Level 3 Communications, Inc. v. Federal Ins. Co.

• Citation: 168 F.3d 956
• Decision Date: 16 February 1999
• Docket Number: No. 98-2094,98-2094
• Parties: LEVEL 3 COMMUNICATIONS, INC., Plaintiff-Appellant, v. FEDERAL INSURANCE COMPANY and Pacific Insurance Company, Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 956

168 F.3d 956

LEVEL 3 COMMUNICATIONS, INC., Plaintiff-Appellant, v. FEDERAL INSURANCE COMPANY and Pacific Insurance Company,

Defendants-Appellees.

No. 98-2094.

United States Court of Appeals,

Seventh Circuit.

Argued Nov. 4, 1998.

Decided Feb. 16, 1999.

Brian D. Sieve (argued), Brett A. Bakke, Kristine L. Anderson, Kirkland & Ellis, Chicago, IL, for Level 3 Commmunications, Inc.

Jonathan A. Constine (argued), Hogan & Hartson, Washington, DC, for Federal Insurance Co.

David L. Koury, Peterson & Ross, Chicago, IL, for Pacific Insurance Co.

Before POSNER, Chief Judge, and BAUER and EVANS, Circuit Judges.

POSNER, Chief Judge.

This diversity suit, governed by Nebraska law (though no peculiarities of that law bear on the case), seeks $14 million in damages for breach of a contract of directors' and officers' liability insurance. Peter Kiewit Sons', Inc. was sued along with one of its directors in 1994 by six (two others joined later, making eight) of its minority shareholders for securities fraud and related torts. Kiewit's successor seeks through the present suit, which is against its primary and excess insurers (but we'll ignore the latter, and pretend there is just one insurance company, Federal, to simplify our opinion further), to recoup the costs that it incurred in defending against and eventually settling the securities case.

One of the plaintiffs in that suit, Pompliano, who joined it six months after it had been filed, had until June 1991 been a director of one of Kiewit's subsidiaries. The insurance contract excludes liability on account of any "Claim made against an Insured Person" if the Claim is "brought or maintained by or on behalf of any Insured." "Insured Person" is defined to include a "person who has been, now is, or shall become a duly elected director or a duly elected or appointed officer of the Insured Organization" (emphasis added), and "Insured Organization" is defined as Kiewit plus its subsidiaries. So Pompliano was an "Insured." The district court held, granting summary judgment for Federal, that the "Insured versus Insured" exclusion (a standard exclusion in D & O policies, 2 William E. Knepper & Dan A. Bailey, Liability of Corporate Officers and Directors § 25-7, p. 443 (5th ed.1993); Nicholas E. Chimicles & M. Katherine Meermans, "The Insured vs. Insured Exclusion in D & O Insurance Policies," C938 ALI-ABA 749 (1994)) was therefore applicable. The result was that Kiewit had no coverage. The issue is whether the presence of one "Insured" in a group of plaintiffs was indeed enough to trigger the exclusion.

Read literally, the contract clearly excludes coverage for the part of the settlement, and other expenses of the securities suit, allocable to Pompliano (the significance of this qualification will become clear later), as he was a plaintiff and a former director of one of Kiewit's subsidiaries. But Kiewit asks us to read the "Insured versus Insured" exclusion in light of its purpose, which is to exclude coverage both of collusive suits--such as suits in which a corporation sues its officers or directors in an effort to recoup the consequences of their business mistakes, e.g., Township of Center v. First Mercury Syndicate, Inc., 117 F.3d 115, 119 (3d Cir.1997); Fidelity & Deposit Co. v. Zandstra, 756 F.Supp. 429, 431-32 (N.D.Cal.1990); 2 Knepper & Bailey, supra, § 25-7, p. 443, thus turning liability insurance into business-loss insurance--and of suits arising out of those particularly bitter disputes that erupt when members of a corporate, as of a personal, family have a falling out and fall to quarreling. Township of Center v. First Mercury Syndicate, Inc., supra, 117 F.3d at 119. Kiewit argues that the suit in which Pompliano is a party is of neither sort, and would not be even if he were the only plaintiff.

The fallacy in the argument is in confusing a rule with its rationale, or in turning a rule into a standard by reference to its rationale. There is a tradeoff between clarity and ease of application, on the one hand, and a tight fit between a legal or contractual norm and its purpose, on the other. A simple, flat rule is deliciously clear and easy to apply, but it may be both underinclusive and overinclusive in relation to the purpose that animates it. A standard, like "no coverage for collusive suits or lovers' quarrels," is contoured exactly to its purpose, but it cannot be applied without a potentially costly, time-consuming, and uncertain inquiry into the nature of the underlying dispute sought to be covered. Caterpillar, Inc. v. Herman, 131 F.3d 666, 668-69 (7th Cir.1997); American Hospital Ass'n v. NLRB, 899 F.2d 651, 659-60 (7th Cir.1990). It is apparent from the wording they chose that the parties opted for the rule, not the standard, in agreeing to the "Insured versus Insured" exclusion.

But when the application of a rule leads to a truly whacky result, a more than suspicion arises that the parties can't have set so high a value on clarity that they would have thought such an application a proper interpretation of the rule. This is true whether the rule is statutory, e.g., Public Citizen v. U.S. Dept. of Justice, 491 U.S. 440, 453-55, 109 S.Ct. 2558, 105 L.Ed.2d 377 (1989); AM Int'l, Inc. v. Graphic Management Associates, Inc., 44 F.3d 572, 577 (7th Cir.1995); cf. Boston Sand & Gravel Co. v. United States, 278 U.S. 41, 48, 49 S.Ct. 52, 73 L.Ed. 170 (1928) (Holmes, J.), or contractual. E.g., Grun v. Pneumo Abex Corp., 163 F.3d 411, 420 (7th Cir.1998); AM Int'l, Inc. v. Graphic Management Associates, Inc., supra, 44 F.3d at 577-78; Chicago Board Options Exchange, Inc. v. Connecticut General Life Ins. Co., 713 F.2d 254, 258 (7th Cir.1983); Outlet Embroidery Co. v. Derwent Mills, 254 N.Y. 179, 172 N.E. 462, 463 (1930) (Cardozo, C.J.); McMahon v. Chicago Mercantile Exchange, 221 Ill.App.3d 935, 164 Ill.Dec. 369, 582 N.E.2d 1313, 1320 (1991). Kiewit argues along these lines that the "Insured versus Insured" exemption can't mean what it says, because if it did then even if Pompliano were merely an unnamed class member in a securities class action, with a stake of $10 in the outcome of the suit, and even if he had resigned his directorship in a subsidiary of Kiewit 20 years ago, Kiewit would lose its insurance coverage. To this, Federal weakly replies that a suit by a class of which an Insured is an unnamed member is not a suit "brought or maintained by or on behalf of any Insured." Of course it is; a class action is brought by the named plaintiff or plaintiffs on his (their) own behalf and on behalf of the unnamed class members. American Pipe & Construction Co. v. Utah, 414 U.S. 538, 550-52, 94 S.Ct. 756, 38 L.Ed.2d 713 (1974); Susman v. Lincoln American Corp., 587 F.2d 866, 869 (7th Cir.1978). Federal further argues that the "on behalf" language of the contract was not intended to apply to an unnamed or "passive" litigant. But in so arguing Federal is abandoning its primary argument, that the contract means what it says.

Maybe applying the contract's "or on behalf of any Insured" language to the case of the unnamed class member is so absurd that the language must bend. Or maybe not, because, as we'll see, the insurance contract requires allocation of covered and uncovered losses rather than barring all recovery because of the presence of an insured on the plaintiff's side of the case. (An argument, however, that Federal is reluctant to make, as we'll also see.) But even if the application of the "Insured versus Insured" exclusion to the unnamed class member would be too nutty to be tolerable as a contractual interpretation despite its literal accuracy, we do not think it follows that the rule barring coverage when an insured is suing another insured collapses into a standard that would require the district court to inquire into the collusive potential of the securities suit or the bitterness of the feelings between Pompliano and the defendants in that suit. It is one thing to carve a hard-edged exception, necessary to avoid absurdity, say for the case in which an "Insured" is an unnamed class member; it is another thing to replace the hard-edged rule of "Insured versus Insured" with a mushy, messy standard that would be hell for an insurance company to apply when asked to indemnify its insured. A rule plus exceptions is not the equivalent of a standard.

So we agree with the district court that Pompliano's claim was not covered. But Kiewit also argues that Federal is estopped to invoke the "Insured versus Insured" exemption because of delay in invoking it. Kiewit notified Federal shortly after Pompliano joined the securities suit of the new plaintiff, yet Federal said...