Using The 'Primary Focus' Test For Reimbursement
August 18, 2010
The 7th U.S. Circuit Court of Appeals recently held that an insurer had an obligation to defend an insured that was alleged, among other things, to have used slogans on packaging similar to the plaintiff's, despite an intellectual property exclusion in the policy, but that the insurer's duty to indemnify the insured would turn on whether covered claims were the "primary focus" of the insured's underlying settlement. Santa's Best Craft LLC v. St. Paul Fire and Marine Insurance Co., 2010 WL 2605874 (7th Cir. July 1, 2010).
The insured, SBC, was represented by David Gauntlett and James Lowe of Gauntlett & Associates in Irvine, Calif. Shaun McParland Baldwin of Tressler LLP in Chicago, represented the insurer, St. Paul.
JLJ Inc., sued SBC over SBC's marketing of Christmas lights, claiming that SBC's packaging of the lights imitated the look and slogans of JLJ's lights. The lawsuit was brought under the Lanham Act for trademark infringement, deceptive trade practices and related torts. Added as a defendant in the lawsuit was Monogram Licensing, with whom SBC had entered into a trademark licensing agreement in which SBC agreed to indemnify Monogram for any claimed infringement of marking rights.
Prior to the lawsuit SBC notified St. Paul, SBC's liability insurer, of JLJ's demand, and St. Paul took the position that JLJ's claims were not covered under the policy. St. Paul denied coverage again after the lawsuit was filed, as the result of which SBC and its two principal members, who also were named defendants, brought the current coverage action to compel a defense by St. Paul. St. Paul counterclaimed with a declaratory judgment action.
While the coverage action was pending, SBC and the other underlying defendants settled the underlying case for $3.5 million and an agreement to refrain from using any colorable imitation of JLJ's marks. One of SBC's members also ended up reimbursing Monogram for its defense costs in the amount of $1.3 million.
The district court in the coverage action held that St. Paul had a duty to defend SBC, but that, by virtue of the filing of St. Paul's counterclaim in the coverage action, SBC had not committed an actual breach of its duty to defend. The court also held that St. Paul did not owe SBC a duty to indemnify for settlement costs because some of the claims were not covered under the policy and SBC and its members failed to allocate between covered and non-covered claims. It further held that St. Paul had no obligation to reimburse SBC for Monogram's fees. The parties appealed and cross-appealed.
In an opinion by Judge Richard D. Cudahy, the 7th Circuit mostly affirmed. Cudahy initially addressed St. Paul's defense duty. St. Paul argued that its policy did not give rise to such a duty in part because, while it covered the unauthorized use of a "slogan," the term "slogan" suggested that the underlying plaintiff must have some ownership interest in the words used, JLJ did not, and, moreover, JLJ's allegations regarding use of a slogan merely served as background for its trade dress infringement claim, the coverage for which was excluded.
Cudahy rejected the arguments finding that, in his view, the allegations in JLJ's complaint suggested that JLJ had some claim of ownership over the slogans in question. He also found that, while many of the slogan allegations did support JLJ's trade dress claim, the relevant inquiry for coverage purposes was the allegations in the complaint, not the legal labels attached to them.
The actual policy exclusion relied on by St. Paul precluded coverage for claims based on trade dress, trademark and "other intellectual property rights or laws," excepting, however, a claim for unauthorized use of a trademarked slogan. According to Cudahy, the mere fact that JLJ's trade dress allegations were a subset of those alleging infringement of a slogan did not eliminate coverage under the policy. Consequently, the exclusion for trade dress did not excuse St. Paul from defending.
St. Paul also relied on a second exclusion for claims based on advertising "material previously made known or used" prior to the policy period. The St. Paul policy here provided coverage for two policy periods, 2002-03 and 2003-04. SBC began using its packaging during the 2002-03 period, and thus, while the exclusion would apply for the 2003-04 period, it would not for the 2002-03 period, and St. Paul therefore had a duty to defend the entire complaint.
With respect to SBC's argument that St. Paul breached its duty to defend by refusing to provide a defense, Cudahy noted Illinois' requirement that an insurer seeking to contest the duty to defend must either defend under a reservation of rights or file a timely declaratory judgment action, at the peril of being estopped from raising coverage defenses if it is found to have breached the duty to defend. He found that SBC's counterclaim filed in response to SBC's coverage action was timely, and that no breach of the duty to defend therefore occurred.
Cudahy then turned to whether St. Paul was obligated to reimburse SBC for its $3.5 million settlement payment. He observed that, under Illinois case law, when a settlement is made in reasonable anticipation of liability for covered damage, and the settlement's "primary focus" is a claim covered under the policy, the insurer must reimburse the insured for its settlement expense.
He also discussed additional case law suggesting that a insured is not required to apportion its liability for different claims in a settlement, because doing so could result in a re-trial of the merits of the underlying lawsuit. But an insured is required to establish when the covered claims arose to allocate responsibility for paying the settlement based on which insurer's policy was in effect at the time.
Consistent with these rules, Cudahy said an insurer should not be required to reimburse a settlement where the claims were not even potentially covered by the insurance policy. In addition, the burden should be on the insured to prove coverage of the settlement in the first place, and then on the insurer to prove the existence of exclusions barring coverage.
In this case, several of the allegations in JLJ's complaint dealt with claims clearly outside the policy coverage, including a trademark claim and a false advertising claim. Since SBC's settlement payment was not allocated to specific claims, the question then becomes whether the primary focus of the settlement was for the covered infringement-of-slogan claim.
Although the district court appeared to apply a test for coverage close to the "primary focus" test, Cudahy decided that a remand would be necessary to allow the district court to consider the record evidence in light of the court's opinion.
Cudahy then addressed whether St. Paul should be required to reimburse SBC for its payment for Monogram's defense costs. He noted that the St. Paul policy obligated St. Paul to pay for an indemnitee's defense costs under certain conditions, including where there was no conflict of interest between the insured's interests and those of the indemnitee. Based on affidavits submitted by SBC itself, the district court found, and Cudahy agreed, that a conflict existed between SBC and Monogram, and this condition therefore was not met.
Cudahy also rejected the argument that St. Paul should pay for Monogram's defense because its defense costs benefited SBC. He therefore concluded that St. Paul had no reimbursement obligation for Monogram's defense costs.
SBC also argued that it was entitled to prejudgment interest on its own defense costs, and Cudahy found that a remand would be necessary for that issue because the district court had not addressed it.
The 7th Circuit therefore affirmed in part, and reversed and remanded in part.
