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COURTS OF THE PHOENIX v. CHARTER OAK FIRE INS. CO.

April 12, 1983

COURTS OF THE PHOENIX, A PARTNERSHIP, WILLIAM REICH, GENERAL PARTNER, MAYNARD M. GARFIELD, FRED SAVINO, LESLIE M. TAITEL, ADRIENNE KAPLAN, PHOENIX-SHEFFIELD COURTS, SALVATORE S. AIELLO, CHARLOTTE A. SMITH, EDDY YUEN, SPENCER TRUST, HOWARD C. ALPER, RICHARD DRAMMER, ALLEN DRAMMER, RICHARD H. DRIEHAUS, JACQUELINE ROCK, BERTHA KUTCHINS, FRANZ ALTSCHULER, CHARLES CALLAHAN, CAROL CALLAHAN, MAX DETRIXHE, JOSEPH KRITZMAN, PATRICIA A. KRITZMAN, DICK A. STOKEN, SKYBLUE PARTNERSHIP, MARION E. GLAZEBROOK, ALLEN KUTCHINS, LIMITED PARTNERS, AND LAKEVIEW TRUST & SAVINGS BANK, AS TRUSTEE UNDER TRUST NO. 4156, PLAINTIFFS,
v.
THE CHARTER OAK FIRE INSURANCE CO., DEFENDANT.



The opinion of the court was delivered by: Prentice H. Marshall, District Judge.

MEMORANDUM OPINION

This is an action by The Court of the Phoenix ("the partnership"), a partnership, and Lakeview Trust & Savings Bank ("Lakeview Bank"), the legal title holder of the building operated by the partnership, against Charter Oak Fire Insurance Company ("Charter Oak") on a fire insurance policy issued by Charter Oak. In May 1980, a fire occurred in the partnership's building, which housed several racquetball and handball courts. The Chicago Fire Department later determined that the fire had been intentionally set. Charter Oak denied the partnership's claim on the insurance policy on the basis that William Reich ("Reich"), the partnership's general partner, had set the fire or had arranged for it to be set in order to liquidate what Charter Oak claims was a failing investment. Charter Oak has raised other defenses to payment as well, including the alleged submission by the partnership of inflated damage claims and the partnership's failure to prevent the building from deteriorating.

At a pretrial conference held on February 8, 1983, it became clear that the parties were in conflict over the applicability of what we will term the "arson defense," that is, the defense that Reich had procured the setting of the fire. The parties had addressed this question in their trial briefs, which they had filed on December 17, 1982. At the February pretrial conference, we told the parties that to the extent that the issue of the sufficiency of this defense was a question of law, we would rule on it before trial.

The facts now before us are as follows. Reich was the general partner of the partnership,*fn1 and the other named plaintiffs, with the exception of Lakeview Bank, were limited partners. None of the limited partners has greater than a 6% interest in the partnership. Reich had the majority interest (over 50%). Defendant has alleged that as general partner, Reich had sole control over the operation and management of the racquetball-handball club. For the purpose of the present inquiry, because we are only determining the sufficiency of the arson defense, we will assume the validity of defendant's assertion.

The case is before us by reason of the diversity of citizenship of the parties. See 28 U.S.C. § 1332(a) (1976). Under Klaxon v. Stentor Electrical Manufacturing Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941), therefore, we must look to the choice of law rules of the forum state, here Illinois. The general rule in Illinois is that the construction of a contract of insurance is governed by the place of execution of the contract. See Hamilton Die Cast, Inc. v. United States Fidelity & Guaranty Co., 508 F.2d 417, 419 (7th Cir. 1975) (applying Illinois choice of law rules). The place of execution is defined as the place where the last act is done that is necessary to make the contract binding, for example, delivery to the insured. See Gray v. Penn Mutual Life Insurance Co., 5 Ill. App.2d 541, 126 N.E.2d 409 (1955); Hartliep Transit Co. v. Central Mutual Insurance Co., 288 Ill. App.? 140, 5 N.E.2d 879 (1937). While we do not doubt that the place of execution is capable of determination in the present case, the parties have not indicated where the contract in question here was executed. In any case, the parties appear to agree that Illinois law applies. Therefore, for the purposes of the present inquiry, we will apply Illinois law.*fn2

There are no Illinois cases that address the specific question at issue here, that is, whether a "limited partnership" can be denied recovery on a fire insurance policy where the partnership's sole general partner has procured the setting of the fire that gave rise to the claim on the policy. The parties agree that the Illinois case that states the general common law rules applicable here is D.I. Felsenthal Co. v. Northern Assurance Co., Ltd., 284 Ill. 343, 120 N.E. 268 (1918). In Felsenthal, the plaintiff, a corporation, brought suit on a fire insurance policy issued by the defendant. The defendant responded by alleging that the fire had been set by or at the behest of a major stockholder in the corporation. At the time of the fire, there were 150 shares of stock outstanding. Fifty shares were held directly by Fox, the alleged instigator of the fire. Another 25 were held by Fox's brother-in-law, but in fact those shares were held for Fox's use and benefit and were in the brother-in-law's name only in order to qualify him to hold an office in the corporation. The other 75 shares were held by three other persons, but all were assigned to Fox as security for debts owed to the corporation. In addition, Fox was the corporation's sole creditor. The court found that he was the only person who would be benefitted financially by the fire, as any amounts that would go to the other shareholders would be subject to being set off against their debts to the corporation. In addition, Fox had absolute control of the corporation's affairs. The court in Felsenthal stated that

  the general rule of law is that the willful burning
  of property by a stockholder in a corporation is not
  a defense against the collection of the insurance by
  the corporation, and [] the corporation cannot be
  prevented from collecting the insurance because its
  agents willfully set fire to the property without the
  participation or authority of the corporation or of
  all of the stockholders of the corporation.

Id. at 348, 120 N.E. at 270. However, the court went on to state that

  [w]hen . . . the beneficial owner of practically all
  of the stock in a corporation, . . . who has the
  absolute management and control of its affairs and
  its property and is its president and a director,
  sets fire to the property of a corporation or causes
  it to be done, there is no sound reason to support
  the contention . . . that the corporation should be
  allowed to recover on a policy for the destruction of
  the corporate property by a fire so occasioned.

Id. at 348-49, 120 N.E. at 270. The court noted that in the circumstances presented, allowing the corporation to recover would be in effect indistinguishable from allowing an individual insured under a fire insurance policy to recover despite having set the fire, as Fox was the sole person who would benefit from the recovery demanded. Id. at 353, 120 N.E. at 272. It stated: "[w]e cannot allow the corporation in this case to be used as a cloak to protect Fox and to aid him in his design to defraud the insurance company and at the same time to profit by his own wrong." Id. at 354, 120 N.E. at 272.

A more recent Illinois case, Economy Fire & Casualty Co. v. Warren, 71 Ill. App.3d 625, 28 Ill.Dec. 194, 390 N.E.2d 361 (1979), is, we think, also instructive. In Economy Fire, the insurer brought an action against two joint tenants of property covered by a fire insurance policy, seeking rescission of a settlement agreement and restitution of proceeds paid out under the policy. The evidence showed that one of the joint tenants had started the fire that had resulted in the claim. The other joint tenant contended that he was innocent of wrongdoing and therefore was entitled to half of the proceeds from the policy, regardless of the other joint tenant's conduct. The insurer argued that the arson of one joint tenant voided the entire policy.

In reaching its decision, the court in Economy Fire considered two divergent lines of authority from other jurisdictions, as the issue was one of first impression in Illinois. The first line of cases considered stood for the proposition that the question whether the rights of obligees are joint and several is one which is to be determined by what a reasonable person in the position of the insured would have understood the words of the policy to mean. An ordinary person with an undivided interest in the property would naturally suppose that his individual interest was covered by a policy that named him as an insured and that his rights were not tied to those of the other joint tenant. Economy Fire, 71 Ill. App.3d at 628, 28 Ill.Dec. at 196, 390 N.E.2d at 363.*fn3 The second line of authority considered in Economy Fire held that the wrongdoing of one co-insured bars recovery as to all insured, because the agreement of the insureds not to commit fraud is joint, with each promising that he and the other will not commit fraud. Id. at 628-29, 28 Ill.Dec. at 196, 390 N.E.2d at 363.

The court in Economy Fire sided with the innocent insured, holding that the fact that his joint tenant had committed arson should not bar him from recovery on the policy. It stated: "[w]e do not think that the reasonable person in the position of [defendant] would have supposed that the wrongdoing of his co-insured would be imputed to him. If the plaintiff intended such a result, it should have made the terms of the policy more express in that regard." Id. 71 Ill. App.3d at 629, 28 Ill.Dec. at 196-97, 390 N.E.2d at 363-64. Thus, the court held that the innocent joint tenant was entitled to retain one-half of the proceeds from the insurance policy.

Economy Fire and Felsenthal represent the extent of Illinois common law doctrine directly pertinent to the issue of insurance law at hand. However, on the more general issue — whether the wrongful conduct of one partner may be imputed to another partner — both common law and statutory law exists. As a matter of Illinois law, the tortious or fraudulent wrongdoing of one partner, not within the scope of his authority or in furtherance of the partnership business, does not subject the other partners (or the partnership) to liability. Saikin v. New York Life Insurance Co., 45 Ill. App.3d 1019, 4 Ill.Dec. 477, 360 N.E.2d 413 ( ...


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