Advanced Ground v. RTW Indus Inc ( 2004 )

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 03-3160
ADVANCED GROUND SYSTEMS ENGINEERING, INC.,
Plaintiff-Appellee,
v.
RTW INDUSTRIES, INC., D/B/A INDIANA BRIDGE DIVISION,
Defendant-Third Party Plaintiff-Appellant,
v.
RAVI R. TALWAR,
Third Party Defendant-Appellee.
____________
Appeal from the United States District Court for the
Southern District of Indiana, Indianapolis Division.
No. IP 00-0076-C-M/S—Larry J. McKinney, Chief Judge.
____________
ARGUED FEBRUARY 10, 2004—DECIDED OCTOBER 28, 2004
____________
Before RIPPLE, ROVNER, and WOOD, Circuit Judges.
WOOD, Circuit Judge. When a work platform under con-
struction for the Indianapolis Airport Authority (IAA) partially
collapsed on May 13, 1999, the inevitable search for com-
pensation began. United Airlines, the facility manager for
IAA, served notice of a claim to Advanced Ground Systems
Engineering (“Engineering”), the principal contractor for
2 No. 03-3160
the project, alleging that faulty welds caused the collapse.
Engineering in turn tendered its defense of the claim to
RTW Industries, Inc., the subcontractor responsible for the
welding work. RTW rejected the tender, and this litigation
followed. It was interrupted, however, by arbitration between
Engineering and United, as called for in the contract be-
tween Engineering and IAA; RTW was not a party to the
arbitration.
The present appeal deals with matters remaining after the
completion of the arbitration. The arbitrator ruled in favor
of United, awarding it $661,152. RTW, still in the lawsuit,
then added a third-party complaint against Ravi Talwar,
the founder and former president, CEO and sole shareholder
of RTW. Talwar had sold his RTW shares in 1996 to an-
other entity, but RTW asserted that Talwar had a duty to
indemnify RTW under the stock purchase agreement. The
district court resolved the claims as follows: (1) it confirmed
the arbitral award in favor of United and against Engineering;
(2) it granted summary judgment for Engineering in its
claim against RTW, finding that RTW owed Engineering a
duty to defend and indemnify it; (3) it granted Engineering’s
motion for costs and attorneys’ fees; and (4) it granted
Talwar’s motion for summary judgment, finding that he had
no duty to indemnify or defend RTW. RTW now appeals. We
affirm the judgment of the district court.
I
Engineering, a California corporation with its principal
place of business in that state, and IAA concluded their
original contract on December 18, 1992. Under the contract,
Engineering undertook to fabricate and construct a horizontal
tail section work platform, which was to be used in perform-
ing work on Boeing 737 aircraft at an IAA maintenance cen-
ter. In 1993, Engineering entered into an agreement with
RTW (which was an Indiana corporation doing business as
No. 03-3160 3
Indiana Bridge Division; we refer to it as RTW, to avoid
confusion with a later Illinois corporation also named Indiana
Bridge). In that agreement, RTW agreed to provide all
material and labor to fabricate, blast clean, and shop paint
the assemblies in accordance with Engineering’s specifica-
tions.
As noted above, on May 19, 1999, there was a partial col-
lapse of the work platform. United, IAA, and Engineering
alleged that RTW’s welding work was responsible for the
accident, because the welds were of insufficient depth and
bonding. After the notices of claim and tenders of defenses
took place, Engineering filed this case, requesting a declar-
ation obliging RTW to defend and indemnify Engineering
with respect to any claims brought by IAA (or United, stand-
ing in IAA’s shoes). Engineering also sought a declaration
of the rights and duties it and United had that arose out of
the contract between Engineering and IAA. The district
court ruled in favor of Engineering on the first claim; the
second no longer concerns us. The court stated that it
understood Engineering to be seeking a declaration that
RTW had a duty both to defend and to indemnify it with
respect to the United claims that went to arbitration and on
which United recovered $661,152. Applying California law,
the court concluded that the clause in which RTW promised
to indemnify Engineering also included a duty to defend. On
appeal, RTW claims that this was an error, as was the
court’s related decision to award attorneys’ fees to Engi-
neering. In a later order, the district court also ruled that
Talwar had no duty to indemnify RTW pursuant to a 1997
stock purchase agreement, under which he sold all of his
shares in RTW to Indiana Bridge, Inc. (the Illinois corp-
oration, to which we refer as IBI), nor did he have a common
law duty to indemnify RTW. This ruling is the target of the
other part of RTW’s appeal.
4 No. 03-3160
II
We begin with the question whether the district court
correctly granted summary judgment in favor of Engineering
on the question of RTW’s duty to defend and indemnify it.
The logical starting point is the contractual language in the
agreement between Engineering and RTW on which this
duty hinges, which we set forth here:
(7) Supplier warrants:
(A) that goods and services covered by this Purchase
Order will conform to the specifications, design,
drawing, samples and other descriptions referred to
it in the Purchase Order,
(B) that such goods will be free from defects in ma-
terial and workmanship, potent [sic] or latent, and
such services will be of workmanlike quality,
(C) that such goods will be fit and sufficient for the
ordinary purposes of such goods and services, and
for such specific purposes which Purchaser informs
Supplier the goods and services are intended.
These warranties shall run to Purchaser, its customers
and subpurchasers.
(8) Supplier shall also indemnify and hold harmless
Purchaser from and against any and all liabilities, judg-
ments and damages suffered because of Supplier’s non-
compliance with any of the warranties in paragraph (7)
hereinabove, which are paid or payable by Purchaser
upon claim or cause of action of any kind asserted by any
part, including without limitation Purchaser’s employ-
ees, Purchaser’s customers, and subpurchasers there-
from, and Supplier’s agents and employees, and Supplier
shall reimburse expenses of Purchaser incidental to
such claim or cause of action.
In paragraph 11 of the agreement, the parties agreed that
California law would apply to the contract.
No. 03-3160 5
It is clear that this contract imposed a duty on RTW to
indemnify Engineering; the district court noted that RTW
did not contest this point. The dispute here is whether it
also imposes the separate duty to defend. As to this, RTW
argues that the final sentence of clause (8) plainly shows
that no such duty existed. Instead, the parties expected that
RTW would have to reimburse Engineering for expenses
“incidental” to any covered claim. The district court acknow-
ledged that this was a reasonable reading of that sentence,
but it concluded that it was a reading at odds with California
law.
The provision of California law that the district court had
in mind was Cal. Civ. Code § 2778, which is titled “Rules for
Interpreting Agreement of Indemnity.” It provides in
relevant part as follows:
In the interpretation of a contract of indemnity, the
following rules are to be applied, unless a contrary in-
tention appears:
***
(4) The person indemnifying is bound, on request of the
person indemnified, to defend actions or proceedings
brought against the latter in respect to the matters
embraced by the indemnity, but the person indemnified
has the right to conduct such defenses, if he chooses to
do so;
(5) If, after request, the person indemnifying neglects to
defend the person indemnified, a recovery against the
latter suffered by him in good faith, is conclusive in his
favor against the former; . . . .
Cal. Civ. Code § 2778(4), (5). The district court read this
language—particularly that in § 2778(4)—to mean that a
contract containing a duty to indemnify should be inter-
preted as including a duty to defend, unless the parties
have expressly excluded such a duty in their agreement. It
6 No. 03-3160
then found that the promise to pay “incidental” expenses in
the Engineering/RTW agreement was not specific enough to
negate a duty to defend.
There is a paucity of California law directly on point;
most of the cases construing this aspect of § 2778 appear to
come from the federal district courts in that state. (Perhaps
this is a price of the apparent preference on the part of
insurance companies for litigating in federal court, when
diversity of citizenship is present.) Not surprisingly, California
recognizes the distinction between the duty to indemnify
and the duty to defend. See Certain Underwriters at Lloyd’s
of London v. Superior Court, 16 P.3d 94, 101-02 (Cal. 2001). It
describes the two duties as “correlative,” id. at 101, and like
other courts, it considers the duty to defend as “perforce”
broader than the duty to indemnify. Id. at 102. But the
question in the 2001 Lloyd’s case was quite different from
the one now before us: there, the court had to decide whether
these duties were limited to civil actions in court, or if they
extended to proceedings before environmental agencies.
One federal district court observed that “[a]n insurer may
assume a duty to reimburse for defense costs without as-
suming a duty to defend.” Save Mart Supermarkets v.
Underwriters at Lloyd’s London, 843 F. Supp. 597, 603 (N.D.
Cal. 1994). But it then held only that an obligation to reim-
burse is not “determinative” of an obligation to defend. Id. In
itself, that statement seems reasonable. An obligation to reim-
burse might be some evidence of an obligation to defend, or
it might be some evidence that the parties intended to
impose an obligation to reimburse in lieu of an obligation to
defend. In short, the obligation to reimburse standing alone
is ambiguous. It accordingly cannot serve, without more, as
proof that the parties intended to exclude the operation of
§ 2778(4). Here, there is nothing else that would demonstrate
an intent to deviate from the statute. We thus agree with
the district court that RTW had an obligation not only to in-
demnify Engineering, but also to defend it with respect to
No. 03-3160 7
matters within the scope of the indemnification agreement
upon Engineering’s tender of the matter, in accordance with
§ 2778(4).
But the district court did not take a close look at what mat-
ters fell within the scope of the indemnification agreement,
and it is that point on which RTW is now focusing. RTW
argues that the contract calls for indemnification only for
non-compliance with the warranties found in paragraph 7
of the agreement. This means, in its view, that proof of non-
compliance is a prerequisite not only for finding a duty to
indemnify, but also for finding a duty to defend (or for that
matter the duty to reimburse the expenses of the arbitra-
tion). Thus, it concludes, the district court could not resolve
this dispute on summary judgment, because there are
disputed issues of fact with respect to RTW’s compliance
with the warranties.
But the same could be said of countless contractual obli-
gations to indemnify someone. The California Supreme Court
long has held that the ultimate duty to indemnify does not
arise unless the indemnitee has been found liable to the
principal plaintiff, as Engineering was found liable to
United. See, e.g., McBeth v. McIntyre, 57 Cal. 49 (1880); Eva
v. Andersen, 137 P. 16 (1913). Only then, from the standpoint
of indemnity, does Engineering need to recoup money from
the indemnitor, here RTW. The ground of the indemnitee’s
liability might be a doctrine like respondeat superior; it
might flow from contractual warranties of a certain quality
of performance or product; or it might be the indemnitee’s
own negligence. In the last situation, it is true, many courts
including those in California hold that “an indemnity agree-
ment may provide for indemnification against an indemnitee’s
own negligence, but such an agreement must be clear and
explicit and is strictly construed against the indemnitee.”
Rossmoor Sanitation, Inc. v. Pylon, Inc., 532 P.2d 97, 100
(Cal. 1975). But there is nothing here to show on what
ground the arbitrator ruled against Engineering. Thus, the
8 No. 03-3160
doctrine requiring an explicit indication that an indemnifi-
cation clause covers the indemnitee’s own negligence might
not even be applicable to this case.
There is another reason, even more powerful, to reject
RTW’s argument. It is common for the scope of an obligation
to indemnify to be contested. In that situation, however, an
indemnitor faces a choice: either defend under a reservation
of rights, or stay out of the lawsuit and gamble that its
interpretation of the scope of the indemnity clause will
ultimately prevail. If the indemnitor loses that gamble, it
will be liable not only for the defense costs, but also for the
full amount that the indemnitee must pay, and it will have
had no say in the litigation process. See Gribaldo, Jacobs,
Jones & Assocs. v. Agrippina Versicherunges, 476 P.2d 406,
414 (Cal. 1970) (noting in the context of insurance, the in-
surer/indemnitor “could stand by and assume the risk that
the loss to the assureds might exceed the deductible amount,
in which event they would become obligated not only to pay
the assureds the excess loss but also all expenses and costs
including attorney fees.”).
Naturally, an indemnitor risks little if it is obvious that
a particular indemnification clause does not cover the risk
that has been tendered to it. But that is not this case.
Engineering introduced evidence that the welds failed, and
the contract between Engineering and RTW was before the
court. It is entirely possible that the reason the welds failed
was because they were defective in either material or work-
manship, and thus that the problem fell squarely within the
scope of the indemnity clause. It is also conceivable that the
welds failed because Engineering was negligent in some
respect, perhaps by failing to tender proper specifications or
by failure to inspect or supervise. But the fact that RTW
may ultimately have had a defense to the duty to indemnify
does not mean that it could refuse to defend the case when
it was informed about it.
No. 03-3160 9
At this point, it is too late for RTW to make these argu-
ments. It is here that § 2778(5) comes into play. Engineering
asked RTW to defend it, and RTW refused to do so. Under
those circumstances, the statute says that “a recovery
against the latter [here, Engineering] suffered by him in good
faith, is conclusive in his favor against the former.” We read
this to mean that as long as Engineering litigated (or here,
arbitrated) the case against United (and IAA) in good
faith—and there is no evidence at all to the contrary— RTW
can no longer dispute either the amount of the award or the
question whether the underlying liability might fall outside
the scope of the indemnity clause. We note in this connec-
tion that while RTW was not a party to the arbitration, if it
had accepted Engineering’s tender of its defense, then RTW
would have been able to ensure that Engineering was not
taking any position detrimental to RTW’s interests. If such
a conflict had arisen, it would have been easy enough to
arrange for separate representation of each party.
III
Finally, we turn to Ravi Talwar’s part of this case. Talwar
formed RTW Industries in 1987. Until 1996, he was its
president, its CEO, and its sole shareholder. In that year,
he was contacted by Robert Smith, who was interested in
buying RTW’s assets. Smith and Talwar negotiated the
terms of the purchase over several months, including the
terms of the Stock Purchase Agreement (“the Agreement”).
As part of his preparations for the transfer, Smith incorpo-
rated a new Illinois entity, “Indiana Bridge, Inc.” or IBI, to
purchase RTW. On August 19, 1997, Smith and Talwar closed
the deal, signing the Agreement and other documents.
The parties to the Agreement were Talwar, as Seller, and
IBI, as Purchaser; it refers throughout to the “Company,”
which article 11.D. of the Agreement defined as “RTW
Industries, Inc., an Indiana corporation.” It also refers to
10 No. 03-3160
the “Purchaser Group,” which article 11.AA defined as “col-
lectively Purchaser and its officers, directors, shareholders,
employees, agents, accountants, attorneys, legal representa-
tives, successors and assigns.” The Company itself, however,
is not what was transferred; as the name of the Agreement
suggests, it was the “[s]hares, free and clear of any and all
[l]iens” that IBI acquired. The Agreement contains a num-
ber of representations and warranties, but the article of
principal interest here is article 8, which addresses indem-
nification. Article 8 reads, in relevant part, as follows:
A. Seller shall defend, indemnify and hold the Pur-
chaser Group harmless of, from and against any and all
Claims incurred or sustained by the Purchaser Group
or the Company, or any of them, arising from or relat-
ing to:
***
(2) the operation of the Business by the Company prior
to the date of this Agreement.
***
Finally, the Agreement specifically addresses the subject of
third-party beneficiaries in article 12.C:
C. This Agreement will be binding upon, inure to the
benefit of and will be enforceable by Seller and Purchaser
and their respective heirs, if applicable, legal represen-
tatives, successors and permitted assigns, if any, and no
other person or entity will be deemed a third-party
beneficiary of this Agreement.
RTW is not a party to the agreement, as it is neither the
Purchaser nor the Seller. Moreover, the language of article
12.C bluntly says that no one will be deemed to be a third-
party beneficiary. Notwithstanding these hurdles, RTW
argues that it is nevertheless a third-party beneficiary, be-
cause under Indiana law (which governed the Agreement,
as stated in article 12.A) one who is not a party to a con-
tract may enforce it directly if she can demonstrate that she
No. 03-3160 11
is a third-party beneficiary. Luhnow v. Horn, 760 N.E.2d
621, 628 (Ind. Ct. App. 2001). To show third-party benefi-
ciary status, one must show (1) a clear intent by the actual
parties to the contract to benefit the third party, (2) a duty
imposed on one of the contracting parties in favor of the
third party, and (3) the necessity of performance of the
terms of the contract in order to render a direct benefit to
that third party. Id.
While this is a correct statement of Indiana law, it is not
complete. Indiana courts also recognize that the general
third-party beneficiary rule is a default rule, which can be
altered by express agreement of the parties. Thus, in Indiana
Gaming Co. v. Blevins, 724 N.E.2d 274 (Ind. Ct. App. 2000),
the court had before it a contract containing a provision ex-
pressly stating that nothing was to be construed as creating
any third-party beneficiaries, using language very much
like that in the Agreement between Talwar and IBI. After
noting that contracts must be read as a whole and that
every provision should be given meaning if at all possible,
the court found that the provision excluding third-party
beneficiaries was enforceable. Id. at 278-79. This was enough
to defeat the claims of the parties before it.
Blevins is directly applicable to this case. RTW the com-
pany was closely connected to the Agreement, but it was not
a party. Article 12.C explicitly defines who gets the benefits
(and the duties) of the Agreement and who does not. RTW
could only be a third-party beneficiary, and article 12.C
operates to defeat the background rules for such parties in
Indiana.
IV
In summary, we conclude that the Engineering/RTW
agreement imposed a duty on RTW to indemnify Engineering
for actions arguably in breach of the warranties contained
in that agreement, and that the claim Engineering tendered
to RTW fell within the potential scope of that indemnity
12 No. 03-3160
clause. Consequently, under California law, RTW also had
a duty to defend Engineering. Because it took no timely ac-
tion, either in the form of a reservation of rights or another
action to explore the scope of the indemnity obligation,
RTW must now live with the consequences of its decisions.
In addition, we conclude that RTW may not assert any
rights arising out of the Stock Purchase Agreement between
Talwar and IBI. For these reasons, we AFFIRM the judgment
of the district court.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—10-28-04