K & T Enterprises, Inc. v. Zurich Ins. Co.

Decision Date09 October 1996
Docket NumberNos. 94-2220,94-2224,s. 94-2220
Citation97 F.3d 171
PartiesK & T ENTERPRISES, INC., d/b/a Dairy Queen of Blissfield, and Tahani Khoury, Plaintiffs-Appellees, Cross-Appellants, v. ZURICH INSURANCE COMPANY, Defendant-Appellant, Cross-Appellee.
CourtU.S. Court of Appeals — Sixth Circuit

Stuart A. Sklar (argued and briefed), Jo Robin Davis (briefed), Michael H. Fabian (briefed), Fabian, Sklar & Davis, Farmington Hills, MI, for K & T Enterprises, Inc., Tahani Khoury in Nos. 94-2220, 94-2224.

John W. Knight, Southfield, MI, Ignatius John Melito (argued and briefed), Melito & Adolfsen, New York City, John J. McInerney, Leahy, Einsenberg & Fraenkel, Chicago, Il, for Zurich Insurance Company in Nos. 94-2220, 94-2224.

David S. Swartz, Bruce N. Elliott, Joseph W. Phillips, Conlin, McKenney & Philbrick, Ann Arbor, MI, for Society Bank, Michigan in No. 94-2224.

Before: MERRITT, CONTIE, and BOGGS, Circuit Judges.

BOGGS, Circuit Judge.

When is fire not the enemy of ice? When the 50% shareholder of a failing Dairy Queen franchise in Blissfield, Michigan torches that franchise outlet for profit, and his wife, who also owns 50% of the franchise, is still permitted by a district court upon a jury verdict to collect fire insurance proceeds for the damage caused by the arson. We reverse this decision, which, if left to stand, would encourage individuals to use the corporate veil to perpetrate insurance fraud. 1

I

Kareem and Tahani Khoury, husband and wife, purchased real estate in Blissfield upon which they built a Dairy Queen franchise incorporated as K & T Enterprises ("K & T"), with each of them holding half of the stock. To finance their business, they borrowed from the Society Bank, Michigan ("Society Bank") and granted the bank a mortgage on the property. Kareem was the president and sole officer. He worked in the cooking area of the Dairy Queen. He also kept the books and performed most management tasks, such as writing checks and negotiating with banks and lessors, while Tahani worked in the front of the store, decorating ice cream cakes and supervising the employees there.

The Khourys obtained fire insurance for K & T from the Zurich Insurance Company ("Zurich"). The policy named K & T as the insured party. Two parts of that insurance policy are particularly relevant to this case. The first provided that the policy is void in any case of misrepresentation by K & T, either before the insurance contract was signed or after, and the second provided that no loss or damage claim would be paid out if losses or damage resulted from a dishonest or criminal act that K & T committed, whether acting alone or in collusion with other persons.

The Khourys' Dairy Queen opened in July of 1989 and quickly began to fail. Blissfield is a town with a population of only 2,550, but has 10 restaurants, including one next door to the Dairy Queen. Moreover, an ice cream parlor is nearby. By January 1990, the Khourys were in default on their franchise payments and in danger of losing their franchise. The Dairy Queen's financial problems continued into the fall of 1990. During that period, Kareem Khoury asked Brent Sweeney, a former employee of the Dairy Queen, whether he would be willing to burn down the business in exchange for $20,000. Sweeney agreed, and early on the morning of January 22, 1991, using a key to the Dairy Queen and gasoline supplied by Kareem, Sweeney set fire to the restaurant. Before trial, the Khourys and Zurich stipulated that (including interest) the fire caused $383,424 in damage to the building, $114,794 in damage to business and personal property, and $5,000 in damage to business revenues.

Later on the morning of the fire, Sweeney went to the Khourys' home. Because he had burned his hands and eyebrows in the fire, he wore gloves and sunglasses inside the Khourys' home to hide the burns. Although Tahani was present, she was apparently not suspicious of Sweeney's behavior and appearance on this occasion. After that, Kareem and Tahani met Sweeney at a mall where Kareem made a partial payment to Sweeney. Sweeney testified that even after this meeting Tahani was still unaware of the plan to commit arson.

K & T, through both Kareem and Tahani, submitted sworn statements of proof of loss to Zurich on March 15, 1991. At the bottom of each statement was the following disclaimer: "The said loss did not originate by any act, design or procurement on the part of your insured, or this affiant; nothing has been done by or with the privity or consent of your insured or this affiant, to violate the conditions of the policy, or render it void...." Both Tahani and Kareem signed this form. During Zurich's investigation of the Khourys' claim, Tahani and Kareem both gave sworn testimony under oath, as required by the insurance policy, on September 12, 1991. When asked about the disclaimer, Kareem maintained that he did not set the fire at the Dairy Queen, pay Sweeney to do it, or instruct anyone else to set the fire.

Sweeney eventually confessed to arson and, after implicating Kareem, was sentenced to one year in prison. On October 31, 1991, Zurich, after finishing its investigation, denied liability under its policy issued to K & T for the damages caused by the fire, on the basis of false disclaimers in the sworn statements of loss and the two relevant parts of the insurance contract voiding the policy in the case of misrepresentations or criminal acts by the insured, K & T. K & T filed a complaint based on diversity jurisdiction against Zurich in the United States District Court for the Eastern District of Michigan on November 21, 1991, alleging breach of contract, violations of Michigan insurance statutes, negligence, and intentional infliction of emotional distress.

On July 16, 1992, Kareem Khoury was indicted in the United States District Court for the Eastern District of Michigan for violating 18 U.S.C. §§ 844(i) (arson) & 1341 (mail fraud for submitting the fraudulent proof of loss statements). He pled guilty to the mail fraud count and was sentenced to serve 21 months in prison.

The Khourys, Zurich, and Society Bank filed summary judgment motions in the civil action. The district court's order denied both the Khourys' and Zurich's motions, but granted Society Bank's motion. (Zurich originally appealed from this decision as well, but has since reached a settlement with Society Bank, and consequently dismissed it as a party to this appeal. Therefore, except in connection with a subrogation issue to be discussed below, Society Bank's involvement in this case is not relevant to this appeal.) The district court held that there was a material factual dispute about whether Tahani knew of the arson when she signed the proofs of loss and testified under oath, and that under Michigan law her ignorance would permit K & T to recover, unless it could be proved at trial that Kareem had complete control of K & T. Kareem stipulated to withdraw as a plaintiff on May 24, 1994. A trial was then held on July 5-6, 1994. The jury found through special interrogatories that Tahani did not know about the arson, that Kareem did not exercise complete control over K & T, and that Zurich had acted in bad faith in denying K & T's claim.

Zurich filed a motion for judgment as a matter of law or alternatively for a new trial. On September 21, 1994, the district court granted the motion for judgment as a matter of law with respect to the jury's finding of bad faith, but denied the motion as to the other portions of the verdict. Zurich timely appealed on October 20, 1994. On October 27, K & T and Tahani Khoury cross-appealed the district court's reversal of the jury's bad faith finding. K & T moved in its brief for sanctions on the ground that Zurich's appeal was frivolous. Zurich then moved for sanctions in its reply brief against K & T on the ground that K & T's motion for sanctions was itself frivolous.

At oral argument, K & T's counsel represented to the court that Tahani now owns all of the shares of K & T. We can infer from K & T's brief, however, that this event occurred after the case was decided by the district court. K & T's Br. at 1.

This appeal presents five issues for resolution: (1) what standard of review applies to the district court's denial of summary judgment and denial of a Fed.R.Civ.P. 50(b) motion for judgment as a matter of law in this case; (2) whether the district court should have granted judgment as a matter of law to Zurich, since Michigan law does not require the arsonist(s) to dominate a corporation completely in order for innocent shareholders in the corporation to be denied recovery; (3) whether the district court should have granted judgment as a matter of law to Zurich because K & T made misrepresentations to Zurich in the sworn statements of proof of loss and in other sworn testimony; (4) whether the district court correctly granted Zurich's motion for judgment as a matter of law with respect to the issue of Zurich's alleged bad faith denial of liability to K & T; and (5) whether Zurich's appeal or K & T's motion for sanctions are frivolous and thus sanctionable.

II. ZURICH'S APPEAL
A. Standard of Review

Zurich does not make clear whether it is appealing from the district court's denial of summary judgment, from the denial of its motion for judgment notwithstanding the verdict or in the alternative for a new trial, or from both. We agree with the Fourth Circuit, which held in Chesapeake Paper Prods. Co. v. Stone & Webster Eng'g Corp., 51 F.3d 1229, 1236 (4th Cir.1995), that, "[r]eviewing a Rule 50 determination is preferable to reviewing a summary judgment decision because the Rule 50 decision is based on the complete trial record and not the incomplete pretrial record available at summary judgment." Therefore, we also hold that in cases where an appellant made a Rule 56 motion for summary judgment that was denied, makes those same arguments in a Rule 50(a) motion at the...

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