Insurance Law

Federal Court Refuses to Confuse Issue of Insurance Limits – Declaratory Relief Action Without Insured Fails

Insurance coverage disputes can be resolved by the seeking a court’s order in a declaratory relief action. Both state and federal courts have procedures available for resolving such disputes. However, to provide a useful declaration it is necessary that both parties to the insurance contract are involved in the suit.

In McCormack v. Scottsdale Insurance Company, Slip Copy, 2015 U.S. Dist. LEXIS 120240 (E.D.Mich., 9/10/15), [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance], the District Court for the Eastern District of Michigan was faced with an unusual dispute that called for an unusual response.

FACTS

The plaintiff, Jonathan McCormack alleged in a lawsuit filed in the Lapeer County, Michigan circuit court that he was injured by employees of Fat Boys Bar & Grill. The Bar apparently had in effect a Comprehensive General Liability Insurance Policy (CGL policy) from Scottsdale Insurance Company. McCormack filed a second action in Lapeer County seeking a declaratory judgment against Scottsdale that the larger of two possible coverage limits ($300,000 versus $25,000) applies to his underlying tort case. However, for reasons known only to the plaintiff, McCormick did not join the Bar as a defendant in the declaratory judgment action.

The Sixth Circuit has “repeatedly held in insurance coverage diversity cases that declaratory judgment actions seeking an advance opinion on indemnity issues are seldom helpful in resolving an ongoing action in another court. It is not one of the purposes of the declaratory judgments act to enable a prospective negligence action defendant to obtain a declaration of non-liability. However, that is not to say that there is a per se rule against exercising jurisdiction in actions involving insurance coverage questions.

Settling the Controversy

In Scottsdale Ins. Co. v. Flowers, 513 F.3d 546, 556 (6th Cir.2008), [subscribers can access an enhanced version of this opinion: lexis.com | Lexis Advance], the Sixth Circuit noted that a district court may consider exercising jurisdiction under the Declaratory Judgment Act when it can conclusively resolve a coverage dispute. This factor may favor exercising jurisdiction, for example, when the plaintiff insurer is not a party to the state litigation or there is a legal, and not a factual, dispute in federal court. In an expression of the obvious, the court stated that “It is difficult to see, however, how a coverage dispute can be resolved when the insured is not a party to the case. The question in this action, after all, is how an insurance contract should be interpreted. When one of the contracting parties is absent, the dispute is one-sided.”

Clarifying the Legal Relations

The relevant inquiry is whether the federal judgment will resolve, once and finally, the question of the insurance indemnity obligation of the insurer. Although a declaratory judgment would clarify the legal relationship between the insurer and the insured pursuant to the insurance contracts, the judgment would not clarify the legal relationship between the parties in the underlying state action.

Once again, there can be no sensible resolution of the legal relationships between an insured and an insurer when both parties are not properly before the Court. It is conceivable that if the insured had notice of this action, it might be bound by a judgment unfavorable to it. For instance, under Michigan’s rather unusual rules of collateral estoppel, an injured person who has knowledge of a declaratory judgment action against his tortfeasor but does not intervene nonetheless is bound by the judgment. Under those rules, this Court’s determination of coverage limits in this case might affect the Bar’s rights under the policy, even in its absence.

The court concluded that it is enough to say that “proceeding with the case in its present posture would complicate, not clarify, the legal relationships of the parties.” Typically, resolving a coverage question in the absence of persons who might be bound by the judgment is disfavored.

Michigan allows insurers to bring declaratory judgment actions in state court. In fact, in this case, the plaintiff brought the declaratory action in state court. This case is only before the District Court because the defendant removed it. The absence of the insured as a party to this case discourages proceeding further with adjudication.

Therefore, the better course in this case is to remand the matter to the state court where the underlying tort case is pending. The same court can resolve insurance coverage questions with all necessary parties present and a complete record can be made.

ZALMA OPINION

Playing games with a court over insurance coverage is contumacious. It would have been simple for the plaintiff, in state court, to include all the necessary parties in the state court action which would have destroyed complete diversity and avoided this situation entirely.

    By Barry Zalma, Attorney and Consultant

Reprinted with Permission from Zalma on Insurance, (c) 2015, Barry Zalma.

Barry Zalma, Esq., CFE, is a California attorney who limits his practice to consultation regarding insurance coverage, insurance claims handling, insurance bad faith and fraud and acting as a mediator or arbitrator on insurance disputes. Mr. Zalma serves as a consultant and expert almost equally for insurers and policyholders. He founded Zalma Insurance Consultants in 2001 and serves as its only consultant. He recently published the e-books, "Zalma on Rescission in California - 2013"; "Random Thoughts on Insurance" containing posts from this blog; "Zalma on Insurance;" "Murder and Insurance Don't Mix;" “Heads I Win, Tails You Lose — 2011,” “Zalma on Diminution in Value Damages,” “Arson for Profit” and “Zalma on California Claims Regulations,” and others that are available at Zalma Books.

Mr. Zalma can be contacted at or zalma@zalma.com, and you can access his free "Zalma on Insurance Fraud" newsletter at Zalma’s Insurance Fraud Letter.

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