we hold, for independent reasons, that the Stowers doctrine does not apply to the case at bar.

The crux of the Stowers claim is negligence or bad faith by the insurer directed against the insured. Home's refusal to accept a settlement offer does not, without more, give rise to a Stowers cause of action; there must be not only negligent refusal to settle by the insurer but also subsequent harm to the insured.3 See Hernandez v. Great Am. Ins. Co., 464 S.W.2d 91, 94 (Tex.1971).

The covenant not to execute, drafted by Home's lawyers, released Home's insured from all legal obligations to pay. Thus, Home's decision to reject the settlement offer never resulted in any injury to its insured.4 Hence, Home did not breach its Stowers duty to its insured5 and therefore has no obligation to the Porcayos beyond those limited obligations that might have arisen directly under the policy.

Foremost argues, though, that the fact that Butler paid nothing should be disregarded because it occurred by operation of a covenant not to execute. In Texas a covenant not to execute by an insured does not release an insurance carrier from liability. See Young Men's Christian Ass'n v. Commercial Standard Ins. Co. ("YMCA "), 552 S.W.2d 497, 504-05 (Tex.Civ.App.--Fort Worth 1977), writ ref'd n.r.e., 563 S.W.2d 246 (Tex.1978) (per curiam). Thus, it might be argued that Home's refusal to settle led to a $3,797,000 judgment against Butler that, if Home were found to have acted negligently or in bad faith, would have given rise to a Stowers claim in Butler against Home but for the existence of the covenant not to execute. Therefore, given the Texas law that a covenant not to execute does not release an insurer from liability, one could argue that upon entry of judgment, the Porcayos, by assignment from Butler through the covenant not to execute, held a Stowers claim against Home.

There are, however, two problems with this theory. First, there was no assignment by Butler of any claims Butler might have against Home, but only of claims against Foremost. Such an assignment of a Stowers claim appears to be necessary to Foremost's position. In Whatley the court stated, "A [Stowers ] claim that an insurer negligently failed to settle an injured party's action against an insured belongs to the insured and the injured party has no standing to assert it" (citing several Texas cases). Whatley further concluded that where the claim had not been assigned by the insured to the injured party, the injured party did not own that claim.6

Second, extending the Stowers doctrine to this case on a basis of the assignment and covenant not to execute does not serve the policy the courts were attempting to advance in YMCA when they created the rule that a covenant not to execute does not relieve the insurer of liability. The purpose of the rule in YMCA was to prevent an insurer from escaping liability by treating the policy as one of indemnity rather than liability. See YMCA, 552 S.W.2d at 504. In YMCA, following a judgment against the insured, an injured party sought damages, in accordance with Texas law, directly from the insurer under a third-party beneficiary theory. The insurer argued, however, that it was not obligated to pay an injured party who had covenanted not to execute against the insured because the covenant insulated the insured from liability, and without liability the insured had no claim to coverage. The court held, though, that the insured's liability attached with the judgment; whether the insured paid it was immaterial.

The YMCA rule should not be extended to the Stowers claim in the instant case. We hold that since Home provided a defense to its insured that ultimately resulted in no injury to its insured, the possible rationales for the YMCA rule that arise where an insurer refuses to defend do not apply here.7

The insurance company's liability for a standard claim under the policy, as in YMCA, arises from a tort by the insured directed against a third party for which the insured is liable. In such a situation, the YMCA rule is needed to protect the insured adequately. Where the insurer refuses to tender a defense, the insured often can protect himself only with a covenant not to execute. See Whatley, 758 S.W.2d at 310. Without such a covenant, the insured either would have to pay the plaintiffs enough to settle their claim or would have to incur defense costs himself, even though the insurer is contractually responsible for payment of such costs. Were a covenant not to execute to absolve the insurer of liability, plaintiffs would have no incentive to enter into such a covenant.

With regard to Stowers damages,8 the insured does not need the benefit of the YMCA rule where the insurer in question, rather than refusing to defend and ignoring its insured, has actively participated in drafting the covenant not to execute that protects its insured. Here, not only does the insured not incur defense costs, but failing to apply the YMCA rule will not improperly chill incentives to covenant not to execute. The insured will still have at its disposal all of its legitimate claims (not the Stowers claim because there was no injury) to offer to plaintiff in order to induce plaintiff to covenant not to execute. The only party adversely affected by the enforceability of the covenant not to execute in this case is Foremost, but Home had no contractual duty to Foremost, and thus Foremost has no right to any Stowers damages from Home. Hence, an insurer does not escape its contractual obligations with a covenant not to execute, but a successful covenant not to execute prevents any injury that could give rise to a Stowers claim.

Under the holding of this case, the insurer is relieved of its liability for a negligent refusal to settle only where it defends its insured and succeeds in obtaining protection for its insured from all liability. Because this release can come only with the approval of the injured plaintiff, not extending the YMCA rule to the instant case would not generally encourage negligent refusals to settle. Even in the case of a settlement offer at the policy limit, where the interests of insurer and insured in settling would be the most divergent (in the absence of a fully enforceable Stowers rule), the insurer will face the same risk by not settling which it normally would confront under Stowers, regardless of whether the YMCA rule is extended to the instant case.

Whether the YMCA rule is applied is material only where there is a covenant not to execute. If no covenant not to execute is forthcoming, the insurer will be responsible for the entire judgment, including any excess over the policy limits, and plaintiff will be aware of this. Thus, in order to induce the plaintiff to enter a covenant not to execute, the insurer must either accept an admission of liability (which is effectively equivalent to a settlement) or permit itself to be exposed to damages in excess of policy limits (which returns the insurer to the Stowers situation).

Therefore, under our decision not to extend the YMCA rule the insurer who negligently refuses to settle will be able to use a covenant not to execute only to the disadvantage of another insurer that has breached its duty to the insured (as in the instant case) and not to the disadvantage of its insured. Moreover, because we rely upon the fact that the insurer provided a defense to its insured, we have not created a vehicle by which insurers can easily simultaneously challenge coverage and avoid any possibility of liability beyond policy limits.9

Having concluded that Home's potential liability is limited to that specified by its policy, we now examine the issue of subrogation. The judgment at trial was $3,797,000. Foremost settled for $3,200,000, even though the limit of its policy was only $250,000. We infer that Foremost's payment of $2,950,000 in excess of policy limits reasonably must have been to settle some potential claims other than those arising directly under the policy.10

The assignment from Butler to the Porcayos explicitly sets forth the assignment of the wrongful-refusal-to-defend claim, and this presumably would be the major reason Foremost settled for such a large amount. In fact, the Porcayos had threatened Foremost with such a lawsuit. Indeed, under Blakely v. American Employers Ins. Co., 424 F.2d 728 (5th Cir.1970), Foremost might be held liable for the entire amount of the judgment ($3,797,000) for having wrongfully refused to defend.

Home's potential liability can also be separated into two categories: (1) liability under the policy, which is limited to $250,000, and (2) liability under a Stowers claim, which is not so limited. Above we have concluded that Butler was covered under Home's policy and that Home's liability is limited to the policy maximum of $250,000. Given these conclusions, together with the rule from YMCA that a covenant not to execute does not relieve an insurer of liability for claims under the policy, it follows that upon entry of the $3,797,000 judgment, Home should have been liable for only $250,000.

The "indemnity" section of the Foremost-Porcayos settlement agreement reveals that the parties were aware, at the time of settlement, of Home's potential liability to the Porcayos. Foremost settled not only the $250,000 it owed under its liability policy but also the potential claims against it for wrongful refusal to defend. Foremost paid $3,200,000 to the Porcayos in return for the Porcayos' release of Foremost and any of its assigns or insureds, including Butler, from all liability. Because any liability of Home to the Porcayos necessarily would be derived through Butler, this release effectively absolved Home of any liability as well.11

Interpreting Texas law, we have held, "It is clear that there are two kinds of subrogation: (1) legal or equitable, and (2) conventional. The first arises by operation of law and the second by contract or agreement." Millers Mut. Fire Ins. Co. v. Farmers Elevator Mut. Ins. Co., 408 F.2d 776, 778 (5th Cir.1969) (citing Commercial Standard Ins. Co. v. American Employers Ins. Co., 209 F.2d 60 (6th Cir.1954)).12 The former kind of subrogation "is applicable when one person, acting involuntarily, has paid a debt for which another was primarily liable, unjustly enriching the latter." Godwin v. Pate, 667 S.W.2d 201, 203 (Tex.App.--Dallas 1983, writ ref'd n.r.e.) (citing Smart v. Tower Land & Inv. Co., 597 S.W.2d 333, 337 (Tex.1980)).

The Foremost-Porcayos settlement did have the effect of extinguishing all of Foremost's and Home's debts. Thus, Foremost did in fact pay for a debt for which Home was primarily liable, and Home would be unjustly enriched thereby. At the time of payment, the amount of Home's debt was, of course, contingent upon a finding of coverage,13 but this does not bar recovery by Foremost. See Employers Casualty Co. v. Transport Ins. Co., 444 S.W.2d 606 (Tex.1969).

Foremost's policy contains a subrogation clause identical to that of the insurer in Employers, and this provides Foremost with a valid basis for contractual subrogation. Foremost was potentially liable to the Porcayos on behalf of Butler, its insured, for the full judgment, and it may have been difficult to effect only a partial settlement of the claims between Butler and the Porcayos. Under such circumstances, where Foremost has a contractual subrogation right, it might not be a volunteer.

In Southwestern Indem. Co. v. National Sur. Corp., 277 F.2d 545 (5th Cir.1960), we allowed, by contractual subrogation under Texas law, one settling insurer to recover against another that had not settled or defended. We stated, "National could not well settle the Hadley and Beard claims piecemeal. It was not a mere volunteer in paying more than its proportionate part of the liability. That excess was paid on behalf of the insured Schwope, and National became subrogated to Schwope's right against Southwestern and Service Mutual." Id. at 549. See also Liberty Mut. Ins. Co. v. General Ins. Corp., 517 S.W.2d 791, 798 (Tex.Civ.App.--Tyler 1974, writ ref'd n.r.e.).

Moreover, the Texas Supreme Court has held that where the subrogation is conventional, contractual subrogation, it is immaterial whether the subrogee's payment of more than its pro rata part of the loss was compulsory or involuntary. See Employers, 444 S.W.2d at 610. Both Southwestern Indemn. Co. and Employers, though, involved insurer-subrogees that, while paying more than their pro rata share of the loss, did not pay more than their policy limits.

The subrogation clause in Foremost's policy reads,

In the event of any payment under this policy, the company shall be subrogated to all the insured's rights of recovery therefor against any person or organization and the insured shall execute and deliver instruments and papers and do whatever else is necessary to secure such rights. The insured shall do nothing after loss to prejudice such rights.

It is uncertain whether a payment beyond policy limits, even if arising from coverage of the policy, can constitute a "payment under this policy." Unless the contract indicates otherwise contractual subrogation is examined within the framework of the doctrine of equitable subrogation and is subject to conformity with its principles. See Commercial Standard Ins. Co. v. American Employers Ins. Co., 209 F.2d at, 64-66. "In conventional subrogation, the extent of the right is measured by the agreement for subrogation; equity will determine the rights of the parties by the contract, enforce the agreement, and give the second or substituted creditor what he contracted for." Id. at 65.

In a case such as the instant one, where the contract does not speak pellucidly to how payments should be allocated, the tenets of the doctrine of equitable subrogation should provide us with guidance. Hence we turn to equitable subrogation principles and again face the question of whether any of Foremost's payments pursuant to coverage under the policy for amounts over $250,000 were those of a volunteer.14

Under equitable subrogation, "If a person has any palpable interest which will be protected by the extinguishment of the debt, he may pay the debt and be entitled to hold and enforce it just as the creditor could." Commercial Standard, 209 F.2d at 64. Thus we consider whether Foremost had any palpable interest in settling Butler's (and, derivatively, Home's) liability as well as its own. Employers and National, in paying more than their pro rata shares of liability, were protecting their respective interests, as until all liabilities had been finally fixed there was a possibility that they might be liable under their policies for the full amount they paid. Foremost, on the other hand, could never have been liable under its policy for more than $250,000. While Foremost's payments relieved its client of all liability, merely protecting its client's interest is insufficient to prevent Foremost from being considered a volunteer. See Standard Marine Ins. Co. v. Scottish Metro. Assur. Co., 39 F.2d 436 (6th Cir.1930), aff'd, 283 U.S. 284, 51 S. Ct. 371, 75 L. Ed. 1037 (1931). Therefore, only $250,000 of Foremost's payment is subject to subrogation.

Foremost and Home each had an "other insurance" clause providing for "contribution by equal shares":

(a) Contribution by Equal Shares. If all of such other valid and collectible insurance provides for contribution by equal shares, the company shall not be liable for a greater proportion of such loss than would be payable if each insurer contributes an equal share until the share of each insurer equals the lowest applicable limit of liability under any one policy or the full amount of the loss is paid, and with respect to any amount of loss not so paid the remaining insurers then continue to contribute equal shares of the remaining amount of the loss until each such insurer has paid its limit in full or the full amount of the loss is paid.

Therefore, since both policies contain the above clause, payment is properly apportioned by the equal shares method.15 Thus, we conclude that Foremost is entitled to $125,000 in subrogation from Home.

REVERSED and RENDERED.