Stonewall Ins. Co. v. Argonaut Ins. Co.

Decision Date03 December 1999
Docket NumberNo. 96 C 3261.,96 C 3261.
PartiesSTONEWALL INSURANCE COMPANY, an Alabama Corporation, Plaintiff, v. ARGONAUT INSURANCE COMPANY, a California Corporation, Defendant. Argonaut Insurance Company, Counter-Plaintiff, v. Stonewall Insurance Company, Counter-Defendant.
CourtU.S. District Court — Northern District of Illinois

Kathy Pinkstaff Fox, Kristin M. Buchholz, Wildman, Harrold, Allen & Dixon, Chicago, IL, Robert L. Kiesler, John J. Piegore, Kiesler & Berman, Chicago, IL, Deborah F Cohen, Aaron Krauss, Donna Elizabeth Correll, Christine L Schubert, Charles E. Leasure, III, Pepper, Hamilton & Scheetz, Philadelphia, PA, Jacqueline M Satherlie, Kiesler & Berman, Chicago, IL, James Thomas Nyeste, Attorney at Law, Glencoe, IL, for Stonewall Insurance Company.

Katherine Smith Dedrick, Kevin J. Kuhn, Kent J. Cummings, Hinshaw & Culbertson, Chicago, IL, for Argonaut Insurance Company.


NORGLE, District Judge.

Before the court are (1) Stonewall Insurance Company's Objections to the Magistrate Court's Report recommending that its motion for summary judgment be "stricken" as moot; and (2) Argonaut Insurance Company's Motion for Entry of Judgment. For the following reasons, the court (1) sustains Stonewall's Objections, but denies its motion for summary judgment; and (2) grants in part and denies in part Argonaut's Motion for Entry of Judgment.


This diversity action involves the business of reinsurance and California law. "Reinsurance occurs when one insurer (the `ceding insurer' or `reinsured') `cedes' all or part of the risk it underwrites, pursuant to a policy or group of policies, to another insurer." Unigard Sec. Ins. Co., Inc. v. North River Ins. Co., 4 F.3d 1049, 1053 (2nd Cir.1993); see also Continental Cas. Co. v. Stronghold Ins. Co., Ltd., 77 F.3d 16, 17 (2nd Cir.1996); Prudential Reins. Co. v. Superior Ct., 3 Cal.4th 1118, 14 Cal.Rptr.2d 749, 753, 842 P.2d 48 (1992); In re Mission Ins. Co., 41 Cal.App.4th 828, 48 Cal.Rptr.2d 209, 211 (1995); Excess and Cas. Reins. Assoc. v. Calif. Ins. Comm., 656 F.2d 491, 492 (9th Cir.1981); Cal.Ins. Code § 620. Put another way, "[r]einsurance is purchased by insurance companies to insure their liability under policies written to their insureds." North River Ins. Co. v. CIGNA Reinsurance Co., 52 F.3d 1194, 1199 (3rd Cir.1995).

"The reinsurance relationship depends on the reinsurer and the reinsured observing high levels of good faith[,]" id., and thus their relationship is "often characterized as one of `utmost good faith.'" Unigard, 4 F.3d at 1054; see also Northwestern Mut. Fire Ass'n. v. Union Mut. Fire Ins. Co., 144 F.2d 274, 276 (9th Cir. 1944). For example, under a "follow the fortunes" clause typically found in a reinsurance contract, "[a] reinsurer cannot second guess the good faith liability determinations made by its reinsured...." Christiania Gen. Ins. Corp. v. Great American Ins. Co., 979 F.2d 268, 280 (2nd Cir.1992). At the same time, however, the reinsurer has the right to question whether the ceding insurer's claims stem from reinsured losses, and therefore the reinsurer must have the cooperation of the ceding insurer. See Unigard, 4 F.3d at 1054, 1069; CIGNA, 52 F.3d at 1199-1200; cf. Cal.Ins.Code § 622.1 It is this proposition that has spawned this messy, protracted litigation between a reinsurer, Stonewall Insurance Company, and a ceding insurer, Argonaut Insurance Company. A summary follows.

Pursuant to a reinsurance contract, Argonaut sought indemnification (i.e., reimbursement) from Stonewall after Argonaut agreed to settle a complex environmental pollution insurance coverage dispute with its original insured, Hughes Aircraft Company.

Hughes had filed separate lawsuits against Argonaut and several other primary insurers in the Superior Court of the State of California, seeking coverage for environmental pollution that its manufacturing plant had leaked into the City of Fullerton's sanitary sewer system and alleging bad faith for wrongful refusal to defend in litigation stemming from past contamination at its plant property. In that underlying pollution litigation, Hughes was left to provide its own defense, and ultimately settled the claims against it. Hughes' insurers, which, in addition to Argonaut, included Hartford Accident and Indemnity Company, Insurance Company of North America, and various syndicates of Lloyd's of London,2 had issued primary insurance policies to Hughes at various times over the last several decades.

Argonaut had issued Hughes two primary insurance policies during this time period. One policy covered the period January 1, 1970 to January 1, 1971, and did not contain a pollution exclusion. This policy was reinsured by various syndicates of Lloyds of London and included a unique provision that gave Lloyds full and complete control of any claim asserted under the primary policy. The other Argonaut policy, most relevant here, covered Hughes for the period January 1, 1972 through April 1, 1975 for $1 million per occurrence, and contained a pollution exclusion, which excluded pollution coverage unless the pollution was "sudden and accidental." (See Compl., Ex. A.) This policy was reinsured by Stonewall via three facultative certificates of insurance.3 (See Compl., Exs. B, C, and D.)

The first of the Hughes primary coverage cases to go to trial was Hughes Aircraft Co. v. Brian E. Beagley.4 On November 14, 1995, a California jury found in favor of Hughes and against Beagley in a special verdict on liability. Specifically, the jury found four different occurrences or sources of environmental contamination (two in 1960 and two in 1961) at Hughes' Fullerton plant, thereby triggering Beagley's coverage. The jury also found that Beagley acted in bad faith for its wrongful refusal to defend Hughes.

Before the damages portion of the trial began, however, Hughes and Beagley reached a settlement and the case was dismissed, without the entry of a final judgment. Although Argonaut did not directly participate in the Beagley litigation it had closely monitored the case because of the potential ramifications the litigation would have on Argonaut's ongoing coverage dispute with Hughes. Argonaut though later settled with Hughes ("the Fullerton Settlement") in early 1996; the Fullerton Settlement included a full site release and encompassed all of Argonaut's policies. Argonaut, in turn, sought indemnification under its reinsurance policy with Stonewall.5

Stonewall, however, balked at submitting the reinsurance monies to Argonaut. Stonewall questioned Argonaut's candidness about the details of the Fullerton settlement and was allegedly unable to discern or meaningfully review the information and mass of documents that Argonaut had submitted. Stonewall contended that Argonaut had violated a provision of the reinsurance contract which required that Argonaut cede its reinsurance claim based on its reasonable, legitimate settlement with the underlying insured — Hughes.6 That is, Stonewall asserted that Argonaut settled with Hughes on the basis of multiple pollution occurrences at the Fullerton plant, a la Beagley, but then turned around and ceded its reinsurance claim to Stonewall on the basis of one occurrence. Stonewall also maintained that Argonaut mishandled and manipulated its Hughes litigation and eventual settlement for several reasons: (1) to trigger Stonewall's "sudden and accidental" reinsurance obligation by sidestepping the policy's pollution exclusion for multiple occurrences; (2) to avoid a finding of bad faith and the resulting punitive damages that it would not be able to cede to Stonewall; (3) to avoid the expense of a costly defense to the Hughes coverage; and (4) to avoid full exposure from the 1970 policy. According to Stonewall,

Argonaut's claimed settlement of a complex environmental pollution claim, purportedly on a `one-occurrence' basis, is inconsistent with the existing facts and law governing its settlement at that time. The evidence of how and why Argonaut settled is overwhelming: Argonaut settled [with Hughes] on the basis of exposure to six occurrences for liability for substantial bad faith damages for Argonaut's wilful refusal to defend, knowingly in contradiction of law and contract. The reason Argonaut manipulated the settlement from the six occurrences and bad faith basis is because of the adverse financial consequences inherent in ceding to its reinsurers, including Stonewall, in accordance with the actual settlement.

(Pl.'s Trial Br. at 2.)7

On May 31, 1996, Stonewall filed the instant suit, seeking a declaratory judgment that Argonaut must respond to inquiries about its claim for reinsurance monies stemming from the Fullerton Settlement. In its complaint, Stonewall accused Argonaut of breaching its duty of utmost good faith and asked the court to declare (1) that Stonewall was entitled to "all information necessary" to evaluate the propriety of the Fullerton Settlement and the basis for Argonaut's coverage and request for indemnification; and (2) that Stonewall was not obligated to reimburse Argonaut unless such information was given. In sum, Stonewall alleged that, although Argonaut had given it factual information regarding its demand for reimbursement, (1) that factual information was not presented in an orderly comprehensible fashion, (2) Argonaut had been evasive in answering Stonewall's questions, and (3) Argonaut had refused to explain to Stonewall why reimbursement was warranted under the reinsurance contract. One of Stonewall's requests was an explanation of how the Fullerton settlement amount was allocated among the multiple insurance years covered and the several co-reinsurers.

In February 1997, Argonaut filed a counterclaim alleging breach of contract, breach of duty of good faith, and breach of duty of utmost good faith under California law. Argonaut also asked for a judgment declaring that Stonewall owed...

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