APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA.
Van Dusen, Gibbons and Garth, Circuit Judges. Gibbons, Circuit Judge, concurring.
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 ...