Carey v. Employers Mutual Casualty Co., 98-7118

• Decision Date: 01 September 1999
• Docket Number: No. 98-7118,98-7118
• Citation: 189 F.3d 414
• Parties: (3rd Cir. 1999) ALAN CAREY; STEPHEN HOFFMAN; JACK LEIB, APPELLANTS v. EMPLOYERS MUTUAL CASUALTY COMPANY
• Court: U.S. Court of Appeals — Third Circuit

Page 414

189 F.3d 414 (3rd Cir. 1999)

ALAN CAREY; STEPHEN HOFFMAN; JACK LEIB, APPELLANTS v. EMPLOYERS MUTUAL CASUALTY COMPANY

No. 98-7118

U.S. Court of Appeals, Third Circuit

Argued December 15, 1998

Decided September 01, 1999

On Appeal from the United States District Court for the Middle District of Pennsylvania (D.C. No. 97-cv-00349) District Judge: Hon. Sylvia H. Rambo

Mark W. Voigt (Argued) Michael I. Levin & Associates Huntingdon Valley, PA 19006 Counsel for Appellants

Timothy Costello (Argued) Marshall, Dennehey, Warner, Coleman & Goggin Philadelphia, PA 19103 Counsel for Appellee

Before: Sloviter, Cowen and Oberdorfer,^* Circuit Judges

OPINION OF THE COURT

Sloviter, Circuit Judge

Plaintiffs Alan Carey, Stephen Hoffman, and Jack Leib (the "Supervisors"), who filed this action for a declaratory judgment against Employers Mutual Casualty Co. ("Employers Mutual"), appeal the decision of the District Court denying their motion for summary judgment and granting summary judgment in favor of Employers Mutual. Employers Mutual had issued an errors and omissions insurance policy in favor of Berwick Township, Pa. (the "Township"). Plaintiffs filed this action seeking a determination that Employers Mutual is obligated to defend and indemnify them from a surcharge filed against them by the Audit Committee of the Township.

I.

The parties stipulated to the material facts. Carey, Hoffman, and Leib were supervisors for the Township during 1993. In May of that year, the Township entered into a contract with Berwick Enterprises, which was constructing a golf course and contiguous residential tracts. The Township agreed to design and construct a sewage treatment system and a storage lagoon that would connect to the golf course's irrigation system. Additionally, the Township agreed to pay certain construction costs associated with the irrigation system. The contract specified that the Township agreed to pay $240,000, but if the construction cost less than that amount, the Township would receive the benefit. Berwick Enterprises constructed the irrigation system and billed the Township the $240,000 referenced in the contract.

After the system was installed, the Township's engineer, Group Hanover, Inc., analyzed the project and concluded that the excavation cost for the irrigation system was only $84,466. However, the report cautioned that the analysis did not take into account a variety of other relevant expenses. As a result of the engineer's estimate, the Supervisors negotiated a compromise and settlement under which Berwick Enterprises received $216,000. The Township paid $65,000 in cash and the remainder by a promissory note for $151,000, with interest at six percent. Appellant Leib signed the promissory note on behalf of the Township on January 24, 1994.

In March 1996, the Township's Audit Committee concluded that the Supervisors had negligently overpaid Berwick Enterprises $140,216.50, representing the excess of principal and interest beyond the engineer's estimate of the cost ($84,466), and entered a notice of surcharge of $140,216.50, the difference between the cost to the Township of $224,682.50 (the settlement figure of $216,000 and interest of $8,682.50 on the note) and the engineer's estimate. The reasons set forth by the Audit Committee for imposition of the surcharge were that the Committee had not been provided with any detailed invoice or other documentation contradicting Group Hanover's valuation of the project, and that the Township should have followed a public bidding process for the project.

Pursuant to the applicable procedure, the Supervisors filed a notice of appeal from the Audit Committee's Report in the Court of Common Pleas of Adams County seeking relief from the Audit Report and notice of surcharge. They claimed, inter alia, that they had acted reasonably and in good faith in compromising the disputed claim and that the Audit Committee had not correctly accounted for all the relevant costs incurred by the contractor in connection with the irrigation project. That litigation was stayed pending resolution of this case.

The Supervisors sought coverage from Employers Mutual under the errors and omissions (E&O) insurance policy purchased by the Township, which was effective June 1995 to June 1996 and which covered claims made for alleged wrongful acts after June 4, 1987. Employers Mutual denied coverage on three separate grounds: the policy specifically excluded from covered losses any "[f]ines or penalties imposed by law," see App. at 120; the policy excluded " `[w]rongful' acts involving . . .[a]mounts actually or allegedly due under the terms of a payment or performance contract," see App. at 121; and the policy excluded "[a]ny claim brought by any federal, state or local governmental regulatory body," see App. at 122. The insurer also contended that its defense and indemnification of the Supervisors would violate public policy.

The Supervisors filed a declaratory judgment action in the Court of Common Pleas of Adams County in February 1997 alleging that they were entitled to defense and indemnification under the insurance policy. Employers Mutual, an Iowa corporation, removed the case to federal court and answered, citing the three exclusions from coverage referred to above. Both parties moved for summary judgment. On January 28, 1998, the District Court granted Employers Mutual's motion, concluding that the surcharge action was a fine or penalty under the policy terms; the court consequently declined to reach the other policy exclusions relied on by Employers Mutual.

The supervisors filed a timely notice of appeal. We have jurisdiction pursuant to 28 U.S.C. § 1291. Our review is plenary. See Nationwide Mut. Fire Ins. Co. v. Pipher, 140 F.3d 222, 224 (3d Cir. 1998). The parties agree that Pennsylvania law applies.

II.

An errors and omissions insurance policy is a form of professional liability insurance designed to insure certain classes of professionals from risks such as negligence. See Lee R. Russ, Couch on Insurance § 131:38, at 131-49 to -50 (3d ed. 1997). In essence, an E&O policy is a form of malpractice insurance. National Ass'n of Realtors v. National Real Estate Ass'n, Inc., 894 F.2d 937, 938 (7th Cir. 1990); Syndicate 420 at Lloyd's London v. Early Am. Ins. Co., 796 F.2d 821, 824 n.2 (5th Cir. 1986).

Other types of policies, such as those issued for corporate directors and officers, which often contain E&O provisions, commonly exclude coverage for fines and penalties. See 3 Rowland H. Long, The Law of Liability Insurance § 12A.05[7][a][iii], at 12A-95 (1989).

The Supervisors urge that the policy language "[f]ine or penalty imposed by law" is ambiguous and must be construed against Employers Mutual as the drafter of the policy. See Commonwealth of Pennsylvania, Dep't of Transp. v. Semanderes, 109 Pa. Commw. 505, 511, 531 A.2d 815, 818 (Commw. Ct. 1987) ("When a contract is ambiguous, it is undisputed that the rule of contra proferentem requires the language to be construed against the drafter . .. and in favor of the other party if the latter's interpretation is reasonable.") The District Court concluded that the issue is not whether the policy itself is ambiguous, but rather whether the surcharge is a fine or penalty and thereby excluded from coverage.

There are not many cases dealing with the scope of a fines and penalties clause in an insurance contract. Counsel for Employers Mutual stated that he had found none. Our research has uncovered only a few, and those are not direct analogs. The decisions often turn on the precise language of the policy.

For example, in Page Wellcome, Professional Service Corp. v. Home Insurance Co., 758 F. Supp. 1375 (D. Mont. 1991), aff'd, 993 F.2d 887 (9th Cir. 1993), Wellcome, an attorney who was sanctioned by a state trial court for giving a closing argument that violated the court's in limine ruling, sought and was denied coverage by his professional liability insurer on the ground that the sanction was a "fine or penalty," which the policy expressly excluded from the definition of covered "damages." The federal district court agreed with the insurer, holding that the policy was clear and unambiguous in its prohibition of fines, which the court defined as "the payment of money imposed upon a person for misconduct." Id. at 1379-80. The court ruled that because the sanction was imposed for misconduct, it constituted a fine and the insurer had no duty to indemnify or defend. Id. at 1380-81.

On appeal, the Ninth Circuit certified the question to the Montana Supreme Court. See Wellcome v. Home Ins. Co., 849 P.2d 190, 191 (Mont. 1993). The Montana Supreme Court rejected Wellcome's argument that the term "fine" is limited to criminal statutes and that sanctions are neither fines, penalties, nor any other type of punishment. The Court referred to Black's Law Dictionary in holding that a fine is a pecuniary punishment, and that this meaning is clear and well understood. Wellcome, 849 P.2d at 193. It thus concluded that the policy excluded coverage for Wellcome because the sanction imposed on him was a punitive fine or penalty. Id. at 194; see also Dixon v. Home Indem. Co., 426 S.E.2d 381, 382-83 (Ga. Ct. App. 1993) (holding that term "sanctions" in exclusion for fines, statutory penalties, and sanctions prevents coverage for award of attorneys fees imposed to deter filing of frivolous lawsuit).

The issue of the scope of a policy exclusion of coverage for fines or penalties also may arise when coverage is sought for the payment of punitive damages.¹ See Long, supra, § 12B.05[1], at 12B-92. For example, in Collins & Aikman Corp. v. Hartford Accident & Indemnity Co., 436 S.E.2d 243 (N.C. 1993), a trucking company, which maintained an umbrella/excess liability policy for damages arising from its operations, was held liable for $2.5 million in compensatory and $4 million in punitive damages following a serious accident. The parties...