Lockwood International, B v. v. Volm Bag Co. ( 2001 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 01-1275
Lockwood International, B.V.
and Lockwood Engineering, B.V.,
Plaintiffs,
and
North River Insurance Company and Fidelity
and Guaranty Insurance Company,
Intervening Plaintiffs-Appellees,
v.
Volm Bag Company, Inc.,
Defendant-Appellant.
Appeal from the United States District Court
for the Eastern District of Wisconsin.
No. 96 C 673--Rudolph T. Randa, Judge.
Argued June 5, 2001--Decided December 6, 2001
Before Flaum, Chief Judge, and Posner and
Manion, Circuit Judges.
Posner, Circuit Judge. This diversity
suit, based on Wisconsin law, presents a
novel but potentially quite important
issue of insurance law: whether a
liability insurer, asked to defend (or
pay the defense costs in) a suit against
its insured that contains some claims
that are covered by the insurance policy
and others that are not, can limit its
responsibility to defend by paying the
plaintiff in the liability suit to
replead the covered claims as uncovered
claims.
For simplicity we treat the case as a
three-cornered dispute among a single
plaintiff, Lockwood; a single intervenor,
North River, the insurance company; and a
single defendant, Volm. It began with
Lockwood, a foreign manufacturer of
machines for weighing and bagging
produce, suing Volm, which Lockwood had
appointed to be its exclusive North
American distributor. Lockwood’s
complaint charged that Volm had secretly
formed and funded a new company, Munter,
staffed by former employees of Lockwood
that Volm had lured to work for Munter.
Having done so, the complaint continued,
Volm stole Lockwood’s intellectual
property and manufactured machines that
copied Lockwood’s. To complete its
infamy, Volm then-- by disparaging
Lockwood and its products (even spreading
false rumors about Lockwood’s financial
solidity), by soliciting purchases of
Lockwood products and then substituting
knock-offs of them manufactured by
Munter, and by warning customers that
Lockwood machines infringed a Volm patent
(acquired by fraud, the complaint
alleged)-- had induced customers for
weighing and bagging machines to switch
their orders from Lockwood’s machines to
Munter’s. The complaint charged that
these acts constituted breach of
fiduciary duty, tortious interference
with contract, unfair competition, and
conspiracy. The suit is still pending.
North River had issued a commercial
general liability (CGL) policy to
Lockwood. Under the heading "personal
injury," the policy covers product and
producer disparagement. Under the heading
of "advertising injury," it covers (so
far as bears on this case and does not
duplicate "personal injury")
misappropriation of "advertising ideas or
style of doing business" or "infringement
of copyright," provided the
misappropriation or infringement occurs
"in the course of advertising" the
insured’s products. Since the complaint
expressly charged disparagement of
Lockwood and its products, and strongly
implied (especially in the bait and
switch allegation) that Volm had
appropriated Lockwood’s "advertising
ideas or style of doing business," North
River agreed to handle Volm’s defense.
Had the case gone through to judgment or
settlement in the usual way, North River
would probably have borne the entire
expense of conducting Volm’s defense,
e.g., School District of Shorewood v.
Wausau Ins. Cos., 488 N.W.2d 82, 88 (Wis.
1992); Curtis-Universal, Inc. v.
Sheboygan Emergency Medical Services,
Inc., 43 F.3d 1119, 1122 (7th Cir. 1994)
(Wisconsin law); United States v.
Security Management Co., Inc., 96 F.3d
260, 268 (7th Cir. 1996) (same); Solo Cup
Co. v. Federal Ins. Co., 619 F.2d 1178,
1183 (7th Cir. 1980); Allan D. Windt, In
surance Claims & Disputes sec. 4.12, pp.
199-200 (3d ed. 1995), although its duty
of indemnifying Volm for any damages that
it was determined through judgment or
settlement to owe Lockwood would have
been limited to so much of the judgment
or settlement as was fairly allocable to
the claims in Lockwood’s suit that were
covered by the policy. E.g., Valley
Bancorporation v. Auto Owners Ins. Co.,
569 N.W.2d 345, 349 (Wis. App. 1997);
Employers Mutual Liability Ins. Co. v.
Hendrix, 199 F.2d 53, 59 (4th Cir. 1952).
The difference reflects the greater
difficulty of apportioning defense costs
than damages. E.g., Grube v. Daun, 496
N.W.2d 106, 122 (Wis. App. 1992); cf.
Jeffrey W. Stempel, Law of Insurance
Contract Disputes sec. 9.03[c], pp. 9-67
to 9-68 (2d ed. 2000). But the rationale
of a rule often limits its scope, and
does here: if defense costs are readily
apportionable between the covered and the
uncovered claims, the insurance company
need pay only for the former. Buss v.
Superior Court, 939 P.2d 766, 776 (Cal.
1997); SL Industries, Inc. v. American
Motorists Ins. Co., 607 A.2d 1266, 1280
(N.J. 1992); Budd Co. v. Travelers
Indemnity Co., 820 F.2d 787, 791 (6th
Cir. 1987); Windt, supra, sec. 5.11, p.
323.
Four years into Lockwood’s suit, North
River paid Lockwood $1.5 million to file
an amended complaint that would delete
the covered claims. Lockwood agreed to
credit that amount against any judgment
it might obtain against Volm. Since the
policy limit was only $1 million, the
agreement (to which Volm was not a party)
protected Volm up to the policy limit
against having to pay any covered claims.
With the agreement in hand, North River,
which had already intervened in the
litigation to obtain a declaration of its
duties to the insured, asked the district
court to rule that it had no further duty
to defend or indemnify Volm, since the
effect of the amended complaint was to
eliminate any possible liability of Volm
to pay the covered claims in Lockwood’s
original complaint. The district judge
agreed and entered a partial final
judgment against Volm, which was
immediately appealable because it
resolved the claim of one of the parties,
namely North River. Fed. R. Civ. P.
54(b). Volm then appealed. It asks us to
rule that North River must continue to
pay its defense costs notwithstanding the
settlement between North River and
Lockwood.
North River’s lawyer acknowledged at
argument--what is anyway obvious--that
either he or other counsel for North
River had gone over the amended complaint
with Lockwood’s counsel line by line to
make sure that all insured claims had
been deleted. In other words, the
insurance company sat down with its
insured’s adversary to contrive a
complaint that would eliminate any
remaining contractual obligation of the
insurance company to defend the insured.
(We limit our attention to defense costs,
ignoring indemnity, in view of the fact
that North River’s settlement agreement
with Lockwood gave Volm more than the
policy limit; thus only defense costs are
at issue in this appeal.) It did this
without consulting the insured or
obtaining the latter’s agreement. We have
difficulty imagining a more conspicuous
betrayal of the insurer’s fiduciary duty
to its insured than for its lawyers to
plot with the insured’s adversary a
repleading that will enable the adversary
to maximize his recovery of uninsured
damages from the insured while stripping
the insured of its right to a defense by
the insurance company. The limits of
coverage, whether limits on the amount to
be indemnified under the policy or, as in
the present case, on the type of claims
covered by the policy, create a conflict
of interest between insurer and insured.
Mowry v. Badger State Mutual Casualty
Co., 385 N.W.2d 171, 177-78 (Wis. 1986);
Transport Ins. Co. v. Post Express Co.,
138 F.3d 1189, 1192 (7th Cir.
1998);Charter Oak Fire Ins. Co. v. Color
Converting Industries Co., 45 F.3d 1170,
1173 (7th Cir. 1995). The insurer yielded
to the conflict, in effect paying its
insured’s adversary to eliminate the
insured’s remaining insurance coverage.
It is true as North River points out
that if in the course of litigation the
covered claims fall out of the case
through settlement or otherwise, the
insurer’s duty to defend his insured
ceases. E.g., Meadowbrook, Inc. v. Tower
Ins. Co., 559 N.W.2d 411, 416 (Minn.
1997); Conway Chevrolet-Buick, Inc. v.
Travelers Indemnity Co., 136 F.3d 210,
214-15 (1st Cir. 1998); North Bank v.
Cincinnati Ins. Cos., 125 F.3d 983, 986
(6th Cir. 1997). That is the easiest case
for readily apportioning defense costs
between covered and uncovered claims. Nor
can the insured prevent the insurer from
settling covered claims for an amount
that protects the assured from having to
pay anything on those claims out of his
own pocket, merely because the
settlement, by giving the insured all
that he contracted for, will terminate
the insurer’s duty to defend the entire
suit. Meadowbrook, Inc. v. Tower Ins.
Co., supra, 559 N.W.2d at 417; Reller,
Inc. v. Hartford Ins. Co., 765 So. 2d 87,
88 (Fla. App. 2000); Allstate Ins. Co. v.
Mende, 575 N.Y.S.2d 520, 522 (App. Div.
1991). But North River did not merely
settle covered claims; as part of the
settlement it paid Lockwood to convert
some of the covered claims to uncovered
claims. That was not dealing in good
faith with its insured.
An example may help make this clear.
Suppose that a suit against the insured
makes two claims, both covered by the
defendant’s liability insurance policy.
The insurer could settle one claim for $1
million and both for $2 million, but $2
million is too high. Instead it says to
the plaintiff, "I’ll give you $1.5
million to settle the first claim if
you’ll agree to redraft the second so
that it’s an uncovered claim, which you
can of course continue to press against
my insured." The only purpose of such a
deal would be to spare the insurance
company the expense of defending against
the second claim, even though it was a
covered claim when filed and would have
continued to be a covered claim had it
not been for the insurer’s bribe of the
plaintiff.
The duty of good faith is read into
every insurance contract, e.g., Danner v.
Auto-Owners Ins., 629 N.W.2d 159, 171
(Wis. 2001); Teigen v. Jelco of
Wisconsin, Inc., 367 N.W.2d 806, 810
(Wis. 1985), as it is into contracts
generally, e.g., Allis-Chalmers Corp. v.
Lueck, 471 U.S. 202, 215-17 (1985);
Market Street Associates Ltd. Partnership
v. Frey, 941 F.2d 588, 592, 594-95 (7th
Cir. 1991), in order to prevent
opportunistic behavior by the contracting
party that has the whip hand. Bourget v.
Government Employees Ins. Co., 456 F.2d
282, 285 (2d Cir. 1972) (Friendly, J.).
That was North River, which neither
needed nor sought its insured’s
permission to settle with Lockwood and by
doing so expose the insured to having to
bear its own defense costs for the
remainder of the litigation.
North River’s maneuver is also defeated
by the principle that the duty to defend
depends on the facts alleged rather than
on the pleader’s legal theory. E.g., Sola
Basic Industries, Inc. v. U.S. Fidelity &
Guaranty Co., 280 N.W.2d 211, 213-14
(Wis. 1979); U.S. Fidelity & Guaranty Co.
v. Wilkin Insulation Co., 578 N.E.2d 926,
930 (Ill. 1991). "[T]he insured is
covered against particular conduct
alleged against it regardless of the
label placed on that conduct by the
pleader." Cincinnati Ins. Co. v. Eastern
Atlantic Ins. Co., 260 F.3d 742, 745 (7th
Cir. 2001). If Lockwood was alleging what
was in fact personal injury or
advertising injury within the meaning of
the policy, the fact that, whether at
North River’s urging or otherwise, it
redrafted its complaint to change the
name of the tort it was charging Volm
with, but retained the same factual
allegations that had triggered North
River’s initial duty to defend, would be
ineffective to terminate that duty. Id.;
Prisco Serena Sturm Architects, Ltd. v.
Liberty Mutual Ins. Co., 126 F.3d 886,
890 (7th Cir. 1997); Hurst-Rosche
Engineers, Inc. v. Commercial Union Ins.
Co., 51 F.3d 1336, 1344 (7th Cir. 1995);
Curtis-Universal, Inc. v. Sheboygan
Emergency Medical Services, Inc., supra,
43 F.3d at 1122.
North River and Lockwood were apparently
mindful of this principle. Their
agreement not only requires Lockwood to
delete the specific claims in the
original complaint that are covered by
the insurance policy that North River had
issued to Volm, such as disparagement,
defamation, misappropriation of
advertising ideas or style of doing
business, and copyright infringement,
plus several of the theories of liability
asserted in its original complaint (the
ones most likely to involve disparagement
or solicitation), such as tortious
interference and unfair competition, and
thus likely to be covered by the policy
that North River had issued to Volm; it
also forbids Lockwood to "undertake to
prove" at trial a number of specific
allegations, such as that Volm caused
Lockwood’s customers to believe that
Lockwood products infringed Volm’s
patent. This effort to get around the
principle that the insurer’s duties to
the insured are determined not by legal
theories but by facts portends unbearable
awkwardness in the forthcoming trial.
Suppose that in an effort to prove its
remaining theories of liability, such as
breach of fiduciary duty, which
disparagement and other excluded charges
would bolster (especially since Lockwood
is seeking punitive damages), Lockwood
presents evidence in support of these
charges at trial. Volm will be delighted,
because the introduction of such evidence
will trigger North River’s duty of
indemnity and defense. North River will
therefore have to have a lawyer in the
courtroom to object whenever Lockwood
crosses the line into forbidden
territory. Either that (and what will the
jury make of it?) or North River will sit
out the trial but later sue Lockwood for
breach of the settlement agreement if by
crossing the line Lockwood resurrects
Volm’s rights under North River’s policy.
No case that has been cited to us or
that our own research has uncovered
authorizes so convoluted a mode of
proceeding. To recapitulate: North River
had every right to settle the claims that
gave rise to its duty to defend in the
first place--the covered claims and the
potentially covered claims in Lockwood’s
suit--in order to avoid having to defend
the claims in the same suit that were not
actually or potentially covered. But that
is not what North River did. The duty to
defend turns on the facts alleged rather
than on the theories pleaded; and even
after its deal with North River, Lockwood
was alleging facts that could well,
depending on the course of trial,
describe a covered claim. Thus North
River did not leave behind only clearly
uncovered claims when it tried to shuck
off its contractual responsibility to pay
for its insured’s defense.
It is irrelevant that the trial may show
that Lockwood’s only meritorious claims
against Volm are ones that are not within
the scope of the policy. The duty to
defend (and hence to reimburse for
defense costs when the insurance company
doesn’t provide the lawyer for the
insured) is broader than the duty to
indemnify. The reason goes beyond the
practical difficulties, noted earlier,
involved in apportioning defense costs
between covered and uncovered claims. The
duty is broader because it "is triggered
by arguable, as opposed to actual,
coverage." General Casualty Co. of
Wisconsin v. Hills, 561 N.W.2d 718, 722
n. 11 (Wis. 1997); Red Arrow Products Co.
v. Employers Ins. of Wausau, 607 N.W.2d
294, 298 (Wis. App. 2000). The insured
needs a defense before he knows whether
the claim that has been made against him
is covered by the policy, assuming there
is doubt on the question. If the duty to
defend were no broader than the duty to
indemnify, there would be the paradox
that an insured exonerated after trial
would have no claim against the insurance
company for his defense costs, since the
company would have no duty to indemnify
him for a loss resulting from a judgment
or settlement in the suit against the
insured. The duty to defend must
therefore be broader than the duty to
indemnify, and so the fact that North
River paid the policy’s limit on
indemnification does not exonerate it.
The judgment is reversed and the case
remanded for further proceedings
consistent with this opinion.
Reversed and Remanded.