Kevin Fox v. American Alternative Insurance , 757 F.3d 680 ( 2014 )

In the
United States Court of Appeals
For the Seventh Circuit
No. 13-1290
KEVIN FOX,
Plaintiff-Appellant,
v.
AMERICAN ALTERNATIVE
INSURANCE CORPORATION,
Defendant-Appellee.
Appeal from the United States District Court for the
Northern District of Illinois, Eastern Division.
No. 1:04-cv-07309 — John W. Darrah, Judge.
ARGUED OCTOBER 31, 2013 — DECIDED JULY 7, 2014
Before BAUER, MANION, and ROVNER, Circuit Judges.
ROVNER, Circuit Judge. The dispute between Kevin Fox, the
plaintiff in this diversity case governed by Illinois law, and
American Alternative Insurance Corporation (AAIC) is about
an insurer’s duties to defend those it insures. This suit arises
from a previous, civil-rights suit brought by Fox and his wife
Melissa against AAIC’s insureds for, among other claims,
2 No. 13-1290
wrongful arrest and prosecution. See Fox v. Hayes, 600 F.3d 819(7th Cir. 2010). The defendants in that first suit included
several detectives from Will County, Illinois, whom Fox had
accused of maliciously pursuing unfounded charges against
him. Following a jury verdict awarding the Foxes a total of
$15.5 million in damages (including $6.2 million in punitive
damages) the detectives reached a deal with the Foxes. They
assigned to the Foxes any indemnity claims they might have
against the insurance companies, including AAIC, who had
controlled their defense. In exchange, they received the Foxes’
agreement not to execute the punitive damages awards (which
were not covered by any insurer’s policy) against their per-
sonal assets. Armed with the assignments, Kevin Fox then filed
the suit that is the subject of this appeal. That suit seeks a
declaratory judgment that AAIC—as an insurer for the detec-
tives’ employer, Will County—had breached its duty to defend
the detectives in the earlier suit. The district court dismissed
Fox’s complaint for failure to state a claim. We conclude that
AAIC did not breach its duty to defend the detectives, so we
affirm the judgment.
Background
Because the district court dismissed Fox’s complaint, we
accept as true all well pleaded facts and draw all permissible
inferences in his favor. See Hecker v. Deere & Co., 556 F.3d 575,
580 (7th Cir. 2009).
Kevin Fox was arrested in 2004 and charged with the sexual
assault and murder of his three-year-old daughter. Will
County detectives coerced a confession out of Fox and delayed
the testing of DNA evidence, leaving Fox imprisoned for
No. 13-1290 3
nearly eight months and separated from his despairing wife
and son. When Fox’s defense team finally obtained the DNA
evidence and had it tested at a private lab, the results excluded
Fox as the source of the DNA on his daughter’s body, and the
prosecution dropped all charges against him. Fox then pro-
ceeded to federal court where he and his wife sued under 42
U.S.C. § 1983 and Illinois state law alleging that the Will
County detectives (Edward Hayes, Michael Guilfoyle, Scott
Swearengen, Brad Watchl, and John Ruettiger) had arrested
and prosecuted Fox without probable cause and in violation of
his right to due process. The Foxes also included state law
claims for malicious prosecution and intentional infliction of
emotional distress. As relevant to the present suit, Fox’s
complaint in his § 1983 action sought both compensatory and
punitive damages.
As employees of Will County, the detectives benefitted
from the county’s insurance policies, which provided liability
coverage to its law enforcement personnel. St. Paul Fire &
Marine Insurance Company supplied the first layer of coverage
and its policy required it to defend the detectives against the
Foxes’ suit until it had exhausted its policy limit of $1 million
by paying covered settlements or judgments. Will County also
had two layers of excess or umbrella liability coverage. Each
layer was for $5 million. One policy was from AAIC and the
other came from Essex Insurance Company; AAIC provided
the secondary and Essex the tertiary layer of coverage. Under
AAIC’s policy it was not required to “assume charge of the
settlement or defense” until “the aggregate Limit of Liability of
the applicable Schedule Underlying Policy [the St. Paul policy]
ha[d] been exhausted by payment of claims.” None of the
4 No. 13-1290
insurance policies provided coverage against liability for
punitive damages.
The Foxes’ suit proceeded to trial where the detectives were
represented by Lowis and Gellen, LLP (a firm retained by St.
Paul).Under some circumstances, their joint representation by
a single law firm could have created a potential conflict of
interest, see, e.g., Williams v. Am. Country Ins. Co., 833 N.E.2d
971, 979 (Ill. App. Ct. 2005) (potential conflict where interests
of multiple insureds are “diametrically opposed”), as could
have the Foxes’ claims for uncovered punitive damages,
see, e.g., Nandorf, Inc. v. CNA Ins. Cos., 479 N.E.2d 988, 991–92
(Ill. App. Ct. 1985) (potential conflict where insurer controls
defense but disclaims coverage for punitive damages). But
neither the attorneys nor any of the insurance companies
informed the detectives of these possible conflicts. Nor were
the detectives told that such potential conflicts might entitle
them to representation by independent counsel at the insurers’
expense. See Nat’l Cas. Co. v. Forge Indus. Staffing Inc., 567 F.3d
871, 874 (7th Cir. 2009) (citing Md. Cas. Co. v. Peppers, 355
N.E.2d 24, 31 (Ill. 1976)); Nandorf, 479 N.E.2d at 991–92.
The jury returned verdicts favorable to the Foxes. It found
for them on their false arrest, due process, malicious prosecu-
tion, and emotional distress claims and awarded them $15.5
million in damages, including $6.2 million in punitive dam-
ages. The Foxes had offered to settle their claims for less than
that sum, both before and after the jury’s verdict on liability,
but their offers were rejected. After the verdict the district
court struck $2.6 million of the punitive damages awarded to
the Foxes.
No. 13-1290 5
By September 2008, St. Paul had exhausted its $1 million
liability policy limit by satisfying the judgment against
Ruettiger (who had died before the trial began). AAIC then
took control of the detectives’ defense. The remaining detec-
tives appealed, but not before striking the deal with the Foxes
to which we alluded earlier. The deal came in two stages. First,
the detectives assigned to the Foxes any claims they might
have against Will County’s three insurers in exchange for the
Foxes’ covenant not to execute the awards of punitive damages
against the detectives’ personal assets. Then, working with
new counsel, the detectives negotiated a supplemental deal
with the Foxes approximately three months later. This time
they also agreed to withdraw their appeal challenging the
punitive damage awards in exchange for a full and complete
release of personal liability for punitive damages.
With the assignments in hand, the Foxes turned their
attention to suing the insurers. They filed an action against St.
Paul, AAIC, and Essex in the Circuit Court of Cook County
under case number 08-CH-14936, seeking as damages for their
breach of duty to the detectives the amount of punitive
damages awarded against the detectives. The suit alleges
substantially the same claims that Fox pursues in this present
suit. That action prompted AAIC and Essex to intervene in the
pending federal appeal of the wrongful prosecution judgment
in order to contest, as the detectives no longer would, the
punitive damage awards. They hoped to overturn that award
and thereby limit any potential exposure to liability in the state
court action. But despite their efforts, this court affirmed the
judgment against the defendants on all but Fox’s due process
claim, and upheld $8,166,000 of the damages awarded,
6 No. 13-1290
including $3.4 million in punitive damages. See Fox, 600 F.3d at
847.
Following the resolution of the § 1983 suit, Fox filed the
present suit. Through his amended complaints and after
stipulations and orders not contested or relevant on appeal, he
targets only the detectives’ excess insurer, AAIC. Fox seeks a
declaratory judgment that AAIC breached its good faith duties
to (1) reasonably settle the claims against the detectives within
policy limits, and (2) inform the detectives of their conflicts of
interest. Fox further asserts that, as assignee of the detectives’
rights against their insurers, his damages for AAIC’s breach
equal the punitive damages awarded against the three detec-
tives. (Although this lawsuit replicates the state-court action,
neither of the parties argues that the state suit has any bearing
on this case.) AAIC moved to dismiss Fox’s complaint for
failure to state a claim, and the district court granted the
motion. It reasoned that AAIC, as excess insurer, never had
any control over the detectives’ defense before judgment and
therefore had no duty to settle the claims against the detectives
or alert them to any potential conflicts of interest.
Discussion
Lurking in the background of this appeal is the question of
whether Fox’s present suit is an impermissible end run around
the public policy ban on an insured’s recovery of punitive
damages from an insurance company. In this case, Fox has
foregone his right to pursue $3.4 million in punitive damages
directly from the three detectives. Instead, seeking AAIC’s
deeper pockets, he has stepped into the shoes of those men
who had so egregiously violated his civil rights. But AAIC’s
No. 13-1290 7
policy excludes coverage for punitive damages, and “in
Illinois, public policy prohibits insurance against liability for
punitive damages that arise out of the misconduct of the
insured.” Crawford Labs., Inc. v. St. Paul Ins. Co. of Ill., 715
N.E.2d 653, 659 (Ill. App. Ct. 1999); see also Bernier v. Burris, 497
N.E.2d 763, 776 (Ill. 1986).
Three states that, like Illinois, have public policies prohibit-
ing insurance against punitive damages have held that an
insured, and any assignee of the insured like Fox, may not shift
to an insurance company through a suit against the insurer for
breach of its duty to defend, the wrongdoer’s duty to pay
punitive damages. See PPG Indus., Inc. v. Transamerica Ins. Co.,
975 P.2d 652, 658 (Cal. 1999); Lira v. Shelter Ins. Co., 913 P.2d
514, 518 (Colo. 1996); Soto v. State Farm Ins. Co., 635 N.E.2d
1222, 1225 (N.Y. 1994). To allow tortfeasors to so escape their
own personal liability for punitive damages, these courts
conclude, would defeat the very purpose of such damages: not
to compensate the plaintiff for injury but to punish the tortfea-
sor. See PPG Indus., 975 P.2d at 656–57; Lira, 913 P.2d at 517;
Soto, 635 N.E.2d at 1224–25.
Illinois has not yet addressed this issue, so ordinarily we
would attempt to predict how it would rule. See Cannon v.
Burge, No. 12–1529, 2014 WL 2185016, at *10 (7th Cir. May 27,
2014) (“Our role in interpreting a question of state law is to
predict how the highest court of the state would answer the
question.”); Bogie v. Rosenberg, 705 F.3d 603, 609 (7th Cir. 2013)
(same). Two of the cases, PPG Industries and Soto, were split
decisions reached over robust dissents, so a prediction is
difficult. In this case, however, we need not struggle to guess
how Illinois would resolve this public policy issue. Even if we
8 No. 13-1290
assume that Fox’s suit does not offend Illinois’s punitive
damage policies, we can conclude that the complaint—taken
together with its attachments, see FED.R.CIV.P. 10(c); Bogie, 705
F.3d at 609, and court records of which we may take judicial
notice, see Scherr v. Marriot Int’l, Inc., 703 F.3d 1069, 1073 (7th
Cir. 2013)—does not state a claim that AAIC breached any
duty owed the detectives.
On appeal, Fox argues that AAIC breached two duties: its
good faith duties to (1) reasonably settle the claims against the
detectives within policy limits, and (2) inform the detectives of
conflicts of interest created by joint representation and Fox’s
punitive damages claim. Fox generally is correct that an
insurer owes these two duties to its insured because of the
control an insurer exercises over the defense of claims. See R.C.
Wegman Constr. Co. v. Admiral Ins. Co., 629 F.3d 724, 728 (7th
Cir. 2011); Cramer v. Insurance Exchange Agency, 675 N.E.2d 897,
903 (Ill. 1996). But AAIC was not the primary insurer (that was
St. Paul). Under both AAIC’s policy and Illinois law it, as an
excess insurer, had no duty to defend the detectives until St.
Paul exhausted its policy limits; absent that duty AAIC had no
obligation to settle any claims or inform the detectives on any
potential conflicts of interest. See North River Ins. Co. v. Grinnell
Mut. Reinsurance Co., 860 N.E.2d 460, 467 (Ill. App. Ct. 2006);
Montgomery Ward & Co. v. Home Ins. Co., 753 N.E.2d 999,
1006–07 (Ill. App. Ct. 2001); Int’l Ins. Co. v. Sargent & Lundy, 609
N.E.2d 842, 855 (Ill. App. Ct. 1993).
Recall that it was on this basis that the district court
dismissed Fox’s complaint. But the district court’s holding was
based in part on a misapprehension—harmless, it turns
out—about timing. The district court believed Fox’s appeal
No. 13-1290 9
was resolved in 2008, and until then St. Paul, as primary
insurer, was still controlling the detectives’ defense. But in fact
the appeal was not decided until 2010, long after St. Paul had
exhausted its policy limits and AAIC’s duty to defend the
detectives arose. The district court’s error would warrant
reversal only if it was harmful. That question turns on whether
AAIC’s actions during the period when it had control of the
detectives’ defense (after September 2008) violated either duty
(to settle or disclose conflicts) to the detectives. For several
reasons, AAIC’s actions did not violate those duties.
First, based on Fox’s factual allegations, AAIC never
acquired, and therefore never violated, a good faith duty to
settle the claims against the detectives. That duty could not
arise unless Fox made a settlement demand within AAIC’s
policy limits. See Powell v. Am. Serv. Ins. Co., 7 N.E.3d 11, 15 (Ill
App. Ct. 2014) (citing Haddick ex. rel Griffith v. Valor Ins., 763
N.E.2d 299, 304–05 ( Ill. 2001)). And although it is true, at least
according to the complaint in this case, that Fox made such
demands at least twice, he did not do so at any point after the
duty to defend passed from St. Paul to AAIC. Moreover, under
Illinois law, AAIC was not required to seek out or initiate fresh
negotiations. See Haddick, 763 N.E.2d at 305–06. Accordingly,
AAIC breached no duty to the detectives by failing to settle the
claims against them.
Second, once AAIC assumed control of the case on appeal,
no potential conflict of interest arose regarding either punitive
damages or joint representation. We begin with punitive
damages. In his complaint and his appellate brief, Fox has
asserted no reason that AAIC’s self-interest in fighting com-
pensatory damages would have been “furthered by providing
10 No. 13-1290
a less than vigorous defense” of the punitive damages award
on appeal. Nandorf, 479 N.E.2d at 992. A conflict does not arise
simply because a plaintiff seeks both punitive and compensa-
tory damages. Id. at 993–94. Rather, only when the plaintiff
seeks punitive damages vastly in excess of compensatory
damages does the potential conflict of interest arise. Id. Given
that the Foxes had sought and been awarded even more in
compensatory damages than punitive damages, no conflict
arose here. See Nat’l Cas. Co., 567 F.3d at 876 (no conflict
without evidence that punitive damages would be dispropor-
tionate to compensatory damages); Littlefield v. McGuffey, 979
F.2d 101, 108 (7th Cir. 1992) (same); Nandorf, 479 N.E.2d at 992(same).
Even if a potential conflict regarding punitive damages
existed when St. Paul controlled the defense of Fox’s § 1983
action, none did by the time AAIC assumed control of the
detectives’ defense. As AAIC points out, by that time the
detectives had negotiated with Fox a covenant not to execute
against their personal assets. Therefore, neither AAIC nor the
detectives faced any harm from the prospect of a punitive
damages award. Fox resists the conclusion, arguing that the
covenant did not erase the judgment, so the detectives re-
mained exposed to the risk that the Foxes might execute the
judgment. The covenants merely provided the detectives with
a contract remedy if the Foxes collected, in breach of the
covenant, the punitive damages from the detectives’ personal
assets. See Guillen ex. rel Guillen v. Potomac Ins. Co., 785 N.E.2d
1, 13 (Ill. 2003). But the “specter of punitive damages … [was]
merely speculative,” Nat’l Cas. Co., 567 F.3d at 876. If the Foxes
executed on the judgment, any recovery would revert back to
No. 13-1290 11
the detectives by virtue of their contract remedy. Under these
circumstances, AAIC would have had no reason to believe that
the presence of punitive damages created a conflict of interest.
Furthermore, if any party had a stake in fighting the
punitive damages award it was AAIC. As a result of the
detectives obtaining, in the second stage of their deal with Fox,
full releases from Fox, AAIC faced the prospect of liability in
Fox’s state court suit against AAIC if the punitive damages
were upheld on appeal in this court. That is precisely why
AAIC intervened in the federal appeal—to fight the award of
punitive damages and fend off the risk of liability in state
court. Fox counters that we cannot consider these releases
because they were not part of the complaint. Fox is incorrect.
The releases became part of the public record on appeal of
Fox’s § 1983 suit for two reasons. First, they were exhibits to
AAIC’s motion to intervene, and second, the detectives, in
responding to that motion, acknowledged the existence and
validity of the attached releases. Thus, they can be considered
in evaluating AAIC’s motion to dismiss. See Scherr, 703 F.3d at
1073.
Finally, AAIC had no conflict in using the same law firm for
joint representation of the detectives. Fox argues that because
all the detectives were represented by the same law firm, AAIC
should have known of a potential conflict. But Fox has not
explained why joint representation automatically creates a
conflict. Such a conflict may arise where an insurer is charged
with providing a defense to multiple insureds whose interests
are “diametrically opposed.” Williams, 833 N.E.2d at 979, see
Murphy v. Urso, 430 N.E.2d 1079, 1083 (Ill. 1981). But here, the
detectives pursued a joint defense at trial when St. Paul
12 No. 13-1290
controlled the litigation—a matter for which AAIC cannot be
blamed. Furthermore, we can see no (and Fox gives us no)
antagonistic arguments that separate counsel could have been
made on their behalf on appeal. But this is all beside the point.
Fox cannot establish that the detectives suffered harm as the
result of any conflict. They have been fully released from
personal liability for punitive damages, and the compensatory
damages awarded to Fox have been paid in full by St. Paul and
AAIC. See Fidelity & Cas. Co. of N.Y. v. Mobay Chem. Corp., 625
N.E.2d 151, 155 (Ill. App. Ct. 1992) (“When an insurer wrong-
fully refuses to defend [its insured], it is liable to the insured
for breach of contract. The measure of damages for such a
contractual breach is generally the amount of the judgment
against the insured. …”), Gruse v. Belline, 486 N.E.2d 398, 404
(Ill App. Ct. 1985) (same). The detectives, therefore, have not
been harmed.
To sum up, we question whether Illinois would even allow
a suit like Fox’s, which shifts the burden of punitive damages
from the tortfeasor to the insurer. But even if such a claim
could proceed under Illinois law, Fox has no claim for relief
against an insurer who breached no duty and, in light of Fox’s
covenants and releases to protect the tortfeasors from punitive
damages enforcement, did not harm them.
Accordingly, the judgment of the district court is
AFFIRMED.