Hendricks v. Novae Corporate Underwriting, Ltd.

• Decision Date: 18 August 2017
• Docket Number: No. 16-1712,16-1712
• Citation: 868 F.3d 542
• Parties: Diane M. HENDRICKS and Hendricks Holding Company, Inc., Plaintiffs-Appellants, v. NOVAE CORPORATE UNDERWRITING, LTD., Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

868 F.3d 542

Diane M. HENDRICKS and Hendricks Holding Company, Inc., Plaintiffs-Appellants,

v.NOVAE CORPORATE UNDERWRITING, LTD., Defendant-Appellee.

No. 16-1712

United States Court of Appeals, Seventh Circuit.

Argued September 19, 2016

Decided August 18, 2017

Steven D. Pearson, Daryl Davis I, for Plaintiff-Appellant.

Peter Francis Lovato III, John E. Black Jr., W. Joel Vander Vliet, for Defendant-Appellant.

Before Posner, Williams, and Sykes, Circuit Judges.

SYKES, Circuit Judge.

As a general rule, choses in action are freely alienable. But courts can—and indeed must—refuse to enforce certain contractual assignments on public-policy grounds. In Texas "assignments of choses in action that tend to increase and distort litigation" violate public policy and are invalid. State Farm Fire & Cas. Co. v. Gandy , 925 S.W.2d 696, 711 (Tex. 1996). The question in this case is whether that public policy prohibits enforcement of a settlement arrangement in which the defendant admitted liability, stipulated to an amount in damages, and assigned its claim against its insurer to the plaintiff; the plaintiff promised to seek the stipulated damages only from the insurer; and the insurer played no role in the settlement because it had no duty to defend. The defendant's insurer, Novae Corporate Underwriting, Ltd., contends that this settlement-and-assignment is neither enforceable nor binding against it. We agree. This type of settlement scheme is collusive and distorts the adversarial process. The assignment is invalid as a matter of Texas public policy.

I. Background

Novae issued an insurance policy to Fairfax Financial Holdings, the parent company of Cunningham Lindsey Claims Management, Inc. The policy had a $1 million retention and covered both Fairfax and Cunningham. After the retention was exhausted, the policy covered losses resulting from any claim made for a wrongful act, including damages, judgments and costs, charges, expenses incurred, and any "reasonable and necessary legal fees and expenses incurred by the [a]ssureds in the defense or investigation of any [c]laim."

While insured by Novae, Cunningham entered into an agreement with American Patriot Insurance Agency, Inc., to provide claims-handling services for insurance products marketed to roofing contractors. Part of Cunningham's responsibilities involved setting aside appropriate monetary reserves for claims. In December 2004 American Patriot and Diane Hendricks, one of American Patriot's shareholders, sued Cunningham in Texas state court. The suit alleged that Cunningham made misrepresentations and negligently handled claims resulting in unwarranted or underpriced policy renewals. Six years later, while the Texas litigation was ongoing, American Patriot filed for bankruptcy in the Northern District of Illinois, and a trustee was appointed for the bankruptcy estate. In the meantime, Novae denied Cunningham's request for coverage. (The reasons are not important to this appeal.) Throughout the long-running Texas state-court litigation, Novae remained largely uninvolved because the policy did not obligate it to defend Cunningham in any legal action.

In 2012 Cunningham, Hendricks, and American Patriot's trustee in bankruptcy resolved the Texas litigation by entering into a Settlement Agreement, Assignment, and Covenant not to Execute. As relevant here, the agreement included (1) a stipulation to the entry of judgment in the amount of $5.12 million against Cunningham and in favor of Hendricks and American Patriot; (2) an assignment to Hendricks and American Patriot of Cunningham's purported right to recover against Novae in the coverage dispute, effective upon entry of the stipulated judgment; and (3) a covenant by Hendricks and American Patriot not to execute on the judgment against Cunningham. The settlement agreement also contained a provision stating that Illinois law would govern its interpretation. The Texas court entered judgment on May 10, 2012, in accordance with the terms of the settlement.

Hendricks and American Patriot's trustee in bankruptcy then sued Novae in the Northern District of Illinois, invoking the court's diversity jurisdiction and asserting their newly assigned rights. American Patriot later transferred its interest in the suit to Hendricks Holding Company, which was substituted into the litigation. (We will refer to Hendricks and the holding company collectively as "Hendricks" unless the context requires otherwise.)

Novae eventually moved for summary judgment on two grounds: (1) the assignment was invalid as a matter of Texas public policy and (2) the Texas state judgment was not binding on Novae under Texas law. The district court rejected the first argument but accepted the second and accordingly entered judgment for Novae, holding that the insurer owed no duty of indemnification. Hendricks appealed.

II. Discussion

We review a summary judgment de novo. See Burton v. Downey , 805 F.3d 776, 783 (7th Cir. 2015). First up is a choice-of-law question: Does Illinois or Texas law govern the validity of the assignment? To decide this question, we apply the choice-of-law rules of the forum state—here, Illinois. Fulcrum Fin. Partners v. Meridian Leasing Corp. , 230 F.3d 1004, 1011 (7th Cir. 2000). Under Illinois law the contract's choice-of-law clause generally controls, id. , which in this case points to Illinois law. But there are two exceptions to this rule. The law chosen by the parties cannot create a result that is contrary to the chosen state's fundamental public policy, id. , and the law chosen by the parties cannot create a result that is contrary to the "fundamental policy of a state which has a materially greater interest" in the subject matter of the litigation, Int'l Surplus Lines Ins. Co. v. Pioneer Life Ins. Co. of Ill. , 209 Ill.App.3d 144, 154 Ill.Dec. 9, 568 N.E.2d 9, 14 (1990) (quoting RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 187 (1971) ).

The first exception doesn't apply here. The parties chose Illinois law, and there's no concern that its application would violate Illinois public policy. Turning to the second exception, the Restatement of Conflict of Laws provides some guidance. See Morris B. Chapman & Assocs., Ltd. v. Kitzman , 193 Ill.2d 560, 251 Ill.Dec. 141, 739 N.E.2d 1263, 1269 (2000) ("Ordinarily, Illinois follows the Restatement (Second) of Conflict of Laws (1971) in making choice-of-law decisions."). Whether another state has a materially greater interest in the subject matter of the litigation depends on "(a) the place of contracting, (b) the place of negotiation of the contract, (c) the place of performance, (d) the location of the subject matter of the contract, and (e) the domicil, residence, nationality, place of incorporation and place of business of the parties." RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 188 (1971).

The parties agree that the first two factors are neutral; the record does not reflect where the settlement agreement was either negotiated or executed. The last factor, too, is neutral. Based on domicile, residence, and place of business, neither state's interest deserves greater weight. Cunningham is a Delaware corporation with a principal place of business in Texas. Diane Hendricks is a resident of Wisconsin. And American Patriot was a Wisconsin corporation headquartered in Illinois.

The only two operative factors, then, are the place of performance and the location of the subject matter of the contract. The settlement agreement contemplated multiple performances occurring in both Texas and Illinois. The agreement was effective on the date the bankruptcy court approved it; that court sits in Illinois. But the agreement called for the entry of a stipulated judgment in the amount of $5.12 million in the state-court litigation in Texas. The agreement also required Cunningham to make a lump-sum payment in the amount of $650,000 to American Patriot's bankruptcy trustee, and the trustee was to pass on a portion of that payment to Hendricks. Both payments were to take place in Chicago. Finally, the agreement prohibited Hendricks from executing on the judgment against Cunningham, but because this performance is a form of forbearance, it cannot be assigned a geographical location.

When the place of performance encompasses more than one state, the place of the initial contemplated performance is sometimes used as a tiebreaker. See Houlihan v. McCourt , No. 00 C 3390, 2002 WL 1759822, at *5 (N.D. Ill. July 29, 2002). That doesn't help us here. The contract initially required performance in both Illinois and Texas. The place of performance, then, results in a draw.

The fourth factor—the location of the subject matter of the contract—is not up for debate and is decisive here. The agreement is centered entirely on resolving the Texas state litigation. The recitals describe the dispute pending in Texas and state that the "[p]arties desire to resolve all disputes between them by entering into this Agreement, including those disputes brought in the Cunningham Action." The subject matter of the agreement is clear and singularly focused on settling the litigation in Denton County, Texas; its validity thus implicates the public policy of that state. We conclude, as did the district judge, that Texas has a materially greater interest in the subject matter of this suit than does Illinois. Texas law controls.

The Texas Supreme Court's magisterial decision in State Farm Fire & Casualty Co. v. Gandy is the most comprehensive exposition of Texas policy on the assignability of choses in action. 925 S.W.2d 696 (Tex. 1996). Gandy begins with a history of the common-law principle, explaining that "[a]t early common law, a chose in action could not be assigned." Id. at 705. The early rule had several justifications, two of which were primary: the law's aversion to the multiplication of suits and the idea that rights at common law were "relational and situational—that is, determined by the identity of the particular individuals involved...