Essex Insurance Company v. Structural Shop, Ltd. ( 2019 )

In the
United States Court of Appeals
For the Seventh Circuit
____________________
Nos. 18-3443 & 18-3530
ESSEX INSURANCE COMPANY,
Plaintiff-Appellee,
v.
BLUE MOON LOFTS CONDOMINIUM ASSOCIATION and
THE STRUCTURAL SHOP, LTD.,
Defendants-Appellants.
____________________
Appeals from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 1:15-cv-2806 — John Z. Lee, Judge.
____________________
ARGUED APRIL 16, 2019 — DECIDED JUNE 27, 2019
____________________
Before EASTERBROOK, KANNE, and SCUDDER, Circuit Judges.
SCUDDER, Circuit Judge. An Illinois state court entered a
$1,356,435 judgment against The Structural Shop in 2009, and
now TSS wants its insurer, Essex Insurance Company, to pay
for it. The terms of TSS’s insurance policy do not cover this
claim, however. The policy covers only claims first made
against TSS between May 2012 and May 2013, and the lawsuit
giving rise to the Illinois court’s judgment was filed against
2 Nos. 18-3443 & 18-3530
TSS in 2002. Recognizing this reality, TSS has resorted to the
common law doctrine of estoppel. Illinois law estops Essex
from denying coverage only if the insurer misled TSS into be-
lieving it would cover the judgment, TSS reasonably relied on
Essex’s misleading statement or act, and TSS suffered preju-
dice. The district court determined that TSS suffered no prej-
udice and declined to apply estoppel. The district court also
rejected TSS’s alternative theories of recovery. Seeing no error
in the district court’s rulings, we affirm.
I
A
In 2002 the Blue Moon Lofts Condominium Association
filed a complaint against TSS in an Illinois state court seeking
damages arising out of TSS’s allegedly defective design and
construction of a building. The lawsuit began as it should
have—with Blue Moon, through a process server, providing
notice of the action to TSS’s registered agent, Thomas
Donohoe, on November 7, 2002. TSS never responded to the
notice or appeared in the state court action to defend itself,
leading in May 2003 to the state court declaring the company
in default. Years later, in 2009, the state court entered a default
judgment and set the damages amount at $1,356,435, tacking
on costs too.
Essex knew nothing of the state court litigation that tran-
spired between 2002 and 2009. For good reason: Essex did not
insure TSS during that period and entered the picture many
years later when it sold TSS an insurance policy for claims
“first made” against TSS from May 2012 to May 2013. The pol-
icy defined “first made” to mean the time when TSS received
either a “written demand for money damages” or “the service
Nos. 18-3443 & 18-3530 3
of suit or institution of arbitration proceedings against the In-
sured.”
The parties agree that Blue Moon’s 2002 claim arose out-
side the policy period. But universal agreement on this point
is only a recent development. In the years leading to this dis-
pute, both TSS and Essex labored under the mistaken belief
that Blue Moon failed back in 2002 to serve TSS with notice of
the lawsuit. Against that mistaken understanding, Blue Moon
and TSS further believed that Blue Moon first made a claim
under the policy in 2012, when it approached TSS to collect
on the default judgment—timing that would have brought
Blue Moon’s claim within the terms of the May 2012 to May
2013 policy.
This confusion set the stage for this dispute. The upshot of
TSS’s position is that, based on Essex’s conduct during 2012
and beyond while helping TSS defend against Blue Moon’s
claim, principles of fairness and equity demand holding Essex
liable for satisfying the default judgment entered against TSS
by the Illinois court. So we need to look closer at Essex’s con-
duct during this period.
B
TSS first became aware of the default judgment in August
2012, when Blue Moon contacted Douglas Palandech, an at-
torney and TSS’s registered agent, seeking to collect. TSS ex-
pressed surprise at the development, believing the company
never received notice of Blue Moon’s lawsuit. Proving as
much became important, for Blue Moon’s failure to provide
notice back in 2002 would have supplied sufficient grounds to
vacate the default judgment, and—even more critically for
TSS—meant that Blue Moon had first made its claim against
4 Nos. 18-3443 & 18-3530
TSS in August 2012 and thus inside the policy’s May 2012 to
May 2013 coverage period.
TSS retained Palandech as outside counsel to defend the
company against Blue Moon’s claim and attempts to collect
the default judgment. Palandech’s first order of business was
asking Blue Moon to supply proof of service. For a time, these
requests went unanswered. Palandech’s review of the state
court’s docket also uncovered no record of service.
Ken Veach, TSS’s principal, reached a similar dead end.
His search of company records revealed no indication of any
lawsuit by Blue Moon. Veach also contacted TSS’s insurance
broker, Melissa Roberts, and she too stated that she had no
record of Blue Moon’s 2002 complaint against TSS.
With all leads coming up empty, TSS concluded—incor-
rectly as it would turn out—that the company had not re-
ceived notice of the 2002 lawsuit. This conclusion led TSS,
with Palandech’s assistance, to petition in the state court to
vacate the default judgment. TSS supported its petition with
two affidavits, one from Veach swearing that Thomas
Donohoe had never acted as TSS’s registered agent, and an-
other from Palandech explaining that his due diligence found
no proof of service. The court granted the motion and vacated
the default judgment.
It was then—after the Illinois court vacated the default
judgment—that TSS informed Essex of these developments
and Blue Moon’s claim. Essex reacted by accepting TSS’s ac-
count that Blue Moon had brought its claim to the company’s
attention for the first time in August 2012. Of course, later
events would prove this false. But Essex, not yet aware that
Blue Moon properly served TSS in 2002, considered the
Nos. 18-3443 & 18-3530 5
dispute to fit within the terms of the policy covering claims
first made against TSS between May 2012 and May 2013. This
meant that Essex had a duty to defend TSS against Blue
Moon’s claim.
Essex acted on its duty to defend by hiring a claims servic-
ing company by the name of Markel to coordinate and partic-
ipate on behalf of Essex in TSS’s defense. Markel then charted
a passive course, leaving TSS’s outside counsel, Palandech, to
call the litigation shots and otherwise lead TSS’s defense ef-
forts. Markel, in short, mostly sat on the sidelines as Palan-
dech managed the defense and made strategic recommenda-
tions to TSS.
The first inkling that something was wrong came in Feb-
ruary 2013. It was then that Blue Moon’s counsel provided
Palandech an invoice from Tri-County Investigations, the spe-
cial process server Blue Moon hired to serve TSS in 2002. The
invoice showed that Blue Moon had paid Tri-County $60 for
serving TSS on November 7, 2002.
This development did little to change Palandech’s per-
spective on the matter, though. For example, in an email to
TSS (with a copy to Markel), one of Palandech’s colleagues
expressed the view that the unverified invoice was a flimsy
basis on which to conclude service occurred. A month later,
in March 2013, Palandech learned that Blue Moon remained
in the process of trying to learn whether service of process in
fact had occurred. Blue Moon indicated that, if the answer
turned out to be yes, the Illinois state court may well revisit
its prior order vacating the default judgment. Another attor-
ney at Palandech’s law firm so informed TSS and Markel.
6 Nos. 18-3443 & 18-3530
Part and parcel of his view that Blue Moon had never
properly served TSS in 2002, Palandech advised TSS to reject
Blue Moon’s May 2014 offer to settle the dispute for $25,000
and instead to file a motion to dismiss Blue Moon’s complaint.
Ken Veach agreed, stating in an e-mail that he was adamantly
opposed to any settlement. Markel’s representative also
agreed with Palandech’s advice.
Everything changed for TSS on July 29, 2014, when Blue
Moon’s counsel sent Palandech a copy of the special process
server’s affidavit—clear evidence that Blue Moon had in fact
served notice of the lawsuit on Thomas Donohoe in 2002. Blue
Moon’s counsel added that records from the Illinois Secretary
of State showed that Donohoe was TSS’s registered agent in
2002.
Bad then went to worse for TSS. In August 2014, Blue
Moon filed a motion to reinstate the default judgment, and, in
November 2014, the court granted the motion. Palandech ad-
vised TSS to petition for relief from the judgment. TSS agreed
and followed Palandech’s recommendation, but to no avail,
as the state court denied the company’s petition on March 5,
2015. Several days later Veach advised Palandech that TSS
had retained a bankruptcy attorney to advise the company of
its options for satisfying the default judgment.
Essex reacted to these developments in two ways. First, on
March 26, 2015, Essex sent TSS a reservation of rights. The let-
ter informed TSS that Essex would continue to defend the
company through the appeal of the state court’s order deny-
ing relief from the final judgment while adding that Essex was
denying coverage because the events showed that Blue Moon
first made its claim in 2002 and thus well before the period
covered by TSS’s policy. Second, Essex decided to become
Nos. 18-3443 & 18-3530 7
more active in managing TSS’s defense. It did so by hiring a
new law firm to handle TSS’s pending appeal.
Essex’s decision to become more active proved futile. TSS
mooted the decision by taking matters entirely into its own
hands and—without any involvement by Essex—settling
with Blue Moon. The settlement required TSS not only to pay
Blue Moon $550,000, but also to assign Blue Moon any rights
of indemnification from Essex.
The case then entered federal court. In March 2015, Essex
brought this action seeking a declaratory judgment that it had
no obligation to indemnify Blue Moon (now the assignee of
TSS) for the cost of the default judgment. Blue Moon re-
sponded with a counterclaim seeking a declaratory judgment
to the contrary, contending that Essex was estopped from
denying coverage, waived its right to assert coverage de-
fenses, and was liable for the default judgment because it
acted in bad faith by refusing to pursue a settlement with Blue
Moon. The district court disagreed on all fronts and entered
summary judgment for Essex.
II
A
We begin, as the district court did, with estoppel. Blue
Moon (as TSS’s assignee) argues that the Illinois common law
doctrine of estoppel requires Essex to pay for the judgment.
Estoppel often arises in cases involving close calls over
whether an insurance policy covers a particular claim brought
against an insured. In those circumstances, the insurer has a
duty to defend the insured because the latter has received a
claim alleging facts within or potentially within the coverage
of the applicable policy. See Maryland Cas. Co. v. Peppers, 64
8 Nos. 18-3443 & 18-3530
Ill.2d 187, 193 (1976). When an insurer steps in to fulfill its ob-
ligation to defend by assuming the defense against such a
complaint, it must do so under a reservation of rights—or else
risk later being estopped from raising policy defenses to cov-
erage. See Standard Mut. Ins. Co. v. Lay, 2013 IL 114617, ¶ 19
(“Generally, where a complaint against an insured alleges
facts within or potentially within the coverage of the insur-
ance policy, and when the insurer takes the position that the
policy does not cover the complaint, the insurer must: (1) de-
fend the suit under a reservation of rights; or (2) seek a declar-
atory judgment that there is no coverage.”).
This basic principle of estoppel that often bars an insurer
from raising a policy defense to coverage—commonly called
“general” estoppel—has limits that bar its application here.
See Nationwide Mut. Ins. Co. v. Filos, 285 Ill. App. 3d 528, 536
(1st Dist. 1996) (“Illinois courts have followed the general rule
that the doctrine of estoppel cannot be used to create primary
liability or to increase coverage provided under an insurance
policy.”). Foremost, “when the policy and the complaint are
compared, [and] there was clearly no coverage or potential for
coverage,” general estoppel does not apply. Employers Ins. of
Wausau v. Ehlco Liquidating Tr., 186 Ill.2d 127, 151 (1999).
Where, as here, everyone agrees that the claim fell outside the
coverage period, general estoppel provides no refuge for Blue
Moon and TSS.
But our inquiry cannot end there because Illinois law rec-
ognizes a second form of estoppel—sometimes called equita-
ble estoppel—that can force an insurer to do what general es-
toppel cannot: pay for a claim that falls outside the terms of
the insurance policy. See Illinois Sch. Dist. Agency v. Pac. Ins.
Nos. 18-3443 & 18-3530 9
Co., 471 F.3d 714, 719 (7th Cir. 2006); see also Peppers, 64 Ill.2d
at 195 (describing the nature of equitable estoppel).
Illinois law requires Blue Moon to make a threefold show-
ing for equitable estoppel to apply. Blue Moon first needs to
show that Essex misled TSS into thinking it would pay for the
default judgment; second, that TSS reasonably relied on Es-
sex’s misleading act or statement; and third, that prejudice re-
sulted to TSS. See Filos, 285 Ill. App. 3d at 536; see also Stand-
ard Mut. Ins. Co., 2013 IL 114617, ¶ 19; Peppers, 64 Ill.2d at 195–
96.
The district court resolved this dispute exclusively on the
prejudice prong. So we, too, start there, and the first step is to
recognize that, in this insurance law context, the word “prej-
udice” is a term of art with a limited meaning. When Illinois
law asks whether Essex acted in a way that prejudiced TSS,
the inquiry is focused on only one question: whether Essex, as
part of defending TSS against Blue Moon’s claim, took control
of TSS’s litigation defense away from TSS. “Prejudice will not
be conclusively presumed from the [insurer’s] mere entry of
appearance and assumption of the defense.” Peppers, 64 Ill.2d
at 196. “If, however, by the insurerʹs assumption of the de-
fense the insured has been induced to surrender his right to
control his own defense, he has suffered a prejudice which
will support a finding that the insurer is estopped to deny pol-
icy coverage.” Id.
As the assignee of any claim TSS had against Essex, Blue
Moon needed to prove prejudice by “clear, concise, and une-
quivocal evidence,” see Filos, 285 Ill. App. 3d at 536, with the
inquiry turning on whether Essex’s “assumption of the de-
fense induce[d] [TSS] to surrender [its] right to control [its]
own defense,” Standard Mut. Ins. Co., 2013 IL 114617, ¶ 19. The
10 Nos. 18-3443 & 18-3530
question, Illinois law makes plain, is one of control, not
whether the insured could have obtained a more favorable
outcome for itself. See Home Ins. Co. v. Three I Truck Line, Inc.,
95 F. Supp. 2d 901, 906 (N.D. Ill. 2000) (citing Peppers, 64 Ill.2d
at 196).
The district court got this right when it concluded Essex
did not act to prejudice TSS. The reason is because, in the
events leading to its decision to settle with Blue Moon, TSS
never lost control of its defense. More specifically, it was TSS’s
outside counsel, Palandech, and not Essex, that controlled the
litigation strategy from the start. Even before Essex became
aware of Blue Moon’s claim, TSS hired Palandech to defend
against the claim, and from then on he steered the company’s
defense. Palandech communicated directly with Blue Moon’s
counsel, crafted TSS’s litigation strategy, and made recom-
mendations to TSS such as whether to accept Blue Moon’s set-
tlement offer. Even after TSS informed Essex of Blue Moon’s
claim, Palandech remained in control and acted to protect
TSS’s interests by working to prove that service never oc-
curred as part of resisting reinstatement of the default judg-
ment. Absent from the record is evidence demonstrating that
Essex did anything more than passively monitor TSS’s de-
fense by allowing the company’s outside counsel, Palandech,
to control the litigation.
Our analysis aligns with observations we made in another
insurance case raising questions about the doctrine of estop-
pel under Illinois law. See Essex Ins. Co. v. Stage 2, Inc., 14 F.3d
1178, 1182–83 (7th Cir. 1994). There, as here, we construed Il-
linois law and explained that equitable estoppel did not apply
because the insured’s counsel protected its interests and mon-
itored the progress of the litigation, and neither the insured
Nos. 18-3443 & 18-3530 11
nor its counsel ever complained about the litigation strategy.
See id.Blue Moon disagrees by pointing us to the fact that, in
March 2015, Essex replaced Palandech with different counsel
to pursue an appeal from the default judgment. But this ob-
servation overlooks a basic underpinning of estoppel—that
the doctrine applies where an insurer assumes control of the
defense without reserving its right to deny coverage. By the
time Essex replaced Palandech as defense counsel, Essex had
reserved its right to deny coverage for the claim upon learn-
ing that Blue Moon properly served notice on TSS in 2002. Es-
sex’s affirmative act to reserve its rights upon learning that
service occurred in 2002 defeats the application of estoppel
based on Essex’s subsequent conduct. See Filos, 285 Ill. App.
3d at 536 (explaining that equitable estoppel applies only
where an insurer assumes control over the insured’s defense
without a reservation of rights while “actually or construc-
tively aware of the facts or circumstances indicating noncov-
erage”). And, in any event, even if Essex’s conduct after re-
serving its rights mattered to our prejudice analysis, the fact
that TSS settled with Blue Moon on the sly—without Essex’s
involvement—undermines any notion that TSS had surren-
dered control of the defense to Essex.
On this record, we agree with the district court that TSS
experienced no prejudice. But there is also reason to think that
other required elements of equitable estoppel are lacking. For
example, the record suggests that TSS knew all along that, if
Blue Moon had properly served notice in 2002, then the com-
pany’s insurance policy with Essex would not cover the claim.
That fact makes it hard to see how TSS could have reasonably
12 Nos. 18-3443 & 18-3530
relied on Essex’s conduct as part of somehow assuming Essex
would pay for the judgment.
In the end, though, the absence of prejudice is enough for
us to conclude that estoppel is not appropriate here. The dis-
trict court properly entered summary judgment for Essex on
this basis.
B
Blue Moon next argues that, even if estoppel does not
carry the day, Essex waived its defense against coverage.
“[A]n insurer may waive a policy defense by continuing under
a policy when it knows, or in the exercise of ordinary dili-
gence, could have known the facts in question giving rise to
the defense.” Kenilworth Ins. Co. v. McDougal, 20 Ill. App. 3d
615, 620 (2d Dist. 1974) (emphasis added). Blue Moon’s
waiver argument fails because Essex is not merely asserting a
policy defense. Examples of waivable policy defenses include
an insured’s failure to timely notify the insurer of a claim, see
State Farm Mut. Auto. Ins. Co. v. Gray, 211 Ill. App. 3d 617, 621
(1st Dist. 1991), or an insured’s failure to comply with a pol-
icy’s requirement to submit a sworn statement 30 days after
an accident, see McMahon v. Coronet Ins. Co., 6 Ill. App. 3d 704,
709 (1st Dist. 1972).
What we have here—a request for coverage relating to a
claim arising in a period that TSS and Essex never contem-
plated would be covered—is altogether different from the as-
sertion of policy defense. Unlike equitable estoppel, waiver
“may not be used to create or extend coverage where none
exists.” Lytle v. Country Mut. Ins. Co., 2015 IL App (1st) 142169,
¶ 30. Everyone agrees that the policy’s terms did not cover
Nos. 18-3443 & 18-3530 13
Blue Moon’s 2002 claim. That fact defeats Blue Moon’s reli-
ance on a theory of waiver.
C
We close with Blue Moon’s contention that Essex refused
in bad faith to settle the state court litigation between TSS and
Blue Moon and therefore must pay for the default judgment.
An insurer assumes a duty to settle only in circumstances
where it assumes exclusive control over the insured’s defense.
See Cramer v. Ins. Exchange Agency, 174 Ill.2d 513, 525 (1996);
see also Transport Ins. Co., Inc. v. Post Express Co., Inc., 138 F.3d
1189, 1193 (7th Cir. 1998). Having already explained that Es-
sex never assumed control of TSS’s defense against Blue
Moon’s claim, we need not say more to dispense with this ar-
gument. In the absence of Essex assuming exclusive control,
Essex never incurred—let alone breached in bad faith—a duty
to settle.
For these reasons, we AFFIRM.