National Sur. Corp. v. Hartford Cas. Ins. Co.

• Decision Date: 30 July 2007
• Docket Number: No. 06-6168.,06-6168.
• Citation: 493 F.3d 752
• Parties: NATIONAL SURETY CORPORATION, Plaintiff-Appellant. v. HARTFORD CASUALTY INSURANCE COMPANY, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

493 F.3d 752

NATIONAL SURETY CORPORATION, Plaintiff-Appellant. v. HARTFORD CASUALTY INSURANCE COMPANY, Defendant-Appellee.

No. 06-6168.

United States Court of Appeals, Sixth Circuit.

Argued: May 31, 2007.

Decided and Filed: July 30, 2007.

ARGUED:

Barry M. Miller, Fowler, Measle & Bell, Lexington, Kentucky, for Appellant. Douglas L. Hoots, Landrum & Shouse, Lexington, Kentucky, for Appellee.

ON BRIEF:

Barry M. Miller, Fowler, Measle & Bell, Lexington, Kentucky, for Appellant. Douglas L. Hoots, Landrum & Shouse, Lexington, Kentucky, for Appellee.

Before: RYAN, DAUGHTREY, and ROGERS, Circuit Judges.

OPINION

ROGERS, Circuit Judge.

When a primary insurer against tort liability refuses to settle and then loses at trial for amounts greater than its coverage limits, what recourse does an excess insurer have against the primary insurer? This case involves the issue of whether, under Kentucky law, an excess insurer can recover against a primary insurer pursuant to the doctrine of equitable subrogation, either for the primary insurer's failure in good faith to settle a claim or for the primary insurer's failure to investigate whether an insured has other insurance.

The excess insurer in this case, National Surety Corporation, argues that the primary insurer, Hartford Casualty Insurance Company, acted in bad faith by failing to settle a tort claim against their mutual insured, Sufix U.S.A., and thereby exposed Sufix to excess liability.¹ National Surety seeks to step into Sufix's shoes, pursuant to the doctrine of equitable subrogation, to assert this bad-faith claim. National Surety also seeks to assert a claim against Hartford for Hartford's failure to discover that Sufix was insured by National Surety. The district court held that National Surety did not have a cause of action under Kentucky law, and accordingly granted Hartford's motion to dismiss.

We reverse the district court's order because the Supreme Court of Kentucky would likely recognize a cause of action in this case. Kentucky law already permits an insured to sue a primary insurer for bad faith failure to settle a claim. Kentucky law also recognizes the doctrine of equitable subrogation, which permits an insurance company to "step into the shoes" of the insured and recover what the insured would have been able to recover against a tortfeasor. Combining these two principles to allow an excess insurer to recover from a primary insurer is a logical extension of these principles and furthers Kentucky's policy goals of encouraging fair and reasonable settlements and preventing third parties from profiting from an insured's insurance coverage. However, the district court's order properly dismissed National Surety's failure-to-investigate claim because an insured does not have a cause of action under Kentucky law against its insurer for failing to discover an insured's other sources of insurance.

National Surety's complaint alleges the following facts, which this court must accept as true, Evans v. Pearson Enters., Inc., 434 F.3d 839, 847 (6th Cir.2006). Hartford and National Surety both issued insurance policies to Sufix U.S.A. Hartford's policy provided $1 million in primary liability coverage and National Surety's policy provided $10 million in excess liability coverage. On or about May 19, 1998, a weed trimmer manufactured by Sufix injured Tommy Cook when the trimmer broke apart while Cook was using it.

In May of 1999, Cook filed suit against Sufix in Jefferson Circuit Court, alleging that the weed trimmer was defectively designed and that Sufix was grossly negligent in failing to discover the defect. Hartford assumed the defense of Sufix pursuant to its insurance contract. Hartford, through its attorneys, engaged in settlement negotiations with Cook, and ultimately rejected Cook's offer to settle for the limits of Hartford's policy (i.e., $1 million).

National Surety did not receive notice of Cook's action against Sufix from Sufix or Hartford until approximately two weeks before trial. National Surety alleges that because of the lack of timely notice, it was (1) unable to evaluate effectively its exposure to Cook under the excess policy, (2) unable to evaluate Cook's settlement demand, (3) not given the opportunity to participate in or direct the preparations for the trial, and (4) unable to engage in informed settlement negotiations with Cook.

On May 21, 2002, a jury found Sufix liable to Cook and awarded Cook $6,486,588.44. After the trial, National Surety assumed the defense of Sufix and brought an unsuccessful appeal to the Court of Appeals of Kentucky.

On February 24, 2005, National Surety filed suit against Hartford in the United States District Court for the Western District of Kentucky. National Surety sued Hartford for breach of contract and for violation of the common-law duty of good faith. National Surety asserted in its complaint that Hartford failed "[t]o perform an adequate investigation of the allegations that form the basis of the Civil Action," failed "[t]o provide Sufix with an adequate and competent defense of the allegations contained in the Civil Action," and failed "[t]o settle claims against Sufix within its policy limits so as not to expose Sufix and its assets to an excess judgment." National Surety claimed that it is subrogated to Sufix pursuant to the terms of the excess policy and the doctrine of equitable subrogation. Hartford filed a motion to dismiss, pursuant to Federal Rule of Civil Procedure 12(b)(6), on the grounds that Kentucky does not recognize the right of excess insurers to sue primary insurers in a situation like this one.

The district court granted Hartford's motion to dismiss. Nat'l Sur. Corp. v. Hartford Cas. Ins. Co., 445 F.Supp.2d 779 (W.D.Ky.2006). The district court predicted that the Kentucky Supreme Court would not recognize a cause of action by an excess insurer against a primary insurer pursuant to the doctrine of equitable subrogation, even though such a rule had been adopted by the overwhelming majority of jurisdictions to have considered the issue. Id. at 781-85. First, the district court observed that "the Kentucky Court of Appeals refused to recognize the theory of equitable subrogation in a similar situation," where an excess insurer sought to sue an insured's defense counsel for malpractice. Id. at 781 (referring to Am. Cont'l Ins. Co. v. Weber & Rose, P.S. C., 997 S.W.2d 12 (Ky.Ct.App.1998)). The court noted that Weber & Rose "is the strongest indicator of how the Kentucky courts would rule in the case at bar." Id. The court reasoned that, as in Weber & Rose, allowing recovery against the primary insurer would "threaten the integrity of the settlement process by allowing the excess carriers, who were not involved in those underlying negotiations, to second-guess the judgment of the primary insurer's representatives." Id. at 782.

Second, the district court concluded that Kentucky would not follow the jurisdictions that have adopted the rule advocated by National Surety because excess insurers do not suffer an injury when a primary insurer, in bad faith, fails to settle a claim within its policy limits. Id. at 782-83. The district court reasoned that the excess insurer, National Surety, has received a premium in exchange for assuming the risk of an excess judgment and therefore suffered no wrong, while the insured, Sufix, who has been fully indemnified, has suffered no loss. Id. at 783. The district court supported this reasoning with several hypotheticals. Id. at 783-85. Finally, the district court refuted the argument that failing to adopt the majority rule would raise excess insurance premium costs by raising the countervailing likelihood that adopting the majority rule would raise primary insurance premiums, thereby ultimately distributing costs unfairly. Id. at 785.

In resolving an issue of state law in a diversity case, this court must "`make [the] best prediction, even in the absence of direct state court precedent, of what the Kentucky Supreme Court would do if it were confronted with'" the same question of law. Managed Health Care Assocs., Inc. v. Kethan, 209 F.3d 923, 927 (6th Cir.2000) (quoting Welsh v. United States, 844 F.2d 1239, 1245 (6th Cir.1988)). Because Kentucky law and policy support the majority rule that an excess insurer may recover against a primary insurer under the doctrine of equitable subrogation, and arguments to the contrary are not persuasive, the Kentucky Supreme Court would likely recognize the rule asserted by National Surety in this case.

The Kentucky Supreme Court would likely adopt the majority rule because that rule naturally follows from two other Kentucky insurance rules: (1) that an insured may sue an insurer who, in bad faith, fails to settle a claim within policy limits, and (2) that an insurer may step into the shoes of the insured, pursuant to the doctrine of equitable subrogation. In addition, the majority rule furthers Kentucky policies of encouraging fair and reasonable settlements and preventing wrongdoers from piggybacking on an insured's insurance.

Kentucky law permits an insured to sue a primary insurer that, in bad faith, fails to settle a claim. Under Kentucky law, the insurance contract between an insured and insurer contains an implied covenant of good faith and fair dealing. Manchester Ins. & Indem. Co. v. Grundy, 531 S.W.2d 493, 498 (Ky.1975). The insured has a cause of action against the insurer if the insurer, in bad faith, fails to settle a claim within the policy limits. Id. at 497-98. Kentucky follows the general rule that "damages recoverable for a wrong are not diminished by the fact that the injured party has been wholly or partly indemnified for his loss by insurance (to whose procurement the wrongdoer did not contribute)." Taylor v. Jennison, 335 S.W.2d 902, 903 (Ky.1960). In the instant case, even though Sufix had excess insurance, and thus was compensated for the entire verdict against it, Sufix still had a...