Hawthorne Savings F.S.B. Hawthorne Financial Corporation v. Reliance Insurance Company of Illinois, Hawthorne Savings F.S.B. Hawthorne Financial Corporation v. M. Diane Koken, Insurance Commissioner of the Commonwealth of Pennsylvania, in Her Capacity as Liquidator of Reliance Insurance Company, Intervenor-Appellant, Reliance Insurance Company of Illinois

Docket: 03-55548

Court: Court of Appeals for the Ninth Circuit; August 24, 2005; Federal Appellate Court

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Hawthorne Savings F.S.B. filed a lawsuit against Reliance Insurance Company of Illinois in California state court, alleging contract-based claims under California law. Reliance removed the case to federal court based on diversity jurisdiction. After Reliance was placed in rehabilitation and later liquidation proceedings in Pennsylvania, the federal district court continued with the case, leading to a jury verdict in favor of Hawthorne for $950,000 in damages. Reliance appealed, arguing that the district court should have abstained from exercising jurisdiction during the rehabilitation proceedings, claiming either lack of jurisdiction or that comity-based doctrines required a stay. Additionally, Reliance contested a $1.1 million litigation bond ordered by the court and one jury instruction. The Ninth Circuit affirmed the district court's decisions in the first appeal (No. 03-55548) and dismissed the second appeal (No. 03-55611) for failure to prosecute.

The case is linked to O.J. Simpson's infamous legal troubles in the 1990s; he took a loan from Hawthorne secured by properties in Los Angeles and New York. Following default on the Los Angeles property, Hawthorne's president approved a substantial loan for a potential bidder, but later opted to outbid this bidder at a foreclosure sale, purchasing the property for $2.631 million, significantly below its market value, and subsequently selling it for $3.7 million.

Bazyler filed a lawsuit against Hawthorne and Braly, alleging deceit, constructive fraud, and a constructive trust under California Civil Code sections 1709, 1573, and 2224. Hawthorne settled the case for $700,000, paying from its own funds. Reliance-Illinois, which had a Directors and Officers Liability policy covering Hawthorne with limits of $10 million and a $100,000 self-insured retention, was informed of the lawsuit and engaged in mediation but later compensated Hawthorne only $10,181.59 of the $364,559.53 in legal fees incurred, resulting in a total out-of-pocket expense for Hawthorne of $1,054,377.94.

In late 1999, Hawthorne sued Reliance in the California Superior Court for breach of contract and breach of the implied covenant of good faith and fair dealing, seeking a declaratory judgment for full coverage of its legal expenses. Reliance removed the case to U.S. District Court under diversity jurisdiction. The district court granted summary judgment on one of Hawthorne's claims, but the others went to trial.

Due to Reliance’s deteriorating financial condition, Hawthorne requested a $1.1 million bond to secure any judgment in its favor, which the court granted. Reliance posted an indemnity bond for this amount. However, shortly after, the Pennsylvania Insurance Commissioner initiated rehabilitation proceedings for Reliance, which the court approved, placing the company under regulatory supervision. Reliance subsequently sought to exonerate the bond, but the district court denied this request. The next day, the Pennsylvania court declared Reliance insolvent and initiated liquidation proceedings, which included a stay on all pending actions against Reliance.

Reliance sought to dismiss the Hawthorne lawsuit, claiming that a liquidation order granted exclusive jurisdiction to the Pennsylvania Commonwealth Court over claims against it, thereby prohibiting further prosecution in other courts. The district court denied this motion. Koken attempted to intervene to challenge subject-matter jurisdiction, but this motion was also denied as untimely. The case proceeded to trial, resulting in a jury verdict favoring Hawthorne for $950,000, which, along with $343,018.36 in pre-judgment interest, totaled $1,293,018.36 before post-judgment interest and costs. Reliance appealed the final order.

Reliance contended that the district court should have ceased jurisdiction once the Commonwealth Court began liquidation proceedings. The court clarified that the lawsuit is a state-law contract claim between private parties, relying on diversity jurisdiction due to the parties' differing citizenship. Reliance, initially removing the case from state court, could not later argue against federal jurisdiction.

The court emphasized that, per Erie Railroad Co. v. Tompkins, federal courts in diversity cases apply state substantive law and federal procedural law. The merits of Hawthorne's claim depend on California substantive law, with no significant federal interest in insurance insolvencies as established by Congress. The Supreme Court affirmed states' primacy in insurance regulation, indicating that claims against insolvent insurers are governed by state law.

Consequently, the court found no federal questions involved, and it determined that a federal district court would apply the same substantive law as an Arizona state court, ensuring consistent outcomes between federal and state proceedings. The approach is to ascertain how a California state court would resolve the legal issues, which is essential for resolving the appeal.

Preemption, abstention, and comity are primarily concerned with federalism and federal/state relations, but this case focuses on the application of state laws to insolvent insurance companies, making federalism concerns less relevant. The case's removal to federal court does not inherently raise traditional federalism issues unless it leads to a different outcome than a California court's decision regarding Pennsylvania's insolvency proceedings.

The McCarran-Ferguson Act, enacted in 1945, aims to preserve states' regulatory authority over the insurance industry and includes a reverse preemption clause. This clause stipulates that federal laws shall not invalidate or interfere with state laws regulating insurance unless they specifically pertain to the insurance business. Reliance argues that this Act prevents the federal diversity statute from interfering with Pennsylvania's liquidation laws, claiming federal jurisdiction undermines the state's liquidation process, thus divesting the district court of jurisdiction while Pennsylvania's proceedings are ongoing.

However, the Fourth Circuit's ruling in a similar case suggests that Reliance's argument is flawed. It posits that Congress did not intend for the McCarran-Ferguson Act to eliminate federal jurisdiction over claims against insurers during state insolvency proceedings. The court highlighted that concurrent federal jurisdiction does not impede Virginia's liquidation efforts and that state courts still retain exclusive jurisdiction over liquidation processes. The defendants would still need to present claims to the state commission for recovery, ensuring state law governs the distribution of assets.

The Fourth Circuit asserts that Pennsylvania holds exclusive jurisdiction over the liquidation of Reliance and its assets. Reliance's interpretation of the McCarran-Ferguson Act, which would restrict federal jurisdiction in cases involving state insurance law, has been rejected by the Tenth and Fifth Circuits. The McCarran Act limits federal regulatory authority over state insurance practices but does not alter the diversity jurisdiction of federal courts. The key consideration is whether federal jurisdiction undermines Pennsylvania's liquidation efforts; if it does, the case should be remanded to state court rather than dismissed due to lack of subject-matter jurisdiction. Reliance's argument would only be valid if its removal of the case impaired state liquidation proceedings, which it did not. The court concludes that 28 U.S.C. § 1332 is not reverse-preempted by the McCarran-Ferguson Act. Regarding abstention, the court notes that strong reasons must exist to justify remanding a case properly removed from state court, especially when the defendant seeks abstention. Although abstention may be warranted to prevent federal interference with state insurance insolvency laws, such scenarios are already addressed by existing jurisdictional principles.

Some circuits have recognized the applicability of abstention in lawsuits against insolvent insurance companies, referencing cases like Callon Petroleum and Lac D'Amiante du Quebec. Courts have often applied the principles from Burford v. Sun Oil Co., which established a doctrine for abstention in favor of state insurance liquidation and rehabilitation proceedings. However, this court has previously declined to abstain under Burford in a similar case, Tucker, which serves as controlling precedent against Reliance's abstention argument.

Burford abstention originated from a legal challenge to the Texas Railroad Commission's actions, where the Supreme Court upheld the dismissal of a federal suit, emphasizing the complexity of the Texas regulatory framework and the state courts' specialization in addressing state law issues. The Court noted the confusion arising from concurrent federal and state jurisdiction and concluded that state courts should have the initial opportunity to resolve these regulatory questions. Burford is regarded as an exceptional and narrow deviation from the obligation of federal courts to adjudicate controversies before them, necessitating careful consideration of its application rather than using it to sidestep state law matters.

Burford abstention is not merely triggered by the existence of a state regulatory scheme but requires examination of whether a federal court's involvement would disrupt that scheme. The Sixth Circuit has clarified that potential disruption, rather than mere existence of a scheme, justifies abstention. Cases like AmSouth Bank v. Dale and City of Tucson v. U.S. West Communications indicate that abstention is not automatic in every instance of state regulatory conflict. Burford emphasized that disputes under state law are best resolved in state courts, particularly when they concern specific state regulatory bodies, such as the Railroad Commission in Texas. However, the case at hand does not pose a similar situation, as it involves the application of one state's law potentially affecting another state's regulatory policy, which does not align with Burford's rationale. 

In the Tucker case, a dispute arose after First Maryland Savings, Loan (FMSL) defaulted on a financing promise to Tucker, leading to a lawsuit in Arizona for breach of contract and other claims. The case was removed to federal court based on diversity jurisdiction, and during the proceedings, FMSL entered receivership in Maryland. The district court ruled for abstention, citing both Burford and Colorado River principles. However, upon review, it was determined that the district court misapplied Burford, as the underlying issues were contractual and did not implicate significant state concerns requiring abstention. The legislation related to Maryland's control over savings and loan institutions is recognized as a substantial state concern, yet does not necessitate federal court abstention in this case.

Tucker initiated a lawsuit in Arizona state court, alleging multiple claims related to a loan agreement for property development in Maricopa County, Arizona. He sought a constructive trust on the property known as Turf Village, along with compensatory and punitive damages, as well as attorneys' fees and costs. The case was subsequently removed to the U.S. District Court for the District of Arizona based on diversity jurisdiction, with no federal questions involved. Both parties agreed that the federal court would apply Arizona's substantive law, ensuring similar outcomes as would occur in state court.

The document clarifies that if abstention were applicable, it would involve a federal court deferring to an out-of-state proceeding (Maryland), rather than the typical scenario where a federal court defers to local state law. Tucker's case does not infringe on Maryland’s liquidation process, as his claims are based on a contract violation rather than depositor assets of an insolvent savings and loan, distinguishing it from a similar case (Brandenburg v. Seidel). 

Tucker argued that Burford abstention, which aims to limit federal interference in state policy matters, is not suitable here since the issues do not primarily involve Maryland law. Furthermore, the document indicates that Colorado River abstention is also inappropriate due to the lack of concurrent state proceedings addressing the same issues. Tucker’s claims, which are solely based on Arizona law, should proceed in the federal court without interference from Maryland's receivership proceedings, as no Maryland case is addressing the claims involved.

Reliance contests the applicability of the Burford abstention doctrine to its case, asserting that it involves a direct attack on the assets of an insolvent insurance company under Pennsylvania's insolvency laws, unlike the situation in Tucker. However, Tucker's case involved a damages suit where recovery depended on the company’s assets, emphasizing that abstention is warranted only when a case unduly affects state regulatory schemes. The comparison to Seidel further supports this distinction. The federal lawsuit at hand is a state-law contract dispute governed by California law, which does not infringe more on state policy than typical diversity cases. The question of whether California law necessitates deferring to Pennsylvania's liquidation proceedings does not invoke Burford abstention principles. The district court's decision not to abstain was not an abuse of discretion.

Additionally, Reliance claims that the district court should have recognized the stay from the Pennsylvania Commonwealth Court's liquidation orders, which prohibits actions against Reliance without the liquidator's consent. However, the argument that a California court must extend full faith and credit to these orders is unpersuasive, whether considering the obligations of state courts or the federal court's responsibilities regarding interstate judgments.

Interstate and state-federal full faith and credit principles dictate that for a judgment to be enforceable across states, it must originate from a court with proper adjudicatory authority over the relevant subject matter and parties. A final judgment, as affirmed in Baker ex rel. Thomas v. Gen. Motors Corp., qualifies for recognition if it meets these criteria. In Underwriters Nat'l Assurance Co. v. N.C. Life, Accident, Health Ins. Guar. Ass'n, the court emphasized that personal jurisdiction over necessary parties is crucial for enforcing a judgment in another state. The Ninth Circuit in Taylor v. Sawyer reiterated that a judgment cannot influence litigation in different courts unless both parties participated in the original court proceedings. In the case at hand, Hawthorne was not a party to the Pennsylvania proceedings, nor did Reliance demonstrate that the Commonwealth Court had personal jurisdiction over him, leading to the denial of full faith and credit for the rehabilitation and liquidation orders. Additionally, even if jurisdiction existed, state courts cannot enjoin in personam federal court proceedings without first acquiring in rem or quasi in rem jurisdiction. This principle, established in Donovan v. City of Dallas and supported by Baker, further invalidates Reliance's argument for full faith and credit concerning Hawthorne's in personam action.

In Duchek v. Jacobi, the Ninth Circuit referenced Donovan in a diversity case, agreeing with the Tenth Circuit that a state court cannot enjoin proceedings in a federal court that has jurisdiction over the matter. The court determined that the liquidation and rehabilitation orders from the Commonwealth Court do not receive full faith and credit in this litigation. Reliance's argument that principles of comity required dismissal of the suit was examined. While comity allows federal courts to consider state government independence, it is a discretionary doctrine that does not inherently require abstention unless specific established doctrines apply. The court clarified that if a case begins in state court, comity may justify remanding to state court. However, the Supreme Court established that a federal court need not relinquish jurisdiction simply due to a similar state court action, especially when the federal case was already pending at the time of the state orders. The district court's continuation of its jurisdiction did not violate comity principles. Furthermore, the court noted that while the Tucker case found abstention inappropriate, it did not address the pivotal question of how a state court would respond in this scenario. Under California law, the determination of whether state courts must defer to Pennsylvania's rehabilitation and liquidation proceedings hinges on whether Pennsylvania is considered a "reciprocal state" under the Uniform Insurers Liquidation Act (UILA). According to California Insurance Code section 1064.9, during delinquency proceedings in a reciprocal state, no actions against the delinquent insurer or its assets can be initiated in California courts.

Hawthorne's lawsuit's applicability under section 1064.9 hinges on whether Pennsylvania qualifies as a reciprocal state. No similar legal restriction exists for UILA states regarding jurisdiction during ongoing delinquency proceedings in non-reciprocal states. Pennsylvania's status as a reciprocal state under California's UILA must be determined, despite Pennsylvania's lack of formal adoption of the UILA. California defines a "reciprocal state" as one with substantial and effective provisions mirroring California's law, including stipulations about receivership and asset recovery for delinquent insurers. The definition contains six key requirements, referred to as the "six central remedies" of the UILA. There is a judicial divide among UILA states regarding Pennsylvania's reciprocal status, though the prevailing view supports reciprocity. No California state court has addressed this issue, necessitating a federal court to predict state law outcomes based on available judicial resources. The text of section 1064.1(f) indicates that a formal agreement is not essential for reciprocal status, underscoring the complexities in determining Pennsylvania's status within this legal framework.

A "reciprocal state" is defined as any state that has established a binding and enforceable written agreement with this state’s commissioner. The key inquiry is whether Pennsylvania law encompasses the six main remedies outlined in the Uniform Insurers Liquidation Act (UILA). Both the district court in *Twin City Bank* and the Louisiana Supreme Court in *All Star Advertising Agency* concluded that Pennsylvania law effectively incorporates these six remedies. They include: 1) the insurance commissioner acting as a receiver; 2) allowing domiciliary receivers to operate in nondomiciliary states; 3) vesting asset titles in the domiciliary receiver; 4) permitting nondomiciliary creditors to present claims to local ancillary receivers; 5) ensuring uniform application of domiciliary state laws for claims preferences; and 6) preventing preferences for diligent nondomiciliary creditors with prior notice.

The California Supreme Court would classify Pennsylvania as a reciprocal state under California law. Nevertheless, it was determined that section 1064.1(f) does not impede the district court's jurisdiction. Citing cases from the Wyoming and Minnesota Supreme Courts, it was held that reciprocity does not influence in personam legal rights but rather pertains to enforcing judgments against an insolvent company's estate. In *Hoiness-LaBar*, the Wyoming Supreme Court ruled that the UILA does not prevent a party from seeking a judgment, even when the insurer is in receivership, indicating that the act only restricts enforcement actions. Similarly, the Minnesota Supreme Court in *Fuhrman* found no necessity to defer a contract action in favor of receivership proceedings in another state.

Not all lawsuits against a receivership defendant interfere with the res. A distinction exists between liquidating a claim and enforcing it post-judgment. An in personam action to determine an insolvent's liability does not interfere with the receivership res, while attempts to attach or levy against the res are considered in rem and conflict with the court's control. Such in personam actions need not occur in the receivership court. The California Insurance Code prohibits actions resembling attachment, garnishment, or execution but allows other actions unless they fall under these categories. A contrary viewpoint was expressed by the Alabama Supreme Court, which noted that a judgment against an insolvent insurer could prioritize the claimant over other policyholders, undermining the goals of the UILA, which aims to protect all policyholders during insolvency. The court highlighted that until further determinations are made, the insurer's assets must remain neutral. However, the Alabama court did not clarify why a judgment would grant priority in liquidation, as Pennsylvania law indicates that judgment creditors typically do not receive such priority. The UILA's purpose is to prevent claimants from disrupting liquidation processes, and allowing certain suits to reach judgment does not violate this principle. Therefore, a California court would adjudicate the merits of the dispute without staying proceedings. Additionally, Reliance contests the district court's order for it to post a $1.1 million litigation bond.

In bankruptcy proceedings, a significant distinction exists between cash deposits and bonds regarding contractor performance guarantees. A cash deposit involves the contractor using their own assets to secure contract performance, whereas a bond introduces a third-party surety, which agrees to pay contract claims up to the bond's limit if the contractor defaults, contingent upon the contractor indemnifying the surety or providing a lien on their assets. This creates a difference in liability risk between the contractor and the surety.

Bankruptcy aims to protect the debtor's property but does not extend this protection to sureties, as doing so would unfairly disadvantage creditors. Reliance initially sought permission to use cash instead of a bond, which was opposed by Hawthorne, leading the district court to mandate a bond. Reliance subsequently posted an indemnity bond for $1.1 million from the Insurance Company of the State of Pennsylvania to satisfy potential judgments against it.

The legitimacy of the bond hinges on two questions: whether it violates the UILA under the California Insurance Code, and whether the district court had the discretion to require it. The first question is answered negatively, as the bond is not considered an asset of Reliance and does not involve any court order affecting Reliance's assets. The bond will only invoke UILA implications if the bonding company seeks to collect on collateral.

Regarding the second question, the district court's authority is evaluated under section 1616 of the California Insurance Code, which stipulates that a nonadmitted foreign insurer must secure a bond to participate in legal proceedings. Since this case involves Reliance-Illinois, now merged with Reliance, the interpretation of section 1616 applies to the insurer being sued, supporting the requirement for the bond despite the merger.

Hawthorne would have had a viable alternative for securing a judgment had the suit been filed against the parent company, Reliance. The district court acted within its discretion by requiring a bond under section 1616, as California Insurance Guaranty Association (CIGA) provides remedies for claimants against insolvent insurers, but only for "covered claims" involving admitted insurers. CIGA does not cover claims against Reliance because it was not a "member insurer" at the time of the merger, which is uncontested. Consequently, Hawthorne’s claim is excluded from CIGA coverage. The bond requirement under section 1616 aims to secure claims from non-admitted insurers, addressing a gap between protections offered by CIGA and those required by section 1616. The court interprets section 1616 as applicable to the insurer involved in the lawsuit, aligning with California law, and finds no intention for gaps in protections for litigants against insolvent insurers. Furthermore, the district court appropriately instructed the jury regarding the presumption of reasonableness of the settlement between Bazyler and Hawthorne, shifting the burden of proof to Reliance to demonstrate that the settlement was unreasonable or fraudulent.

Reliance argued that Hawthorne could only presume the reasonableness of the Bazyler settlement if Reliance had wrongfully failed to defend or settle, implying that such a presumption applies only when the insurer has a duty to defend. However, this perspective overlooks the principle that jury instructions must be considered as a whole for accuracy, as established in White v. Ford Motor Co. The jury was instructed that if any claims in the Bazyler case were covered, Reliance had a duty to pay for the Braly defense, and the plaintiffs needed to prove by a preponderance of the evidence that a claim was covered. The jury was to conclude on liability before addressing damages, leading them to understand that Reliance had a duty to defend, which it did not fulfill. Consequently, Hawthorne was entitled to presume the settlement's reasonableness. The district court's decisions regarding the litigation bond and jury instruction were upheld, affirming the decision in case No. 03-55548 and dismissing case No. 03-55611 for lack of prosecution. Key points include the exclusion of insurance companies from federal bankruptcy laws, the original jurisdiction of the Commonwealth Court of Pennsylvania over related civil actions, and the undisputed facts of the original settlement. The appeal concerning Koken's intervention was also dismissed due to lack of argument presented by either party.

A state cannot use Eleventh Amendment sovereign immunity to prevent federal litigation of state-law damages claims if it has voluntarily moved those claims to federal court. The question of whether abstention requirements are met is reviewed de novo, while the district court's decision to abstain under Burford or Colorado River is reviewed for abuse of discretion. The case of Louisiana Power & Light Co. v. City of Thibodaux supports that abstention may be appropriate in cases involving state interests, particularly regarding the power of eminent domain. However, abstention is not warranted if the state court from which the case was removed is not better positioned to address the state interests at stake. The principles behind Colorado River abstention focus on judicial efficiency and resource conservation rather than constitutional adjudication or federal-state relations. The case Seidel, which involved questions of Maryland law in a federal court, is distinguished from the present case due to its unique procedural context and the lack of interstate issues.

Seidel involved the civil remedy provision of the RICO statute, 18 U.S.C. § 1964, in federal court, addressing claims against an insolvent savings and loan association and raising significant Burford federalism concerns. Unlike Tucker, Seidel was viewed as an attempt to bypass state regulatory proceedings, prompting the Fourth Circuit's decision. Several circuit court rulings have endorsed Burford abstention in state insolvency cases, particularly those with intra-state claims requiring state law application. However, only a few cases, such as Martin Insurance Agency and Lac D'Amiante du Quebec, are comparable to the current issues, but they misapplied the Burford analysis. The Third Circuit recently declined to abstain in a case involving a simple contract action against an insolvent insurance company, emphasizing that such matters do not invoke complex state regulatory interests. Additionally, a rehabilitation order from May 29, 2001, imposed broad injunctions against legal actions involving the insolvent entity and its assets. In Baker, while the Court was divided on other issues, a majority agreed that a lack of in personam jurisdiction prevented a Missouri court from recognizing a Michigan injunction.

Michigan lacks authority to influence legal actions involving GM in other states where claims haven't been evaluated by Michigan, particularly as the Bakers were not involved in the Michigan proceedings. The notion that Michigan's earlier injunction could bind parties not under its jurisdiction is unfounded. This principle aligns with full faith and credit analysis, which prevents one state from imposing its laws on another regarding legal outcomes from actions within its territory.

Additionally, the Commonwealth Court's ability to issue an anti-suit injunction with effects beyond Pennsylvania is questionable under state law, as demonstrated by a Texas Court of Appeals case that deemed such injunctions outside the court's jurisdiction. The Pennsylvania statutory framework indicates that the court can seek relief from courts outside Pennsylvania but does not allow for proactive injunctions against out-of-state litigation.

The ongoing Pennsylvania liquidation proceedings at the time of the rehabilitation and liquidation orders also complicate matters, as the litigation stay invoked did not resolve the merits of the current case. The finality of the stay orders is uncertain, affecting their recognition under the Full Faith and Credit Clause. Although the court does not resolve the finality issue, it concludes that the orders are not entitled to full faith and credit, given the lack of jurisdiction. Furthermore, the action is defined as in personam, which pertains to determining the rights of the parties involved rather than affecting others. Finally, the Uniform Insurers Liquidation Act was enacted to create a consistent system for managing the assets and liabilities of multistate insurers.

The excerpt presents a legal analysis regarding the applicability of collateral estoppel and bond procedures in insurance-related cases. It references several court cases that have predominantly upheld certain legal principles, with only a few instances where courts have reached contrary conclusions. Specifically, it discusses Hawthorne's argument that Reliance is collaterally estopped from contesting a bond's validity due to prior bankruptcy court rulings involving a different entity (Reliance of Illinois). The court rejects this argument, highlighting that the factual distinctions between the two cases, particularly regarding the admission of Reliance in California versus Reliance of Illinois, make collateral estoppel inappropriate. It emphasizes that collateral estoppel cannot be applied if there is uncertainty about whether an issue was fully litigated in a prior case. Additionally, the excerpt mentions the discretionary bond procedures outlined in California Insurance Code section 1620, noting that these procedures apply only to specific types of insurance contracts, none of which appear to fit the current case.