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AMER. HOME ASSUR. v. DYKEMA
August 20, 1985
AMERICAN HOME ASSURANCE COMPANY, PLAINTIFF,
DYKEMA, GOSSETT, SPENCER, GOODNOW & TRIGG, A PARTNERSHIP, AND NORTHBROOK EXCESS AND SURPLUS INSURANCE COMPANY, DEFENDANTS. DYKEMA, GOSSETT, SPENCER, GOODNOW & TRIGG AND NORTHBROOK EXCESS AND SURPLUS INSURANCE CO., COUNTER-PLAINTIFFS, V. AMERICAN HOME ASSURANCE COMPANY, COUNTERDEFENDANT.
The opinion of the court was delivered by: Holderman, District Judge:
MEMORANDUM OPINION AND ORDER
American Home Assurance Company ("American Home") brought this
action for declaratory judgment in order to have the Court
determine (1) to what extent Dykema, Gossett, Spencer, Goodnow &
Trigg ("Dykema"), a Michigan law firm once insured by American
Home, is entitled to insurance coverage for certain claims made
against it; and (2) to what extent should payments made on behalf
of Dykema to settle those claims be apportioned between American
Home and Northbrook
Excess and Surplus Insurance Company ("Northbrook"), another
insurer of Dykema. Dykema and Northbrook counterclaimed, seeking,
inter alia, a declaration that American Home was obligated to pay
the full amount necessary to satisfy the claims. Before the Court
are the parties' cross-motions for summary judgment. Summary
judgment is appropriate, of course, only if the pleadings,
depositions, answers to interrogatories and admissions on file,
together with the affidavits show that there is no genuine issue
as to any material fact. Fed.R.Civ.P. 56(c). For the reasons
stated below, American Home's motion for summary judgment is
denied. Summary judgment for Dykema and Northbrook is granted in
part and denied in part.
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
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
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
C. Settlement Opportunities.
Sometime prior to June 24, 1980, the Barker plaintiff class
offered to settle with all of the Michigan defendants, including
Dykema, for $750,000. Karon reported the settlement offer to
American Home and
recommended a contribution from Dykema to the proposed settlement
pool of approximately $100,000. American Home, however, refused
to grant settlement authority at that figure but suggested
possible authority of $75,000. The Barker plaintiffs' counsel
flatly rejected the $75,000 figure and told Karon that it would
no longer entertain settlement discussions with Dykema. In its
report to American Home after these initial settlement
discussions, Karon noted: "If Dykema could have escaped
entanglement in this complex lawsuit for a contribution of
one-third of its anticipated cost of defense it would have
represented a clear victory for the firm."
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
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
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.
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.
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
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
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
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.
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.
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
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 ...