Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—EDWis: Insurer Liable for Paying Portion of Sandwich Shop Franchisor’s Settlement with Franchise Investors, (Feb 11, 2013)

By Peter Reap, J.D., LLM

Under a policy that sandwich shop franchisor Cousins Submarines, Inc. and its affiliate Cousins Sub Systems, Inc. purchased from Federal Insurance Company, the insurer was liable to cover some of the $750,000 settlement that Cousins paid to settle its dispute with a group of franchise investors, the federal district court in Milwaukee has decided (Cousins Submarines, Inc. v. Federal Insurance Company, February 8, 2013, Stadtmueller, J.).

There was a question of fact, however, as to which of the many claims upon which the settlement was based were covered by the policy, and which were not. Moreover, Cousins failed to show that Federal’s denial of coverage constituted bad faith under Wisconsin law. Thus, the parties’ respective motions for summary judgment were granted in part and denied in part, and the dispute would proceed to trial on the issue of allocation.

Background. Cousins and a number of its representatives enticed—through arguably illegal means—a group of investors to open Cousins franchises in Indiana. That franchise deal fell through, prompting Cousins to file suit against the investors in the Eastern District of Wisconsin. The investors quickly filed twelve counterclaims against Cousins and its representatives.

Shortly thereafter, Federal wrote a letter to Cousins, informing Cousins that Federal would not provide coverage for any award against Cousins stemming from those counterclaims. In that letter, Federal stated that it viewed the losses as being excluded from coverage under Exclusions (C)(2) and (C)(8) of the insurance policy. Federal argued—and continues to maintain this position in the matter at hand—that Cousins’ activities all resulted from contracts or unfair trade practices, and are thus excluded from coverage by Exclusions (C)(2) and (C)(8), respectively.

Despite Federal’s continued opposition to coverage, Cousins unilaterally decided to settle the remaining claims on the eve of trial. That settlement required Cousins to dismiss its claims against the investors and further to pay $750,000 to the investors, in exchange for dismissal of the six counterclaims remaining against Cousins.

Those remaining six counterclaims were: (1) intentional misrepresentation; (2) breach of two contracts between Cousins and the investors; (3) rescission of those contracts; (4) violation of the Wisconsin Franchise Investment Law; (5) violation of the Wisconsin Theft statute; and (6) violation of the Indiana Franchise Disclosure Act and Deceptive Trade Practices Act.

Cousins then filed this suit, alleging that Federal breached its insurance contract with Cousins by denying coverage. Cousins seeks damages for breach of contract and bad faith, as well as a declaratory judgment that Federal breached its obligations under the contract.

Coverage. The first disputed exclusion from coverage in the policy was Exclusion (C)(2) which the court distilled into plain terms as: no coverage is available for any claim arising from any actual or alleged liability under any contract or agreement, unless the insured would have been liable even if the contract did not exist. For each of the remaining six counterclaims, the court examined whether Cousins would have been liable in the absence of its contracts with the investors for any otherwise excluded losses.

The court determined that: Federal was not responsible to cover any portion of settlement attributable to the breach of contract, Wisconsin Franchise Investment Law, or theft claims; nor was Federal required to cover any portion of the settlement attributable to contract-based liability under the intentional misrepresentation, rescission, or Indiana Franchise Disclosure Act and Deceptive Trade Practices Act claims. Federal is, however, responsible to cover the portion of settlement attributable to pre-contract damages for the intentional misrepresentation and Indiana Franchise Disclosure Act and Deceptive Trade Practices Act claims, as well as the rescissory damages portion of the rescission claim.

In analyzing the Wisconsin Franchise Investment Law counterclaim, for example, the court noted that the liability rested upon the existence of misrepresentations that induced the investors to enter into a contract to purchase franchise rights. Cousins’ liability under Wis. Stat. § 553.51(2) stemmed from the entry of the contract between it and the investors, and, accordingly, Exclusion (C)(2) applied to the investors’ claim under that statute, the court held.

Second, turning to the extent that Exclusion (C)(2) barred coverage, because an award of damages is available under Wis. Stat. § 553.51(2) only when there has been a purchase of a franchise, Cousins would not have been liable for damages under that statute in the absence of a contract, the court reasoned.

Therefore, Exclusion (C)(2) applied to exclude coverage by Federal for any liability under Wis. Stat. § 553.51(2). Cousins could not succeed in arguing that Federal should cover any portions of the settlement that are attributable to Wis. Stat. § 553.51(2), and therefore that portion of Cousins’ claim was dismissed.

The court then looked to the second exclusion, Exclusion (C)(8) to determine whether it barred coverage of any of the claims to which the court found Exclusion (C)(2) inapplicable. Exclusion (C)(8) did not apply to any of the claims asserted by the investors against Cousins for which it paid the settlement, the court held.

Federal argued that the term “unfair trade practices” in Exclusion (C)(8) applied to Cousins’ misrepresentations, such that all of the claims against Cousins were barred by Exclusion (C)(8). However, the plain language of Exclusion (C)(8) made fairly clear that the Exclusion was meant to apply only to activities related to anti-trust, price fixing, and other similar forms of business misconduct, according to the court. It was not a broad exclusion meant to gather in all otherwise-nonexcluded bad acts of a business.

Bad faith. Cousins was unable to satisfy either prong of the two-part test that an insured must satisfy under Wisconsin Law to establish bad faith against an insurer, the court decided. Under that test, first, Cousins was required to establish that there was no objectively reasonable basis for Federal to have denied Cousins’ claim for benefits. Second, Cousins had to show that, subjectively, Federal knew or should have known that there was no reasonable basis to deny the claim.

As to the first part, the court’s analysis of the exclusions and the merits of Federal’s denial of coverage showed that such denial was proper as to many of the claims settled by Cousins. As to the second prong, a number of non-Wisconsin cases affirmed Federal’s interpretation of its policy, supporting Federal’s subjective belief that it was reasonable to deny Cousins’ claim, the court noted.

Allocation. The policy provided that all losses other than defense costs are to be “allocated between covered loss and uncovered loss based upon the relative legal exposures of the parties to such matters.” Therefore, allocation of the settlement amount between the covered and uncovered claims was appropriate under the policy, the court stated.

There were many claims upon which the settlement in this case was based, some of which were covered and some of which were not, the court noted. The amount appropriately allocable to any claim was an issue for trial. At that time, Federal will have the burden of showing how the settlement should be allocated between covered and uncovered claims.

The case is No. 12-CV-387-JPS.

Attorneys: Dean P Laing (O'Neil Cannon Hollman DeJong & Laing SC) for Cousins Submarines Inc. Gary L Gassman (Meckler Bulger Tilson Marick & Pearson LLP) for Federal Insurance Company.

Companies: Cousins Submarines, Inc.; Cousins Sub Systems, Inc.; Federal Insurance Company.

Cases: FranchisingDistribution WisconsinNews