Terra Nova Insurance v. Associates Commercial Corp.

Citations: 697 F. Supp. 1048; 1988 U.S. Dist. LEXIS 11941; 1988 WL 113184Docket: Civ. A. 87-C-1153

Court: District Court, E.D. Wisconsin; October 26, 1988; Federal District Court

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In the case of Terra Nova Insurance Company et al. v. Associates Commercial Corporation et al., the United States District Court for the Eastern District of Wisconsin addressed a dispute stemming from fraudulent insurance claims related to a stolen truck belonging to Brian Scharbarth. In February 1982, Scharbarth orchestrated the theft of his truck at a truck stop in Nevada to claim insurance money. Despite clear signs of fraud, the plaintiffs—three insurance companies—paid Scharbarth $62,210 for the loss, primarily to avoid liability for bad faith in handling his claim. Associates Commercial Corporation, which held a security interest in the truck, received a portion of this payment while Scharbarth retained only $1,057.49.

The FBI investigated the incident, leading to Scharbarth's indictment for mail fraud in 1985, to which he pleaded guilty, receiving a two-year prison sentence. After informing Associates of Scharbarth's fraud in 1986, the insurers sought the return of the funds paid, but Associates refused to return the money. The plaintiffs then filed a lawsuit in October 1987. The court granted summary judgment in favor of Associates, recognizing it as an innocent party unaware of the fraud at the time of payment. Conversely, summary judgment was also granted against Scharbarth due to his admission of fraud in the case. The court noted diversity jurisdiction based on the parties' residency and corporate status, highlighting that the insurance policy specifically excluded coverage for theft resulting from the insured's own fraudulent actions.

Brian Scharbarth, doing business as Jafak Transport, was the assured party in an insurance claim, with Associates Commercial Corporation as the loss payee. Associates, having a security interest in Scharbarth's truck, required him to obtain insurance naming them as payee. Following Scharbarth's conviction in February 1986, the plaintiffs gained proof of his involvement in an alleged theft, leading to a belief that there was no coverage for the truck loss. However, prior to the conviction, they had strong suspicions that Scharbarth orchestrated the theft, while the claim was being handled by Casualty Underwriters, Inc. 

Floyd Johnson from Commercial Equipment Adjustors managed the investigation, employing three outside investigators: Gar Riddle, Don Kluxdal, and an unnamed third investigator. Riddle highlighted discrepancies in Scharbarth's account, particularly noting that he had not informed any employees about the theft. Kluxdal found no definitive evidence against Scharbarth but expressed skepticism about his honesty, recommending settlement due to insufficient proof to deny the claim. Meanwhile, Rost's report indicated that the insured was likely dishonest and recommended withholding payment until clarification was obtained. 

Despite the investigators' findings, the claim was paid on May 4, 1982, with a check issued to both Scharbarth and Associates, transferring rights to the truck to the plaintiffs. On May 28, 1982, Rost informed Johnson of an informant linking Scharbarth to the theft, but the plaintiffs did not act to recover their payment until April 1986. Key points include that the plaintiffs typically settle theft claims within sixty days but took nearly ninety days in this instance, and neither Scharbarth nor Associates pursued legal action for payment, despite Scharbarth's desire for prompt settlement. The plaintiffs seek restitution based on unjust enrichment, while Associates argue that the claim arises from a mistake of fact regarding the legitimacy of the loss.

Associates argues that the law of mistake of fact does not support the plaintiffs' claim because they were aware of the potential for fraud in the claim. Associates also contends that the plaintiffs are estopped from pursuing their claim due to laches, as Associates relied on the plaintiffs' check and did not attempt to mitigate its loss. These matters are suitable for summary judgment. It is established that neither Associates nor Scharbarth had an initial right to payment from the plaintiffs. However, once payment was made, Associates might have gained certain rights to the funds. Generally, an insurer may recover payments made under fraud or factual mistakes that would have defended against the insured's claim, but not if the mistake is one of law. An insurer must prove ignorance of the true facts at the time of payment and a lack of means to discover them. Furthermore, payments made voluntarily with full knowledge of the facts cannot be recovered if made under a claim where material facts were disputed and brought to attention. Applying these principles, the plaintiffs cannot recover their payment simply to avoid bad faith allegations, as this constitutes a mistake of law. The determination of mistake of fact is more complex; while the Couch formulation may favor the plaintiffs due to their reasonable diligence, the American Jurisprudence rule seems to favor Associates because the plaintiffs were uncertain about Scharbarth's truthfulness. A precedent from Wisconsin indicates a preference for the American Jurisprudence rule, as seen in Meeme Mutual Home Protective Fire Insurance Co. v. Lorfeld, where restitution was denied to an insurance company despite suspicions of fraud, due to lack of proof.

The state Supreme Court determined that a party waives the right to claim a mistake of fact if they fail to investigate after being alerted to potential facts. In this case, the plaintiff was aware that a fire might be incendiary and had investigated, yet chose to pay a claim anyway, indicating a business decision rather than a legal mistake. Consequently, the plaintiffs cannot recover from Associates, as they effectively accepted the risk of an incendiary fire. Furthermore, the plaintiffs are barred from seeking restitution from Associates because Associates relied on the insurance settlement to its detriment. 

The court noted that Scharbarth, who defrauded the plaintiffs, has been unjustly enriched and is liable for damages. Scharbarth's defenses, claiming the plaintiffs failed to mitigate damages and asserting a limit on his liability, were deemed weak. He has thirty days to justify why his liability shouldn’t match the entire amount claimed by the plaintiffs, which totals $62,210 plus interest. The plaintiffs' motion for summary judgment against Associates is denied, while their motion against Scharbarth is granted. Associates' motion for summary judgment is granted, resulting in its dismissal from the case. Scharbarth must respond to the potential damages within the specified timeframe, failing which judgment will be entered against him for the full amount.