LANDAU, J.
This case is before us on a certified question of Oregon law from the United States Court of Appeals for the Ninth Circuit. A & T Siding, Inc. v. Capitol Specialty Ins. Corp., 356 Or. 399, 337 P.3d 128 (2014) (accepting certified question); ORS 28.200 to 28.255 (granting Oregon Supreme Court authority to answer certified questions and describing procedure). The question arises out of a construction contract dispute in which a homeowner's association sued a builder in state court for construction defects. The homeowner's association and the builder settled, and the settlement included an unconditional release and covenant not to execute against the builder. When the homeowner's association attempted to garnish the builder's liability insurance policy, however, the insurer claimed that it had no liability because the settlement unconditionally released its insured from any liability. The state trial court agreed, and the builder appealed.
Meanwhile, in response to the state trial court's conclusion that the settlement agreement eliminated the insurer's liability, the homeowner's association and the builder amended their settlement agreement to eliminate the unconditional release and covenant not to execute. Then, pursuant to the new agreement, the builder initiated this action — which we refer to as "the federal court action" because it eventually was removed to federal court — against its insurer. In the federal court action, the insurer argued that the state court already had determined that, given the terms of the original settlement, the builder could not recover under its insurance policy and that the parties lacked authority to create any new insurance coverage obligation by amending their settlement agreement. The federal district court agreed. On appeal, the Ninth Circuit certified a question to us asking whether the homeowner's association and the builder could amend their settlement agreement in such a way as to revive the liability of the builder's insurer.
We accepted the certified question, but, to ensure consistent application of the law in the pending state and federal appeals, we asked the parties to address additional issues concerning the legal basis for the amended settlement agreement and the legal effect of the amended settlement agreement. We limit the scope of this opinion, however, to the Ninth Circuit's certified question. In brief, we conclude that, although the parties possessed authority to amend the terms of their settlement agreement, they could not do so in a way that retroactively revived the
The Brownstone Homes Condominium Association discovered defects in the construction of its 26-building condominium complex, including wood decay, flashing delamination, and water penetration. In consequence, Brownstone initiated a negligence action against the general contractor who built the complex, as well as one of its subcontractors, A & T Siding. Brownstone estimated that A & T's share of the cost of repair was approximately $2 million. A & T was insured by Capitol Specialty Insurance Corporation and Zurich Insurance.
Initially, both Capitol and Zurich undertook to defend A & T in the action, but Capitol later withdrew its defense on the ground that the damage for which Brownstone sought recovery from A & T was not within the terms of A & T's coverage. Brownstone eventually settled with A & T and Zurich. The settlement agreement included the following provisions that are relevant to the certified questions before us. First, A & T agreed to a $2 million stipulated judgment against it and in favor of Brownstone, $900,000 of which would be deemed satisfied by Zurich's payment to Brownstone of that amount on A & T's behalf. Second, Brownstone covenanted that "in no event will it execute upon or permit the execution of the stipulated judgment against A & T or its assets." Instead, the parties agreed that Brownstone would be entitled "to seek recovery of the unexecuted portion of the judgment against Capitol." Third, A & T assigned to Brownstone any claims arising out of the matter that A & T might have against Capitol. Fourth, A & T promised that it would "reasonably and in good faith cooperate with [Brownstone]" in pursuing any assigned claims. Fifth, the parties mutually agreed to release each other from "all past, present and future claims" arising out of the dispute. Finally, the parties declared that they did not intend to release any claims against Capitol as A & T's insurance carrier.
Brownstone then served a writ of garnishment on Capitol under ORS 18.352
In Stubblefield, the plaintiff and the defendant in a tort action entered into a settlement agreement that was much like the one Brownstone and A & T executed in this case: It included a stipulated money judgment against the defendant, an assignment of the defendant's rights against his insurance company to the plaintiff, and the plaintiff's covenant not to execute against the defendant, but instead to seek satisfaction of the judgment solely from the defendant's liability insurer. After the plaintiff initiated a breach of contract action against the insurer under the assignment, this court held that the plaintiff had acquired no enforceable claims or rights against the insurance company under the assignment. This court reasoned that the defendant's insurance policy limited an insured's coverage to sums that the insured was "legally obligated" to pay as damages, and, under the covenant not to execute that the plaintiff had given in exchange for the defendant's assignment of his claims, the
In response to Capitol's summary judgment motion, A & T argued that, for various reasons, the Stubblefield rule did not apply. The trial court disagreed, granted Capitol's summary judgment motion, and entered judgment against Brownstone.
After judgment had been entered, Brownstone and A & T executed an "addendum" to their settlement agreement, which they believed would avoid the application of Stubblefield. The addendum began by reciting that the intent of the parties in entering into the original settlement agreement had been "to provide [Brownstone] with the right and capability to collect the $1.1 million unsatisfied balance of the stipulated judgment from Capitol," that the trial court's decision in the garnishment action had been contrary to that intent, and that the addendum had been executed "to further and more clearly express" the intent of the parties in entering into the settlement agreement. The addendum thereafter eliminated the original assignment of A & T's claims against Capitol and replaced it with a requirement that A & T itself pursue any claims it might have against Capitol under Brownstone's direction and at Brownstone's expense. The addendum also replaced the original unconditional covenant not to execute against A & T with a narrower promise not to execute against A & T while A & T's action against Capitol was pending.
Brownstone said nothing to the trial court or to the Court of Appeals about the execution of the addendum; rather, it pursued the appeal as if the addendum did not exist. Meanwhile, A & T initiated a separate state court action against Capitol, as required under the addendum. A & T alleged that Capitol was liable for $1.1 million of the unpaid stipulated judgment against it under either of two theories: breach of its fiduciary duty to defend A & T or breach of its contractual duties to defend and to indemnify. A & T also alleged claims for its defense costs and for punitive damages. Capitol removed the action to the United States District Court of Oregon, where it moved for summary judgment on a variety of grounds, including that A & T's claims were barred by the state court's decision in the garnishment action and that, in any event, the insurance policy did not cover the liability that A & T had "voluntarily assumed" in the addendum. The federal district court granted Capitol's motion and dismissed A & T's claims asserting that Capitol was obligated to pay the remaining $1.1 million of the stipulated judgment. The court rejected Capitol's contention that the state court action precluded A & T's recovery of that amount in federal court, but it agreed that Capitol's policy did not cover such liabilities, explaining:
In other words, having determined that the original settlement agreement had unconditionally released A & T from liability to Brownstone in damages, the district court concluded (as had the circuit court in the earlier state proceeding) that the liability to Brownstone described in the addendum could only be a new contractual liability. In the district court's view, that contractual liability would not support any claims against Capitol based on the insurance policy it had issued to A & T for two reasons: (1) It does not fall within the policy's basic term of coverage — for sums the insured is "legally obligated to pay as damages because of * * * property damage"; and (2) it falls under an express exclusion in the policy for liabilities assumed in a contract.
The district court also set out another reason, unrelated to the terms of the policy, for rejecting A & T's indemnification claims based on the addendum: It would not "enforce an agreement entered into by the parties the express intent of which is to circumvent the finality of a valid order, and resulting judgment, that bar[s] the claim * * * sought to be asserted," because doing so would undermine the finality of court actions.
A & T appealed. Before the Ninth Circuit, A & T argued that the addendum had not created a new contractual obligation running from A & T to Brownstone, but instead sought merely to give effect to the parties' original intent that Capitol pay for the property damage A & T had caused. It also argued that no Oregon authority precludes parties to a settlement agreement from amending their agreement after a court has issued a ruling based on that agreement. Apparently unsure as to whether and how Oregon law pertaining to the amendment of agreements would apply in those circumstances, the Ninth Circuit certified the following question of Oregon law to this court:
This court accepted the certified question. As we have noted, in light of the pendency of the state court appeal involving related issues, we reformulated the question to be briefed by the parties to address additional matters. Allen v. Hall, 328 Or. 276, 278 n. 1, 974 P.2d 199 (1999) ("This court reserves the authority to reformulate certified questions."). Nevertheless, we limit the scope of this opinion to the question that the Ninth Circuit certified.
At the outset, we observe that no one contests the right of Brownstone and A & T to negotiate an amendment to the original settlement agreement. That original settlement agreement — which included an assignment of rights in exchange for, among other things, a covenant not to execute — was a contract, the effect of which is determined by application of ordinary contract principles. Lancaster v. Royal Ins. Co. of America, 302 Or. 62, 67, 726 P.2d 371 (1986) ("When an insured gives an injured party an assignment of rights in exchange for a `covenant not to execute,' the agreements are a contract and their effect is determined by standard contract
The issue that the parties do contest is the extent to which Brownstone and A & T could reform the original settlement agreement, which would have the effect of undoing the legal effect of the original agreement, as determined in the prior litigation. Capitol contends that, in the original settlement agreement, Brownstone released A & T from any liability arising out of the Brownstone litigation and further unconditionally covenanted not to execute a judgment against A & T for such liability. In Capitol's view, the addendum that Brownstone and A & T executed could not lawfully undo that release and unconditional covenant in the absence of rescission or reformation of the original agreement, neither of which, Capitol asserts, the parties did. According to Capitol, any liability that A & T agreed to in the addendum amounts to a new contractual obligation, one that is not covered under its policy with Capitol.
A & T does not dispute that a new contractual obligation would not be covered under its policy with Capitol. It also appears to acknowledge that it could not retroactively undo the original settlement agreement except by rescission or by reformation; at least, it does not offer any alternative theories as to how that result might be achieved. It expressly concedes that neither it nor Brownstone attempted to rescind that agreement. And it further concedes that neither of those parties attempted to obtain the remedy of reformation from any court. Instead, A & T's sole argument appears to be that it and Brownstone, in effect, reformed the original settlement agreement, even if they did so without calling on the equitable authority of a court to effectuate that remedy.
As A & T sees things, the original agreement contained a "mistake of law," in that the parties "misapprehended" the legal effect of what they had agreed to. Specifically, A & T argues, the parties did not intend to execute an unconditional release and covenant not to execute that would relieve A & T — and, ultimately, Capitol — of any further liability. The negotiated reformation, A & T contends, rendered the original agreement void, so that any liability to which A & T agreed under the later, reformed agreement was not a new contractual liability, but instead related back to the underlying Brownstone litigation, which was covered by Capitol's policy.
Capitol rejoins that reformation was not available to Brownstone and A & T because the equitable doctrine requires the existence of an antecedent agreement to which the original settlement could be reformed, and in this case there is no evidence of such an antecedent agreement. Moreover, Capitol argues, the fact that Brownstone and A & T did not foresee the legal consequences of their original agreement is not the sort of mistake that justifies reformation.
We turn, then, to the question whether Brownstone and A & T, in effect, reformed the original settlement agreement by executing the addendum. Reformation, strictly speaking, is an equitable remedy by which a court may revise the written expression of an agreement to conform to the intentions of the parties to it. See generally Dan B. Dobbs, 2 Law of Remedies § 11.6(1) (2d ed. 1993). Early common-law courts hewed strictly to the form of an instrument and offered no relief for such errors in reducing the terms of an agreement to writing. See William H. Thomas, Jr., Comment, Reformation of Written Instruments in Missouri, 37 Mo. L. Rev. 54, 54-55 (1972). English equity courts responded to the harshness of the common-law tradition by adopting a doctrine of "rectification," which authorized a court to remedy drafting errors that failed to embody the terms of the parties' intended agreement. See George W. Keeton, Rectification of Instruments for Mistake in England 14 NYU L. Rev. 319, 319 (1937). The English equity doctrine was adopted by courts in this country, including Oregon. See, e.g., De Tweede v. Barnett Estate, 160 Or. 406, 413-15, 85 P.2d 361 (1939) (discussing rectification doctrine).
Restatement (Second) of Contracts § 155 comment a (1981); see also Richmond v. Ogden Street Ry. Co., 44 Or. 48, 54, 74 P. 333 (1903) (where a written contract fails to express the actual agreement of the parties as contemplated, "court of equity will reform the writing so as to effectuate the intentions of the parties"). In Oregon, a court will reform a written agreement if the party seeking that remedy establishes three things: (1) an antecedent agreement to which the contract can be reformed; (2) a mutual mistake or, alternatively, a unilateral mistake by one party along with inequitable conduct by the other party; and (3) the party seeking reformation was not grossly negligent. Jensen v. Miller, 280 Or. 225, 228-29, 570 P.2d 375 (1977). Those elements must be proved by clear and convincing evidence. Ray v. Ricketts, 235 Or. 243, 250, 383 P.2d 52 (1963). In addition, insofar as reformation is an equitable remedy, a court will not grant a reformation when the result would be inequitable to an innocent third party. See Crahane et al. v. Swan, 212 Or. 143, 149, 318 P.2d 942 (1957) (equity will "not grant relief by the way of reformation to the injury of innocent third persons such as bona fide purchasers, lien holders and others who without notice have acquired intervening or vested rights and who cannot be placed in status quo").
As we have noted, reformation is a judicial remedy. As we have also noted, in this case, Brownstone and A & T did not seek that remedy. Instead, they negotiated the addendum on their own, without invoking the court's equitable power. According to A & T, even though the parties did not obtain the judicial remedy of reformation, they effected their own private reformation by executing the addendum to the original agreement. This court has not yet decided whether parties may voluntarily reform an agreement without the intervention or aid of the court. We need not decide that question in this case, however, because, at all events, the parties in this case did not satisfy the requirements for reformation.
The first such requirement is the existence of an antecedent agreement that was not adequately expressed in the parties' written contract. Jensen, 280 Or. at 228, 570 P.2d 375. Because reformation is used to revise the written contract so that it conforms to the antecedent agreement, there can be no reformation without such an antecedent agreement. Moyer et ux. v. Ramseyer et al., 226 Or. 122, 134, 359 P.2d 407 (1961). In this case, A & T does not identify the nature of the antecedent agreement to which it wanted its original written settlement agreement reformed. The entirety of its argument in its briefing as to that element of reformation consists of the assertion that "there is an antecedent agreement (App. A)." Appendix A of A & T's brief is a copy of the original written settlement agreement.
A & T apparently misapprehends the requirements of reformation. The equitable doctrine applies when the parties have reached a mutual understanding as to the material terms of a contract, but that mutual understanding is confounded by an error in the form of the written terms of that contract. In this case, A & T makes no effort to identify the terms of its agreement with Brownstone that were not given proper form in the written settlement. It simply offers the original settlement agreement and asserts that the parties wanted that agreement, as drafted, to have different legal consequences.
That leads to the second element of reformation, namely, a mistake in the drafting of the agreement such that it does not accurately express the parties' actual agreement. In Jensen, for example, this court upheld the reformation of a deed — specifically, the deed's description of a boundary — based on the parties' mutual mistake as to the actual location of that boundary. 280 Or. at 230, 570 P.2d 375. Similarly, in Webb v. Culver,
In this case, A & T argues that its original agreement contained a mutual mistake of law, in the sense that it and Brownstone did not anticipate the legal consequences of the original settlement agreement as they drafted it. As A & T explains, "Brownstone and A & T believed their original agreement was legally sufficient to seek recovery from Capitol." That belief turned out to be incorrect, at least as determined by the trial court in the state garnishment proceeding. In the words of the addendum to the settlement agreement, "the trial court's decision in favor of Capitol [was] contrary to the settling parties' intent." Again, however, A & T misunderstands the nature of the requirements of reformation.
Oregon cases recognize a distinction between different types of mistakes of law that may occur in the drafting of contracts. As this court explained in Richmond, 44 Or. at 56, 74 P. 333:
The distinction between the two categories of mistake can be hard to pin down, because both may involve a mistake as to "legal effect" in some sense, as the foregoing quotation illustrates. From the case law, however, the key consideration is whether the mistake goes to the terms of the written agreement itself. If it does, then reformation is not available. See, e.g., Weatherford v. Weatherford et al., 199 Or. 290, 301, 260 P.2d 1097 (1953) ("`[e]quity will not ordinarily reform the contract merely because one or both of the parties were mistaken as to its legal consequence'") (quoting Richmond, 44 Or. at 54, 74 P. 333); Smith et al. v. Cram et al., 113 Or. 313, 323, 230 P. 812 (1925) ("[I]f the agreement is as the parties intended it should be, and the parties were simply mistaken as to the legal effect, the contract will not be reformed.").
On the other hand, a mistake of fact or a mistake of law as to the effect of an underlying agreement may result in the drafting of an agreement that does not accurately express the substance of the parties' agreement. In such cases, the written agreement may be reformed to conform to the terms that the parties actually agreed to. As the court explained in Richmond, if,
44 Or. at 55, 74 P. 333 (emphasis added) (quoting John Norton Pomeroy, 2 A Treatise on Equity Jurisprudence § 845 (2d ed. 1892)).
Harris Pine Mills v. Davidson, 248 Or. 528, 435 P.2d 310 (1968), illustrates the distinction. In that case, the parties executed a land sale contract that contained a reservation of rights to certain timber. Following the final payment on the contract, the parties executed a deed to land, but the deed failed to mention explicitly that the seller retained the timber reservation. The successor to the seller initiated an action to reform the deed,
Our case law drawing a distinction between mistakes in drafting that fail to express the terms of an agreement and mistakes as to legal effect is consistent with the longstanding general rule in other jurisdictions. As the Michigan Court of Appeals recently explained in Johnson Family, Ltd., Partnership v. White Pine Wireless, LLC., 281 Mich.App. 364, 379-80, 761 N.W.2d 353 (2008), "mistakes of law are divided into two classes: mistakes regarding the legal effect of the contract actually made and mistakes in reducing the instrument to writing. In the former, the contract actually entered into will seldom, if ever, be relieved against."
In this case, A & T's own description of the transaction places it squarely in the category of mistakes for which the equitable remedy of reformation is not available. There is no suggestion that Brownstone and A & T negotiated an agreement that was not accurately or adequately described in the terms of the original settlement. Rather, A & T asserts only that the parties misunderstood the legal consequences of the settlement agreement to which they agreed. As we have noted, the underlying historical and equitable rationale for reformation is that parties should not be held hostage to a mistake in drafting. In this case, there was no mistake in drafting, only a mistake in predicting how a court at some time in the future would rule on the legal effect of what the parties unquestionably agreed to. Equity, at least as it is exercised under the doctrine of reformation, has no role in remedying the parties' mistaken prediction of court decisions.
We conclude, then, that A & T's theory of reformation does not justify treating the addendum as relating back to the original settlement agreement. In so concluding, we express no opinion about whether other theories not argued by the parties — legal or equitable — might justify that treatment.
Certified question answered.
