Montgomery Ward & Co., Inc. v. Pacific Indem. Co.

• Decision Date: 28 March 1977
• Docket Number: No. 76-2092,76-2092
• Citation: 557 F.2d 51
• Parties: MONTGOMERY WARD & CO., INC. v. PACIFIC INDEMNITY COMPANY, Appellant. . Submitted under Third Circuit Rule 12(6)
• Court: U.S. Court of Appeals — Third Circuit

Page 51

557 F.2d 51

MONTGOMERY WARD & CO., INC. v. PACIFIC INDEMNITY COMPANY, Appellant.

No. 76-2092.

United States Court of Appeals Third Circuit.

Submitted under Third Circuit Rule 12(6) March 28, 1977.

Decided June 7, 1977.

John W. Jordan IV, Thomson, Rhodes & Grigsby, Pittsburgh, Pa., for appellant.

Stanley V. Ostrow, and G. Ashley Woolridge, Kaplan, Finkel, Lefkowitz, Roth & Ostrow, Pittsburgh, Pa., for appellee.

Before VAN DUSEN, GIBBONS and GARTH, Circuit Judges.

OPINION OF THE COURT

VAN DUSEN, Circuit Judge.

This appeal is from an award of attorney's fees incurred as a result of bringing a declaratory judgment action in a diversity case. ¹ Although the district court recognized that state law will normally govern the award of attorney's fees in diversity cases, the court found that, irrespective of state law and as part of the historic equity jurisdiction of the federal courts, the court could award attorneys' fees where bad faith or its equivalent is found to exist. Although our reasoning differs from that of the district court, we affirm its grant of a motion for summary judgment and award of fees.

I.

Montgomery Ward (Montgomery) commenced this declaratory judgment action on December 5, 1974, to obtain a determination that Pacific Indemnity Company (Pacific) was obligated to defend and indemnify it ² in a products liability diversity action which was then pending in the United States District Court for the Western District of Pennsylvania. Montgomery was named as "a person insured" on the "vendors endorsement" to the policy Pacific had issued to Royal Industries, the manufacturer and also a defendant in the tort action. ³

The relief sought included prayers that the district court enter a declaratory judgment construing the pertinent provisions of the Vendor Insurance Endorsement issued by Pacific and designating Montgomery as a named insured, determine the respective liabilities of Pacific and Montgomery under the endorsement, determine that Montgomery should be afforded coverage under the endorsement in regard to the personal injury action against Montgomery pending in the same court, and order that Montgomery be entitled to its private counsel fees and expenses in the personal injury action as well as in the declaratory judgment action.

On June 24, 1975, the products liability claim was settled. ⁴ Pacific paid $50,000. of the settlement and reimbursed Montgomery for its costs and counsel's fees incurred in defending the products liability case to that point in the litigation. ⁵ Pacific did not reimburse Montgomery for the fees incurred in bringing the declaratory judgment action. Montgomery continued to prosecute the present action solely to recover the attorneys' fees expended in bringing the declaratory judgment action. The district court found that Pacific had a duty to defend Montgomery under the provisions of the contract and that Pacific's obduracy in refusing to either defend Montgomery or acknowledge its contractual obligations before settlement was not taken in good faith because the refusal was made without reasonable cause. ⁶ The district court's opinion acknowledged Pennsylvania's adherence to the American Rule, which disfavors the allowance of attorneys' fees in the absence of statutory or contractual obligation, ⁷ but went on to conclude that the state law in this area would be inapplicable where bad faith was found. The court stated:

"The power to award such fees which are not ordinarily included in the costs is part of the historical equity jurisdiction of the federal courts. Vaughn (Vaughan) v. Atkinson, supra, 369 U.S. (527) at 530 (82 S.Ct. 997, 8 L.Ed.2d 88). Therefore, where bad faith or its equivalent is found to exist, the court may award attorneys' fees irrespective of state law since the court's equitable powers transcend the applicable state law under those circumstances. See Sprague v. Ticonic National Bank, 307 U.S. 161, 166 (59 S.Ct. 777, 83 L.Ed. 1184) (1939); Hall v. Cole, 412 U.S. 1, (93 S.Ct. 1943, 36 L.Ed.2d 702) (1974). And this is true notwithstanding the general rule that state law will normally govern the award of attorneys' fees in diversity cases. Toland v. Technicolor, Inc., 467 F.2d 1045, 1047 (10th Cir. 1972); Culbertson v. Jno. McCall Coal Co., Inc., 495 F.2d 1403, 1406 (4th Cir.), cert. den. 419 U.S. 1033, (95 S.Ct. 516, 42 L.Ed.2d 308) (1975). Thus, while we agree with defendant that the law of Pennsylvania would normally preclude the award of attorneys' fees, see Arcos Corp. v. American Mutual Liability Ins. Co. (350 F.Supp. 380 (E.D.Pa.), aff'd without opinion, 485 F.2d 678 (3d Cir. 1973)), the rule is inapplicable if defendant's refusal to defend was in bad faith."

The district court did not consider whether Pennsylvania courts would apply a "bad faith" exception to the American Rule under the circumstances of this case.

II.

A. Alyeska and Diversity Actions

The question of the recovery of attorneys' fees, was recently considered by the Supreme Court in Alyeska Pipeline Service Co. v. Wilderness Society, 421 U.S. 240, 95 S.Ct. 1612, 44 L.Ed.2d 141 (1975). After pointing out the limited situations in which attorneys' fees may be awarded in federal question cases, the Court noted "31. A very different situation is presented when a federal court sits in a diversity case. '(I)n an ordinary diversity case where the state law does not run counter to a valid federal statute or rule of court, and usually it will not, state law denying the right to attorney's fees or giving a right thereto, which reflects a substantial policy of the state, should be followed.' 6 J. Moore, Federal Practice P 54.77(2), pp. 1712-1713 (2d ed. 1974) (footnotes omitted). See also 2 S. Speiser, Attorneys' Fees §§ 14:3; 14:4 (1973) (hereinafter Speiser); Annotation, Prevailing Party's Right to Recover Counsel Fees in Federal Courts, 8 L.Ed.2d 894, 900-901. Prior to the decision in Erie R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938), this Court held that a state statute requiring an award of attorneys' fees should be applied in a case removed from the state courts to the federal courts: '(I)t is clear that it is the policy of the state to allow plaintiffs to recover an attorney's fee in certain cases, and it has made that policy effective by making the allowance of the fee mandatory on its courts in those cases. It would be at least anomalous if this policy could be thwarted and the right so plainly given destroyed by removal of the cause to the federal courts.' People of Sioux County v. National Surety Co., 276 U.S. 238, 243, 48 S.Ct. 239, 241, 72 L.Ed. 547 (1928). The limitations on the awards of attorneys' fees by federal courts deriving from the 1853 Act were found not to bar the award. Id., at 243-244, 48 S.Ct. at 241. We see nothing after Erie requiring a departure from this result. See Hanna v. Plumer, 380 U.S. 460, 467-468, 85 S.Ct. 1136, 1141-1142, 14 L.Ed.2d 8 (1965). The same would clearly hold for a juridically created rule, although the question of the proper rule to govern in awarding attorneys' fees in federal diversity cases in the absence of state statutory authorization loses much of its practical significance in light of the fact that most States follow the restrictive American rule. See 1 Speiser §§ 12:3; 12:4."

Id. at 259, note 31, 95 S.Ct. at 1622 (emphasis supplied).

The plain meaning of the wording quoted is that state rules concerning the award of attorneys' fees are to be applied in diversity cases whether these rules provide for an award or deny it, provided such rules do not run counter to federal statutes or policy considerations. ⁸ See Tryforos v. Icarian Development Company, S. A., 518 F.2d 1258, 1265 (7th Cir. 1975), cert. denied, 423 U.S. 1091, 96 S.Ct. 887, 47 L.Ed.2d 103 (1976).

". . . choices between state and federal law are to be made not by application of any automatic 'litmus paper' criterion, but rather by reference to the policies underlying the Erie rule. . . .

"The Erie rule is rooted in part in a realization that it would be unfair for the character or result of a litigation materially to differ because the suit had been brought in a federal court.

"The decision was also in part a reaction to the practice of 'forum-shopping' which had grown up in response to the rule of Swift v. Tyson, 304 U.S. at 73-74, 58 S.Ct. at 819-820. That the York test was an attempt to effectuate these policies is demonstrated by the fact that the opinion framed the inquiry in terms of 'substantial' variations between state and federal litigation. 326 U.S., at 109, 65 S.Ct. at 1469. Not only are nonsubstantial, or trivial, variations not likely to raise the sort of equal protection problems which troubled the Court in Erie ; they are also unlikely to influence the choice of a forum. The 'outcome-determination' test therefore cannot be read without reference to the twin aims of the Erie rule: discouragement of forum-shopping and avoidance of inequitable administration of the laws. 9 Hanna v. Plumer, 380 U.S. 460, 467-68 & note 9, 85 S.Ct. 1136, 14 L.Ed.2d 8. The Alyeska Court's citation to Hanna is significant because the same policy considerations which formed the foundation of Hanna and the line of cases following Erie would apply, of necessity, were a federal court to engraft federal notions of attorneys' fees awards onto state substantive rights tried in a diversity action. It is apparent that permitting an award of attorneys' fees in a federal court but denying them for an identical action brought in a state court would represent a significant reason to choose the federal forum. Even if we assume that this difference could be restricted to cases involving obdurate conduct or bad faith, it is clear that the possibility of such an award in many cases would color the substantive aspects of the case and could significantly alter the legal theories presented by the parties as a claim or defense. Under Erie and Hanna,...