Joe Partain v. Mid-Continent Casualty Compa , 756 F.3d 388 ( 2014 )

Case: 13-20099 Document: 00512675397 Page: 1 Date Filed: 06/24/2014
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
United States Court of Appeals
Fifth Circuit
No. 13-20099 FILED
June 24, 2014
Lyle W. Cayce
WILLIAM GRAPER, Clerk
Plaintiff – Appellant
v.
MID-CONTINENT CASUALTY COMPANY,
Defendant – Appellee
v.
BEN B. FLOYD, Chapter 7 Bankruptcy Trustee for Joe B. Partain and Laura
Partain,
Appellant
Appeal from the United States District Court
for the Southern District of Texas
Before STEWART, Chief Judge, and JOLLY and SMITH, Circuit Judges.
E. GRADY JOLLY, Circuit Judge:
William Graper and Ben B. Floyd 1 (the “Insureds”) appeal the district
court’s grant of summary judgment in favor of Mid-Continent Casualty
Company (“Mid-Continent). The Insureds filed suit against Mid-Continent
alleging that it failed in its obligation to defend them when it refused to pay
the fees of the Insureds’ chosen attorney who represented them in an
1 Floyd is acting as Bankruptcy Trustee for Joe and Laura Partain.
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underlying lawsuit brought against them by Kipp Flores Architects (“KFA”).
Mid-Continent argues that it fulfilled its duty to defend the Insureds by
tendering its selected counsel to defend the suit. The Insureds argue that a
disqualifying conflict of interest arose between them and Mid-Continent,
entitling them to their choice of counsel at Mid-Continent’s expense. Because
we hold that no disqualifying conflict of interest existed under Texas law, and
Mid-Continent fulfilled its duty to defend the Insureds by tendering its chosen
attorney, the district court did not err. We thus AFFIRM its final judgment
granting Mid-Continent’s motion for summary judgment.
I.
Mid-Continent issued successive general liability policies to Hallmark
Design Homes, LP, a builder of production homes located in Texas, and
Hallmark Collection of Homes LLC, its general partner (collectively
“Hallmark”), covering a time period between May 2004 and January 2009. 2 In
March 2009, KFA filed a lawsuit against Hallmark and Joe Partain, as a
principal of the company, alleging that Hallmark had violated several of its
copyright rights in several architectural designs. The other individuals, Laura
Partain and William Graper, also principals of Hallmark, were added to the
suit at a later time. KFA maintained that the named individuals were
vicariously liable for the actions of Hallmark.
KFA’s complaint alleged that Hallmark used KFA’s copyrighted designs
when constructing homes and used those same designs in promotional
materials. It further alleged that once KFA discovered Hallmark’s infringing
conduct, it sent a cease and desist letter to Hallmark; notwithstanding this
letter, Hallmark’s infringing conduct continued. KFA pled for actual damages,
and, in the alternative, statutory damages under the Copyright Act of 1976.
2 The successive policies, for all intents and purposes, were essentially the same.
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Following KFA’s filing of its complaint, the Insureds tendered the claim
to Mid-Continent. After a preliminary investigation, Mid-Continent agreed to
defend the Insureds subject to a reservation of rights. In the reservation of
rights, Mid-Continent listed several provisions in the Insureds’ insurance
policy that could preclude coverage of KFA’s claim against Hallmark. Two of
the potential bases for exclusion included: (1) that the injury may not have
occurred during policy coverage dates and (2) that the infringing conduct may
have been intentional or willful.
After receiving this reservation of rights, the Insureds notified Mid-
Continent that they would select their own counsel because they believed there
was a disqualifying conflict of interest between them and any counsel Mid-
Continent chose. Mid-Continent offered its own counsel to defend the Insureds
but refused to fund their defense if they insisted on hiring their own counsel.
The Insureds refused Mid-Continent’s tender and elected to continue
defending the KFA suit with their own counsel. They later filed a declaratory
action in Texas state court seeking a determination of their rights and powers
under the successive insurance policies. Mid-Continent removed the case to
the Southern District of Texas, and the Insureds amended their complaint to
allege a breach of contract claim, violations of the Texas Insurance Code, and
violations of the Texas Deceptive Trade Practices Act. Mid-Continent filed
both a motion to dismiss and a motion for summary judgment on all claims;
the district court granted both, dismissing several of the Insureds’ claims
against Mid-Continent and granting Mid-Continent summary judgment on the
rest. The district court held that no disqualifying conflict of interest existed
between the Insureds and Mid-Continent, and that Mid-Continent had fulfilled
its duty to defend when it tendered its chosen counsel to represent the
Insureds. The district court entered a final judgment against the Insureds and
the Insureds timely appealed.
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We observe as an aside, that this court recently upheld an award of 3.2
million dollars in favor of KFA in its underlying suit against the Insureds. See
Kipp Flores Architects, L.L.C. v. Hallmark Design Homes, L.P., 544 F. App’x
553 (5th Cir. 2013). The litigation over whether this award is covered by the
Mid-Continent policies is pending in the Western District of Texas. The only
issue in this appeal is whether Mid-Continent was obligated to pay for the
Insureds’ selected counsel to defend the KFA claims.
II.
A.
We now turn our attention to that issue and begin by addressing the law
governing this appeal. A federal district court “appl[ies] state substantive law
in diversity jurisdiction cases.” DP Solutions, Inc. v. Rollins, Inc., 353 F.3d
421, 427 (5th Cir. 2003). That law must be applied “as interpreted by the
state’s highest court.” Barfield v. Madison Cnty., 212 F.3d 269, 271-72 (5th
Cir. 2000). If the state’s highest court has not ruled definitively on an issue,
“it is the duty of the federal court to determine as best it can, what the highest
court of the state would decide.” Id. at 272 (internal quotation marks and
citation omitted). We apply Texas law in this diversity case.
The issues in this appeal were decided on summary judgment, and this
court reviews grants of summary judgment de novo. Royal v. CCC&R Tres
Arboles, L.L.C., 736 F.3d 396, 400 (5th Cir. 2013). “Summary judgment is
proper if there is no genuine dispute as to any material fact and the moving
party is entitled to judgment as a matter of law.” Id. (citing FED. R. CIV. P.
56(a)).
B.
When an insured is sued and the “petition contains allegations which,
when fairly and reasonably construed, state a cause of action that is potentially
covered by the policy, then the insurer has a duty to defend the insured in the
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underlying lawsuit.” Burlington Ins. Co. v. Texas Krishnas, Inc., 143 S.W.3d
226, 229 (Tex. App.–Eastland 2004). Because the duty to defend is based solely
upon allegations in the pleadings, it “is broader than the duty to indemnify”
and, in certain cases, an insurer may have had a duty to defend even when it
is later found that coverage (the duty to indemnify) does not exist. Id.
Ordinarily, however, if the duty to defend arises, liability insurance policies
grant the insurer “complete, exclusive control of the defense.” Unauthorized
Practice of Law Comm. v. Am. Home Assur. Co., 261 S.W.3d 24, 26 (Tex. 2008).
This authority includes the right to select counsel to defend the lawsuit.
Although an insurer may have an obligation to defend, oftentimes actual
coverage of the claim “cannot be determined when a claim is first filed.” Id. at
40.
Thus, when an insurer acknowledges that it has the duty to defend the
insured, but still questions whether it must indemnify, “it [will] usually issue[]
a reservation of rights letter when it accepts the defense, agreeing to defend
the insured without waiving its right to decline coverage later.” Id. Therein
reside the seeds of a conflict of interest. Even though the insurer’s chosen
counsel owes a duty of unqualified loyalty to its insured, that duty can be
threatened where the insured’s interests contrast sharply with those of the
insurer. State Farm Mut. Auto Ins. Co. v. Traver, 980 S.W.2d 625, 628 (Tex.
1998). If a conflict of interest actually exists it may be disqualifiable, giving
the insured the “privilege of rejecti[ng] th[is] limited representation and hiring
a lawyer of [its] own choosing and looking to [the insurer] for the payment of
the attorney’s fees.” Britt v. Cambridge Mut. Fire Ins. Co., 717 S.W.2d 476,
481 (Tex. App.–San Antonio 1986).
C.
So, we take the next step to resolving this appeal by asking when will a
conflict of interest entitle an insured to select its own counsel. Texas law is
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controlling, and the principal case on such conflicts of interest as are raised in
this appeal is N. Cnty. Mut. Ins. Co. v. Davalos, 140 S.W.3d 685 (Tex. 2004).
Davalos recognizes that an insurer’s issuance of a reservation of rights can
“create[] a potential conflict of interest.” Id. The reservation of rights,
however, “does not, by itself, create a conflict between the insured and insurer;
it only recognizes the possibility that such a conflict may arise in the future.”
Am. Home Assur. Co., Inc., 261 S.W.3d at 40. Instead, the test to apply is
whether “the facts to be adjudicated in the [underlying] lawsuit are the same
facts upon which coverage depends.” 3 Davalos, 140 S.W.3d at 689.
The Insureds argue that this conflict of interest rule is not a strict rule,
but that it is flexible to permit a disqualifying conflict of interest to arise when
insurer-hired attorneys may be tempted to develop facts or legal strategy that
ultimately could support the insurer’s coverage position. We expressly rejected
this argument in Downhole Navigator, L.L.C. v. Nautilus Ins. Co., in which we
held that the “same facts” test in Davalos was the proper analysis to determine
whether a disqualifying conflict of interest exists. 686 F.3d 325, 328-29 (5th
Cir. 2012). Therefore, we conclude that the “same facts” standard controls our
analysis. Applying that standard, we will decide whether the district court
erred in holding that no facts deciding coverage issues would be adjudicated in
the trial of the underlying KFA suit.
III.
A.
We begin by setting the stage: Mid-Continent, the insurer, has reserved
the right to deny coverage of the underlying copyright infringement claims on
3We have addressed the meaning of the words “to be adjudicated” before in Downhole
Navigator, L.L.C. v. Nautilus Ins. Co., 686 F.3d 325, 330 n. 2 (5th Cir. 2012). There we said
that while “the Texas Supreme Court has not clarified the meaning of ‘facts to be adjudicated,’
the term ‘adjudicate’ plainly means ‘to rule upon judicially.’” Id. (quoting BLACK’S LAW
DICTIONARY (9th ed. 2009)).
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grounds that the alleged acts of infringement against the Insureds “occurred”
outside the time the policy was in effect; the Insureds are defending KFA’s
copyright claims on grounds that the claims “accrued” outside the applicable
time provided by the statute of limitations. The Insureds argue that the timing
related to coverage of the claims and timing relating to accrual of the claims
run on the same factual track, which creates a disqualifiable conflict because
adjudication of many of the same facts will determine both the Insureds’
liability and the Insureds’ coverage. 4 Closer scrutiny of the Insureds’
argument shows that it misconceives which facts are necessary to adjudicate
the Insureds’ defense that the statute of limitations bars KFA’s claims.
As we have noted more than once, KFA brought these claims in the
underlying case against the Insureds under the Copyright Act. In litigating
the Insureds’ statute of limitation defense Mid-Continent’s chosen counsel, as
far as we can tell from the briefs and the record, would only need to have
adjudicated the fact of when the claim accrued, not the fact of when the acts of
infringement occurred. Makedwde Pub. Co. v. Johnson, 37 F.3d 180, 181 (5th
Cir. 1994). A claim accrues once the plaintiff “kn[ows] or ha[s] reason to know
of the injury upon which the claim is based.” 5 Jordan v. Sony BMG Music
Entm’t Inc., 354 F. App’x 942, 945 (5th Cir. 2009) (quoting Pritchett v. Pound,
473 F.3d 217, 220 (5th Cir. 2006)) (internal quotation marks omitted).
Davalos explicitly rejects the notion that an insured is entitled to select
its own counsel merely because the potential for a conflict of interest exists.
4 The relevant exclusion, exclusion 2(c), bars coverage for “personal and advertising
injury” arising out of oral or written publication of material that took place before the
beginning of the [first] policy period.”
5 Other circuits agree that this is the proper inquiry. See Cooper v. NCS Pearson, Inc.,
733 F.3d 1013 (10th Cir. 2013) (holding that a copyright claim accrues when a plaintiff has
actual or constructive knowledge of infringement); William A. Graham Co. v. Haughey, 568
F.3d 425, 433 (3d Cir. 2009) (noting that eight of its sister circuits “have applied the discovery
rule to civil actions under the Copyright Act”).
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Here, as between occurrence and accrual, we have two different concepts; an
occurrence determines the date of the actual injury and accrual determines the
date of the discovery of the injury. The only common fact between the timing
of these two determinations is that the occurrence inevitably occurred before
the discovery. While the adjudication of the date when KFA discovered the
injury would signal, in subsequent litigation, that the infringing conduct
occurred before that date of discovery, such a determination would only be a
general finding, and would lack the specificity necessary to decide whether the
claim was covered under the Insureds’ policy. An adjudication of the accrual
date (the fact to be adjudicated in the underlying lawsuit) need not be a judicial
ruling necessarily deciding the date of when the infringing conduct occured
(the fact upon which coverage depends). Thus, under the Davalos same facts
test, there is no disqualifiable conflict of interest between the Insureds and
Mid-Continent in litigating the statute of limitations defense.
B.
There is a second “same” fact that the Insureds argue creates a
disqualifying conflict of interest; that is the willfulness of the Insureds’
conduct. The question of willfulness arises under the policy exclusion for
knowing conduct that violates the rights of another. In this respect, KFA
alternatively pled for statutory damages under 17 U.S.C. § 504(c). Section
504(c) allows a copyright owner to receive an award of “not less than $750 or
more than $30,000” for each incident of infringement. Id. at § 504(c)(1). This
award is in lieu of “actual damages and profits” and is receivable at the
copyright owner’s election. Id. Statutory damages under this section may be
upwardly adjusted if the “infringement was committed willfully.” Id. at §
504(c)(2) (emphasis added). According to the Insureds, if KFA elected to
receive statutory damages, those damages would be enhanced by a finding of
willfulness. The Insureds argue that because willfulness necessarily
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encompasses knowing conduct, the underlying court would, in deciding
willfulness, necessarily adjudicate whether Hallmark’s infringement was
knowing and thereby determine an issue of coverage under the policy.
It is significant, however, that the exclusionary provision in Mid-
Continent’s policy extends only to knowing violations of the rights of another. 6
A finding of willfulness in the underlying suit would not adjudicate the fact of
whether the infringement was knowing because a finding of willfulness under
the Copyright Act does not require proof of knowing conduct. In short, a
finding of willful conduct under § 504(c)(2) would not be equivalent to a finding
of knowing conduct necessary to settle the issue of whether exclusion 2(a)
applies to exclude coverage.
We have had limited opportunities to interpret the meaning of a willful
violation under 17 U.S.C. § 504(c)(2). In an unpublished decision, we
interpreted “willful” under the Copyright Act to cover situations where “the
defendant has recklessly disregarded the plaintiff’s rights, or upon a showing
that the defendant knew or should have known it infringed upon a copyrighted
work.” Lance v. Freddie Records, Inc., No. 92-7561, 1993 WL 58790, at *2 (5th
Cir. 1993) (emphasis added); see also Phillip Morris USA Inc. v. Lee, 547 F.
Supp. 2d 685, 693 (W.D. Tex. 2008) (noting that “courts within the Fifth
Circuit[] have found willful conduct where a defendant acts with ‘reckless
disregard’”), and Berg v. Symons, 393 F. Supp. 2d 525, 540 (S.D. Tex. 2005)
(holding that willful violations under § 504(c)(2) include a “defendant’s actions
[that] were the result of ‘reckless disregard’ for, or ‘willful blindness’ to, the
copyright holder’s rights”).
6 The specific exclusion in the policy, exclusion 2(a), acts to eliminate coverage for
“’personal and advertising injury’ caused by or at the direction of the insured with the
knowledge that the act would violate the rights of another and would inflict ‘personal and
advertising injury.’”
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Although the Supreme Court has not directly addressed the definition of
“willful” under the Copyright Act, “the general rule [is] that a common law
term in a statute comes with a common law meaning, absent anything pointing
another way.” Safeco Ins. Co. of America v. Burr, 551 U.S. 47, 58 (2007)
(internal citation omitted). Because the common law construction of the term
“willful” covers behavior that is “wanton” or “reckless[,]” the “standard civil
usage” should as well. Id. Thus, when “willfulness is a statutory condition of
civil liability, [it] cover[s] not only knowing violations of a standard, but
reckless ones as well.” Id. Safeco mandates that we interpret “willful” under
§ 504(c)(2) as encompassing more than just “knowing” infringements. 7
In sum, we hold that an application of the Davalos “same facts” standard
evidences no conflict here. The underlying trial court’s determination that
there was a willful violation of KFA’s copyright under § 504(c)(2) would not
settle the issue of whether that violation was knowing; a violation can amount
to reckless conduct and still be willful under the statute. Because the
infringement could be willful conduct under § 504(c)(2), entitling KFA to
enhanced damages, without a finding of knowing infringement thereby
excluding coverage, there is no disqualifying conflict of interest under
Davalos. 8
7 We recognize that this position is consistent with the one taken by our sister circuits.
See N.A.S. Import, Corp. v. Chenson Enters., Inc., 968 F.2d 250, 252 (2d Cir. 1992) (holding
that a finding of “reckless disregard of the copyright holder’s rights (rather than actual
knowledge of infringement) suffices to warrant [an] award of enhanced damages”); Video
Views, Inc. v. Studio 21, Ltd., 925 F.2d 1010, 1020–21 (7th Cir. 1991) (holding that the term
“willful” encompasses the “reckless disregard of the copyright owner’s right”); RCA/Ariola
Intern., Inc. v. Thomas & Grayston Co., 845 F.2d 773, 779 (8th Cir. 1988) (holding that
“willfully” under the Copyright Act encompasses reckless disregard).
8 The Insureds’ two remaining issues on appeal are decided based on our finding that
there was no disqualifying conflict of interest. Mid-Continent possessed the right to select
counsel, and it did not breach the insurance contract by insisting upon exercising that right.
Furthermore, the Insureds’ claim for fees paid to their selected counsel was not a valid claim,
and the district court did not err in granting summary judgment on this issue in favor of Mid-
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VI.
The district court did not err in finding that there were no facts capable
of being adjudicated in the underlying KFA litigation that would decide issues
of coverage between the Insureds and Mid-Continent. A finding that there was
no disqualifying conflict of interest entitled Mid-Continent to summary
judgment on both the Insureds’ breach of contract claim and its claim under
the Texas Insurance Code. Accordingly, the district court’s final judgment
granting Mid-Continent’s motion for summary judgment is
AFFIRMED. 9
Continent. See TEX. INS. CODE ANN. § 542.058(b) (there is no violation of the prompt payment
statute where “it is found as a result of arbitration or litigation that a claim received by an
insurer is invalid and should not be paid by the insurer”).
9 The motion to certify questions to the Texas Supreme Court is denied.
11