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RSUI Indemnity Co. v. New Horizon Kids Quest, Inc.

United States Court of Appeals, Eighth Circuit

August 12, 2019

RSUI Indemnity Company Plaintiff- Appellant
v.
New Horizon Kids Quest, Inc. Defendant-Appellee

          Submitted: February 12, 2019

          Appeal from United States District Court for the District of Minnesota - Minneapolis

          Before LOKEN, COLLOTON, and KELLY, Circuit Judges.

          LOKEN, CIRCUIT JUDGE.

         New Horizon Kids Quest, Inc. ("New Horizon"), operates a childcare facility at the Grand Casino Mille Lacs in Onamia, Minnesota. In 2011, the guardian of J.K. sued New Horizon, alleging that negligent employee training and supervision resulted in J.K., then age three, suffering physical and sexual assaults by N.B., then age nine, when the two children were under New Horizon's care. At the time of the incident, commercial general liability and excess liability policies issued by Travelers Property Casualty Company of America ("Travelers") provided New Horizon $3, 000, 000 of liability coverage for insured occurrences. A Commercial Excess Liability Policy issued by RSUI Indemnity Company ("RSUI") provided additional excess liability coverage of up to $8, 000, 000 per occurrence. The RSUI policy included a Sexual Abuse or Molestation Exclusion.[1]

         Travelers as New Horizon's primary insurer accepted defense of J.K.'s suit. Prior to trial, New Horizon conceded liability but disputed "the nature, type and extent" of J.K.'s injuries and damages. Following trial, the jury awarded J.K. more than $13 million, but the trial court granted New Horizon's motion for a new trial. Following a second trial at which New Horizon again conceded liability but contested J.K.'s claims of injuries and damages, the jury awarded total damages of $6, 032, 585, segregating its award into four damage categories but not finding whether J.K. suffered sexual as well as physical abuse and not allocating its award between those two claims. Travelers paid its policy limits, plus interest. New Horizon paid the remaining $3, 224, 888.59 and demanded indemnity from RSUI under its excess liability policy. RSUI then brought this action seeking a declaratory judgment that the policy's "Sexual Abuse or Molestation" exclusion barred coverage for that part of the award above Travelers' policy limits.

         The district court granted summary judgment for New Horizon, concluding that RSUI could not prove that any part of the jury's unallocated award was based on sexual assault subject to the policy's exclusion. RSUI appeals. We review de novo the district court's interpretation of an insurance policy and its grant of summary judgment; Minnesota substantive law controls this diversity action. Jerry's Enters., Inc. v. U.S. Specialty Ins. Co., 845 F.3d 883, 887 (8th Cir. 2017). We conclude that RSUI, an excess liability insurer that did not control the defense of its insured in the underlying suit, must be afforded an opportunity to prove in a subsequent coverage action that the jury award included damages for uncovered as well as covered claims. If the insurer sustains that burden, the district court must then allocate the award between covered and uncovered claims. Accordingly, we reverse and remand for further proceedings.

         I.

         We begin with basic principles under Minnesota insurance law. "The insured bears the initial burden of proving prima facie coverage of a third-party claim under a liability insurance policy. If the insured meets its burden of establishing coverage of the claim, the burden shifts to the insurer to prove the applicability of an exclusion under the policy as an affirmative defense." Remodeling Dimensions, Inc. v. Integrity Mut. Ins. Co, 819 N.W.2d 602, 617 (Minn. 2012) (citation omitted). The insured's primary insurer -- here, Travelers -- has both a duty to indemnify covered claims and a broader duty to defend its insured in the third party's action. A primary insurer who accepts the duty to defend, but reserves the right to contest its duty to indemnify, may bring a separate declaratory judgment action to determine coverage while the third party action is pending, [2] or it may seek to have the jury make findings in the third party action to resolve coverage issues. See, e.g., Prahm v. Rupp Const. Co., 277 N.W.2d 389, 391 (Minn. 1979). If the primary insurer refuses to defend the third party action, even improperly, and the insured brings a coverage action seeking indemnity for a judgment in the third party's favor, whether the third party claim was covered by the policy is an issue the insurer is "entitled to litigate." Brown v. State Auto. & Cas. Underwriters, 293 N.W.2d 822, 825 (Minn. 1980).

         An award entered against the insured may include sums for which it is entitled to be indemnified under the policy, and sums for claims not covered by the policy. If the evidence in a post-award coverage action establishes that the third party action included both covered and uncovered claims, then the total award must be allocated, by the court in the coverage action if necessary. See Remodeling, 819 N.W.2d at 618-19 & n.4; Duke v. Hoch, 468 F.2d 973, 984 (5th Cir. 1972); United Health Group Inc. v. Columbia Cas. Co., 941 F.Supp.2d 1029, 1033-34 (D. Minn. 2013). If the insurer accepted defense of the third party action under a reservation of rights but failed to disclose to the insured its interest in obtaining an allocated award, then the insured's burden to allocate the award between covered and uncovered claims is shifted to the insurer in the post-award coverage or declaratory judgment action. Remodeling, 819 N.W.2d at 617-18.

         II.

         In this case, Travelers, the primary insurer, accepted defense of New Horizon in J.K.'s action, subject to a reservation of rights based on an Abuse and Molestation exclusion in its commercial general liability policy. Neither Travelers nor New Horizon commenced a declaratory judgment action regarding this coverage issue before the first trial. At that trial, defense counsel stipulated that New Horizon conceded liability but contested damages, a strategy communicated to RSUI. At the second trial, New Horizon again admitted liability.[3] The jury was not asked to find whether J.K. suffered sexual as well as physical assault, and its total award of $6, 032, 585 was not allocated between those two claims. After the second trial, Travelers paid its $3 million policy limits, without contesting coverage.

         RSUI's policy provided that it has the right to participate in the defense of claims "to which this insurance may apply" but has no duty to defend unless the applicable limits of "underlying Insurance" have been exhausted. RSUI did not communicate a coverage position before the first trial and did not attend the first trial. After the first trial, RSUI sent New Horizon a coverage position letter noting that damages awarded may be barred by its Sexual Abuse or Molestation Exclusion. During the second trial, RSUI retained a jury consultant to work with defense counsel, and its claims representative attended the first two days of trial. Following the ...


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