Grey Direct Inc v. Erie Insur Exchange

In the

United States Court of Appeals

For the Seventh Circuit

____________

No. 05-4514

GREY DIRECT, INC.,

Plaintiff-Appellant,

v.

ERIE INSURANCE EXCHANGE,

Defendant-Appellee.

____________

Appeal from the United States District Court

for the Northern District of Illinois, Eastern Division.

No. 04 C 5790—Amy J. St. Eve, Judge.

____________

ARGUED MAY 11, 2006—DECIDED AUGUST 21, 2006

____________

Before POSNER, EASTERBROOK, and WOOD, Circuit Judges.

WOOD, Circuit Judge. The question in this case is who

should bear the loss from a printing company’s mistake that

wound up costing the company (or a related firm) nearly $1

million. The company, Unicomm Direct (“Unicomm”),

assigned its rights under an insurance policy with Erie

Insurance Exchange to Grey Direct, Inc., the direct mail

company whose work Unicomm was handling. Grey now

takes the position that the insurance covered this loss. Erie

begs to differ: in its view, Unicomm did not even purchase

the relevant coverage until well after the error occurred and

the loss was established, and thus Erie had neither a duty

to defend nor a duty to indemnify Unicomm. Furthermore,

it continues, nothing in the dealings between the parties

2 No. 05-4514

supports the notion that Erie graciously agreed after the

fact to cover this large known loss. The district court was

persuaded by Erie’s arguments and granted summary

judgment in its favor. Our de novo review brings us to the

same conclusion; we therefore affirm.

I

In 2003, Grey managed an advertising campaign for

United Airlines called “Fly Three, Fly Free.” Under that

program, customers who purchased three round-trip flights

on United during a specified time period were entitled to a

travel certificate that could be redeemed for one free round-

trip flight. Grey decided to hire another firm, CommDirect,

a direct-mail advertising production company, to print and

mail the travel certificates to qualifying customers. Mary

Manade Lipuma is the director, sole shareholder, and only

employee of CommDirect. Together with her husband, she

also owns Unicomm, which is in the same business as

CommDirect.

After Grey hired CommDirect to produce the travel

certificates, Lipuma transferred the job to Unicomm. She

did not inform Grey about this decision, but the record does

not reflect whether there was anything in the agreement

with Grey that specifically prohibited subcontracting. On

September 11, 2003, Unicomm made a grave error: it

mailed two travel certificates, instead of one, to roughly

6,000 United customers. Lipuma admitted responsibility for

the error on September 18, 2003, in a letter to Grey. Grey

indemnified United for the resulting loss, to the tune of

$967,720. On December 3, 2003, Grey sued CommDirect;

during the course of those proceedings, it learned that

Unicomm had actually done the work and committed the

error. Upon learning this, Grey voluntarily dismissed the

action against CommDirect and filed a new suit for breach

of contract against Unicomm, in which it obtained a default

No. 05-4514 3

judgment on June 20, 2004, for the full loss, plus court costs

and attorney’s fees. At that point, the court ordered

Unicomm to assign its rights against its insurer, Erie, to

Grey.

Unicomm had purchased its business owners’ insurance

from Erie in August of 2003. The policy, which was issued

September 4, 2003, for the period of August 25, 2003,

through August 25, 2004, did not include a Printers Errors

and Omissions provision. After the expensive September 11

printing error, Grey told Lipuma that she would have to

purchase this type of coverage if she wanted to continue to

work with Grey. Lipuma accordingly added this coverage to

Unicomm’s policy on October 23 or 24, 2003; the effective

date on the amended declaration page Erie issued at the

time was October 15, 2003. Erie charged $54 for the Errors

and Omissions provision, pro-rating the price to cover the

partial period from October 15, 2003 through August 25,

2004, rather than the full annual fee of $63. Whether later

events changed the effective date of the Printers Errors and

Omissions provision is a matter of dispute, which we

address below.

One month after Grey filed suit against CommDirect,

Unicomm sent a copy of the complaint to Erie. That letter,

dated January 2, 2004, requests coverage under the

Unicomm policy and represents that Grey’s complaint

was “against the Company [i.e., Unicomm] and Comm-

Direct, Inc.” The enclosed complaint, however, plainly

names only CommDirect as a defendant. Erie responded on

January 21, 2004, acknowledging receipt of Unicomm’s

demand and denying coverage on the ground that the

lawsuit did not involve any of the types of injury the

policy covered (bodily injury, property damage, personal

injury, or advertising injury). Erie reserved the right to

assert other grounds for disclaiming coverage, but it did not

specifically mention the Errors and Omissions endorsement.

Erie did, however, note that “some of the damages being

4 No. 05-4514

claimed occurred prior to our policy inception.” Unicomm

wrote back on February 23, 2004, asserting for the first

time that the Printers Errors and Omissions endorsement

that had been added after the incident covered the loss;

Erie (which claims it never received that letter) stood firm

and continued to deny that it had either a duty to defend or

a duty to indemnify under the policy. There is no record

that Erie was given notice of Grey’s second suit, the one

against Unicomm, until after the default judgment was

entered.

At this point, Grey (Unicomm’s assignee) filed the present

suit against Erie, alleging that Erie had breached its

alleged duties to defend and indemnify Unicomm in

the underlying action. The district court found, on Erie’s

motion for summary judgment, that Erie had no duty to

defend, because the September 11, 2003, error was a

“known loss” of which Unicomm was aware in October 2003

when it contracted for Printers Errors and Omis-

sions coverage and there was no evidence that the parties

intended it to be covered. Finding no disputed issues of

material fact, it entered judgment for Erie. Grey now

appeals.

II

Grey offers three reasons why we should reverse the

district court: first, that Erie should be estopped from

relying on the “known loss” doctrine; second, that the

“known loss” doctrine does not apply to a policy docu-

ment issued after the insurance company has learned about

the loss; and third, that Erie is precluded from raising

defenses that it did not mention in its reservations of rights

letters or in earlier pleadings. Erie’s response boils down to

the simple assertion that Unicomm’s policy did not include

coverage for Printers Errors and Omissions until October

15, 2003, well after the date when the loss occurred, and

No. 05-4514 5

nothing in Illinois’s “known loss” doctrine, rules of estoppel,

or other insurance rules required Erie to defend Unicomm.

Even taking the facts in the light most favorable to Grey, as

we must, see Valentine v. City of Chicago, 452 F.3d 670, 677

(7th Cir. 2006), it is hard to imagine what the thread is on

which Grey hangs its case. A closer look, however, shows

that a single error on Erie’s part is what seems to underlie

this litigation.

Erie does not keep hard copies of the original insurance

policies that it delivers to its clients, because of the prohibi-

tive amount of space this would require. Instead, Erie

stores in electronic format the various documents that make

up a policyholder’s contract. When Erie receives a request

from its insured or another authorized person for a copy of

a policy, it refers that request to a processor (not to an

underwriter). The processor must ascertain whether any

endorsements were added after the original issuance of the

policy. If, as in the case of the Unicomm policy, there was a

later endorsement with a different effective date, the

processor must work backwards through the different

versions of the policy to arrive at the actual language of the

policy on any given earlier date.

In this case, Erie’s processor, Rebecca Murzynski, failed

to notice that there was an endorsement to the Unicomm

policy added effective October 15, 2003. When, in January

2004, she created a paper copy of the policy, she there-

fore failed to back up and re-create the policy as it had

existed prior to October 15, 2003. This meant that the

copy of the policy she printed in January 2004 erron-

eously indicated that Printers Errors and Omissions

coverage had existed from the outset (August 2003), rather

than only from October 15, 2003. Nonetheless, Grey in-

sists that the January 2004 version of the policy that

Murzynski mistakenly generated is controlling, notwith-

standing the fact that undisputed evidence shows that

it was not until after the September 11 error that Grey

6 No. 05-4514

asked Lipuma to procure the additional insurance, and that

she did not do so until October 23 or 24 of 2003. In other

words, Grey suggests that the copy of the policy re-created

months after its purchase materially altered the terms of

the contract. But nothing in the record supports this rather

outlandish hypothesis. First, other evidence makes it clear

that Lipuma purchased the Errors and Omissions provision

in October in response to the September 11, 2003, printing

mistake so that Grey would continue to work with Unicomm

in the future. Nothing indicates that either party, at that

time, thought that the change would be retroactive. Second,

there is no evidence indicating that either Erie or Lipuma

asked for a change in terms in January 2004, when

Unicomm asked for a copy of the policy. The fact that the

insurance company inadvertently provided flawed evidence

of the policy, in the form of the computer-generated copy

does not change the terms of the contract itself.

Nevertheless, even if we did treat the January 2004

copy as somehow modifying the policy, the September

printing error remains a “known loss” that would not be

covered by the policy. Illinois, whose law governs here,

holds that “the insurer has no duty to defend or indemnify

the insured with respect to the known loss ab initio, unless

the parties intended the known loss to be covered.” Out-

board Marine v. Liberty Mut. Ins., 607 N.E.2d 1204, 1210

(Ill. 1992). A known loss occurs when “the insured knows or

has reason to know, when it purchases a [ ] policy, that

there is a substantial probability that it will suffer or has

already suffered a loss.” Id. Viewed from the perspective of

October 15, 2003, or any time thereafter, the loss incurred

as a result of the September 11 mailing was known.

Outboard Marine indicates that Erie had no duty either to

defend in proceedings relating to that loss or to indemnify

any resulting judgment. Even if we thought that

Murzynski’s January 2004 error had the effect of adding the

Printers Errors and Omissions clause to the policy effective

No. 05-4514 7

August 2003, it would cover only other unknown events

meeting that description, not the September 11, 2003, gaffe,

unless there is evidence that the parties intended also to

cover the known loss. Grey argues that the January

document is exactly the kind of evidence of intent to assume

the known risk to which the Illinois Supreme Court re-

ferred, but we cannot accept it as such. The loss, recall, was

known by that time to be at least $967,720; Unicomm paid

$54 for the Printers Errors and Omissions endorsement. It

is simply beyond the pale to think that Erie was willing to

accept $54 in exchange for a certain duty to pay out nearly

a million dollars.

Another way of looking at this problem is through the

lens of the doctrine of mistake. The Restatement (Second)

of Contracts recognizes that under some circumstances a

mistake of one party makes a contract voidable:

Where a mistake of one party at the time a contract was

made as to a basic assumption on which he made the

contract has a material effect on the agreed exchange of

performances that is adverse to him, the contract is

voidable by him if he does not bear the risk of the

mistake under the rule stated in § 154, and

(a) the effect of the mistake is such that enforce-

ment of the contract would be unconscionable, or

(b) the other party had reason to know of the

mistake or his fault caused the mistake.

RESTATEMENT (SECOND) OF CONTRACTS § 153 (1981). See

also People ex rel. Department of Public Works & Bldgs. v.

South East Nat’l Bank, 266 N.E.2d 778, 780-81 (Ill. App.

1971). Here, the relevant time relates to the endorsement

to the Unicomm policy. Erie, taking matters as favorably to

Grey as we can, thought that the effective date of the en-

dorsement was October 15, 2003; because of Murzyn-

ski’s mistake, one version of the contract said that the

Printers Errors and Omissions coverage had existed from

8 No. 05-4514

the start, and thus prior to the September 11, 2003, loss.

This mistake has a material effect on the agreed exchange,

as we have just noted; the criteria spelled out in § 154

do not suggest that Erie should bear this loss (it was not

allocated by the agreement, Erie did not enter into the

contract aware that its knowledge was limited about the

facts relevant to the mistake, nor is it reasonable for the

court to allocate the risk to Erie), see RESTATEMENT (SEC-

OND) OF CONTRACTS § 154; and the effect of holding Erie to

the erroneous January version of the policy would indeed be

unconscionable. Moreover, the record leaves no doubt that

Unicomm had reason to know that it did not have this

coverage, well before it received the erroneous version of the

policy and long before it filed this lawsuit.

Our view of the case makes it unnecessary to dwell on

Grey’s other arguments. As the district court held, an

insurance company is not estopped from arguing that

it should be relieved of a duty to defend, if there was

never any such duty in the first place. See Employers Ins.

of Wausau v. Ehlco Liquidating Trust, 708 N.E.2d 1122,

1135 (Ill. 1999) (“Application of the estoppel doctrine is not

appropriate if the insurer had no duty to defend. . . . These

circumstances include . . . when the policy and the com-

plaint are compared, there clearly was no coverage or

potential for coverage.”); U.S. Fidelity & Guar. Co. v. Wilkin

Insulation Co., 578 N.E.2d 926, 930 (Ill. 1991). We thus

have no need to speculate about whether the Illinois

Supreme Court would hold that the known loss defense

is exempt from general estoppel doctrine. Second, we

disagree with Grey that Erie waived its arguments that it

had no duty to defend Grey’s first suit against CommDirect

because it never issued a policy to CommDirect, and that it

had no duty to defend Unicomm because it did not learn of

the new suit against Unicomm until after the default

judgment was entered. Erie’s answer to Grey’s second

amended complaint pleaded that CommDirect was never an

No. 05-4514 9

insured under any Erie policy. The record is devoid of

evidence showing that Erie received actual notice of the

second complaint—the one against Unicomm—prior to the

time when Grey’s counsel sent it a letter in June 2004

alerting it to the default judgment. It is noteworthy, in this

regard, that the CommDirect suit and the Unicomm suit

were filed under separate docket numbers and heard by two

different district court judges. The record thus does not

support the proposition that they were really just one big

integrated piece of litigation that Erie failed to handle

properly.

Finally, there is no evidence suggesting that Erie waived

either the known loss defense or any other defenses. To the

contrary, its letter of January 21, 2004, said that “Erie

Insurance specifically reserves the right to assert such

other grounds for disclaiming coverage and/or liability

under the policy that may be discovered during the course

of Erie Insurance’s investigation of the facts [ ] underlying

the claim or any claim arising there from [sic] . . . .” Grey

suggests that this language does not save Erie, because

by January 21, 2004, as a company it already knew about

the printing error and thus its known loss defense, and

so this was not something it discovered later during the

course of its investigation. Erie’s actual knowledge about

the error changed over time, however. More importantly, we

have noted that under Illinois law, a person claim-

ing waiver “has the burden of proving that the insurer’s

words or conduct were inconsistent with an intent to rely on

the provisions of the policy.” Loyola Univ. of Chicago v.

Human Ins. Co., 996 F.2d 895, 901 (7th Cir. 1993) (citing

Buchalo v. Country Mutual Ins. Co., 404 N.E.2d 473, 478

(Ill. App. 1980)). The evidence must be “clear, precise, and

unequivocal.” Id. Grey’s evidence of waiver does not

satisfy this demanding standard.

10 No. 05-4514

III

The district court correctly ruled that Erie had no duty to

defend Unicomm in the litigation over the expensive error

it committed on September 11, 2003. Had it not been for

Erie’s inadvertent printing of a copy of the insurance policy

that made it appear that the Printers Errors and Omissions

coverage had been in effect throughout the duration of the

policy—a proposition that the record unequivocally shows

is not correct—this lawsuit could never have been filed.

Nothing indicates that Erie had any intention of providing

coverage for the known loss from that mistake, nor did any

of its actions estop it from taking that position here. The

judgment of the district court is AFFIRMED.

A true Copy:

Teste:

________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit

USCA-02-C-0072—8-21-06