ESICORP v. Liberty Mutual Ins.

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
___________
No. 98-2912
No. 98-3040
___________
Esicorp, Inc.; St. Louis Testing *
Laboratories, Inc., *
*
Plaintiffs - Appellees/ *
Cross - Appellants, * Appeal from the United States
* District Court for the
v. * Eastern District of Missouri.
Liberty Mutual Insurance Company, *
*
Defendant - Appellant/ *
Cross - Appellee. *
___________
Submitted: May 10, 1999
Filed: October 19, 1999
___________
Before LOKEN and MORRIS SHEPPARD ARNOLD, Circuit Judges, and WATERS,*
District Judge.
___________
LOKEN, Circuit Judge.
Esicorp, Inc. (“Esicorp”) sued St. Louis Testing Laboratories, Inc. (“SLT”) for
negligence. SLT’s liability insurer, Liberty Mutual Insurance Company (“Liberty
*
The HONORABLE H. FRANKLIN WATERS, United States District Judge for
the District of Arkansas, sitting by designation.
Mutual”), refused to defend SLT. Esicorp and SLT then settled that lawsuit -- which
we shall call the underlying action -- agreeing that most of SLT’s settlement obligation
could be recovered only from Liberty Mutual. Esicorp, suing on behalf of itself and
SLT, then commenced this diversity action against Liberty Mutual to recover the
settlement amount and punitive damages for bad faith breach of the insurer’s duties to
defend and indemnify. Ruling on cross motions for summary judgment and applying
Missouri law, the district court concluded that Liberty Mutual had breached its duty to
defend SLT and granted Esicorp judgment for the full amount of the settlement plus
SLT’s costs of defense in the underlying action. The court rejected Esicorp’s claim for
punitive damages and refused to award Esicorp its attorneys’ fees in this action. Both
sides appeal. We agree that Liberty Mutual breached its duty to defend, and that
Esicorp may not recover punitive damages or its attorneys’ fees in this action.
However, we conclude that Liberty Mutual’s liability for SLT’s settlement may not
exceed its duty to indemnify under the policy, and we therefore remand for resolution
of coverage and apportionment issues the district court did not address.
I. Liberty Mutual’s Duty to Defend
This dispute arose when Esicorp’s predecessor, acting as prime contractor,
purchased large diameter, welded steel “Penstock” pipe sections for a construction
project at a California hydroelectric plant. Progressive Fabricators of St. Louis
manufactured the pipe sections by welding together pieces of rolled metal in its shop.
SLT was hired to inspect and approve Progressive Fabricators’ shop welds before the
pipe sections were shipped from St. Louis to the project site in California. Once on
site, the pipe sections were field-welded together to form an integrated pipe system.
With the project well under way, spot checks of field welds led to the discovery of
defects in Progressive’s shop welds. The project owner then suspended further work
and required Esicorp to re-examine all the shop welds and repair rejectable defects.
-2-
In August 1994, Esicorp sued SLT, alleging that its negligent testing and
approval of over four hundred defective shop welds caused Esicorp as general
contractor to incur over $3,000,000 in increased costs of performance and liquidated
damages to the project owner. SLT tendered defense of the action to Liberty Mutual
under the comprehensive general liability (CGL) policies it issued to SLT during the
period in question. Liberty Mutual refused to defend, advising SLT by letter that the
losses alleged in Esicorp’s complaint were not covered “property damage” and in any
event were excluded under the policies’ “impaired property” exclusion. Defending
itself, SLT then settled with Esicorp for $2,125,000. Under the settlement agreement,
SLT satisfied this liability by paying Esicorp $125,000 and assigning to Esicorp SLT’s
rights against Liberty Mutual. Esicorp agreed to pay SLT five percent of any amounts
recovered from Liberty Mutual, but not more than $115,000.
Esicorp then commenced this action against Liberty Mutual, alleging bad faith
breach of its contractual duties to defend and indemnify. The district court concluded
that Liberty Mutual breached its duty to defend SLT in the lawsuit brought by Esicorp.
On appeal, Liberty Mutual argues it had no duty to defend because Esicorp’s complaint
did not seek damages for covered losses. The interpretation of an insurance policy is
an issue of law we review de novo. See McCormack Baron Mgmt. Servs., Inc. v.
American Guar. & Liab. Ins. Co., 989 S.W.2d 168, 171 (Mo. banc 1999).
A liability insurer such as Liberty Mutual has two distinct duties, the duty to
indemnify the insured for covered losses, and the duty to defend the insured in any
lawsuit seeking damages that would be covered losses. The duty to defend arises
when the insured is first sued and thus is understandably broader than the duty to
indemnify. If the complaint against the insured “alleges facts that give rise to a claim
potentially within the policy’s coverage, the insurer has a duty to defend.”
McCormack, 989 S.W.2d at 170-71. The duty to defend is normally determined by
comparing the policy language with the allegations in the complaint. But the insurer
may not ignore “actual facts,” that is, “facts which were known, or should have been
-3-
reasonably apparent at the commencement of the suit.” Marshall’s U.S. Auto Supply,
Inc. v. Maryland Cas. Co., 189 S.W.2d 529, 531 (Mo. 1945). Thus, in reviewing the
district court’s conclusion that Liberty Mutual breached its broad duty to defend, we
ignore Esicorp’s reliance on facts that emerged during discovery and focus on Liberty
Mutual’s policy provisions and the allegations in Esicorp’s complaint against SLT.1
Liberty Mutual’s CGL policies promised to indemnify SLT for non-excluded
“property damage” caused by an “occurrence.” The policies defined property damage
as “[p]hysical injury to tangible property, including all resulting loss of use of that
property.” Esicorp’s complaint against SLT alleged that the first Penstock pipe
sections were delivered to the project site in August 1989, that the sections were
assembled and field welded as they arrived, that defective shop welds were first
discovered in late December 1989, that work was suspended in May 1990, and that
Esicorp incurred increased performance costs as a result of having to repair “rejectable
defects.” Like the district court, we conclude it was reasonably apparent to a liability
insurer from these allegations that “property damage” to the pipe system, and perhaps
to surrounding project property and equipment, would likely result from this type of on-
site repair operation. Thus, while most of the damages alleged in Esicorp’s complaint
appeared to be economic losses, not covered property damage, cf. SLA Prop. Mgmt.
v. Angelina Cas. Co., 856 F.2d 69, 72-73 (8th Cir. 1988), Esicorp’s complaint included
1
Esicorp argues as the premise for its claim of bad faith that the duty to defend
includes a duty to make a “reasonable investigation” when the insured tenders the
defense of a newly filed lawsuit. But the duty not to ignore “actual facts” as defined
by the Supreme Court of Missouri in Marshall’s does not mean the insurer has an
affirmative duty to conduct a far-reaching investigation of the facts underlying the third
party’s claims. Of course, as Liberty Mutual acknowledged in refusing SLT’s tender
of defense, if the insured later submits an amended pleading or additional facts that
suggest the presence of covered claims, the insurer has an obligation to reconsider its
refusal to defend. But there is no evidence that SLT made such a submission. Thus,
we focus on what “should have been reasonably apparent” from Esicorp’s complaint.
-4-
allegations giving rise to a claim “potentially within the policy’s coverage” – unless this
type of property damage was subject to a policy exclusion. The district court
considered and rejected Liberty Mutual’s contention that two exclusions applied, and
Liberty Mutual has not appealed those rulings.2 Accordingly, we affirm the court’s
ruling that Liberty Mutual breached its duty to defend SLT in the underlying lawsuit.
II. Liberty Mutual’s Contractual Liability
A. May Liability Exceed the Insurer’s Duty To Indemnify? As the district court
recognized, the duty to defend is a contractual obligation. A breach makes the insurer
liable for damages reasonably flowing from the breach. Those damages typically
include the insured’s cost of defending the underlying action. See Wood v. Safeco Ins.
Co., 980 S.W.2d 43, 55 (Mo. App. 1998). Here, the district court awarded damages
of $61,654.68 for SLT’s costs of defense, and Liberty Mutual does not appeal that
portion of the damage award.
In addition, Missouri law recognizes that, by refusing to defend, the insurer gives
up its contractual right to control the defense of the underlying action and frees the
insured to negotiate a reasonable settlement with the plaintiff. In this situation, the
general rule in Missouri is that the insured (or an assignee such as Esicorp) may recover
the amount of the settlement absent collusion or bad faith. See, e.g., Western Cas. &
Sur. Co. v. Southwestern Bell Tel. Co., 396 F.2d 351, 355 (8th Cir. 1968). But this
case raises a more specific issue, whether an insurer that breaches its duty to defend
is liable for a portion of the insured’s settlement that is attributable to claims not
2
Briefly stated, Liberty Mutual relied upon the exclusion for “property damage
to your work arising out of [your work],” and the exclusion for “impaired property”
that can be restored by repair of “your work.” As the district court noted, SLT’s
“work” was the testing of the shop welds, not the welding itself. Even if pipe sections
containing defective shop welds were “impaired property,” they could not be restored
simply by further testing.
-5-
covered by the policy. Stated differently, does breach of the duty to defend expand the
insurer’s duty to indemnify, thereby entitling the insured to a windfall in the form of
greater insurance coverage than it would have obtained had the insurer defended the
underlying case?
Though Esicorp’s brief on appeal cites eight federal and state court decisions for
the general Missouri rule, not one discusses this issue – in each of those cases, the full
amount of the judgment or settlement was a covered loss. On the other hand, Liberty
Mutual relies upon a Missouri Court of Appeals decision that directly addressed the
issue, Dickman Aviation Servs., Inc. v. United States Fire Ins. Co., 809 S.W.2d 149,
152 (Mo. App. 1991):
In the case of a liability insurer’s refusal to defend an action against the
insured which involves both claims within the coverage of the policy and
claims which are not covered by the policy, if the liability insurer fails to
defend the action, and the insured unsuccessfully defends the action, then
the insurer is liable for the recovery against the insured if such recovery
is on a claim covered by the policy, but no liability for the recovery will
rest upon the insurer if the recovery is on a noncovered claim.
(Citation omitted; emphasis in the original.) Moreover, on this point Dickman is
consistent with a prior decision of the Missouri Supreme Court. In Butters v. City of
Independence, 513 S.W.2d 418 (Mo. 1974), the insured rejected the insurer’s offer to
defend under a reservation of rights. Concluding that the insured was not required to
accept defense under a reservation of rights, the Court held that the insurer had
breached its duty to defend and turned to the question of damages:
That leaves the question of whether or not the evidence showed
that the loss was within the coverage and of whether or not the settlement
between plaintiffs and the [insured] was collusive. . . . In this case, the
court purported to determine the question [of coverage] without a trial and
the insurer has had no opportunity to be heard on the issue of the factual
-6-
basis for the [insured’s] liability [in the underlying lawsuit]. . . . [The
insurer] was entitled to a trial on the coverage issue.
513 S.W.2d at 425; accord Triple U Enters., Inc. v. New Hampshire Ins. Co., 766 F.2d
1278, 1281-82 (8th Cir. 1985) (applying S.D. law).3
We conclude that the above-quoted portions of Butters and Dickman reflect the
law of Missouri – an insurer’s liability when the insured has settled the underlying
action may not exceed the policy coverages; therefore, a settlement encompassing both
covered and noncovered claims must be fairly apportioned between the two. Here, as
in Butters, the district court made no finding as to what portion of the $2,125,000
settlement was attributable or apportionable to covered losses. The potential windfall
to Esicorp and SLT of awarding the full $2,125,000 would be substantial if Liberty
Mutual accurately stated at oral argument the extent of Esicorp’s noncovered claims.
That is an issue to be addressed in the first instance by the district court. Accordingly,
we remand for determination of these coverage and apportionment issues.
B. May the Insurer’s Liability Exceed the Insured’s Obligation under the
Settlement? Liberty Mutual argues that its contractual liability to indemnify SLT for
its settlement cannot exceed SLT’s $125,000 out-of-pocket payment to Esicorp. We
disagree. Liberty Mutual relies on Missouri cases that involved assignments of
indemnification rights. “Contracts of indemnity are not synonymous with contracts of
insurance.” Holiday Inns, Inc. v. Thirteen-Fifty Investment Co., 714 S.W.2d 597, 602
(Mo. App. 1986). This issue arises because Liberty Mutual abandoned its insured by
3
Because Esicorp’s initial brief responded to Liberty Mutual’s initial brief, when
counsel for Esicorp misleadingly cited Missouri cases stating the general rule as
addressing the issue in this case, and failed to mention the more pertinent contrary
discussion in Dickman, they came perilously close to breaching their duty of candor to
this court. See MO. SUP. CT. R. 4-3.3(a)(1). Thus, even if we had discretion to award
Esicorp its attorneys’ fees on this appeal, we would decline to do so.
-7-
refusing to defend, leaving SLT to face both the costs of defense and the risk of
substantial liability. A Missouri statute expressly authorizes an insured to settle a
personal injury or wrongful death action by agreeing that the plaintiff may collect the
settlement only against the insurer. See MO. REV. STAT. § 537.065. We applied that
statute’s “sound reasoning” beyond its express purview in O’Donnell v. St. Luke’s
Episcopal Presbyterian Hosps., 800 F.2d 739, 741 (8th Cir. 1986). Here, we likewise
conclude that the Missouri Supreme Court would not limit Liberty Mutual’s liability to
the amount SLT paid out of its own pocket under the settlement. So long as the
settlement was reasonable and non-collusive, Liberty Mutual is liable for covered
losses within the policy limits.
III. Esicorp’s Cross-Appeal
Esicorp argues the district court erred in granting summary judgment dismissing
its claim for punitive damages for Liberty Mutual’s bad faith refusal to defend SLT in
the underlying lawsuit. “In Missouri, a breach of the duty to defend sounds in contract,
while a breach of the duty to settle sounds in tort.” Quick v. National Auto Credit, 65
F.3d 741, 744 (8th Cir. 1995), cert. denied, 516 U.S. 1153 (1996); accord Bonner v.
Automobile Club Inter-Ins. Exch., 899 S.W.2d 925, 928 (Mo. App. 1995). Punitive
damages are not recoverable under Missouri law for breaches of contract, “even where
the breach is intentional, willful, wanton or malicious.” Peterson v. Continental Boiler
Works, Inc., 783 S.W.2d 896, 903 (Mo. banc 1990). We conclude the Missouri
Supreme Court would not recognize a new, independent cause of action sounding in
tort that would permit an award of punitive damages for a liability insurer’s “bad faith
refusal to defend.”
Esicorp next argues the district court erred in refusing to include Esicorp’s
attorneys’ fees in this action in the damages awarded for Liberty Mutual’s breach of
the duty to defend. We disagree. When the insurer breaches its duty to defend, it is
liable for the insured’s attorneys’ fees in defending the underlying action, but not for
-8-
attorneys’ fees incurred in suing to recover damages for the failure to defend. See
Missouri Prop. & Cas. Ins. Guar. Ass’n v. Pott Indus., 971 S.W.2d 302, 306 (Mo.
banc 1998).
The judgment of the district court is reversed, and the case is remanded for
further proceedings not inconsistent with this opinion. Liberty Mutual’s motion to
strike the “Introduction” section of Esicorp’s reply brief is granted. Esicorp’s letter
submissions of May 11, 1999, and July 21, 1999, are stricken from the record on
appeal for non-compliance with Fed. R. App. P. 28(j).
A true copy.
Attest:
CLERK, U. S. COURT OF APPEALS, EIGHTH CIRCUIT.
-9-