COMBUSTION ENGINEERING, INC. v. IMETAL

The opinion of the court was delivered by: VICTOR Marrero, United States District Judge.

DECISION AND ORDER

I. BACKGROUND*fn1

This case arises out of a stock purchase agreement entered into in May 1990 between CE and Imetal (the "Agreement"), whereby CE agreed to sell to Imetal the stock of several corporations, including Tennessee Electra Minerals, Inc. ("TECO").*fn2 The Agreement provided that Imetal would assume a portion of the liability arising from the "Minco patent litigation," which term in the Agreement specifically referred to a lawsuit brought by Minco, Inc. ("Minco") against CE for patent infringement regarding a rotary kiln that TECO used in the production of fused silica. That litigation was pending at the time in the Eastern District of Tennessee ("Minco v. CE"). (See JA 255.)*fn3 CE agreed, pursuant to § 12.1(c) of the Agreement, to indemnify Imetal for up to 80 percent of all damages Imetal incurred in connection with the Minco patent litigation, with an upward cap of $8 million. Minco v. CE resulted in a judgment against CE for $30,429,373. See Minco v. Combustion Eng'g, 903 F. Supp. 1204 (E.D.Tenn. 1995). The case was settled for $29.4 million.

After its success against CE, Minco filed suit in 1995 against TECO seeking damages for the period following Imetal's acquisition of TECO ("Minco v. TECO"). (See JA 1157-69.) Ultimately, TECO settled with Minco by paying about $12 million for a 40 percent non-controlling blind trust interest in Minco.

When Imetal refused to pay CE for the amount of damages in Minco v. CE exceeding the $8 million cap, CE filed a lawsuit in this Court claiming breach of contract on the theory that the Agreement clearly required that Imetal pay the damages in Minco v. CE in the amount exceeding $8 million. In defense, Imetal claimed that its indemnity obligations in the contract were nullified by CE's breach of representations and warranties in the agreement.

Imetal also filed a counter-claim alleging that CE breached representations and warranties in the Agreement and was therefore obligated to indemnify Imetal for the amounts paid to settle the patent infringement suit brought in 1995 by Minco against TECO. CE countered that schedules 6.8 and 6.14, exempting the Minco patent litigation from the representations and warranties in the Agreement, preclude Imetal's counterclaim. Furthermore, CE alleged that as to Minco v. TECO, the warranties in § 6.14 had expired pursuant to § 12.3(b) of the Agreement, which provided a one year limit on the representations and warranties in § 6 unless notice of a claim was given within the year. Imetal argued that a letter sent on June 6, 1990 ("1990 Letter"), referring CE to a letter sent by Minco indicating that it intended to hold TECO liable for its use of the allegedly infringing patent it was purchasing from CE, constituted notice sufficient to toll the relevant warranty. (JA 1235-36) CE disputed the adequacy of the notice provided in the 1990 Letter.

Finally, Imetal claimed that even if the Court finds that Imetal is responsible for indemnifying CE for damages exceeding $8 million, CE failed to make good faith efforts to settle the Minco patent litigation for a reasonable amount and thus Imetal's indemnity obligations should be adjusted to account for this failure.

CE and Asea moved for summary judgment pursuant to Fed. R. Civ. P. 56(b) on its breach of contract claims, and Imetal cross-moved for summary judgment on its counterclaim. This court granted CE's motion for summary judgment and denied Imetal's cross-motion on its counterclaim. See Combustion Eng'g I, 158 F. Supp.2d 327. Specifically, this Court held that (i) Imetal was obligated to indemnify CE for the Minco patent litigation under the terms of the Agreement; (ii) while a duty of good faith might lie under the Agreement, based on the undisputed facts, Imetal cannot establish that CE breached that duty; and (iii) CE did not breach the representations and warranties in the Agreement because the allegedly breached warranty expired one year after closing, and because the Agreement excepts the Minco patent litigation from the representations in § 6.14 through disclosure in schedules 6.8 and 6.14 of the Agreement.

Imetal appealed this Court's decision to the Second Circuit Court of Appeals. In a Summary Order, the Circuit Court affirmed this Court's judgment in part, vacated in part, and remanded. See Combustion Eng'g II, 37 Fed. Appx. 573. The Second Circuit vacated this Court's judgment on the issue of whether CE breached a duty to settle the Minco patent litigation in good faith and on the issue of whether CE and Asea breached their representations and warranties as alleged in Imetal's counterclaim. On remand, the Circuit directed this Court to fully consider in the first instance: (i) whether CE had a duty under the Agreement to act in good faith on behalf of Imetal at the settlement negotiations of Minco v. CE and, if so, to determine whether, considering the relevant factual record, CE breached that duty; and (ii) whether the 1990 Letter constitutes notice under the Agreement, thereby tolling the expiration of the warranty in § 6.14.

II. DISCUSSION

A. DUTY TO ACT IN GOOD FAITH

The first question posed by the Second Circuit is the legal question of whether Combustion Engineering had a duty to act in good faith on behalf of Imetal at the settlement negotiations of the Minco patent litigation.

Imetal urges that the requirement to act in good faith on behalf of a third party at settlement negotiations, which arises frequently in the context of insurance contracts, should apply here. Under New York law, there is a direct obligation placed on the primary insurer to conduct settlement negotiations in good faith on behalf of the insured: "The notion that an insurer may be held liable for the breach of its duty of `good faith' in defending and settling claims over which it exercises exclusive control on behalf of its insured is an enduring principle, well settled in this State's jurisprudence." Pavia v. State Farm Ins. Co., 626 N.E.2d 24, 26-27 (N.Y. 1993) (citations omitted); see also Forest Ins., Ltd. v. American Motorists Ins. Co., No. 89 Civ. 4326, 1994 WL 97138, at *12 (S.D.N.Y. March 21, 1994).

The New York State Court of Appeals has recognized that a primary insurer owes fiduciary duties to an excess insurer. See Hartford Accident and Indem. Co. v. Michigan Mut. Ins. Co., 463 N.E.2d 608, 610 (N.Y. 1984); St. Paul Fire and Marine Ins. Co. v. United States Fidelity and Guaranty Co., 375 N.E.2d 733, 734 (N.Y. 1978). Those duties are derived from "the same fiduciary obligation which the primary insurer owes to its insured, namely, a duty to proceed in good faith and in the honest exercise of discretion, the violation of which exposes the primary carrier to liability beyond its policy limits." Hartford Accident and Indem. Co. v. Michigan Mut. Ins. Co, 462 N.Y.S.2d 175, 178 (App. Div. 1st Dep't 1983). In Forest, the court explains that "the rationale of Pavia subsumes that a primary carrier charged with bad faith had a first party contractual duty to its policy holder to negotiate settlement in good faith which carries over to the excess insurer." 1994 WL 97138, at * 13. "This duty of good faith stems from the `inherent conflict' between the primary insurer's desire to settle the claim for as little as possible and the excess insurer's desire to avoid liability." Federal Ins. Co. v. Liberty Mutual Ins. Co., 158 F. Supp.2d 290, 294 (S.D.N.Y. 2001) (citing Smith v. Gen. Accident Ins. Co., 697 N.E.2d 168 (N.Y. 1998) (insurer's failure to inform insured of settlement offers evidenced bad faith).

Here, since as to the first $8 million of liability CE is 80 percent liable, but thereafter the entire burden falls on Imetal, under the terms of the Agreement, the indemnification provisions essentially create a situation wherein Imetal can be likened to an excess insurer and CE a primary insurer. Similar to a primary insurer's relationship to an excess insurer, CE engaged in litigation settlement negotiations in which it had liability only up to a certain limit, the remainder of which would be borne by a third party, who, as evidenced by the record, was often not present.

However, despite the possible analogy to a primary insurer and excess insurer, in this case the duty to act in good faith at settlement negotiations does not pertain to CE for two reasons. First, because there is no provision in the parties Agreement that, unlike the typical insurance contract, specifically imposes a duty on CE to conduct settlement negotiations on Imetal's behalf, there is no explicit duty to conduct settlement negotiations in good faith. Second, since it is uncontested that CE did not retain exclusive control of the settlement negotiations, the analogy to insurance contracts fails in a crucial respect.

Every contract contains an implied covenant of good faith and fair dealing. See Uniform Commercial Code § 1-203; Restatement (Second) of Contracts § 205 (the obligation of good faith may not be disclaimed by agreement); Rowe v. Great Atl. & Pac. Tea Co., 385 N.E.2d 566, 569 (N.Y. 1978). A breach of the covenant of good faith is considered to be a breach of the underlying contract. See Wolff v. Rare Medium, 210 F. Supp.2d 490, 497 (S.D.N.Y. 2002) (citing Fasolino Foods Co., Inc., v. Banca Nazionale del Lavoro, 961 F.2d 1052, 1056 (2d Cir. 1992)). However, as this Court has previously stated, "the obligation of good faith does not create obligations that go beyond those intended and stated in the language of the contract." Wolff, 210 F. Supp.2d at 497 (citing Granite Partners L.P. v. Bear Stearns & Co. Inc., 17 F. Supp.2d 275, 305 (S.D.N.Y. 1998); Gordon v. Nationwide Mut. Ins. Co., 285 N.E.3d 849, 854 (N.Y. 1972) ("Bad faith requires an extraordinary showing of a disingenuous or dishonest failure to carry out a contract.")

The requirement that good faith obligations be tied to specific provisions of a contract has been stressed in the context of the good faith duty to settle derived from insurance contracts as well. See, e.g., Certain Underwriters v. Fidelity and Cas. Ins. Co., 4 F.3d 541 (7th Cir. 1993) (on appeal from district court's summary judgment for the defendant primary insurer, the issue of primary insurer's liability to excess insurer for negligent refusal to settle lawsuit against their mutual insured turned on whether the primary insurer had a contractual duty to defend or settle the lawsuit); Pavia, 626 N.E.2d at 26. For instance, in Forest, the insurance policy at issue was unlike the standard general liability policy, in that under American Motorists Insurance Company's ("AMICO") policy the insurer had the "`right but not the duty to investigate claims, defend suits and tender payments in settlement of claims.'" 1994 WL 97138, at *10 (emphasis in original). Because of this condition the court found that the duty to conduct settlement negotiations in good faith inherent in ordinary insurance contracts did not apply. Therefore, the issue for consideration by this Court is whether the Agreement creates an obligation to settle to which the implied covenant of good faith would apply.

In Forest, the plaintiff contended that defendants' duty to negotiate settlement in good faith was predicated on the right to conduct settlement negotiations. Id. But the court would not allow a duty to settle to be inferred from the right. The Forest court noted: "It is legally significant that neither of the defendants had any contractual duty whatever to IPC to attempt to negotiate a settlement in [this] case. If neither defendant had a contractual duty concerning settlement to [primary insurer], as a matter of law there could be no cause of action . . . for breach of a direct duty to settle or for wrongful refusal to settle." 1994 WL 97138, at *11. (citations omitted).

In this case, under § 12.1(c) of the Agreement, it is unclear as to whether the parties contemplated that CE would even have a right to control the defense, compromise or settlement of the Minco v. CE litigation.*fn4 In any event, Imetal does not point to any duty to defend or settle Minco v. CE imposed upon CE by the Agreement. Therefore, since no explicit contractual duty to settle the Minco v. CE claim was placed upon CE, CE can not be held to a good faith duty to settle that claim.

Furthermore, this case can be distinguished from the typical insurance contract situation because exclusive control of settlement is a central factor in determining that the good faith duty applies to insurance contracts. In Pavia the Court of Appeals of New York explained that: "At the root of the `bad faith' doctrine is the fact that insurers typically exercise complete control over the settlement and defense of claims against their insureds, and, thus, under established agency principles, may fairly be required to act in the insured's best interest." 626 N.E.2d at 27 (citing 7C Appleman, Insurance Law and Practice § 4711 [Berdal ed]). The fact that CE did not have the right to negotiate a settlement in the Minco patent litigation without the consent of Imetal pursuant to § 12.1 of the Agreement, (JA 203), and that neither CE nor Imetal ...