Seventh Circuit says "complete defense" rule does not apply to title insurance, thinks Illinois Supreme Court is likely to agree

A title insurance company will not have to foot the bill to defend a commercial mortgage lender in a complex web of foreclosure-related litigation, after a federal appeals court determined that title insurers are not subject to the so-called "complete defense" rule because they are different than general liability insurers.

The Seventh Circuit Court of Appeals on Nov. 13 overturned the decision of U.S. District Judge Matthew F. Kennelly to rule in favor of Chicago Title Insurance in its legal imbroglio with litigants, international commercial lender Western Capital Partners LLC and liability insurer Philadelphia Indemnity Insurance.

The panel's opinion was authored by Judge Diane S. Sykes, with judges Joel M. Flaum and Ilana Diamond Rovner concurring.

The opinion stems from years of legal tussling among the three parties and the developers of a strip mall and mixed-use property on Ridgeland Avenue on Chicago’s South Side.

The dispute began in 2007, when Western Capital initiated foreclosure actions against the developer for failing to make sufficient payments on a $2.77 million loan issued by Western Capital for the Ridgeway project.

In response, the developer counter-sued, prompting Western Capital to reach out to its insurers, beginning with Chicago Title.

Chicago Title, however, informed Western Capital its policy only covered a defense for a few of the multiple counts brought in the developers’ complaint against the lender.

Western Capital also turned to Philadelphia Indemnity for coverage, and that company agreed to cover the defense with a certain reservation of rights.

In 2009, however, Philadelphia Indemnity opened a new front in the legal fight, suing Western Capital and Chicago Title, asking a court to clarify the situation.

Chicago Title then removed the matter to federal court, and sued Western Capital, asking the court to declare it free of any further obligations to defend the lender in the foreclosure suits. Western Capital also filed counterclaims against the two insurance companies.

The district court judge found in favor of Western Capital and Philadelphia Indemnity, ruling that the “complete defense rule" --which stipulates an insurance company is obligated to defend its insured against the entirety of a lawsuit if even one allegation would trigger coverage-- requires Chicago Title to defend Western Capital in the actions.

Chicago Title appealed, arguing that Kennelly, the district court judge, erred in applying that legal doctrine to title insurers.

The Seventh Circuit judges agreed, saying they believed title insurance, which insures only against legal questions pertaining to property title, is fundamentally different from general liability insurance, and should be treated as such.

The panel noted the question has not yet been addressed by the Illinois courts, and has actually only been ruled upon in one state supreme court, the Massachusetts Supreme Court.

There, the justices had reached the same decision, ruling that the complete defense rule should not be applied, and title insurers should be allowed to limit their coverage in litigation defense.

The Seventh Circuit judges said they believed the Illinois Supreme Court, should it be faced with the same question, “would find its (the Massachusetts Supreme Court’s) analysis persuasive.”

“We hold that the complete-defense rule does not apply to title insurance,” Sykes wrote for the panel. “The limited-defense language in Chicago Title’s policy is enforceable.”

The panel remanded the case to district court for further proceedings and clarification of the “rights and obligations” of each of the parties in light of its ruling.