Diane Hendricks, et al v. Novae Corporate Underwriting

Filing

Filed opinion of the court by Judge Sykes. AFFIRMED. Richard A. Posner, Circuit Judge; Ann Claire Williams, Circuit Judge and Diane S. Sykes, Circuit Judge. [6862630-1] [6862630] [16-1712]

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In the

United States Court of Appeals
For the Seventh Circuit
____________________
No. 16-1712
DIANE M. HENDRICKS and
HENDRICKS HOLDING COMPANY, INC.,
Plaintiffs-Appellants,
v.
NOVAE CORPORATE UNDERWRITING, LTD.,
Defendant-Appellee.
____________________
Appeal from the United States District Court
for the Northern District of Illinois, Eastern Division.
No. 13 C 5422 — Sarah L. Ellis, Judge.

____________________
ARGUED SEPTEMBER 19, 2016 — DECIDED AUGUST 18, 2017
____________________
Before POSNER, WILLIAMS, and SYKES, Circuit Judges.
SYKES, Circuit Judge. As a general rule, choses in action are
freely alienable. But courts can—and indeed must—refuse to
enforce certain contractual assignments on public-policy
grounds. In Texas “assignments of choses in action that tend
to increase and distort litigation” violate public policy and
are invalid. State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d
696, 711 (Tex. 1996). The question in this case is whether that

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public policy prohibits enforcement of a settlement arrangement in which the defendant admitted liability, stipulated to an amount in damages, and assigned its claim
against its insurer to the plaintiff; the plaintiff promised to
seek the stipulated damages only from the insurer; and the
insurer played no role in the settlement because it had no
duty to defend. The defendant’s insurer, Novae Corporate
Underwriting, Ltd., contends that this settlement-andassignment is neither enforceable nor binding against it. We
agree. This type of settlement scheme is collusive and distorts the adversarial process. The assignment is invalid as a
matter of Texas public policy.
I. Background
Novae issued an insurance policy to Fairfax Financial
Holdings, the parent company of Cunningham Lindsey
Claims Management, Inc. The policy had a $1 million retention and covered both Fairfax and Cunningham. After the
retention was exhausted, the policy covered losses resulting
from any claim made for a wrongful act, including damages,
judgments and costs, charges, expenses incurred, and any
“reasonable and necessary legal fees and expenses incurred
by the [a]ssureds in the defense or investigation of any
[c]laim.”
While insured by Novae, Cunningham entered into an
agreement with American Patriot Insurance Agency, Inc., to
provide claims-handling services for insurance products
marketed to roofing contractors. Part of Cunningham’s
responsibilities involved setting aside appropriate monetary
reserves for claims. In December 2004 American Patriot and
Diane Hendricks, one of American Patriot’s shareholders,
sued Cunningham in Texas state court. The suit alleged that

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Cunningham made misrepresentations and negligently
handled claims resulting in unwarranted or underpriced
policy renewals. Six years later, while the Texas litigation
was ongoing, American Patriot filed for bankruptcy in the
Northern District of Illinois, and a trustee was appointed for
the bankruptcy estate. In the meantime, Novae denied
Cunningham’s request for coverage. (The reasons are not
important to this appeal.) Throughout the long-running
Texas state-court litigation, Novae remained largely uninvolved because the policy did not obligate it to defend
Cunningham in any legal action.
In 2012 Cunningham, Hendricks, and American Patriot’s
trustee in bankruptcy resolved the Texas litigation by entering into a Settlement Agreement, Assignment, and Covenant
not to Execute. As relevant here, the agreement included
(1) a stipulation to the entry of judgment in the amount of
$5.12 million against Cunningham and in favor of Hendricks
and American Patriot; (2) an assignment to Hendricks and
American Patriot of Cunningham’s purported right to recover against Novae in the coverage dispute, effective upon
entry of the stipulated judgment; and (3) a covenant by
Hendricks and American Patriot not to execute on the judgment against Cunningham. The settlement agreement also
contained a provision stating that Illinois law would govern
its interpretation. The Texas court entered judgment on
May 10, 2012, in accordance with the terms of the settlement.
Hendricks and American Patriot’s trustee in bankruptcy
then sued Novae in the Northern District of Illinois, invoking the court’s diversity jurisdiction and asserting their
newly assigned rights. American Patriot later transferred its
interest in the suit to Hendricks Holding Company, which

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was substituted into the litigation. (We will refer to
Hendricks and the holding company collectively as
“Hendricks” unless the context requires otherwise.)
Novae eventually moved for summary judgment on two
grounds: (1) the assignment was invalid as a matter of Texas
public policy and (2) the Texas state judgment was not
binding on Novae under Texas law. The district court rejected the first argument but accepted the second and accordingly entered judgment for Novae, holding that the insurer
owed no duty of indemnification. Hendricks appealed.
II. Discussion
We review a summary judgment de novo. See Burton v.
Downey, 805 F.3d 776, 783 (7th Cir. 2015). First up is a choiceof-law question: Does Illinois or Texas law govern the validity of the assignment? To decide this question, we apply the
choice-of-law rules of the forum state—here, Illinois. Fulcrum
Fin. Partners v. Meridian Leasing Corp., 230 F.3d 1004, 1011
(7th Cir. 2000). Under Illinois law the contract’s choice-of-law
clause generally controls, id., which in this case points to
Illinois law. But there are two exceptions to this rule. The law
chosen by the parties cannot create a result that is contrary
to the chosen state’s fundamental public policy, id., and the
law chosen by the parties cannot create a result that is
contrary to the “fundamental policy of a state which has a
materially greater interest” in the subject matter of the
litigation, Int’l Surplus Lines Ins. Co. v. Pioneer Life Ins. Co. of
Ill., 568 N.E.2d 9, 14 (Ill. Ct. App. 1990) (quoting
RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 187 (1971)).
The first exception doesn’t apply here. The parties chose
Illinois law, and there’s no concern that its application would

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violate Illinois public policy. Turning to the second exception, the Restatement of Conflict of Laws provides some guidance. See Morris B. Chapman & Assocs., Ltd. v. Kitzman,
739 N.E.2d 1263, 1269 (Ill. 2000) (“Ordinarily, Illinois follows
the Restatement (Second) of Conflict of Laws (1971) in
making choice-of-law decisions.”). Whether another state
has a materially greater interest in the subject matter of the
litigation depends on “(a) the place of contracting, (b) the
place of negotiation of the contract, (c) the place of performance, (d) the location of the subject matter of the contract,
and (e) the domicil, residence, nationality, place of incorporation and place of business of the parties.” RESTATEMENT
(SECOND) OF CONFLICT OF LAWS § 188 (1971).
The parties agree that the first two factors are neutral; the
record does not reflect where the settlement agreement was
either negotiated or executed. The last factor, too, is neutral.
Based on domicile, residence, and place of business, neither
state’s interest deserves greater weight. Cunningham is a
Delaware corporation with a principal place of business in
Texas. Diane Hendricks is a resident of Wisconsin. And
American Patriot was a Wisconsin corporation headquartered in Illinois.
The only two operative factors, then, are the place of performance and the location of the subject matter of the contract. The settlement agreement contemplated multiple
performances occurring in both Texas and Illinois. The
agreement was effective on the date the bankruptcy court
approved it; that court sits in Illinois. But the agreement
called for the entry of a stipulated judgment in the amount
of $5.12 million in the state-court litigation in Texas. The
agreement also required Cunningham to make a lump-sum

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payment in the amount of $650,000 to American Patriot’s
bankruptcy trustee, and the trustee was to pass on a portion
of that payment to Hendricks. Both payments were to take
place in Chicago. Finally, the agreement prohibited
Hendricks from executing on the judgment against
Cunningham, but because this performance is a form of
forbearance, it cannot be assigned a geographical location.
When the place of performance encompasses more than
one state, the place of the initial contemplated performance
is sometimes used as a tiebreaker. See Houlihan v. McCourt,
No. 00 C 3390, 2002 WL 1759822, at *5 (N.D. Ill. July 29,
2002). That doesn’t help us here. The contract initially required performance in both Illinois and Texas. The place of
performance, then, results in a draw.
The fourth factor—the location of the subject matter of
the contract—is not up for debate and is decisive here. The
agreement is centered entirely on resolving the Texas state
litigation. The recitals describe the dispute pending in Texas
and state that the “[p]arties desire to resolve all disputes
between them by entering into this Agreement, including
those disputes brought in the Cunningham Action.” The
subject matter of the agreement is clear and singularly
focused on settling the litigation in Denton County, Texas; its
validity thus implicates the public policy of that state. We
conclude, as did the district judge, that Texas has a materially greater interest in the subject matter of this suit than does
Illinois. Texas law controls.
The Texas Supreme Court’s magisterial decision in State
Farm Fire & Casualty Co. v. Gandy is the most comprehensive
exposition of Texas policy on the assignability of choses in
action. 925 S.W.2d 696 (Tex. 1996). Gandy begins with a

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history of the common-law principle, explaining that “[a]t
early common law, a chose in action could not be assigned.”
Id. at 705. The early rule had several justifications, two of
which were primary: the law’s aversion to the multiplication
of suits and the idea that rights at common law were “relational and situational—that is, determined by the identity of
the particular individuals involved and their transaction or
circumstances.” Id. at 706.
The early rule eventually gave way to the demands of
modern commerce and the evolution of the rights of inheritance, “which expanded to include not only property rights
but rights of action.” Id. Other common-law developments
also contributed. Gandy traces the role of chancery courts,
the growth of commerce, and the expansion of the personal
right to appoint an attorney to act in litigation. 1 Id. at 705–07.
Interested readers may look to Gandy for a fuller discussion
of the evolution and weakening of the early common-law
rule. For our purposes, the case explains current Texas policy
in a way that leaves little doubt about the outcome here, so
we’ll skip right to the heart of the matter.
Julie Gandy sued her stepfather, Ted Pearce, for sexually
abusing her when she was a child. Id. at 697. The abuse
occurred more than 325 times over the course of two years.
Id. at 703. During at least part of this time, Pearce was covered under a homeowner’s policy issued by State Farm Fire
and Casualty Company, so the insurer agreed to pay an

1

“In the thirteenth century only the king could appoint an attorney to
conduct prospective litigation,” but “[o]ver time, the right to appoint an
attorney for such purposes was extended to the king’s subjects.” State
Farm Fire & Casualty Co. v. Gandy, 925 S.W.2d 696, 706 (Tex. 1996).

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attorney to defend him but reserved the right to deny coverage based on several policy exclusions. Id. at 697. Without
giving any notice to State Farm, Pearce settled with his
stepdaughter. Under the terms of the settlement agreement,
Pearce admitted liability, consented to the entry of a judgment in Gandy’s favor in excess of $6 million, and assigned
to her his rights against State Farm. Id. at 698. In exchange
Gandy promised to collect the judgment from State Farm
rather than from Pearce. Id. at 701.
The Texas Supreme Court invalidated the assignment as
contrary to public policy, observing that “[t]he point of this
settlement was not to end the litigation but to prolong it.”
Gandy, 925 S.W.2d at 712. In other words, the objective of the
settlement was to make it possible for Gandy to recover
against State Farm in subsequent litigation.
The court explained that a settlement and assignment of
this nature is collusive and impermissibly distorts litigation
incentives because the defendant “no longer has any incentive to oppose” the plaintiff. Id. at 713. It would be a different
case if the parties had agreed to the settlement and assignment after an adversarial trial; in that situation “the value of
[the plaintiff’s] claim can be taken to be the amount of the
judgment obtained.” Id. But when an agreement of this type
is made before trial, the incentives of the parties are aligned,
which distorts—or at least complicates—a fair evaluation of
the claim. As the court put it, it’s hard enough “to try to
determine what [the plaintiff] would have recovered had he
gone to trial against [the defendant]; the determination is
even more difficult when [the defendant’s] opposing
position must be reconstructed and its merits assessed
without [the defendant’s] cooperation.” Id.

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Accordingly, the court held as follows:
[W]e hold that a defendant’s assignment of his
claims against his insurer to a plaintiff is invalid if (1) it is made prior to an adjudication of
plaintiff’s claim against defendant in a fully
adversarial trial, (2) defendant’s insurer has
tendered a defense, and (3) either (a) defendant’s insurer has accepted coverage, or (b) defendant’s insurer has made a good faith effort
to adjudicate coverage issues prior to the adjudication of plaintiff’s claim. We do not address
whether an assignment is also invalid if one or
more of these elements is lacking. In no event,
however, is a judgment for plaintiff against defendant, rendered without a full adversarial
trial, binding on defendant’s insurer or admissible as evidence of damages in an action
against defendant’s insurer by plaintiff as defendant’s assignee.
Id. at 714. Hendricks hangs her hat on the second of the socalled Gandy factors—the insurer’s tender of a defense—and
tries to escape the force of the decision because this element
is absent here. But it’s absent for good reason: Novae had no
contractual duty to defend Cunningham.
Gandy expressly declined to address whether an assignment is invalid if any of the three listed elements is missing.
Id. When a state supreme court has not squarely addressed a
question, our task is “to predict what the state’s highest court
would do if presented with the same issue.” Todd v. Societe
Bic, S.A., 21 F.3d 1402, 1412 (7th Cir. 1994). Fortunately, two
later opinions by the state’s highest court provide some

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guidance. See Great Am. Ins. Co. v. Hamel, No. 14-1007, 2017
WL 2623067 (Tex. 2017); Evanston Ins. Co. v. ATOFINA Petrochemicals, Inc., 256 S.W.3d 660 (Tex. 2008).
In ATOFINA the court explained that when faced with an
assignment similar to the one at issue in Gandy, a court
should first evaluate whether it fits within the “formal
bounds of Gandy.” 256 S.W.3d at 673. If it does not, the court
should consider whether Gandy’s broader rationale applies.
“Gandy’s reason for invalidating assignments was simple:
Those assignments made evaluating the merits of a plaintiff’s claim difficult by prolonging disputes and distorting
trial litigation motives.” Id.; see also Great Am., 2017 WL
2623067, at *5 (noting that the assignment in Gandy violated
public policy because of “two principal defining characteristics of the overall settlement: (1) it served to prolong litigation rather than end it; and (2) it distorted the litigation”).
Here the settlement-and-assignment distorted the litigation incentives of the parties in much the same way as the
assignment in Gandy. Had Cunningham been on the hook, it
would have mounted a defense with the aim of minimizing
liability. But it wasn’t on the hook. This “increased the
complexity of the litigation” because it “unduly distorted the
posture of the litigation[] and misaligned the parties” by
placing Cunningham and Hendricks on the same side.
Gandy, 925 S.W.2d at 715 (quoting H.S.M Acquisitions, Inc. v.
West, 917 S.W.2d 872, 881 (Tex. App. 1996)). It was in
Hendricks’s interest to seek the largest sum possible in the
settlement, and it was in Cunningham’s interest to agree,
knowing that the burden would fall solely on Novae.
In other circumstances, a settlement and assignment of
rights against an insurer may not raise the specter of collu-

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sion or pervert litigation incentives—say, when the settlement follows a fully adversarial trial, as noted in Gandy. Id.
at 714. But that is not this case. This settlement arrangement
distorted, complicated, and prolonged the litigation by
roping in an insurer that otherwise had no obligation to be
involved. Applying Gandy, the assignment contravenes
Texas public policy and is invalid.
For completeness, we note that even if the assignment
were not unenforceable, Hendricks would be blocked from
using the Texas judgment as evidence of how much Novae
owes. This was the basis of the district judge’s decision; her
reasoning on this point was sound. Gandy’s second holding
is that a judgment agreed to between a plaintiff and defendant without a fully adversarial trial is not binding on the
defendant’s insurer and is inadmissible as evidence of
damages “in an action against [the] defendant’s insurer by
[the] plaintiff as defendant’s assignee.” Id. at 714. “If an
insurer’s liability is to be litigated in an action by a plaintiff
as a defendant’s assignee after such a judgment is rendered,
it should be done on the strength of [the] plaintiff’s claims
rather than the generosity of [the] defendant’s concessions.”
Id. at 719.
Cunningham’s assignment to Hendricks of its claim
against Novae violates the public policy of Texas and is
therefore invalid. In addition, and independently, the
agreement is not binding on Novae and the Texas judgment
is inadmissible against the insurer. For these reasons, the
judgment of the district court is
AFFIRMED.