Edward T. Joyce & Associates v. Professionals Direct Insurance

In the
United States Court of Appeals
For the Seventh Circuit
____________________
No. 14-3341
EDWARD T. JOYCE & ASSOCIATES, P.C.,
Plaintiff-Appellant,
v.
PROFESSIONALS DIRECT INSURANCE
COMPANY,
Defendant-Appellee.
____________________
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 13 CV 2475 — Charles R. Norgle, Judge.
____________________
ARGUED APRIL 16, 2015 — DECIDED MARCH 21, 2016
____________________
Before BAUER, EASTERBROOK, and SYKES, Circuit Judges.
SYKES, Circuit Judge. The Illinois law firm of Edward T.
Joyce & Associates, P.C., purchased professional-liability
insurance from Professionals Direct Insurance Company, a
Michigan-based insurer. In 2007 the Joyce firm won a large
damages award for a class of securities-fraud plaintiffs and
hired another law firm to sue to collect the money from the
2 No. 14-3341
defendant’s insurers. Some of the class members thought the
Joyce firm should have handled this aspect of the litigation
itself under the terms of its contingency-fee agreement. The
class members took the firm to arbitration over the extra fees
incurred in the satellite collection litigation.
Professionals Direct paid for the Joyce firm’s defense in
the arbitration. But when the arbitrator found for the clients
and ordered the firm to reimburse some of the fees they had
paid, the insurer refused the firm’s demand for indemnifica-
tion. The Joyce firm initiated coverage litigation in state
court, which the insurer promptly removed to federal court.
Ruling on cross-motions for summary judgment, the district
judge sided with the insurer, concluding that the arbitration
award was a “sanction” under the insurance policy’s exclu-
sion (o), which excludes coverage for “fines, sanctions,
penalties, punitive damages or any damages resulting from
the multiplication of compensatory damages.”
We affirm, though on a different rationale. The arbitra-
tion award was not functionally a sanction, so exclusion (o)
does not apply. But another provision in the policy excludes
“claim[s] for legal fees, costs or disbursements paid or owed
to you.” Because the arbitration award adjusted the attor-
ney’s fees owed to the firm in the underlying securities-fraud
class action, the “legal fees” exclusion applies.
I. Background
Professionals Direct issued a professional-liability insur-
ance policy to the Joyce firm promising to pay “all sums
which you [the firm] become legally obligated to pay as
damages because of any claim or claims first made against
No. 14-3341 3
you.” 1 The policy defines “claim” as “a demand or suit for
money or services you receive, including any arbitration
proceedings.” Eligible claims are those “aris[ing] out of the
rendering of or the failure to render professional services.”
And “professional services” include “services you [the Joyce
firm] render in a lawyer-client relationship as a lawyer,
mediator, arbitrator, notary public, administrator, conserva-
tor, receiver, executor, guardian, trustee, or in any similar
fiduciary capacity.”
“Damages” are defined as “monetary judgments, awards
or settlements unless otherwise excluded.” (Emphasis added.)
To that end, the policy lists 27 exclusions, two of which are
relevant here. Exclusion (o) excludes coverage for “any claim
for fines, sanctions, penalties, punitive damages or any
damages resulting from the multiplication of compensatory
damages.” Exclusion (p) excludes coverage for “any claim
for legal fees, costs or disbursements paid or owed to you.”
A. The Securities-Fraud Class Action
In 2002 a class of plaintiffs retained the Joyce firm to
prosecute a securities-fraud action against EPS Solutions
Corporation and Enterprise Profit Solutions Corporation
(collectively, “EPS”). Under the retainer agreement, the Joyce
firm would receive a $200,000 flat fee and 25% of any award
or settlement, plus reimbursement of costs. The agreement
permitted the Joyce firm to retain local counsel outside
Illinois if the firm deemed such assistance necessary, with
1Bolded words appear as they do in the policy and are terms specially
defined in section (D) of the policy.
4 No. 14-3341
any resulting third-party legal fees to be treated as costs
under the agreement.
In 2007 the Joyce firm won a substantial arbitration
award against EPS. By that point, however, EPS had become
insolvent, and its insurers were the only source of funding to
collect on the award.
This is where the dispute between the firm and its clients
arose. The Joyce firm thought it had fully satisfied its obliga-
tions under the terms of the original retainer agreement by
securing the arbitration award. The firm recommended the
retention of Morgan, Lewis & Bockius LLP, a California law
firm, to handle the collection litigation against EPS’s insur-
ers. The clients, however—or at least a large subset of the
class that later pursued a claim against the Joyce firm—
thought the firm should have continued to represent them
under the terms of the original retainer agreement.
Regardless, the Joyce firm arranged for Morgan Lewis
and later Reed Smith LLP to pursue the insurance litigation.
Because of its “intimate knowledge of the facts and legal
theories,” the Joyce firm assisted in the litigation on an
hourly-fee basis, with payment deferred until and only if
there was an actual recovery. The case ultimately settled
when EPS’s insurers agreed to pay $8.6 million.
B. The Arbitration Demand by the Class Members
In January 2011 Walter Duemer, a plaintiff in the securi-
ties-fraud class action, filed a demand for arbitration against
the Joyce firm on behalf of roughly 90% of his fellow plain-
tiffs. He alleged claims for breach of fiduciary duty, wrong-
ful conversion of client trust funds, and breach of contract.
The claims centered on the Joyce firm’s retention of the
No. 14-3341 5
Morgan Lewis and Reed Smith firms to handle the satellite
litigation against EPS’s insurers. 2 The Joyce firm denied any
wrongdoing and retained counsel to defend it in the arbitra-
tion, forwarding counsel’s invoices to Professional Direct for
payment. The insurer agreed to pay for the firm’s defense
under a reservation of rights and paid the invoices as they
were submitted. (There were two exceptions, which we’ll
discuss later.)
The arbitrator rejected the conversion and breach-of-
contract claims but found the Joyce firm liable for breach of
fiduciary duty in the manner in which it had arranged for
the two outside firms to handle the satellite litigation. More
specifically, the arbitrator found that the Joyce firm did not
make “up front full disclosure about the change in legal
representation” and that the new fee arrangement “was
presented [to the clients] as already accomplished,” suggest-
ing “an element of undue influence about the purported
negotiation of a new fee agreement.”
As a remedy, the arbitrator sought to unwind some of the
additional attorney’s fees incurred by the Duemer claimants
in the satellite litigation. The arbitrator ordered the Joyce
firm to remit the $405,674.87 in fees it had charged for
consultative work with Morgan Lewis and Reed Smith. And
because the original retainer agreement had called for a
75/25 client/attorney split of any recovery yet the clients had
footed the entire bill for the satellite litigation, the arbitrator
2 The arbitration demand also challenged the acceptance of a settlement
offer of $8.6 million—$400,000 below the $9 million threshold authorized
by the plaintiffs. This claim was not part of the arbitrator’s final award
and is immaterial to this appeal.
6 No. 14-3341
also ordered the Joyce firm to pay 25% of the fees charged by
Morgan Lewis and Reed Smith. This added $150,127.15 to
the award. Finally, the arbitrator ordered the firm to pay
$72,725.45 to offset the costs incurred in the arbitration.
The Joyce firm unsuccessfully challenged the arbitration
award in Illinois state court on grounds unrelated to this
appeal. The firm was thus on the hook for $628,527.47. At
this point Professionals Direct balked and refused to pay the
award, relying on exclusions (o) and (p) in the policy
(among other policy defenses).
The Joyce firm filed suit in state court seeking a declara-
tion that the insurer had breached its duty to indemnify.
Professionals Direct removed the action to federal court
based on diversity jurisdiction. See 28 U.S.C. § 1332. On
cross-motions for summary judgment, the district court
honed in on the arbitrator’s use of the word “sanction” to
describe the final award against the Joyce firm. Since “claims
for … sanctions” are expressly excluded from coverage
under exclusion (o) of the policy, the judge held that the
insurer owed no indemnification duty and entered summary
judgment for Professionals Direct. This appeal by the Joyce
firm followed.
II. Discussion
The primary question in this case is how to classify the
arbitration award won by the Duemer claimants: Is it a
sanction, the return of disputed fees, or simply damages? If
the award qualifies as a sanction, then exclusion (o) knocks
out coverage. If the award is an adjustment of disputed legal
fees, then exclusion (p) applies and the result is the same. If
No. 14-3341 7
the arbitrator awarded ordinary compensatory damages,
then Professionals Direct may be required to pay.
We review de novo the district court’s ruling on cross-
motions for summary judgment. Dunnet Bay Constr. Co. v.
Borggren, 799 F.3d 676, 688 (7th Cir. 2015). Because this case is
in federal court under diversity jurisdiction, Illinois substan-
tive law controls.
A. Estoppel
As a threshold matter, the Joyce firm asserts that Profes-
sional Direct is estopped from relying on any policy exclu-
sions because it reneged on its duty to defend in the arbitra-
tion. Under Illinois law “an insurer’s duty to defend under a
liability insurance policy is so fundamental an obligation
that a breach of that duty constitutes a repudiation of the
contract.” Emp’rs Ins. of Wausau v. Ehlco Liquidating Tr.,
708 N.E.2d 1122, 1135 (Ill. 1999). A breach of the duty to
defend estops the insurer from raising policy defenses to
coverage. Id.The district judge declined to address the estoppel argu-
ment because it was underdeveloped and therefore waived.
The Joyce firm challenges that conclusion on appeal.
We don’t need to address waiver because the estoppel
argument is so obviously meritless. An insurance company
has two options when an insured requests a defense and the
insurer disputes coverage: The insurer can “(1) defend the
suit under a reservation of rights or (2) seek a declaratory
judgment that there is no coverage.” Id. Professionals Direct
elected the first option. The Joyce firm had retained counsel
of its choosing for the arbitration, and under a reservation of
8 No. 14-3341
rights, Professionals Direct agreed to reimburse defense
costs. It followed through on this reimbursement promise.
The Joyce firm’s estoppel argument rests entirely on the
timing of two of the reimbursement payments. The firm
asserts that after the arbitrator issued his final award, Profes-
sionals Direct claimed it had no further responsibility for
defense costs and left two outstanding invoices unpaid.
Multiple phone calls and e-mails followed, and the firm
threatened litigation. Professionals Direct then paid the two
outstanding invoices, belatedly, a few weeks later.
The Joyce firm contends that this brief delay in payment
amounts to a breach of the duty to defend. There’s no sup-
port for this argument. To the contrary, in Santa's Best Craft,
L.L.C. v. Zurich American Insurance Co., 941 N.E.2d 291 (Ill.
App. Ct. 2010), the Illinois Appellate Court expressly de-
clined to find a breach of an insurer’s duty to defend based
solely on “the amount of time between the insured's submis-
sion of expenses … and its subsequent receipt of reim-
bursement,” id. at 300. So even if properly preserved, the
estoppel argument plainly fails. Because there was no failure
to defend, Professionals Direct is not estopped from raising
its policy defenses to coverage.
B. Exclusion (o)
As we’ve explained, exclusion (o) knocks out coverage
for “any claim for fines, sanctions, penalties, punitive dam-
ages or any damages resulting from the multiplication of
compensatory damages.” The district judge classified the
arbitration award as a “sanction” and thus concluded that
exclusion (o) applies. The judge’s reasoning rests heavily on
the language used by the Illinois courts in their rulings
No. 14-3341 9
rejecting the Joyce firm’s challenge to the arbitration award.
Because the state courts occasionally used the word “sanc-
tion” to describe the award, the judge evidently thought
himself bound by that label.
But the character of the award was not at issue in the
state-court proceedings, which focused narrowly on whether
the dispute was subject to arbitration and whether the
arbitrator exceeded his authority. It’s true that the Illinois
Appellate Court’s decision uses the word “sanctions” three
times—each time closely mirroring language found in the
arbitrator’s award. Duemer v. Edward T. Joyce & Assocs., P.C.,
995 N.E.2d 321, 326 (Ill. App. Ct. 2013). But this perfunctory
repetition of the arbitrator’s terminology doesn’t determine
the proper characterization of the award.
Nor does the arbitrator’s occasional use of the word
“sanction” conclusively resolve the matter. Indeed, the
arbitrator used a bevy of different terms to describe the
award, including “damages,” “disgorgement,” the “equita-
ble result,” “remedy,” and the “final award” (among other
terms). In the end, what the arbitrator called the award is
less important than what was actually alleged and proved,
what was awarded, and why. See Cont'l Cas. Co. v. Donald T.
Bertucci, Ltd., 926 N.E.2d 833, 842 (Ill. App. Ct. 2010) (ex-
plaining that Illinois courts “compare the language of the
policy with the facts alleged in the complaint, rather than
examine whether the client has pled any particular theory of
relief”).
Exclusion (o) lists “sanctions” alongside “fines,” “penal-
ties,” “punitive damages,” and “damages resulting from the
multiplication of compensatory damages”—all terms that
describe penalties rather than compensatory remedies. The
10 No. 14-3341
arbitration award, on the other hand, is crafted as a remedy
for the Joyce firm’s breach of fiduciary duty in connection
with its handling of the retention of the outside firms for the
collection litigation against EPS’s insurers. The arbitrator
sought to make the clients whole for a portion of the extra
fees they incurred in the satellite litigation.
To be sure, the arbitrator rooted his holding in part on an
ethics rule that carries the threat of sanctions. Specifically, he
noted that “the Joyce law firm violated Rule 1.5c of the 1990
Illinois Rules of Professional Conduct by entering into a
verbal agreement for a contingent fee engagement, even
though this was a contingent hourly fee and not your stand-
ard ‘percentage of recovery’ contingent fee agreement.” But
the power to issue sanctions for violation of the Rules of
Professional Conduct belongs exclusively to the Illinois
Supreme Court and to any inferior courts acting with its
blessing. Lustig v. Horn, 732 N.E.2d 613, 620 (Ill. App. Ct.
2000) (“Courts other than the supreme court may adjudicate
matters touching on attorney discipline only when acting as
agents of the supreme court upon direct order of that
court. … [A] denial of attorney[’s] … fees, imposed solely as
a sanction for unprofessional conduct on his part, would
constitute an impermissible infringement on the exclusive
power of the supreme court … to adjudicate disciplinary
matters.”). This narrow aspect of the arbitrator’s decision
doesn’t determine the character of the award.
The arbitrator used a variety of different terms to de-
scribe the award to the Duemer claimants, but the label
ultimately doesn’t matter. Because the award is functionally
and in substance a remedy for the firm’s fiduciary breach—
and not a sanction—exclusion (o) does not apply.
No. 14-3341 11
C. Exclusion (p)
The stronger argument against coverage is that the arbi-
trator’s award falls within exclusion (p), which excludes
coverage for “any claim for legal fees … owed to” the firm.
The request for relief in the arbitration demand fits squarely
within this exclusion. The Duemer claimants sought “relief
for legal fees wrongfully collected under Contingency Fee
Agreements signed by each of Claimants and Respondent in
connection with Respondent’s agreement to provide legal
services to investigate and prosecute any and all claims
which Claimants might have in connection with the pur-
chase of EPS stock.” (Emphasis added.) This straightforward
request grows a bit murkier in the “[p]rayer” for relief,
which more broadly asks for “[a]ctual damages as deter-
mined by the Arbitrator.” Still, the award fashioned by the
arbitrator adjusted the legal fees recovered by the Joyce firm
in the underlying securities-fraud action. That brings exclu-
sion (p) into play.
Recall that the arbitration award had three components:
(1) $405,674.87 to be remitted from the Joyce firm to the
Duemer claimants for the hourly fees they paid to the firm
for its consultancy with Morgan Lewis and Reed Smith;
(2) $150,127.15 from the Joyce firm to offset 25% of the legal
fees paid by the claimants directly to Morgan Lewis and
Reed Smith; and (3) $72,725.45 to cover arbitration costs. The
costs are not at issue here.
The first component of the award straightforwardly qual-
ifies as a “claim for legal fees … paid or owed to [the firm]”
within the meaning of exclusion (p) because the claimants
were seeking and received remittance of fees they had paid
12 No. 14-3341
directly to the Joyce firm. This part of the award is plainly
excluded from coverage.
The second component of the award is somewhat more
difficult to classify. It isn’t directly an order for reimburse-
ment of legal fees paid to the Joyce firm. After all, the
Duemer claimants had paid the $150,127.15 to the two outside
law firms. But substance is what matters here, and in sub-
stance this part of the arbitrator’s award reduced the fees the
Joyce firm was entitled to recover from the proceeds of the
settlement with EPS’s insurers. In other words, the arbitrator
adjusted the legal fees owed to the firm for its work in the
underlying securities-fraud arbitration, lopping off an
amount equal to its share of the fees the Duemer claimants
paid to the two outside firms. So although it’s a closer ques-
tion, we conclude that this part of the award, too, falls within
exclusion (p) and is excluded from coverage. 3
3 Professionals Direct also argues that the arbitration award falls outside
the basic grant of coverage in the policy because the award did not “arise
out of the rendering of or the failure to render professional services.”
That strikes us as a stretch. The arbitrator found the Joyce firm liable for
breach of fiduciary duty arising directly out of the attorney-client
relationship with the plaintiff class. Professionals Direct cites Continental
Casualty Co. v. Donald T. Bertucci, Ltd., 926 N.E.2d 833 (Ill. App. Ct. 2010),
but that case is distinguishable; it involved a pure billing dispute that
arose after litigation concluded and the attorney-client relationship
ended.
Professionals Direct also argues that the second component of the
arbitration award—the order that the firm reimburse the Duemer
claimants for 25% of the fees paid to the two outside firms—is uninsura-
ble restitution under Illinois law. See Local 705 Int’l Bhd. of Teamsters
Health & Welfare Fund v. Five Star Managers, LLC, 735 N.E.2d 679 (Ill. App.
Ct. 2000) (explaining that “disgorgement or restitution of fees do not
No. 14-3341 13
Accordingly, although we part company with the district
court on which of the two exclusions applies, we agree that
the arbitration award is excluded from the policy’s coverage
and Professionals Direct owes no duty to indemnify.
AFFIRMED.
constitute insurable damages … as a matter of Illinois law”). We don’t
need to address this argument because we’ve already concluded that this
part of the award amounts to a claim for legal fees and is therefore
excluded from coverage by exclusion (p).