Insured Entitled to Pursue Federal Damage Claim Based on State Liability Finding

By Don R. Sampen, published, Chicago Daily Law Bulletin, December 6, 2022

The 7th U.S. Circuit Court of Appeals recently held that, following a declaratory action in state court finding that an insurer breached its duty to defend, an insured was not precluded from seeking damages for such breach in federal court. The insured could do so due to a dismissal of the insured’s damage claim in state court with express leave to pursue the claim in federal court.

The case is Creation Supply, Inc. v. Selective Insurance Co. of the Southeast, 51 F.4th 759 (October 19). The insured, Creation Supply, was represented by Bishop Diehl & Lee Ltd. of Schaumburg. Litchfield Cavo LLP of Chicago represented the insurer, Selective.

A competitor of Creation Supply sued it in 2012 for trademark violations, and it tendered the defense to its insurer, Selective, which declined to defend. Selective then filed a declaratory action in state court seeking a determination that it owed no defense. Creation Supply counterclaimed for a declaration of coverage, and it also alleged breach of contract.

The state court found Selective owed a defense and afforded some incidental relief to Creation Supply, but not including any consequential damages flowing from the breach. The state court litigation became final in 2017.

Prior to then, however, Creation Supply filed a separate federal action against Selective for breach of contract and bad faith under Section 155 of the Illinois Insurance Code. Following the filing of the federal action, Creation Supply sought dismissal without prejudice of its state court breach of contract claim. The state court allowed that motion with the express reservation that Creation Supply had leave to pursue the claim in federal court.

Subsequently, back in federal court, Selective moved for judgment on the pleadings. It argued that Creation Supply was precluded from further litigating what was left of its contract claim in federal court because that claim arose out of the same facts as the duty-to-defend claim in state court. The district court agreed and dismissed the action, and Creation Supply took this appeal.

Analysis

In an opinion by Judge Michael Y. Scudder, the 7th Circuit reversed. He noted that, because the court was dealing with a state claim, Illinois preclusion law would apply. He noted the requirements for claim preclusion under Illinois law, which included a final judgment on the merits, the claims in the two actions being the same, and the two actions involving the same parties or their privies.

Scudder then observed an exception to the doctrine of claim preclusion in Illinois.  The exception permitted a claim to proceed that would otherwise be barred, if the court in the first action expressly reserved the plaintiff’s right to maintain the second action.

Since that was exactly what occurred here, Scudder found Creation Supply’s action was not barred, regardless of whether all the usual elements were met for claim preclusion.

Selective argued Creation Supply was at least guilty of claim splitting. It based its argument on case law disallowing a plaintiff to voluntarily dismiss some claims without prejudice, pursuing others to judgment, and later reviving the dismissed claims to further harass the defendant.

Scudder rejected that argument on the ground that Selective’s case law did not involve circumstances where a dismissal order expressly reserved the plaintiff’s right to pursue litigation later. He wrote, moreover, that Creation Supply was not so much guilty of claim splitting as damages splitting — i.e., seeking different damages for breach of contract in different forums. Nonetheless, Scudder said the federal court would respect the state court’s express reservation.

He also rejected Selective’s issue preclusion argument. While acknowledging that the “issue” of damages had been raised in state court, he said the federal claim did not involve the identical issue of damages — consequential damages for breach of contract — as the state case, which had a narrower focus.

The appeals court therefore reversed in favor of Creation Supply and remanded for resolution of the remaining breach-of-contract damages.

Key Point

Under Illinois law, a claim is not subject to being dismissed on claim preclusion grounds where the claim was earlier dismissed without prejudice with an express reservation by the court allowing the plaintiff to refile.