Title Indus. Assurance Co., R.R.G. v. First Am. Title Ins. Co.

853 F.3d 876

TITLE INDUSTRY ASSURANCE COMPANY, R.R.G., Plaintiff–Appellant,

v.FIRST AMERICAN TITLE INSURANCE COMPANY, et al., Defendants–Appellees.

No. 15-3310

United States Court of Appeals, Seventh Circuit.

Argued April 4, 2016

Decided April 10, 2017

Tyler Steven Mertes, Attorney, Troutman Sanders, Chicago, IL, Sean M. Hanifin, Attorney, Jeffrey John Ward, Attorney, Loss, Judge & Ward, LLP, Washington, DC, for Plaintiff–Appellant.

Ronald A. Damashek, Attorney, Melissa J. Lettiere, Attorney, Stahl Cowen Crowley & Addis, Chicago, IL, for Defendant–Appellee First American Title Insurance Company.

David Francis Wentzel, Attorney, Wentzel Law Offices, Chicago, IL, for Defendant–Appellee Coastal Funding LLC.

Before Easterbrook and Hamilton, Circuit Judges, and Pepper, District Judge.^*

Hamilton, Circuit Judge.

This appeal illustrates a recurring issue for liability insurers and their insureds: how to determine whether the insurer owes a duty to defend its insured when a claim is first asserted against the insured, before the insurer knows the underlying facts. The insured here was Chicago Abstract Title Agency LLC, which was in the title and escrow services business. In 2008, Chicago Abstract was sued in state court by a title insurance company and two financial firms. Chicago Abstract tendered these lawsuits to its "errors and omissions" liability insurer, plaintiff Title Industry Assurance Company, R.R.G., known in this case as TIAC. TIAC then faced a choice. It could (a) defend Chicago Abstract without reservation; or (b) defend while reserving its rights; or (c) seek a declaratory judgment concerning the scope of coverage. TIAC could also (d) decline to defend, but only if the allegations in the complaints against Chicago Abstract clearly fell outside the scope of the insurance policy, and then only at its peril. Under Illinois law, when a liability insurer unjustifiably refuses to defend a suit against its insured, the insurer will be estopped from later asserting policy defenses to coverage.

TIAC declined to defend the suits. The suits proceeded and years passed without further communications between TIAC and its insured. In 2014, one of the state court plaintiffs, Coastal Funding, LLC, filed a fourth amended complaint against Chicago Abstract. An attorney appointed by TIAC then made a belated appearance in that case. At about the same time, TIAC filed this diversity jurisdiction action in federal court, seeking a declaration that coverage was unavailable primarily because of two exclusions in the policy. Chicago Abstract did not defend in the federal case (the company had been involuntarily dissolved in 2009), but two of the state-court plaintiffs—Coastal Funding and First American Title Insurance Company—appeared in this federal case as defendants. To avoid confusion, we refer to these two firms as the Claimants.

TIAC and the Claimants filed cross-motions for summary judgment. The district court granted judgment to the Claimants. We affirm. We disagree with portions of the district court opinion, particularly its ruling that TIAC was required to plead legal theories in its federal complaint. That ruling is squarely at odds with settled federal pleading practice. See Johnson v. City of Shelby , 574 U.S. ––––, 135 S.Ct. 346, 190 L.Ed.2d 309 (2014) (summarily reversing dismissal of action for failure to identify legal theory in complaint). Nevertheless, we agree that the undisputed facts show that TIAC breached its duty to defend Chicago Abstract in the underlying litigation. TIAC is therefore estopped from asserting at this very late stage any policy defenses to coverage that might have been available if TIAC had made a different choice when the complaints were first tendered.

I. Undisputed Facts and Procedural Background

A. Errors and Omissions Policy

Chicago Abstract was a title insurance agency operating in Cook County, Illinois. As an agent for First American, a title insurance company with a nationwide footprint, Chicago Abstract provided property owners and lenders with real estate closing, loan closing, and title and escrow services. In 2008, TIAC issued to Chicago Abstract an "Abstracters, Title Insurance Agents and Escrow Agents Professional Liability Insurance" policy, more commonly known as an errors and omissions policy. The policy provided that TIAC would pay costs for which its "Insured" became liable "by reason of a wrongful act ... aris[ing] out of professional services rendered or that should have been rendered." The term "Insured" was defined to include Chicago Abstract as well as its members and employees acting within the scope of their duties. Coverage applied both to acts occurring during the policy period and to prior acts if, as of the policy's effective date, the Insured had no knowledge of those prior acts.

The policy listed two exclusions relevant in this appeal. Under exclusion (a), coverage did not apply to any claim arising out of or relating to "any dishonest, fraudulent, criminal, malicious or intentional wrongful acts committed by or at the direction of the Insured." A caveat in the policy, labeled condition (1), stated that whenever exclusion (a) was triggered, insurance would remain available for each Insured "who did not personally commit or personally participate in committing any of the wrongful acts described in [that] exclusion ... and who had neither notice nor knowledge of such wrongful acts, if such Insured, upon receipt of notice or knowledge thereof, immediately notifies the Company of the aforesaid wrongful acts." Under exclusion (j), coverage did not apply to any claim arising out of or relating to "any defalcation, commingling of, or failure to pay any funds, notes, drafts, or other negotiable instruments."

B. Underlying Complaints and Procedural History

In the fall of 2008, Chicago Abstract was underwater and failing fast. Records were out of order. Transactions were askew. Employees were unsupervised. Most alarming, an outside audit uncovered a significant shortfall in the agency's escrow account. In this unfolding crisis, without the benefit of a comprehensive investigation and with only a hazy understanding of the facts, First American and two lenders that had done business with Chicago Abstract sought help in court.

On November 5, 2008, First American sued Chicago Abstract and its two members, Michael Kons and Steve Knupp, in the Circuit Court of Cook County. First American alleged that Chicago Abstract had facilitated escrow closings for "irregular and suspicious" real estate "flip" transactions using First American's insurance policies and closing protection letters. A "flip" or A–B–C transaction involves an investor (B) who buys discounted property from a defaulting homeowner or foreclosing lender (A) using a short-term unsecured loan and then immediately "flips" the property by selling to a third-party buyer (C) for a higher price. Assuming both sides of the transaction close, the investor (B) pays off the short-term loan and pockets the profits. First American's complaint accused Chicago Abstract of executing "flip" transactions "contrary to the spirit and purpose" of its agency contract. First American added that Chicago Abstract was not maintaining proper documentation; that Chicago Abstract had commingled escrow funds belonging to property owners, investors, and lenders; and that Chicago Abstract may have misappropriated some of those funds. First American sought emergency injunctive relief, up to and including appointment of a receiver, as well as damages for breach of contract.

Several weeks later, 1st Funding Source, LLC, a private capital firm, intervened in the First American action. 1st Funding had agreed to finance the A–B side of four "flip" transactions for which Chicago Abstract served as title agent. For each transaction, Chicago Abstract was authorized to disburse the short-term loan proceeds only on condition that both sides (A–B and B–C) had irrevocably closed. Chicago Abstract allegedly breached its agreement with 1st Funding by disbursing the proceeds before ensuring that the B–C transaction closed. 1st Funding pled counts for breach of contract, breach of fiduciary duty, and negligence.

Finally, on Christmas Eve 2008—less than two months after First American filed suit—Coastal Funding brought a separate action in the Circuit Court of Cook County against Chicago Abstract, First American, and a person named Donnel Thomas (elsewhere spelled "Donell"). Like 1st Funding, Coastal Funding had supplied short-term financing for "flip" transactions for which Chicago Abstract served as title agent. Back in October 2008, Coastal Funding had wired $1,370,000 into Chicago Abstract's general escrow account with the expectation that the funds would be segregated in a fiduciary trust account. According to Coastal Funding, Chicago Abstract breached its fiduciary duty and committed the tort of conversion by "misappropriating" those funds. Coastal Funding also alleged that Donnel Thomas duped it into participating in a Ponzi scheme using Chicago Abstract's services and that the "flip" transactions—which it had believed were lawful and legitimate—were mere stages of the scheme.

Chicago Abstract tendered the three underlying complaints to TIAC "for defense and indemnification" on February 3, 2009. On July 8, 2009, Chicago Abstract, operating by then under receivership, notified TIAC of two potential claims by First American for missing escrow funds. In letters dated July 31 and August 13, 2009, TIAC denied coverage for the underlying suits and the potential claims. The denial letters cited policy exclusions (a) and (j) and asserted that the policy did not cover the remedies that the state court plaintiffs sought. TIAC reiterated its coverage position without explanation in a letter dated August 12, 2011.

The state-court litigation proceeded without TIAC's involvement. In 2011, the state court entered two orders granting default judgment against Chicago Abstract on six...