Seventh Circuit Reminds That Failure to Timely Plead an Affirmative Defense Can Be Fatal

Published by Jeffrey A. Mandell, Kurt M. Simatic on | Permalink

The Seventh Circuit’s recent decision in Reed v. Columbia St. Mary’s Hospital contains a noteworthy discussion of timeliness requirements for pleading affirmative defenses.

Reed, a troubled individual with several disabilities, went to Columbia St. Mary’s Hospital in Milwaukee, seeking help warding off suicidal thoughts. What happened during her four-day stay is disputed. But Reed later filed suit, alleging that the hospital discriminated against her in violation of the Americans with Disabilities Act, the Rehabilitation Act, and state law. The hospital denied Reed’s allegations and filed affirmative defenses to her complaints. However, the hospital did not claim a religious exemption from the ADA in its responsive pleadings. 

Title III of the ADA prohibits “public accommodations,” including hospitals, from discriminating against individuals with disabilities. However, Title III exempts “religious organizations” and “entities controlled by religious organizations, including places of worship.” 42 U.S.C. § 12187. This religious exemption is an affirmative defense, because it assumes that, even if the plaintiff can prove her claim, the exemption may still defeat liability. 

After the parties conducted discovery, the hospital moved for summary judgment. Only then, for the first time, did it assert that the religious exemption shielded it from liability on Reed’s ADA claim. The district court granted summary judgment for the hospital on the federal claims and declined to exercise supplemental jurisdiction over the state claim. In so doing, the district court accepted the hospital’s late assertion of the ADA religious exemption. The district court reasoned that (1) the exemption is not expressly listed in Federal Rule of Civil Procedure 8(c), so it was not clear that failure to assert the defense in the answer constituted waiver, and (2) Reed had adequate notice of the hospital’s possible reliance on the defense based on a specific exchange between the hospital’s counsel and a witness during a deposition.

The Seventh Circuit reversed the district court’s decision. It began by confirming that even an affirmative defense not listed in Rule 8(c) must still be pleaded if the defendant bears the burden of proof on an issue under state law or if (as here) “the defense does not controvert the plaintiff’s proof.” Reed, slip op. at 7. This requirement exists “to avoid surprise and undue prejudice to the plaintiff by providing her notice and the opportunity to demonstrate why the defense should not prevail.” Id. 

Having set forth a clear “rule,” the court explains it should not be rigidly applied. Instead, courts should enforce forfeiture for failure to assert an affirmative defense in an answer “only if the plaintiff is harmed by the defendant’s delay in asserting [the defense].” Id. at 8. Thus, courts have discretion to allow amendments that add affirmative defenses not initially pleaded. For example, a defendant may uncover a possible defense to liability during discovery. In such a case, if the defendant promptly alerts the parties and the court of his intent to pursue the defense, it would be reasonable for the court to permit it. However, courts should also consider whether the belated assertion would cause unreasonable delay or make the litigation more costly.

Applying these principles, the Seventh Circuit deemed the district court’s decision to let the hospital assert the religious exemption for the first time at the summary judgment stage was not only unreasonable but also an abuse of discretion. First, the hospital knew, from the outset of litigation, all of the facts relevant to the exemption; therefore, the affirmative defense needed to be pleaded in the initial answer. Second, the Seventh Circuit dismissed the district court’s conclusion that Reed had notice of the defense based on an exchange at a deposition; according to the appellate court, this truncated exchange with a witness did not compare to “a lawyer’s statement that the party intends to assert a defense.” Id. at 13. Finally, the Seventh Circuit determined that the delay was prejudicial. Because the defense was first asserted after discovery had closed, both parties (particularly Reed) had spent time and money investigating what they reasonably expected the issues to be; allowing the religious exemption to be invoked as a “last-minute defense” would raise new factual and legal issues, increasing the cost of litigation and prejudicing Reed, who had no reasonable notice that the defense would be raised. Id. at 16.

The Seventh Circuit suggested that the outcome may have been different had the hospital offered some explanation for the delay in asserting the defense and/or the prejudice to Reed been minimal. However, this decision demonstrates that the belt-and-suspenders approach is best: defendants should plead all possible affirmative defenses in their answers, promptly seek to amend those answers when any additional defenses reveal themselves in the course of litigation, and be prepared to explain any delay in asserting those defenses.

Wisconsin Supreme Court Weighs in on Defense Costs Dispute Between Liability Insurers

Published by Bruce Huibregtse, Gregory M. Jacobs on | Permalink

Last month, the Wisconsin Supreme Court confronted several insurance coverage issues that can arise when allegations against an insured trigger the defense obligations of multiple liability insurers.  See Steadfast Ins. Co. v. Greenwich Ins. Co., 2019 WI 6.

At issue was defense coverage for lawsuits filed against the Milwaukee Metropolitan Sewerage District (“MMSD”) following the historic June 2008 rainfall that resulted in raw sewage backing up into thousands of Milwaukee-area residences.  The main theory of liability against MMSD was that the sewerage system had been negligently repaired, maintained, and/or operated prior to and during the rainfall.  MMSD had outsourced those responsibilities to United Water Services Milwaukee, LLC (“United Water”) from 1998 through February 2008 and subsequently to Veolia Water Milwaukee, LLC (“Veolia”) from March 2008 leading up to the June 2008 heavy rainfalls.

MMSD’s operating agreements with United Water and Veolia required each entity to maintain liability insurance that named MMSD as an additional insured.  United Water had a $20 million policy from Greenwich Insurance Company (“Greenwich”) and Veolia had a $30 million policy from Steadfast Insurance Company (“Steadfast”).

MMSD faced a myriad of lawsuits seeking to recover for property damages related to the rainfall. The lawsuits alleged MMSD negligence during the respective time periods when United Water and Veolia operated the sewerage system. MMSD tendered defense of the lawsuits to both insurers and also opted to retain its own counsel.  While Steadfast agreed to pay for MMSD’s defense, Greenwich denied its defense obligations on the grounds that an “other insurance” provision rendered the Greenwich policy excess to the Steadfast policy.

MMSD ultimately resolved the lawsuits without agreeing to any liability payments to the underlying claimants.  In the process of settling for no liability, however, it incurred $1.55 million in defense fees.  Steadfast reimbursed MMSD the full $1.55 million and then exercised its contractual subrogation rights, which allowed it to “stand in the shoes” of MMSD and sue Greenwich for breaching the insurer’s defense obligations under its policy with MMSD.

The circuit court found that Greenwich had breached its defense obligations to MMSD and consequently granted Steadfast judgment against Greenwich for recovery of the full $1.55 million paid in defense fees and an additional $325,000 in attorney’s fees incurred bringing the lawsuit. The court of appeals affirmed.  The Supreme Court granted Greenwich’s petition for review and issued a decision addressing the following interesting coverage issues.

Interpretation of “Other Insurance” Policy Provisions

Greenwich ultimamely denied its obligation to defend MMSD by invoking what is commonly referred to as an “other insurance” provision in its policy.  Such provisions exist to resolve disputes among insurance companies regarding which insurer must pay first when multiple policies are triggered.  In a nutshell, Greenwich believed that its “other insurance” provision rendered its coverage excess over the Steadfast policy; on that basis, Greenwich argued it was obligated to provide MMSD a defense only after MMSD exhausted the full limits of its coverage from Steadfast.

In rejecting this position, the Supreme Court held that “other insurance” provisions apply only when multiple policies are concurrent—that is, they insure the same risk, and the same interest, for the benefit of the same insured, during the same period.  Slip Op. at ¶ 26 (citing Plastics Eng’g Co. v. Liberty Mut. Ins. Co., 2009 WI 13).  The Court concluded that the Steadfast and Greenwich policies were successive, not concurrent.  Id. ¶ 27.  Because the policies insured different risks at different points in time, both insurers’ defense obligations were triggered by the lawsuits against MMSD notwithstanding any particular “other insurance” policy language.  The Court therefore affirmed the lower courts’ decision that Greenwich had breached its defense obligations to MMSD.

Justice Rebecca Grassl Bradley was the only dissenter on this point, noting that the majority erred by issuing a blanket conclusion regarding “other insurance” provisions rather than examining the particular policy language at issue in the Steadfast and Greenwich policies.  Slip Op. at ¶ 89 (R.G. Bradley, J., concurring in part, dissenting in part).  Upon examining the respective provisions, Justice Bradley concluded that they operated to designate the Greenwich policy as excess of the Steadfast policy, thus relieving Greenwich of its defense obligations.  Id. at ¶¶ 90-105.

Allocation of Defense Costs

Having concluded that Steadfast’s claim against Greenwich was pursuant to the subrogation rights it acquired from MMSD under its policy rather than a traditional contribution claim (see Slip. Op. at ¶¶ 32-38), the Court then addressed whether Greenwich was entitled to an allocation of defense costs between itself and Steadfast.  The Court found that allowing Steadfast to recover from Greenwich 100% of the defense costs incurred would amount to an unjustified windfall because Steadfast indisputably was also an insurer with a contractual duty to defend MMSD.  Id. at ¶¶ 39-41.  Rather, in the Court’s eyes, an allocation was necessary to prevent Steadfast, as the subrogee, from being placed in a better position than MMSD would have been as the subrogor.  Id.

Noting that allocation of defense costs among multiple insurers was an open question under Wisconsin law, the Court examined various methodologies used in other jurisdictions and concluded that a pro rata allocation based on the insurers’ respective policy limits was the most equitable method.  Id. at ¶¶ 42-45.  The Court therefore held that Steadfast was entitled to reimbursement of 40% of the defense costs from Greenwich (amounting to $620,000), as the Greenwich policy had insured 40% of the $50 million worth of coverage in place (with Steadfast insuring the remaining 60%).  Id.

In a concurring separate opinion, Justices Ann Walsh Bradley and Rebecca Frank Dallet issued a strong argument against granting Greenwich any allocation under the circumstances.  The two Justices noted that, under settled Wisconsin law, insurers that breach their defense obligations face severe financial consequences (often times greater than what they would have paid had they defended).  Slip. Op. at ¶¶ 66-67 (A.W. Bradley, J., concurring in part, dissenting in part).  The two Justices further reasoned that allowing breaching insurers to offset these consequences at the expense of non-breaching insurers contravenes those principles, incentivizing a “proliferation of a game of chicken between insurers” in which the loser faces minimal adverse financial consequences.  Id. at ¶¶ 68-71.  The two Justices argued that the only logical way to deter insurers from breaching their defense obligations under these circumstances would be to allow the non-breaching insurer to recover 100% of the costs incurred in defending the insured.  Id. at ¶¶ 73-75.

Recovery of Attorney’s Fees

The final issue addressed by the Court was whether Steadfast was entitled to recover its legal costs in pursuing its subrogated breach of contract claim against Greenwich.  Interestingly, after allocating MMSD’s defense costs to prevent Steadfast from receiving a windfall, the Court held that Steadfast was entitled to recover its attorney’s fees from Greenwich.  The Court noted that MMSD undoubtedly would have been entitled to recover its legal fees from Greenwich as a breaching insurer under settled Wisconsin law, and that Steadfast had acquired all of MMSD’s “rights of recovery” through the Steadfast policy’s subrogation provision.  Slip. Op. at ¶¶ 51-52.  The Court ultimately “decline[d] to create an exception to this longstanding rule by excluding attorney fees from the bundle of contractual subrogation rights.”  Id. at ¶ 51.

Justices Ann Walsh Bradley, Rebecca Frank Dallet, and Rebecca Grassl Bradley all dissented from the majority’s holding as inconsistent with previous Wisconsin decisions holding that exceptions to the “American Rule” (under which each party pays its own attorney) should be limited and narrow.  The justices asserted that Elliott, the precedent entitling an insured to its attorney’s fees when an insurer breaches its defense coverage obligations, has appropriately been limited to its particular factual circumstances by subsequent cases refusing to allow one insurer to recover legal fees from another.  Slip Op. at ¶¶ 77-85 (A.W. Bradley, J., concurring in part, dissenting in part).  According to the dissenters, there was no legitimate reason to deviate from the American Rule under these circumstances.

Conclusions

Taken in full, both the majority and the partial concurrences likely leave most readers puzzled by their inconsistencies.  Steadfast brought a contractual subrogation claim against Greenwich, asserting the rights of MMSD as Greenwich’s insured. The most logical approach would seem to be treating the dispute no differently than if MMSD itself had brought the breach of coverage claim against Greenwich.

Instead, both the majority and concurrence pick and choose when to view Steadfast as “standing in the shoes” of MMSD and when to ignore that context.  The majority recognizes this principle with respect to the recovery of attorney’s fees, but finds that a different result is warranted on how much of MMSD’s defense costs are recoverable.  The concurrence is similarly inconsistent in the opposite way; it argues that the insurer should be allowed to stand in the insured’s shoes to recover 100% of the defense costs but cannot recover any of its own attorney’s fees from the coverage suit because of its status as a subrogated insurer.  This leaves insurers with little guidance as to what precise “rights to recovery” they acquire from an insured via contractual subrogation.

The most settled takeaway appears to be that Wisconsin law limits the circumstances under which “other insurance” provisions may be invoked by insurers.  Six of the seven justices agree that such provisions apply only when policies are truly “concurrent,” insuring the same risk and interest, for the benefit of the same entity, during the same coverage period.  Going forward, insurers should be especially cautious when seeking to rely on such provisions to avoid any coverage responsibilities, regardless of how straightforward and unambiguous they deem the particular policy language.

A potentially more complicated issue in the wake of this decision is an insured’s ability to recover its defense costs where allegations of liability trigger coverage under multiple successive policies issued by more than one insurer.  The Supreme Court previously had decided that Wisconsin was an “all sums” jurisdiction, meaning that an insurer must provide a full defense and indemnify its insured for all sums up to the policy limits, even if the time periods implicated by the relevant allegations exceed the coverage period.  See Plenco, 2009 WI 13, ¶¶ 60-61.  Applying this standard to the multiple insurer context, an insured would be entitled to choose which insurer to provide it a full defense and that insurer would be obligated to do so regardless of the presence of other potentially applicable coverage.

In Plenco, however, there were not multiple insurers.  Because the Court here adopted a pro rata allocation of defense costs in the context of contractual subrogation claim (where the insurer stood in the shoes of the insured rather than in a traditional insurer v. insurer contribution claim), one could envision insurers interpreting this decision to abrogate the “all sums” Plenco decision under circumstances involving policies issued by multiple insurers.  That interpretation would oblige insureds to pursue each and every liability insurer to receive a fully funded defense under such circumstances.  Given that none of the justices cited Plenco with regard to the allocation issue, they likely intended to limit application of the pro rata defense cost allocation only to disputes between insurers (either through subrogation or contribution) after an insured has received a complete defense. Nonetheless, insurers and insureds will want to follow how this issue plays out in the lower courts.

Finally, it is worth noting that only four of the seven current justices concluded that an insurer should be able to recover its attorney’s fees when bringing a contractual subrogation claim against a fellow insurer for reimbursement of defense costs.  This holding certainly seems vulnerable to be narrowed or even overturned as the composition of the Supreme Court changes.

 

 

 

 

 

Stafford Helps Municipalities Preserve “Discretionary” Immunity in Wisconsin Supreme Court

Published by Kyle Engelke, Ted Waskowski on | Permalink

Last month, in a decision with far-ranging consequences, the Wisconsin Supreme Court rejected a call to abrogate the existing “discretionary” immunity standard applied to tort claims made against municipal actors.  Representing the League of Wisconsin Municipalities, the Wisconsin Towns Association, and the Wisconsin Counties Association as amici curiae (friends of the court), we filed a brief and participated in oral argument.

In Engelhardt v. City of New Berlin, 2019 WI 2, 385 Wis. 2d 86, 921 N.W.2d 714, the Court held that the City of New Berlin was not protected by governmental immunity because the known-and-present-danger exception applied.  However, as urged by Stafford, the Court preserved the discretionary immunity standard for tort claims against municipal actors.  As explained below, because only a narrow, 4-3 majority of the Wisconsin Supreme Court favored preserving the “discretionary” immunity standard, further challenges to that long-established standard are foreseeable.

Background on Governmental Immunity

Stafford Rosenbaum frequently defends municipal parties against tort claims. Immunity is often a key issue in such cases. Wis. Stat. § 893.80 provides immunity to a municipal actor “for acts done in the exercise of its legislative, quasi-legislative, judicial or quasi-judicial functions.”  Recognizing the separation of powers pitfalls implicated by permitting individual parties to use the courts to intrude and review the policy decisions of elected bodies (e.g., Town and Village boards, City councils, etc.), the Court has long interpreted Wis. Stat. § 893.80 to provide immunity for the “discretionary” decisions of municipal actors. 

However, there are two main exceptions to immunity – one for ministerial duties and another for known and present dangers.  Duties are ministerial for the purposes of governmental immunity when a duty is “absolute, certain and imperative, involving merely the performance of a specific task” imposed by law.  This exception to immunity applies when statutes, ordinances, or policies obligate the municipality to take a specific action.  Where there is no discretion, there is no immunity.  For example, the Court held that where regulations require railings on a stadium’s camera stand, there is no discretion to place the railings, and therefore no immunity from claims to recover damages caused by the failure to install such railings.

The second exception, the known-and-present-danger exception, applies only “where the danger is so severe and so immediate” that a response is demanded.  Once again, because there is no discretion, there is no immunity.  However, application of this judicially created exception is narrow and very fact-specific.  For example, the seminal case involves a fall, arguably caused by a park ranger’s failure to give warning that a path passed within inches of a partially concealed 90-foot drop. 

Case Background for the Engelhardt decision

The Engelhardt case arose when Lily Engelhardt, age eight, drowned during a summer camp field trip to a swimming pool.  Lily’s mother had informed the camp supervisor that Lily could not swim; however, no other camp staff were informed of this fact.  Lily’s mother granted permission for Lily to attend the field trip after assurances that Lily would be given a swim test upon arrival at the pool.  If Lily did not pass the swim test, the camp supervisor promised to keep her in the shallow, splash pad area. 

However, when the nearly 80 campers arrived at the pool, Lily was not tested before she entered the water.  Although campers like Lily were instructed to see a camp staff member for a swim test, no one was directly supervising Lily. As camp staff completed ushering campers through the locker rooms, Lily was discovered drowned in the pool by lifeguards who were unable to revive her.

Lily’s parents brought suit against the City (which ran the summer camp program) for wrongful death.  The City moved for summary judgment, arguing that the suit was barred by governmental immunity.  After the circuit court denied the City’s motion, the Court of Appeals reversed. The appellate court held that the City had not breached any alleged “ministerial duty” and that the facts of the case did not constitute a known and present danger. 

Majority Opinion

The Wisconsin Supreme Court reversed. It denied the City’s invocation of immunity because the “obvious dangers” under the circumstances met the standard for the “narrow” known-and-present danger exception. 

The portion of the decision with broader impact is the majority’s rejection of the plaintiffs’ request that the Court eliminate the “discretionary” immunity standard.  The majority, written by Justice Shirley Abrahamson, highlighted the seminal 1976 decision in Lister v. Board of Regents. There, the Court applied the discretionary standard based on the “public policy considerations” of protecting the public purse and a preference for “political rather than judicial redress for the actions of public officers.” 

The Engelhardt majority also highlighted the fact that the Legislature has acquiesced for decades in the discretionary-immunity standard; this acquiescence includes, but is not limited to, the 1977 repeal and recreation of the immunity statute.  Because this revision was after the Lister decision applying the discretionary standard, the Engelhardt majority found that the Legislature’s inaction expressed implicit approval of that standard.  In other words, the majority reasoned that if the Legislature thought the Court was wrong to interpret the statute as applying to “discretionary” decisions in 1976, then the Legislature would have addressed that issue when it repealed and recreated the immunity statute in 1977. 

Finally, the majority noted that just two years ago, in Melchert v. Pro Elec. Contractors, the Court rejected the interpretation proposed by the Engelhardts (which was reflected in the dissent written by Justice Rebecca Bradley and joined by Justice Daniel Kelly). 

Concurrence

The three Justices (Rebecca Dallet, Rebecca Bradley, and Daniel Kelly) who did not join the majority filed a separate opinion. That opinion, while technically a concurrence, agreed with nothing in the majority except the end-result that the City was not entitled to immunity.  In her first opinion on the Court, Justice Dallet argued that the majority “expanded” the “narrow” exception for known and present dangers to accommodate the facts of this case. She explained that the exception typically applied only where the potential danger was high and imminent and the act required to prevent the danger was clear. By comparison, Justice Dallet reasoned that, if camp staff had seen Lily walking along the edge of the deep end of the pool, then the exception may have applied.  Because Lily’s presence at the pool facility did not on its own create a compelling danger, she concluded that the exception should not apply.

Instead of invoking the known-and-present-danger exception, the concurrence would have rejected immunity outright. To reach that outcome, the concurring Justices recommended eliminating the existing “discretionary” immunity standard.  In proposing abrogation of this standard, Justice Dallet referred to the “plain language” of statute and harkened back to the Court’s 1962 seminal decision in Holytz v. City of Milwaukee, which abrogated common-law immunity.  One year later in 1963, the Legislature enacted the predecessor to today’s Wis. Stat. § 893.80 which re-instated immunity based upon language in the Holytz decision.  In light of the relationship between Holytz and the re-instated statutory immunity, the concurrence emphasized Holytz’s assertion that, “so far as governmental responsibility for torts is concerned, the rule is liability – the exception is immunity.”

Justice Dallet went on to catalogue what she called the judicial chaos created by the discretionary standard, which, she asserted, seemed “almost random at times.”  The three-justice concurrence declared there was “no time like the present” to eliminate the existing “discretionary” immunity standard.  In its place, Justice Dallet proposed an interpretation that provides immunity “only for agents or employees of a governmental entity who are engaged in an act that, in some sense or degree, resembles making laws or exercising judgments related to government business.” 

Applying this proposed standard, the concurrence reasons that the “promulgation” of the City’s camp guidelines would receive immunity for the content of the guidelines, but the City would not be immune “from suit for its camp staff negligently failing to supervise Lily in accordance with the guidelines.”  Justice Dallet’s opinion highlighted that the camp guidelines provided clear instructions to “know where the kids in your care are at all times” and “under no circumstances should kids be left alone.”  Because the City allegedly failed to meet these guidelines, she concluded that no immunity should apply.

Analysis

The weakness of the majority’s opinion is that (as charged by the concurrence) it arguably expands the “narrow” known-and-present-danger exception.  In other words, Lily’s mere presence at the pool cannot create a known and compelling danger, at least as that exception had been applied previously.  Nonetheless, the facts of Lily’s drowning are tragic.  Perhaps, as footnoted by the concurrence, a modest expansion of the “known danger” exception would serve former Justice Crooks’ wish to strike a better “balance between too much immunity . . . and too much liability.”  Such a re-balancing could help to address the constant refrain to Holytz declaring that “liability is the rule, immunity the exception” and the repeated calls to eliminate the existing “discretionary” immunity standard.    

By comparison, the concurrence fails to mention any of the legislature’s acquiescence to the “discretionary” standard or its acting in reliance upon it – an argument emphasized by the majority.  After all, the governmental immunity applicable today is statutory, while the immunity abrogated by Holytz was judicially created.  Even in Holytz, which abrogated immunity and is relied upon by the concurrence, the court painstakingly distinguished its ability to abrogate immunity in 1962 because the doctrine was judicially created – which is entirely different from the present-day review of statutory immunity enacted by the Legislature.  The concurrence offers no explanation on how to rectify this distinction in order to alter now the longstanding application of statutory immunity.  Instead, the concurrence would simply overrule the Court’s precedent on the “discretionary” immunity standard.

It is also hard to see how the proposed alternative standard offers any more clarity than the standard the concurrence wants to abandon.  The proposed standard applies only where the municipal actor is “engaged in an act that, in some sense or degree, resembles making laws or exercising judgment related to government business.”  How this standard differs from the existing discretionary standard is entirely unclear.  To be fair, the proposed standard would apply to the promulgation of policies, but, if it did not extend to “acts done in the exercise of” such policies, it would directly contradict the statutory language (which the concurrence claims to be reliant upon).  Even more to the point, it would create a legal fiction to grant immunity to the decision to enact a policy yet deny immunity from the results of those policies being acted upon. 

Applying this newly proposed standard, Justice Dallet concludes that, because the camp staff negligently failed to supervise Lily according to camp guidelines, there would be no immunity.  There is a view of the facts that support such a conclusion in this case.  However, how this conclusion differs from the existing ministerial-duty standard is once again unclear.  If the three-justice concurrence concluded that the camp staff failed to comply with guidelines imposed upon them, then this constitutes a breach of a ‘ministerial duty’ and there is no “discretion” under the existing immunity standard.  In other words, the concurrence need not create a whole new standard just to reach the same result.  The concurrence could have simply applied the “ministerial-duty” exception under the existing discretionary immunity standard.  The concurrence does not explain why it did not.

Conclusion

For municipal clients, setting aside the fact-specific application of the known-and-present-danger exception in Engelhardt, the main takeaway from the decision is that Justice Dallet joined Justices Rebecca Bradley and Daniel Kelly in seeking to eliminate the existing discretionary-immunity standard.  Justice Abrahamson wrote the majority opinion preserving the standard; however, with an April judicial election to replace her on the bench (and Justice Kelly’s seat being up for election in April 2020), her following words appear likely prescient:

It is unwise for a court to frequently call into question existing and long-standing law.  Doing so gives the impression that the decision to overturn prior cases is ‘undertaken merely because the composition of the court has changed.’

            In light of the sharp disagreements on the court regarding the interpretation and application of Wis. Stat. § 893.80, the existing discretionary immunity standard for municipal actors is likely to remain a flashpoint for the Wisconsin Supreme Court in the coming years.

Stafford Rosenbaum attorneys (left to right) Ted Waskowski and Kyle Engelke in front of the Wisconsin Supreme Court Hearing Room in the East Wing of the State Capitol building in Madison, WI.

Wisconsin Supreme Court Confirms Limited Liability Exposure For Banks Upon Embezzlement By Employees

Published by Richard Latta, Gregory M. Jacobs on | Permalink

UPDATE: On January 29, 2019, the Wisconsin Supreme Court affirmed in a 5-2 decision the dismissal of a Wisconsin Uniform Fiduciaries Act (“UFA”) claim against the Park Bank located in Milwaukee, Wisconsin.  See Koss Corp. v. Park Bank, Case No. 2016AP636, 2019 WI 7.  The Justices did not agree, however, on the applicable standard for proving bad faith under the UFA statute as enacted in Wisconsin.  Chief Justice Roggensack and Justice Ziegler citing in general to N.J. Title Ins. Co. v. Caputo, 748 A.2d 507, 514 (N.J. 2000), concluded that bad faith requires proof of “some evidence of bank dishonesty such as a bank willfully failing to further investigate compelling and obvious known facts that suggest fiduciary misconduct because of a deliberate desire to evade knowledge of fiduciary misconduct.”  Id. ¶ 55.

Justices Ann Walsh Bradley, Abrahamson, and Dallet held they would expressly adopt the Caputo standard that: “bad faith denotes a reckless disregard or purposeful obliviousness of the known facts suggesting impropriety by the fiduciary.  It is not established by negligent or careless conduct or by vague suspicion.  Likewise, actual knowledge of and complicity in the fiduciary’s misdeeds is not required.  However, where facts suggesting fiduciary misconduct are compelling and obvious, it is bad faith to remain passive and not inquire further because such inaction amounts to a deliberate desire to evade knowledge.”  Id. ¶ 86.

The Court ultimately found the facts at issue in this dispute did not meet either bad faith standard.  So, while the precise bad faith standard applicable to a UFA claim in Wisconsin remains unsettled, the clear takeaway from this holding is businesses must continue to vigilantly monitor their financial activities internally, as they will not be able to recover from financial institutions for losses stemming from fraudulent transactions except where there has been egregious conduct by the financial institution.

On December 12, 2017, the Wisconsin Court of Appeals addressed a civil dispute arising from the high-profile criminal embezzlement scheme committed by Koss Corporation Vice President of Finance, Sujata (“Sue”) Sachdeva.  At issue were allegations Koss made against its bank seeking recovery on the theory that the bank committed bad faith in not detecting the embezzlement scheme. See Koss Corp. v. Park Bank, No. 2016AP636 (Wis. Ct. App. Dec. 12, 2017).

Koss’s complaint alleged that Park Bank of Milwaukee, Wisconsin, violated Wisconsin’s Uniform Fiduciaries Act (“UFA”) by allowing Ms. Sachdeva to embezzle about $34 million from Koss accounts for personal use. Ms. Sachdeva used a variety of ways to embezzle the $34 million, including requesting cashier’s checks and cashing checks made out to “petty cash,” as well executing wire transfers to pay personal credit card bills.  Koss alleged the bank’s failure to discern Ms. Sachdeva’s embezzlement scheme amounted to a violation of Wis. Stat. § 112.01(9), which exposes a bank to liability if it permits transactions “with knowledge of such facts that [the Bank’s] action in paying the check amounts to bad faith.”

The bank moved for summary judgment, asserting that no material facts established it had intentionally or deliberately allowed the transactions to occur in bad faith.  At the circuit court, the court held that Koss had failed to cite any evidence that the bank “intentionally ignored Sachdeva’s embezzlement,” without which there was no way to show the bank acted in bad faith.  The court further noted that the circumstances established only the bank may have been negligent in failing to uncover the fraudulent conduct, but that one of the purposes in adopting the UFA was to eliminate negligence claims against banks arising from transactions where employees or other persons acting as an agent of a depositor commit an act causing a loss to the depositor. 

On appeal, Koss took the position that, although the bank lacked actual knowledge of Ms. Sachdeva’s embezzlement scheme, the circumstances raised enough red flags that a factfinder could conclude that the bank’s failure to detect the fraudulent transactions amounted to bad faith under the UFA.  In support of its position, Koss cited to (1) the large volume of improper checks—adding up to millions of dollars—Sachdeva requested, (2) the bank allowing unauthorized Koss representatives to request, endorse, and pick up checks, (3) the bank’s acceptance of checks payable to companies with cryptic initials (e.g., “N.M., Inc.” for Neiman Marcus and “S.F.A., Inc.” for Saks Fifth Avenue), (4) after-the-fact deposition testimony from a bank employee that the large number of cashier’s checks requested were “strange,” (5) Ms. Sachdeva’s testimony that she chose the bank at issue because of the ease in which she could conduct her fraudulent transactions, and (6) the bank’s failure to implement and/or enforce proper fraud-detection policies and procedures.

Despite this evidence, the Court of Appeals affirmed the circuit court by dismissing Koss’ claim of bad-faith.  Consistent with cases from other jurisdictions interpreting the UFA, our Court of Appeals concluded that to effectively bring a claim of bad faith under the UFA a depositor needs “proof of two elements: (1) circumstances that are suspicious enough to place a bank on notice of improper conduct by the [employee embezzling the depositor’s money on deposit]; and (2) a deliberate failure [by the bank] to investigate the suspicious circumstances because of a belief or fear that such inquiry would disclose a defect in the transaction at issue.”  Id., ¶ 27.

While the Appeals Court acknowledged that Koss cited ample evidence to establish the bank’s negligent failure to investigate and discover Ms. Sachdeva’s embezzlement scheme, it concluded that Koss failed to adduce facts sufficient to allow a factfinder to determine that the elements of proof for bad faith under the UFA were satisfied:

 

Although the transactions Sachdeva engaged in may appear suspicious or odd in hindsight, Koss has not cited any evidence to indicate that, in the larger context of Koss’s banking practices and the banking practices of Park Bank’s other corporate clients, the transactions were suspicious enough to put Park Bank on notice of Sachdeva’s misconduct.  Koss also fails to cite any evidence indicating that Park Bank deliberately declined to investigate Sachdeva’s transactions due to a fear that further inquiry would disclose defects in them.

 

Id., ¶ 51.  The Appeals Court then concluded that allowing Koss’ claim to proceed would be contrary to the UFA’s purpose of insulating banks from the misconduct of a depositor’s employees.  Id., ¶ 52.

This decision highlights how important it is for businesses to adopt and enforce internal monitoring protocols for financial activities by their employees and agents.  By adopting the UFA, Wisconsin has allocated the risk of loss stemming from fraudulent financial transactions to businesses rather than banks in all but the most egregious circumstances.  Businesses failing to take notice of suspicious financial activities (1) not only expose themselves to the risk of severe financial losses, but also (2) if the business has publicly traded securities then they may expose themselves to possible violations of federal securities law for failing to properly ensure the accuracy of their financial reporting.  See id., ¶ 12 n.4 (noting an adverse judgment entered against Koss pursuant to SEC lawsuit).

Please feel free to contact Greg Jacobs or Rich Latta if you would like to discuss any of the matters discussed above.

While a law firm with which Mr. Latta was previously affiliated may have provided legal representation of a party mentioned in Koss Corporation v. Park Bank, Mr. Latta did not represent any party involved and the thoughts expressed herein are strictly his own.

Seventh Circuit Throws Ice Cold Water on Attempt to Undo Adverse State Court Decision

Published by Jeffrey A. Mandell, Kurt M. Simatic on | Permalink

In a relatively short opinion, EOR Energy LLC v. Illinois Environmental Protection Agency, the Seventh Circuit categorically rejected a defendant’s attempt to undo a series of adverse decisions from the Illinois state courts. Although it could be classified as a civil procedure “no-brainer,” litigants would be well served to remember, in this era of constantly evolving state administrative rules and prosecutions, that do-overs in the federal courts are the rare exception rather than the rule.

The Illinois Environmental Protection Agency (“IEPA”) charged EOR and another company with violating state law for transporting hazardous waste acid, storing the waste, and then injecting the waste into EOR’s industrial wells. IEPA prosecuted the claims before the Illinois Pollution Control Board (the “Board”). Although the IEPA originally prevailed (unopposed) on summary judgment, EOR filed a motion for reconsideration and argued, for the first time, that the Board lacked jurisdiction. Specifically, EOR asserted that it was not injecting “waste” into its wells because the acid was being used to treat the wells. Because the acid was not “waste,” reasoned EOR, the Illinois Department of Natural Resources, not the Board, had exclusive jurisdiction. The Board rejected EOR’s argument and denied the motion for reconsideration.

EOR appealed to the Appellate Court of Illinois. Interpreting Illinois’s statutory scheme, the appellate court concluded that the acid was indeed a “waste,” giving the Board exclusive jurisdiction over the matter. The Supreme Court of Illinois and the United States Supreme Court both declined EOR’s requests for further appellate review.

Undeterred, EOR filed a new lawsuit in federal district court, seeking a declaratory judgment under the federal Resource Conservation and Recovery Act and the Safe Drinking Water Act. EOR’s federal “hook” appeared to be that it was seeking a declaration of its rights under these acts; it envisioned a declaration stating that it was allowed to continue injecting acid into the wells without fear of IEPA prosecution.

The district court dismissed EOR’s complaint for failure to state a claim. First, the district court ruled that the federal government’s approval of Illinois’s hazardous waste program superseded the application of federal regulations and ensured that the IEPA (rather than the federal government and instead of the Board) had regulatory jurisdiction. Then, the district court took judicial notice of the adverse Illinois state court decisions (which EOR conveniently omitted from their federal complaint) and concluded that the Eleventh Amendment, issue preclusion, and the Rooker-Feldman doctrine preluded relief for EOR in the federal courts.

EOR appealed to the Seventh Circuit, which affirmed the district court. The Seventh Circuit did not mince words in condemning EOR’s tactics: “We emphatically reject this undisguised attempt to execute an end-run around the state court’s decision.” Slip op. at 5. The Seventh Circuit cited multiple rationales. The state court’s decision was final. Federal courts must respect state-court judgments. And, to the extent that EOR wanted the federal courts to set aside the adverse state-court decision, the Rooker-Feldman doctrine barred that outcome. Rather, if EOR believed that the Illinois courts were wrong, its relief lay with the Illinois Supreme Court and the United States Supreme Court. Those courts’ denial of EOR’s petitions for review “was the end of the line” for EOR, such that “it may not come to the federal courthouse for Round Two.” Slip op. at 6. The court could have stopped there, but it went on to cite claim preclusion and the Eleventh Amendment as additional bars to EOR’s efforts.

One could speculate that a hazardous-waste-dumping oil company may have had a better chance in front of the Seventh Circuit if the panel had not included the only two Democratic appointees left on the circuit (Chief Judge Wood and Judge Hamilton). However, given the strong, unequivocal language that the panel used, it is doubtful that EOR would have prevailed in front of any panel combination. Therefore, although this case originated in Illinois, all litigants in the Seventh Circuit should be on notice that this court of appeals is clearly asserting that it will not abide any attempted end-runs around final judgments issued in state-court enforcement actions.

Has the Wisconsin Court of Appeals Shown A Path to Change Successor Liability Law?

Published by Jeffrey A. Mandell, Kurt M. Simatic on | Permalink

Ordinarily, an appellate court’s per curiam opinion—an unsigned ruling issued “by the court” rather than in the name of the authoring judge—does not merit close examination. In Wisconsin, per curiam opinions are unpublished and may not be cited in future cases, even for persuasive value.

Thus, it would be easy to overlook the court of appeals’ recent per curiam opinion in Veritas Steel, LLC v. Lunda Construction Company. At first blush, the decision appears to be a straightforward affirmance of the circuit court’s order dismissing two claims: successor liability and fraudulent transfer. However, the analysis is illuminating, and it seems to telegraph—pretty clearly—that the Wisconsin Supreme Court should reconsider long-standing precedent that narrows the exceptions to the general law of non-liability for corporate successors.

Facts:

PDM was a steel fabricating entity. It had a credit agreement with multiple lenders, who in turn had first-priority liens on PDM’s assets. When PDM defaulted, the lenders granted forbearance in exchange for PDM’s agreement to sell itself with the help of an investment bank. None of the bids to acquire PDM were sufficient to cover PDM’s outstanding debt to secured creditors (much less to unsecured creditors like Lunda, which had obtained a $16 million judgment against PDM).

Atlas, the common parent company of the lenders, was the highest bidder. Through a series of transactions, Atlas and the lenders acquired PDM’s assets and shed any obligations to pay additional debts. They did this in several steps. First, a “transition support agreement” between PDM and the lenders expressed “a mutual desire” to transition PDM’s business to the lenders. In the wake of that agreement, Atlas and its affiliates purchased all of PDM’s outstanding debt directly from the lenders at a steep discount. Then Atlas created a new entity, Veritas Steel, which was assigned a first-priority lien on PDM’s assets. Finally, PDM conveyed its assets to Veritas in exchange for the discharge of the secured debts. “Under Veritas’s ownership,” PDM continued operating as it had before these transactions, employing the same workforce and pursuing the same type of work.  See slip op. ¶13.

Meanwhile, Lunda took steps to execute its judgment against PDM. Eventually, Veritas responded by seeking a judicial declaration that Lunda had no claim against Veritas for payment of the judgment against PDM. Lunda counterclaimed against Veritas and brought a third-party complaint against Atlas and others. Lunda alleged that the defendants schemed to control PDM and continue to operate it, “albeit under a different name.” Id. ¶ 15. Applying Wisconsin precedent, the circuit court dismissed Lunda’s successor liability and fraudulent transfer claims.

Court of Appeals decision:

In its discussion of the successor liability claim, the court of appeals began with the general rule that when an acquiring corporation purchases assets of a target corporation it does not also succeed to the liabilities of the target corporation. There are well-recognized exceptions to this general rule, two of which Lunda invoked: (1) the “de facto merger exception,” which applies when the transaction amounts to a consolidation or merger of the two corporations, and (2) the “mere continuation exception,” which applies when the acquiring corporation is essentially a continuation of the target corporation.

The court of appeals recognized that earlier precedent supported Lunda’s argument. In Tift v. Forage King Industries, the Wisconsin Supreme Court expanded these exceptions and allowed piercing the corporate veil so that a court could “look to the substance and effect of business transformations or reorganizations to determine whether the original organization continues to have life or identity” in a subsequent organization. Id. ¶24 (quoting Tift, 108 Wis. 2d 72, 78–79, 322 N.W.2d 14 (1982)).

However, the court of appeals concluded that later Supreme Court precedent cut the other way. This newer precedent, Fish v. Amsted Industries, Inc., rejected “relaxation of the traditional test of successor liability and instead requires attention to concrete evidence of identity of ownership.” Id. ¶27 (citing Fish, 126 Wis. 2d 293, 300–02, 376 N.W.2d 820 (1985)). As the court of appeals noted, this focus on the “identity of ownership” appears to require a transfer of stock to trigger the de facto merger exception, and the common identity of officers, directors, and stockholders for the mere continuation exception. As neither key element was present here, neither exception applied and Lunda’s successor liability claim failed.

The court of appeals cited federal case law that similarly understood Fish to foreclose claim, even where the results may be “‘unsettling’ because an asset transfer has occurred under what appear to have been ‘quite cozy’ circumstances.” Id. ¶28 (quoting Gallenberg Equip., Inc. v. Agromac Int’l, Inc., No. 98-3288, slip op. at 5 (7th Cir. Aug. 4, 1999)). The court of appeals also observed that Lunda’s argument would have “traction” in other jurisdictions, but not in Wisconsin “at this time.” Id. (emphasis added). And the court of appeals cautioned that it may be “impossible to square our reading of Fish with statutory merger language under ch. 180” of the Wisconsin Statutes. Id. ¶32, n.11. Finally, the court of appeals noted that Fish was a closely decided case, from which three justices dissented, “urging more flexible approaches to the exceptions.” Id. ¶33. But the court of appeals ultimately acknowledged its hands were tied, as only the Supreme Court can overrule its prior decisions.

Conclusion:

It may very well be that the court of appeals deemed this an open-and-shut case, meriting no more than an unsigned ruling. It may also be true that the court of appeals felt aggrieved by an unsecured judgment creditor getting the short end of the stick and went out of its way to explain why it could not offer relief. However, given the tone, the length, and the word choice of this opinion, the court of appeals may indeed have been urging litigants to ponder, and perhaps even providing rhetorical ammunition to use in, pursuing a change in the controlling precedent by seeking further review at the Wisconsin Supreme Court.

Two Strikes and You’re Out:  7th Circuit Addresses Federal and State Rules on Voluntary Dismissal

Published by Kurt M. Simatic, Jeffrey A. Mandell on | Permalink

Earlier this week, in Dvorak v. Granite Creek GP Flexcap I, LLC, No. 18-1892, 2018 WL 5801244 (7th Cir. Nov. 6, 2018), the Seventh Circuit addressed the interaction between federal and state rules governing voluntary dismissals of actions. Both Federal Rule of Civil Procedure 41(a) and its corresponding Illinois statute provide a “two strikes” rule: a plaintiff may dismiss an action once without prejudice, but refiling and dismissing again serves as an adjudication on the merits that bars plaintiff from filing any future action based on the same claim.

Dvorak presented a twist: What if a plaintiff files and dismisses a federal suit, then refiles and dismisses in state court, and then files again in federal court? The Seventh Circuit’s ultimate holding—the plaintiff’s third suit was barred and properly dismissed—provides an important lesson for litigants and litigators alike. 

All three suits Dvorak filed arose from an allegedly “mishandled … capital call for a limited partnership.” Dvorak first filed in federal court on the basis of diversity jurisdiction. But he and at least one other partner were both Florida citizens, destroying diversity as a basis for federal jurisdiction. So, he dismissed his initial federal suit with the consent of the defendants and refiled in Illinois state court. In this second suit, the state court dismissed one claim on the merits. Rather than litigate the remaining claims in the state court, Dvorak dismissed the rest of his suit and refiled those claims in the federal court where he had started. This new, third suit omitted the partnership and the claim dismissed by the state court.

The defendants moved to dismiss the third suit on the ground that Dvorak had refiled twice, even though under Illinois law his prior dismissals both counted as strikes. In response, Dvorak argued that his first dismissal did not count as a strike under Illinois law because it was entered with the consent of all parties. The district court rejected Dvorak’s argument, and dismissed the third suit with prejudice. Dvorak appealed.

The Seventh Circuit affirmed the district court’s dismissal order, in an opinion authored by Judge Frank Easterbrook and issued only eight days after oral argument. As an initial matter, the court had to characterize the dismissal of the first federal suit, as that characterization would affect the treatment of the second, state-court dismissal. Looking to the text of Rule 41(a), the court concluded that, regardless of whether Dvorak dismissed unilaterally or by stipulation of the parties, “both situations [are] voluntary dismissals by the plaintiff.” Slip op. at 5. A stipulated dismissal “is not less a voluntary dismissal by the plaintiff just because other parties agree that the suit should end.” Id. The court then held that, under Illinois precedent, the stipulated dismissal in the first federal suit was also voluntary for purposes of the state dismissal statute, 735 Ill. Comp. Stat. 5/13-217. 

Applying the Illinois two-strikes rule, the Seventh Circuit reasoned that, if the dismissal of Dvorak’s first federal suit was one strike and dismissal of the unadjudicated claims in state court was the second strike, then the refiled suit in federal court (Dvorak’s third suit overall) was barred by § 5/13-217. The court was unmoved by Dvorak’s argument that his third suit included two defendants who had not been named parties to the first suit, because the Illinois statute “applies with respect to all persons who could have been named in the initial suits, whether or not they were, provided that the new suit arises from the same transaction (or, equivalently, the same core of operative facts).” Slip op. at 6.

The outcome would be the same if the state suit had been filed and dismissed in Wisconsin, which also has a “two-strikes” statute. Wis. Stat. § 805.04. Section one of that statute explicitly states that

“(u)nless otherwise stated in the notice of dismissal or stipulation, the dismissal is not on the merits, except that a notice of dismissal operates as an adjudication on the merits when filed by a plaintiff who has once dismissed in any court an action based on or including the same claim.”

(emphases added). As the second emphasized phrase demonstrates, Wisconsin clearly addresses the issue of forum. The Wisconsin statute expressly counts prior dismissals “in any court.” Note, however, that the first clause expressly encompasses both dismissals and stipulations, but that the exception references only notices of dismissals only. Does the statutory text leave room to argue that a stipulated dismissal does not count as a strike under the Wisconsin statute? Possibly, but such an argument would now need to overcome Dvorak’s interpretation of Rule 41(a). 

Wisconsin Court of Appeals Affirms Limited Scope of Insurance Agents’ Duties to Insureds

Published by Gregory M. Jacobs, Susan Allen on | Permalink

District III of the Wisconsin Court of Appeals recently addressed the scope of an insurance agent’s duties to an insured when retained to procure insurance coverage.  See Olson et al. v. Wisconsin Mutual Ins. Co. et al., Case No. 2017AP1567 (Oct. 2, 2018) [https://wscca.wicourts.gov/caseDetails.do?caseNo=2017AP001567&cacheId=FD38D2808B90DA8A4890651728193F6B&recordCount=1&offset=0].  By affirming the circuit court’s decision to dismiss the insured’s negligence claim against its agent, the Court confirmed that, absent unique circumstances, in Wisconsin an insurance agent is not obligated to actively advise an insured regarding the appropriate coverages for the insured’s circumstances.  Rather, an agent is obligated to exercise reasonable care in procuring only the coverages specifically requested by the insured.

At issue in this case was coverage for injuries suffered by the Olsons due to an automobile collision with Jeffrey Keyes, who was in the process of towing a gooseneck trailer full of cattle between his family farm properties.  Keyes was towing the trailer with a truck that he owned personally.

Keyes had in place a personal automobile insurance policy issued by Wisconsin Mutual Insurance Company, as well as a $1 million umbrella liability endorsement attached to a farmowners policy for his family farm issued by Rural Mutual Insurance Company. Keyes submitted a claim to both insurers for the accident with the belief that the umbrella endorsement attached to the Rural policy would cover any damages that exceeded the limit of the Wisconsin Mutual policy.

Rural denied the claim based on an exclusion in the endorsement disclaiming coverage for personal injury or property damage arising from off-farm use of personal automobiles.  This exclusion was in line with Rural’s standard business practice of not providing umbrella coverage for personal automobiles unless the insured purchased primary automobile coverage from Rural.  While Keyes asserted a contextual ambiguity argument to try to avoid the exclusion, the court found the provision unambiguous and concluded that the Rural policy did not provide coverage for the Olson claim.

In the alternative, Keyes pursued a claim against his agent, Lon Truax, for failure to procure coverage arising from the use of off-farm personal automobiles as part of the umbrella endorsement attached to the Rural policy.  In support of his claim, Keyes cited to evidence demonstrating that he had informed Truax that he wanted “full coverage” for “anything and everything,” that Truax sold only Rural insurance products and was aware of Rural’s practice to not offer umbrella automobile insurance unless the insured purchased primary automobile insurance from Rural, and that Keyes and Truax had specific conversations about switching Keyes’ automobile coverage from Western Mutual to Rural.  Keyes asserted that, under these circumstances, it was reasonable to expect Truax to inform him of the off-farm automobile exclusion in the umbrella endorsement, which he had failed to do.

The court was not persuaded by this argument.  The court noted that in Wisconsin an insurance agent-insured relationship is an ordinary agency relationship in which the agent assumes only a limited duty to carry out the principal’s instructions in good faith and, absent special circumstances, is not obligated to advise the insured regarding the availability or adequacy of coverage.  The court found that Keyes’ generalized requests for full coverage were insufficient to put Truax on notice that he specifically sought umbrella coverage for off-farm use of personal automobiles and, despite the specific conversations about switching his primary automobile coverage to Rural, there was nothing in the record sufficient to establish that Truax was obligated to advise Keyes regarding any potential gaps in the procured coverage.  The court accordingly held that the circuit court had properly granted summary judgment for Truax on this issue.

The Olson decision demonstrates how important it is for commercial enterprises and businesses to take an active role in procuring adequate insurance to protect their interests.  In Wisconsin, insurance agents are not fiduciaries that should be relied on to weigh in regarding the adequacy of an insurance portfolio unless they specifically offer such services and agree to do so (likely for an additional fee).  In any event, before procuring insurance products, commercial entities should ensure that their coverage forms are reviewed carefully by those who are familiar with all aspects of their operations and resulting risk profile (either an internal risk management department and/or coverage counsel) to minimize the potential for any coverage gaps.

Court of Appeals Interprets Wisconsin’s Fraudulent Transfer Law in a Garnishment Action

Published by Susan Allen, Olivia M. Pietrantoni on | Permalink

The Wisconsin court of appeals clarified in Beck v. BidRX, LLC the requisite elements to proving a fraudulent transfer claim under Wis. Stat. Ch. 242. App. No. 2017AP2043 (Ct. App. Aug. 15, 2018). The court reversed the circuit court’s ruling that a fraudulent transfer occurred because there was no evidence that the transfers were for an antecedent debt.

The Becks were awarded $108,235 in a default judgment against BidRX, LLC (“BidRX”) for an unpaid promissory note.  The Becks filed a nonearnings garnishment action against BidRX as the debtor and Fiscal Intermediary Third Party Funds Services, LLC (“Fiscal”) as garnishee. The Becks alleged in the garnishment action that BidRX fraudulently transferred funds to Fiscal. In addition to pointing to bank records allegedly showing a number of transfers between BidRX and Fiscal, the Becks argued that Fiscal was an “insider,” in part, because the entity had been formed by an attorney working for BidRX. The circuit court held that BidRX made fraudulent transfers to Fiscal under Wis. Stat. § 245.05(2). Additionally, the circuit court imposed a judgment of $2,073.77 against BidRX. The court of appeal reversed.

The court of appeals stated that a plaintiff must prove the following elements to establish a fraudulent transfer claim:

  1. The creditor’s claim arose before the transfer,
  2. The transfer was made to an insider for an antecedent debt,
  3. The debtor was insolvent when the transfer was made, and
  4. The insider-transferee had reasonable cause to believe the debtor was insolvent.

The only evidence the Becks submitted was over 300 pages of bank records showing transfers between BidRX to Fiscal. The court held that the Becks failed to prove element number two, and that no evidence was offered to show “why any transfer was made and for what debt.” ¶ 16. “The fact of a transfer to an insider is not enough; it is the preferential payment of prior debts to insiders to which the statute is addressed.” Id. The court rejected the Becks’ argument that Wis. Stat. 242.05(2) assumes the existence of an antecedent debt as the reason for the conveyance.

The court of appeals further held that the circuit court did not have the authority to order a judgment against BidRX because BidRX was the debtor, and not the garnishee, in this garnishment action. The purpose of a garnishment action is to recover debtor’s property held by third parties that is owed to a creditor; nothing in the garnishment statutes permits a court to issue a money judgment against non-garnishees.

Beck v. BidRX, LLC is the first Wisconsin case to definitively set out the elements for a fraudulent transfer claim under Wis. Stat. 242.05(2), and follows other courts across the nation in construing the elements in accordance with the Uniform Fraudulent Transfers Act. Additionally, this case establishes that circuit courts may not impose money judgments against debtors in garnishment actions.

What Will Follow from Wholesale Changes to Wisconsin’s Class-Action Statute?

Published by Jeffrey A. Mandell on | Permalink

On July 1, 2018, for the first time in more than a century, major changes to Wisconsin’s class-action statute took effect. See Supreme Court Order No. 17-03, 2017 WI 108. As a result, Wis. Stat. § 803.08 now mirrors, nearly identically, Federal Rule of Civil Procedure 23, which governs class-action suits in federal courts. The harmonization of § 803.08 with Rule 23 expands the breadth of guidance and precedent available in Wisconsin class actions, as lawyers and judges can now refer to extensive federal case law interpreting and applying Rule 23. While the effect this change will have on the volume, variety, and outcome of class actions in Wisconsin remains to be seen, several questions are foreseeable.

Will this change increase the number of class-action lawsuits in Wisconsin courts?

State-court class actions have been relatively rare in Wisconsin. So few occur annually that the Wisconsin Court system does not track class actions as a category in its yearly “Civil Disposition Summary.” Among the reasons for this scarcity may be the fact that, prior to July 1, Wisconsin’s previous class-action statute provided very little guidance (and therefore very little predictability) for potential litigants, making federal court or other jurisdictions preferable venues. Now that Wisconsin class-action law parallels federal law, Wisconsin state courts may become a more appealing venue. (Note, however, that Congress relaxed removal rules for class actions, see 28 U.S.C. §§ 1332(d) & 1446, so that, even if more class-action plaintiffs choose to file in Wisconsin state courts, defendants will often have the option to move those cases to federal court.)

There are also some unique features of Wisconsin law that may make litigating class actions here more attractive to plaintiffs and defendants alike. For example, consider the opportunity for appellate review early in the class-action process. The crucial moment in many class-action suits is the trial court’s decision whether to certify a class. Where certification is granted, the defendant often faces enormous potential liability, which is why a certification order sometimes constitute a “death knell” for defendants, forcing them to settle rather than risk an adverse judgment after a full trial on the merits. See Balser et al., Interlocutory Appeal of Class Certification Decisions under Rule 23(f): An Untapped Resource, Bloomberg BNA (Mar. 16, 2017). And where certification is denied, the named plaintiff must decide whether to settle or proceed alone, which often means continuing in extensive, expensive litigation though the potential damages for their individual injury do not justify the costs of the process.

In federal court, litigants do not have an appeal as of right from the trial court’s critical decision of whether to certify a class. Instead, the party aggrieved by that decision must convince a federal appeals court to accept a discretionary appeal under Rule 23(f). By contrast, Wis. Stat. § 803.08(11) now grants litigants an appeal as of right from a class certification order. The chance to appeal class certification before proceeding to final judgment could be a substantial boon for whichever party loses on that issue in the trial court. It may be enough to encourage class-action plaintiffs to file in Wisconsin state court and to make class-action defendants sued in Wisconsin state court think twice before opting for removal to federal court.

Another feature of Wisconsin law that could attract more class-action suits is Wisconsin’s comparatively lenient standing requirements. In federal courts, standing is a constitutionally mandated jurisdictional prerequisite. But Wisconsin state courts view standing more leniently. In Wisconsin, standing is a prudential doctrine, “aimed at ensuring that issues and arguments presented will be carefully developed and zealously argued.” McConkey v. Van Hollen, 2010 WI 57, ¶¶15-16, 326 Wis. 2d 1, 783 N.W.2d 855. The greater flexibility Wisconsin law affords state courts to allow suits to proceed may be particularly advantageous for class-action plaintiffs, who frequently face arguments that the named plaintiff has not suffered a concrete and particularized injury sufficient to trigger federal jurisdiction. Additionally, it remains an unresolved question whether federal standing doctrine requires that all absent class members have standing or if the named plaintiff’s proof of standing is sufficient. Wisconsin’s more pragmatic approach to standing allows state-court plaintiffs to sidestep this thorny question.

How will Wisconsin courts address some of the open questions under federal class-action law?

While functionally adopting Rule 23 will likely bring improved clarity to Wisconsin’s class-action law in many respects, Wisconsin may be adopting some of Rule 23’s unresolved questions as well. To the extent that the language now incorporated into § 803.08 has led to disagreements among federal courts, Wisconsin courts will now face those same bedeviling questions.

One such question, which has divided federal appellate courts, concerns whether Rule 23 has an ‘implicit’ requirement that the members of a proposed class be “ascertainable.” See, e.g., In re Petrobas Securities, 862 F.3d 250, 264 (2d Cir. 2017), petition for cert. filed (No. 17-664). Traditionally, “a class is ascertainable if it is clearly defined by ‘objective criteria.’” Andrew J. Ennis and Catherine A. Zollicker, The Heightened Standard of Ascertainability in Class Actions, ABA Section of Litigation (Mar. 13, 2018). Most circuits, including the Seventh Circuit, adhere to this traditional rule. Id. However, the Third Circuit has held that “a class action plaintiff must also ‘demonstrate his purposed method for ascertaining class members is reliable and administratively feasible.’” Id. (quoting Carrera v. Bayer Corp., 727 F.3d 300, 308 (3d Cir. 2013)). The U.S. Supreme Court has thus far declined several requests to address this issue.

Another involves the propriety of side-deals with individual objectors to a class-action settlement. Because the outcome of a class-action suit is binding upon all members of the class, when the named plaintiff and the defendant negotiate a settlement, the terms are submitted for the court’s review and all absent (that is, unnamed) class members have the opportunity to lodge objections to the settlement. Fed. R. Civ. P. 23(e)(5). Sometimes an absent class member files such an objection for the sole purpose of gaining an individual benefit in the form of a separate settlement payment in exchange for dismissing their objection. At least one litigant has characterized this practice as “objector blackmail.” See Pearson v. Target Corp., 893 F.3d 980, 982 (7th Cir. 2018).

This issue is a particularly interesting example because the U.S. Supreme Court has adopted an amendment to Rule 23 to address this by requiring court approval of any payment provided in connection with dismissing an objection to settlement. Unless Congress takes action to stop it, this proposed amendment will take effect on December 1, 2018. However, Wis. Stat. § 803.08 mirrors Rule 23’s text prior to the proposed amendment. Absent a further change to section 803.08, the settlement issue will remain one for the Wisconsin courts to handle in state-court class actions.

Conclusion

The first wholesale changes to Wisconsin’s class-action statute in a century might have unintended consequences. While changes to harmonize Wisconsin class-action law with federal class-action law mean that Wisconsin lawyers and judges have greater guidance on class-action procedures, they also bring to Wisconsin several thorny questions as yet unresolved by federal courts. And some differences between Wisconsin law and federal law could lead to an increased incidence of class-action litigation in Wisconsin state courts.

Law Clerk Collin Weyers assisted with researching and writing this post.

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