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US District Court : INSURANCE - 'insured v. insured'; definition v. definition; defense costs

UNITED STATES DISTRICT COURT
DISTRICT OF MINNESOTA
Westchester Fire Insurance Company,
a New York corporation,
Plaintiff,
Civ. No. 07-2145 (RHK/AJB)
MEMORANDUM OPINION
AND ORDER
v.
Douglas Wallerich, Patrick Lowther, and
Sharon OReilly,
Defendants.
Jeffrey M. Thompson, Dorothy M. Jaworski Paxton, Meagher & Geer, PLLP,
Minneapolis, Minnesota, for Plaintiff.
Paula D. Vraa, Larson King, LLP, St. Paul, Minnesota, for Defendants.
INTRODUCTION
This case involves an insurance-coverage dispute. Plaintiff Westchester Fire
Insurance Company (Westchester) filed this declaratory-judgment action against
Defendants Douglas Wallerich, Patrick Lowther, and Sharon OReilly, seeking a
determination as to whether it must provide coverage to them in defending an underlying
lawsuit. Westchester also seeks reimbursement of the expenses it has paid thus far in
defense of that lawsuit. Defendants answered and counterclaimed for coverage fees for
Westchesters initial denial of coverage and for defending this declaratory-judgment
action. Westchester now moves for summary judgment on the grounds that the Insured
2
v. Insured exclusion in the insurance policy precludes coverage. For the reasons set
forth below, the Court will grant Westchesters Motion in part.
BACKGROUND
I. The Jewel Partnership
In 1996, Defendants formed the partnership Jewel of the Mississippi, LLP (Jewel
Partnership) with Mark Fayette, Shayna Fayette, and others, for the purpose of acquiring
and developing the Jewel Nursery property in Lake City, Minnesota. (Wallerich Aff.
7.) Mark Fayette and Shayna Fayette each owned 9.3 percent of the partnership. (Id.)
Mark Fayette and Shayna Fayette are married, but each had separate voting rights and
partnership benefits. ( Id.) In addition, each made separate cash contributions and
contributed separately to a convertible-debt program. (Id. 8.)
In July 2002, the Jewel Partnership and Hale Irwin Golf Properties, LLC (HIGP)
formed the Residences at the Jewel, LLC (the Residences) to develop the property for
commercial and residential use. The Jewel Partnership owned an 85% interest in the
Residences and HIGP owned the remaining 15%.1 (Id. 9.) In addition to being
investors, Mark Fayette and Defendants held various officer and director positions within
the Residences from July 2002 until its dissolution on December 28, 2006. (Wallerich
Aff. Ex. A.) Shayna Fayette, however, was never an officer, director, or employee of the
Residences. ( Id. Ex. B.)
1 HIGP received its 15% interest in the Residences in exchange for designing and managing the
Residences golf operations. (Wallerich Aff. 9.)
3
II. The Policy
On September 20, 2006, Wallerich, in his capacity as Chief Manager of the
Residences, filed an application with Westchester for a business and management
indemnity insurance policy. (Wallerich Aff. Ex. A.) Westchester issued the Policy to the
Residences, with effective dates of October 19, 2006 to October 19, 2007. (Id.) Two
sections of the Policy are relevant to the issues in this case: the General Terms and
Conditions section and the Directors, Officers, and Company Indemnity Coverage
(D&O) section. (Bigger Aff. Ex. 1 at 007, 013.)
A. General Terms and Conditions
The General Terms and Conditions apply to each and every Coverage Section of
[the] Policy. The terms and conditions of each Coverage Section apply only to that
Coverage Section and shall not be construed to apply to any other Coverage Section.
(Id. at 007). The Definitions section of the General Terms and Conditions explains that:
Whenever used in this Policy, the terms that appear below in boldface type
shall have the meanings set forth in this Definitions subsection of the
General Terms and Conditions. However, if a term also appears in boldface
type in a particular Coverage Section and is defined in that Coverage
Section, that definition shall apply for purposes of that particular Coverage
Section. Terms that appear in boldface in the General Terms and
Conditions but are not defined in this Definitions subsection and are defined
in other Coverage Sections of the Policy shall have the meanings ascribed
to them in those Coverage Sections.
(Id. (emphasis added).)
Finally, the General Terms and Conditions section contains a clause dealing with
spouses, which provides in pertinent part:
4
The . . . spouses . . . of natural persons who are Insureds shall be
considered Insureds under this Policy; provided, however, coverage is
afforded to such . . . spouses . . . only for a Claim arising solely out of
their status as such and, in the case of a spouse . . . where the Claim seeks
damages from marital community property, jointly held property or
property transferred from the natural person who is an Insured to the
spouse . . . .
(Id. at 010 (emphases added).)
B. D&O Section
The insuring clause of the D&O section provides that: Insurer shall pay the Loss
of the Directors and Officers for which the Directors and Officers are not indemnified
by the Company and which the Directors and Officers have become legally obligated
to pay by reason of a Claim . . . for any Wrongful Act taking place prior to the end of
the Policy Period. (Bigger Aff. Ex. 1 at 013.)
Loss means damages, judgments, settlements, pre-judgment or post-judgment
interest awarded by a court, and Costs, Charges and Expenses incurred by the Directors
and Officers under the Insuring Clause[] . . . . (Id. at 014.) Cost, Charges, and
Expenses means reasonable and necessary legal costs, charges, fees and expenses
incurred by any of the Insureds in defending Claims . . . . ( Id. at 013-014.) Claim is
defined in pertinent part as a civil proceeding against any Insured seeking monetary
damages, or non-monetary or injunctive relief, commenced by the service of a complaint
or similar pleading. (Id. at 013.) Wrongful act means any actual or allege d error,
omission, misleading statement, misstatement, neglect, breach of duty or act allegedly
5
committed or attempted by: any of the Directors or Officers while acting in their
capacity as such . . . . (Id.)
The D&O section defines Insureds as the Company and the Directors and
Officers. (Id. at 014.) Finally, the D&O coverage section contains an Insured v.
Insured exclusion, which provides:
Insurer shall not be liable for Loss under this Coverage Section on account
of any Claim:
* * * *
e) brought or maintained by, on behalf of, in the right of, or at the direction
of any Insured in any capacity, any Outside Entity or any person or entity
that is an owner of or joint venture participant in any Subsidiary in any
respect and whether or not collusive, unless such Claim:
(i) is brought derivatively by a securities holder of the Parent
Company and is instigated and continued totally independent
of, and totally without the solicitation, assistance, active
participation of, or intervention of, any Insured[.]
(Id. at 016.)
III. The Underlying Fayette Action
On February 1, 2007, Mark Fayette and Shayna Fayette, individually and on
behalf of the Residences, filed a lawsuit in Minnesota state court against Defendants
alleging breach of various fiduciary duties in connection with the management and
auction of certain residential and commercial properties held by the Residences. (Levine
Decl. Ex. 1.) Defendants timely notified Westchester of this lawsuit and sought coverage
for their defense. (Wallerich Af f. 1.) In response, Westchester denied coverage and
refused to defend Defendants. (Id. 2-3.) Defendants then hired coverage counsel who
6
urged Westchester to reconsider its position. (Id. 2.) On April 26, 2007, Westchester
changed its position; it agreed to defend Defendants against the Fayette lawsuit, subject
to a full reservation of rights, including the right to file a declaratory-judgment action,
challenging its obligation to defend Defendants in that case. ( Id. 5.)
Thereafter, Westchester filed this declaratory-judgment action, seeking a
determination that it owes no coverage to Defendants. Westchester also asserts that it is
entitled to reimbursement for the fees and costs it has incurred to date in defending the
underlying Fayette action. Defendants have counterclaimed for coverage fees, which
they have incurred as a result of Westchesters initial denial of coverage as well as for
defending this declaratory-judgment action.
STANDARD OF DECISION
Summary judgment is proper if, drawi ng all reasonable inferences in favor of the
nonmoving party, there is no genuine issue as to any material fact and the moving party is
entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c); Celotex Corp. v. Catrett,
477 U.S. 317, 322-23 (1986). The moving party bears the burden of showing that the
material facts in the case are undisputed. Celotex, 477 U.S. at 322; Mems v. City of St.
Paul, Dept of Fire & Safety Servs., 224 F.3d 735, 738 (8th Cir. 2000). The Court must
view the evidence, and the inferences that may be reasonably drawn from it, in the light
most favorable to the nonmoving party. Graves v. Ark. Dept of Fin. & Admin., 229
F.3d 721, 723 (8th Cir. 2000); Calvit v. Minneapolis Pub. Schs., 122 F.3d 1112, 1116
(8th Cir. 1997). The nonmoving party may not rest on mere allegations or denials, but
7
must show through the presentation of admissible evidence that specific facts exist
creating a genuine issue for trial. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 256
(1986); Krenik v. County of Le Sueur, 47 F.3d 953, 957 (8th Cir. 1995).
ANALYSIS
There is no dispute that Mark Fayette and Defendants are Insureds under
the Policy, as each held officer and/or director positions within the Residences.
There is a dispute, however, as to whether Shayna Fayette is an Insured under
the Policy (as the spouse of Mark Fayette), and hence, whether the Insured v.
Insured exclusion is applicable here.
I. Interpretation of Insurance Policies
State law governs the interpretation of insurance policies.2 Natl Union Fire Ins.
Co. of Pittsburgh v. Terra Indus., Inc., 346 F.3d 1160, 1164 (8th Cir. 2003). Under
Minnesota law, the interpretation of an insurance policy is a question of law for the
Court. Watson v. United Servs. Auto. Assn, 566 N.W.2d 683, 688 (Minn. 1997). When
an insurance policys language is unambiguous, the Court interprets that language in
accordance with its plain and ordinary meaning. Ill. Farmers Ins. Co. v. Glass Serv. Co.,
683 N.W.2d 792, 799 (Minn. 2004). When an insurance policys language is ambiguous,
however, the Court will generally construe that language against the drafter and in favor
2 Neither party has argued that another states law governs the Policy. Indeed, both parties assert
that Minnesota law applies. See BBSerCo, Inc. v. Metrix Co., 324 F.3d 955, 960 n.3 (8th Cir.
2003) (law of forum state applies by default where parties do not raise choice-of- law issue).
8
of the insured. Nathe Bros., Inc. v. Am. Natl Fire Ins. Co., 615 N.W.2d 341, 344 (Minn.
2000).
II. Duty to Defend
An insurers duty to defend is broader than the duty to indemnify in three ways:
(1) the duty to defend extends to every claim that arguably falls within the scope of
coverage; (2) the duty to defend one claim creates a duty to defend all claims; and (3) the
duty to defend exists regardless of the merits of the underlying claims. Wooddale
Builders, Inc. v. Maryland Cas. Co., 722 N.W.2d 283, 302 (Minn. 2006) (citations
omitted). An insurer seeking to avoid its duty to defend has the burden of demonstrating
that all claims fall outside the scope of the insurance policy. Metropolitan Prop. & Cas.
Ins. Co. v. Miller, 589 N.W.2d 297, 299 (Minn. 1999).
With these principles in mind, the Court will address whether Shayna Fayette is an
Insured under the Policy and whether the Insured v. Insured exclusion precludes
coverage for the underlying lawsuit.
III. Shayna Fayette is Not an Insured under the Policy
Westchester asserts that Shayna Fayette is an Insured under the D&O Policy
and, therefore, her claims against Defendants are barred by the Insured v. Insured
exclusion.3 It relies on the General Terms and Conditions section, which provides that
[t]he . . . spouses . . . of natural persons who are Insureds shall be considered Insureds
under this Policy. (Bigger Aff. Ex. 1 at 010.)
3 As explained earlier, there is no dispute that Mark Fayette is an Insured under the Policy.
9
First, the Court must look to the language of the Policy to determine whether
Shayna Fayette is an Insured. The D&O section of the Policy defines the term
Insureds to mean the Company and the Directors and Officers. (Id. at 014.) The
General Terms and Conditions section, however, provides that a spouse is an Insured
under the Policy. Thus, there is an ambiguity here because the definition of an Insured is
subject two different meanings.4 Westchester argues that the General Terms and
Conditions apply to each and every section of the Policy and, accordingly, spouses are
considered Insureds under the D&O section of the Policy. (Pl.s. Reply Mem. at 4-5.)
But, the Definitions section of the General Te rms and Conditions contradicts this
language it states in pertinent part that Terms that appear in boldface in the General
Terms and Conditions but are not defined in this Definitions subsection and are defined in
other Coverage Sections of the Policy shall have the meanings ascribed to them in those
Coverage Sections. (Bigger Aff. Ex. 1 at 007 (emphasis added).) The term Insureds
is not defined in the General Terms and Conditions section. That term is only defined in
the D&O coverage section, and is defined there to mean the Company and the
Directors and Officers. (Id. at 014.) Nowhere does this definition include spouses.
Furthermore, it is undisputed that Shayna Fayette was never a director, officer, or
employee of the Residences. Because t he term Insureds is defined in the D&O
Coverage Section, that definition is the only definition applicable to the D&O Coverage
4 When an insurance policys language is ambiguous, the Court generally construes that language
against the drafter and in favor of the insured. Nathe Bros., 615 N.W.2d at 344.
10
Section and to its exclusions, including the Insured v. Insured exclusion. Had
Westchester intended to cover spouses as Insureds under the D&O policy it could
have included spouses in that definition. It did not. Accordingly, the Court concludes
that Shayna Fayette is not an Insured under the D&O Policy.
IV. The Insured v. Insured Exclusion Precludes Coverage
Defendants assert that, because Shayna Fayette is not an Insured under the D&O
Policy, the Insured v. Insured exclusion does not apply, and as a result, Westchester
must defend the entire lawsuit. In response, Westchester contends that even if Shayna
Fayette is not an Insured under the D&O Policy, the Insured v. Insured exclusion
precludes coverage for the entire underlying lawsuit because Mark Fayette is a plaintiff in
the underlying lawsuit and is an Insured under the D&O Policy.
Insured v. Insured exclusions are common in Director and Officer liability
insurance policies. See Murray v. Loewen Group, 133 F. Supp. 2d 1110, 1117 (E.D.
Wis. 2001). The purpose of an Insured v. Insured exclusion is to prevent collusion,
such as suits in which a corporation sues its officers and directors in an effort to recoup
the consequences of their business mistakes . . ., thus turning liability insurance into
business-loss insurance . . . . Level 3 Commcns, Inc. v. Fed. Ins. Co., 168 F.3d 956,
958 (7th Cir. 1999) (internal citations omitted) (citing Twp. of Ctr., Butler County, Pa. v.
First Mercury Syndicate, Inc., 117 F.3d 115, 119 (3d Cir. 1997)).
Here, the Policy excludes coverage for any Claim . . . brought or maintained by,
on behalf of, in the right of, or at the direction of any Insured in any capacity . . .
11
whether or not collusive . . . . (Bigger Aff. Ex. 1 at 016.) It is undisputed that Mark
Fayette is an Insured under the Policy. However, as determined above, Shayna Fayette
is not an Insured under the Policy. Thus, the Court must decide whether the presence
of a non-insured joined with an Insured in the underlying action defeats the Insured v.
Insured exclusion.5 The Court has found no cases in Minnesota addressing whether an
Insured v. Insured exclusion bars coverage for an underlying lawsuit brought by both
an insured and non-insured plaintiff. However, cases from other jurisdictions do provide
some, albeit conflicting, guidance on this issue.
Defendants rely on Bodewes v. Ulico Casualty Co., 336 F. Supp. 2d 263, 276-77
(W.D.N.Y. 2004), for the proposition that an insurers duty to defend, under New York
law, requires the insurer to defend the entire action despite the presence of both insured
and non-insured plaintiffs in the underlying suit. The Court in Bodewes explained that
the facts and circumstances of that case were similar to the Level 3 decision from the
Seventh Circuit. Bodewes, 336 F. Supp. 2d at 277.
Level 3 involved a claim for coverage under a D&O policy for costs incurred by
the insured corporation in defending a securities-fraud lawsuit brought by several
minority shareholders. 168 F.3d at 957. A former director of a subsidiary of the insured
corporation joined the underlying lawsuit as a plaintiff six months after it was filed, and
5 If the Court were to find that Shayna Fayette is an Insured under the Policy, there is no
question that the Insured v. Insured exclusion would bar coverage in this case.
12
the insurance company denied coverage based on the Insured v. Insured exclusion in
the policy. Id. at 957-58.
Critical to Level 3s analysis was the lone insured plaintiff who joined the lawsuit
six months after it was filed. The Seventh Circuit concluded that the exclusion would
lead to the odd result that a claim fully covered when made could become fully
uncovered when another plaintiff was permitted to join it. Id. at 960. The court held
that the claims of the former director were not covered, but that the claims of the
remaining plaintiffs were, taking note of the policys allocation clause, which allowed for
an appropriate proportion of a judgment or settlement amount to be allocated to the
uninsured plaintiffs. Id. at 960-61.
Defendants also rely on Megavail v. Illinois Union Insurance Co., No. 05-1374-
AS, 2006 WL 2045862, at *2 (D. Or. July 19, 2006) (applying Oregon law). In
Megavail, an insured corporation sued its insurer for breach of contract and indemnity
after the insurer declined to defend the corporation in an action brought by its
shareholders. Id. at *1. Two of the six plaintiffs in the underlying lawsuit were former
officers and directors and were therefore considered insureds under the insurance
policy. Id. The insurance company claimed that the Insured v. Insured exclusion
barred coverage. Id. The district court found that the underlying lawsuit, which was not
collusive, fell outside of the category of suits against which the insurance policys socalled
Insured v. Insured exclusionary clause was designed to protect. Id. at *2. It held
that the insurers duty to defend was triggered by the presence of four uninsured
13
shareholders even though two of the other plaintiffs were insured shareholders. Id. The
court reasoned that the allocation clause in the policy required allocation between
covered and uncovered losses, rather than barring all recovery because of the presence of
uncovered claims. Id. at *3.
This Court concludes that the cases cited by Defendants are factually dissimilar to
the case here. The Level 3 court did not find that the presence of an uninsured plaintiff,
alone, resulted in partial coverage. To the contrary, the court stated:
The contract . . . defines Claim as a civil proceeding . . ., and the district
court thought this meant that if any of the plaintiffs were Insureds, there
was no coverage . . . . The presence of an Insured in the litigation could
conceivably contaminate the entire litigation. . . . But the contract deals
with this problem in another way, by requiring allocation of covered and
uncovered losses.
Id. at 960 (emphasis added). Similarly, critical to the courts analysis in Megavail, was
the (1) presence of an allocation clause in the insurance policy, and (2) determination that
the underlying lawsuit was not a collusive action.
The Court recognizes that under Minnesota law, an insurance company has a duty
to defend when any part of the claim against the insured is arguably within the policy
scope. Metropolitan, 589 N.W.2d at 299. However, Minnesota courts must also apply
the language of an insurance policy as written. Miller v. ACE USA, 261 F. Supp. 2d
1130, 1138-39 (D. Minn. 2003) (applying Minnesota law). Here, the Policy does not
contain an allocation clause. Furthermore, the language of the exclusion whether or
not collusive- eliminates any inquiry into whether the underlying lawsuit was collusive.
14
Westchester relies on Sphinx International, Inc. v. National Union Fire Insurance
Co. of Pittsburgh, PA, 226 F. Supp. 2d 1326 (M.D. Fla. 2002) and PowerSports, Inc. v.
Royal & Sunalliance Insurance Co., 307 F. Supp. 2d 1355 (S.D. Fla. 2004), as support for
its contention that the Insured v. Insured exclusion bars coverage for an underlying
lawsuit brought by both insured and non-insured plaintiffs. (Pl.s Mem. at 14.)
In Sphinx, a former officer and director (an insured) and shareholders (noninsureds)
filed a securities class action against the company. 226 F. Supp. 2d at 1329.
The company sought coverage for the underlying lawsuit under its D&O policy, but its
insurer invoked the Insured v. Insured exclusion and denied coverage. Id. The
company then filed suit against the insurance company and sought a declaration of
coverage. Id. The court held that the exclusion barred coverage for the entire action
because of the presence of the insured plaintiff. Id. at 1336-37. The court distinguished
Level 3 on the ground that in Sphinx, the plaintiffs claims were uncovered from the
moment they were filed, whereas in Level 3, the exclusion would have turned a covered
claim into an uncovered claim because an insured plaintiff joined the underlying lawsuit
six months after it was filed. Id.
Likewise, the court in PowerSports, held that the Insured v. Insured exclusion
barred coverage for the underlying suit by two former directors (insureds) and a noninsured.
307 F. Supp. 2d at 1359, 1362. The court found the case more similar to
Sphinx than Level [3] . . . . Unlike Level [3], but like Sphinx, this action was uncovered
15
from the date it was filed . . . [and] the plain language of the [Insured v. Insured] clause
bars coverage for the underlying action in its entirety. Id. at 1361.
Here, the Court determines that the underlying action was not covered from the
date it was filed. The Policy excludes coverage for any Claim . . . brought or
maintained by, on behalf of, in the right of, or at the direction of any Insured in any
capacity . . . . (Bigger Aff. Ex. 1 at 016 (emphases added).) Claim is defined as a
civil proceeding against any Insured. (Id. at 013.) It is undisputed that Mark Fayette is
an Insured under the Policy and that he filed suit against Defendants in this case.
Consequently, this triggered the Insured v. Insured exclusion, which bars coverage for
the civil proceeding in the underlying action. [W]here policy language is explicit and
unambiguous, the court may not create ambiguity to afford coverage. General Mills,
Inc. v. Gold Medal Ins. Co., 622 N.W.2d 147, 151 (Minn. Ct. App. 2001); accord Noran
Neurological Clinic, P.A. v. Travelers Indem. Co., 229 F.3d 707, 709 (8th Cir. 2000)
(noting duty of interpreting courts to fastidiously guard against the invitation to create
ambiguities where none exist) .
Defendants, however, argue that Westchester has a duty to defend the entire action
because the Insured v. Insured exclusion is not applicable as Shayna Fayette is not an
Insured under the Policy. This, however, would effectively trump the unambiguous
language of the Insured v. Insured exclusion and would be contrary to the intent of the
parties. The Policy does not contain an allocation clause; thus there is not a contractual
basis for finding separate covered and uncovered claims, let alone coverage for the entire
16
action. In the Courts view, for an insured to avoid the Insured v. Insured exclusion in
a D&O policy, there must be an allocation clause in the policy that specifically addresses
coverage for claims brought by both insureds and non-insureds in an underlying lawsuit.
The Court finds that the Insured v. Insured exclusion precludes coverage in this case
and Westchester owes no defense for the underlying Fayette lawsuit.
V. Reservation of Right to Seek Reimbursement for Defense Costs
The parties agree that the Minnesota Supreme Court has not dealt with the issue of
an insurers right to recover defense costs incurred before an adjudication of coverage.
The Court must therefore predict how the Minnesota Supreme Court would rule on this
issue based on the circumstances presented here. See Marvin Lumber & Cedar Co. v.
PPG Indus., Inc., 401 F.3d 901, 917-18 (8th Cir. 2005) (in absence of precedent from
states highest court, court must predict what that court would do).
Most courts appear to allow insurers to seek reimbursement pursuant to a
unilateral reservation of rights, on the theory that the reservation creates an implied
contract when the insured accepts the defense. See, e.g., Buss v. Superior Court, 939
P.2d 766, 776-78 (Cal. 1997) (approving of the right).6 Some courts, however, refuse to
permit an insurer to recover defense costs pursuant to a reservation of rights, absent an
express provision to that effect in the insurance policy. See, e.g., LA Weight Loss Ctrs.,
6 The majority approach follows Buss. See, e.g., Cincinnati Ins. Co. v. Grand Pointe, LLC,
__ F. Supp. 2d. __, 2007 WL 2301179, at *11-18 (E.D. Tenn. Aug. 10, 2007) (applying
Tennessee law; insurer entitled to reimbursement of defense costs under a reservation-of-rights
letter); United Natl Ins. Co. v. SST Fitness Corp., 309 F.3d 914, 922-23 (6th Cir. 2002)
(applying Ohio law; insurer was entitled to reimbursement of defense costs where insurer
reserved right to recover defense costs and insured accepted payment of defense costs).
17
Inc. v. Lexington Ins. Co., No. 1560, 2006 WL 689109, at *5 (Pa. Com. Pl. Mar. 1, 2006)
(finding that unless the policy itself permits an insurer to recover defense costs, such a
right may not be created by a reservation-of-rights letter because that would amount to a
unilateral amendment of the policy by the insurer); General Agents Ins. Co. of Am. v.
Midwest Sporting Goods Co., 828 N.E.2d 1092, 1101 (Ill. 2005) (refusing to permit
insurer to recover defense costs pursuant to reservation of rights absent express provision
to that effect in insurance contract); Shoshone First Bank v. Pac. Employers Ins. Co., 2
P.3d 510, 511 (Wyo. 2000) (same).
Westchester argues that the Court should follow Buss and the majority of courts
that allow an insurer to recover defense costs when a court subsequently determines that
an insured was not entitled to coverage. In Buss, the insured sought coverage for an
underlying lawsuit that contained twenty-seven claims, only one of which was potentially
covered. 939 P.2d at 769. The insurer agreed to defend its insured under a reservation of
rights, including the right to recover its defense costs if the court determined that there
was no coverage for that suit. Id. at 770. The court found that the insurer was obligated
to defend the entire case to make sure the insured received a meaningful defense. Id. at
775. However, the Court also found that the insurer had the right to an allocation and
reimbursement for defense costs for claims that were not potentially covered. Id. at 776.
The court reasoned that the insurance policy did not require the insurer to defend against
claims that were not potentially covered because the insured did not pay a premium for
defense of such claims and the insurer did not bargain to bear these costs. Id. The court
18
explained that shifting these defense costs to the insurer would upset this arrangement,
and therefore, found a right to reimbursement implied in law. Id.
Westchester also argues that a unilateral reservation of rights on reimbursement is
effective, even where the insured objects to reimbursement. See Walbrook Ins. Co. Ltd.
v. Goshgarian & Goshgarian, 726 F. Supp. 777, 783-84 (C.D. Cal. 1989) (finding that an
implied agreement to the right to reimbursement was established where insured objected
to insurers reservation of rights to seek reimbursement of defense costs, but accepted
insurers payment to independent counsel). Westchester asserts that it expressly reserved
the right to reimbursement, Defendants objected, but did accept the defense provided. As
such, Westchester argues that it is entitled to reimbursement.
Defendants, however, urge this Court to follow the minority rule as set forth in the
Illinois Supreme Courts decision in General Agents, which refused to permit an insurer
to recover defense costs pursuant to a reservation of rights absent an express provision to
that effect in the insurance contract between the parties. 828 N.E.2d at 1104. The court
concluded that this reimbursement right would permit an insurer to unilaterally modify
its contract without any input from the insured. Id. at 1102. The Illinois Supreme Court
reasoned that public policy dictates that an insurer not be allowed to recover defense
costs from their insureds under a reservation of rights:
The question as to whether there is a duty to defend an insured is a difficult
one, but because that is the business of an insurance carrier, it is the
insurance carriers duty to make that decision. . . . [T]o allow the insurer to
force the insured into choosing between seeking a defense under the policy,
and run the potential risk of having to pay for this defense if it is
subsequently determined that no duty to defend existed, or giving up all
19
meritorious claims that a duty to defend exists, places the insured in the
position of making a Hobsons choice. Furthermore, endorsing such
conduct is tantamount to allowing the insurer to extract a unilateral
amendment to the insurance contract.
Id. (quoting Shoshone, 2 P.3d at 514). Similarly, the Fourth Circuit, applying Maryland
law, rejected an insurers right of reimbursement, finding that it would lead to a
backdoor narrowing of the duty to defend. Perdue Farms, Inc. v. Travelers Cas. & Sur.
Co., 448 F.3d 252, 258 (4th Cir. 2006). The court explained that Maryland law would
not support a right of reimbursement because it would leave an insured with an up-front
defense whose line-item costs would then be the subject of subsequent litigation. Id. at
259. The court concluded that it was unwilling to grant insurers a substantial rebate on
their duty to defend. Id.
This Court finds persuasive those decisions refusing to allow reimbursement
unless an agreement to the contrary is found in the insurance policy. The Illinois
Supreme Court accurately summarized the crux of this issue as follows:
[W]hen an insurer tenders a defense or pays defense costs pursuant to a
reservation of rights, the insurer is protecting itself at least as much as it is
protecting its insured. Thus, we cannot say that an insured is unjustly
enriched when its insurer tenders a defense in order to protect its own
interests, even if it is later determined that the insurer did not owe a
defense. Certainly, if an insurer wishes to retain its right to seek
reimbursement of defense costs in the event it later is determined that the
underlying claim is not covered by the policy, the insurer is free to include
such a term in its insurance contract.
General Agents, 828 N.E.2d at 1103 (emphasis added) (citing Terra Nova Ins. Co. v. 900
Bar, Inc., 887 F.2d 1213, 1219-20 (3d Cir. 1989).
20
Within our own circuit, cases applying Minnesota and Missouri law provide
support for the contention that the Minnesota Supreme Court would refuse to allow
reimbursement unless an agreement to the contrary is found in the insurance policy. The
Eighth Circuit, applying Missouri law, has held that when the duty to defend is triggered,
the insurer has a duty to defend the insured until a coverage determination is made.
Liberty Mut. Ins. Co. v. FAG Bearings Corp., 153 F.3d 919, 924 (8th Cir. 1998).7 The
Eighth Circuit explained that the insurer remained obligated to defend its insured as long
as any question remained as to whether the underlying claims were covered by the
insurance policy. Id. Once the district court determined that such claims were excluded
from coverage, then the insurers duty to defend ended. Id.
Similarly, a decision from this District, applying Minnesota law, followed the
reasoning in Liberty Mutual and found that even though the insurer included a right to
seek reimbursement of its defense costs in a reservation-of-rights letter, the insurance
policy did not specifically provide for reimbursement. Employers Mut. Cas. Co. v.
Indus. Rubber Products, Inc., No. Civ. 04-3839, 2006 WL 453207, at *5-6 (D. Minn.
Feb. 23, 2006) (Davis, J.) .8 Therefore, the Court held that an insurer is not entitled to
7 Although Liberty Mutual applied Missouri law to the scope of the duty to defend, this Court
recognizes that Minnesota law has interpreted the duty to defend consistent with Missouris
interpretation. Employers Mut. Cas. Co. v. Indus. Rubber Products, Inc., No. Civ. 04-3839, 2006
WL 453207, at *6 (D. Minn. Feb. 23, 2006) (citing Brown, 293 N.W.2d at 825-26).
8 A decision from this District initially determined that Minnesota might recognize an insurers
right to reimbursement of defense costs. See Knapp v. Commonwealth Land Title Ins. Co., 932
F. Supp. 1169, 1171-72 (D. Minn. 1996) (Davis, J.) (where an insurer has properly met its duty
and subsequently successfully challenges policy coverage, it should be entitled to the full benefit
21
the reimbursement of defense costs expended prior to the determination of coverage,
unless specifically provided for in the insurance policy. Id. at *6 (emphasis added).9
Accordingly, this Court is of the view that the Minnesota Supreme Court would
refuse to allow reimbursement unless an agreement to the contrary is found in the
insurance policy. Here, the Policy does not contain a provi sion for reimbursement of
defense costs in the event a court determines that Westchester owes no coverage. Thus,
Westchesters reservation-of-rights letter could retain only those defenses that it had
under the Policy. Consequently, Westchesters attempt to include the right to
reimbursement in its reservation-of-rights letter must fail. Therefore, the Court will deny
Westchesters Motion with respect to its claim for reimbursement of its defense costs.
VI. Defendants Claim for Coverage Fees
In Minnesota, insurers are encouraged to resolve coverage disputes by assuming
the defense of the insured in the underlying action and promptly bringing a separate
declaratory-judgment action against the insured. Mut. Serv. Cas. Ins. Co. v. Luetmer,
474 N.W.2d 365, 369 (Minn. Ct. App. 1991) (The Minnesota Supreme Court has
repeatedly advised the use of a declaratory-judgment action in a reservation of rights
situation.). Under Minnesota law, an insured may not recover attorneys fees incurred
of such a challenge and be reimbursed for the benefits it bestowed, in good faith, to its insured).
However, the Knapp decision came before the Eighth Circuits decision in Liberty Mutual.
9 See also St. Paul Fire & Marine Ins. Co. v. Compaq Computer Corp., 457 F.3d 766, 773 (8th
Cir. 2006) (applying Texas law and finding that insurer was entitled to reimbursement because
insurers reservation-of-rights letter was not unilateral, but was made pursuant to a separate
agreement with the insured, in which the insurer agreed to relinquish a right it had under the
policy in return for the reservation of the right to recover).
22
defending a declaratory-judgment action brought by his insurer, with two exceptions.
First, if either a statute or the insurance contract expressly provides for that recovery.
Rent-A-Scooter, Inc. v. Universal Underwriters Ins. Co., 173 N.W.2d 9, 12 (Minn. 1969).
Second, if the insurer has breached the insurance contract in some respect[.] Am.
Standard Ins. Co. v. Le, 551 N.W.2d 923, 927 (Minn. 1996). Such a breach usually
occurs when the insurer wrongfully fails to defend the underlying action. Chicago Title
Ins. Co. v. F.D.I.C., 172 F.3d 601, 605 (8th Cir. 1999) (citing Am. Standard, 551
N.W.2d at 927); see also In re Silicone Implant Ins. Coverage Litig., 667 N.W.2d 405,
422 (Minn. 2003) ([I]n the insurance context, we have carved out a narrow exception to
the general rule: attorney fees are recoverable when an insurer breaches its duty to
defend.).
Here, Defendants sought insurance coverage for the defense of the underlying
Fayette lawsuit in February 2007, and Westchester denied coverage. Consequently,
Defendants were forced to hire coverage counsel, who urged Westchester to reconsider
its position. Westchester eventually changed its position and agreed to defend
Defendants, subject to a full reservation of rights, including the right to file a declaratoryjudgment
action. Defendants seek to recoup the coverage fees they incurred as a result of
Westchesters initial denial of coverage in the amount of ,335.33.
The issue before the Court is whether Westchesters initial denial of coverage
constituted a breach of its duty to defend. Westchester argues that Defendants are not
entitled to recovery of these coverage fees because it had no duty to defend. In particular,
23
Westchester asserts that the Insured v. Insured exclusion bars all coverage for the
underlying lawsuit. Westchester also argues that it has provided a defense to Defendants
pending the resolution of the present action. These arguments, however, fail to address
Westchesters initial denial of coverage.
In Minnesota, the duty to defend is read broadly. See Brown v. State Auto. & Cas.
Underwriters, 293 N.W.2d 822, 825 (Minn. 1980). Indeed, the duty to defend is
triggered when any part of the claim arguably falls within the coverage of the policy.
Wooddale Builders, 722 N.W.2d at 302. Westchesters duty to defend was triggered the
moment Defendants sought coverage for the underlying dispute because the claims at
issue were arguably covered under the Policy. As discussed above, it was not clear
whether Shayna Fayette was an Insured under the Policy or whether the Insured v.
Insured exclusion applied when the underlying action contained both an insured and
non-insured plaintiff. Thus, Westchester breached its duty to defend when it initially
denied coverage.
Although Defendants did not move for summary judgment for the recovery of
these fees, the Court enjoys the power to grant summary judgment sua sponte in these
circumstances. See, e.g., Madewell v. Downs, 68 F.3d 1030, 1048 (8th Cir. 1995)
(district court may enter summary judgment sua sponte where party had adequate
opportunity to address issues and was on notice that right to judgment as a matter of law
was at issue). Because the Court concludes that Defendants are entitled to recoup their
coverage fees in the amount of ,335.33, and because Westchester had an opportunity to
24
address the merits of this issue, there is no reason to delay awarding coverage fees to
Defendants merely because Defendants did not file a Motion seeking such relief.
Finally, Defendants also argue that they are entitled to recover their attorneys fees
in defending this declaratory-judgment action because Westchester has not faithfully
accepted its duty to defend, but has only grudgingly accepted the defense with an
extensive reservation of rights. (Defs. Resp. Mem. at 22.) The Court disagrees.
Westchesters initial denial of coverage and its subsequent acceptance of the defense
under a reservation of rights are two separate acts and therefore must be analyzed
separately. As described above, the Court determined that Westchester breached its duty
to defend when it initially denied coverage because it was unclear whether Shayna
Fayette was an Insured under the Policy and if the Insured v. Insured exclusion
barred coverage for the underlying action. However, the Court has also determined in
this declaratory-judgment action that the Insured v. Insured exclusion precludes
coverage in this case and Westchester owes no defense for the underlying Fayette
lawsuit. Therefore, Defendants are not entitled to recovery of their attorneys fees in
defending this declaratory-judgment action.
CONCLUSION
Based on the foregoing, and all the files, records, and proceedings herein, IT IS
ORDERED that:
1. Westchesters Motion for Summary Judgment or, Alternatively, for Partial
Summary Judgment (Doc. No. 7) is GRANTED IN PART and DENIED IN
PART as follows:
25
a. Westchesters Motion is GRANTED as to Count One of its Complaint,
and it is DECLARED, ADJUDGED, and DECREED that Westchester
has no duty to defend or indemnify Defendants in the underlying
Fayette litigation;
b. Westchesters Motion is DENIED as to Count Two of its Complaint for
reimbursement of its defense costs in the underlying litigation;
c. Westchesters Motion for dismissal of Count 1 of Defendants
Counterclaims (Doc. No. 2), which seeks a declaration that Westchester
has a duty to defend Defendants in the underlying litigation, is
GRANTED;
d. Westchesters Motion for dismissal of Count 2 of Defendants
Counterclaims, which seeks coverage fees for Westchesters initial
denial of coverage, is DENIED; and
e. Westchesters Motion for dismissal of Count 3 of Defendants
Counterclaims, which seeks attorneys fees for defending this
declaratory-judgment action, is GRANTED; and
2. Summary Judgment is GRANTED, sua sponte, to Defendants in the amount
of ,335.33, with respect to Count 2 of their Counterclaims.
LET JUDGMENT BE ENTERED ACCORDINGLY.
Date: September 25 , 2007
s/Richard H. Kyle
RICHARD H. KYLE
United States District Judge
 

 
 
 

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