Summary
finding sufficient uncertainty so as to give defendant a reasonable basis for denying coverage
Summary of this case from THOMPSON HARDWOODS INC. v. H/K TRANSPORTATION, INS. CO., (S.D.Ind. 2002)Opinion
CAUSE NO. NA 00-74-C H/K
March 15, 2002
ENTRY ON CROSS-MOTIONS FOR PARTIAL SUMMARY JUDGMENT
This case comes before the court on cross-motions for summary judgment. The motions present the vexing problem in insurance law that has sometimes been called "corporate arson," when a corporation submits an insurance claim for a fire loss allegedly caused by a corporate officer, director, and principal shareholder.
In this case, a fire destroyed the business premises of plaintiff Thompson Hardwoods, Inc. Its property insurer, defendant Transportation Insurance Company, Inc., has refused to cover the loss. Transportation Insurance suspects that the fire was deliberately set by Reed Thompson, who is a director and the president of Thompson Hardwoods, and who owns about 23 percent of the company's stock. Thompson Hardwoods has sued for breach of contract and for bad faith denial of coverage. See Erie Ins. Co. v. Hickman, 622 N.E.2d 515 (Ind. 1993) (recognizing tort of bad faith denial of insurance coverage). This court has subject matter jurisdiction based on the parties' diverse citizenship and the amount in controversy. Both sides agree that Indiana law governs the case. Each side has moved for partial summary judgment on plaintiff's claim for bad faith denial of coverage. The issue of coverage for the loss remains unresolved.
As explained below, however, the court grants Transportation Insurance's motion and denies Thompson Hardwoods' motion. Whether Mr. Thompson started the fire is disputed, but the undisputed facts show that Transportation Insurance had a reasonable factual basis for believing that he was responsible for the fire. Whether Thompson Hardwoods as a corporation would suffer the consequences of such an act by Mr. Thompson is a closer question. But the undisputed facts regarding Mr. Thompson's role as a corporate officer, director, and substantial shareholder show that Transportation Insurance had a reasonable legal basis for denying coverage to the corporation. The applicable law in this situation permits reasonable arguments in favor of each side. A jury could not reasonably find that Transportation Insurance acted in bad faith in denying coverage.
I. Summary Judgment Standard
The purpose of summary judgment is to "pierce the pleadings and to assess the proof in order to see whether there is a genuine need for trial." Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). Summary judgment is appropriate when there are no genuine issues of material fact, leaving the moving party entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c). The moving party must show there is no genuine issue of material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986). A factual issue is material only if resolving the factual issue might change the suit's outcome under the governing law. Clifton v. Schafer, 969 F.2d 278, 281 (7th Cir. 1992). A factual issue is genuine only if there is sufficient evidence for a reasonable jury to return a verdict in favor of the non-moving party on the evidence presented. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986). The fact that the parties have filed cross-motions for summary judgment does not affect the applicable standard; the court should deny both motions if there is a genuine issue of material fact. E.g., Heublein, Inc. v. United States, 996 F.2d 1455, 1461 (2d Cir. 1993). In considering each side's motion, the court must consider the evidence in the light reasonably most favorable to the opposing side.
II. Undisputed Facts
A. The Insurance Policy
Plaintiff Thompson Hardwoods was a manufacturer of wooden door panels and other wooden furniture parts in Milan, Indiana. Defendant Transportation Insurance issued a property and casualty insurance policy to Thompson Hardwoods for the period November 19, 1997 to November 19, 1998. The policy provided total coverage of more than $1.25 million for business property, business personal property, loss of business income, and additional expenses.
B. The Fire
About noon on May 18, 1998, a Thompson Hardwoods employee had discovered a charred spot on the floor near the planer/sander machine. No flames were visible, and that fire was easily extinguished with water. Many employees inspected the scene to be sure that the fire was out before they left the plant at the end of the day. A "fire watch" schedule was set up so that an employee would check the property every hour that night to be sure that the fire did not reignite. The local fire department was not called regarding the first small fire.
Later that evening, a fire substantially destroyed the business property of Thompson Hardwoods. The last person known to have left the building that night was Reed Thompson. He later stated that he turned off the lights between 8:30 and 8:45 p.m. Transportation Insurance later received information to the effect that Mr. Thompson called the employee who was scheduled on the fire watch to inspect the building at 9:00 p.m. and told her that it was no longer necessary to check the building.
Thompson Hardwoods and Mr. Thompson deny that he made any such call. It is undisputed, however, that this information was provided to Transportation Insurance. On the claim for bad faith denial of coverage under Erie Insurance Co. v. Hickman, the issue is not whether the denial of coverage was correct, but whether the insurance company had "a rational, principled basis for the denial of the claim." 622 N.E.2d at 523. On that issue, the undisputed material fact is whether Transportation Insurance received information about the call, not whether Mr. Thompson actually made the call.
A large fire was reported to authorities a few minutes after 9:00 p.m. The damage was extensive. After the fire, all of Thompson Hardwoods' business operations ended. Employees were laid off, and the company became insolvent.
C. The Fire Investigations
After learning of the fire, Transportation Insurance hired cause and origin specialist Gerry Mang to investigate the fire. Mang visited the fire site on May 19th and 20th. He submitted his report on October 12, 1998. Mang told Transportation Insurance that the fire had been incendiary, meaning that it had been set intentionally, resulting from the application of open flame to combustible materials adjacent to the north side of a machine identified as a surface planer and sander. Mang reported to Transportation Insurance that all accidental causes for the fire had been eliminated and that there was no evidence of heat-producing devices common to the site of the fire's origin. Mang did not find evidence of any use of a liquid accelerant. See Mang Aff. Ex. B at 5.
In September 1998, Thompson Hardwoods hired its own cause and origin investigator, Kim May, who reached a different conclusion. He concluded that the fire had originated elsewhere, above the planer-sander machine. May said that he could not rule out an accidental fire resulting from smoldering in the dust collection ducts between the planer/sander and the central dust collection line. May found no evidence that the fire was incendiary in origin. Mang and May both agreed that there was no evidence of any failure in the planer/sander machine.
Thompson Hardwoods sent the May report to Transportation Insurance, who sent it on to Mang for further review. Mang wrote a supplemental report discussing the May report. Mang did not agree with May's analysis and conclusions. See Mang Aff. Ex. D. May later reviewed Mang's supplemental report. Each expert is adhering to his original conclusions.
Local fire authorities also investigated the cause and origin of the fire. Mang reported that the local authorities had told him that they had listed the fire as incendiary in origin. Mang Aff. Ex. B at 6. An affidavit from Paul Hildebrand, an arson investigator for the fire department, states: "I believe I eliminated all accidental causes, other than human element, as to the second fire of May 18, 1998 and, therefore, determined the fire to be incendiary in nature." Hildebrand said that he found no direct evidence of arson, however. Transportation Insurance's internal records indicate that, on April 29, 1999, a sergeant from the sheriff's department stated there were no doubts that the fire was deliberately set. Weidt Aff. ¶ 41.
Thompson Hardwoods has objected to this evidence as hearsay. With respect to the bad faith claim, however, this evidence is not being offered to prove that the fire was in fact incendiary but only to help prove that Transportation Insurance had reason to conclude that the fire was incendiary. See Erie Ins. Co. v. Hickman, 622 N.E.2d at 523 (issue is whether insurer had "rational, principled basis" for denying claim, not whether denial was correct). For that purpose, the information the insurer received from the sheriff's department is not hearsay. See Fed.R.Evid. 801(c).
D. Thompson Hardwoods' Finances
Transportation Insurance also investigated the finances of Thompson Hardwoods and hired a forensic accountant, Steven J. Meils, to evaluate the company. Meils opined that Thompson Hardwoods, as of the date of the fire, "was under severe economic stress and that business failure was imminent." Meils Aff. Ex. B. at 16. Meils also opined that the claimed insurance proceeds exceeded the "net realizable value of liquidated property necessitated by business failure." Id. Thompson Hardwoods has objected to this opinion, but it does not dispute the fact that Transportation Insurance received the opinion, which is the material fact for purposes of the bad faith claim.
Meils also learned that a complaint had been filed with the Indiana Department of Labor in May 1998 regarding alleged safety hazards at Thompson Hardwoods. Thompson Hardwoods' hearsay objection to this information is also overruled with respect to the bad faith claim. See note 2, above.
The insurance company's cause and origin investigator Mang was told by Thompson Hardwoods' plant manager, Charles Miller, that at the time of the fire, the company had only about two weeks worth of work to do on pending orders and had no more orders coming in. Transportation Insurance also learned that Reed Thompson was one of three individuals personally liable for a mortgage of about $75,000 on the business property.
Thompson Hardwoods has come forward with evidence that it was current in payments on its mortgage, lease payments, taxes, and wages. Thompson Hardwoods has also come forward with a letter from the organization that was both its sole supplier and sole customer. The organization praised Thompson Hardwoods' business prospects at the time of the fire. At the time of the fire, finished and partially finished products with a value of about $64,000 were being prepared for shipping.
E. Thompson Hardwoods' Business Structure
Reed Thompson was a director and shareholder of Thompson Hardwoods. He was also an employee of the company, employed by the board of directors to serve as the president and general manager of the company. There was no more senior manager on site at the business on a daily basis.
Thompson Hardwoods was formed in August 1996. Reed Thompson and Gary Anderson contributed property to the new company. Five other shareholders contributed cash. Reed Thompson and Gary Anderson were the two largest shareholders of the company but did not control a majority of the stock. Mr. Thompson held about 23 percent of the shares. The five other shareholders who were not employed by the company held slightly more than 50 percent of the stock between them. All seven shareholders were members of the board of directors. The board did not have a regular schedule for meetings but met as needed for major decisions. The first and second meetings of the board of directors were held in October 1997. The last board meeting before the May 1998 fire was held in February 1998.
There is no evidence that the board of directors authorized Reed Thompson or anyone else to commit arson to destroy the business property. As the Fifth Circuit has observed, "proof of corporate assent to arson, like proof of any other conspiracy, is not likely to be found in the archives of the corporation." Cora Pub, Inc. v. Continental Casualty Co., 619 F.2d 482, 486 (5th Cir. 1980).
F. Transportation Insurance's Denial of Coverage
On June 11, 1999, Transportation Insurance formally and conclusively denied Thompson Hardwoods' claim for coverage of the fire loss. At that time, Transportation Insurance had received the final reports of both its cause and origin investigator and its forensic accountant. The denial letter stated that Transportation Insurance believed "that the fire was the result of an act by an individual, who, because of position and the degree of control with regard to the operation of the company, must necessarily be deemed to have been acting on its behalf." The denial letter referred to the following exclusion provisions in the policy:
2. We will not pay for loss or damage caused by or resulting from any of the following:
h. Dishonest or criminal acts by you, any of your partners, employees (including leased employees), directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose:
1. Acting alone or in collusion with others; or
2. Whether or not occurring during the hours of employment. This exclusion does not apply to acts of destruction by your employees (including leased employees); but theft by employees (including leased employees) is not covered.
Thompson Hardwoods later filed this action in state court, which Transportation Insurance removed to this court based on diversity jurisdiction.
Thompson Hardwoods also named "CNA Insurance Companies" as a defendant. The defense has responded without contradiction that there is no such legal entity; the name is simply a trade name for a number of companies including Transportation Insurance Company, which is the only proper defendant here. Judge Dillin earlier dismissed a non-diverse defendant, Booher and Taylor Agencies, Inc., finding that Thompson Hardwoods had failed to allege a viable claim for negligent procurement of insurance, and treating the joinder of the agency as a fraudulent joinder that could not defeat diversity jurisdiction. See Entry of June 19, 2000, and order of July 18, 2000.
III. The Motions for Summary Judgment
Recognizing that there are substantial factual disputes concerning the actual cause of the fire at Thompson Hardwoods, Transportation Insurance has moved for partial summary judgment only on the plaintiff's claim for bad faith denial of insurance coverage, including the prayer for punitive damages. Transportation Insurance argues that the undisputed facts show it acted in good faith because it had a rational and principled basis for denying coverage based on its investigation of the fire, the policy's exclusion for criminal acts by directors and employees, and Indiana common law.
Thompson Hardwoods has also moved for partial summary judgment in its favor on the claim for bad faith denial of coverage. Reed Thompson denies that he played any part in causing the fire that destroyed the business. However, Thompson Hardwoods' motion for summary judgment assumes, only for purposes of the motion, that Mr. Thompson was responsible for setting the fire, as Transportation Insurance suspects.
The specific issues presented here must be considered in light of the basic principles of the tort of bad faith denial of insurance coverage. The Supreme Court of Indiana recognized the tort in Erie Insurance v. Hickman. The state court took pains to preserve the right of an insurer to deny a claim erroneously, so long as it did so in good faith: "a good faith dispute about the amount of a valid claim or about whether the insured has a valid claim at all will not supply the grounds for a recovery in tort for the breach of the obligation to exercise good faith. This is so even if it is ultimately determined that the insurer breached its contract." 622 N.E.2d at 520; accord, McLaughlin v. State Farm Mutual Automobile Ins. Co., 30 F.3d 861, 867-68 (7th Cir. 1994) (applying Erie Insurance v. Hickman and reversing award of punitive damages for bad faith denial of coverage). However, "an insurer which denies liability knowing that there is no rational, principled basis for doing so has breached its duty" of good faith. Erie Ins. Co. v. Hickman, 622 N.E.2d at 520.
Thus, the question presented by Transportation Insurance's motion for partial summary judgment is whether, when the record evidence is viewed in the light reasonably most favorable to Thompson Hardwoods, a reasonable jury would have to find that Transportation Insurance had a rational, principled basis for denying coverage. The question presented by Thompson Hardwoods' motion for partial summary judgment is whether, when the record evidence is viewed in the light reasonably most favorable to Transportation Insurance, a reasonable jury would have to find that the insurer did not have a rational, principled basis for denying coverage.
A. Evidence of Arson
Transportation Insurance's denial of coverage was built upon its suspicion that Reed Thompson was responsible for intentionally starting the fire. The undisputed facts show that Transportation Insurance had a reasonable basis for concluding that it was more likely than not that Reed Thompson intentionally caused the destructive fire.
Transportation Insurance hired an independent expert to try to determine the cause and origin of the fire. Gerry Mang began his investigation within a day of the fire and concluded that the fire was incendiary in origin. Thompson Hardwoods has not come forward with any evidence that would allow a reasonable jury to find that the insurer acted unreasonably in relying on his findings. For purposes of the bad faith claim, the fact that another cause and origin expert reached a different conclusion does not matter, at least so long as Mang could offer, as he has, a reasoned explanation for his opinion.
Mang's investigation also produced evidence indicating that Mr. Thompson had the opportunity and ability to set the fire. Mr. Thompson was the last person in the building before the fire started that evening. Also, firefighters found the fire burning in a locked building without any sign of a break-in. Adding to the suspicion of Mr. Thompson, Mang's investigation turned up evidence that shortly before the fire started, Mr. Thompson contacted the employee scheduled for the next visit of the "fire watch" and told her she did not need to visit the building. Although Thompson Hardwoods disputes that underlying fact, there is no dispute over whether Mang turned up that information, nor is there any indication that it was unreasonable for the insurer to rely on that information.
Transportation Insurance also discovered evidence of a motive for Mr. Thompson to commit arson. An independent forensic accountant, Steven Meils, initially encountered resistance and delay in obtaining the information he needed. After he finally got the information, he concluded that Thompson Hardwoods had been on the brink of financial collapse at the time of the fire. He also found evidence of Mr. Thompson's personal stake in the business, its debts, and the potential insurance proceeds. Mr. Thompson was personally liable on a mortgage on the business property, and of course he owned about 23 percent of the company stock. For purposes of the bad faith claim, the fact that Thompson Hardwoods and its accountant expressed a different view about the company's finances does not matter as long as Meils provided, as he did, a reasoned explanation for his conclusions.
This circumstantial evidence of arson by Mr. Thompson is obviously not conclusive to prove his guilt, which he denies. However, the circumstantial evidence is sufficient as a matter of law to support Transportation Insurance's conclusion that the claimed loss was the result of arson by Mr. Thompson. See Indiana Ins. Co. v. Plummer Power Mower Tool Rental, Inc., 590 N.E.2d 1085, 1094 (Ind.App. 1992) (reversing punitive damage award for bad faith denial of coverage of fire loss where investigator had opined that fire was incendiary in origin; "reliance upon incorrect, but reasonable, theories is not sufficient to justify an award of punitive damages"); Hoosier Ins. Co. v. Mangino, 419 N.E.2d 978, 986-87 (Ind.App. 1981) (reversing punitive damage award for bad faith denial of coverage of fire loss where investigator — one "Gary Mang," by the way — had concluded that the fire was incendiary); see also Cincinnati Ins. Co. v. Compton, 569 N.E.2d 728, 729-30 (Ind.App. 1991) (circumstantial evidence of incendiary origin, motive, and opportunity can support arson defense). On this record, a jury could not reasonably find that Transportation Insurance lacked a rational, principled basis for believing the Thompson Hardwoods fire was intentionally caused by Mr. Thompson.
B. "Corporate Arson"
The principal debate between the parties stems from the fact that the insured on the Transportation Insurance policy was not Reed Thompson but the corporation, Thompson Hardwoods, Inc. Transportation Insurance argues that Mr. Thompson's roles in the corporation — as president, director, and major shareholder — make the corporation responsible for what the insurer believes was Mr. Thompson's arson and coverage is excluded under Exclusion 2-h for criminal acts "by you, any of your partners, employees . . ., directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose." Thompson Hardwoods responds that, even if Mr. Thompson set the fire, the plain language of the policy covers this loss because Exclusion 2-h also provides: "This exclusion does not apply to acts of destruction by your employees . . . ." It is undisputed that Mr. Thompson was an employee of Thompson Hardwoods, Inc.
In addition, apart from the specific provisions of the policy, the common law of Indiana imposes some limits on insurance coverage for such moral hazards as allowing an insured to collect for a loss the insured has intentionally caused. See Wood v. Allstate Ins. Co., 21 F.3d 741, 742 (7th Cir. 1994) (Indiana law would imply a criminal acts exclusion for insured's own arson even without an express exclusion provision in the policy), citing American Economy Ins. Co. v. Liggett, 426 N.E.2d 136, 140 (Ind.App. 1981). Under the common law, the underlying issue is whether an act of arson by Mr. Thompson would be deemed an act of "the insured," the corporation itself, so as to bar coverage.
Transportation Insurance's motion for summary judgment does not require the court to determine the precise scope of Indiana law on these closely related questions, but only whether the insurer had a rational and principled basis for denying coverage. For Thompson Hardwoods to prevail on its motion for summary judgment, however, it would need to show that Indiana law on these questions is so clear that Transportation Insurance could not have had a rational and principled basis for denying coverage.
1. Common Law Principles
Reported cases of "corporate arson" are numerous and difficult. Courts facing these cases have struggled with them. The extreme cases show the problem in drawing the legal lines. On one side, consider a company whose stock is widely distributed among many shareholders and whose property is damaged or destroyed by the act of one senior executive who owns some shares of company stock. Courts have not wanted to penalize innocent shareholders for crimes committed by one officer or shareholder. On the other side, consider a corporation in which one person owns all shares, is the sole officer and director, and who then destroys the business by arson. In such cases, courts have not wanted to reward arson for profit where legal recognition of the corporate form would allow such rewards. In drawing lines between these extreme cases, decisions have turned out differently depending on the wording of particular policy terms and the specifics of the role the arsonist (presumed or proven) had played in the corporation, including the extent of the arsonist's control of the business and his or her personal financial interest in the insurance proceeds.
Indiana law governs here, but it appears that the Supreme Court of Indiana has not addressed the issue directly. The Indiana Court of Appeals case most closely on point is Hoosier Insurance Co. v. North South Trucking Supplies, Inc., 684 N.E.2d 1164 (Ind.App. 1997). The case involved a small corporation. One person was president and owned all the shares, but was not familiar with the actual business. The day-to-day operations were run by the corporate secretary, who owned no shares. The secretary-manager set a fire that destroyed the business. In the coverage lawsuit, a jury found in favor of the corporation.
The appellate court affirmed. The court reviewed cases from around the country. The court stated that the majority rule was that "an arsonist's status as an officer, stockholder, employee or agent of an insured corporation does not necessarily preclude recovery by a corporate insured on an insurance policy." 684 N.E.2d at 1169. In the formulation most favorable to Thompson Hardwoods, the court said that "the cases suggest that an analysis must be made to determine whether the arsonist exercised absolute control in the conduct of the corporation's business or stood to benefit from its recovery." Id. (emphasis in original). However, the Indiana court went on to quote a number of cases that used less demanding standards to deny coverage. In Miller Dobrin Furniture Co. v. Camden Fire Insurance Co., 150 A.2d 276, 282, 284-86 (N.J.Super. 1959), the court held that arson by a 50 percent shareholder, officer, and director barred recovery because he was "the dominant force" in the company's affairs and "largely dominated" the affairs. In Kimball Ice Co. v. Hartford Fire Insurance Co., 18 F.2d 563, 567 (4th Cir. 1927), the court denied coverage where the arsonist was the "general manager" who "entirely directed, managed, and controlled" the business and held a substantial interest as a shareholder, though the court also used the phrase "exclusive management and control." In United Gratiot Furniture Mart, Inc. v. Michigan Basic Property Insurance Ass'n, 406 N.W.2d 239, 242 (Mich.App. 1987), the court denied coverage based on arson by a person who had "pervasive control over the corporation." In Continental Insurance Co. v. Gustav's Stable Club, Inc., 317 N.W.2d 734, 740 (Neb. 1982), the court denied coverage where the arsonist owned half the stock and was "the dominant force in running the corporation" at the time.
From its review of these and other cases, the Indiana Court of Appeals summarized the principle as follows. A corporation will not be precluded from recovery simply because an arsonist owns 50 percent of its stock. The decisive issues are the degree of control that the arsonist exerts over the affairs of the corporation and whether the arsonist stands to gain from his wrongdoing:
If the individual who set or procured the setting of the fire dominates the corporation to such an extent that he has exclusive control over the corporation and stands to gain from his wrongdoing, the corporation is precluded from recovering benefits under its fire insurance policy. However, in instances where it is not shown that the incendiarist had exclusive control over the corporation and stood to gain from his wrongdoing, insurers are not permitted to deny coverage.684 N.E.2d at 1171 (citation omitted). In support of this summary, the court also cited Fidelity-Phenix Fire Insurance Co. v. Queen City Bus Transfer Co., 3 F.2d 784, 785 (4th Cir. 1925) (arsonist who owned one-fourth of shares was "not the substantial owner" and his actions would not foreclose coverage for corporation, though finding of coverage was reversed on other grounds). The Indiana court also found that where the focus was the potential benefit for the arsonist, recovery would be denied only if the arsonist owns "all or substantially all of the corporate stock." 684 N.E.2d at 1171, citing Erlin-Lawler Enterprises, Inc. v. Fire Insurance Exchange, 73 Cal.Rptr. 182, 185 (Cal.App. 1968); Miller Dobrin, 150 A.2d at 283; D.I. Felsenthal Co. v. Northern Assur. Co., 120 N.E. 268, 270 (Ill. 1918).
After this review of cases from other states, the Indiana court found that the corporation was entitled to insurance coverage where the arsonist had been a corporate officer who conducted the business but who did not own any stock at all. 684 N.E.2d at 1171-72. The court emphasized the fact that the arsonist would not benefit directly or indirectly from his wrongdoing.
The actual holding in Hoosier Insurance v. North South Trucking Supplies is plainly distinguishable from this case because the arsonist in that case owned no stock and thus apparently had no financial motive for the arson. The court's opinion in the case offers substantial guidance here, of course, but it leaves reasonable room for both sides to argue their side of this case. Mr. Thompson was the president and general manager of Thompson Hardwoods, and he appears to have been in day-to-day charge of the business with occasional oversight from the board, the precise extent of which is subject to proof and argument. Mr. Thompson did not own all the stock — only about 23 percent — yet there was no shareholder with a larger percentage.
In addition, although the Hoosier Insurance case provides an important guide for Indiana law, it is one case from an intermediate appellate court addressing an issue that has divided courts around the country for many years. An insurer like Transportation Insurance could reasonably decide that Indiana law remains open for argument and further decision. Cf. State Farm Mut. Auto. Ins. Co. v. Pate, 275 F.3d 666, 668 (7th Cir. 2001) (decisions of intermediate appellate state court must be accorded great weight when federal court decides state law, but they are not always controlling); Dameron v. City of Scottsburg, 36 F. Supp.2d 821, 831 (S.D.Ind. 1998) (predicting that certain intermediate appellate court decisions would not be followed by state supreme court).
Keeping in mind that the issue is whether Transportation Insurance had a reasoned and principled basis for denying coverage, and assuming that Mr. Thompson was the arsonist, a number of cases from around the country support Transportation Insurance's denial. In Kimball Ice Co. v. Hartford Fire Insurance Co., 18 F.2d 563 (4th Cir. 1927), which was cited in Hoosier Insurance, the arsonist was the general manager and owned one-fourth of the stock. The jury was instructed that such arson was a complete defense, and it rendered a verdict for the insurer. The Fourth Circuit affirmed, noting in addition that the corporation had been insolvent and the arsonist was also a large creditor of the corporation and was in "exclusive control and management of the property." 18 F.2d at 565. The parallels to this case are close and obvious.
The Kimball Ice panel did not cite the Fourth Circuit's decision from two years earlier in Fidelity-Phenix Fire Insurance Co. v. Queen City Bus Transfer Co., 3 F.2d 784, 785 (4th Cir. 1925) (arsonist's ownership of one-fourth of shares did not foreclose coverage for corporation), though the author of Kimball Ice and another member of that panel had also sat on the Fidelity-Phenix panel. On this issue of law the two cases are difficult to reconcile.
More recently, the Fifth Circuit reached a similar result. In Vicksburg Furniture Manufacturing, Ltd. v. Aetna Casualty and Surety Co., 625 F.2d 1167 (5th Cir. 1980), the insurer denied coverage on the belief that the fire was caused by an officer and director who owned one-fourth of the shares. The jury verdict in favor of the insurer was affirmed. The district court had instructed the jury that if it found that the fire was caused by that person and that he had been "vested with virtually exclusive management and control of the corporate affairs." The Fifth Circuit found this a proper instruction. 625 F.2d at 1170.
Even more recently, the Sixth Circuit reversed a jury verdict in favor of a corporation arising from an arson committed by a 50 percent shareholder. In KT Enterprises, Inc. v. Zurich Insurance Co., 97 F.3d 171 (6th Cir. 1996), a husband and wife each owned half the stock of a small corporation they used to run an ice cream franchise. The husband was the only corporate officer. The business was failing, and the husband arranged for another man to burn the property. (Both men later went to prison.) The insurer denied coverage, and the corporation sued for coverage and other damages. A jury found that the wife had not known about the arson, that the husband had not exercised "complete control" of the business, and that the insurer had acted in bad faith. The appellate court reversed the judgment and directed entry of judgment for the insurer on all claims. The court viewed the question as whether an arson defense could succeed where the arsonist-shareholder is "the dominant power in the corporation, but is not in exclusive control of it." 97 F.3d at 177. That is a fair description of the issue in this case, as well.
The Sixth Circuit pointed out the problems inherent in requiring "complete" or "exclusive" control of the corporation. Such a rule, wrote Judge Boggs: (1) would require proof that is very difficult except in the smallest businesses; (2) would "encourage some corporate officers deliberately to remain blissfully ignorant of any plans for arson" by others; (3) would create incentives to disperse at least apparent authority in distressed corporations; and (4) would "encourage arson for profit." Id. at 177-78. The Sixth Circuit also found that the "exclusive control" test articulated in an often-quoted passage from American Jurisprudence 2d Insurance § 494, was not supported by the case law. "An examination of the cases cited in the American Jurisprudence entry and in United Gratiot does nothing to make more definite the prevailing standard in the common law." Id. at 179 (citing divided results for corporate arson by 50 percent shareholders). The Sixth Circuit declined the impossible task of drawing a sharp line, but held as a matter of law that the line had been crossed when "the arsonist, who is the president and sole officer of the corporation, as well as a 50% shareholder, is married to the other 50% shareholder and the couple is neither divorced nor separated and conduct the day-to-day operations of the corporation jointly." Id. In this case, no shareholders were married to one another, and Mr. Thompson was not the only officer. Nevertheless, the Sixth Circuit's accurate description of the uncertainty of the law in this area and the substantial parallels between KT Enterprises and this case lend strong support to Transportation Insurance's ability to act in good faith, providing a reasoned and principled basis for its denial of coverage.
These cases illustrate the point that the common law of corporate arson is not drawn with sharp and bright lines. The court is not convinced that Indiana would impose a standard of "exclusive control" by the arsonist, whatever that might mean, before allowing the arson defense to a corporate claim. The common law and the uncertain scope of Indiana law on the subject gave Transportation Insurance reasonable grounds for denying coverage on the reasonable belief that the claimed loss had been caused by a man who was president, director, and general manager of the corporation's business, and who owned 23 percent of the shares and was personally liable for some loans to the corporation.
2. The Policy Language
Thompson Hardwoods does not rely on only the common law, however, for it argues that the plain language of the insurance policy shows that Transportation Insurance had no reasonable basis for denying coverage. The policy provisions set forth the controlling terms of the parties' contract. The policy excluded coverage for loss to the company caused by "Dishonest or criminal acts by you, any of your partners, employees (including leased employees), directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose." Reed Thompson certainly falls within the definition of employees, directors, and trustees.
Thompson Hardwoods relies on the exception to the exclusion: "This exclusion does not apply to acts of destruction by your employees (including leased employees); but theft by employees (including leased employees) is not covered." Reed Thompson was an employee of Thompson Hardwoods, goes the argument, hence any act of destruction by him is not excluded from coverage. The argument continues, because the language of the exception is so clear, and because even if it were deemed ambiguous, ambiguities are construed in favor of the insured, Transportation Insurance lacked a reasonable basis for denying coverage for arson caused by the employee-president. See, e.g., Federal Ins. Co. v. Stroh Brewing Co., 127 F.3d 563, 569 (7th Cir. 1997) (applying Indiana law, ambiguous policy exclusions are construed in favor of insured); Wood v. Allstate Ins. Co., 21 F.3d 741, 744 (7th Cir. 1994) (applying Indiana law, ambiguities in insurance policies are generally interpreted in favor of insured); Meridian Mutual Ins. Co. v. Auto-Owners Ins. Co., 698 N.E.2d 770, 773 (Ind. 1998) (principle applies with special force to provisions limiting or excluding coverage).
Thompson Hardwoods' straightforward reasoning has considerable force, but it is not unanswerable. In similar cases, insurers have argued successfully that coverage is excluded when the "employee" responsible for the arson is also a corporate officer, director, or substantial shareholder.
The corporate insurance policy in Kabob House, Inc. v. Houston General Insurance Co., 17 F. Supp.2d 1090 (D.N.D. 1997), contained an essentially identical exclusion for criminal acts of employees and directors, with an exception for "acts of destruction by your employees." The arsonist in the case was one of three officers and directors, and she was also an employee of the corporation. (The case was complicated by issues as to whether the arsonist's action was in fact criminal because of mental illness.) In response to an argument like the one Thompson Hardwoods makes here, based on the exception for employees' acts of destruction, the court held as a matter of law that coverage was not available for acts of destruction by employees who were also officers or directors:
It is true that Zhaleh [the arsonist] was an employee of Kabob House, Inc., but she was also an officer, director, and shareholder. When the exception is read in conjunction with the exclusion which immediately precedes it, it is clear that the exception does not apply to an employee who is also a director. The exclusion applies to "partners, employees, directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose." The exception applies only to "employees." If the exception was meant to apply to any act of destruction committed by any of the individuals listed in the exclusion, it would have so stated. Thus, Zhaleh's actions as a director of the corporation will bar recovery if they were criminal or dishonest.17 F. Supp.2d at 1092.
Also, in a case in which the parties' positions were essentially reversed, the Eleventh Circuit distinguished between employees in general and employees who were also corporate officers. In Golden Door Jewelry Creations, Inc. v. Lloyds Underwriters Non-Marine Ass'n, 117 F.3d 1328 (11th Cir. 1997), the insurance policy had been issued to a jeweler. One Credini and his wife each owned 50 percent of the shares. Credini stole $9 million worth of jewelry from the company and from companies that had consigned gold to the company. Credini was later convicted on criminal charges. In the civil insurance coverage litigation, the insurer denied coverage in part based on an exclusion for loss resulting from theft or dishonest acts "on the part of the Assured or his or their employees." The insurer argued that the exclusion barred coverage because Credini had been an employee as well as an officer. 117 F.3d at 1337. The Eleventh Circuit disagreed, finding that the policy distinguished in other provisions between corporate officers and employees, identifying them separately, for example, in a provision for jewelry worn by "the Assured, officer of the corporation, member of the firm, director, agent, employee, servant, or messenger of the Assured." Id. at 1337-38.
Transportation Insurance's reliance on the Golden Door case also is not unanswerable, for the Eleventh Circuit also relied in part on the principle that ambiguities should be interpreted in favor of the insured. Id. In this case, that principle would tend to work in favor of treating Mr. Thompson as an employee for purposes of the "employee destruction" exception to the criminal act exclusion. Nevertheless, Golden Door still lends legal support to Transportation Insurance's decision to distinguish between acts of destruction by employees and by employees who are also corporate officers, directors, and shareholders.
For reasons that are not clear to the court, both parties discussed in their briefs the district court's decision in Golden Door, see 888 F. Supp. 1150 (S.D.Fla. 1995), without mentioning the Eleventh Circuit decision affirming in part and reversing in part, 117 F.3d 1328 (11th Cir. 1997).
At this stage of the case, the court need not try to predict exactly how the Supreme Court of Indiana would express and apply Indiana law to the underlying issue of coverage. Nor must the court reach a decision about whether, for example, it finds the reasoning of Kabob House and Golden Door persuasive. It is enough to say that Indiana law does not show definitively that Thompson Hardwoods would still be entitled to coverage even if Transportation Insurance can prove that Mr. Thompson was responsible for the arson. In other words, Transportation Insurance had a reasonable legal basis for denying coverage, even though it may ultimately be found to have breached the policy.
Plaintiff has tried to distinguish Kabob House on immaterial grounds, but also asserts that the case is simply wrong and not persuasive. Pl. Reply Br. at 3-4.
IV. Conclusion
Accordingly, the court grants Transportation Insurance's motion for partial summary judgment on Thompson Hardwoods' claim for bad faith denial of coverage, and denies Thompson Hardwoods' motion for partial summary judgment on the same claim. The grant of summary judgment on the bad faith claim has the effect of removing any legal basis for Thompson Hardwoods' prayer for punitive damages.
So ordered.
ENTRY ON PENDING MATTERS
The court will hold a scheduling conference on Thursday, April 18, 2002, at 10:30 a.m. in Room 330, U.S. Courthouse, Indianapolis, Indiana, to set a trial date and address other matters. Several motions related to the motions for summary judgment also must be resolved. Defendant's motion to strike plaintiff's statement of additional material facts is denied. Plaintiff's motion to strike a portion of defendants' surreply is also denied. Defendant's motion to strike the affidavit of Daniel Free is granted in part, with respect to Paragraphs 6 to 9, which attempt to offer legal opinions in the form of testimony, and denied in other respects because the delay in identifying Mr. Free as an expert witness caused no prejudice to defendant.
So ordered.