Zurich American Ins. Co. v. Watts Industries, Inc.

• Decision Date: 02 August 2005
• Docket Number: No. 03-3851.,No. 03-3853.,03-3851.,03-3853.
• Citation: 417 F.3d 682
• Parties: ZURICH AMERICAN INSURANCE COMPANY, Petitioner-Appellee/Cross-Appellant, v. WATTS INDUSTRIES, INC., Respondent-Appellant/Cross-Appellee, and James Jones Company, Respondent/Cross-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 682

417 F.3d 682

ZURICH AMERICAN INSURANCE COMPANY, Petitioner-Appellee/Cross-Appellant, v. WATTS INDUSTRIES, INC., Respondent-Appellant/Cross-Appellee, and James Jones Company, Respondent/Cross-Appellee.

No. 03-3851.

No. 03-3853.

United States Court of Appeals, Seventh Circuit.

Argued May 3, 2005.

Decided August 2, 2005.

COPYRIGHT MATERIAL OMITTED

Michael M. Marick, Meckler, Bulger & Tilson, Chicago, IL, Patrick A. Cathcart (argued), Cathcart Collins & Kneafsey, Los Angeles, CA, for Petitioner-Appellee/Cross-Appellant.

Richard A. Fiore, Freeborn & Peters, Chicago, IL, David S. MacCuish (argued), Weston, Benshoof, Rochefort, Rubalcava & MacCuish, Los Angeles, CA, for Respondent-Appellant/Cross-Appellee.

Richard A. Fiore, Freeborn & Peters, Chicago, IL, Faustin A. Pipal, Jr., Keating, Keating & Pipal, Chicago, IL, Jordan S. Stanzler, Ruben Castellon (argued) Stanzler, Funderburk & Castellon, San Francisco, CA, for Respondent/Cross-Appellee.

Before FLAUM, Chief Judge, and KANNE and SYKES, Circuit Judges.

KANNE, Circuit Judge.

Zurich American Insurance Company insured Watts Industries, Inc., and James Jones Company under a program consisting of both primary liability policies and deductible agreements. Only the deductible agreements contained arbitration clauses. Watts and Jones successfully sued Zurich in California state court for defense costs in two lawsuits filed against them by other parties. Thereafter, the parties contested application of the deductible agreements, and Zurich petitioned the district court to compel arbitration. The district court granted the petition with respect to Watts, and denied it with respect to Jones. Both Watts and Zurich appeal; for the reasons stated herein, we affirm the order compelling arbitration as to Watts and exempting Jones from arbitration. We remand to the district court for clarification of precisely which deductible agreements give rise to an arbitrable dispute.

I. History

We begin with a brief introduction of the parties and a recap of the long and tortured history of this case. Zurich is an insurer incorporated under New York law, with its home office in New York City and its main administrative office in Schaumburg, Illinois. Watts is a manufacturer of valves and other waterworks parts that are used in municipal water systems. Watts is incorporated under Delaware law, with its principal place of business in Massachusetts. Jones is another manufacturer of valves used in public water systems, with both its incorporation and principal place of business in California. Jones was a wholly owned subsidiary of Watts from 1987 until it was sold in September 1996.

Zurich issued six primary liability insurance policies to Watts, in effect for successive one-year periods between June 30, 1991, and June 30, 1997. The policies provided coverage for both Watts and its subsidiary, Jones. The insurance contracts do not contain arbitration clauses. Watts entered into separate deductible agreements with Zurich during these same six years.¹ Each deductible agreement contains a broad arbitration clause. For example, the 1991-92 agreement requires arbitration of "any dispute [that] arise[s] between the Company and the Insured with reference to the interpretation of [the] Agreement or their rights with respect to any transaction involved[.]" (Zurich's App. at 337.) Each agreement provides for arbitration in Schaumburg, Illinois. Jones did not sign any of the deductible agreements.

Watts and Jones were sued for fraud by third parties in two cases in the California state courts in 1997 and 1998. The cases were titled Los Angeles Department of Water and Power, et al. ex rel. Armenta v. James Jones Co., et al., Los Angeles County Superior Court, Case No. BC 173487 ("Armenta"), and Rothschild v. James Jones Co., San Diego County Superior Court, Case No. 726930 ("Rothschild"). Both claims were tendered to Zurich, but Zurich denied its duty to defend and indemnify Watts and Jones.

In February 2001, Watts filed suit against Zurich in the Los Angeles Superior Court seeking defense and indemnity for the Armenta and Rothschild actions under the primary liability policies. Watts asserted claims for breach of contract and bad faith. Jones filed a similar coverage suit against Zurich in June 2001, and the two actions were consolidated. The California court conducted a mandatory settlement conference in August 2001. Zurich raised the deductible agreements as a defense to entering a settlement agreement during this conference, claiming that even if Zurich were liable under the policies, Watts would be responsible for fully reimbursing Zurich under the deductible agreements. In an order issued August 3, 2001, the court gave the parties 60 days to attempt to resolve the issues discussed during settlement.

In a letter to Watts dated August 31, 2001, Zurich indicated that it would address the applicability of the deductible agreements "in due course, as required." Watts responded with a letter on September 6, 2001, ("the September 6 letter") stating that there was "no need for any further delay" in resolving the issues of the deductibles and setting out four points regarding the application of the deductible agreements. First, Watts stated that the deductible agreements do not apply to Jones. Second, Watts claimed that "[b]ecause [Zurich] repudiated [the insurance] policies and agreements by wrongfully refusing to fund the defense of its insureds, Zurich [was] foreclosed from relying upon the deductible agreements." Third, Watts asserted that because Zurich failed to mention the deductible agreements until 3½ years after Watts tendered the Armenta and Rothschild actions, it "waived any rights it may have had to seek to enforce those agreements." Finally, Watts claimed that even if the deductible agreements could be invoked, "Zurich would remain liable for providing Jones with a full defense in the underlying cases and would remain liable to fund Watts' defense once Watts satisfied the $500,000 deductible. . . set forth in each deductible agreement[.]" Watts then proposed a resolution whereby Zurich would pay the full amount of defense costs for Armenta and Rothschild.

On September 21, 2001, Zurich responded to the September 6 letter with a demand for arbitration against both Watts and Jones, which Watts and Jones rejected. On October 4, 2001, Zurich filed a petition to compel arbitration in federal court in Illinois and asked the California superior court to stay the California coverage action. The superior court refused to do so, and on November 27, 2001, granted Watts's motion for summary judgment. Zurich was held to have a duty to defend the Armenta action and any arbitrable disputes under the deductible agreements were deemed severable from the claims and issues in the California coverage action.

Back to the Illinois proceedings. Zurich initially asked for arbitration of everything—the duty to defend both Watts and Jones and application of the deductible agreements with respect to both companies—in its October 2001 motion to compel arbitration. On May 1, 2002, Zurich filed a motion for a temporary restraining order in the district court seeking to restrain the California court from enforcing its November 2001 duty to defend order, which the district court granted.² On September 9, 2002, the district court ruled on Zurich's petition to compel arbitration in the order that gives rise to this appeal. At that point, Zurich had made a partial payment to Watts and Jones (more than $4 million, according to Zurich's memorandum in support of its petition) for claimed defense costs. The district court's initial order stated that Jones was not subject to arbitration, that the duty to defend in the Armenta action was not arbitrable, and that Zurich had not waived its right to arbitrate under the deductible agreements. The district court granted the petition to compel arbitration as follows:

(1) as to Armenta, whether Zurich's breach of the duty to defend found by the California court constituted a repudiation by Zurich of the deductible agreement;

(2) as to Rothschild, whether the provision of the 1991-1992 deductible agreement stating that Zurich "assumes responsibility for the investigation, defense and settlement obligations under this Agreement as respects the policies . . ." creates a duty to defend under the deductible agreement, and if so whether it was breached; and

(3) with respect to Rothschild, what the obligations of the parties are with respect to payment and reimbursement of defense costs above the $500,000 deductible.

Then, on September 30, 2002, this court reversed the injunction staying coverage litigation in the California courts. See Zurich Am. Ins. Co. v. Sup.Ct. for the State of Cal., 326 F.3d 816, 827-28 (7th Cir.2002). The district court vacated its September 9, 2002, order pending the Seventh Circuit opinion concerning the injunction, which was issued on April 17, 2003. On September 25, 2003, the district court reinstated its September 9 order, "amended only to reflect the fact that the duty to defend in Armenta is arbitrable to the same extent [the court] previously found the duty to defend in Rothschild arbitrable under the deductible agreement."

The parties agree that the second issue slated for arbitration by the district court, concerning a duty to defend the Rothschild case arising out of the deductible agreement, was erroneously ordered by the district court. Neither Watts nor Zurich has ever contended that any deductible agreement imposed a duty to defend on Zurich. Also, because the California Court of Appeal affirmed the superior court's summary judgment order finding that Zurich was bound to pay for Watts's and Jones's defense, and the California Supreme Court declined to review that decision, the issue of whether Zurich has a duty to defend is moot. See Watts Indus., Inc. v. Zurich Am. Ins. Co., 121 Cal.App.4th 1029, 1035, 18 Cal.Rptr.3d 61 (Cal...