author: HILLMAN, District Judge.

text:
    CENTURY BOAT COMPANY, Plaintiff and Counter-Defendant, v. MIDLAND INSURANCE CO. and Johnson & Higgins of Illinois, Inc., Defendant and Counter-Plaintiff.
    No. G82-663 CA7.
    United States District Court, W.D. Michigan, S.D.
    Feb. 25, 1985.

      Douglas E. Wagner, Warner, Norcross & Judd, Grand Rapids, Mich., for plaintiff and counter-defendant.
    Alvin D. Treado, Culver, Lague & McNally, Muskegon, Mich., for Midland Ins. Co.
    David O. Haughey, Smith, Haughey, Rice & Roegge, Grand Rapids, Mich., for Johnson & Higgins.
   OPINION

HILLMAN, District Judge.

This case involves a dispute concerning the interpretation and application of an insurance policy, specifically whether certain defense costs incurred by the insured are covered by the disputed policy. It was tried to the court from August 28-30,1984, with closing arguments on November 9, 1984. This opinion constitutes the court’s finding of facts and conclusions of law as required by Fed.R.Civ.P. 52.

FINDINGS OF FACT

Plaintiff, Century Boat Company (“Century”), is a Michigan corporation, located in Manistee County, Michigan, which manufactures and markets a line of power boats. Defendant, Johnson & Higgins of Illinois, Inc. (“Johnson & Higgins”), is an insurance broker. Its general business involves advising insureds and potential insureds on insurance matters, arranging insurance programs or risk management programs on behalf of insureds or self-insureds, and acting in an intermediary capacity between insureds and insurance companies. Defendant, Midland Insurance Company (“Midland”), is a Delaware insurance company engaged generally in casualty insurance business. At all pertinent times, Midland maintained an agency agreement with Capacity Managers, Inc. (“CMI”), to underwrite and issue on its behalf various types of insurance contracts, including the class of insurance contract involved in this case.

Prior to August 31, 1978, Century had purchased product liability insurance from various insurance companies. These policies were of a standard form, without any deductible or self-insured retention, requiring the insurance company to pay all defense costs, as well as the entire amount of every claim subject to a stated limit of liability. Also, the insurance company had substantial control over investigation and management of claims, settlement of claims, selection of counsel, and management of the defense of litigated claims. In August of 1978, Century decided to investigate other product liability programs which would: (1) substantially reduce its insurance premiums; (2) give Century a right to greater participation in claims investigation, settlement, selection of counsel, and management of litigation; and (3) provide for self-insurance up to reasonable levels of risk. Century also considered a total self-insurance program. In order to pursue those objectives, Century contacted Johnson & Higgins for advice on a product liability program and for assistance in putting a satisfactory program into place. After preliminary discussions between Century and Johnson & Higgins, it was decided that the idea of total self-insurance would not be pursued, but that Johnson & Higgins would attempt to find a suitable product liability program for Century, which would meet its other above-stated objectives.

In the later part of 1978 and early 1979, Johnson & Higgins did considerable work in connection with Century’s requirements, including surveys of Century’s operations and products, preparation of detailed underwriting presentations, and negotiations with a number of potential insurers. This work culminated in three specific written proposals for insurance which were presented to Allan Hegg, the president of Century Boat Company, at a meeting in Chicago on January 5, 1979. All three proposals were presented by Johnson & Higgins as being suitable, but of the three, a proposal represented as that of Midland was recommended as the best. All three were based on coverage to start February 15, 1979, which was the date of the expiration of Century’s then existing coverage. All three proposals, through the same hypothetical examples, indicated that defense costs were included in the self-insured retention or deductible. All three had a self-insured retention of $100,000 per occurrence.

On January 30, 1979, Leonard Holmes, the Century officer primarily responsible for its insurance program, telephoned Rick Voss, the officer of Johnson & Higgins who was managing the Century account. Holmes advised Voss that Century was rejecting all three of the written proposals submitted January 5th, and had tentatively decided to accept an insurance proposal presented to them by another insurance broker, Alexander & Alexander. However, Holmes advised Voss that Century would delay acceptance of the Alexander & Alexander offer until at least February 1, to allow Johnson & Higgins the opportunity to make a new proposal which would equal or improve upon the Alexander & Alexander proposal. A deadline of February 1, 1979, was set for any new proposal to be made by Johnson & Higgins. A primary reason that Century was rejecting the January 5 proposal of Johnson & Higgins was Century’s decision, based on its size and financial situation, that a self-insured retention of $100,000 per occurrence was an unacceptable level of retained risk.

Voss telephoned CMI, general agent for Midland, and obtained oral authorization to make a new proposal to Century. The new proposal was made over the telephone by Voss to Holmes of Century on February 1, 1979. The terms of this proposal regarding the handling of defense costs are disputed between Century and Johnson & Higgins. In all other respects, the parties are in agreement as to the terms of that proposal. Neither party has been able to present a contemporary written memorandum of the terms agreed upon. Nevertheless, both agree that the proposal was for a policy to be issued by Midland, to run for one year, from February 15, 1979, to February 15, 1980, covering product liability and completed operations, with a combined aggregate bodily injury and property damage coverage of $3 million. To this extent, the new proposal was the same as the written proposal of January 5, 1979. The premium was changed from a rate of $5 per $1,000 of sales and a minimum premium of $150,000 to a rate of $37.80 per unit manufactured and a minimum premium of $170,000. The self-insured retention was changed from $100,000 each occurrence and $500,000 aggregate to $50,000 each occurrence and $500,000 aggregate. As noted, in the earlier Johnson & Higgins’ proposal of January 5th, defense costs were represented as being included as part of the self-insured retention. Coverage of defense costs in the telephoned proposal of February 1st is in dispute. Century claims that the feature was unchanged, while Johnson & Higgins claims that the February 1st proposal provided for a division of defense costs between the insurance company and the insured in proportion to the amoúnt ultimately paid by each on a claim, and that counsel would be hired by the insured. It is undisputed, in any event, that claim investigation and management would be primarily the responsibility of Century through retention of a claims management agency to be approved by Midland.

Regarding the factual dispute outlined in the preceding paragraph, the court finds that Century understood the proposal of February 1, 1979, to provide for the inclusion of defense costs in the self-insured retention as contained in the January 5 proposal. Although the court is satisfied that Voss believed he had explained the changes in the proposed insurance program to Century, the following factors convince me that any attempted explanation by Voss was not successful. First, Holmes made a comparison chart of the programs receiving consideration following the February 1, 1979, telephone call. The chart compared Century’s current insurance program, the Johnson & Higgins proposal, and the Alexander & Alexander proposal. It demonstrated that Holmes understood each program as having a “deductible,” which included defense costs. Second, at least one reason Century had rejected Johnson & Higgins’ earlier proposals was because it thought it could not handle a deductible risk of $100,000 per occurrence. Yet, the pro rata sharing of defense costs, which defendants maintain was provided for in the February 1, 1979, proposal, exposed Century to a greater potential risk than $100,000 per occurrence. Third, I find Holmes’ testimony on this point credible. Finally, evidence at trial demonstrated that Voss’ telephone call to Holmes on February 1, 1979, to present the new proposal, lasted only five minutes. Explanation of a complicated insurance program, which included a major change in coverage from the prior proposals, to a non-expert in a five-minute telephone call must have been superficial at best.

On February 5, 1979, the February 1 proposal was accepted by Century by a telephone call to Johnson & Higgins, without any further discussion of its terms. An insurance binder was prepared by Johnson & Higgins on February 7, was signed by Midland on February 9, and sent to Century with a letter dated February 12, 1979. The binder set forth the principal features of the insurance policy but was silent regarding defense costs. On March 3, 1979, the insurance policy, which by that time had been issued' by Midland, was sent by Voss of Johnson & Higgins to Holmes of Century with a letter dated March 6, 1979. The letter stated in substance that the policy, as issued, had been reviewed by Voss and conformed to the parties’ negotiations. This letter mentioned no change in the way defense costs would be allocated. The premium was paid.

The Midland policy, as delivered to Century, included all the terms and conditions of the policy, including an attachment identified as “ENDORSEMENT NO. 2,” which purports to deal, among other things, with defense costs. Holmes of Century, received the policy and read it, including those portions which were not part of the printed form, e.g., Endorsement No. 2. At the time of his review, he concluded that the policy did in fact conform to his understanding of the bargain that had been struck. The policy was then filed away and was not examined again by anyone until the spring of 1982, shortly before the filing of this suit. The disagreement concerning the terms of the policy coverage became apparent only when a claim arose under the policy.

On September 3, 1979, a person named Davidow was injured in Pennsylvania while riding as a passenger in a Century boat. An action was commenced by her in the State of Pennsylvania, and Century was served with the complaint on January 28, 1980. Mrs. Davidow claimed that her injuries (she was rendered quadraplegic) were caused by a defect in the Century boat in which she was riding at the time it collided with another boat. This claim (hereinafter “the Davidow ease”) fell within the coverage provided by Midland’s policy. A wholly-owned subsidiary of Midland, All Risk Management Service (“ARMS”), with which Century had contracted for claims management, handled the Davidow claim. ARMS, on the recommendation of Century’s local counsel, selected a Pittsburg lawyer to defend the case. Pittsburg counsel, Harry Zimmer (“Zimmer”), kept Century, Midland and ARMS advised of the progress of the litigation.

In early spring of 1982, the Davidow case was approaching trial. Century had thus far paid all defense costs under the assumption it had a $50,000 cap. It was determined by Attorney Zimmer that an outside engineering expert should be retained and that certain experiments should be commissioned in preparation for trial. The estimated cost of these tests was approximately $60,000. Century, through ARMS, asked Midland to approve the hiring of the expert (Miller) and the commissioning of the experiments and to pay all defense costs once they exceeded $50,000. This demand for payment of defense costs was refused by Midland, which took the position that the payment of defense costs was entirely the responsibility of Century until such time (if at all) as a claim was paid by way of settlement or judgment. It was Midland’s position that the first $50,-000 of any such payment was the obligation of Century. At that time, Midland would reimburse Century for defense costs incurred by Century in proportion to the amount paid by each on the Davidow claim. However, despite the dispute regarding payment, Midland approved the retention of Dr. Miller, an engineer, and the performance of certain accident reconstruction tests in March, 1983. Century paid the costs of Dr. Miller’s retention under a reservation of rights.

Century’s insurance policy provided in Endorsement No. 2, that Midland had the right, but not the duty, to defend or participate in the defense of any claim made against its insured. I find that Midland began to actively participate in the defense of the Davidow case at least by March 10, 1983, when it approved the retention of Dr. Miller, which retention all parties agreed proved indispensable in Century’s defense of the Davidow claim. Marsh, the ARMS agent handling the Davidow claim, testified that the ultimate decision regarding the retention of Dr. Miller, and the performance of the tests was Midland’s. In April of 1982, Attorney Zimmer was told by Marsh to begin contacting Midland personnel directly. Zimmer then had direct contact with and accepted guidance from Midland at least on settlement matters. Both Zimmer’s and Marsh’s invoices demonstrate the substantial participation Midland took in the defense of the Davidow case.

Another dispute arose just prior to the trial of the action, when pre-trial settlement conferences were being held. When Attorney Zimmer indicated to Marsh of ARMS that he needed settlement authority for the pre-trial, Marsh informed Midland of the status of the case. In light of the upcoming settlement discussions, Midland demanded that Century be prepared to tender its $50,000 under the SIR so a settlement proposal could be made. Century contested its obligation to contribute to any settlement because in its view it had already expended the entire SIR, or deductible, toward defense of the Davidow claim. Eventually, Century agreed to tender the $50,000 if a settlement could be reached.

While settlement was being discussed, just prior to and during the trial, the parties (Davidow and Century) were never closer than $500,000 to settling the claim. Attorney Zimmer stated that he never recommended more than $300,000 as Century’s contribution to settlement in the Davidow action, although at one time, according to Midland’s records, Midland authorized an offer as high as $500,000 if the matter could be settled. Century, however, thought a settlement offer in excess of $500,000 was necessary to protect its interest and urged that one be tendered. Apparently due to the lack of contribution by other defendants, settlement was never reached.

At the conclusion of a trial in Pennsylvania, a jury verdict was returned in favor of Century. Other defendants were also released from the case, but a substantial verdict was rendered for Mrs. Davidow against her husband, the operator of the boat. Because no settlement or judgment was rendered against Century, Midland has taken the position that it is not obligated to contribute to the defense costs under the terms of Endorsement No. 2 of Century’s-policy. Since there was no loss by way of judgment or settlement against the insured (Century), Midland claims there is no basis for apportioning any defense costs to Midland. Century claims that this interpretation by Midland constitutes a breach of contract, bad faith and unfair dealings. Century claims it is entitled to $62,930.02 in compensatory damages, this amount having been paid in excess of $50,000 toward defense costs in the Davidow case. Century also requests declaratory relief that Midland and/or Johnson and Higgins are responsible for all post-trial defense costs in the Davidow case, which is currently on appeal. Century further requests assessment against Midland of punitive damages .and, finally, penalty interest and attorney fees pursuant to statute.

Century’s theory of the case is one of the following two factual scenarios: (1) If the policy provides the coverage for defense costs that Johnson & Higgins allegedly told Century it provided, then Midland is responsible for all defense costs in excess of $50,000; or (2) if the policy does not provide that coverage, Century claims Johnson & Higgins misrepresented the terms of the policy and must compensate Century for the damages it suffered as a result of Johnson & Higgins’ misrepresentation.

Johnson & Higgins asserts two different defenses to Century’s claim. First, Johnson & Higgins maintains that it fully informed Century of Midland’s interpretation that defense costs would be apportioned and then only in the event of a settlement or a judgment and, therefore, was not guilty of any negligence in the brokerage services it provided Century. In the alternative, Johnson & Higgins claims that the policy itself is ambiguous and should be construed in favor of the insured (Century) to include defense costs in the $50,000 self-insured retention. Johnson & Higgins thus contends that, under that construction, the policy provides for Century the coverage it claims it bargained for and, therefore, Century has suffered no damage by reason of Johnson & Higgins’ conduct.

Midland responds that any deviation between the written terms of the insurance policy and the coverage Century now claims it bargained for is the result of negligence on the part of Johnson & Higgins. Consequently, Midland has filed a cross-complaint against Johnson & Higgins for contribution or indemnification in the event Midland is found liable for any damages claimed by Century.

CONCLUSIONS OF LAW

I find Midland and Johnson & Higgins jointly liable for all past and future defense costs in excess of $50,000 incurred by Century in the Davidow case. I find Midland’s insurance contract ambiguous. Further, I find Johnson . & Higgins was negligent in its communication to Century of the terms of the contract. Both contributed equally to Century’s obtaining a policy which did not contain the coverage for which Century believed it had bargained and paid.

Ambiguity of the Midland Contract

While I am persuaded that Century’s insurance contract with Midland provides for proportionate sharing of defense costs in some circumstances, I find the precise definition of those circumstances illusive, to say the least. Initially, I note that the court has spent literally hours both listening to oral presentations, and reviewing written briefs containing plausible and conflicting interpretations of how the policy operates with respect to Endorsement No. 2, which purports to address apportionment of defense costs. Moreover, the witness for Johnson & Higgins, an experienced insurance broker, testified in court it wasn’t clear to him what the language meant. If an insurance company foists on the public an insurance policy, which experienced insurance salesmen and trained lawyers cannot fathom after reading, re-reading, and studying, then it seems only good sense and sound public policy that the insurance company must bear the risk of an unfavorable interpretation.

Requiring the insurance company to bear this risk when it issues an ambiguous policy is amply supported by applicable case law. In this diversity action, Michigan’s conflict of law rules apply. Insurance Co. of North America v. Forty-eight Insulations, Inc., 633 F.2d 1212, 1219 (6th Cir.1980), cert. denied, 454 U.S. 1075, 102 S.Ct. 626, 70 L.Ed. 609. Michigan’s conflict of law rules require that construction of a contract be governed by the law of the state in which the last act necessary to make the contract a binding agreement occurs. State of Ohio v. Eubank, 295 Mich. 230, 233-234, 294 N.W. 166 (1940); Insurance Co. of North America, 633 F.2d at 1219. The last act necessary to make an insurance contract a binding agreement is the counter-signature of the insurer. Chrysler Corp. v. Insurance Co. of North America, 328 F.Supp. 445, 449 (E.D.Mich.1971). The insurance contract involved in this action was counter-signed in Chicago, Illinois, in February of 1979. Thus, its interpretation is governed by Illinois law.

It is well settled in Illinois that any ambiguity in an insurance policy is construed against the insurer and in favor of the insured. Kirk v. Financial Life Ins. Co., 75 Ill.2d 367, 27 Ill.Dec. 332, 389 N.E.2d 144 (1978); State Farm Fire & Casualty Co. v. Moore, 103 Ill.App.3d 250, 58 Ill.Dec. 609, 430 N.E.2d 641 (1981). Midland’s refusal to pay is based on a limitation clause inserted in the policy, namely Endorsement No. 2. When such an attempt is made, the limitation is always construed in favor of the insured. As stated by the Illinois Supreme Court:

“[W]hen an insurer attempts to limit its liability under the ... policy, such limitation must be construed liberally in favor of the policy holder, and most strongly against the insurer.”

Squire v. Economy Fire & Casualty Co., 69 Ill.2d 167, 13 Ill.Dec. 17, 22, 370 N.E.2d 1044, 1049 (1977).

This rule was further explained in State Farm Fire & Casualty Co. v. Moore, 58 Ill.Dec. at 614, 430 N.E.2d at 646:

“Where an insurer attempts to limit liability, the insurer must show that the claim falls within the exclusion as the insured’s intent was to obtain coverage [citation omitted]____ [F]urther, the insurer, as the drafter of the policy, could have stated exclusions clearly and specifically. [Citation omitted] Exclusionary provisions, therefore, are applied only where the terms are clear, definite and explicit.”

Accord, see State Farm Mutual Automobile Ins. Co. v. Schmitt, 94 Ill.App.3d 1062, 50 Ill.Dec. 493, 494, 419 N.E.2d 601, 602 (1981); Barnes v. Powell, 49 Ill.2d 449, 454, 275 N.E.2d 377 (1971);

In determining if an ambiguity exists, the court should consider the subject matter of the contract, the facts surrounding its execution, the situation of the parties, and the predominant purpose of the contract, which is to indemnify the insured. Dora Township v. Indiana Ins. Co., 78 Ill.2d 376, 36 Ill.Dec. 341, 400 N.E.2d 921 (1980). Moreover, as stated by the court in Garman v. New York Life Ins. Co., 501 F.Supp. 51, 53 (N.D.Ill.1980), “a literal interpretation of one provision should be avoided if such interpretation leads to unreasonable or absurd results.”

The court finds it was at all times the intention of Century to obtain coverage for all defense costs once the $50,000 limit was reached. This was communicated to Johnson & Higgins and should have been relayed by Johnson & Higgins to Midland when Johnson & Higgins solicited a proposal from Midland. It was Johnson & Higgins’ duty to know and understand Century’s insurance needs; to communicate them accurately to Midland; to understand Midland’s latest offer to Century; and, finally, to explain the proposal carefully and accurately to Century. If it failed in this responsibility, as this court finds it did, such failure constituted negligence, as hereafter explained.

Midland now asserts that because Century successfully defended the Davidow case, it is not entitled to reimbursement for any of the expenses it incurred in that defense. Although Century admittedly wanted greater participation in the defense of claims, I am satisfied from the evidence that it was never Century’s intention to bear total responsibility for that defense. As discussed, Midland clearly participated in defending the Davidow case. Based on the above, I am satisfied that Century should be provided the coverage it thought it had obtained.

As indicated above, Illinois courts nearly always find in favor of the insured when there is ambiguity as to the excluding or limiting provision of the contract. Any time a provision is subject to more than one reasonable interpretation, it is ambiguous. See, e.g., State Farm Fire & Casualty Co., 58 Ill.Dec. at 614, 430 N.E.2d at 646. Thus, even if this court finds that Century’s interpretation of the language found in Midland’s policy is not the only reasonable interpretation, the language of Endorsement No. 2 is, at the very least, ambiguous and must be construed against Midland.

I find the policy issued to Century by Midland, when read as a whole, ambiguous with respect to payment of defense costs, in the following respects. As stated earlier, when Century received the policy issued by Midland, it understood that the coverage included attorney fees and that the deductible was $50,000. Century had been lead to believe by Johnson & Higgins, and the policy seems to state, that once $50,000 was paid by Century toward the defense of a claim, it became Midland’s obligation to pay all remaining defense costs.

For example, the printed portion of the policy contains a section under the heading, “Supplementary Payments,” which provides as follows:

“The company will pay, in addition to the applicable limits of liability: (a) All expenses incurred by the company, all costs taxed against the insured in any suit defended by the company and all interest on the entire amount of any judgment therein which accrued after the entry of judgment and before the company has paid or tendered or deposited in court that part of the judgment which does not exceed the limit of the company’s liability thereon; (b) * * *; (c) * * *; (d) Reasonable expenses incurred by the insured at the company’s request assisting the company in the investigation or defense of any claim or suit including actual loss of earnings not to exceed $25 per day.”

The policy also provides under Coverage A Bodily Injury Liability and Coverage B Property Damage Liability that:

“The company shall have the right and duty to defend any suit against the insured seeking damages on account of such bodily injury or property damage, even if any of the allegations of the suit are groundless, false or fraudulent, and may make such investigation and settlement of any claim or suit as it deems expedient, but the company shall not be obligated to pay any claim or judgment or to defend any suit after the applicable limit of the company’s liability has been exhausted by the payment of judgment or settlement.”

From the foregoing provisions of the printed portions of the policy, it is clear that the insurance company has the right and duty to defend any suit against the insured and this is an obligation over and above its obligation to pay valid claims or judgments against the insured.

This obligation is reinforced by the provisions of the section on supplementary payments, which requires the company to pay all expenses incurred by the company, and also reasonable expenses incurred by the insured at the company’s request. Midland claims that the attorneys defending the Davidow suit were hired by Century, that the experts were hired by Century, and that all defense costs were incurred by Century. But, under Coverages A and B, above quoted, Midland had the “right and duty to defend any suit against the insured seeking damages on account of such bodily injury.” The Davidow case was certainly a suit against the insured seeking damages for bodily injury alleged to have arisen out of hazards (product liability) specifically covered by the policy. Therefore, the obligation for these costs was the obligation of Midland unless there is some other provision of the policy which must be deemed to modify the quoted sections. The only items in the policy which could be construed to modify the above-quoted portions of the printed section of the policy are Endorsements 1, 2 and 3.

Endorsement 1 is entitled, “Single Limit of Liability,” and provides, in Section 1, that the company’s limit of liability for bodily injury and property damage is $3 million “excess of a $50,000 each occurrence — $500,000 aggregate self-insured retention.” This endorsement supports Century’s interpretation of its policy with Midland.

Midland relies on Endorsement 2 of the policy to avoid payment of defense costs in excess of $50,000 in the particular circumstances of this case. However, the first paragraph of the Endorsement says, in pertinent part:

“It is agreed that, notwithstanding anything herein to the contrary ... no . coverage shall apply unless or until any loss shall exceed $50,000...”

The word “loss” is not defined in the policy, but Century understood it to include defense costs. Indeed, Johnson & Higgins’ written explanation of Midland’s first quote used the word “loss” to include defense costs.

The second paragraph of Endorsement 2 contradicts the language in the body of the policy by giving Midland “the right, but not the duty, to defend or participate in the defense, at its option, of any claim made against the Insured.” The policy does not explain, nor define, what constitutes “participation” in the defense of a claim. Nor does it say what happens if that option is exercised. One reasonable interpretation is that the language in the body of the policy then controls and that Midland must assume the obligation to pay defense costs. By the time Dr. Miller’s reconstruction accident tests were approved by Midland, the point at which Century’s defense costs began to exceed $50,000, Midland was at least participating in the defense of the Davidow claim, if not controlling it.

The final paragraph of Endorsement 2 contains the language upon which Midland’s refusal to pay is based. Midland claims that clause limits application of the deductible in the context of defense costs. The first part of the paragraph is totally consistent with Century’s claim in this case. It provides that Midland shall be obligated to pay expenses incurred in the “investigation, settlement or defense of any suit when those expenses exceed the $50,000 deductible.” However, the final phrase of the endorsement apparently attempts to reduce Midland’s obligation to pay defense costs in the event of settlement.

The application of this final paragraph of Endorsement 2 to the circumstances of this case is ambiguous in several respects. First, it is not clear whether it controls over the first paragraph of Endorsement 2 providing that “notwithstanding anything herein to the contrary” coverage applies once the insured’s “loss” exceeds $50,000 per occurrence. Neither is it clear whether the proportional sharing of defense costs applies where, as here, a claim goes to trial with the insured obtaining a favorable verdict, or whether it applies only when a pre-trial settlement is reached. Finally, it is not clear whether the attempted limitation on Midland’s obligation to pay defense costs exceeding the $50,000 self-insured retention applies when Midland participates in the defense of a claim, as it did in the Davidow case. Because the answers to these questions are not clear when the policy is considered as a whole, the attempted limitation must be construed in favor of the insured, and in favor of coverage. The insured read the policy and believed defense costs were included in its $50,000 self-insured retention. Given the ambiguity of Endorsement 2 and its conflict with other policy provisions, I find this entirely reasonable, particularly in light of the insured’s prior negotiations with Johnson & Higgins.

Johnson & Higgins’ Joint Liability

Johnson & Higgins agreed to negotiate and procure a product liability insurance policy acceptable to Century. By undertaking this task, Johnson & Higgins owed a duty to Century to “exercise reasonable skill, care and diligence” in procuring a policy. 16 Appleman “Insurance Law and Practice” § 8841, p. 171. When an insurance broker or agent undertakes to procure an insurance policy for an insured, an action in tort will lie for breach of the duty to exercise due care in performance of the undertaking. Clark v. Dalman, 379 Mich. 251, 261, 150 N.W.2d 755 (1967); see also Stein v. Continental Casualty, 110 Mich.App. 410, 417, 313 N.W.2d 299 (1981) (where a special relationship exists between insurance agent and insured, there is a duty to advise of adequacy of coverage); 14 Callaghan’s Michigan Civil Jurisprudence, Insurance, § 82, p. 101.

Despite the ambiguous language of the Midland insurance policy, the uncontroverted testimony of Johnson & Higgins’ agent Voss was that he understood that Midland’s intent was that defense costs would be apportioned between Century and Midland in proportion to the amount contributed by Century and Midland to any settlement or judgment paid to a third party under the policy. In short, Voss testified that he understood the proposal exactly as Midland now claims it was made. This intended limitation on coverage with respect to defense costs was a significant departure from Johnson & Higgins’ representation of Midland’s earlier proposal in January of 1979. It was likewise a significant departure from prior negotiations between Century and Johnson & Higgins, and was markedly different from the Alexander & Alexander proposal which was also receiving serious consideration by Century.

Johnson & Higgins failed to effectively bring home these differences. Voss, Johnson & Higgins’ agent, admitted at trial that it would have been “good practice” to explain to Century in writing the change which he had thought he had communicated to Holmes of Century in a five minute telephone conversation on February 1, 1979. This failure to follow “good practice” was particularly important in the instant case because Century had earlier balked at accepting Johnson & Higgins’ Midland proposal with a $100,000 deductible, on the grounds that Century was concerned it could not handle that high a per-occurrence exposure. As is illustrated by this case, the potential per-occurrence exposure under the February 1, 1979, Midland proposal, as Johnson & Higgins admits it understood its terms, potentially exceeded $100,000. Finally, Johnson & Higgins again failed to clarify the operation of the Midland policy’s SIR after reading it, when it forwarded the policy to Century. Instead it stated that the policy conformed to Century’s “negotiations” with Johnson & Higgins. This lack of clarification demonstrates an absence of due care, particularly in light of the fact that Johnson & Higgins now concedes that the meaning of the language of the Midland policy is ambiguous, at best, and/or contrary to Johnson & Higgins’ own understanding of its terms at the time the policy was issued.

A broker, who was negligent in obtaining a policy of insurance, is liable for any damages proximately caused by his negligence, up to the amount of the insurance he was employed to procure. Cf. Stein v. Continental Casualty, 110 Mich. App. at 417, 313 N.W.2d 299. (The negligent agent in Stein was unquestionably the agent of the insurer. The rationale of that case, however, applies with equal force when an independent broker acts in a dual-agency capacity.)

Yet I do not find Johnson & Higgins solely responsible for Century’s failing to get the coverage it thought it had paid for since the ambiguity of Midland’s contract was an equally contributing factor. There were two distinct points at which the limitations on coverage, which Midland claims it provided, and Johnson & Higgins concedes it understood, could have been made clear to Century. Johnson & Higgins, as Century’s agent, could have made certain that Century understood any limitations on coverage. Additionally, however, Midland also could have avoided this dispute by drafting a policy in clear and unambiguous language. Holmes, of Century, read the Midland policy. Had the policy language been clear, Century would have understood the alleged limitation and the policy could have been renegotiated to provide the coverage desired by Century, or Century could have looked for coverage elsewhere. Accordingly, I find Johnson & Higgins and Midland equally responsible for this dispute. Under Michigan law, concurrent negligent acts of two parties render them jointly liable if their acts are the proximate cause of a single injury or wrong. Solis v. Norfolk & W. Ry. Co., 352 F.Supp. 209 (E.D.Mich.1972).

Century’s Claim for Punitive Damages, Penalty Interest and/or Costs and Attorney Fees

Century also claims entitlement to punitive damages against Midland. Under Illinois law, “[WJhere a plaintiff demonstrates that the insurer’s conduct was outrageous, malicious and/or threatening” punitive damages are available. Kelly v. Stratton, 552 F.Supp. 641, 643 (N.D.Ill.1982).

Century also claims that it is entitled to 12% penalty interest under the Michigan Uniform Trade Practices Act, M.C. L.A. § 500.2001, et seq.; M.S.A. § 24.1200, et seq. Interest under that Act will not be awarded unless the liability of the insurer for the claim is not reasonably in dispute and the insurer’s refusal to pay was in bad faith. Medley v. Canady, 126 Mich.App. 739, 743, 337 N.W.2d 909 (1983).

Similarly, Century contends that Midland is liable for a penalty award and Century’s attorney fees and costs pursuant to the Illinois Insurance Code of 1935, specifically, §. 155 Ill.Rev.Stat.1973, ch. 73 para. 767. Section 155 provides for attorney fees, costs and a penalty if an insurance company unreasonably and vexatiously refuses to settle a claim or delays in such settlement.

I do not find Century entitled to any of these items of damages, because I am not persuaded that Midland’s dispute concerning the terms of coverage was unreasonable. Nor do I find that Midland was guilty of bad faith in its assertion of its own interpretation of Century’s coverage. To find that insurance policy language is ambiguous is not the equivalent of finding one interpretation of that language unreasonable. This is particularly true when, as is true here, the insurer’s interpretation of the disputed language is initially supported by a reputable insurance broker acting on behalf of the insured.

Further, I do not find that Midland’s insistence that Century tender its $50,000 self-insured retention toward a settlement package, lest Century otherwise jeopardize its coverage, sufficient to rise to a level of bad faith or threatening conduct. I am convinced that when Midland made the demand, it believed it had every right to do so. Additionally, Midland has entered into agreement with the plaintiff and a co-defendant in the Davidow case, which protects Century from a verdict in excess of its policy limits should the Davidow case be retried.

CONCLUSION

For the reasons stated herein, Century is entitled to recover $62,930.02, plus judgment interest provided by law, from Johnson & Higgins and Midland. Further, Johnson & Higgins and Midland are jointly liable for all post-trial defense costs incurred in the Davidow case.

      . The Midland proposal stated: “Defense costs will be included in the SIR [self-insured retention] and in the limits of liability. Thus, a $200,000 loss, $100,000 of which is for defense costs, would be divided evenly between Century and Midland. Claim investigation and reserving would be the responsibility of Century Boat Company."

      . Voss testified at trial that at the time Midland authorized him to make the new proposal to Century, he understood that defense costs were to be apportioned between the insurer.and the insured. Further, Voss understood the proposal as covering no defense costs until the insured expended its self-insured retention on a settlement or judgment.

      . The duty of an insurer to clearly express the limitations of its policy is also the law in Michigan. See, e.g., Ornamental Iron and Stair Company v. General Accident and Life Association Corporation, Ltd., 68 Mich.App. 259, 242 N.W.2d 544 (1976); Union Investment Company v. Fidelity & Deposit Co. of Maryland, 549 F.2d 1107, 1110 (6th Cir.1977). Thus, even if Michigan law were to apply, the provision must be construed. against Midland.

      . That paragraph provides:
      "It is further agreed that the Company shall not be obligated to bear any expense incurred in the investigation, settlement or defense of any suit, unless or until the amount paid as respects any one occurrence or in the aggregate shall exceed the Insured's $50,000 each occurrence of $500,000 in the aggregate retention, and then the Company’s obligation shall be for only the porportion [sic] of total costs as the Company’s payment to effect settlement shall bear to the total amount of such payment, inclusive of the Named Insured’s retention."


source: Caselaw Access Project

author: WARREN, District Judge.

license: Public Domain

text:
    Leon IRBY, Plaintiff, v. Harvey D. WINANS and Charles R. Michaels, Defendants.
    No. 80-C-665.
    United States District Court, E.D. Wisconsin.
    Feb. 26, 1985.

      Leon Irby, pro se.
    John R. Sweeney, Asst. Atty. Gen., Madison, Wis., for defendants.
   DECISION AND ORDER

WARREN, District Judge.

BACKGROUND

This action was initiated nearly five years ago, on July 25, 1980, when the plaintiff, presently incarcerated at the Waupun Correctional Institution at Waupun, Wisconsin, filed his pro se complaint pursuant to 42 U.S.C. § 1983, seeking injunctive and declaratory relief and monetary damages for alleged violations of his civil rights. The plaintiff’s principal charges are that the defendants, all employees of the State of Wisconsin assigned to the institution, interfered with his 1974 criminal trial for the second degree murder of a fellow inmate by harassing him, falsifying his presentence report, tampering with evidence, and interfering with communications between him and his attorney. The specific events and circumstances upon which this lawsuit is premised are recounted in some detail in the Court’s Order of July 21,1982.

By its Memorandum And Order of August 4, 1980, the Court considered the several allegations in the plaintiff’s pro se complaint and granted him leave to prosecute his claims in forma pauperis, pursuant to 28 U.S.C. § 1915(a), as to defendants Harvey D. Winans, Charles R. Michaels, and Henry J. Laub. On October 21, 1980, defendant Michaels filed his answer to the complaint, denying all substantive allegations therein and asserting several affirmative defenses — among them, that he is immune from liability under 42 U.S.C. § 1983, that at all times during the course of events giving rise to this action he has acted in good faith, and that the plaintiff has both failed to exhaust his state administrative and judicial remedies and failed to state a claim upon which relief may be granted in this forum.

Ten days later, on October 31, 1980, defendant Winans answered the charges in the plaintiff’s complaint, likewise denying all substantive allegations and raising several affirmative defenses. It appears from the record in this case that although the United States Marshal attempted to serve defendant Laub with the summons and complaint in this action, the State of Wisconsin advised that this defendant has not been one of its employees since 1979. Accordingly, defendant Laub has never been made a proper party defendant to this lawsuit, as reflected in the Court’s captioning of this case to incorporate the names of defendants Winans and Michaels alone.

In early November of 1980, the parties initiated their discovery and almost immediately became embroiled in what was to be the first of numerous disputes as to the propriety of their respective requests and the nature and scope of the compliance required pursuant to the Federal Rules of Civil Procedure. In the midst of these initial skirmishes, the plaintiff, on November 24,1980, filed a motion for appointment of counsel to represent him in the prosecution of his claims. Although the Court, by its Order of December 15, 1980, denied that request on the basis that it had no authority to compensate attorneys appointed in civil actions, it did indicate that it had already referred this matter to an attorney to determine if he or she would be willing to try the case on a contingent fee basis.

Indeed, on December 12, 1980, the Court had sent to a lawyer practicing in this district — one who had previously indicated an interest in representing indigent civil litigants — a letter of solicitation, the relevant portion of which follows:

... [Y]our name [has been provided] to me as an attorney who would be willing to accept an appointment to represent an indigent plaintiff in a case brought pursuant to 42 U.S.C. § 1983____
To that end, I request that you review the above-mentioned file. If you conclude that there is merit to the plaintiff’s contentions, you may then get in touch with the plaintiff and attempt to arrive at an arrangement with him regarding fees and representation. The file is available for your inspection at my chambers.
If after reviewing this file and communicating with the plaintiff, you determine that you do not wish to undertake this assignment, please notify me at your earliest convenience.

On December 15, 1980, that attorney advised the Court by phone, and subsequently confirmed by his letter of December 18, 1980, that although he had carefully examined the case file, his own civil docket prevented him from accepting an appointment; as he concluded, “[t]his case would require intensive and lengthy research and interviews, and I do not feel with good conscience, that I could spend the appropriate time needed to adequately pursue the rights of the plaintiff in this case.”

The next day, December 16, 1980, the Court sent a second letter of solicitation to another local attorney with an interest in representing indigent parties. On December 27, 1980, the Court received from that lawyer a letter likewise declining the Court’s invitation to undertake the prosecution of the plaintiff’s case. On January 6, 1981, in yet another attempt to secure representation for the plaintiff, the Court sent a letter to a third local attorney, asking that he review the case file and consider prosecuting this action. On January 21, 1981, counsel responded to the Court’s request in this fashion:

... I have had an opportunity to examine the file in this case. This is to inform you that I will not be representing Mr. Irby with regard to these proceedings. I have recently been involved in several lawsuits involving events taking place at the Wisconsin State Prison. These cases have been extremely time consuming and at present I am unable to undertake additional cases of this nature.

Thus unsuccessful in its three initial attempts to secure an attorney for the plaintiff, the Court allowed the parties to continue with discovery; unfortunately, their efforts at cooperation in this undertaking continued to prove unsuccessful, prompting both to file cross-motions to compel. Those petitions were resolved by the Court’s Memorandum And Order of October 13, 1981, in which the Court also established a briefing schedule on the defendants’ proposed motion for summary judgment.

That motion, along with a supporting brief, was filed on February 16, 1982, but not before the plaintiff had interposed two more petitions for the production of documents in this case. Moreover, within one month of the defendants’ Rule 56(b) motion, plaintiff filed yet another motion to compel discovery, premised principally on an earlier request that he be granted an additional thirty days in which to compile affidavits and submit documentary evidence in opposition to the pending summary judgment petition.

By its Order of July 21, 1982, the Court denied the defendants’ motion for summary judgment, pursuant to Rule 56(b) of the Federal Rules of Civil Procedure, but orr dered stricken paragraphs 14, 23, and 25 of the plaintiff’s complaint. In addition, the Court ordered the defendants to respond forthwith to the plaintiff’s discovery motion of March 15, 1982. Five days later, on July 26, 1982, the plaintiff filed what the Court construed as a motion for reconsideration of its decision, insofar as it struck the above-noted paragraphs of the plaintiffs complaint. During the following ten weeks, the plaintiff filed additional requests to compel discovery of the defendants in this action.

Finally, in its Decision And Order of March 31, 1983, the Court addressed that portion of the plaintiffs motion of July 26, 1982, by which he requested appointment of counsel to represent him in the prosecution of his claims. As a threshold matter, the Court observed that, in the two-year period since its unsuccessful attempts at securing counsel for the plaintiff, the Court of Appeals for the Seventh Circuit had identified in 28 U.S.C. § 1915(d) the discretionary authority of the trial courts to appoint counsel for indigent litigants. See infra at 488, McKeever v. Israel, 689 F.2d 1315 (7th Cir.1982); Maclin v. Freake, 650 F.2d 885 (7th Cir.1981). Recording its inclination to agree with the view expressed by the dissenting judge in McKeever, 689 F.2d at 1323, this Court nonetheless analyzed the circumstances and factual foundation of the present case in the context of the five touchstones for the appointment of counsel, as established by the McKeever majority. In the end, the Court determined, for the reasons set forth in its Decision And Order of March 31, 1983, that counsel should be appointed to represent the interests of the plaintiff in this matter. Consistent with this ruling, the Court denied the plaintiffs motion for reconsideration of its Order of July 21, 1982, “without prejudice to any similar motions which his appointed counsel may wish to file.” Decision And Order at 4 (March 31, 1983).

On that same day, the Court sent to a local attorney with an interest in representing indigent civil litigants the following letter:

From time to time, the Court is required to appoint counsel to represent indigent civil rights plaintiffs pursuant to 28 U.S.C. § 1915(d). See e.g., McKeever v. Israel, 689 F.2d 1315 (7th Cir.1982). Although the Court cannot ensure that counsel will be compensated for services, there always exists the possibility of an award of attorney’s fees pursuant to 42 U.S.C. § 1988 for the prevailing party. For the most part, however, these appointments in these types of cases seek the pro bono services of counsel.
In regard to the above-captioned case, the Court is requesting that you represent the indigent plaintiff. The file is available for inspection in the Court’s chambers, Room 364, Federal Building. If, after reviewing the file you determine that you are unable to represent the plaintiff, please notify the Court promptly-
The Court appreciates your willingness to consider this request.

Approximately one week later, on April 8, 1983, counsel advised the Court by letter that, since he was previously involved with a state court prosecution of the plaintiff several years ago, it would be inappropriate for him to undertake the prosecution of this case.

During the summer of 1983, as the Court continued with informal efforts to make an appointment in this matter, counsel for the defendants acceded to the plaintiff’s request to suspend all further discovery until a court-appointed attorney was named. On September 19, 1983, the Court contacted again the attorney it had initially solicited in December of 1980, requesting that he reconsider taking this assignment. As before, however, counsel notified the Court, this time by his letter of September 20, 1983, that his trial calendar would effectively prevent him from devoting a sufficient amount of time to the adequate development and presentation of the plaintiff’s case.

One day later, on September 21, 1983, the Court sent a sixth formal letter of solicitation to yet another local attorney, requesting that he consider accepting the Court’s appointment. Approximately one week later, however, that lawyer likewise advised that his own docket prevented him from undertaking the role as plaintiff’s legal representative.

Pursuant to the Court’s subsequent request, made on October 24, 1983, still another attorney reviewed the case file and undertook some preliminary investigation with respect to the merits of the plaintiff’s principal claims. Although interested in the case, counsel subsequently notified the Court that he would not be able to accept an appointment, principally because of the geographic distance between his office in the Milwaukee area and the Waupun Correctional Institution, where principal discovery would likely take place.

Finally, in the wake of additional informal, yet unsuccessful, efforts to appoint counsel in this matter, the Court sent its letter of solicitation to an assistant state public defender, requesting that he consider representing the plaintiff in this matter or recommending another attorney, perhaps in the Waupun area, who might be willing to do so. While counsel did undertake some preliminary investigation of the plaintiff's cause of action, he has recently advised that he, too, is not in a position to assist the Court in making an appointment to represent the indigent plaintiff in this matter.

Having thus been unsuccessful in nine attempts with eight different attorneys to secure counsel for the plaintiff, the Court, for the reasons stated herein, declines to pursue further efforts toward this end and instead schedules this matter for further proceedings, aimed at bringing this already long-delayed action to some final disposition.

SECTION 1915(d) AND PLAINTIFF’S REQUEST FOR COURT-APPOINTED COUNSEL

There is little doubt that there is no constitutional right to appointed counsel in a civil case. Caruth v. Pinkney, 683 F.2d 1044, 1048 (7th Cir.1982); Ehrlich v. Van Epps, 428 F.2d 363, 364 (7th Cir.1970). Nonetheless, as the Court has already noted, trial judges are empowered by statute to appoint counsel when the circumstances justify it; section 1915(d) of Title 28 of the United States Code specifically authorizes the Court to request an attorney to represent a party in a civil action who is proceeding in forma pauperis. 28 U.S.C. § 1915(d).

In general, the Court has broad discretion to appoint counsel for indigents under 28 U.S.C. § 1915(d), McKeever v. Israel, 689 F.2d 1315, 1318 (7th Cir.1982); Maclin v. Freake, 650 F.2d 885, 886 (7th Cir.1981), and its denial of counsel will not be overturned unless it would result in fundamental unfairness impinging on due process rights. LaClair v. United States, 374 F.2d 486, 489 (7th Cir.1967); Heidelberg v. Hammer, 577 F.2d 429, 431 (7th Cir.1978). However, discretionary choices are not left to the Court’s inclination but to its judgment, and its judgment is to be guided by sound legal principles. Caruth v. Pinkney, 683 F.2d 1044, 1048 (7th Cir.1982); Ekanem v. Health & Hospital Corporation of Marion County, 589 F.2d 316, 319 (7th Cir.1978).

It is within this context that the Court of Appeals, as already indicated, has fashioned standards for the exercise of discretion in considering whether court-appointed counsel for indigent civil litigants is appropriate. These five non-exclusive factors are:

1. whether the merits of the indigent’s claim are colorable;
2. the ability of the indigent plaintiff to investigate crucial facts;
3. whether the nature of the evidence indicates that the truth will more likely be exposed where both sides are represented by counsel;
4. the capability of the indigent litigant to present the case; and
5. the complexity of the legal issues raised by the complaint.

Merritt v. Faulkner, 697 F.2d 761, 764 (7th Cir.1983); Maclin v. Freake, 650 F.2d 885, 887-889 (7th Cir.1981). As the parties to this action recognize, these touchstones formed the basis for the Court’s Decision And Order of March 31, 1983.

While the district court is obliged to consider each of these factors in determining whether the appointment of counsel is appropriate under the circumstances, it is well-established that

[fjoremost among the “certain factors” that an appointing court must consider is an analysis of the merits of the indigent litigant’s claim from both a factual and legal standpoint. Maclin [v. Freake] makes clear that a court need not appoint counsel when it considers the indigent’s chances of success to be extremely slim____
When justifying a decision to appoint, a district court must apply the Maclin standards to the facts of each ease and if counsel is both warranted and available, the court should request representation____ As noted, of primary importance in an indigent’s request for counsel is an evaluation of the factual and legal merits of the claim and its chances for success.

Caruth v. Pinkney, 683 F.2d 1044, 1048, 1049-1050 (7th Cir.1982) (emphasis original).

Although the complaint filed by plaintiff in the present case arguably states a claim under 42 U.S.C. § 1983, see Court’s Memorandum And Order of August 4, 1980, it is now apparent to those members of the state bar who have investigated plaintiff’s allegations more closely that the merits of his ease are tenuous, at best, and that any limited benefits that might accrue from an attorney’s prosecution of this cause of action would likely be far outweighed by huge expenditures of time and money devoted to a case with a highly uncertain result. Indeed, independent inquiry by numerous attorneys interested in precisely this sort of litigation has apparently produced little, if any, basis upon which such an expenditure of prosecutorial resources might be justified.

To be sure, the standard to be applied in the context of § 1915(d) requests is not whether the bar feels that the litigant’s chances of success in prosecuting his or her claims are poor, but whether the merits of the indigent’s complaint are, in fact, colorable. At the same time, it is settled that under § 1915(d), the district court “has the authority only to request an attorney to represent an indigent, not to require him to do so.” Caruth v. Pinkney, 683 F.2d 1044, 1049 (7th Cir.1982) (emphasis original). Beyond this, the Court is under no affirmative duty to investigate a litigant’s allegations on its own initiative, even if that litigant is indigent and unschooled in the practice of law.

Moreover, the Seventh Circuit has made clear that the primary purpose of appointing counsel in an appropriate case is to “insure[] that the meritorious claims of a pro se plaintiff are not defeated____” Stringer v. Rowe, 616 F.2d 993, 1001 (7th Cir.1980) (emphasis supplied). Where, as here, there is reason to believe that plaintiff’s case may be something less than meritorious, the Court opines that further attempts to secure prosecutorial counsel would only meet with failure and result in the purposeless suspension of proceedings in this action.

Accordingly, while the Court regrets that it has been unsuccessful in meeting plaintiff’s request for appointed counsel, it feels obliged to ensure that the prosecution of this case proceeds with regularity to safeguard the interests of all parties involved and to resolve their disputes with reasonable dispatch. To this end, the Court will make no further attempts to secure counsel to represent plaintiff in this matter.

Instead, the Court now INSTRUCTS the parties to proceed apace with discovery in this matter; in particular, counsel for the defendants shall be permitted to depose the plaintiff, pursuant to Rule 27 of the Federal Rules of Civil Procedure, as soon as arrangements for that deposition might reasonably be made.

In addition, the Court hereby ORDERS both parties to file and serve status letters stating explicitly the nature and scope of the discovery they have yet to complete; an estimated date by which all discovery in this matter will be concluded; the chances, if any, for the pretrial settlement of this action; and a date by which this case might be readied for trial. The parties are also invited to incorporate in their letters, which should.be submitted no later than Friday, March 15, 1985, any additional information or insight with respect to the prosecution and defense of this case that might warrant the Court’s attention.

Following its receipt of the parties’ letters, the Court will conduct a pretrial conference at 1:30 p.m., on Wednesday, March 20, 1985, to set final discovery deadlines, to discuss settlement prospects, if any, and to schedule the matter for further proceedings, including trial, if appropriate. Counsel for the defendants should be present at that hearing, as should the plaintiff, whose appearance will be made possible by the Court’s execution of a writ prior to the hearing date.

If, in the interim between today’s order and the hearing of March 20, 1985, the parties encounter additional discovery problems, they are hereby DIRECTED to file, appropriate motions to compel discovery, pursuant to Rule 37(a) of the Federal Rules of Civil Procedure and Local Rule 6.02, which the Court will resolve at the pretrial conference.


author: SHAPIRO, District Judge.

text:
    Candelario LAMBOY: Joaquin Suarez; Pablo Lamboy and Antonio Lamboy, T/A L & S Tropical Food Products, Inc. v. UNITED STATES of America.
    Civ. A. No. 83-5747.
    United States District Court, E.D. Pennsylvania.
    Feb. 27, 1985.
    John Matrullo, Philadelphia, Pa., for plaintiffs.

      Stanley Weinberg, Alexander Ewing Jr., Asst. U.S. Attys., Philadelphia, Pa., for defendant.
   MEMORANDUM and ORDER

SHAPIRO, District Judge.

This is a civil action to obtain a de novo review of a Department of Agriculture Food and Nutrition Service (“FNS”) decision disqualifying L & S Tropical Food Products, Inc. (“L & S”) from participating in the Food Stamp Program for a period of one (1) year. This court has jurisdiction of this matter under 7 U.S.C. § 2023(a).

L & S is a Pennsylvania corporation organized in August, 1980. The shareholders of the corporation are Candelario Lamboy, President of the corporation, his brother Antonio (Tony) Lamboy, and Joaquin (Jack) Suarez, Secretary/Treasurer of the corporation. The corporation owns and operates a store in a warehouse-type building at 401 West Columbia Avenue in Philadelphia, Pennsylvania. Jack Suarez and Tony Lam-boy operate the business on a daily basis. Mr. Suarez is generally responsible for listing merchandise on invoices, pricing items and accepting payment for merchandise. In August and September, 1982, the store had two employees, Pablo Ayala and his son Edwin Ayala, who are related to Tony Lamboy.

On October 19, 1981, Joseph Devereaux, Food Stamp Specialist, visited the store and spoke with Mr. Suarez. Devereaux told Suarez that the store had an unusually high rate of coupon redemptions and warned him that the store might be violating the Food Stamp Program in that regard. Devereaux reviewed the Good Stamp Regulations, including those regarding the sale of ineligible items.

The October 19, 1981 visit was followed by a letter dated October 21, 1981 from the FNS. The letter summarized the October 19 visit, enclosed a copy of the Food Stamp Regulations, warned that “[vjiolations may lead to your disqualification,” and stated that all store employees must “know the program regulations and adhere to them.”

On or about March 31, 1982, the FNS issued a Request for Investigation (“RFI”) of L & S based upon the unusually large volume of food stamp transactions at the store. The FNS had also received an anonymous report that this store was accepting food stamps from retailers.

Clifford Rank undertook the investigation for the Government and hired Carmen Vadiz to test-buy merchandise for food stamp coupons from the store. Ms. Vadiz was the sole investigative aide assigned to the case. The court finds the testimony of Ms. Vadiz credible; notwithstanding her lack of formal education and her failure to report the income received to welfare agencies, she stood up well to rigorous and thorough cross-examination. She testified that she visited the store on four occasions: August 18, 1982, September 8, 1982, September 13, 1982, and September 15, 1982. The Government presented receipts for all of these transactions other than the September 8, 1982 visit.

On August 18, 1982, Ms. Vadiz purchased $72 worth of merchandise with food stamps. The purchase included $14.95 worth of insulated cups and $26 worth of paper towels, which were ineligible for purchase with food stamps. When she left the store after making her purchases, she met with Mr. Rank, told him what happened, and returned the excess food stamps to him. She provided a description of a clerk but not his name. There was no mention or description of more than one clerk. A transaction report was filed out by Mr. Rank and signed by Ms. Vadiz.

On the September 8, 1982 visit, Ms. Vadiz purchased $67.95 worth of merchandise. Once again Ms. Vadiz stated she purchased from the same clerk involved in the transaction on August 18, 1982. The ineligible items she purchased with food stamps included cases of bathroom tissue, toothpaste, cleaner ($13.95), and seven packages of plastic forks. The receipt for this transaction was not in evidence nor was its unavailability adequately explained.

On the September 13, 1982 visit, Ms. Vadiz purchased $65.79 worth of merchandise with food stamps from the same clerk as in the two preceding transactions. The ineligible items she purchased totalled $43 and included six packages of shampoo ($6.95), a case of towels ($16.95) and four packages of cups and cup lids ($10.69).

On September 15, 1982, Ms. Vadiz purchased $89.15 worth of merchandise. The ineligible items totalled $58 and included cases of cleanser ($19.25), oven cleaner ($21.25), soap pads ($7.45) and bathroom tissue ($10.95). Because Ms. Vadiz was carrying only $88 worth of food stamps, the clerk gave her credit for the $1.15 balance. Her testimony suggested L & S personnel expected that Ms. Vadiz would use the cups for the sale of coffee in her own business. Her description of the clerk involved in this transaction was different than in the prior transactions; the transaction report she signed on this occasion stated that this clerk had been present on prior occasions. But the contemporaneous transaction reports neither described nor referred to him. This clerk was later identified as Mr. Suarez. The court rejects the conclusions of the investigator on September 28, 1982 as inconsistent with the contemporaneous records and not supported by the preponderance of the evidence.

By letter of February 18, 1983, Malachy P. Cox, FNS Chief of Federal Operations Section, notified plaintiffs that FNS had reason to believe that plaintiffs had violated the Food Stamp Regulations and provided the reasons for that belief. By letter dated February 21, 1983, Candelario Lam-boy responded to FNS’ February 18, 1983 letter and requested a meeting to discuss the charges. By letter of March 17, 1983, N. Harwood, FNS Unit Supervisor, Federal Operations Section, denied Mr. Lamboy’s request for a meeting and informed him that he had ten (10) days to respond to the charges. By letter dated March 26, 1983 Mr. Lamboy responded that he would wait until the FNS made a final determination before answering the charges. By letter of April 1, 1983, Malachy P. Cox notified plaintiffs that they were disqualified from participation in the Food Stamp Program for one year for violation of applicable regulations. Candelario Lamboy timely requested an administrative review of this decision and an opportunity to appear before the Food Stamp Review Officer. Plaintiffs were furnished with copies of materials on file and with the investigative report. On June 5, 1983, plaintiffs Suarez and Candelario Lamboy met with Administrative Review Officer John P. Kraynak to discuss the case. After administrative review, Kraynak sustained the one-year disqualification of plaintiffs by letter of October 28, 1983; this letter constitutes the final Agency action.

Plaintiffs filed the current action on November 29, 1983. Their complaint challenged both the factual determination underlying the administrative decision and the severity of the sanction imposed.

On November 30, 1983, the parties stipulated to a stay of disqualification pending disposition of the matter. This stipulation was approved by the court on December 3, 1983, but on December 6, 1984, the court vacated the stay effective January 31, 1985; the stay was subsequently reinstated pending disposition of this case.

The Food Stamp Act of 1977 provides judicial review in state or federal court of a final Agency determination; it provides that “[t]he suit in the United States district court or state court shall be a trial de novo by the court in which the court shall determine the validity of the questioned administrative action in issue.” 7 U.S.C. § 2023. The court may review the Agency determination that the allegedly violative transactions occurred and its application of the regulations to the facts of the case. See, e.g., Broad Street Food Market v. United States, 720 F.2d 217 (1st Cir.1983); Bruno’s, Inc. v. United States, 624 F.2d 592 (5th Cir.1980).

However, Congress did not intend de novo judicial review of the sanction imposed by the Agency.

The Committee wants to go on record as noting that, when there is imposition of disqualification for such period of time as may be determined in accordance with regulations ... the Committee does not intend that in the trial de novo in the United States district court or state court of the final administrative determination of disqualification, the sanction or period of disqualification imposed would itself be subject to judicial review as several courts have held that it is. [Citations omitted]. The trial de novo as set forth in section 14 should be limited to a determination of the validity of the administrative action, but not of the severity of the sanction.

H.Rep. No. 464, 95th Cong., 1st Sess. 397-98, reprinted in 1977 U.S.Code Cong. & Ad.News 1704, 1978, at 2326-27.

The regulations establishing penalties for violations of the Food Stamp Act are set forth at 7 C.F.R. § 278.6. The regulations in effect at the time of the violative transactions in this case provided for a one-year disqualification:

(e) Penalties. FNS shall take action as follows against any firm determined to have violated the Act or regulations. The FNS regional office shall:
* Jft * * * *
(2) Disqualify the firm for 1 year if:
(i) The evidence shows that: (A) It is the firm’s policy to sell expensive or conspicuous nonfood items, cartons of cigarettes, or alcoholic beverages, in exchange for food coupons, and the firm has engaged in such practices ... and
(ii) The firm was warned about the possibility that violations were occurring and of the possible consequences of violating the regulations. The regional office may disqualify a firm for 1 year, even though the firm was not warned about the possibility that violations were occurring, if the regional office finds that the firm has committed unusually serious violations of the kind described in (i)(A) ... of this sub-paragraph.

7 C.F.R. § 278.6(e)(2). The FNS informal guidelines used in 1982 as official policy by the Agency defined store policy in the following manner:

a disregard of program regulations, as opposed to carelessness or poor supervision, when there have been a minimum of four clearly violative sales of ineligible items, and any or all of the following persons took an active part in the violations:
a. The owner, spouse, sons, daughters, or other close relatives of the owner who are regularly involved in the operation of the store.
b. Members of management, including a person designated as a clerk, but who is in effect running the store in the absence of the owner for extended periods of time or on a regular basis.
c. Two or more clerks who sell common grocery-type or major non-grocery-type ineligible items without a consistent effort by these clerks to refuse to sell such items. Lack of consistent refusal effort by the clerks will be considered to reflect the operating policy of the store only in those cases in which there is a record of previous compliance action. Such compliance action must include documentation that the owner or appropriate store official had been warned about the possibility of violations occurring in the store and the consequence of future violations.

Major non-grocery ineligible items are defined at ¶ A.2.a(3)(d) to include:

High Cost Ineligible Items. Easily identifiable ineligible items costing in the range of $5 or more.

Examples of easily identifiable ineligible items are described in ¶ III.A.2.(a)(2) as:

cleaning products, paper products, and other low-cost household items.

A transaction is clearly violative if it includes thirty percent or more ineligible items. ¶ III.A.2.b.

The court finds that the factual basis upon which the Agency determined to impose a one-year disqualification was erroneous in two critical respects. First, Administrative Review Officer Kraynak’s determination letter of October 28, 1983 stated that Jack Suarez, Secretary/Treasurer of the corporation, was present during each of the violative sales and that Tony Lam-boy transacted three of the sales of ineligible items. However, the contemporaneous transaction reports signed by Ms. Vadiz refer to one clerk in each of the four transactions; her description of these clerks fits Jack Suarez on only the fourth occasion. Although comments in Ms. Vadiz’ fourth transaction report suggest that Mr. Suarez had been present on prior occasions, the contemporaneous records for those three transactions neither describe nor refer to him. Mr. Suarez testified at trial that he was on vacation in Florida at the time of the August 18 and September 8, 1982 transactions and that he was not present during the September 13, 1982 transaction. Although plaintiffs produced no documentary evidence that Mr. Suarez was on vacation, the Government bears the burden of proving that Mr. Suarez was present during the transactions. Because Ms. Vadiz’ contemporaneous reports of three visits describe a clerk other than Mr. Suarez and do not refer to him, the Government failed to meet its burden of proving that he was present on other than one occasion.

Moreover, Mr. Kraynak’s determination letter stated that Tony Lamboy, another shareholder of L & S, transacted three of the four violative sales. However, it was not Tony Lamboy but Pablo Lam-boy, a clerk at L & S, not one of the owners, who transacted the other three sales. Pablo Lamboy's testimony was corroborated by Ms. Vadiz’ contemporaneous descriptions in the transaction reports and her testimony at trial. That an employee of L & S rather than one of the owners transacted all but one of the violative sales might have been material to the Agency in deciding the appropriate penalty.

The Agency determination was also based on an erroneous finding that the owners had been warned of violations of the Food Stamp Regulations involved. Following a visit in October, 1981, an FNS agent warned Mr. Suarez about the unusually high rate of coupon redemptions and reminded him that acceptance of food stamps from retailers without wholesale authorization was in violation of Program regulations. No prior warning was provided concerning the violation for which plaintiffs were penalized — the sale of ineligible non-food items under the FNS Regulations establishing penalties for violations of the Food Stamp Act, set forth at 7 C.F.R. § 278.6. The Agency has based its determination in part on the fact that a warning had been given but it did not acknowledge that the warning concerned a different violation than the one for which the store was disqualified. A warning of possible violation is material because the regulations provide that a firm may be disqualified for one year without a warning only if the Agency finds that “the firm has committed unusually serious violations.” 7 C.F.R. § 278.6(e)(2).

Where a court finds that the Agency determination was based upon an errone: ous factual basis, the statute directs the court to “enter such judgment or order as it determines is in accordance with the law and the evidence.” 7 U.S.C. § 2023. In this particular case, whether the severe penalty of a one-year disqualification is warranted on the facts as they have been determined at trial should be determined by the Agency in the first instance. Therefore, the court remands the case for consideration by the Agency. See Broad Street Food Market, Inc. v. United States, 720 F.2d 217, 220 (1st Cir.1983); Goodman v. United States, 518 F.2d 505, 512 (5th Cir.1975).

The Agency is directed to determine the appropriate penalty based on the court’s findings of fact. Furthermore, the Agency must determine the penalty based upon the proved violations of the Food Stamp Regulations, not on anonymous reports that the store was accepting food stamps from retailers without wholesaler authorization. Although the unusually high volume of coupon redemption at the store might suggest the reasonableness of further investigation of such reports, any disqualification from participation in the Food Stamp program must be based not on rumor but upon established fact. An appropriate Order follows.

ORDER

AND NOW, this 27th day of February, 1985, for the reasons set forth in the foregoing Memorandum, it'is ORDERED that this case is REMANDED to the Department of Agriculture Food and Nutrition Service for reconsideration of the penalty as the facts have been determined by the court; all proceedings are STAYED for thirty (30) days following a final decision on Remand.