James River Insurance Company v. Kemper Casualty Insurance Comp

In the
United States Court of Appeals
For the Seventh Circuit
No. 08-3570
JAMES R IVER INSURANCE C OMPANY,
Plaintiff-Appellant,
v.
K EMPER C ASUALTY INSURANCE C OMPANY,
Defendant-Appellee.
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 07 C 4233—Harry D. Leinenweber, Judge.
A RGUED S EPTEMBER 24, 2009—D ECIDED O CTOBER 28, 2009
Before P OSNER, M ANION, and T INDER, Circuit Judges.
P OSNER, Circuit Judge. This diversity suit pits the James
River insurance company against the Kemper insurance
company. James River seeks a declaration that it had no
duty to defend or indemnify two lawyers (and their law
firm, but we can ignore that detail) who were sued for
malpractice and whom Kemper had also insured. As is
often true in a declaratory-judgment suit, the plaintiff in
2 No. 08-3570
the suit is really the defendant. For James River wants
nothing from Kemper, while Kemper wants James River
to contribute to the expense it incurred in defending the
lawyers in the malpractice suit and in paying the settle-
ment that ended the suit. The district court granted
summary judgment in favor of Kemper.
Both insurance policies are “claims made” policies.
That means they insure against liability based on legal
claims against the insured filed during the period
covered by the policy (the “policy period,” as it is
called), provided those claims are based on acts com-
mitted after the policy’s “retroactive date.” The policy
period in the Kemper policy was September 27, 2000, to
September 27, 2002, and the retroactive date was
January 1, 1937. The policy period in the James River
policy was November 8, 2004, to November 8, 2005, and
the retroactive date was November 8, 2002. (The six-
week gap between the end of Kemper’s coverage and the
beginning of James River’s is immaterial.) The malpractice
suit (the “claim”) accused the lawyers of wrongful acts
during both the period covered by Kemper’s policy and
the later period covered by James River’s policy.
The lawyers had represented the wife in a divorce
case. In December 1999, well within the coverage of
Kemper’s policy for acts giving rise to claims, the parties
made a property settlement as a prelude to the entry of
a divorce decree. The settlement gave the wife a big
chunk of her soon-to-be ex-husband’s employee stock
options. But in February of the following year the
employer wrote the parties that the method by which the
No. 08-3570 3
property settlement had tried to transfer the stock
options was invalid. Two months later the insureds
instituted on the ex-wife’s behalf a proceeding in state
court against her ex-husband, complaining of his failure
to effectuate the transfer. The proceeding was pending
when, in July 2001, his employer declared bankruptcy
and the employee stock options evaporated.
The malpractice suit accused the lawyers of professional
negligence in failing to get the stock options transferred
before the bankruptcy rendered the options worthless.
They could and should have done this, the suit
charged, either by insisting that the property settlement
(drafted by the husband’s lawyer) use a proper method
of conveyance, or by amending the settlement. Instead
they had negligently decided to institute a legal pro-
ceeding that dragged on until the stock options became
worthless.
The alleged misconduct occurred mainly during
Kemper’s policy period, but not entirely; the plaintiff
alleged that it continued into 2003 (which was during the
James River policy period), when the Illinois appellate
court dismissed the proceeding to recover the options.
The options were worthless by then, so it’s hard to see
how the ruling could have hurt the plaintiff. Its signifi-
cance rather was in confirming the futility of the pro-
ceeding and thus reinforcing the claim that the
lawyers should have been doing something else to
recover the options, rather than just appealing their
defeat in the trial court.
The malpractice suit further alleged that the defendants
had concealed a business relationship that they had
4 No. 08-3570
with the husband’s divorce lawyer. This charge also
overlapped the coverage of the two polices, as did the
further charge that the defendants had conspired to
prevent the plaintiff from bringing the malpractice
suit against her former lawyers until the statute of limita-
tions had run.
James River points to several exclusions in its policy
that it contends excuse it from having to pay for the
lawyers’ defense against the claim of wrongful acts com-
mitted during the James River policy period, or to pay any
part of the settlement that resolved the malpractice suit.
Kemper argues that James River has the burden of proving
that the exclusions apply, and that is correct, but it is
important to distinguish between two grounds for that
placement of the burden.
The first ground is simply that James River is the plain-
tiff, and plaintiffs have the burden of proof except with
respect to defenses. The second ground is based on insur-
ance law. If the insureds (the lawyers) had been suing
James River, it would have had the burden of proving
that its insurance policy didn’t cover any of the claims
against them. That is the rule in Illinois. Hildebrand v.
Franklin Life Ins. Co., 455 N.E.2d 553, 564 (Ill. App. 1983);
Sokol & Co. v. Atlantic Mutual Ins. Co., 430 F.3d 417, 422-23
(7th Cir. 2005) (Illinois law). And the allocation of the
burden of proof in a diversity case (or any other case
governed by state law) is determined by state law. Raleigh
v. Illinois Dept. of Revenue, 530 U.S. 15, 20-21 (2000); Dick
v. New York Life Ins. Co., 359 U.S. 437, 446 (1959); In re
Stoecker, 179 F.3d 546, 551-52 (7th Cir. 1999). At least this
No. 08-3570 5
is so when there is no direct conflict with a federal statute,
or with a rule adopted under the Rules Enabling Act.
Walker v. Armco Steel Corp., 446 U.S. 740, 747-58 (1980). The
allocation of burden of proof (in the sense of burden of
persuasion—which side loses a tie) absolutely determines
the outcome in cases where the evidence is in equipoise,
and by doing so advances the substantive policies of a
state, cf. Thorogood v. Sears, Roebuck & Co., 547 F.3d 742, 746
(7th Cir. 2008); Harbor Ins. Co. v. Continental Bank Corp., 922
F.2d 357, 364-65 (7th Cir. 1990), here a policy of favoring
insureds in litigation with their insurance companies.
American States Ins. Co. v. Koloms, 687 N.E.2d 72-75 (Ill.
1997); Connecticut Specialty Ins. Co. v. Loop Paper Recycling,
Inc., 824 N.E.2d 1125, 1130 (Ill. App. 2005). To apply a
different rule in a diversity suit would make the hap-
penstance of diversity provide a decisive advantage to
one of the litigants if the evidence was evenly balanced.
This suit, however, is not between an insured and
an insurance company, but between two insurance compa-
nies (the insureds were parties but are no longer), and
the real plaintiff is Kemper, which is seeking a money
judgment against James River. A plaintiff has the
burden of proof, except with regard to affirmative de-
fenses, and this should be the rule also for a declaratory-
judgment defendant who is the real plaintiff, the
declaratory-judgment action having been brought merely
to accelerate the defendant’s suit for damages or other
relief. By seeking declaratory relief in lieu of simply
balking at a demand for payment, an insurance company
protects itself from being found to have refused the in-
sured’s demand in bad faith, a finding that would expose
the company to having to pay punitive damages.
6 No. 08-3570
It is sensible to place the burden of proof of an affirma-
tive defense on the defendant, rather than making the
plaintiff prove a negative; and the sense of the rule is not
diminished just because the “defendant” has made
himself a “plaintiff” by filing a declaratory-judgment
action rather than waiting to be sued. Lenience extended
to insureds who find themselves in litigation with an
insurance company has no place when the plaintiff in a
suit against an insurer is another insurer. As explained in
Royal Indemnity Co. v. Wingate, 353 F. Supp. 1002, 1004
(D. Md.), affirmed without opinion, 487 F.2d 1398
(4th Cir. 1973), in a declaratory-judgment action “the
burden of proof should not be mechanically placed on
the doorstep of the plaintiff simply because it is the one
seeking relief . . . . [I]t would seem unwise to apply
any general formulation with respect to the burden of
proof but rather to address such a question from the
standpoint of which party must lose where there is
failure of proof.”
Still, that approach, sensible as it seems, is not univer-
sally followed. 10B Charles A. Wright, Arthur R. Miller &
Mary Kay Kane, Federal Practice and Procedure § 2770, pp.
677-80 (3d ed. 1998). But is it law in Illinois? After we said
in International Hotel Co. v. Libbey, 158 F.2d 717, 721 (7th Cir.
1946), though without explanation, that “when an issue of
fact is tendered by the complaint and denied by the
answer, the plaintiff must prove its complaint, even though
it is a complaint for a declaratory judgment,” the Supreme
Court of Illinois, quoting this language from our opinion
without any elaboration, said that this was the rule in
Illinois. Board of Trade of City of Chicago v. Dow Jones & Co.,
No. 08-3570 7
456 N.E.2d 84, 87 (Ill. 1983). Neither case was an insurance
case, but the “rule” was repeated in Stoneridge Development
Co. v. Essex Ins. Co., 888 N.E.2d 633, 650 (Ill. App. 2008).
How the state’s supreme court would decide the ques-
tion were it posed in an insurance case in which the
pros and cons of the rule were argued, we do not know;
but neither need we decide in order to resolve the
present case. There are no issues of fact and therefore
no reason for Kemper to have raised the question of the
burden of proof. And anyway Illinois law treats
exclusions in an insurance policy as affirmative de-
fenses. Raprager v. Allstate Ins. Co., 539 N.E.2d 787, 791-
92 (Ill. App. 1989); Wahls v. Aetna Life Ins. Co., 461
N.E.2d 466, 470 (Ill. App. 1983); Illinois School Dist. Agency
v. Pacific Ins. Co., 471 F.3d 714, 716-17 (7th Cir. 2006)
(Illinois law). That is another example of a procedural
rule that has a substantive motivation and therefore
binds the federal courts in diversity suits.
James River bases its appeal mainly on a provision of
its policy that excludes any claim “directly or indirectly
arising from . . . any common fact, circumstances, transac-
tion advice or decision involved in a ‘professional service’
reported as a claim or potential claim under any prior
Policy.” The lawyer defendants in the malpractice suit
duly reported the malpractice claim to both insurers
when the claim was filed in May 2005; and it is apparent
that the wrongful acts alleged to have occurred during
the James River policy period arose from the decisions
that the insured lawyers had made during the Kemper
policy period. Those were the decisions relating to their
8 No. 08-3570
efforts to obtain the stock options for their client both in
the initial property settlement and after the husband’s
employer refused to transfer the options, contending that
the method of transfer in the property settlement was
invalid. The Illinois appellate ruling is the only wrongful
act alleged to have occurred entirely during the later
policy period (though we repeat our puzzlement that a
judicial ruling could be an act of malpractice rather than
at most evidence of malpractice by a lawyer handling the
case in which the ruling was rendered), and it too arose
from the lawyers’ initial handling of the stock-options
issue.
We mustn’t press the concept of “arising from” too
hard, however. What if the defendants in the malpractice
suit, because their resources had been depleted by the
suit, cut corners in handling an unrelated matter during
James River’s policy period and were sued for mal-
practice; would James River’s prior-policy provision
exclude coverage for that suit? It would not, because
“arising from” implies a tighter connection than a mere
“but for” cause creates. Maybe if Columbus hadn’t dis-
covered America the federal courts of appeals would not
have been created in 1891; but it would be odd to say
that the federal appellate judiciary “arose from” Colum-
bus’s voyages.
It is true that Illinois cases say that “arising from” is
satisfied by a showing of “but for” causation. E.g., American
Economy Ins. Co. v. DePaul University, 890 N.E.2d 582, 588
(Ill. App. 2008); Shell Oil Co. v. AC&S, Inc., 649 N.E.2d 946,
951-52 (Ill. App. 1995). But what they mean is that a claim
No. 08-3570 9
need not have been foreseeable to be deemed to arise from
an act by the insured. Illinois distinguishes between “but
for” causation (which the cases call “cause in fact”) and
“legal cause,” which means foreseeability. City of Chicago
v. Beretta U.S.A. Corp., 821 N.E.2d 1099, 1127 (Ill. 2004);
Abrams v. City of Chicago, 811 N.E.2d 670, 674-75 (Ill. 2004);
Majetich v. P.T. Ferro Construction Co., 906 N.E.2d 713, 717
(Ill. App. 2009); Cleveland v. Rotman, 297 F.3d 569, 573
(7th Cir. 2002) (Illinois law). If Illinois understood “but
for” literally, to mean just a condition that had to exist
for the event in question to occur (a subsequent act of
malpractice, in this case), liability insurance companies
would have no way of setting premiums equal to
expected cost; they would be insuring against a range of
possible claims so vast that an estimate of the probability
that a claim within that range would actually be filed
would be arbitrary.
The outer bounds of “but for” causation applied to
insurance cases are suggested by the American Economy
case, cited above. An office worker was injured by ultra-
violet radiation from fluorescent lights installed by a
contractor in her workplace. She had lupus, and it was
the interaction of the radiation with her condition that
caused the injuries; they would not have occurred, she
claimed, had “commercially available and reasonably
priced diffusers or filters that would diffuse or reduce
the ultraviolet (UV) rays emitted by the fluorescent lights
to a safe level” been installed. 890 N.E.2d at 585. It
is understandable why in determining the scope of
a liability-insurance policy a court would think it
irrelevant whether the contractor should have foreseen
10 No. 08-3570
the presence of workers suffering from lupus or some
other light-sensitive disease and taken precautions ac-
cordingly. For one doesn’t purchase liability insurance
just to protect oneself against being sued for inflicting
foreseeable injuries; one buys protection against any
claim arising from the potential liability-causing activity
in which one engages, and a claim can arise from the
activity without being foreseeable.
There are limits to what can be said to “arise from” some
event. But they are not based on unforseeability. If Chris-
topher Columbus had bought insurance against liability
for claims arising out of his voyages and had later been
sued for assaulting an Indian in Hispaniola, he could not
have required the insurance company to defend him on
the ground that had it not been for his voyage to Hispan-
iola he would not have assaulted anyone there.
A way to help partition liability between successive
insurers, and thus decide when a claim made during the
policy period of the second insurer should be deemed
to arise out of activity during the policy period of the
first insurer, is to ask what sense it would make for the
defense of the malpractice suit, and the cost of the indem-
nification of the defendants in that suit, to be shared
between two insurance companies. The suit against the
insureds in this case alleged an intertwined set of
wrongful acts that straddled the two policy periods. It
wouldn’t be feasible to apportion defense or settlement
costs between acts committed in the two periods. Overlap-
ping coverage, requiring apportionment of defense and
indemnity costs between insurers, is sometimes unavoid-
No. 08-3570 11
able, see, e.g., Outboard Marine Corp. v. Liberty Mutual Ins.
Co., 670 N.E.2d 740, 757 (Ill. App. 1996), but there is no
reason to manufacture occasions for such apportionment.
As in Continental Casualty Co. v. Coregis Ins. Co., 738 N.E.2d
509, 523 and n. 3 (Ill. App. 2000), it is apparent that the
second insurer (James River) excluded coverage in situa-
tions in which the wrongful acts committed during its
policy period were a continuation of wrongful acts com-
mitted during the policy period of the previous in-
surer—and they were.
But that does not end the case. The district court ruled
that Kemper’s policy was not a “prior Policy” within the
meaning of the James River policy, and if that is right
then the exclusion we’ve been discussing does not apply.
Kemper’s policy grants the insured an “extended re-
porting period option”: for a fixed fee, the insured can
extend the period within which it is required to report a
claim against it to Kemper. The claim must still have
arisen from professional services rendered between the
retroactive date of January 1, 1937, and the end of the
policy period, which remember was September 27, 2002,
but it can be reported later. The lawyers purchased a five-
year extension, which therefore expired on September 27,
2007, well after the James River policy period, which
ended in November 2005. (The malpractice suit was
filed in 2005, but that was within the extended reporting
period, which is why Kemper had to defend it and indem-
nify the insureds for the settlement with the plaintiff.)
Therefore, the judge ruled, Kemper’s policy was not
“prior” to James River’s.
12 No. 08-3570
The extended-reporting-period option (or “tail cover-
age” as it is called) may seem a curious animal. It may
seem that an insured would want such an option (for
which he would have to pay Kemper $48,033, which was
225 percent of the regular annual premium of $21,348)
only if he expected to be sued, and one would think
that such an expectation would greatly increase the risk
to the insurance company of incurring liability on the
policy and thus the cost to the company of the addi-
tional coverage sought. The price of the extension of the
reporting period seems, in those circumstances, awfully
low, though typical of lawyers’ professional liability
policies. Michael Davidson, “Choosing the Right Tail
Coverage,” 19 Experience 34, 35 (2009); Bert Linder, “Law-
yers Professional Liability Insurance Marketplace,” 609
PLI/Lit 371, 427 (1999). The insurer is protected to a
degree by the dollar limits on liability in the policy;
yet because of the potential for adverse selection (that is,
the purchase of insurance by persons who have an above-
average likelihood of experiencing the insured-against
event), such “’tail’ coverage must be rated for the individ-
ual risk. The risk’s [i.e., the insured’s] history of insured
exposures, previous types and amounts of insurance, the
possibility of partial exhaustion of the aggregate limits,
the amount and types of hazards relating to latent
injury potential and the insured’s previous loss history are
among the many factors which may influence the price
of the ‘tail’ coverage.” James K. Killelea, “Format of
Liability Insurance Policies,” 296 PLI/Lit 229, 243 (1985).
In any event, the reporting period is not the policy
period—Kemper’s policy is explicit that a claim
No. 08-3570 13
reported in the extended reporting period must have
arisen “prior to the end of the policy period.” And
nothing in the prior-policy exclusion in James River’s
policy limits the time within which a claim under a
prior policy must be reported for the exclusion to apply.
James River cites two other exclusions. One is for a
claim “directly or indirectly arising out of or resulting
from any conspiracy” and the other a claim “directly
or indirectly arising out of or resulting from any act
committed with knowledge of its wrongful nature or
with the intent to cause damage.” The principal wrongful
acts alleged against the insured lawyers in James River’s
policy period concern the conspiracy to prevent the
client from filing a timely suit; and a claim of conspiracy
is explicitly excluded. The negligent failure both to
reveal the conflict of interest involving the husband’s
lawyer, and to accomplish the transfer of the stock
options before the bankruptcy, is alleged to have con-
tinued until May 2003 (which was within the James River
policy period), when the Illinois Appellate Court rejected
the ex-wife’s suit to obtain the promised options. The
bankruptcy had occurred nearly two years before the
appellate ruling, and after the bankruptcy the only
further harm the lawyers could do their client was to
cover up their negligence so that she wouldn’t sue them.
So only the negligent failure to disclose the conflict of
interest could have harmed the client by delaying her
suing them. But the alleged negligent failure persisted
into James River’s policy period and doesn’t fall into the
policy’s conspiracy or wrongful-knowledge exclusions.
14 No. 08-3570
Nevertheless the prior-policy exclusion applies. The
lawyers’ alleged misconduct occurred within the policy
period, and the suit was filed during the tail. Kemper’s
policy applies, and it therefore follows that James River’s
does not, since it excludes coverage of conduct covered
by a prior insurer; all the wrongful acts alleged in the
malpractice suit arose from events that took place in
Kemper’s policy period.
The judgment is reversed with instructions to enter
the declaratory judgment requested by the plaintiff.
R EVERSED WITH INSTRUCTIONS.
10-28-09