The opinion of the court was delivered by: VICTOR Marrero, United States District Judge.
Combustion Engineering, Inc. ("CE") brought this action, invoking the
Court's diversity jurisdiction, against Imetal for breach of contract and
unjust enrichment. Imetal asserted counterclaims against CE and its
parent, Asea Brown Boveri, Inc. ("Asea"), for breach of representation and
warranty, breach of implied covenant of good faith and fair dealing, and
indemnification. CE and Asea moved for summary judgment, and Imetal
cross-moved for summary judgment. By Decision and Order dated August 15,
2001, this Court granted CE's motion for summary judgment on its claims
and denied Imetal's motion for summary judgment on its counterclaims.
See Combustion Eng'g v. Imetal, 158 F. Supp.2d 327 (S.D.N.Y. 2001)
("Combustion Eng'g I"). By summary order dated June 18, 2002, the Second
Circuit Court of Appeals affirmed this Court's decision in part, vacated
in part and remanded for further findings of law and fact, while
retaining jurisdiction of the case pursuant to United States v.
Jacobson, 15 F.3d 19 (2d Cir. 1994). See Combustion Eng'g v. Imetal, 37
Fed. Appx. 573 (2d Cir. 2002) ("Combustion Eng'g II"). The parties have
made submissions on the remanded issues. For the reasons set forth
below, this Court makes the following findings as directed by the Second
Circuit: (1) CE did not have a duty to act in good faith on behalf of
Imetal at settlement negotiations; and (2) Imetal's letter dated June 6,
1990 did. constitute notice of its indemnification claim, thus tolling
the expiration of the relevant representation and warranty.
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.
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.
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.
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 ...