James River Insurance Company v. Herbert Schenk, Pc. ( 2008 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
JAMES RIVER INSURANCE COMPANY,  No. 06-15622
a foreign corporation, D.C. No.
Plaintiff-Appellee, CV-05-01213-FJM
v.
 ORDER
HEBERT SCHENK, P.C., AMENDING
Defendant-Appellant. OPINION AND
AMENDED
 OPINION
Appeal from the United States District Court
for the District of Arizona
Frederick J. Martone, District Judge, Presiding
Argued and Submitted
February 13, 2008—San Francisco, California
Filed March 18, 2008
Amended April 25, 2008
Before: William C. Canby, Jr., David R. Thompson, and
Milan D. Smith, Jr., Circuit Judges.
Opinion by Judge Milan D. Smith, Jr.
4459
4462 JAMES RIVER INS. v. HEBERT SCHENK
COUNSEL
Steven Plitt and Joshua D. Rogers, Kunz Plitt Hyland Dem-
long & Kleinfeld, Phoenix, Arizona, for the defendant-
appellant.
Martha E. Gibbs, Snell & Wilmer LLP, Phoenix, Arizona, for
the plaintiff-appellee.
ORDER
The opinion filed on March 18, 2008 is amended as fol-
lows:
At Slip Op. p. 2540, line 33, to p. 2541, lines 1-2, replace
Stewart, 817 P.2d at 49, we must conclude that Ques-
tion 10(c) elicits a subjective determination.> with 2008
WL 382934, at *2, ___ P.3d ___ (Ariz. Feb. 14, 2008), Ques-
JAMES RIVER INS. v. HEBERT SCHENK 4463
tion 10(c) is more appropriately viewed as eliciting a subjec-
tive determination.>
The petitions for panel rehearing and certification to the
Arizona Supreme Court are DENIED.
OPINION
MILAN D. SMITH, JR., Circuit Judge:
In this appeal we decide whether the district court erred in
granting summary judgment to a professional liability insurer
on a claim seeking a declaration of no coverage, and on coun-
terclaims for breach of contract and bad faith under Arizona
law. The insurer argued that it could permissibly refuse to
provide for its insured’s defense against a legal malpractice
lawsuit because the insured failed to mention the possibility
of the lawsuit in the insurance application. The district court
agreed and held that Arizona Revised Statutes § 20-1109 per-
mits a denial of coverage because the insured’s omission con-
stitutes legal fraud. The court rejected the counterclaims
because the insurer provided for the malpractice defense. We
reverse and remand for trial.
FACTUAL AND PROCEDURAL BACKGROUND
David and Cheryl Nolan and Tony and Shirley Wall
formed a limited liability company in 2000 for the purpose of
constructing and developing two commercial buildings. Due
to poor management, the business failed shortly thereafter,
resulting in a loss of over $2 million.
In November 2001, the Nolans retained attorney Jack
Hebert (Hebert) from Defendant-Appellant law firm Hebert
Schenk, P.C. (Hebert Schenk) to represent them in connection
with negotiations and any litigation that might arise out of the
4464 JAMES RIVER INS. v. HEBERT SCHENK
failed business venture. On February 5, 2004, Hebert met with
the Nolans to discuss the possibility of initiating litigation
against the Walls. Hebert agreed to provide a tentative litiga-
tion budget and to return originals of certain loan documents
to the Nolans. After the meeting the Nolans attempted to
reach Hebert many times by telephone, but Hebert did not
return their calls or otherwise communicate with them for a
period of almost three months.
On April 19, 2004, Hebert Schenk applied for a profes-
sional liability insurance policy with Plaintiff-Appellee James
River Insurance Company (James River). Question 10(c) of
the application stated:
After inquiry, are any [lawyers within the firm]
aware of any circumstances, allegations, Tolling
[sic] agreements or contentions as to any incident
which may result in a claim being made against the
Applicant or any if [sic] its past or present Owners,
Partners, Shareholders, Corporate Officers, Asso-
ciates, Employed Lawyers, Contract Lawyers or
Employees or its predecessor in business? . . . . If
yes, please complete enclosed Supplement Number
6.
Supplement 6 stated, “This form is to be completed if the
applicant or any lawyer [in the firm] is currently or has been
involved in any claim or suit during the last ten years and [sic]
indicated by a ‘Yes’ answer to question[ ] . . . 10(c).” Hebert
Schenk responded to Question 10(c) in the affirmative and, in
Supplement 6, listed several actual and potential claims
against the firm, but did not disclose any information concern-
ing a potential claim by the Nolans.
On April 27, 2004, approximately one week after the sub-
mission of the insurance application, the Nolans wrote a letter
to Hebert indicating that they wished to terminate their rela-
JAMES RIVER INS. v. HEBERT SCHENK 4465
tionship with his firm on the ground that his representation
had been deficient. The letter stated in part:
Dear Jack:
It is time to bring your representation of us . . . to an
end. It is certainly ironic that when Cheryl and I last
met with you on February 5, you spent some time
describing your interchange with Neil Thomson,
reporting how you chastised him for abandoning his
client. Without a doubt, you have abandon [sic] us as
well. I have made no fewer than a dozen attempts to
communicate with you since that meeting. I have not
received a single call or email. This is despite your
advice to us on 2/5, that we should file a lawsuit
against Wall in order to secure some future recovery
potential for our $2.264 million investment. As with
the similar experience in the Spring of 2003, com-
munication simply dried up. The least we were owed
was some notice that you were unable to represent us
and a referral to alternative counsel. If you truly
believed that it was too late in the game and our best
course was to take the loss and move on, we were
owed that message, and some closure as well. For
reasons we may never really understand, and could
never be justified, you have stopped communicating
and have failed to follow through on specific actions
you recommended to protect our interests.
To “bring [the] matter to a close,” the Nolans demanded that
Hebert return their documents and waive $1,162.38 in legal
fees. Hebert responded on April 29 by acknowledging his
fault and stating that the Nolans’ letter of complaint was “cor-
rect in every aspect.” He also agreed to return the Nolans’
documents and waive the fees.
Less than two weeks after this correspondence, James
River faxed an insurance quote to Hebert Schenk. The quote
4466 JAMES RIVER INS. v. HEBERT SCHENK
required as a precondition to issuance of the policy “[u]pdated
signatures of the application and of all of the application sup-
plements.” The quote also required a “no known claims and
no known claims incidents statement.” Hebert Schenk
responded that it “ha[d] no known claims and no known
claims incidents” to report.
In reliance on the representations made in the application
and subsequent correspondence, James River issued a one-
year professional liability insurance policy to Hebert Schenk
on June 12, 2004. Section I(1)(a) of the policy provided:
We will pay on behalf of the “Insured” those sums
in excess of the deductible the “Insured” becomes
legally obligated to pay as “Damages” and “Claims
Expenses” because of a “Claim” first made against
the “Insured” and reported to [James River] in writ-
ing during the “Policy Period” by reason of a
“Wrongful Act” in the performance of or failure to
perform “Professional Services” by the “Insured” or
by any other person or entity for whom the “Insured”
is legally liable.
Section III(a)(1) of the policy excluded coverage for any
“Claim” “[b]ased on or directly or indirectly arising from . . .
[a] ‘professional service’ rendered prior to the effective date
of the Policy if any insured knew or could have reasonably
foreseen that the ‘professional service’ could give rise to a
‘claim.’ ” Section III(a)(3) excluded coverage for any
“ ‘claim,’ suit, act, error or omission disclosed in the applica-
tion for [the] Policy.” The policy defined “Claim” as “a writ-
ten demand for monetary damages arising out of or resulting
from the performing or failure to perform ‘Professional Ser-
vices.’ ” “Professional Services” denoted “those services per-
formed by the ‘Insured’ for others . . . as a lawyer.”
“Wrongful Act” was defined as “any actual or alleged act,
error, omission . . . neglect or breach of duty in the perform-
ing of or failure to perform ‘Professional Services.’ ”
JAMES RIVER INS. v. HEBERT SCHENK 4467
On October 7, 2004, the Nolans, having retained new coun-
sel, informed Hebert Schenk that they intended to assert legal
malpractice claims against Hebert and the firm for the reasons
articulated in the April 27, 2004 letter. Shortly thereafter, the
Nolans filed claims for negligence and breach of fiduciary
duty in Arizona Superior Court. Citing the insurance policy,
Hebert Schenk demanded that James River provide for its
defense. James River explained that it would provide for the
defense while reserving the right to later deny coverage on the
ground that the Nolans’ claims were both reasonably foresee-
able and undisclosed prior to the issuance of the policy. James
River subsequently retained the firm of Jones, Skelton &
Hochuli, P.C. to defend Hebert and Hebert Schenk and paid
a total of $142,692.17 in legal fees.
While providing for Hebert’s and Hebert Schenk’s defense,
James River filed an action in district court seeking (1) a dec-
laration that the Nolans’ malpractice claims are not covered
by the insurance policy and (2) recoupment of the payments
made for the defense. Hebert Schenk counterclaimed that
James River breached the insurance contract by refusing to
defend against the Nolan lawsuit. Hebert Schenk also counter-
claimed that James River committed bad faith by engaging in
a series of wrongful acts for the purpose of denying coverage.
James River moved for summary judgment on the declara-
tory judgment action and the counterclaims. In support of the
motion on the counterclaims, James River submitted copies of
billing records from Jones, Skelton & Hochuli to demonstrate
that a defense had been provided. The district court granted
both motions. Armed with new expert testimony, Hebert
Schenk moved for reconsideration with respect to the counter-
claim of bad faith, but the court denied the motion on the
view that the evidence should have been provided earlier. The
firm appeals the adjudication of the declaratory judgment
action and the counterclaim of bad faith.1
1
There are some indications in Hebert Schenk’s appeal brief that the
firm also contests the disposition of its counterclaim for breach of con-
4468 JAMES RIVER INS. v. HEBERT SCHENK
STANDARD OF REVIEW AND JURISDICTION
We review de novo a district court’s grant of summary
judgment pursuant to Federal Rule of Civil Procedure 56.
Buono v. Norton, 371 F.3d 543, 545 (9th Cir. 2004). Rule
56(c) provides that summary judgment is warranted when
“the pleadings, the discovery and disclosure materials on file,
and any affidavits show that there is no genuine issue as to
any material fact and that the movant is entitled to judgment
as a matter of law.” A “genuine issue” of material fact will be
absent if, upon “viewing the evidence and inferences which
may be drawn therefrom in the light most favorable to the
adverse party, the movant is clearly entitled to prevail as a
matter of law.” Jones v. Halekulani Hotel, Inc., 557 F.2d
1308, 1310 (9th Cir. 1977). Summary judgment is inappropri-
ate if a reasonable juror, drawing all inferences in favor of the
nonmoving party, could return a verdict in the nonmoving
party’s favor. United States v. Shumway, 199 F.3d 1093,
1103-04 (9th Cir. 1999).
We have jurisdiction under 28 U.S.C. § 1291.
DISCUSSION
A. Denial of coverage based on fraud
[1] Arizona law allows an insurer to deny coverage because
of a misrepresentation in the insurance application or “in
negotiations therefor” if (1) the misrepresentation is fraudu-
lent, (2) the misrepresentation is “material either to the accep-
tance of the risk, or to the hazard assumed by the insurer,” and
tract, but we find the issue inadequately presented, and therefore waived.
See Greenwood v. FAA, 28 F.3d 971, 977 (9th Cir. 1994) (“We review
only issues which are argued specifically and distinctly in a party’s open-
ing brief.”). Accordingly, our ruling does not affect the district court’s
entry of summary judgment on that counterclaim.
JAMES RIVER INS. v. HEBERT SCHENK 4469
(3) the “insurer in good faith would . . . not have issued the
policy . . . if the true facts had been made known to the
insurer as required either by the application for the policy or
otherwise.” Ariz. Rev. Stat. § 20-1109; see also State Comp.
Fund v. Mar Pac Helicopter Corp., 752 P.2d 1, 5 (Ariz. Ct.
App. 1988) (explaining that all three prongs of § 20-1109
must be satisfied even though the statute does not clearly
phrase them in the conjunctive).
[2] The parties agree that the second and third requirements
of § 20-1109 are satisfied. Thus, the only question concerning
the applicability of the statute is whether Hebert Schenk made
a fraudulent misrepresentation. Hebert Schenk could not have
notified James River of the prospect of the Nolan claim when
it completed the insurance application on April 19, 2004
because the Nolans first complained of deficient representa-
tion on April 27. However, James River requested updates of
the application signatures and Supplement 6 approximately
two weeks after Hebert Schenk received the Nolans’ letter.
We must decide whether the failure to mention the Nolans in
response to this latter request so clearly constituted a fraudu-
lent misrepresentation as to entitle James River to summary
judgment. We hold that it did not.
[3] A showing of either legal or actual fraud can satisfy the
fraud requirement of § 20-1109. Russell v. Royal Maccabees
Life Ins. Co., 974 P.2d 443, 450 (Ariz. Ct. App. 1998). Legal
fraud occurs when (1) a question asked by the insurer seeks
facts that are “presumably within the personal knowledge of
the insured,” (2) the insurer would naturally contemplate that
the insured’s answer represented the actual facts, and (3) the
answer is false. Id. By contrast, actual fraud occurs only when
a question calls for an opinion and the answer is intended to
deceive. Stewart v. Mut. of Omaha Ins. Co., 817 P.2d 44, 48
(Ariz. Ct. App. 1991). “Whether a question elicits a factual
response or an opinion is a matter for the trier of fact to
decide based on the particular facts of each case, unless rea-
sonable persons could not differ as to whether the answer was
4470 JAMES RIVER INS. v. HEBERT SCHENK
a statement of opinion or a statement of fact.” Equitable Life
Assurance Soc’y of the U.S. v. Anderson, 727 P.2d 1066, 1070
(Ariz. Ct. App. 1986).
[4] The parties agree that summary judgment cannot be
entered in this case on the basis of actual fraud because there
is no evidence of intent to deceive. They disagree, however,
about the applicability of the doctrine of legal fraud. Hebert
Schenk argues that the doctrine does not apply because Ques-
tion 10(c) of the insurance application elicited an opinion
rather than a factual response.
[5] We agree with Hebert Schenk and conclude that sum-
mary judgment was inappropriate because reasonable persons
could differ as to whether Question 10(c) elicited a statement
of opinion or fact. Anderson, 727 P.2d at 1070. The Question
asked whether, “[a]fter inquiry,” any lawyers in the firm were
“aware” of any circumstances “as to any incident which may
result in a claim being made against” the firm. “Awareness”
of a circumstance is a factual condition rather than a matter
of opinion, and the phrase “after inquiry” suggests that the
firm representative who answered Question 10(c) was to
report on, rather than opine on, the awareness of lawyers in
the firm. However, whether the circumstances of which the
lawyers were aware were of the kind described in the question
—i.e., that which “may result” in a malpractice claim—is
fairly viewed as a matter of opinion. The reasonable interpre-
tation of Question 10(c) requires that “may result” denotes
something more than a purely theoretical possibility of a law-
suit. Whether the factual circumstances concerning any indi-
vidual client gave rise to a sufficient probability of legal
action was a judgment call reflecting an analysis of those cir-
cumstances.2 Reasonable persons could thus find that the
2
Some of the factors that might reasonably inform this analysis include
the perceived merit of the possible claim at the time of application, the
degree to which the client is dissatisfied with the representation, and the
character of the specific attorney-client relationship, among others.
JAMES RIVER INS. v. HEBERT SCHENK 4471
omission of the Nolan communications from Supplement 6
reflected Hebert Schenk’s opinion that the Nolans’ dissatis-
faction would not result in a claim. See Citizens Bank of
Jonesboro, Ark. v. W. Employers Ins. Co., 865 F.2d 964, 966
(8th Cir. 1989) (finding that similar language “call[ed] for the
applicant’s belief about whether any known fact or circum-
stance might give rise to a future claim”); Shaheen, Cappiello,
Stein & Gordon, P.A. v. Home Ins. Co., 719 A.2d 562, 566
(N.H. 1998) (same).
Some courts have held that similarly worded questions
elicit factual answers by making an objective, reasonable-
person standard the basis for determining whether the proba-
bility of a malpractice claim is high enough to require insurer
notification. See, e.g., Int’l Surplus Lines Ins. Co. v. Wy. Coal
Refining Sys., Inc., 52 F.3d 901, 904 (10th Cir. 1995); Mt.
Airy Ins. Co. v. Thomas, 954 F. Supp. 1073, 1080 (W.D. Pa.
1997). In the view of these courts, the objective standard
makes the applicant’s opinion irrelevant because the standard
substitutes for a subjective probability assessment as the basis
for the applicant’s answer to the question posed.
Given the facts of this case, we find the approach in Inter-
national Surplus Lines Insurance Co. and Mt. Airy Insurance
Co. unpersuasive for two reasons. First, Question 10(c) is
ambiguous about whether the basis for the probability deter-
mination should be the applicant’s subjective assessment or
an objective, reasonable-person standard. Because Arizona
tends to construe ambiguity in insurance applications in favor
of the insured, Employers Mut. Cas. Co. v. DGG & Car, Inc.,
2008 WL 382934, at *2, ___ P.3d ___ (Ariz. Feb. 14, 2008),
Question 10(c) is more appropriately viewed as eliciting a
subjective determination. Second, even assuming that the
Question clearly references an objective standard, answering
the Question still required Hebert Schenk to exercise judg-
ment in applying that standard to the facts concerning particu-
lar clients. We see no meaningful difference between an
opinion question and a “fact” question that requires the appli-
4472 JAMES RIVER INS. v. HEBERT SCHENK
cant to engage in a standard-based analysis to determine
whether the specified factual condition exists. Questions typi-
cally understood as seeking factual answers, such as name or
date of birth, do not require such analysis. See, e.g., Mann v.
N.Y. Life Ins. & Annuity Corp., 222 F. Supp. 2d 1151, 1154
(D. Ariz. 2002) (holding that a question about past incidents
of drug use elicited a factual response).
[6] We therefore hold that the district court erred in grant-
ing summary judgment on James River’s claim under § 20-
1109. Actual fraud is not a viable basis for denying coverage
because the parties agree that there is no evidence of intent to
deceive. Summary judgment also cannot be entered on the
alternative basis of legal fraud because reasonable persons
could conclude that Question 10(c) elicited a statement of
opinion. Anderson, 727 P.2d at 1070.
B. Denial of coverage based on the language of the
policy
James River argues that it was entitled to summary judg-
ment on the issue of coverage even if fraud did not occur
because Section III(a)(1) of the policy excludes coverage for
claims arising from a legal service “rendered prior to the
effective date of the Policy if any insured knew or could have
reasonably foreseen that the . . . [service] could give rise to
a ‘claim.’ ” James River contends that this language excluded
coverage for the Nolan claim because the claim was reason-
ably foreseeable.
[7] We hold that summary judgment is also unwarranted on
the basis of policy Section III(a)(1) because it is not clear that
the Nolan claim was reasonably foreseeable. The Nolans
never suggested in their communications with Hebert Schenk
that they would bring a “claim.”3 Nothing in the April 27,
3
Because the application does not define “claim,” we interpret the use
of that word in Question 10(c) in accordance with its ordinary meaning.
JAMES RIVER INS. v. HEBERT SCHENK 4473
2004 letter demanded or threatened a future demand for
money damages or other legal remedies. To the contrary, the
Nolans stated that Hebert could “bring [the] matter to a close”
simply by returning their documents and waiving fees. Hebert
promptly complied with these requests. Viewing this evidence
in the light most favorable to Hebert Schenk, Jones, 557 F.2d
at 1310, the firm could reasonably conclude that a malpractice
claim would not follow.
C. Bad faith
[8] To commit bad faith, an insurer must (1) act unreason-
ably toward the insured and (2) either know that it was acting
unreasonably or demonstrate such reckless disregard to the
reasonableness of its actions that knowledge of reasonable-
ness may be imputed. Trus Joist Corp. v. Safeco Ins. Co. of
Am., 735 P.2d 125, 134 (Ariz. Ct. App. 1986). The first ele-
ment of this test is objective and asks whether the insurer
acted in a “manner consistent with the way a reasonable
insurer would be expected to act under the circumstances.” Id.
The second element is subjective and requires “consciously
unreasonable conduct.” Id. The insurer may commit bad faith
not only by intentionally and unreasonably denying a claim,
but also by intentionally processing, evaluating, or paying a
claim in an unreasonable manner. Zilisch v. State Farm Mut.
Auto. Ins. Co., 995 P.2d 276, 279 (Ariz. 2000).
Hebert Schenk’s counterclaim alleged that James River is
liable for bad faith for (1) failing to promptly process the
claim for coverage, (2) failing to investigate the claim, (3)
failing to effectuate a prompt and fair settlement, (4) failing
to act reasonably in evaluating the claim, (5) failing to con-
State Farm Mut. Auto. Ins. Co. v. Novak, 807 P.2d 531, 535 (Ariz. Ct.
App. 1990). A “claim” is a “demand for money, property, or a legal rem-
edy to which one asserts a right.” Black’s Law Dictionary 264 (8th ed.
2004). The insurance policy employs a similar definition. See supra Fac-
tual and Procedural Background.
4474 JAMES RIVER INS. v. HEBERT SCHENK
sider the firm’s interests, and (6) jeopardizing the firm’s
security under the insurance policy. One alleged result of this
conduct was that Hebert Schenk was required to provide its
own defense against the Nolans’ claim. The firm also alleges
that James River is liable for bad faith for submitting privi-
leged and detailed billing records from the malpractice
defense to support the motion for summary judgment on the
issue of coverage.
[9] We conclude that the district court erred in entering
summary judgment on the counterclaim of bad faith. James
River could satisfy its initial burden of production under Rule
56 either by introducing “evidence negating an essential ele-
ment” of the counterclaim or by showing that Hebert Schenk
“does not have enough evidence of an essential element of
[bad faith] . . . to carry its ultimate burden of persuasion at
trial.” Nissan Fire & Marine Ins. Co. v. Fritz Cos., 210 F.3d
1099, 1105-06 (9th Cir. 2000). James River did neither. Its
motion sought summary judgment only “to the extent [that the
counterclaims] are based on the allegation that James River
‘failed’ to provide a defense in the underlying litigation.” The
motion was accompanied by evidence demonstrating that a
defense had been provided. Hebert Schenk’s counterclaim of
bad faith, however, does not rely upon the alleged failure to
provide a defense. It is clear to us that James River could both
arrange for Hebert Schenk’s defense under a reservation of
rights and also, for example, commit bad faith by failing to
investigate the claim prior to seeking declaratory judgment, or
by submitting privileged billing records from the malpractice
defense to support its motion for summary judgment on the
coverage dispute. See Zilisch, 995 P.2d at 280 (explaining that
a failure to investigate adequately can constitute bad faith);
Parsons v. Cont’l Nat’l Am. Group, 550 P.2d 94, 99 (Ariz.
1976) (holding that it is against public policy for an insurer
to provide for an insured’s defense and then use confidential
information gathered from the defense against the insured in
a subsequent coverage dispute). That James River provided a
defense merely negates one of the alleged consequences of
JAMES RIVER INS. v. HEBERT SCHENK 4475
the bad faith, not that the handling of the claim was in various
respects objectively and subjectively unreasonable. Because
James River did not satisfy its initial burden of production,
Hebert Schenk was not required to demonstrate a genuine
issue of material fact.4 Celotex Corp. v. Catrett, 477 U.S. 317,
323 (1986).
CONCLUSION
For the foregoing reasons, the judgment of the district court
is
REVERSED and REMANDED.
4
We need not decide whether the district court appropriately refused to
consider the expert testimony that Hebert Schenk submitted in support of
its motion for reconsideration. Because James River failed to meet its ini-
tial burden under Rule 56, summary judgment was inappropriate regard-
less of the content of the additional evidence.