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STONEWALL INSURANCE COMPANY v. ARGONAUT INSURANCE COMPANY

December 3, 1999

STONEWALL INSURANCE COMPANY, AN ALABAMA CORPORATION, PLAINTIFF,
v.
ARGONAUT INSURANCE COMPANY, A CALIFORNIA CORPORATION, DEFENDANT. ARGONAUT INSURANCE COMPANY, COUNTER-PLAINTIFF, V. STONEWALL INSURANCE COMPANY, COUNTER-DEFENDANT.



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

  OPINION and ORDER

Before the court are (1) Stonewall Insurance Company's Objections to the Magistrate Court's Report recommending that its motion for summary judgment be "stricken" as moot; and (2) Argonaut Insurance Company's Motion for Entry of Judgment. For the following reasons, the court (1) sustains Stonewall's Objections, but denies its motion for summary judgment; and (2) grants in part and denies in part Argonaut's Motion for Entry of Judgment.

I. BACKGROUND

This diversity action involves the business of reinsurance and California law. "Reinsurance occurs when one insurer (the `ceding insurer' or `reinsured') `cedes' all or part of the risk it underwrites, pursuant to a policy or group of policies, to another insurer." Unigard Sec. Ins. Co., Inc. v. North River Ins. Co., 4 F.3d 1049, 1053 (2nd Cir. 1993); see also Continental Cas. Co. v. Stronghold Ins. Co., Ltd., 77 F.3d 16, 17 (2nd Cir. 1996); Prudential Reins. Co. v. Superior Ct., 3 Cal.4th 1118, 14 Cal.Rptr.2d 749, 753, 842 P.2d 48 (1992); In re Mission Ins. Co., 41 Cal.App.4th 828, 48 Cal.Rptr.2d 209, 211 (1995); Excess and Cas. Reins. Assoc. v. Calif Ins. Comm., 656 F.2d 491, 492 (9th Cir. 1981); Ca.Ins. Code § 620. Put another way, "[r]einsurance is purchased by insurance companies to insure their liability under policies written to their insureds." North River Ins. Co. V. CIGNA Reinsurance Co., 52 F.3d 1194, 1199 (3rd Cir. 1995).

"The reinsurance relationship depends on the reinsurer and the reinsured observing high levels of good faith[,]" id., and thus their relationship is "often characterized as one of `utmost good faith.'" Unigard, 4 F.3d at 1054; see also Northwestern Mut. Fire Ass'n. v. Union Mut. Fire Ins. Co., 144 F.2d 274, 276 (9th Cir. 1944). For example, under a "follow the fortunes" clause typically found in a reinsurance contract, "[a] reinsurer cannot second guess the good faith liability determinations made by its reinsured. . . . Christiania Gen. Ins. Corp. v. Great American Ins. Co., 979 F.2d 268, 280 (2nd Cir. 1992). At the same time, however, the reinsurer has the right to question whether the ceding insurer's claims stem from reinsured losses, and therefore the reinsurer must have the cooperation of the ceding insurer. See Unigard, 4 F.3d at 1054, 1069; CIGNA, 52 F.3d at 1199-1200; cf. Cal.Ins.Code § 622.*fn1 It is this proposition that has spawned this messy, protracted litigation between a reinsurer, Stonewall Insurance Company, and a ceding insurer, Argonaut Insurance Company. A summary follows.

Pursuant to a reinsurance contract, Argonaut sought indemnification (i.e., reimbursement) from Stonewall after Argonaut agreed to settle a complex environmental pollution insurance coverage dispute with its original insured, Hughes Aircraft Company.

Hughes had filed separate lawsuits against Argonaut and several other primary insurers in the Superior Court of the State of California, seeking coverage for environmental pollution that its manufacturing plant had leaked into the City of Fullerton's sanitary sewer system and alleging bad faith for wrongful refusal to defend in litigation stemming from past contamination at its plant property. In that underlying pollution litigation, Hughes was left to provide its own defense, and ultimately settled the claims against it. Hughes' insurers, which, in addition to Argonaut, included Hartford Accident and Indemnity Company, Insurance Company of North America, and various syndicates of Lloyd's of London,*fn2 had issued primary insurance policies to Hughes at various times over the last several decades.

Argonaut had issued Hughes two primary insurance policies during this time period. One policy covered the period January 1, 1970 to January 1, 1971, and did not contain a pollution exclusion. This policy was reinsured by various syndicates of Lloyds of London and included a unique provision that gave Lloyds full and complete control of any claim asserted under the primary policy. The other Argonaut policy, most relevant here, covered Hughes for the period January 1, 1972 through April 1, 1975 for $1 million per occurrence, and contained a pollution exclusion, which excluded pollution coverage unless the pollution was "sudden and accidental." (See Compl., Ex. A.) This policy was reinsured by Stonewall via three facultative certificates of insurance.*fn3 (See Compl., Exs. B, C, and D.)

The first of the Hughes primary coverage cases to go to trial was Hughes Aircraft Co. v. Brian E. Beagley.*fn4 On November 14, 1995, a California jury found in favor of Hughes and against Beagley in a special verdict on liability. Specifically, the jury found four different occurrences or sources of environmental contamination (two in 1960 and two in 1961) at Hughes' Fullerton plant, thereby triggering Beagley's coverage. The jury also found that Beagley acted in bad faith for its wrongful refusal to defend Hughes.

Stonewall, however, balked at submitting the reinsurance monies to Argonaut. Stonewall questioned Argonaut's candidness about the details of the Fullerton settlement and was allegedly unable to discern or meaningfully review the information and mass of documents that Argonaut had submitted. Stonewall contended that Argonaut had violated a provision of the reinsurance contract which required that Argonaut cede its reinsurance claim based on its reasonable, legitimate settlement with the underlying insured — Hughes.*fn6 That is, Stonewall asserted that Argonaut settled with Hughes on the basis of multiple pollution occurrences at the Fullerton plant, a la Beagley, but then turned around and ceded its reinsurance claim to Stonewall on the basis of one occurrence. Stonewall also maintained that Argonaut mishandled and manipulated its Hughes litigation and eventual settlement for several reasons: (1) to trigger Stonewall's "sudden and accidental" reinsurance obligation by sidestepping the policy's pollution exclusion for multiple occurrences; (2) to avoid a finding of bad faith and the resulting punitive damages that it would not be able to cede to Stonewall; (3) to avoid the expense of a costly defense to the Hughes coverage; and (4) to avoid full exposure from the 1970 policy. According to Stonewall,

  Argonaut's claimed settlement of a complex
  environmental pollution claim, purportedly on a
  `one-occurrence' basis, is inconsistent with the
  existing facts and law governing its settlement at
  that time. The evidence of how and why Argonaut
  settled is overwhelming: Argonaut settled [with
  Hughes] on the basis of exposure to six occurrences
  for liability for substantial bad faith damages for
  Argonaut's wilful refusal to defend, knowingly in
  contradiction of law and contract. The reason Argonaut
  manipulated the settlement from the six occurrences
  and bad faith basis is because of the adverse
  financial consequences inherent in ceding to its
  reinsurers, including Stonewall, in accordance with
  the actual settlement.

(Pl.'s Trial Br. at 2.)*fn7

In February 1997, Argonaut filed a counterclaim alleging breach of contract, breach of duty of good faith, and breach of duty of utmost good faith under California law. Argonaut also asked for a judgment declaring that Stonewall owed it reimbursement for Stonewall's contractual portion of the Fullerton Settlement, and for defense fees and costs incurred by Hughes in its underlying pollution litigation. Argonaut alleged that Stonewall asked unreasonable questions about the Fullerton Settlement and that Stonewall feigned an inability to understand the facts and reasoning behind the Fullerton Settlement. For example, Argonaut alleged that Stonewall repeatedly contended that Argonaut should not have settled because of the existence of a pollution exclusion. Argonaut maintained, however, that Stonewall had settled other environmental cases despite the existence of a pollution exclusion because of its fear of litigation.

In October 1997, the court referred the case to Magistrate Judge Ashman to conduct all pretrial duties consistent with his constitutional and statutory authority. See 28 U.S.C. § 636; Fed.R.Civ.P. 72(b); N.D.Ill. Local Gen.R. 2.41(b). Numerous discovery disputes ensued, along with several objections to Magistrate Judge Ashman's rulings. On November 19, 1998, this court set a trial date of January 25, 1999. On December 3, 1998, each party cross-moved for summary judgment, and the motions became fully-briefed on January 8, 1999.

On January 25, 1999, the trial began before this court, as scheduled. The parties' respective motions for summary judgment, however, remained pending before the Magistrate Judge. After over three weeks of trial; the jury returned a verdict in favor of Argonaut and against Stonewall on February 16, 1999. The jury awarded Argonaut (1) $2,455,986.35 (plus prejudgment interest) on its breach of contract claim; (2) $6 million in punitive damages on its claim that Stonewall breached its duty of good faith; and (3) $7 million in punitive damages on its claim that Stonewall breached its duty of utmost good faith.*fn8 Additionally, the jury (1) found in favor of Argonaut on its declaratory judgment count, i.e., the jury declared that Stonewall was obligated to reimburse Argonaut for Stonewall's contractual portion of the Fullerton Settlement and for defense fees and costs incurred by Hughes in its underlying pollution litigation; and (2) found against Stonewall on its declaratory judgment, i.e., the jury declared that Stonewall received all information necessary to evaluate the propriety of the Fullerton Settlement and the basis of coverage for the primary insurance policy and the reinsurance certificate and that Stonewall was obligated to reimburse Argonaut for the Fullerton Settlement. Finally, the jury answered "NO" to the following five Special Interrogatories that Stonewall had tendered:

  1) Do you find that because of the jury finding of
  four occurrences in Beagley and the two sudden and
  accidental spills, Argonaut settled with Hughes
  Aircraft based on exposure to six occurrences?
  2) Do you find that Argonaut's settlement was based in
  part on Argonaut's exposure to bad faith liability for
  its failure to defend Hughes?
  3) Do you find that Argonaut failed to provide
  Stonewall with all the information necessary for
  Stonewall to understand Argonaut's settlement with
  Hughes [the Fullerton Settlement] and/or the
  subsequent cession of that settlement to Stonewall?
  4) Do you find that the questions asked by Stonewall
  pertaining to Argonaut's settlement were not in bad
  faith?
  5) Do you find that any amount of the billings charged
  to Stonewall contain amounts charged for bad faith?

On February 18, 1999, Magistrate Judge Ashman issued a Report recommending that the parties' cross-motions for summary judgment "be stricken as moot." Also on February 18, 1999, Argonaut moved for entry of judgment on the jury's verdict. On March 4, 1999, Stonewall filed objections to Magistrate Judge Ashman's recommendation that its motion for summary judgment be stricken as moot. After extensive briefing, Argonaut's motion and Stonewall's objections are now ripe for disposition. The court turns first to Stonewall's objections to Magistrate Judge Ashman's recommendation to strike its motion for summary judgment as moot.

II. DISCUSSION

Whether the Trial Mooted Stonewall's Motion far Summary Judgment

In its objections, Stonewall argues that, because its motion for summary judgment asserted the legally, as opposed to factually, dispositive issue of collateral estoppel, the Magistrate Court erred in deeming it moot. In other words, Stonewall contends that because its motion involved a purely legal question, the general rule that a trial moots a motion for summary judgment, see Watson v. Amedco Steel, Inc., 29 F.3d 274, 277-78 (7th Cir. 1994), does not apply. Stonewall argues a ruling on its motion was critical because, if granted, "the Beagley jury's finding of multiple occurrences would have collaterally estopped Argonaut from relitigating the number of occurrences had it tried its own coverage case and therefore, Argonaut could not possibly have settled on the basis of one occurrence." (Objs. at 2.) In short, Stonewall asks the court to reserve entering judgment on the jury's verdict until its assertion of collateral estoppel is addressed.

In response, Argonaut maintains that "Stonewall expressly submitted the collateral estoppel issue to the jury, instructing the jury at length as to all of its, elements." (Resp. at 2.) Argonaut then excerpts those jury instructions in its response, which do indeed ask the jury to resolve the collateral estoppel issue:

  The jury in Beagley found four different occurrences
  or sources of environmental contamination at the site
  in Fullerton, California under California law,
  resulting occurrences for which the insurer was
  obligated to indemnify Hughes. You need not reconsider
  the jury finding of multiple recurrence [sic]
  occurrences in the Beagley trial.
  Stonewall also contends that the cessation of
  settlement was unreasonable because Argonaut
  considered that the effect of the Beagley verdict,
  about which you have just heard, would, in all
  probability, result in a verdict against Argonaut for
  multiple occurrences on the Fullerton claim.
  Essentially, Stonewall claims that because the  jury
  in Beagley found multiple occurrences for the same
  environmental claim over which Argonaut was
  litigating,

  Argonaut felt it could not relitigate the point based
  on the doctrine of collateral estoppel.
  Stonewall bases its argument on a doctrine called
  collateral estoppel. The doctrine of collateral
  estoppel means that when an issue of ultimate fact has
  been previously determined by valid and final
  judgment, that issue cannot be relitigated between the
  same parties or parties closely related. A jury
  verdict is a final judgment.
  The doctrine of collateral estoppel requires four
  elements: (1) the issue is identical to an issue in a
  prior action; (2) the issue was actually litigated in
  the prior action; (3) the issue was essential to the
  prior judgment; and (4) ...

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