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Ward v. Pacific Indemnity Co.


filed: June 7, 1977.



Van Dusen, Gibbons and Garth, Circuit Judges. Gibbons, Circuit Judge, concurring.

Author: Van Dusen

Opinion of the Court

VAN DUSEN, Circuit Judge.

This appeal is from an award of attorney's fees incurred as a result of bringing a declaratory judgment action in a diversity case.*fn1 Although the district court recognized that state law will normally govern the award of attorney's fees in diversity cases, the court found that, irrespective of state law and as part of the historic equity jurisdiction of the federal courts, the court could award attorneys' fees where bad faith or its equivalent is found to exist. Although our reasoning differs from that of the district court, we affirm its grant of a motion for summary judgment and award of fees.


Montgomery Ward (Montgomery) commenced this declaratory judgment action on December 5, 1974, to obtain a determination that Pacific Indemnity Company (Pacific) was obligated to defend and indemnify it*fn2 in a products liability diversity action which was then pending in the United States District Court for the Western District of Pennsylvania. Montgomery was named as "a person insured" on the "vendors endorsement" to the policy Pacific had issued to Royal Industries, the manufacturer and also a defendant in the tort action.*fn3

The relief sought included prayers that the district court enter a declaratory judgment construing the pertinent provisions of the Vendor Insurance Endorsement issued by Pacific and designating Montgomery as a named insured, determine the respective liabilities of Pacific and Montgomery under the endorsement, determine that Montgomery should be afforded coverage under the endorsement in regard to the personal injury action against Montgomery pending in the same court, and order that Montgomery be entitled to its private counsel fees and expenses in the personal injury action as well as in the declaratory judgment action.

On June 24, 1975, the products liability claim was settled.*fn4 Pacific paid $50,000. of the settlement and reimbursed Montgomery for its costs and counsel's fees incurred in defending the products liability case to that point in the litigation.*fn5 Pacific did not reimburse Montgomery for the fees incurred in bringing the declaratory judgment action. Montgomery continued to prosecute the present action solely to recover the attorneys' fees expended in bringing the declaratory judgment action. The district court found that Pacific had a duty to defend Montgomery under the provisions of the contract and that Pacific's obduracy in refusing to either defend Montgomery or acknowledge its contractual obligations before settlement was not taken in good faith because the refusal was made without reasonable cause.*fn6 The district court's opinion acknowledged Pennsylvania's adherence to the American Rule, which disfavors the allowance of attorneys' fees in the absence of statutory or contractual obligation,*fn7 but went on to conclude that the state law in this area would be inapplicable where bad faith was found. The court stated:

"The power to award such fees which are not ordinarily included in the costs is part of the historical equity jurisdiction of the federal courts. Vaughn v. Atkinson, supra, 369 U.S. at 530. Therefore, where bad faith or its equivalent is found to exist, the court may award attorneys' fees irrespective of state law since the court's equitable powers transcend the applicable state law under those circumstances. See Sprague v. Ticonic National Bank, 307 U.S. 161, 166, [83 L. Ed. 1184, 59 S. Ct. 777] (1939); Hall v. Cole, 412 U.S. 1, [36 L. Ed. 2d 702, 93 S. Ct. 1943] (1974). And this is true notwithstanding the general rule that state law will normally govern the award of attorneys' fees in diversity cases. Toland v. Technicolor, Inc., 467 F.2d 1045, 1047 (10th Cir. 1972); Culbertson v. Jno. McCall Coal Co., Inc., 495 F.2d 1403, 1406 (4th Cir.), cert. den. 419 U.S. 1033, [42 L. Ed. 2d 308, 95 S. Ct. 516] (1975). Thus, while we agree with defendant that the law of Pennsylvania would normally preclude the award of attorneys' fees, see Arcos Corp. v. American Mutual Liability Ins. Co. [350 F. Supp. 380 (E.D. Pa.), aff'd without opinion, 485 F.2d 678 (3d Cir. 1973)], the rule is inapplicable if defendant's refusal to defend was in bad faith."

The district court did not consider whether Pennsylvania courts would apply a "bad faith" exception to the American Rule under the circumstances of this case.


A. Alyeska and Diversity Actions

The question of the recovery of attorneys' fees, was recently considered by the Supreme Court in Alyeska Pipeline Service Co. v. The Wilderness Society, 421 U.S. 240, 44 L. Ed. 2d 141, 95 S. Ct. 1612 (1975). After pointing out the limited situations in which attorneys' fees may be awarded in federal question cases, the Court noted:

"31. A very different situation is presented when a federal court sits in a diversity case. 'In an ordinary diversity case where the state law does not run counter to a valid federal statute or rule of court, and usually it will not, state law denying the right to attorney's fees or giving a right thereto, which reflects a substantial policy of the state, should be followed.' 6 J. Moore, Federal Practice para. 54.77 [2], pp. 1712-1713 (2d ed. 1974) (footnotes omitted). See also 2 S. Speiser, Attorneys' Fees §§ 14:3; 14:4 (1973) (hereinafter Speiser); Annotation, Prevailing Party's Right to Recover Counsel Fees in Federal Courts, 8 L. Ed. 2d 894, 900-901. Prior to the decision in Erie R. Co. v. Tompkins, 304 U.S. 64, 82 L. Ed. 1188, 58 S. Ct. 817 (1938), this Court held that a state statute requiring an award of attorneys' fees should be applied in a case removed from the state courts to the federal courts: 'It is clear that it is the policy of the state to allow plaintiffs to recover an attorney's fee in certain cases, and it has made that policy effective by making the allowance of the fee mandatory on its courts in those cases. It would be at least anomalous if this policy could be thwarted and the right so plainly given destroyed by removal of the cause to the federal courts.' People of Sioux County v. National Surety Co., 276 U.S. 238, 243, 72 L. Ed. 547, 48 S. Ct. 239 (1928). The limitations on the awards of attorneys' fees by federal courts deriving from the 1853 Act were found not to bar the award. Id., at 243-244. We see nothing after Erie requiring a departure from this result. See Hanna v. Plumer, 380 U.S. 460, 467-468, 14 L. Ed. 2d 8, 85 S. Ct. 1136 (1965). The same would clearly hold for a judicially created rule, although the question of the proper rule to govern in awarding attorneys' fees in federal diversity cases in the absence of state statutory authorization loses much of its practical significance in light of the fact that most States follow the restrictive American rule. See 1 Speiser §§ 12:3; 12:4."

Id. at 259, note 31 (emphasis supplied).

The plain meaning of the wording quoted is that state rules concerning the award of attorneys' fees are to be applied in diversity cases whether these rules provide for an award or deny it, provided such rules do not run counter to federal statutes or policy considerations.*fn8 See Tryforos v. Icarian Development Company, S.A., 518 F.2d 1258, 1265 (7th Cir. 1975), cert. denied, 423 U.S. 1091, 96 S. Ct. 887, 47 L. Ed. 2d 103 (1976).

". . . choices between state and federal law are to be made not by application of any automatic 'litmus paper' criterion, but rather by reference to the policies underlying the Erie rule. . . .

"The Erie rule is rooted in part in a realization that it would be unfair for the character or result of a litigation materially to differ because the suit had been brought in a federal court.

"The decision was also in part a reaction to the practice of 'forum-shopping' which had grown up in response to the rule of Swift v. Tyson, 304 U.S. at 73-74. That the York test was an attempt to effectuate these policies is demonstrated by the fact that the opinion framed the inquiry in terms of 'substantial' variations between state and federal litigation. 326 U.S., at 109. Not only are nonsubstantial, or trivial, variations not likely to raise the sort of equal protection problems which troubled the Court in Erie ; they are also unlikely to influence the choice of a forum. The 'outcome-determination' test therefore cannot be read without reference to the twin aims of the Erie rule: discouragement of forum-shopping and avoidance of inequitable administration of the laws.*fn9

Hanna v. Plumer, 380 U.S. 460, 467-68, 14 L. Ed. 2d 8, 85 S. Ct. 1136 & note 9. The Alyeska Court's citation to Hanna is significant because the same policy considerations which formed the foundation of Hanna and the line of cases following Erie would apply, of necessity, were a federal court to engraft federal notions of attorneys' fees awards onto state substantive rights tried in a diversity action. It is apparent that permitting an award of attorneys' fees in a federal court but denying them for an identical action brought in a state court would represent a significant reason to choose the federal forum. Even if we assume that this difference could be restricted to cases involving obdurate conduct or bad faith, it is clear that the possibility of such an award in many cases would color the substantive aspects of the case and could significantly alter the legal theories presented by the parties as a claim or defense. Under Erie and Hanna, such a federal shaping of the state substantive right is unwarranted.*fn9a

This does not mean that the federal forums are to become a haven for the obdurate and the vexatious: first, it may be expected that the attorneys, as officers of the court, will adhere to the rightful boundaries of zealous advocacy; second, the Federal Rules of Civil Procedure provide sanctions in the form of reasonable expenses, including reasonable attorneys' fees, which may be assessed against an offending party, see Moore's, supra, at 1715; third, in the extreme case, the district court may conclude that state courts would apply an exception to the American Rule to award attorneys' fees because failure to remedy the obdurate conduct or bad faith would undermine a major area of state policy or substantive law.*fn10

B. State Law*fn11

It is clear as a general matter that Pennsylvania courts adhere to a close application of the American Rule, which precludes the award of attorneys' fees. For instance, in Corace v. Balint, 418 Pa. 262, 210 A.2d 882 (1965), the Pennsylvania Supreme Court vacated an award of attorneys' fees with its oft repeated statement that:

"'* * * Over and over again we have decided there can be no recovery for counsel fees from the adverse party to a cause, in the absence of express statutory allowance of the same * * *', Smith v. Equitable Trust Co., 215 Pa. 413, 417, 64 A. 591, 592 (1906), or clear agreement by the parties, Fidelity-Philadelphia Trust Company v. Philadelphia Transportation Company, 404 Pa. 541, 548, 173 A.2d 109, 113 (1961), or some other established exception, see Hempstead v. Meadville Theological School, 286 Pa. 493, 134 A. 103, 49 A.L.R. 1145 (1926)."

Id. at 271-72, 210 A.2d at 887. Although it appears that an award of attorneys' fees would not lie in Pennsylvania in a suit for ordinary breach of contract or specific performance of a contract, see Balint, supra at 273, 210 A.2d at 888, an insured may recover attorneys' fees expended in defending an initial negligence action against him in a later action on the contract of insurance against the insurer who wrongfully refused to defend the earlier action. See, e.g., Cadwallader v. New Amsterdam Casualty Co., 396 Pa. 582, 152 A.2d 484 (1959). In addition, the Pennsylvania Supreme Court has permitted the imposition of attorneys' fees on the offending party as a part of the fine imposed in civil contempt proceedings where contumacious or obdurate conduct has been involved. See Bata v. Central-Penn National Bank of Philadelphia, 448 Pa. 355, 372 & n.13, 293 A.2d 343, 352-53 & n.13 (1972); Brocker v. Brocker, 429 Pa. 513, 520, 241 A.2d 336, 339 (1968); Lichtenstein v. Lichtenstein, 481 F.2d 682, 684 (3d Cir. 1973).*fn12

We are aware of no Pennsylvania case which has applied the "obdurate behavior" or "bad faith" exception to the general American Rule concerning the award of attorneys' fees in a declaratory judgment action involving contract. However, Bata and Brocker suggest, at least by analogy, that if the Pennsylvania Supreme Court were to consider the question they would apply the "obdurate behavior" exception consistently with the broad outlines reiterated in Balint, supra.*fn13

Also, even if Pennsylvania would not generally adopt the bad faith exception to the American Rule, there is reason to expect that the Pennsylvania courts would allow recovery of attorneys' fees in the circumstances of this case as a matter of public policy in order to prevent insurers from frustrating the contractual rights of the insured by forcing the insureds to bring a declaratory judgment action when the refusal to defend was unreasonable and in bad faith.

The Pennsylvania Unfair Insurance Practices Act, 40 P.S. §§ 1171.1, et seq., provides in 40 P.S. § 1171.5(10)i-vi and xiv:

"(10) Any of the following acts if committed or performed with such frequency as to indicate a business practice shall constitute unfair claim settlement or compromise practices:

"(i) Misrepresenting pertinent facts or policy or contract provisions relating to coverages at issue.

"(ii) Failing to acknowledge and act promptly upon written or oral communications with respect to claims arising under insurance policies.

"(iii) Failing to adopt and implement reasonable standards for the prompt investigation of claims arising under insurance policies.

"(iv) Refusing to pay claims without conducting a reasonable investigation based upon all available information.

"(v) Failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have been completed and communicated to the company or its representative.

"(vi) Not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which the company's liability under the policy has become reasonably clear.

"(xiv) Failing to promptly provide a reasonable explanation of the basis in the insurance policy in relation to the facts or applicable law for denial of a claim or for the offer of a compromise settlement."

The Act goes on to provide for a system of administration to investigate violations and authority within the broad responsibility of the State Insurance Commissioner to impose civil fines. Thus, it is clear that obdurate behavior and bad faith on the part of an insurer in refusing to defend an insured is contrary to explicit expressions of state law and policy as found in the expressions of the Pennsylvania courts and legislature.*fn14

Under the facts presented in this case, Pennsylvania law required Pacific to defend Montgomery under the provisions of the contract with Royal under which Montgomery was an additional insured. Since Montgomery had established a prima facie case of coverage, Pacific was obliged to defend Montgomery "even if such suit was groundless, false or fraudulent" or to make a prompt and thorough investigation to establish that other insurance or policy limitations or exceptions would have insulated it from ultimate liability; it did neither. The district court found that Pacific never had a valid reason for its procrastination and that its obduracy was not in good faith. These findings of fact are well supported in the record. We disagree with Pacific's final contention that material issues of fact remain which make summary judgment improper.

For the reasons stated, the judgment of the district court will be affirmed.


The judgment of the district court will be affirmed.

GIBBONS, Circuit Judge, concurring:

I join in the court's judgment because I believe the result would be the same whether we applied Pennsylvania law or a federal rule. The prediction made by Judge Van Dusen that Pennsylvania would follow Vaughan v. Atkinson, 369 U.S. 527, 8 L. Ed. 2d 88, 82 S. Ct. 997 (1962), and allow an award of attorneys' fees, is convincing. I do not agree, however, that in a state which would not follow Vaughan v. Atkinson, a federal forum would be precluded from awarding attorneys' fees for what amounts to a vexatious abuse of its process. I regard the award of attorneys' fees on the authority of Vaughan v. Atkinson as more in the nature of costs than are such awards under the other exceptions to the American rule. Certainly the notions of federalism which underlie the Erie rule do not require that a federal forum accept the public policy of the state in which it happens to sit on a matter such as the award of costs for abuse of its process. Cf. Byrd v. Blue Ridge Cooperative, 356 U.S. 525, 2 L. Ed. 2d 953, 78 S. Ct. 893 (1958). The issue need not, of course, be resolved here.

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