Santa's Best Craft, LLC v. St. Paul Fire & Marine Insurance

In the

United States Court of Appeals

For the Seventh Circuit

Nos. 08-3572 & 08-3773

S ANTA’S B EST C RAFT, LLC;

S ANTA’S B EST; and H.S. C RAFT

M ANUFACTURING C O .,

Plaintiffs-Appellants/

Cross-Appellees,

v.

S T. P AUL F IRE AND M ARINE

INSURANCE C OMPANY,

Defendant-Appellee/

Cross-Appellant.

Appeals from the United States District Court

for the Northern District of Illinois, Eastern Division.

No. 04 C 1342—Robert W. Gettleman, Judge.

A RGUED N OVEMBER 4, 2009—D ECIDED JULY 1, 2010

Before C UDAHY, FLAUM, and E VANS, Circuit Judges.

C UDAHY, Circuit Judge. This is an insurance case about

twinkling Christmas lights. JLJ, Inc. and its licensee

2 Nos. 08-3572 & 08-3773

Inliten, LLC (collectively JLJ) sued Santa’s Best Craft, LLC

(SBC) over its marketing of “Stay-On” lights. The present

case is about an insurer’s duties to SBC and others in

that underlying action.

JLJ alleged that SBC copied JLJ’s “Stay Lit” lights pack-

aging design and that SBC sold Stay-On lights using

false and deceptive language. SBC asked its insurer,

St. Paul Fire and Marine Insurance Company (St. Paul),

for a defense and then sued St. Paul when none was

forthcoming. St. Paul counterclaimed with a declaratory

action about its duty to defend and then tendered hun-

dreds of thousands of dollars to SBC for its litigation

expenses after the district court held that St. Paul had

a duty to defend. The district court, however, agreed

with St. Paul that it was not obliged to cover defense

expenditures for SBC’s contract indemnitee Monogram

Licensing (Monogram) or to reimburse the settlement

payment that resolved the underlying action. Each party

appealed. We agree with the district court that St. Paul

had, but did not breach, a duty to defend. We also

agree that the district court properly declined to require

St. Paul to reimburse SBC for Monogram’s expenses, but

we remand for further proceedings to resolve whether

St. Paul owes prejudgment interest on litigation expenses

and reimbursement for the settlement expenses.

I. Background

A. The relevant parties.

The present litigation has its roots in August 2002, when

JLJ sent SBC a cease-and-desist letter, demanding that

Nos. 08-3572 & 08-3773 3

SBC change the packaging of its Stay-On lights. JLJ claimed

that the Stay-On lights boxes aped the look and slogans

of JLJ’s Stay Lit lights. SBC forwarded the letter to St. Paul,

which responded that the commercial general liability

(CGL) coverage policy SBC purchased did not cover

the claims in the demand letter. Specifically, St. Paul

claimed that false representation claims were not

covered by the policy in the first instance and that two

policy exclusions, relating to intellectual property and

material previously made known or used, meant that

it owed no defense for the remaining claims.

In November 2002, JLJ sued SBC in federal court in

the southern district of Ohio for Lanham Act trademark

infringement, false designation of origin, false ad-

vertising, trademark dilution and deceptive trade prac-

tices. See JLJ, Inc. v. Santa’s Best Craft, LLC, No. C-3-02-

00513 (S. D. Ohio). St. Paul again denied coverage. In 2004,

after JLJ joined as defendants Santa’s Best and H.S. Craft

Manufacturing Co., two principal members of SBC, as well

as Monogram, St. Paul continued an investigation of

its duties, but reserved the right to determine that the

policy provided no coverage.

SBC did not wait for St. Paul to finish its investiga-

tion. In February, SBC and the other plaintiffs filed this

declaratory action to compel St. Paul to defend them

and, in June, St. Paul counterclaimed for a declaratory

judgment that it had no such duty. In December 2004, the

underlying action settled after SBC and its members

agreed to pay JLJ $3.5 million and to refrain from using

the mark Stay-On or any colorable imitation of the Stay

Lit mark.

4 Nos. 08-3572 & 08-3773

As noted above, Monogram was added as a defendant

in the underlying action based on claims of unjust enrich-

ment and conspiracy for approving SBC’s use of the

allegedly offending marks and slogans. Monogram, a

General Electric (GE) Company subsidiary, and SBC had

entered into a trademark licensing agreement (Licensing

Agreement) in which SBC promised to “defend,

indemnify and hold harmless [Monogram] and GE . . .

from and against any and all claims . . . arising out of or

in connection with . . . the Licensed Products including . . .

any infringement of any rights . . . in connection with the

manufacture, advertising, promotion, sale, possession or

use of [the] Licensed Products.” Santa’s Best (recall, one

of the members of SBC, which is a limited liability com-

pany) reimbursed Monogram’s defense expenses of ap-

proximately $1.3 million. St. Paul’s CGL policy requires

it to defend its insured’s contract indemnitees, assuming

certain control and cooperation requirements are satis-

fied. These requirements include the indemnitee’s obliga-

tion to provide St. Paul notice of each legal paper “as

soon as possible after it is received”; St. Paul’s obligation

to first determine that there is no conflict between the

insured’s interests and those of the indemnitee; and the

indemnitee and insured’s agreement in writing that they

can share the same counsel. Monogram never tendered

a defense to St. Paul. Instead, in August 2004, the plain-

tiffs advised St. Paul that, under the Licensing Agree-

ment, they believed that Monogram was a contract

indemnitee and that St. Paul owed coverage. Monogram,

in the underlying action, was represented by counsel

separate from plaintiffs’, although the two legal teams

coordinated a defense.

Nos. 08-3572 & 08-3773 5

B. The district court’s orders.

The district court held that St. Paul had, but did not

breach, a duty to defend because the complaints in

the underlying action potentially sketched a claim for

infringement of slogan, which was covered as an “adver-

tising injury offense.” See Santa’s Best Craft v. St. Paul

Fire & Marine Ins. Co. (Santa’s Best I), 1:04-cv-01342,

2004 WL 1730332, at *10 (N.D. Ill. July 30, 2004). It also

held that the intellectual property exclusion did not

apply or that, even if it did, the allegations could be

construed as a infringement of a trademarked slogan,

which was an exception to the exclusion. See id. at **7-8.

In addition, the court held that the “material previously

made known or used” exclusion did not apply because

not all of the slogans were finalized until 2002, after

St. Paul’s policy became effective. See id. at **8-10. In a

subsequent order, the district court stayed the action

pending the outcome of state-court litigation involving

St. Paul. See Santa’s Best Craft v. St. Paul Fire & Marine

Ins. Co. (Santa’s Best II), 353 F. Supp. 2d 966 (N.D. Ill. 2005).

This state-court litigation primarily involved a

coverage action instituted by SBC against the last sig-

nificant party in this case—Zurich American Insurance

Company (Zurich), SBC’s insurer before St. Paul’s policy

took effect in January 2002. 1 Before they filed the present

lawsuit, the plaintiffs also looked for a defense from

Zurich and, even though Zurich provided one, they filed

a declaratory action in the Circuit Court of Cook County,

1

Zurich is not a party to the present appeal.

6 Nos. 08-3572 & 08-3773

Chancery Division, to address several issues about

Zurich’s reimbursement of the defense expenses. See

Santa’s Best Craft, LLC v. Zurich Am. Ins. Co., Case No. 04

CH 01885 (Cook County Ct., Ch. Div.) (Zurich action).

Zurich drew St. Paul into the action via a third-party

complaint for contribution. In a December 2005 order, the

Zurich court indicated that St. Paul “agree[d] that it is

bound by this Court’s determination as to the reason-

ableness of fees at issue both in this proceeding and also

in [our present case on appeal].” Santa’s Best Craft, LLC v.

Zurich Am. Ins. Co., Case No. 04 CH 01885 (Cook County

Ct., Ch. Div. Dec. 14, 2005). It entered a judgment of

$1.54 million in defense costs for the plaintiffs, of which

approximately $1.27 million were Monogram’s defense

costs.2 The Zurich court then denied the plaintiffs’ motion

for prejudgment interest for reasons stated on the record.

See id. To date, according to the parties’ briefing, all of the

costs the plaintiffs incurred in the underlying action

have been reimbursed except the Monogram defense

costs and the settlement payments (and possible interest

payments).

After the Zurich action was terminated, the district

court held that St. Paul did not owe the plaintiffs

a duty to indemnify them for settlement costs in the

2

For reasons neither party explained to the district court,

Zurich was “not currently responsible” for reimbursing plain-

tiffs for the Monogram costs. Santa’s Best Craft v. St. Paul Fire

& Marine Ins. Co. (Santa’s Best III), 1:04-cv-01342, 2008 WL

4328192, at *6 (N.D. Ill. Sept. 16, 2008).

Nos. 08-3572 & 08-3773 7

underlying action because some of the claims were not

covered under the CGL policy exclusions and because

the plaintiffs failed to allocate the settlement between

covered and non-covered claims. See Santa’s Best III, 1:04-

cv-01342, 2008 WL 4328192, at *9 (N.D. Ill. Sept. 16, 2008).

It also held that St. Paul did not owe prejudgment

interest or reimbursement for Monogram’s defense

costs because of other CGL policy exclusions and the

Zurich court’s findings. See id. at **6-7, 9.

II. Standard of Review

Since this is a diversity case, we apply state substantive

law and federal procedural law. See Hanna v. Plumer, 380

U.S. 460 (1965); Bevolo v. Carter, 447 F.3d 979, 982 (7th

Cir. 2006). No party raises a choice of law issue and

therefore, as did the district court, we apply the law of

the forum state, Illinois. See Casio, Inc. v. S.M.& R. Co., 755

F.2d 528, 531 (7th Cir. 1985). A district court’s grant of

summary judgment is reviewed de novo, Narducci v.

Moore, 572 F.3d 313, 318 (7th Cir. 2009), examining the

record in the light most favorable to the non-moving

party. Trade Fin. Partners, LLC v. AAR Corp., 573 F.3d

401, 406 (7th Cir. 2009). Insurance contracts are inter-

preted to effectuate the intent of the parties as expressed

through the contract language. See Nicor, Inc. v. Assoc.

Elec. & Gas Ins. Servs. Ltd., 860 N.E.2d 280, 285-86 (Ill. 2006).

Ambiguities are construed against the insurer, as drafter.

See, e.g., McKinney v. Allstate Ins. Co., 722 N.E.2d 1125,

1127 (Ill. 1999). The construction of an insurance

contract is a question of law, reviewed de novo. See

Nicor, Inc., 860 N.E.2d at 285.

8 Nos. 08-3572 & 08-3773

III. Discussion

A. Duty to defend.

The plaintiffs argue in support of the district court’s

decision that St. Paul owed them a defense because the

complaint in the underlying action included allegations

that made out a claim for “[u]nauthorized use of . . . any

slogan . . . of others in your advertising,” where a slogan

is defined as “a phrase that others use and intend to

attract attention in their advertising.” The term slogan

excludes a phrase “used as, or in, the name of” organiza-

tions or businesses other than the insured or “any of the . . .

products . . . of any person or organization, other than

[the insured].” St. Paul responds that these allegations

serve as background for JLJ’s trade dress infringement

claim, a claim that St. Paul is not required to defend

because the CGL policy has an exclusion for certain

intellectual property claims.

“To determine whether the insurer has a duty to defend

the insured, the court must look to the allegations in

the underlying complaint and compare these allegations

to the relevant provisions of the insurance policy. . . . If

the facts alleged in the underlying complaint fall within,

or potentially within, the policy’s coverage, the insurer’s

duty to defend arises.” Outboard Marine Corp. v. Liberty

Mut. Ins. Co., 607 N.E.2d 1204, 1212 (Ill. 1992) (internal

citations omitted). St. Paul’s policy provided that “[w]e’ll

have [the right and duty to defend] . . . even if all of the

allegations of the claim or suit are groundless, false, or

fraudulent.” And, Illinois law specifies that “[w]e give

little weight to the legal label that characterizes the under-

Nos. 08-3572 & 08-3773 9

lying allegations. Instead, we determine whether the

alleged conduct arguably falls within at least one of the

categories of wrongdoing listed in the policy.” Lexmark

Int’l, Inc. v. Transp. Ins. Co., 761 N.E.2d 1214, 1221 (Ill.

App. Ct. 2001). “[I]f the underlying complaints allege

several theories of recovery against the insured, the duty

to defend arises even if only one such theory is within

the potential coverage of the policy.” See id. (quoting

with internal citations omitted, U.S. Fidelity & Guar. Co.

v. Wilkin Insulation Co., 578 N.E.2d 926 (Ill. 1991)); see

also Outboard Marine Corp., 607 N.E.2d at 1220.

The district court properly found that the CGL policy

requires St. Paul to defend the plaintiffs. It held that the

insurer owed a duty to defend because the allegations

may potentially give rise to a claim for unauthorized use

of slogan. See Cincinnati Ins. Co. v. Zen Design Group, Ltd.,

329 F.3d 546, 553-57 (6th Cir. 2003) (Michigan law) (insurer

owed duty to defend an action with trademark and

trade dress claims partially based on the fact that the

competitor’s trademarked phrase “The Wearable Light”

was potentially an infringement of slogan).

St. Paul’s CGL policy covers “unauthorized use” of a

“slogan,” which suggests that the claims underlying this

conduct include as an element the defendant’s owner-

ship or, at least, control, over the slogan. See, e.g., Applied

Bolting Tech. Prods., Inc. v. U.S. Fidelity & Guar. Co., 942

F. Supp. 1029, 1034-35 (E.D. Pa. 1996) (Vermont law)

(holding that allegations that a company falsely adver-

tised that it complied with an industry standard did not

fall within insurance coverage for lawsuits about infringe-

10 Nos. 08-3572 & 08-3773

ment of slogan); see also B LACK’S LAW D ICTIONARY (7 TH

E D . 1999) (defining authorize as “1. To give legal authority;

to empower 2. To formally approve; to sanction.” and

unauthorized as “Done without authority; specif., made

without actual, implied or apparent authority.”) 3 St. Paul

contends that JLJ has no ownership or exclusive right to

the slogans on the packages and, therefore, cannot

have asserted an unauthorized use/infringement of

slogan claim. See Lexmark Int'l, 761 N.E.2d at 1226 (de-

clining to find a duty to defend based on infringe-

ment of slogan when the insured was accused of breach

of contract and unfair business practices but not accused

of lifting any of the plaintiff’s slogans). The present case

is distinguishable because Lexmark’s underlying suit did

not contain claims for relief based on the plaintiff’s own

advertising ideas or slogans, or claim ownership or the

exclusive right to the language it used. Id. In contrast,

the JLJ complaints contain allegations that SBC copied

3

Beyond the use of the words “authorize” or “unauthorized”

in the sections about infringement of slogan, the CGL policy

also used “authorize” as a verb in conjunction with the

indemnitee defense control and authority requirements, to

wit: “The indemnitee must give us authority in writing to

conduct its defense against the claim or suit,” suggesting

that the term “authority” may be either the first or second

Black’s Law Dictionary definition above. The policy’s indeter-

minate use of the word suggests that “unauthorized” might

encompass the informal second Black’s Law Dictionary defini-

tion of “authority” and therefore conduct that triggers

coverage under infringement of slogan need not consist of

formal claims of ownership.

Nos. 08-3572 & 08-3773 11

certain JLJ slogans, suggesting that JLJ had some claim

of ownership over them. Cf. Zen Design Group, 329 F.3d

at 555 n.9, 556-57 (discussing “assertions of ownership”

over the contested phrase such as the advertiser’s

trademarking of the slogan, its widespread use of the

slogan and the good will it developed that is associated

with the phrase).4 In addition, although many of these

allegations about slogans support JLJ’s trade dress

claim, as noted above, our inquiry is based on the allega-

tions in the complaint, not the legal labels attached to

them. See, e.g., id. at 554 n.4, 555-56 (noting that the com-

plaint’s failure to refer to the offending phrase as a

“slogan” and failure to include a specific claim labeled

“infringement of slogan” did not preclude the finding

that the insurer had a duty to defend based on allega-

tions of infringement of slogan). Given the presumptions

at play, the complaint triggered St. Paul’s duty to defend.

We now address whether any exclusions in St. Paul’s

policy apply so that St. Paul has no duty to defend.

4

We note that, under the language of the contract, this idea of

indicia of ownership or control does not mean that the under-

lying complaint must include allegations that the slogans

were trademarked or copyrighted. In other parts of the CGL

policy, St. Paul specifically refers to slogans or advertising

material as copyrighted or trademarked instead of using

the word “slogan” without modifier as St. Paul does in the

section about infringement of slogan.

12 Nos. 08-3572 & 08-3773

1. IP exclusion.

St. Paul contends that JLJ’s slogans are not trademarked

and therefore the claims are not covered because of the

intellectual property (IP) exclusion. Insurers have the

burden of proving that an exclusion applies. See, e.g. Ins.

Corp. of Hanover v. Shelborne Assocs., 905 N.E.2d 976, 982

(Ill. App. Ct. 2009). Insureds, in turn, have the burden to

prove that an exception to an exclusion restores cover-

age. See, e.g., 17A G. C OUCH , C OUCH ON INSURANCE

§ 254:13 (2009). St. Paul’s IP exclusion disallows coverage

for “injury or damage . . . that results from any actual

or alleged infringement or violation of any of the

following rights or laws: . . . trade dress, . . . trademark,

other intellectual property rights or laws.”An exception

to the IP exclusion is “unauthorized use of … trademarked

slogan … of others in your advertising.”

St. Paul argues that, because the conduct the plaintiffs

identify as making out a claim for infringement of slogan

is all conduct that, in the language of St. Paul’s policy,

“results from” a trade dress claim, the IP exclusion pre-

cludes coverage. Under any authority we could find

indicating when a non-covered claim may affect

coverage for a covered claim based on the similarity of

allegations, the fact that the trade dress allegations are

a subset of those alleging infringement of slogan does not

eliminate coverage under the policy. That is, unless a

slogan infringement claim would not have arisen but

for the trade dress violation claim (or necessarily arises

out of the trade dress violation claim)—clearly not the

case here—we cannot find that the exclusion for trade

Nos. 08-3572 & 08-3773 13

dress claims excuses St. Paul from a duty to defend the

underlying action. See, e.g., St. Paul Fire & Marine Ins. Co.

v. Antel Corp., 899 N.E.2d 1167, 1176 (Ill. App. Ct. 2008) (if

an insurer relies on an exclusion, it must be “clear and

free from doubt” that the exclusion applies); cf. Hugo

Boss Fashions, Inc. v. Fed. Ins. Co., 252 F.3d 608, 623 n.15

(2d Cir. 2001) (New York law) (suggesting that the

breach of contract exclusion might apply if, “but for” a

breach of contract, there would be no advertising injury

or other covered injury, but noting also that it was uncer-

tain what was meant by the “arising out of” language

of the exclusion); Cent. Mut. Ins. Co. v. StunFence, Inc., 292

F. Supp. 2d 1072, 1081-82 (N.D. Ill. 2003) (holding that

knowledge of falsity exception did not preclude cov-

erage because some of the claims were based on uninten-

tional, rather than knowing, conduct). The district court

properly found a duty to defend that was not affected by

the IP exclusion.

Additionally, the district court found, however, that

even if the IP exclusion applies, the differences between

trade dress and trademark have so narrowed that, if the

IP exclusion applied, the exception for trademarked

slogans likely did as well. It noted that what is or is not

trademarked is a decision for the court in the under-

lying action. We agree with the district court that, even

if the IP exclusion applied, the trademark exception

would require St. Paul to defend the action given the

uncertainty whether the court in the underlying action

would have decided the slogan qualified as trade-

markable. But, because St. Paul has not met its

burden to prove that the IP exclusion applies in the

first instance, we need not reach this alternative holding.

14 Nos. 08-3572 & 08-3773

2. Material previously made known or used exclusion.

St. Paul claims that its “material previously made

known or used” (MPMK) exclusion applies to defeat a

duty to defend with respect to the 2003-04 policy

period, but acknowledges that it did not make this argu-

ment with respect to the 2002-03 policy period (although

it argues that the exclusion defeats any duty to

indemnify under either policy because facts revealed in

the course of litigation demonstrated that much of the

offending behavior predated 2002). The district court

held that St. Paul was obligated by the 2002-03 policy

to defend the plaintiffs because the insurer must defend

if even one allegation of liability falls within the policy’s

coverage.

The MPMK exclusion bars coverage for personal or

advertising injury that results from “any material that

was first made known before this agreement begins” and

“any advertising idea or advertising material, or any

slogan or title, of others, whose unauthorized use in your

advertising was first committed before this agreement

begins.” Given that the parties agree that the allegations

in the relevant complaints describe some language first

used by the plaintiffs in 2002, this exclusion bars coverage

under the 2003-04 policy but not under the 2002-03 pol-

icy. 5 Cf. Taco Bell Corp. v. Continental Cas. Corp., 388 F.3d

1069, 1073 (7th Cir. 2004) (Illinois law) (unless the differ-

5

In a deposition taken for the Zurich action, SBC’s lawyer

testified that the settlement talks did not address allocating

settlement amounts based on the policy in effect at the time

of settlement.

Nos. 08-3572 & 08-3773 15

ences in the subsequent advertising are immaterial,

modified advertising can serve as “fresh wrongs” that

are not excluded from insurance coverage by a “prior

publication” exclusion).

B. Complying with the duty to defend.

The district court found no breach of the duty to defend

because St. Paul timely filed a cross-motion and a counter-

claim seeking a declaration that it did not have a duty

to defend. Under Illinois law, an insurer has three op-

tions if it contests its duty to defend: (1) seek a declara-

tory judgment regarding its obligations before trial of

the underlying action; (2) defend the insured under a

reservation of rights; or (3) refuse either to defend or to

seek a declaratory judgment at the insurer’s peril that it

might later be found to have breached its duty to

defend and estopped from asserting defenses as to pay-

ment based on non-coverage. See, e.g., County Mut. Ins. Co.

v. Olsak, 908 N.E.2d 1091, 1098 (Ill. App. Ct. 2009). That

is, if it declines to defend under a reservation of rights, to

avoid estoppel, the insurer must file a declaratory action

or answer and cross claim in an action against an insured.

See, e.g., L.A. Connection v. Penn-America Ins. Co., 843

N.E.2d 427, 431 (Ill. App. Ct. 2006) (collecting cases and

deciding that the weight of Illinois authority holds that

the insured may file the declaratory judgment action,

even though contrary authority exists); Roman Catholic

Diocese of Springfield in Ill. v. Md. Cas. Co., 139 F.3d 561, 565-

66 (7th Cir. 1998) (Illinois law). But see Supreme Laundry

Serv., L.L.C. v. Hartford Cas. Ins. Co., 521 F.3d 743, 749 (7th

16 Nos. 08-3572 & 08-3773

Cir. 2008) (Illinois law) (explaining, without citation, that

because the insured instituted the declaratory action

regarding coverage, the insurer was estopped from

raising a policy defense).6

St. Paul claims that it did not breach its duty to defend

because the plaintiffs initiated a declaratory judgment

action in February 2004, before St. Paul had time to

finish its investigation of coverage of the amended com-

plaint, tendered in January 2004. Moreover, St Paul

counterclaimed in June 2004, seeking a declaration that

it owed no duty to defend before the case reached settle-

ment, talks for which began in late 2004. Illinois courts

have three tests to measure the timeliness of the declara-

tory action. It must be filed: (1) before the underlying

6

We are not bound by our prior decisions regarding our

predictions of state law, especially if state law has evolved. See,

e.g., Taco Bell Corp., 388 F.3d at 1077. In Supreme Laundry,

however, the insurer’s policy defense was one not raised

until very late in the game, after the underlying action was

settled (the coverage action was also not filed until after the

underlying action was resolved in late 2005). See 521 F.3d at 745-

46. Supreme Laundry also did not involve a duty to indemnify.

See Mot. Judgment on the Pleadings, C.A. 1:06-cv-4476, Doc. 17,

at 3 n.1 (Nov. 7, 2006). The issues in the present case were, in

contrast, squarely addressed in Roman Catholic Diocese. More

importantly, our prediction of the Illinois Supreme Court’s

opinion on the matter, based on the trend in Illinois appellate

decisions, is that a declaratory judgment action initially filed

by the insured may satisfy an insurer’s duty to defend as

described in the main body of our opinion.

Nos. 08-3572 & 08-3773 17

action is resolved, see Employers Ins. of Wausau v. Ehlco

Liquidating Trust, 708 N.E.2d 1122, 1138 (Ill. 1999);

(2) before settlement or trial is imminent, Westchester

Fire Ins. Co. v. G. Heileman Brewing Co., 747 N.E.2d 955,

965 (Ill. App. Ct. 2001) (finding no breach when declara-

tory judgment was filed 15 months before settlement); or

(3) within a reasonable time of being notified of the under-

lying suit. L.A. Connection, 843 N.E.2d at 432-33 (timely

when insurer cross-claimed 4 months after it denied

insurance coverage); Sears, Roebuck & Co. v. Seneca Ins. Co.,

627 N.E.2d 173, 178 (Ill. App. Ct. 1993) (seven months not

untimely). St. Paul satisfies all of these timeliness tests.

Because St. Paul did not breach its duty to defend, we

do not address the plaintiffs’ arguments based on a breach.

C. Reimbursement of defense costs already advanced

to the plaintiffs.

In its cross-appeal, St. Paul asks us to reverse the

district court’s decision to deny St. Paul’s request for

reimbursement of costs it already submitted to the plain-

tiffs because of the district court’s finding that St. Paul

had a duty to defend. Because the district court did not

err, St. Paul’s request for leave to amend its counterclaim

to seek reimbursement was properly denied.

D. St. Paul may need to reimburse the JLJ settlement

payment.

St. Paul argues, as held the district court, that the plain-

tiffs failed to designate which of the claims addressed

18 Nos. 08-3572 & 08-3773

by the settlement were covered by the St. Paul CGL

policy and, therefore, St. Paul properly declined to reim-

burse the settlement. The plaintiffs argue that they have

no burden to allocate, citing Federal Ins. Co. v. Binney &

Smith, Inc., 913 N.E.2d 43, 53-54 (Ill. App. Ct. 2009).

They acknowledge that JLJ’s threatened damages in the

underlying action were undifferentiated as to the various

claims, and they argue that there is no practical way of

allocating the settlement.

In Binney, an Illinois appellate court confirmed that an

insurer must reimburse an insured for its settlement

expenses when the settlement was made in “reasonable

anticipation of liability” 7 for damage covered by the

insurer’s policies, U.S. Gypsum Co. v. Admiral Ins. Co., 643

N.E.2d 1226, 1244 (Ill. App. Ct. 1994), and the settlement’s

primary focus was a claim covered under the insurer’s

policy, see Commonwealth Edison v. Nat’l Union Fire of

Pittsburg, Pa., 752 N.E.2d 555, 565 (Ill. App. Ct. 2001). See

Binney, 913 N.E.2d at 48-49, 53-54. Both Gypsum and

Edison relied on the record developed in the under-

lying action, including allegations in the complaint and

evidence presented in the coverage action (Edison) or the

evidence presented in underlying companion cases that

went to trial before settling (Gypsum) to conclude that the

settlement resolved litigation primarily focused on covered

damage. See, e.g., Gypsum, 643 N.E.2d at 1244-47; Edison,

7

The district court held that the settlement was reasonable. See

Santa’s Best III, 2008 WL 4328192, at *8. St. Paul does not chal-

lenge the reasonableness of the settlement on appeal.

Nos. 08-3572 & 08-3773 19

752 N.E.2d at 565. Edison explains that an insured is not

required to apportion its liability for different claims

because that would either require the coverage litigation

to be a retrial of the merits of the insured’s underlying

lawsuit and/or would discourage settlement because the

insured would essentially have to prove its own liability

for the underlying conduct even if it had not made that

concession in arriving at a settlement. See Edison, 752

N.E.2d at 565-66 (discussing Gypsum). Illinois courts do

require the insured to establish when the covered claims

arose to allocate responsibility for paying the settlement

based on which insurer’s policy was in effect at the

time. See Binney, 913 N.E.2d at 54, 56-57; see also St. Mi-

chael’s Orthodox Catholic Church v. Preferred Risk Mut. Ins.

Co., 496 N.E.2d 1176, 1179 (Ill. App. Ct. 1986) (because the

insured failed to meet its burden to prove that some of the

roof damage occurred during the effective dates of the

insurer’s policy, judgment was wrongly rendered for

insured); Fidelity & Cas. v. Mobay Chem. Corp., 625 N.E.2d

151, 159 (Ill. App. Ct. 1992) (placing burden on insureds

to allocate settlements for periods of policy coverage and

non-coverage).

The district court, relying on Illinois School District

Agency v. Pacific Insurance Company, held that the plaintiffs

had to allocate the settlement into covered and uncovered

claims. See 471 F.3d 714, 723 (7th Cir. 2006) (holding that

the policy at issue included no duty to allocate defense

costs but that if, on remand, the insurer owed the

insured a duty to defend a contested claim, the insured

might have to prove how much it spent defending that

contested claim). This case relied on the specific contract

20 Nos. 08-3572 & 08-3773

at issue and cited St. Michael’s, which addresses alloca-

tion based on when claims arose rather than based

on liability.

Legal commentators have noted the lacuna in the

caselaw regarding apportionment of settlements in lieu

of litigation that would likely have involved both

covered and uncovered claims. See, e.g., A LLAN D. W INDT,

2 INSURANCE C LAIMS AND D ISPUTES § 6:31 (Supp.

Mar. 2010). Some states place on the insurer the burden

of proving (by a preponderance of the evidence) that

specific settlement costs could be allocated solely to

claims for relief that are not even potentially covered by

the insurance policy. See, e.g., Buss v. Superior Ct., 939 P.2d

766, 778 (Cal. 1997) (holding that an insurer may seek

reimbursement of defense costs that may be allocated to

claims that are not even potentially covered because a

party desiring relief carries the burden of proof); C OUCH

ON INSURANCE 3 D § 226:129, at 226-127-128 (2005). Other

courts place the burden to segregate claims on the in-

sured. See, e.g., Comsys Info. Tech. Servs., Inc. v Twin City

Fire Inst. Co., 130 S.W.3d 181, 198-200 (Tex. Ct. App.

[Houston-14th Dist.] 2003), pet. denied. Still others vary

the burden: initially on the insured to prove coverage,

on the insurer to prove the existence of an exclusion,

and back to the insured to prove an exception to an

exclusion. Lastly, courts generally addressing corporate

directors and officers liability insurance policies (D&O

policies) sometimes use the larger-settlement rule, where

an insurer is responsible for the settlement except to the

extent it is larger because of uncovered claims. See, e.g.,

Nos. 08-3572 & 08-3773 21

Caterpillar, Inc. v. Great Am. Ins. Co., 62 F.3d 955, 961-62

(7th Cir. 1995) (Illinois law).8

Consistent with the Illinois policy that a coverage

action should not require the insureds to conclusively

establish their own liability in the interest of promoting

settlement, we think the proper inquiry is whether the

claims were not even potentially covered by the insurance

policy. See, e.g., Gypsum, 643 N.E.2d at 1244 (noting the

benefits of settlement). A competing policy interest is

equity—it is inequitable to require an insurer to pay for

a settlement that is clearly not within the terms of its

policy. Consequently, our prediction is that Illinois

courts, in cases in which it is possible that none of the

settlement was attributable to the dismissal of claims for

damage covered by the insurer’s policy, would evaluate

whether a “primary focus” of the claims that were

settled was a potentially covered loss (burden on the

insured). Conversely, if it can be established that the

claims were not even potentially covered (burden on the

insurer), then the insurer is not required to reimburse

the settlement. This “primary focus” language is derived

from the Commonwealth Edison case. See Edison, 752 N.E.2d

at 565; see also Binney, 913 N.E.2d at 54 (citing Edison).

Because, in this case, the parties contest whether the

settlement was made in anticipation of covered claims, the

burden should be on the insured to prove coverage of

the settlement in the first place and then on the insurer

8

In that case, we declined to allocate the burden of proof.

See id. at 964 n.11.

22 Nos. 08-3572 & 08-3773

to prove the existence of exclusions barring coverage. As

the district court held, several of the allegations in the

underlying action’s complaint deal with claims and

conduct outside of the policy coverage, including the

trademark claims based on the product names and JLJ’s

false advertising claim. See Santa’s Best III, WL 4328192,

at **8-9. We agree with these holdings based on the

plain language of St. Paul’s policy.

The only remaining coverage dispute, therefore, is

whether the allegations and record evidence supporting

the trade dress claim suggest that the primary focus

of settlement was damages payments for a covered in-

fringement of slogan claim. The district court concluded

that plaintiffs had not made an allocation of the settle-

ment and therefore denied any reimbursement for the

settlement. Although the district court’s inquiry is close

to the one we predict Illinois courts would require, we

will remand to allow the district court to consider the

record evidence (and supplemental briefing or an eviden-

tiary hearing if it so chooses, although it may choose not

to do so) of whether a primary focus of the underlying

action was a covered loss. In addition, St. Paul may

attempt to prove that the MPMK exclusion applies to

defeat recovery under the policy.

E. St. Paul does not have to reimburse SBC for Mono-

gram’s defense expenditures.

Under the License Agreement, Monogram gave SBC

permission to market its Christmas lights under the GE

brand. The plaintiffs contend that this Agreement required

them to defend and indemnify Monogram for any litiga-

Nos. 08-3572 & 08-3773 23

tion arising out of products marketed with the GE label

and that St. Paul was required to reimburse expenditures

for this purpose because Monogram was their contract

indemnitee.

St. Paul’s CGL policy covers the advertising injury

of insureds’ indemnitees if several conditions are met.

The plaintiffs argue that they complied with all precon-

ditions to reimbursement that were feasible in view of

St. Paul’s failure to timely defend, and (or, alternatively)

the defense of Monogram was “reasonably related” to

their own defense, requiring St. Paul to reimburse them

for Monogram’s costs.

In December 2005, the plaintiffs amended their com-

plaint in the present case to seek reimbursement for

Monogram’s expenses, which were paid by Santa’s Best.

The district court determined that St. Paul owed Mono-

gram nothing because Santa’s Best was under no obliga-

tion to pay Monogram’s expenses and, therefore, even

if SBC were a contract indemnitee under the St. Paul

policy, SBC is responsible for its own liabilities, not

those of Santa’s Best. See Santa’s Best III, 2008 WL 4328192,

at **6-7. Alternatively, the district court noted that the

plaintiffs failed to tender the complaint for many

months and a conflict of interest existed between Mono-

gram and the plaintiffs. See id.

St. Paul is not required under its policy to reimburse

the Monogram expenses. The CGL policy required

St. Paul to determine that there was no conflict between

24 Nos. 08-3572 & 08-3773

the insured’s interests and those of the indemnitee 9 and

required the indemnitee to provide St. Paul with a copy

of any demand and give notice of the claim or suit.1 0

In support of the plaintiffs’ motions for partial summary

judgment quantifying defense expenses, counsel for the

plaintiffs and Santa’s Best as well as SBC’s CFO testified

via declaration that a separate firm represented Mono-

gram in the underlying action because of a “potential

conflict of interest” between the plaintiffs and Monogram

that precludes Monogram’s representation by counsel

for the plaintiffs. The plaintiffs now argue that they

never conceded there was a conflict of interest. They cite

a later declaration in support of a separate summary

judgment motion, in which the CFO testified that the

claims against Monogram and against the plaintiffs “are

9

“We must determine there’s no conflict between your

interests and those of the indemnitee, based on the allegations

in the claim or suit and on what we know about the factual and

legal basis for the damages being sought.”In its Defendant’s

Response to Plaintiffs’ Motion for Summary Judgment on the

Monogram defense issue, St. Paul explained that the plaintiffs

claimed, in a sworn affidavit filed with the district court, that

a conflict of interest prevented Monogram and the plaintiffs

from having common counsel in the underlying action.

10

St. Paul’s policy provides: “You and the indemnitee must ask

us to conduct and control the defense of that indemnitee

against the claim or suit under this agreement.” This require-

ment does not limit when the indemnitee and the insured can

“ask”—it is arguable that this condition was met by

August 2004.

Nos. 08-3572 & 08-3773 25

essentially the same” and that “[t]he work of all defense

counsel . . . benefitted Santa’s defense.” Regardless

whether the earlier declarations constituted a conces-

sion, the CFO’s declaration does not call into doubt the

district court’s determination that a conflict existed

between Monogram and the plaintiffs such that they

did not comply with all preconditions to St. Paul’s pro-

viding Monogram’s defense. We acknowledge that

certain of St. Paul’s requirements were impossible for

the plaintiffs to satisfy because St. Paul did not immedi-

ately defend it in the underlying action. That said, the

plaintiffs could have complied with other requirements

but chose not to.

Assuming, arguendo, that they did not waive the argu-

ment, the plaintiffs also argue that, because defense of

Monogram was “reasonably related” to their defense, St.

Paul should cover Monogram’s expenses. The plaintiffs

note that Monogram’s liability is largely derivative of their

own. See Ryland Mortgage Co., Inc. v. Travelers Indem. Co.,

177 F. Supp. 2d 435, 439-40 (D. Md. 2001) (stating in dicta:

if defense expenses are “reasonably related” to a covered

claim, the expenses may be wholly apportioned to this

covered claim so that an insurer must reimburse some

defense costs that aid in the defense of an uncovered

claim; same goes for coverage of defense expenses for an

uninsured party), vacated on other grounds, 70 Fed. App’x.

673 (4th Cir. July 18, 2003); Fed. Realty Inv. Trust v. Pac.

Ins. Co., 760 F. Supp. 533, 537 (D. Md. 1991) (requiring

insurer to cover all uncovered claims, including against

uncovered parties, if the insured proves, by a preponder-

ance of the evidence, that the defense of these uncovered

26 Nos. 08-3572 & 08-3773

claims is reasonably related to covered claims/parties).1 1

Separately, in the particular case of directors and officers

insurance (D&O policies), several courts use a “reasonably

related” rule to require the insurer issuing the D&O

policy to cover some defense expenditures also used to

defend the directors and officers’ uninsured corporation.

See, e.g., Safeway Stores, Inc. v. Nat’l Union Fire Ins. Co., 64

F.3d 1282, 1289 (9th Cir. 1995) (noting that the insurer

conceded that the defense costs were covered under the

D&O policy).

While insurance contracts should be construed against

the drafter, nothing in the St. Paul’s policy supports the

plaintiffs’ argument here that the Illinois Supreme

Court would apply a “reasonably related” test to hold

that Monograms’ costs are covered. In Illinois, as the

plaintiffs acknowledge, a duty to defend encompasses

“defensive” claims that serve to reduce liability—but its

courts are mum on coverage for uninsured parties.

See Great West Cas. Co. v. Marathon Oil Co., 315 F. Supp. 2d

879, 882-83 (N.D. Ill. 2003). Cf. Int’l Ins. Co. v. Rollprint

Packaging Prods., Inc., 728 N.E.2d 680, 684-85 (Ill. App. Ct.

2000) (holding that the insurer did not have to reim-

burse defense expenses related to an offensive counter-

claim). The plaintiffs therefore ask us to extend our limited

acceptance of the “larger settlement rule” for certain

D&O policies to require reimbursement for defense ex-

11

The Fourth Circuit has noted that the “reasonably related”

rule is generally confined to D&O polices, not at issue here.

See Perdue Farms, Inc. v. Travelers Cas. & Surety Co. of Am.,

448 F.3d 252, 260 (4th Cir. 2006).

Nos. 08-3572 & 08-3773 27

penses of related parties unless total defense costs are

higher because of the uninsured party’s defense. Cf. Cater-

pillar, Inc., 62 F.3d at 962 (emphasizing that the proper

allocation method is primarily an issue of contract).

None of these cases allows us to predict that the Illinois

Supreme Court would require an insurer to reimburse

the defense costs of all parties whose defense may have

benefitted an insured, given the contract provisions at

issue here. The plaintiffs’ “reasonably related” rule

would swallow the contract provisions limiting St. Paul’s

liability to its insureds’ contract indemnitees. St. Paul

also argues that Monogram’s defense expenditures were

not in fact reasonably related to the plaintiffs’ and ques-

tions whether defense costs would have been the same

whether or not Monogram was a party to the underlying

action—it notes, for example, that Monogram had

separate counsel. We need not address this argument,

although Monogram’s separate counsel, which incurred

a known amount of expenses, militates against such a

finding were we able to make one. We conclude that

St. Paul does not owe reimbursement for Monogram’s

defense costs, and we therefore need not address

St. Paul’s further arguments on this issue.

F. St. Paul may owe prejudgment interest on the de-

fense costs.

In its briefing, St. Paul appears to acknowledge that

the plaintiffs would like us to determine whether St. Paul

owes prejudgment interest for the plaintiffs’ general

defense costs, in addition to those costs incurred by

Monogram and the settlement payment. St. Paul contends

28 Nos. 08-3572 & 08-3773

that an order in the Zurich action works to collaterally

estop an award of interest and, moreover, the sums are

unliquidated. The district court denied the plaintiffs’

motion for prejudgment interest because it held that St.

Paul was not responsible for the settlement payment or

Monogram’s expenses—it did not address pre-judgment

interest as to plaintiffs’ defense costs apart from those

sums. See Santa’s Best III, 2008 WL 4328192, at *9.

An Illinois statute allows prejudgment interest for

written sums. 815 ILCS 205/2 provides:

§ 2. Creditors shall be allowed to receive at the rate

of five (5) per centum per annum for all moneys

after they become due on any bond, bill, promissory

note, or other instrument of writing; on money lent

or advanced for the use of another; on money

due on the settlement of account from the day of

liquidating accounts between the parties and ascer-

taining the balance; on money received to the use of

another and retained without the owner’s knowledge;

and on money withheld by an unreasonable and

vexatious delay of payment. In the absence of an

agreement between the creditor and debtor

governing interest charges, upon 30 days’ written

notice to the debtor, an assignee or agent of the credi-

tor may charge and collect interest as provided in

this Section on behalf of a creditor.

Prejudgment interest is available for sums due on insur-

ance policies. See, e.g., Couch v. State Farm Ins. Co., 666

N.E.2d 24, 27 (Ill. App. Ct. 1996). The decision to award

prejudgment interest is within the trial court’s sound

discretion and will not be reversed absent an abuse of

Nos. 08-3572 & 08-3773 29

that discretion. See Statewide Ins. Co. v. Houston Gen. Ins.

Co., 920 N.E.2d 611, 624 (Ill App. Ct. 2009).

Interest begins to accrue when the underlying attor-

neys’ fees become liquidated, i.e. “due and capable of exact

computation.” See Conway v. Country Cas. Ins. Co., 442

N.E.2d 245, 250 (Ill. 1982) (finding that insurer breached

its duty to defend). A sum is liquidated if calculation

does not require “judgment, discretion, or opinion.” See

Dallis v. Don Cunningham & Assocs., 11 F.3d 713, 719 (7th

Cir. 1993) (quoting First Nat’l Bank Co. of Clinton, Ill. v.

Ins. Co. of N. Am., 606 F.2d 760, 770 (7th Cir. 1979)). But,

a good-faith defense to liability does not bar prejudg-

ment interest if the amount is ascertainable. See, e.g.,

Couch, 666 N.E.2d at 27.

The court should examine the relevant insurance policy

and the circumstances of the case. See Cent. Nat. Chi. Corp.

v. Lumbermens Mut. Cas. Co., 359 N.E.2d 797, 802-03 (Ill.

App. Ct. 1977); DiLeo v. U.S. Fid. & Guar. Co., 248

N.E.2d 669, 676-77 (Ill. App. Ct. 1969) (holding that

interest began to accrue as specified by the terms of the

policy—60 days after the defendants were furnished the

proof of loss). St. Paul’s policy provides that it will:

pay the interest that accumulates before a judgment

and is awarded against the protected person on that

part of a judgment we pay. But if we make a settle-

ment offer to pay the available limit of coverage,

we won’t pay the prejudgment interest that accumu-

lates after the date of our offer.

Because the district court never explicitly considered the

issue of prejudgment interest as to St. Paul’s defense

30 Nos. 08-3572 & 08-3773

expenditures, it is instructed to make such a holding

on remand.

As for St. Paul’s arguments about collateral estoppel: the

Zurich court’s December 2005 order denied the plaintiffs’

motion for prejudgment interest on Zurich’s payments.

St. Paul agreed to be bound by certain rulings in the

Zurich action, and the December 2005 holding suggests

that the plaintiffs “may” be bound by the Zurich court’s

order’s language about prejudgment interest. See Santa’s

Best Craft, LLC v. St. Paul Fire & Marine Ins. Co., No. 04 C

1342 (N.D. Ill. Mar. 21, 2006). Collateral estoppel bars

a party from asserting a claim that has been resolved in

another lawsuit between the same parties (or those in

privity with them). See Aaron v. Mahl, 550 F.3d 659, 665

n.5 (7th Cir. 2008). It applies if: “(1) the issue decided in

the prior adjudication is identical with the one presented

in the suit in question, (2) there was a final judgment on

the merits in the prior adjudication, and (3) the party

against whom estoppel is asserted was a party or in

privity with a party to the prior adjudication.” Gumma v.

White, 833 N.E.2d 834, 843 (Ill. 2005); see also Marrese v. Am.

Acad. of Orthopaedic Surgeons, 470 U.S. 373, 380 (1985)

(applying state laws of preclusion to determine the

effect of a prior state court action on a federal diversity

case). The plaintiffs argue that, in the Zurich action,

they never litigated the issue of St. Paul’s duty to pay

prejudgment interest on the defense costs. It seems doubt-

ful that St. Paul is correct that the Zurich court’s order

affects prejudgment interest as to St. Paul’s defense

expenses generally but, on remand, the district court

should evaluate whether any issues decided in the

Nos. 08-3572 & 08-3773 31

Zurich action act as collateral estoppel for a determina-

tion about prejudgment interest on St. Paul’s defense

cost reimbursements. As noted above, on remand, the

parties are admonished to restrict their briefing to a

succinct statement of the issues and the district court

may certainly consider sanctions for any further

excessive commitments to briefing and arguing the

few remaining issues in this case, consistent with the

foregoing.

A FFIRMED in part,

R EVERSED and R EMANDED in part.

7-1-10