MAUREEN TIGHE, Bankruptcy Judge.
This Memorandum addresses cross motions for summary judgment in an adversary proceeding seeking to resolve coverage under an errors and omissions policy issued to the debtor in this chapter 11 case. These motions were filed on July 28, 2016.
1. C.M. Meiers Company, Inc. ("C.M. Meiers" or "Debtor"), a commercial and personal insurance firm, was owned and controlled by Herbert Rothman (CEO and 89% owner and director), Rebecca Rothman (officer and director), and Eric Rothman (Vice President, director, and 11% owner)(collectively, the "Rothmans"). Trustee's Statement of Undisputed Facts ("TSUF"), ¶1;
2. C.M. Meiers acted as an insurance agent for approximately 18 carriers and as a broker for approximately 162 carriers.
3. In any given month, C.M. Meiers would withdraw money from the Trust Account to pay commissions, or to remit client premiums, less commission to carriers. TSUF, ¶14. The Trust Account was "out of trust" by November 2011.
4. On November 3, 2011, the Rothmans paid to the order of C.M. Meiers checks and cashier checks totaling $272,032.40, which was deposited into Trust Account.
5. On January 9, 2012, C.M. Meiers filed for chapter 11 bankruptcy. TSUF, ¶21;
6. As of January 25, 2012, C.M. Meiers had a "net payable" to various insurance companies totaling $1,085,659.14.
7. On April 5, 2012, BTJ Insurance Services, LLC. ("BTJ") filed an adversary proceeding against the Rothmans asserting (1) common law unfair competition; (2) unfair competition under Business & Professional Code §17200; (3) misappropriation of trade secrets; (4) intentional interference with contractual relations; and (5) intentional interference with prospective economic advantage.
8. On April 19, 2012, Trustee filed a complaint-in-intervention against the Rothmans, Adelman, Affinity, and Wen-Er Farms, LLC. ("Wen-Er"). TSUF, ¶37;
9. On July 10, 2012, Sharp filed a first amended complaint in intervention ("First Amended Complaint"). The First Amended Complaint alleges (1) injunctive relief, (2) breach of fiduciary duty, (3) recovery of fraudulent conveyance under 11 U.S.C. §548(a)(1)(A), §544, and §550 and (4) recovery of fraudulent conveyance under Cal. Civ. Code §3439.04(a)(1), §3439.04(a)(2), and §3439.05.
10. Trustee's allegations in the First Amended Complaint focus on the Rothmans' handling of the Trust Account and improper use of Debtor's assets. It alleges:
b. (2) The Rothmans transferred Debtor's key-man life policy to Herbert Rothman;
c. (3) Herbert Rothman used corporate funds to put a down payment on a building purchased by Wen-Er;
d. (4) The Rothmans repurchased stock from Herbert Rothman's son in law (Jeff Kleid) in a "sweetheart" deal;
e. (5) The Rothmans paid $272,032.40 into the Trust Account in November 2011;
f. (6) Herbert and Eric Rothman gave Adelman control of C.M. Meiers, including confidential information after proposed asset sale to his company, Affinity;
g. (7) Affinity sent letters to insurance carriers and agencies without disclosing that Affinity would assume C.M. Meiers' book of business and agency appointments and directing insurers to issue payments to Affinity; and
h. (8) Herbert and Eric Rothman transferred C.M. Meiers' "house accounts" to themselves.
11. On November 3, 2011, the Rothmans paid to the order of C.M. Meiers checks and cashier checks totaling $272,032.40, which were deposited in to the Trust Account.
12. The Rothmans were insured by Scottsdale Insurance Company ("Scottsdale") for the policy period between October 27, 2011 to October 27, 2012 under the "Business and Management Indemnity Policy, Policy No. EKS3050577" (the "Scottsdale Policy") with a $1 million limit per claim. Trustee's Request for Judicial Notice, Ex. 5.
13. On May 29, 2012, the Rothmans tendered the complaint to Scottsdale. Essex's Statement of Undisputed Facts ("ESUF"), ¶22.
14. On June 28, 2012, Scottsdale denied coverage.
15. Jacobson shared with Trustee's counsel the communications exchanged with Scottsdale regarding insurance coverage.
16. For the period between June 1, 2011 through June 1, 2012, the Rothmans were also insured by Essex Insurance Company ("Essex") under the "Insurance Agents and Brokers Errors and Omissions Liability Insurance Policy AB35140-00 (the "Essex Policy") with a $5 million limit per claim and subject to a $25,000 deductible. TSUF, ¶26, 27.
17. Markel Services, Incorporated ("MSI") is a separate entity solely owned by Essex; it is responsible for claims management.
18. On August 20, 2012, the Rothmans tendered the First Amended Complaint and the Rothmans' defense to Essex.
19. On October 4, 2012, WCB submitted a coverage letter (the "October 4, 2012 Letter") stating that the Trustee's lawsuit against the Rothmans does not fall within the Essex Policy's language. TSUF, ¶45. It is disputed whether Essex reserved its rights to review coverage upon further investigation.
20. On the same day, in an email, the Rothmans' counsel shared Essex's coverage declination with Trustee's counsel. ESUF, ¶30.
21. On or about August 24, 2013, Essex, by its claims examiner, Emily Lukes, received a copy of the Trustee's First Amended Complaint from Trustee's counsel, Larry Gabriel. TSUF, ¶49.
22. On September 11, 2013, Gabriel wrote to Waxler a letter (the "September 11, 2013 Letter") requesting Essex to reconsider its coverage decision.
23. On September 13, 2013, Gabriel again wrote to Waxler a letter (the "September 13, 2013 Letter"), with argument and support for why Essex's coverage position was unjustified as a matter of law, including a reference to a Maryland court decision —
24. Fischer did not read
25. Herbert Rothman consulted Jason White of Swett & Crawford, an insurance intermediary, regarding the coverage declinations of both Scottsdale and Essex. ESUF, ¶34. Rothman testified at deposition that he considered Jason White as "my expert in the field of D &O and E & O who I feel is the foremost authority" and that White advised Rothman that Scottsdale "owed a duty of defense" under the policy. ESUF, ¶35.
26. On July 31, 2013, Scottsdale withdrew its coverage declination.
27. On September 13, 2013, Trustee and the Rothmans attended a mediation conducted by the Honorable Dickran Tevrizian (Ret.). TSUF, ¶54. Essex did not participate.
28. During his deposition, Herbert Rothman, in response to a question of when he became aware of the $4.3 million number, responded, "I guess when Gabriel typed it up and sent it over to our counsel." ESUF, ¶53.
29. It is disputed when the Rothmans and Trustee first agreed to attend mediation; Essex was not advised of the mediation until September 6, 2013.
30. On October 30, 2013, Essex, through its coverage counsel, responded to the September 11, 2013 Letter and the September 13, 2013 Letter, reiterating its decision to deny coverage in a letter (the "October 30, 2013 Letter").
31. On November 27, 2013, Trustee's counsel sent another letter ("November 27, 2013 Letter") to Essex's counsel in furtherance of the Trustee's position that coverage should be afforded. The letter also presented a settlement offer by Trustee to Essex.
32. Trustee filed this adversary proceeding on March 4, 2014 against Essex for its denial of coverage to the Rothmans, asserting claims for (1) declaratory relief that Defendant was obligated to provide coverage to the Rothmans, (2) breach of contract, (3) tortious breach of implied covenant of good faith and fair dealing, (4) bad faith administration, (5) "Brandt fees," and (6) punitive damages.
33. On March 20, 2015, the Court issued its Memorandum of Decision on the Trustee's Motion for Summary Judgment (the "MOD"). TSUF, ¶64; ECF No. 57. The motion was granted in part as to the Trustee's claims for breach of contract, granting declaratory relief that Essex had a duty to defend the Rothmans; it was denied in part without prejudice as to (1) Essex's duty to indemnify the full settlement amount, (2) Trustee's claim for breach of the implied covenant of good faith and fair dealing, and (3) Trustee's request for attorney's fees. ECF No. 57.
34. On Essex's duty to indemnify, the Court left open the question of allocation of covered and uncovered claims in the Settlement:
These cross motions for summary judgment followed discovery and the first summary judgment ruling. This Memorandum addresses the following issues not addressed in the first MOD:
2. Whether Trustee is Entitled to Punitive Damages and "Brandt Fees"; and
3. Whether Essex has a Duty to Indemnify the Rothmans for the Full Amount of the Settlement. If Not, Whether Essex Can Apportion That Settlement Into Covered and Uncovered Causes of Action. If Apportionment is Allowed, Whether Either Side Has Presented Sufficient Undisputed Facts to Support a Judgment at This Time.
35. "A trial court can only consider admissible evidence in ruling on a motion for summary judgment."
36. At the September 13, 2016 hearing, the Court made rulings on numerous evidentiary objections. Essex's objections included: (a) Motion to Strike Sharp's Declaration and Gabriel's Declaration, (b) Objection to Declaration of Larry Gabriel, and (c) Response to Plaintiff's Statement of Additional Facts. Trustee's objections included: (a) Objection to Declaration Report of Charles G. Ehrlich, and (b) Objection to Declaration of Sean Hanifin. Each side raised both factual and evidentiary objections to the other's Statement of Undisputed Facts.
37. "Findings and Evidentiary Rulings for the Submission of Undisputed Facts" was entered on October 26, 2016. See ECF No. 196. The facts relied on for this ruling are detailed therein, along with the ruling on each of the evidentiary objections. Those facts are incorporated herein and will only be repeated where necessary to the discussion. The facts ruled on in the attachments to those orders constitute the Court's Findings of Fact.
1. Trustee has argued that many statements in the MOD are established "facts" and that various statements made in the ruling on the first summary judgment motion are now "law of the case." While certain rulings were made in the MOD, there were not as many as the Trustee alleges. The MOD granted summary judgment only as to specific claims as stated in the order:
Order Granting Partial Judgment on Plaintiff's Motion for Summary Judgment, ECF No. 61, 2-8.
It did not decide all causes of action. Plaintiff's Motion for Summary Judgment was denied as to (1) Trustee's request for attorney's fees; (2) the amount of damages sustained by Essex's breach of contract; (3) whether Essex breached its Implied Covenant of Good Faith and Fair Dealing; and (4) whether Trustee may recover punitive damages for Essex's conduct in administering the claim submitted by the Insureds and the amount of those damages. Id. at 11-17.
2. Under the law of the case doctrine, a court is generally precluded from reconsidering an issue previously decided by the same court or an appellate court. The application of the doctrine is discretionary, and not an "inexorable command."
3. The Court has no reason to revise its ruling as to the two claims where partial summary judgment was granted. As to the causes of action where there was a denial of summary judgment, it is even more inappropriate to construe statements made in the course of that ruling as "law of the case." See
4. Trustee properly points out that he has relied on the earlier summary judgment ruling. He correctly relies on the matters that were actually ruled on and contained in the order. Rescinding a ruling is not appropriate where it would cause undue harm to a party that had benefitted from the ruling.
5. The statements made as part of the discussion of undecided issues were dicta informed by what was briefed at that point in the case. The current round of memoranda of law and proposed statements of undisputed facts follows extensive discovery and is more detailed on these undecided issues than with the earlier motion, where the focus was heavily on the duty to defend issue. Where appropriate, the Court has gone back and looked at what supported any statements in the undecided causes of action and will revise where additional facts or law have been submitted with this motion. This may not be construed as a motion for reconsideration as the Court will not reconsider issues that were decided in the last ruling.
6. As each party has brought a cross motion for summary judgment, the issues will be discussed jointly and the relevant burden of proof for each side will be kept in mind, depending on the issue and the cross motion.
7. Summary judgment should be granted "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P 56(c)(incorporated by Fed. R. Bankr. P. 7056).
8. The moving party has the burden of establishing the absence of a genuine issue of material fact.
9. Rule 56(d), however, empowers the court to continue or deny a motion for summary judgment if the opposing party needs time to discover facts essential to justify the opposition.
10. In the MOD, the Court found there was an issue of material fact as to whether the Trustee is entitled to attorney's fees based on the assignment of the Essex Policy or whether those fees were already covered and owed to Scottsdale Insurance. MOD, 14:16-18. This issue has been explained more thoroughly in the most recent motions. Per the Settlement, Rothmans' rights to recover defenses costs, including attorney's fees and expenses expended by the Rothmans in defense of the adversary proceeding, were assigned to the Trustee. Trustee's Request for Judicial Notice, Ex. 5. 3.1. Regardless of how the indemnity issue is determined, Essex is liable for unpaid attorney's fees expended in the underlying action.
11. California law clearly provides for payment of the insured's defense costs where the duty to defend has been breached.
12. Trustee asserts that Essex's (1) wrongful denial of an insurance defense, (2) wrongful denial of coverage, (3) failure to properly investigate the claim, and (4) failure to respond to a settlement offer constitute breaches of the implied covenant of good faith and fair dealing — thereby entitling Trustee to "Brandt fees." Essex's cross motion for summary judgment requests that the Court dismiss Trustee's claims on these same issues.
13. "As in every other contract, an implied covenant of good faith and fair dealing is implicit in an insurance contract."
14. To prevail, the insured must show that the insurer has (1) withheld benefits due under the policy, and (2) that such withholding was "unreasonable" or "without proper cause."
15. The duty to defend is contractual; it is an exchange of considerations: premium for a defense. The remedies from a breach of that duty should therefore stem from the contract itself unless some independent tortious act justifies tort remedies. "Bad faith" requires a showing of more than "honest mistake, bad judgment, or negligence" but rather a "conscious and deliberate act, which unfairly frustrates the agreed common purposes and disappoints the reasonable expectation of the other party [. . .]."
16. The undisputed record shows that (1) the claim was originally sent by the Rothmans to MSI, the claim management arm of Essex. TSUF, ¶30; (2) the claim was assigned to claims adjuster Cathy Daly.
17. In that letter, Waxler analyzed BTJ's complaint and Sharp's amended complaint-in-intervention. He questioned whether the Rothmans qualified as "Insureds" under the policy, whether the alleged acts were done in performance of "Professional Services," whether the acts fell under Exclusion A, E, G, or M, and whether the damages were covered.
18. A year later, Trustee re-tendered the claim. In two letters (dated September 11 and 13, 2013), Larry Gabriel contended that the Rothmans' actions fell within the scope of "Professional Services" as defined in Essex's E & O policy and also notified Essex of the mediation, scheduled with Judge Tevrizian.
19. Trustee's letter focused on Essex's failure to consider
20. On October 30, 2013, Waxler responded to Gabriel. Declaration of Larry Gabriel, Ex. 8. The letter clearly considered
21. Essex has filed a declaration of an insurance coverage expert, Charles Ehrlich. Trustee has objected to its consideration on a number of grounds. The objection is sustained for the purposes of this motion and the Court has not considered the Ehrlich declaration in reaching any conclusions on this motion. As stated at the hearing with respect to evidentiary objections, the declaration seeks to relitigate the duty to defend decision which has already been resolved. To the extent Ehrlich opines on what was proper to consider in declining coverage, the testimony of those actually involved in the claims adjustment process was sufficient for the Court to consider in evaluating whether Trustee has shown a lack of good faith, even if the facts are disputed. In addition, to the extent that the late turnover of coverage counsel's file precluded Trustee from deposing Waxler, any reference to coverage counsel communications in Ehrlich's declaration should not be considered. The Court has considered Trustee's citations to the Waxler file to see if they raise sufficient grounds in support of Trustee's position. If any portions of the opinion are still relevant at trial, they will be considered then.
22. Citing to
23.
24. Essex's decision not to change its coverage decision and not to participate in settlement discussions following Trustee's counsel's letter on September 11, 2013, does not demonstrate a lack of good faith and fair dealing. Essex's coverage counsel responded in detail to Trustee's coverage arguments and explained the reasonable difference in their view of coverage under the contract.
25. Trustee also argues that Essex showed bad faith by failing to thoroughly investigate the facts underlying the complaint since its determination was based solely on an examination of the complaint, calls with Rothman and Trustee's counsel, and the terms of the policy. This level of review satisfies Essex's duty to investigate in a claim of this nature.
26. Trustee seeks to preclude Essex from invoking any advice of counsel defense because of Essex's previous assurance that it would not do so and its opposition to any inquiry into any discussions between its employees and coverage counsel.
27. On June 5, 2015, Trustee served Essex with a request for production of documents. Declaration of Larry Gabriel in Support of Motion to Compel, Ex. 3. Essex responded by asserting the attorney-client privilege to Request numbers 6-8, which sought all communications between Essex and its outside counsel — Andrew Waxler. Opposition to Motion to Compel, Ex. F, "Essex's Objection and Response for Production." On or about July 1, 2015, Trustee served Waxler with a Notice of Deposition. Waxler did not attend the deposition. On July 14, 2015, Hanifin responded in a letter:
28. On August 26, 2015, Trustee filed a Motion to Compel Production of Documents by Defendant and to Compel Further Testimony of Essex's Designee. ECF No. 70. On October 22, 2015, after notice and hearing, the Court denied Gabriel's motion to compel discovery as to communications between Essex and coverage counsel on the basis of attorney-client privilege. ECF No. 79. About two months thereafter, Essex presented Trustee with its coverage file, including communications between its coverage counsel and Essex with no explanation for why it suddenly waived privilege. Essex later stated that it turned over all documents because it wanted to obviate the issue of advice of counsel. Transcript of Record, 153:14-24, Sep. 13, 2016, ECF No. 191. Trustee asserts that he has been prejudiced by the assertion of the attorney-client privilege followed by a sudden waiver of the privilege as to coverage counsel's file.
29. Reasonable reliance on the advice of counsel is a defense for bad faith as it demonstrates that the insurer had "proper cause" for its failure to defend even if the advice it received was ultimately erroneous.
30. Essex has repeatedly stated that it is not relying on advice of counsel as a defense. It is precluded from doing so now or at trial. It may, however, rely on the fact that in addition to the claims examiner's review, it was careful to also consult counsel to show it acted reasonably and did not simply automatically or deliberately deny coverage.
31. Trustee also asserts that Essex violated California Insurance Regulations by failing to certify written guidelines and standards to ensure that "claims agents have been trained regarding [California insurance] regulations and any revisions thereto."
32. Lastly, Trustee's argument that Essex should have reassessed its coverage when Scottsdale revoked its earlier denial of coverage is without merit. The Essex policy is different from the Scottsdale policy. No information has been presented to indicate Scottsdale was interpreting the same policy language.
33. Although an insurer's bad faith is a question of fact to be determined at trial as evidence of motive, intent, and state of mind, the question becomes one of law where only one reasonable inference can be drawn from the undisputed facts.
34. Whether Essex had a duty to defend was an issue of genuine dispute. It took adequate steps to investigate the claim, and it provided detailed reasoning in denying coverage under the Rothmans' D&O Policy. The facts cited by Trustee do not describe a situation where the insurer consciously disregarded its legal obligation. Essex's claims adjuster's handling of the case, from registering the claim in MSI's internal system to reviewing the allegations and policy language, to retaining coverage counsel to investigate the merits of Gabriel's arguments for coverage, evidences a defensible legal position of no coverage.
35. Thus, Essex's motion for partial summary judgment on the Breach of Implied Covenant of Good Faith and Fair Dealing will be granted.
36. Trustee argues that he is entitled to punitive damages totaling $15 million for Essex's refusal to offer coverage and failure to participate in settlement discussions. A plaintiff may recover punitive damages in connection with non-contractual claims if he proves "by clear and convincing evidence that the defendant has been guilty of oppression, fraud, or malice." Cal. Civ. Code. §3294. An insured alleging that the insurer breached the implied covenant of good faith and fair dealing may seek punitive damages in connection with that claim.
37. Trustee also argues that he is entitled to "Brandt fees" for fees incurred in his prosecution of this adversary action — totaling $284,911.44 ($280,000 in attorneys' fees plus $4,911.44 in costs).
38. As discussed above, Essex's failure to defend the Rothmans did not rise to the level of bad faith and was insufficient to show oppression, fraud, or malice.
39. Even viewing the facts in light most favorable to Trustee, Essex's motion for summary judgment on the issue of punitive damages and "Brandt fees" is granted.
40. An insurer's duty to indemnify is recognized as narrower than its duty to defend. While an insurer has a duty to defend any claim that potentially falls within the terms of the underlying policy, it only has a duty to indemnify claims that are actually insured.
41. Essex requests the opportunity to contest the Settlement on the basis that it was unreasonable and collusive. Essex argues that the final $4.3 million settlement figure cannot possibly consist of only covered actions. It asserts that at most, C.M. Meiers suffered only $1.2 million in damages — the amount of the trust shortfall. It further argues the claims leading to this shortfall are not covered by the E & O Policy, such as: breach of the fiduciary duty for error and omissions — corporate waste, transfer of life insurance policy, over-market office space rental to Wen-Er Farms, LLC., the Kleid Stock Repurchase, and the adverse judgment from the Capitol Insurance Services lawsuit.
42. Trustee avers that Essex is precluded from litigating the issue of allocation based on a number of theories. First, he argues that the breach of the duty to defend proximately caused the settlement, so Essex is liable for the entire amount. Second, he argues that the "larger settlement rule" requires the entire amount be included. Third, he argues that challenge to the settlement is not permitted where the duty to defend was breached. Finally, even if Essex is permitted to litigate allocation, Trustee avers that the effort would be futile as the settling parties made no attempt at parsing between covered and uncovered claims.
43. This section discusses each of the parties' theories as to liability and concludes that summary judgment as to allocation should be denied on both cross motions. As discussed below, when an insurer fails to defend an action, the insured is entitled to make a reasonable settlement of the claim in good faith, and maintain an action against the insurer to recover the amount of the settlement.
44. Trustee relies on
45. Trustee also relies on
46. The Court may not rely on
47. One inference that may be drawn is that but for Essex's failure to defend the Rothmans in the underlying action, the Rothmans would not have settled with Trustee. Despite being represented by Scottsdale, the Scottsdale Policy had a limit of $1 million. For the deficiency, the Rothmans' only recourse was to defend the action with their own funds or enter into a settlement of the claim, and maintain an action against Essex. That conclusion may not be drawn in this motion because it requires the resolution of inferences against Essex, so it can only be properly done at trial where the Rothmans would be subject to cross examination.
48. As such, the proximate cause analysis fails to resolve the summary judgment motion brought by the Trustee. The theory may be pursued at trial as part of the indemnification claim as Trustee may have inferences made in his favor.
49. Under the "larger settlement rule, "[a]llocation is appropriate only if, and only to the extent that, the defense or settlement costs of the litigation were, by virtue of the wrongful acts of uninsured parties, higher than they would have been had only the insured parties been defended or settled."
50. The "larger settlement rule" is not applicable here. Safeway Stores allocates costs between covered and uncovered parties — not allocation between covered and uncovered claims.
Here, the need to protect the insured party's bargain does not apply. C.M. Meiers did not purchase insurance to protect uncovered claims. This is not a situation where the insured is cheated out of its bargain because of a second wrongdoer's involvement in the settlement. Requiring allocation between covered and uncovered claims does not deprive them of the "insurance protection it sought and bought." See Harbor, 922 F.2d at 368.
51. Trustee next contends that Essex's challenge is procedurally flawed. Relying on
52. Relying on
53. If an insurer wrongfully fails to provide coverage or a defense, and the insured then settles the claim, the insured is given the benefit of an evidentiary presumption.
54. To invoke the presumption, the insured bears the initial burden to show the "basic or foundational facts" by a preponderance of the evidence. The insured must show that: (1) the insurer wrongfully failed or refused to provide coverage or a defense, (2) the insured thereafter entered into a settlement of the litigation which was (3) reasonable in the sense that it reflected an informed and good faith effort by the insured to resolve the claim.
55. Once the "basic or foundational facts" are established, the insured enjoys the presumption that the settlement accurately reflects the liability and amount of the liability for purposes of an action against the insurer.
This approach is pragmatically sound; the insured should bear the initial burden as he or she has access to information regarding the facts and events leading up to the settlement and the discussions during the settlement.
56. Having been abandoned, the insured should be free to protect his or her rights by electing to settle rather than risking an adverse judgment. See Pruyn, 36 Cal. App. 4th at 530 (agreeing with
57. The first two elements have been satisfied in earlier rulings. The Court has already found that Essex breached the E & O policy by failing to defend the Rothmans, and the Rothmans and Trustee entered into the Settlement in resolution of Trustee's claims. The third requires discussion.
58. The third element considers whether the settlement was "reasonable in the sense that it reflected an informed and good faith effort by the insured to resolve the claim."
59. On January 17, 2014, Trustee filed the Motion for Good Faith Settlement Determination ("877.6 Motion"), moving for an order finding that the settlement agreement was entered into in good faith pursuant to Cal. Civ. Code §877.6(a)(1).
60. The California Supreme Court in
61. Essex argues that regardless of the findings at the hearing, 877.6 determinations are not binding on Essex, because it did not have standing to contest the settlement and any objection to the Settlement could be construed as breaching its duty to its insured. In
62. The
63. As Essex is not bound by the 877.6 hearing, the Court's findings as to the Tech-Bilt factors are not binding on Essex. We now turn to the effect of the Fed. R. Bankr. P. 9019 hearing.
64. On December 11, 2013, Trustee filed a Motion for Order Authorizing Trustee to Enter into and Consummate Settlement Agreement — under Fed. R. Bankr. P. 9019 ("9019 Motion"). ECF No. 305. Bankruptcy Rule 9019(a) empowers the bankruptcy court to approve a settlement on motion by the trustee after notice and a hearing is provided to all creditors. Although the bankruptcy court has great latitude in authorizing a compromise, it may only approve a proposal that is fair and equitable to the creditors.
65. As opposed to the rigid standing restrictions of Cal. Civ. Code §877.6, Fed. R. Bankr. P. 9019 only requires that the insurer be a "party in interest" to object to a settlement. 11 U.S.C. §1109(b)("a party in interest, including the debtor, trustee [. . .] a creditor [. . .] may raise and may appear and be heard on any issue in a case under this chapter"). The `party in interest' definition has generally been construed broadly.
66. In
67. While the present case differs in that it is in the context of a 9019 hearing, Essex is a "party in interest" with a comparable level of pecuniary interest at stake and the Settlement was likewise not "insurance neutral." Three interests identified in
68. Essex argues that had it objected at the 9019 hearing, it would have breached its duty to the Rothmans. This may be so, but, having been properly notified of its potential liability under the Settlement, it could have appeared at the hearing to reserve its right to challenge indemnification at a later date. Trustee's Request for Judicial Notice, Ex. 7 (The Settlement Agreement language specifically states that Trustee would be entitled to right to assert an adversary proceeding against Essex for its "refusal [. . .] to acknowledge its indemnity and/or settlement obligations [amounting to] [. . .] $3,800,000.00"). The Court also could have considered the likelihood of indemnification or asked for more detail in the settlement agreement in terms of evaluating the reasonableness of the settlement had it heard Essex's arguments at the time the settlement was evaluated. Had Essex shown there was no duty to defend or coverage of any settled claims at that time, it would also not have been breaching any duty to its insured. Challenging the Settlement nearly three years after the 9019 hearing prejudices Trustee and creditors where all were given an opportunity to be heard. The duty to the insured has not been defined to outweigh these important estate interests, and the insurance coverage of the debtor must be evaluated in the context of all of the interests of the estate and the creditors.
69. Having found that Essex inopportunely failed to object at the 9019 hearing, we now look to the substance of Trustee's 9019 Motion to assess whether it contained sufficient findings to satisfy Trustee's initial burden of proof that the Settlement was "reasonable."
70. Trustee's 9019 Motion applied the Ninth Circuit's four-factor test: (a) the probability of success in the litigation; (b) the difficulties, if any, to be encountered in the matter of collection; (c) the complexity of the litigation involved, and the expense, inconvenience and delay necessarily attending it; (d) the paramount interest of the creditors and a proper deference to their reasonable views in the premises."
71. The Court's findings as to the 9019 hearing are sufficient to satisfy Trustee's initial burden of proof that the settlement was "reasonable." In reviewing Trustee's motion and approving the resulting order, the Court considered whether the settlement terms were "reasonable."
72. The standard to establish the "basic and foundational facts" are met by a 9019 hearing where all impacted by a settlement have standing to be heard. To require the insured to overcome a higher initial burden of proof would lead to a counterintuitive result: an insured who was abandoned must then bear the heavy burden of proving its indemnification claim against an insurer who breached its contractual duty to defend. The insurance industry would have little incentive to honor its duty to defend as it would be permitted a second chance to challenge coverage at the indemnification stage.
73. Trustee therefore enjoys the presumption that the Settlement accurately reflects the liability for a covered claim and the amount of the liability for purposes of an action against Essex. The burden now shifts to Essex to rebut the presumption.
74. In rebutting this presumption, Essex seeks to show in this motion how none of the settlement amount can be for covered losses. It adds up the value of all the uncovered causes of action and concludes they total $4,167,434. Essex Memorandum in Support of Motion for Summary Judgment, ECF No. 135-1, 17.
75. Trustee argues that that Essex is per se precluded from challenging the Settlement's allocation and he seeks summary judgment based on the presumptions afforded him. This argument conflates Essex's breach of the failure to defend and failure to settle to mean that Essex is now fully liable for the settlement outcome. This is only true where the failure to defend also violates the implied covenant of good faith and fair dealing.
76. Where there are mixed covered and uncovered causes of action and no bad faith, there is no such bright line rule. In
77. An insurer who wrongfully refuses to defend is liable for failing to accept a reasonable settlement, only if the claim is in fact covered by the policy.
78. In
79. An insurer's right to contest uncovered claims even after a settlement is consistent with Supreme Court cases on the allocation of defense costs even after a default judgment. In
80. It is a "heavy burden" that the insurer must overcome where there is an "evidentiary presumption" that the insured enjoys in proving liability and the amount of that liability.
81. The Settlement, which presumably covers all causes of action in the complaint, resolves claims of mismanagement of the Trust Account in rendering "Professional Services for others" (covered) as well as allegations of intentional looting and fraud (uncovered). Trustee's Request for Judicial Notice, Ex. 7, 2.
82. Inconsistency in Trustee's varying estimation of loss leaves an issue of material disputed fact as to what is covered by the settlement. Per Gabriel Declaration, Trustee estimates his claims against the Rothmans in excess of $10 million. See Declaration of Gabriel, ¶14 ("This [$4.3 settlement] amount was agreed to taking into consideration what I deemed to be the loss of the value of C.M. Meiers' business in the amount of $10,979,863.00 all of which can be directly attributable to the out of trust loss."). Yet this estimation is inconsistent with Trustee's previous estimation. In support of its 9019 Motion, Trustee asserted that he estimated the total exposure suffered by the estate to be between $2.5 million and $4 million. 9019 Motion,
83. As this is a motion for summary judgment, the burden at this stage is for Essex to raise material disputed facts showing that either Trustee's evidence as to attribution of the Settlement is not possible or other facts showing the settlement was based on uncovered claims. The Court may not weigh the strength of the evidence at this stage. Because Essex's theory of how the settlement amount reached differs substantially from Trustee's declaration of how the settlement amount was calculated, reasonable inferences can be made in favor of both parties. In addition, the shifting burden of proof prohibits evaluating each of the theories at this stage. As there are still material disputed facts as to allocation, Trustee's motion for summary judgment must be denied on how to allocate the total amount. Essex's request to conclude that none of it is covered is also denied.
84. Essex has raised collusion as an affirmative defense and has the burden to show collusion.
85. Collusion has been variously defined as (1) `a deceitful agreement or compact between two or more persons, for the one party to bring an action against the other for some evil purpose, as to defraud a third party of his right'; (2) `a secret arrangement between two or more persons, whose interests are apparently conflicting, to make use of the forms and proceedings of law in order to defraud a third person, or to obtain that which justice would not give them, by deceiving a court or its officers'; and (3) `a secret combination, conspiracy, or concert of action between two or more persons for fraudulent or deceitful purposes.'"
86. Essex argues that the settlement was collusive because (1) the Rothmans' counsel shared with Trustee's counsel communications between Essex and the Rothmans, notwithstanding the adversity of interest between the parties; (2) Essex was notified of the mediation at the 11
87. Both Trustee and Essex agree that the discussions between Trustee and Rothmans leading to a settlement in September 2013 are privileged. Section 408 of the Federal Rules of Evidence bars the admission of settlement negotiations offered to prove liability; however, it does not require exclusion when the evidence is offered for another purpose. Fed. R. Evid. 408. The rationale is (1) irrelevance, as an offer to compromise may not be an admission, but rather an attempt to purchase peace; and (2) policy, in that the admissibility of such evidence would discourage parties to enter into settlements.
88. Recognizing that the settlement discussions are privileged, the undisputed facts that can be considered will be addressed. First, it was no secret that it was Trustee's intention to pursue insurance coverage with Essex. Trustee disclosed in the Settlement Agreement that as part of the consideration for Trustee's claims release, the Rothmans would be assigning their right to assert a lawsuit against "Essex Insurance Company in connection with and arising out of the Essex E&O Policy" for its "failure to defend," "any refusal [. . .] to acknowledge its indemnity," and "settlement obligations owed Defendants." Trustee's Request for Judicial Notice, Ex. 6-7, Section 3.3. By definition, the deal between Trustee and the Rothmans is therefore not a "secret."
89. Second, Essex's claim that it was not notified of the mediation until the last minute is rebutted by the undisputed fact that it was notified on September 6, 2013 — five days before the mediation. ESUF, ¶43. This was unquestionably very short notice, but Essex was afforded the opportunity to participate or request a continuance so that it could attend. As the settlement terms specifically provided that it was not binding until court approval, Essex had the opportunity to contest the settlement on the grounds of collusion or lack of adequate notice of the mediation. Had it intervened, Essex would have been able to reserve its rights. The length of the notice of the mediation session is also somewhat irrelevant where Essex has made clear that it was not providing a defense anyway so would not be attending the mediation.
90. Third, the only communication the Rothmans gave Trustee was the letter from Essex's counsel regarding Essex's denial of coverage. Essex's Appendix of Exhibits, Ex. 18, "October 4, 2012 Email from Lawrence Jacobson to Larry Gabriel." One of primary duties of the chapter 11 trustee is to determine whether the cost of pursuing litigation is worth the recovery that can be made.
91. Lastly, Essex points to Herbert Rothman's deposition to assert that the $4.3 million was never agreed upon in the mediation, and was only added after the fact. Essex relies on deposition testimony of Herbert Rothman where he stated that he did not know of the $4.3 figure until after the mediation. When pressed about when he became aware of that figure, Herbert Rothman responded, "I guess when Gabriel typed it up and sent it over to our counsel." ESUF, ¶53. The response may only show that Herbert Rothman was not aware of the figure, not that the figure was somehow concocted by the Rothmans and Trustee. Rothman's "guess" is not enough to show collusion. The Trustee has explained the basis for his damages calculation. It is also hard to believe that no estimates of likely damage awards were given in the course of an all-day mediation. No party or counsel may testify about the discussion they had on damages as those matters are subject to the mediation privilege. It is also not clear if Rothmans' counsel negotiated this figure on behalf of the Rothmans, but no inquiry is permitted because of the attorney-client privilege.
92. Essex has failed to show that there is no material disputed fact warranting summary judgment in its favor as to collusion. While the facts it cites in support of its theory do not affirmatively show collusion on a motion for summary judgment, Essex may pursue this issue at trial where it bears the burden of proof and reasonable inferences may be made.
93. Essex previously brought a motion to compel seeking a resolution of a dispute over the scope of discovery. Trustee argued that Essex could not inquire into any of the facts supporting the underlying complaint against the Rothmans. Essex argued that it could revisit all of the complaint's allegations because they could show no duty to indemnify. The Court required Trustee to answer Requests for Admission ("RFA") 13 through 18, and 35 — questions pertaining to the timing of C.M. Meiers' insolvency and Rothman's misuse of trust account funds. Order on Defendant's Motion to Compel Responses to Discovery, ECF No. 125, 2:5. The Court ordered that Trustee is not required to answer RFA #1 through 6, 10, 11, 20 through 34, and 35 — questions pertaining to whether trust funds were negligently collected or paid and the coverage of Essex's policy.
94. Essex seeks to show with additional discovery that controverting evidence may show that the $3.8 million settlement covers uncovered claims. Essex still seeks bank account records of C.M. Meiers' general accounts. While Trustee believed all account records he has were turned over, it is not entirely clear what records Essex actually obtained. To support its argument that Trustee inflated a $1.2 million trust shortfall into a $4.3 million insurance claim, Essex has retained a forensic accountant to analyze the financial records of C.M. Meiers, including the records of the Trust Account. It proposes that with additional discovery of trust ledgers, it can show through large deviations in cash flow that any trust account shortfall was the result of intentional wrongdoing rather than mere error or mismanagement. Declaration of Hanifin, ¶10.
95. Because those records would not resolve either the Trustee's motion for summary judgment that Essex is liable for the entire settlement amount or Essex's motion that there is no indemnity coverage for any of the settlement, there is no need to postpone this summary judgment ruling while further discovery is conducted under Fed. R. Civ. P. 56(d).
96. To the extent that discovery not allowed in the earlier hearing is now relevant to the narrowed trial issues, the parties should raise specific inquires at the status conference. Most discovery is complete, but, after the parties meet and confer, the Court will discuss narrow and limited additional discovery, in addition to expert witness discovery and deadlines.
97. At trial, Essex must rebut the presumption that the Settlement is reasonable and fully enforceable against Essex. As described in
98. Even taking Essex's calculation of the shortfall and the amount of damages of each respective claim as true, the inquiry may be less about the actual damages suffered by C.M. Meiers, and more about what the parties considered in coming to a compromise. The parties are using different methods of calculating damages. In Sharp's version of the settlement discussion, the final figure focused on a proximate cause analysis of damages. Sharp, via his declaration, proffers two theories for damages proximately caused by the Rothmans' failure to provide "Professional Services" in the administration of the C.M. Meiers Trust Account: $10,979,863 (loss of value of C.M. Meiers' business)
99. Another crucial disputed detail that Essex must address is Trustee's contention that the settling parties did not parse the claims in covered and uncovered funds in reaching the $4.3 million figure. Sharp stated:
Declaration of Sharp, 5:3-8.
100. The findings of fact and legal conclusions herein will constitute the court's findings under Fed. R Civ. P. 52(a), applicable in this bankruptcy proceeding under Fed. R. Bankr. P. 9014 once the ruling is complete.
101. Where the Bankruptcy Court may not have authority to enter a final judgment in core matters to which a party does not give consent, the Bankruptcy Court is still directed to consider core claims and make findings of fact and conclusions of law and a recommendation to the district court if the district court should conclude that review is appropriate before trial is concluded on the remaining issues.
Trustee's motion for summary judgment is denied as to breach of the duty to indemnify, tortious breach of implied covenant of good faith and fair dealing, Brandt fees, and punitive damages. Trustee's motion is granted as to full costs of insured's defenses with a procedure to be established to evaluate the amount following resolution of all issues.
Essex's motion for summary judgment is granted as to the tortious breach of implied covenant of good faith and fair dealing. Essex's motion is denied as to the breach of the duty to indemnify.
Trustee and Essex should submit respective orders in accordance with this ruling.
