Federal Ins. Co. v. X-Rite, Inc., 1:89-CV-470.

• Decision Date: 24 September 1990
• Docket Number: No. 1:89-CV-470.,1:89-CV-470.
• Parties: FEDERAL INSURANCE COMPANY, a New Jersey corporation, Plaintiff and Counter-Defendant, v. X-RITE, INC., a Michigan corporation, and Darrell Thompson, Individually and as an Officer and Director of X-Rite, Inc., Defendants and Counter-Plaintiffs, X-RITE, INC., a Michigan corporation, and Darrell Thompson, individually, and as an Officer and Director of X-Rite, Inc., Defendants and Third-Party Plaintiffs, v. AMERICAN CASUALTY COMPANY OF READING, PA, a Pennsylvania corporation, Third-Party Defendant.
• Court: U.S. District Court — Western District of Michigan

748 F. Supp. 1223

FEDERAL INSURANCE COMPANY, a New Jersey corporation, Plaintiff and Counter-Defendant, v. X-RITE, INC., a Michigan corporation, and Darrell Thompson, Individually and as an Officer and Director of X-Rite, Inc., Defendants and Counter-Plaintiffs, X-RITE, INC., a Michigan corporation, and Darrell Thompson, individually, and as an Officer and Director of X-Rite, Inc., Defendants and Third-Party Plaintiffs, v. AMERICAN CASUALTY COMPANY OF READING, PA, a Pennsylvania corporation, Third-Party Defendant.

No. 1:89-CV-470.

United States District Court, W.D. Michigan, S.D.

September 24, 1990.

John R. Monnich, Troy, Mich., for plaintiff and counter-defendant.

Mark S. Allard and Charles M. Denton, Grand Rapids, Mich., for defendants and counter-plaintiffs.

Michael P. Tone, Chicago, Ill., for third party defendant.

OPINION OF THE COURT

ROBERT HOLMES BELL, District Judge.

This case presents complementary actions for declaratory judgment concerning the parameters of an insurer's contractual duty to defend claims brought against the insured. Specifically, the fundamental questions posed may be stated as follows: Where the insurer assumes its contractual duty to defend but reserves its right to contest its liability to indemnify the insured for certain of the claims, such that a potential conflict of interest arises, who is ultimately entitled to choose counsel and control the litigation; and if the insured is entitled to do so, is the insurer liable to reimburse the insured for the reasonable costs of defense? With respect to these questions, there appears to be no genuine issue as to any material fact; the parties have filed cross-motions for summary judgment.

I

Plaintiff Federal Insurance Company ("Federal") issued a comprehensive general liability insurance policy to defendant X-Rite, Inc., for the period June 22, 1984 to June 22, 1986. The policy includes the following covenant:

The company will pay on behalf of the insured all sums which the insured shall become obligated to pay as damages by reason of liability to which this insurance applies, imposed by law or assumed by the insured under any incidental contract, for bodily injury, property damage or personal injury caused by an occurrence and the company shall have the right and duty to defend any suit against the insured seeking damages on account of such bodily injury, property damage or personal injury, even if any of the allegations of the suit are groundless, false or fraudulent, and may make such investigation and settlement of any claim or suit as it deems expedient.

(Emphasis added.)

In August 1987, an action naming X-Rite and its president and chief executive officer, Darrell Thompson, as defendants, was commenced in the Kent County (Michigan) Circuit Court. The complaint was filed by Robert O'Connor and Medical I.D. Systems, Inc., and contained eight counts precipitated by O'Connor's discharge from employment with X-Rite on May 10, 1985 and his subsequent efforts to compete with X-Rite:

I—Wrongful Discharge II—Intentional Infliction of Emotional Distress III—Negligence IV—Malicious Prosecution V—Abuse of Process VI—Antitrust VII—Unfair Competition

VIII—Intentional Interference with Prospective Contractual Relations

The complaint was served on defendants X-Rite and Thompson on September 30, 1987, whereupon the firm representing X-Rite as corporate counsel, Varnum, Riddering, Schmidt & Howlett, undertook their representation in the "O'Connor litigation." Notice of the litigation and of the Varnum, Riddering firm's representation was given to Federal by letter dated December 4, 1987.

After several intermediate communications, Federal responded by letter dated February 17, 1988. The letter communicated (a) Federal's acknowledgement of its contractual duty to defend X-Rite and Thompson with respect to all claims asserted in the O'Connor litigation; (b) Federal's unwillingness to pay the fees of the Varnum, Riddering firm for continued representation; (c) the proposed substitution of the law firm Vandeveer, Garzia, Tonkin, Kerr & Heaphy as counsel; (d) acknowledgement of limited indemnification coverage for certain potential unintentionally caused damages under counts I, III and IV; and (e) Federal's reservation of rights to decline coverage for any damages not covered under the policy. X-Rite and Thompson did not, apparently, respond to this letter, but proceeded in defense of the O'Connor claims with Varnum, Riddering as counsel. From time to time thereafter, copies of miscellaneous documents reflecting progress in the litigation were forwarded to Federal by Varnum, Riddering.

On November 17, 1988, Federal mailed a letter to Thompson "insisting" that Federal by permitted to carry out its right and duty to defend and that the Vandeveer, Grazia firm be permitted to assume representation in the O'Connor litigation. By "status letter" of the same date, the Varnum, Riddering firm informed Federal that a mediation award of $125,000 for O'Connor had been returned and that the deadline for X-Rite's and Thompson's acceptance or rejection thereof was November 24th. The next material communication between the parties was a letter dated March 30, 1989, from Varnum, Riddering informing Federal that X-Rite and Thompson had accepted the mediation award of $125,000 and the O'Connor litigation had been settled for that amount. The letter demanded indemnification in this amount as well as reimbursement of attorney fees in the amount of $71,249.89.

Federal thereupon commenced this action for declaratory judgment. The complaint asks the Court to declare Federal free from all liability to X-Rite because X-Rite breached the insurance contract (a) be refusing to allow Federal to exercise its right and duty to defend; (b) by refusing to cooperate with Federal in the conduct of the litigation; and (c) by entering into the settlement and making payments without Federal's consent. X-Rite and Thompson filed a counter-claim asking the Court to declare Federal liable for the settlement amount as well as costs and attorney fees associated with the litigation. Also, X-Rite and Thompson filed a third-party claim against American Casualty Company of Reading, Pennsylvania, alleging it, too, is liable for the amounts in controversy under a directors' and officers' liability insurance policy. By agreement of the parties, the question of American Casualty's liability is held in abeyance pending adjudication of the present cross-motions for summary judgment concerning Federal's duty to defend.

II

Michigan law controls in this action, removed to this Court because of diversity of citizenship. Under Michigan law, an insurer has two options when it is asked to defend an action brought against its insured:

It can undertake the defense with notice to the insured that it is reserving the right to challenge its liability on the policy. The second alternative for the insurer is to repudiate liability, refuse to defend and take its chances that there will be a showing that there is no coverage for the insured's liability.

Detroit Edison Co. v. Michigan Mutual Ins. Co., 102 Mich.App. 136, 145, 301 N.W.2d 832 (1982). See also Van Hollenbeck

v. Ins. Co. of North America, 157 Mich.App. 470, 480, 403 N.W.2d 166 (1987) lv. app. denied 428 Mich. 903 (1987); St. Paul Ins. Co. v. Bischoff, 150 Mich.App. 609, 613, 389 N.W.2d 443 (1986). Here, Federal exercised the first option, said in Detroit Edison, supra, 102 Mich.App. at 145, 301 N.W.2d 832, to be the "best" option. Federal undertook to defend X-Rite and Thompson while giving notice of intent to reserve its rights to challenge its liability.

To ensure such a reservation of rights is effective, notice must be timely given. Meirthew v. Last, 376 Mich. 33, 38, 135 N.W.2d 353 (1965); Multi-States Transport, Inc. v. Michigan Mutual Ins. Co., 154 Mich.App. 549, 553-54, 398 N.W.2d 462 (1986) lv. app. denied 428 Mich. 866 (1987). The potential conflict of interests is such that if the insurer has undertaken the defense without having given timely notice, it may be estopped to deny indemnification coverage, based upon a rebuttable presumption that the insured's defense would have been prejudiced. Id. Federal's notice, given approximately nine weeks after it learned of the action, was reasonably timely as a matter of law. Fire Ins. Exchange v. Fox, 167 Mich.App. 710, 714, 423 N.W.2d 325 (1988).

While Michigan law recognizes the potential conflict posed by an insurer's reservation of rights and requires timely notice thereof, it fails to delineate the insured's options upon receipt of such notice. If the insured, upon notice of the reservation of rights, is not content to proceed with the defense provided and controlled by the insurer, can it insist on provision by the insurer of independent counsel or retain counsel of its choice at the insurer's expense; or is it constrained to retain independent counsel at its own expense? Since the Michigan Supreme Court has not definitively spoken on this precise question, this Court must ascertain what the state law is from "all available data." Angelotta v. American Broadcasting Corp., 820 F.2d 806, 807 (6th Cir.1987). "Available data" include "relevant dicta from the state supreme court, decisional law of appellate courts, restatements of law, law review commentaries, and the `majority rule' among other states." Id.

Reviewing these sources, the Court finds relevant dicta in the opinion of Supreme Court Justice Patricia J. Boyle in Allstate Ins. Co. v. Freeman, 432 Mich. 656, 443 N.W.2d 734 (1989), an opinion in which four other justices concurred. Justice Boyle explained that whether an insurer has a duty to defend is a function of the insurance contract. 432 Mich. at 703, 443 N.W.2d 734. "In contrast," she wrote, "once a duty to defend is found, public policy comes to bear upon the exercise of the duty by the insured," citing the following passage from 14 Couch, Insurance 2d (rev....