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August 20, 1985


The opinion of the court was delivered by: Holderman, District Judge:


I. Undisputed Facts*fn1

A. The Barker lawsuit.

On March 27, 1977, the Michigan Baptist Convention (the "Convention") retained Dykema as counsel. More than two years later in May of 1979, the Convention was sued in this Court by a class of purchasers of note certificates sold and offered for sale by an organization known as the Michigan Baptist Foundation (the "Foundation"). This case was entitled Barker, et al. v. Farrell, et al., No. 79 C 2047 (the "Barker lawsuit"). Six months later in November of 1979, Dykema itself was served as a party defendant in the Barker lawsuit. The first amended class action complaint alleged that since 1977 Dykema had represented the Convention and another entity, American Baptist Churches of Michigan. Dykema's representation, the complaint alleged, included "certain activities with respect to the affairs of the Foundation including matters pertaining to its offer and sale of Note Certificates." (first amended class action complaint, ¶ 23). The complaint charged Dykema, among many others, with violation of the federal securities law, common law fraud and violation of Florida securities laws. Finally, the first amended complaint specified generally that each count arose from "defendants' unlawful acts in connection with the sale . . . of more than $3 million in unsecured note certificates issued by the [Foundation] during the years 1976, 1977 and 1978." (first amended class action complaint, ¶ 1.)

There were two subsequent amendments to the Barker complaint. The third (and last) amended complaint, by then captioned Barker, et al. v. Lee County Bank, et al., was filed in April of 1980. This document was a highly detailed document charging the defendants with unlawful acts in connection with the public sale of more than $7 million in mortgage bonds and notes issued by the Foundation during the period of 1974-1978. Dykema's participation in the bond and note offerings was specified in paragraphs 66 through 82 of the third amended complaint. That document charged Dykema with knowing participation in conduct which resulted in the unlawful sale of securities. Dykema was also alleged to have prevented material facts from becoming known by the purchasers of the securities. Specifically, paragraph 67 alleged that shortly after being retained by the Convention in March of 1977, Dykema became aware of the grave financial condition of the Foundation and the fact that, among other things, the Foundation had not made legally-required disclosures in connection with the sale of certain note certificates, mortgage bonds and life lease contracts. Subsequent paragraphs alleged actions taken by Ronald Rose, a partner at Dykema, in April, May, June, July and early August of 1977. Finally, in paragraph 82, the third amended complaint alleged that "[e]ven as late as the spring of 1978, when the Foundation's future was hopeless, attorney Ronald Rose urged and advised that the sale of the Note Certificates be continued."

The third amended complaint set forth eight causes of action, five of which were directed at Dykema. Count I alleged that Dykema aided and abetted violations of § 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder; Count II alleged that Dykema's conduct constituted common law fraud and deceit; Count III alleged that Dykema was guilty of reckless or negligent misrepresentation; Count IV alleged that Dykema was guilty of professional or fiduciary recklessness or negligence; and Count VI alleged that Dykema violated Florida securities laws.

B. The Insurance Companies.

On August 19, 1976, American Home issued a professional liability insurance policy to Dykema. The policy was countersigned in Michigan by American Home's agent. The relevant portions of American Home's policy are discussed at length below. Originally, the American Home policy provided professional liability insurance up to a limit of $1,000,000. An endorsement dated January 12, 1977 raised the policy limit to $2,000,000. Dykema was responsible for a $100,000 deductible applicable to the policy. American Home's policy expired on August 19, 1977.

Two years later on August 19, 1979, Northbrook issued a professional liability insurance policy to Dykema. The specific provisions of Northbrook's policy at issue in this lawsuit are also discussed below.

When Dykema was served with the Barker first amended class action complaint in November of 1979, it immediately notified American Home and Northbrook. It is unclear from the record what action, if any, Northbrook took in response to Dykema's notice. By letter dated December 6, 1979 American Home, however, acknowledged Dykema's notice. American Home informed Dykema that it had assigned the law firm of Hinshaw, Culbertson, Moelmann, Hoban & Fuller to represent Dykema in the Barker lawsuit and to fully protect Dykema's interest. Six days later, American Home reassigned the case to Karon, Morrison & Savikas, Ltd. ("Karon"). The last paragraph of the December 6, 1979 letter provided as follows:

  If through discovery and/or other procedures it
  becomes apparent that there are claims made against
  your firm which are not covered by your policies of
  insurance the American Home Assurance Company
  reserves its rights to set forth at a future time
  those claims and/or judgment rendered against you
  which are not covered by your insurance policy.

As a result of American Home's assumption of Dykema's defense of the Barker lawsuit, Dykema did not retain separate legal counsel. Dykema satisfied the $100,000 deductible obligation and otherwise fully complied with all provisions of the American Home policy.

C. Settlement Opportunities.

Approximately five months later, however, the Barker plaintiffs did again offer to settle with Dykema, this time for the sum of $475,000. In November of 1980, Karon once again conveyed the settlement offer to American Home and sought settlement authorization up to the sum of $250,000. American Home once again refused to grant authority to settle for any sum greater than $75,000.

D. American Home Questions Coverage.

In February of 1982, Karon learned that American Home had retained another law firm, Conklin and Adler, Ltd. to review Karon's file on the Barker lawsuit. (Conklin and Adler represents American Home in this action.) Conklin and Adler indicated to Karon that it might recommend that further efforts be made to settle the Barker lawsuit.

Neither American Home nor Conklin and Adler informed Dykema at this time that any question of Dykema's coverage under the American Home policy had arisen. Apparently, however, it had, for in January of 1982, Conklin and Adler wrote to American Home stating that "a serious question of policy period" had arisen from their initial review of the Barker lawsuit. (Conklin and Adler admitted, however, that it had never examined the policy issued to Dykema and that its comments were based on its "understanding of the general form which such policies take.") Conklin and Adler advised American Home that the Barker complaint concerned Dykema's activities between March of 1977 and April of 1978. Since American Home's policy expired August 19, 1977, Conklin and Adler reasoned, some other policy "ought to at least contribute to the coverage of the alleged loss." It was in apparent response to this advice that American Home directed Conklin and Adler to review Karon's file on the Barker litigation.

In February of 1982, Conklin and Adler wrote to Karon stating that it had been retained by American Home "to represent their interests" and directing Karon thereafter to submit all reports concerning the Barker litigation to it. This letter, however, did not apprise Karon of any coverage issue.

On August 26, 1982, Karon met with Conklin and Adler. At this meeting Conklin and Adler for the very first time raised the issue of whether Dykema was covered by the American Home policy for its liability under the Barker complaint. On September 1, 1982, Conklin, on American Home's behalf, met with Gregory Kopacz of Dykema and an attorney representing Northbrook. Conklin for the first time directly revealed the policy limitations claimed by American Home to preclude, at least in part, coverage of Dykema's liability. At this meeting Conklin suggested a formula whereby American Home would be responsible for only 5/13 of any settlement amount and claim expenses. At this same meeting American Home attempted to discharge Karon and bar its further participation in the Barker lawsuit.

E. Settlement of the Barker lawsuit.

On July 23, 1982, a stay of discovery which had been in effect in the Barker litigation for nearly 18 months was lifted. At the urging of the trial court to pursue settlement, Dykema wrote to Conklin advising it that "now would be the propitious time to begin negotiations in earnest." The Barker plaintiffs subsequently demanded $750,000 to settle against Dykema only, such offer to remain open for two weeks only. Karon advised American Home that in light of Dykema's potential exposure to a multi-million dollar verdict, "efforts [should] be made to extricate Dykema for an amount up to the $750,000 demand." American Home did not respond to either Karon's advice or the settlement offer prior to its expiration date.

The Barker plaintiffs renewed the settlement offer on August 16, 1982. Karon once again wrote to Conklin and Adler reiterating its belief that settlement should be pursued.

At Dykema's request, Karon pursued negotiations with the Barker plaintiffs. The claims were finally settled for the amount of $612,500. American Home contributed $306,250 towards the settlement without prejudice to its right to contest coverage. Northbrook, by virtue of a loan receipt agreement with Dykema, contributed an additional $306,250. Dykema was granted leave by the trial court in Barker to pay one-half of Karon's fees (upon refusal to do so by American Home) without prejudice to its right to seek reimbursement.

II. Discussion

A. Choice of Law.

The Court's jurisdiction in this matter is founded upon 28 U.S.C. § 1332. In such a diversity action, the Court is required to apply the law of the state in which the Court sits, including the forum state's choice-of-law rules. Klaxon v. Stentor Electric Manufacturing Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941). Conflict rules are examined, however, only when a difference in law will make a difference to the resolution of an issue. International Administrators, Inc. v. Life Insurance Co. of North America, 753 F.2d 1373, 1376 n. 4 (7th Cir. 1985). On issues about which there is no disagreement among the contact states, a federal court will apply the law of the forum state. Id. Finally, the choice-of-law inquiry must be made for each issue separately. Id.

The Court will first determine which law controls the dispute between American Home and Dykema. Under Illinois law, the factors that determine which law should be applied to insurance contract disputes are the location of the subject matter, the place of delivery of the contract, the domicile of the insured or of the insurer, the place of the last act to give rise to a valid contract, the place of performance, or other place bearing a relationship to the general contract. Hofeld v. Nationwide Life Insurance Co., 59 Ill.2d 522, 528, 322 N.E.2d 454 (1975) (citing 12 Appleman, Insurance Law and Practice sec. 7074 (1943)).

Here, Dykema is a Michigan partnership engaged in the practice of law, primarily in Michigan. American Home is a New York corporation with its principal place of business in New York. The last act to give rise to the insurance contract between American Home and Dykema was the countersignature by American Home's agent, which took place in Michigan. In short, Michigan would appear to be the state with the most significant stake in the resolution of the insurance coverage dispute.

Nevertheless, American Home has argued that since the public policy of Illinois would preclude coverage of Dykema for the unlawful conduct alleged by the Barker plaintiffs, then this Court must apply Illinois law. More particularly, American Home argues that because (1) the Barker complaint sought punitive damages, and (2) the settlement sum of $612,500 did not specify whether the payment represented compensatory or punitive damages, then the Illinois policy prohibiting insurance coverage for punitive damages precludes Dykema's coverage for its liability in the Barker lawsuit.

American Home's reliance on this Illinois public policy is misplaced. Illinois public policy has little or no bearing on this lawsuit. Except for the fact that Northbrook's principal place of business is in Illinois, Illinois has no stake whatsoever in the outcome of this case. See International Administrators, Inc. v. Life Insurance Co. of North America, 753 F.2d at 1377 n. 4 ("Even if the Illinois policy [according insurance company a statutory privilege] is a strong one, it is hard to see why Illinois policy comes into the picture at all."); Aetna Casualty & Surety Co. v. Enright, 258 So.2d 472 (Fla.App. 1972) (Florida public policy did not apply where insurance policy in dispute was issued to a New York resident in New York).

Moreover, American Home has offered no evidence to show that the Barker settlement figure included a sum for punitive damages. In the absence of such a showing, Illinois' policy prohibiting insurance coverage for punitive damages should play no part in the determination of whether and to what extent Dykema was covered under the American Home policy. Cf. Space Conditioning, Inc. v. Insurance Co. of North America, 294 F. Supp. 1290, 1296 (E.D.Mich. 1968) aff'd 419 F.2d 836 (6th Cir. 1970) (the fact that verdict against the insured was a general one and may have included damages not covered by insurance policy was no defense to action against the insurer by insured for wrongfully refusing defense of the initial action).

Finally, American Home has misapplied the Illinois policy. In Beaver v. Country Mutual Insurance Co., 95 Ill.App.3d 1122, 51 Ill.Dec. 500, 420 N.E.2d 1058 (5th Dist. 1981), the Illinois appellate court held that Illinois public policy prohibits insurance for punitive damages arising out of one's own conduct. The Illinois court specifically noted, however, that the holding in Beaver did not affect the earlier ruling in Scott v. Instant Parking, Inc., 105 Ill.App.2d 133, 245 N.E.2d 124 (1st Dist. 1969). In Scott the court held that an employer may insure itself against vicarious liability for punitive damages assessed against it as a result of its employee's wrongful conduct. The Beaver court explained the rationale behind Scott:

  "In these cases a factor not always focused upon, yet
  of crucial importance, is the point that if the
  employer did not participate in the wrong, the policy
  of preventing the wrongdoer from escaping the
  penalties for his wrong is inapplicable."

95 Ill.App.3d at 1125, 51 Ill.Dec. 500, 420 N.E.2d 1058, quoting from Northwestern National Casualty Co. v. McNulty, 307 F.2d 432, 439-40 (5th Cir. 1962).

Illinois courts have yet to address specifically the issue of whether Illinois public policy prohibits insurance of a partnership for the punitive damages resulting from one of its partner's wrongdoing. The arguments that can be made on both sides of the issue are obvious. In the absence of clear Illinois authority precluding a partnership's coverage, however, this Court will not find that a law firm cannot insure itself against liability for punitive damages assessed by reason of a partner's wrongdoing.

In any event, Illinois public policy does not prohibit the application of Michigan law to the dispute between Dykema and American Home. Therefore, based upon the various factors properly considered in resolving the issues of the Dykema-American Home dispute, the Court will apply Michigan law.

The Court is similarly convinced that Michigan law controls resolution of the dispute between American Home and Northbrook. Both parties insured a risk located in Michigan; Michigan's interest in the insurance coverage of its residents is the most significant state interest in this case. Michigan law, therefore, governs resolution of the dispute between American Home and Northbrook.

B. The Merits of the Parties' Respective Motions.

American Home's motion only seeks summary judgment with respect to apportionment of liability between American Home and Northbrook. Dykema's and Northbrook's motion for summary judgment seeks, inter alia, a determination of American Home's obligations to Dykema. The Court will address this latter issue first.

  1. American Home is Estopped from Denying Coverage to

American Home is mistaken. Under either Michigan or Illinois law, American Home is estopped from denying coverage to Dykema more than two and one-half years after litigation commenced and more than seven months after Conklin and Adler apprised American Home that a policy period issue existed.

Under Michigan law, when even a mere possibility of a conflict of interest arises between an insurer and an insured, an insurer must act "promptly and openly, on peril of estoppel" to protect the rights of both the insured and the insurer. Meirthew v. Last, 376 Mich. 33, 135 N.W.2d 353 (1965). In Meirthew, plaintiff had won judgment in a suit arising out of a car accident. When he was unable to collect against the defendant in that action, he sued in garnishment against defendant's insurer. The insurer sought to avoid liability for the judgment on the basis of a "Reservation of Rights" letter it had sent to its insured more than two and one-half years after hiring counsel to represent it and its insured. The letter stated in relevant part as follows:

  [T]he Company in undertaking your defense, does so
  under a reservation of rights, and without prejudice,
  and subject to the conditions, limitations,
  exclusions and agreements of said policy, and subject
  to the express understanding that by so doing the
  Company does not waive any of its rights to rely upon
  the provisions of said policy, and does not waive any
  defense it may have to any claimed liability under
  said policy.

135 N.W.2d at 355. After three years of litigation, the insurance company sought to avoid coverage by reason of a "Risks Excluded" clause in the insurance policy. The Michigan Supreme Court held that the notice was legally insufficient, vague, uncertain and too late. The reservation, the Court held, "smack[ed] of bad faith for want of a specific reference" to the clause in the contract upon which the insurer intended to rely to deny coverage. Id. at 355. The Michigan Court, in summarizing, held that the insurer's notice was

  unreasonably and prejudicially tardy. It failed [the
  "reasonableness"] test because it left [the insured]
  in the dark as to the nature of the policy defense or
  defenses the insurer had in mind; if indeed it had
  any in mind save such as might be conceived later as
  the principal case proceeded.

135 N.W. at 356. The Court explained the reason for its holding:

  In no field of law is legal duty more rigidly
  enforced than in instances as at bar. The insurer
  must fulfill its policy-contracted obligation with
  utmost loyalty to its insured; not for the purpose of
  developing, secretly or otherwise, a policy defense.

Id. at 355.

American Home's reservation of rights in its December 6, 1979 letter, and its subsequent attempt in August of 1982 to deny coverage, are similarly defective. The 1979 letter did not refer to any aspect of the insurance policy upon which American Home hoped to avoid coverage of the Barker claims. Both the first and third amended complaints in the Barker lawsuit should have apprised American Home of the time period during which Dykema was alleged to have acted unlawfully. American Home was on notice as early as November of 1979 of the defense to coverage which it did not assert until August of 1982.

American Home's conduct is particularly egregious in light of the advice it received from Conklin & Adler in January of 1982 to the effect that a policy period issue existed. Instead of notifying Dykema or Karon, American Home chose to stall settlement while it indeed "secretly" developed a policy defense. Such behavior cannot be tolerated and American Home is estopped under Michigan law from denying coverage.*fn2

This result, however, does not turn on the application of Michigan law (which, as discussed above, governs this dispute) since the outcome would be the same under Illinois estoppel doctrine. In Illinois, a party claiming the benefit of an estoppel must prove "reasonable reliance upon the acts or representations of the party sought to be estopped, without knowledge of a convenient means of learning the true facts." National Ben Franklin Insurance Co. v. Davidovitch, 123 Ill. App.3d 88, 93, 78 Ill.Dec. 577, 462 N.E.2d 696 (1st Dist. 1984) (insurer's representation of doctor in a malpractice lawsuit for over two years before notification of withdrawal, doctor's reliance thereon in not hiring separate counsel, and insurer's decision not to settle until more than two years of litigation created an estoppel). If an insurer's assumption of the defense induces the insured to relinquish his right to control his own defense, the insured has suffered the requisite prejudice. See, e.g., Textile Machinery, Inc. v. Continental Insurance Co., 87 Ill.App.3d 154, 157, 42 Ill.Dec. 506, 409 N.E.2d 1 (1st Dist. 1980) (when insurer did not assert lack of policy coverage until more than two and one-half years after it undertook defense on behalf of its insured and retained a law firm to represent insured, insurer was estopped to deny coverage).

In this case, Dykema reasonably relied on American Home's representations and conduct in initially assuming the defense and continuing the control of the Barker lawsuit. Dykema reasonably believed that American Home's policy insured Dykema for the misconduct alleged in the Barker complaint. Dykema did not know of any "true facts" that could preclude coverage under the policy. Indeed, American Home has not even attempted to argue that the law firm should have known it was not covered. Finally, American Home's failure to authorize settlement ...

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