Okada v. MGIC Indem. Corp.

• Decision Date: 31 July 1986
• Docket Number: No. 85-2501,85-2501
• Citation: 795 F.2d 1450
• Parties: Glenn K. OKADA, William E. Takabayashi, and Richard A. Cooke, Jr., Plaintiffs-Appellees, v. MGIC INDEMNITY CORP., also known as Ambac Indemnity Corp. and Wmbic Indemnity Corp., Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1450

795 F.2d 1450

Glenn K. OKADA, William E. Takabayashi, and Richard A Cooke, Jr., Plaintiffs-Appellees, v. MGIC INDEMNITY CORP., also known as Ambac Indemnity Corp. and Wmbic Indemnity Corp., Defendant-Appellant.

No. 85-2501.

United States Court of Appeals Ninth Circuit.

Argued and Submitted March 25, 1986.

Decided July 31, 1986.

John S. Edmunds, Honolulu, Hawaii, for plaintiffs-appellees.

Wallace A. Christensen, Washington, D.C., for defendant-appellant.

Appeal from the United States District Court for the District of Hawaii.

Before FERGUSON, CANBY, and HALL, Circuit Judges.

FERGUSON, Circuit Judge:

Defendant MGIC Indemnity Corporation ("MGIC") appeals the district court's grant of summary judgment in favor of plaintiffs Glenn K. Okada, William E. Takabayashi, and Richard A. Cooke, Jr. ("insureds"), who were insured under a Directors and Officers Errors and Omissions policy issued by MGIC. The district court ruled that MGIC had a duty to defend the insureds in lawsuits alleging losses caused by the insureds as directors of a savings and loan association ("the underlying lawsuits"); that more than one potentially covered "loss" was involved; and that MGIC acted in bad faith by refusing to pay, without condition, the insureds' defense costs in the underlying lawsuits, refusing to affirm or deny coverage of claims in the underlying lawsuits, and refusing to enter settlement negotiations in the underlying lawsuits. Okada v. MGIC Indemnity Corp., 608 F.Supp. 383 (D.Hawaii 1985).

We affirm the rulings finding a duty to defend and more than one potentially covered "loss," but reverse the ruling that MGIC acted in bad faith.

I.

Plaintiff insureds were three of the eight directors of First Savings & Loan Association of Hawaii ("First Savings"). MGIC issued a Directors and Officers Errors and Omissions insurance policy, the relevant terms of which are:

[T]he insurer agrees:

(a) With the Directors and Officers of the Association that if, during the policy period, any claim or claims are made against the Directors and Officers, individually or collectively, for a Wrongful Act, the Insurer will pay, in accordance with the terms of this policy, on behalf of the Directors and Officers or any of them, their heirs, legal representatives or assigns all Loss which the Directors and Officers or any of them shall become legally obligated to pay.

....

1. DEFINITIONS

....

(d) The term "Loss" shall mean any amount which the Directors and Officers are legally obligated to pay or for which the Association is required to indemnify the Directors or Officers, or for which the Association has, to the extent permitted by law, indemnified the Directors and Officers for a claim or claims made against the Directors and Officers, for Wrongful Acts and shall include but not be limited to damages judgments, settlements, costs (exclusive of salaries of officers or employees), and defense of legal actions, claims or proceedings and appeals therefrom and cost of attachment or similar bonds; provided however, such Loss shall not include fines or penalties imposed by law or matters which may be deemed uninsurable under the law pursuant to which this policy shall be construed.

....

4. LIMITS OF LIABILITY

....

(d) Claims based on or arising out of the same act, interrelated acts, or one or more series of similar acts, of one or more of the Directors or Officers shall be considered a single Loss and the Insurer's liability shall be limited to the limit of liability stated in Clause 4(b) and 4(c). In the event that more than one Director or Officer is included in the same Loss, it shall be expressly understood that the total amount of such Loss, for the purpose of determining the aggregate limit for each such involved Director or Officer, shall be apportioned pro rata among each such involved Director or Officer unless otherwise mutually agreed upon by the Director or Officer and the Insurer.

5. COSTS, CHARGES AND EXPENSES

(a) No costs, charges and expenses shall be incurred or settlements made without the Insurer's consent which consent shall not be unreasonable withheld; however, in the event such consent is given, the Insurer shall pay, subject to the provisions of Clause 4, such costs, settlements, charges and expenses.

....

(c) The Insurer may at its option and upon request, advance on behalf of the Directors or Officers, or any of them, expenses which they have incurred in connection with claims made against them, prior to disposition of such claims, provided always that in the event it is finally established the Insurer has no liability hereunder, such Directors and Officers agree to repay to the Insurer, upon demand, all monies advanced by virtue of this provision.

The policy covered each loss for up to $1 million each year for each director, with an aggregate annual limit for each director.

In 1980, First Savings became insolvent and the Federal Savings and Loan Insurance Corp. ("FSLIC") took it over. In 1982, First Hawaiian Bank and FSLIC, as assignees of various shareholders' direct and derivative claims, filed the underlying lawsuits in federal district court against all eight directors of First Savings. See FSLIC v. Alexander, 590 F.Supp. 834 (D.Hawaii 1984). Each director hired defense counsel in the underlying lawsuits and sought payment from MGIC for the fees incurred. MGIC agreed to pay the costs as they came due, but reserved its rights to contest coverage and to demand reimbursement if the policy did not cover the claims involved.

All eight directors accepted payments with MGIC's reservation of rights for nearly two years. After that time three of them, the insureds here, refused to accept payment with the attached reservation of rights. MGIC therefore stopped paying the defense costs of the three directors, who then filed this action in federal district court seeking a declaratory judgment that MGIC had a duty to defend the underlying lawsuits without condition. The defense costs in the underlying lawsuits exceeded $1 million at the time of the district court decision.

The district court granted the insureds' motion for summary judgment. It ruled, first, that the policy was ambiguous because clause 5(c) conflicted with clause 1(d) and that the policy should be read against MGIC as the drafter of the adhesion contract. The court concluded that MGIC had a duty to pay the insureds' defense costs in the underlying action as they came due.

Second, the district court ruled that the underlying lawsuits involved separate alleged acts, each of which was a potential "loss" and could have given rise to a distinct claim. Therefore, even though the acts culminated in one result, First Savings' financial collapse, multiple potentially covered "losses" were involved. Because of the policy limits, MGIC could be liable for "multiple millions" in the underlying lawsuits.

Finally, the district court found that MGIC acted in bad faith because it "has refused to affirm or deny coverage, tender defense costs when due, or enter into settlement negotiations." MGIC timely appealed.

II.

The district court had diversity jurisdiction over this case. ¹ "A federal court applies the choice of law rules of the state in which it sits ... to determine the substantive law to apply in a diversity action." Lettieri v. Equitable Life Assurance Society of the United States, 627 F.2d 930, 932 (9th Cir.1980) (citing Klaxon Co. v. Stentor Electric Manufacturing Co., 313 U.S. 487, 496, 61 S.Ct. 1020, 1021, 85 L.Ed. 1477 (1941)). Hawaii courts apply Hawaii state law when the acts covered by the policy occur in Hawaii, the insureds are Hawaii citizens, and the insurance company is not a Hawaii citizen. See, e.g., Crawfor v. Ranger Insurance Co., 653 F.2d 1248, 1250 (9th Cir.1981); State Farm Mutual Automobile Insurance Co. v. Bailey, 58 Hawaii 284, 568 P.2d 1185 (1977). Thus, Hawaii law governs this case.

We review de novo grants of summary judgment, First Insurance Co. of Hawaii, Inc. v. Hawaii, 66 Hawaii 413, 416, 665 P.2d 648, 651 (1983), and contract interpretations, Hanagami v. China Airlines, Ltd., 688 P.2d 1139, 1144 (Hawaii 1984).

III.

Clause 5 of the insurance policy, read as a whole and subject to the reasonable expectations of the policyholder, establishes this policy as a duty to defend policy. Under clause 5(a), although the insurer does not have a duty to pay frivolous or unreasonable costs, it is required to pay those reasonable costs requested by the insureds. This clause establishes a duty to pay defense costs as they come due, with the insurer reserving the right not to pay unreasonable costs.

Clause 5(c) buttresses this interpretation of clause 5(a). Since clause 1(d) defines a "Loss" as defense costs, and requires the Insurer to pay for covered claims, clause 5(c) can refer only to potentially covered claims for which costs may be reimbursed if the claims are not covered. Thus, clause 5(c) is merely a reservation of rights clause that attempts to contract out of the general rule that insurers have a duty to defend potentially covered claims. See First Insurance Co. of Hawaii v. Hawaii, 66 Hawaii 413, 665 P.2d 648 (1983) (parties may alter common law rules of contract interpretation by use of clear and unambiguous language). Thus, clause 5(a) creates a duty to pay reasonable defense costs for uncontestedly covered claims, whereas 5(c) is an attempt to escape the duty to defend potentially covered claims, or claims whose coverage has not yet been established or conceded.

However, 5(c) is ambiguous because it does not specifically state which types of claims it is intended to cover, and thus it may confuse insureds. When an insurance policy is ambiguous, it is read in favor of the insured as a contract of adhesion. Hurtig v. Terminix Wood Treating & Contracting Co., 692 P.2d 1153 (Hawaii 1984). In addition, the ambiguity defeats the attempt to contract out of the duty to defend potentially covered claims. Therefore,...