In a multi-layered decision, Century Surety Company v. Belvins, (United States Court of Appeals for the Fifth Circuit, August 18, 2015), the Fifth Circuit found that a policyholder could assert non-statutory bad faith claims against an insurer under Louisiana law. It also held that a district court could not sua sponte dismiss unchallenged counterclaims without notice to the parties, and affirmed that Brillhart v. Excess Ins. Co. of Am., 316 U.S. 491 (1942)’s broad abstention doctrine (applicable in declaratory judgment action) did not apply in the Fifth Circuit where there were coercive claims involved in the suit.
In the underlying action, a boy’s mother brought a claim against the policyholder hotel, stating that her son was injured after he found and drank sodium hydroxide he found in an ICEE cup in the hotel laundry room. The insurer initially agreed to defend the hotel, but reserved its rights. The insurer then brought an action for declaratory judgment for an order that it had no duty to defend based on the policy, which excludes coverage for bodily injuries from harmful substances.
The policyholder filed counterclaims against the insurer: (1) breach of contract based on the coverage denial; (2) “bad faith” coverage denial; (3) unspecified “estoppel”; (4) “vicarious liability” for the fault of the insurers’ agents; and (5) a state unfair commercial practices claim. The underlying plaintiff brought counterclaims seeking a declaration that the policy applies and “payment”
The insurer moved to dismiss the policyholder’s bad faith cause and unfair commercial practices claims. The District Court dismissed those two claims based on the insurer’s motion, and dismissed the policyholder’s other three claims on its own accord based on “failure to state a cause of action”, and without any further explanation. Finally, because the policyholder’s five coercive counterclaims were dismissed, it dismissed the entire declaratory judgment action sua sponte with prejudice, applying the, abstention doctrine, and holding that the action could be resolved in the underlying state action. The District Court later amended its dismissal of the counterclaims to be without prejudice. Both parties appealed.
Between the time the appeal was briefed and argument, the insurer was added to the state court action. At oral argument, both the insurer and the policyholder agreed that all the issues related to the declaratory judgment action were not also before the state court, and that if the policyholder’s counterclaims were not dismissed with prejudice (which was subject to debate), it could file its claims in state court.
The Fifth Circuit reversed everything but the dismissal of the unfair commercial practices counterclaim, stating with regard to the three unchallenged claims that the District Court was required to give the parties notice of the its intention to dismiss the unchallenged claims and an opportunity to respond.
With regard to dismissal of the bad faith cause of action, the Fifth Circuit noted that based on a party’s relation to the policy, it may claim different bases for bad faith under Louisiana law. More specifically, it noted the Louisiana Supreme Court’s decision in Kelly v. State Farm, 2014-1921 (La. May 5, 2015), answering questions certified to it by the Fifth Circuit, issued after the District Court’s ruling. In Kelly, the Louisiana Supreme Court held that although a third party’s bad faith claims were both created and limited by statute (La. R.S 22:1973(B)), the policyholder’s right to bring a cause of action for breach of good faith and fair dealing preceded the statute, and thus the policyholder the had both statutory and common law bases to assert bad faith claims under the broad language of La. R.S. 1973(A). Following Kelly, the Fifth Circuit held that the court’s dismissal of the bad faith claim was in error because it did not consider whether the policyholder properly alleged a breach of good faith and fairly dealing other than under the statute.
The Fifth Circuit also vacated and remanded the District Court’s sua sponte dismissal of the declaratory judgment action based on the abstention doctrine.
It noted that the Brillhart standard does not apply when there are both declaratory and coercive claims involved and federal courts have a “virtually unflagging obligation” to exercise jurisdiction over coercive claims, citing Colo. River Water Conservation Dist. V. United States, 424 U.S. 800 (1976). Since the policyholder’s coercive counterclaims were restored and the declaratory judgment claims had now been brought in state court, the issue required reconsideration by the District Court, including those two factors.