Ixthus and CityDeck: Two Recent Wisconsin Supreme Court Decisions on Duty to Defend, the Four Corners Rule, and Stays of Underlying Disputes

WDC Journal Edition: Summer 2019
By: Jeffrey Leavell, Jeffrey Leavell S.C.

The Wisconsin Supreme Court issued two noteworthy decisions concerning the duty to defend within one week of each other in February of this year: West Bend Mutual Insurance Company v. Ixthus Medical Supply, Inc. (“Ixthus”) and State ex rel. CityDeck Landing LLC v. Circuit Court for Brown County (“CityDeck”) . Ixthus applied the four corners rule in an unusual way. CityDeck narrowed an insurer’s options in seeking a declaration of its duty to defend a claim subject to arbitration. This article discusses both decisions and examines the effect they may have on an insurer’s duty to defend.

I. West Bend Mutual Insurance Company v. Ixthus Medical Supply, Inc.

In Ixthus, the Wisconsin Supreme Court analyzed the duty to defend in the context of advertising injury coverage. The decision addressed the elements of advertising injury coverage, particularly the causal connection element, and an exclusion often at issue in advertising and personal injury cases, the knowing violation exclusion. The Supreme Court’s decision has important ramifications for advertising injury coverage, and duty to defend analysis. The decision also puts a spin on the four corners rule, important to duty to defend decisions. It is expressly a duty to defend decision, and disclaims any ruling on duty to indemnify.

In Ixthus, West Bend sought a declaration on duty to defend Ixthus Medical Supply in connection with an underlying lawsuit pending in the Eastern District of New York. Abbott Laboratories had filed suit against more than one hundred defendants, including Ixthus, for trademark infringement, fraud, unfair competition, and other alleged statutory and common law violations. The complaint alleged the defendants improperly diverted and sold in the United States international blood glucose test strips manufactured by Abbott for international sale with market-specific labeling that were not authorized for sale in the United States. Abbott alleged that Ixthus sold the strips within the United States as part of a fraudulent scheme benefitting from the lower price of the international strips and receiving unwarranted rebates that were meant only for domestic strips. In short, it was alleged that Ixthus purchased Abbott’s cheaper test strips made for the overseas market, sold them in the United States as if they were made for the domestic market and got rebates from Abbott, wrongfully enjoying profits, all at Abbott’s expense.

The complaint alleged that various classes of defendants including “distributor defendants” and “pharmacy defendants” were part of this scheme for “receiving fraudulent” rebate payments. The complaint specifically alleged that Ixthus had purportedly run this scheme before under a different corporate name and had previously been sued by Johnson & Johnson in 2006 for the unlawful importation and sale of blood glucose test strips. The complaint specifically alleged that the Ixthus predecessor had been enjoined in that case from selling counterfeit strips.

All of the complaint’s claims for relief were pleaded under separately entitled subheadings, with express incorporation of all prior allegations in them at the initial paragraph of each subheading. The Ixthus decision side stepped these facts, saying instead “an allegation of willful conduct … does not destroy potential coverage when the complaint contains a covered claim that does not require proof of a knowing violation.

West Bend had issued liability policies to Ixthus that defined “personal and advertising injury” to include the use of another’s advertising idea in an advertisement and the infringing upon another’s copyright trade dress or slogan in an advertisement. The policies also contained exclusions for knowing violation of rights of another and for criminal acts, exclusions commonly found in personal and advertising injury coverages.

After Ixthus tendered defense of the complaint to West Bend, West Bend filed a declaratory action in Racine County Circuit Court, the county where Ixthus resided, and moved for summary judgment on duty to defend and indemnify. West Bend joined Abbott as an interested party, consistent with Basten v. Fire Insurance Exchange. The chief issues at the circuit court level were whether there was sufficient causal connection between Abbott’s injury and Ixthus’ advertising activity in the allegations, and whether the allegations described a knowing violation of Abbott’s rights.

The circuit court found a causal connection, but concluded that the knowing violation exclusion precluded coverage and thus there was no duty to defend. The circuit court said that the complaint alleged a series of acts “intended to cause injury” to Abbott, an alleged fraudulent “scheme,” and that no “reasonable insured would expect liability coverage for the acts of intentionally diverting the test strips.”

The court of appeals reversed, per curiam, saying that the sole question on appeal was “whether the policies’ knowing violation exclusion applies and relieves West Bend of its duty to defend Ixthus.” The court of appeals decision held that there were claims in the complaint that would survive the exclusion, specifically those claims that did not require proof of intent to injure like trademark dilution.

At the supreme court level, West Bend argued that the allegations lacked the necessary causal connection between injury and the alleged advertising activity. The supreme court previously said in Fireman’s Fund Ins. Co. v. Bradley that to satisfy the causal connection necessary to make for a covered advertising injury, the complaint must allege that the advertising contributed materially to the injury. The crux of the allegations against Ixthus were that importation and sale of diverted international test strips by Ixthus with fraudulent rebates injured Abbott, not that something intrinsic to the advertising was connected to the injury. Ixthus had not advertised the product to the consuming public for sale, but rather it sold to pharmacies, which then sold to consumers. The complaint alleged very little about advertising and only two paragraphs out of a total of 645 paragraphs in the second amended complaint contained a general, nonspecific allegation that the “defendants” imported, advertised and distributed test strips, leading to consumer confusion. On the causal connection question, the supreme court decision rejected the significance of the specific fact allegations about Ixthus as a distributor selling to pharmacies. It concluded the generalized allegations concerning the actions of “the defendants” were sufficient to satisfy the test for causation.

On the knowing violation exclusion, West Bend argued that the complaint alleged Ixthus knew it was defrauding Abbott because the complaint alleged the purposeful rebate scheme that injured Abbott in detail. The complaint alleged that Ixthus knew what it was doing because it had been caught in a similar scheme under a predecessor corporate name and was permanently enjoined from the conduct. The deliberate and intentional scheme alleged against Ixthus was dramatized in a diagram of the scheme in the complaint entitled “Illegal Distribution Chain.”

Most importantly for the four corners rule, each of the separate claims for relief in the complaint expressly incorporated all the preceding allegations, so that the knowingly fraudulent scheme was reiterated constantly throughout the complaint in every claim. Other courts have determined that such a pleading style imports allegations of intentional injury into each claim, including the Wisconsin Court of Appeals in Baumann v. Elliott. There the court of appeals stated:

Elliott concedes that the “occurrence” prerequisite to personal injury coverage purports to afford coverage only for negligent defamation. No fair reading of this complaint reveals such a claim. Rather, the allegations assert intentional, willful, malicious defamation. In setting forth its second cause of action, defamation, para. 19 of the complaint specifically incorporates the allegations related to its first cause of action, which alleges intentional interference with EPS’ business relationships. Paragraph 19 is fatal to Elliott’s position that the complaint does not allege intent to defame because it makes clear that the first and second causes of action arise from the same set of facts.

Similarly, the Wisconsin Court of Appeals held in James Cape & Sons that the intentional injury exclusion barred coverage for causes of action for “negligence” that expressly incorporated the preceding factual allegations of intentional criminal conduct.

On the knowing violation exclusion, the supreme court’s Ixthus decision focused on what might have to be proved to recover, rather than what facts had been alleged:

The knowing violation exclusion will preclude coverage at the duty-to-defend stage only when every claim alleged in the complaint requires the plaintiff to prove the insured acted with knowledge that its actions “would violate the rights of another and would inflict ‘personal and advertising injury.’“ If the complaint alleges any claims that can be proven without such a showing, the insurer will be required to provide a defense.

….

Abbott’s claim for trademark dilution under Section 43(c) of the Lanham Act, 15 U.S.C. § 1125(c)(1)—a strict liability statute—does not require proof that Ixthus acted knowingly or intentionally.

….

Even though the complaint generally asserts Ixthus acted wrongfully and with knowledge that it was defrauding Abbott, West Bend is not relieved of its duty to defend because this complaint alleges at least one potentially covered advertising-injury claim, which does not depend on whether Ixthus acted with knowledge that it was violating Abbott’s rights or with knowledge that it was inflicting advertising injury …

West Bend had argued that the facts alleged were dispositive for duty to defend, and that theories of liability were not dispositive; rather, the facts alleged in the complaint were controlling. The supreme court had said so in Water Well, citing a number of decisions going back decades. Water Well relied on, for example, the supreme court decision in Doyle v. Engelke, which said, “In determining an insurer’s duty to defend, we apply the factual allegations present in the complaint to the terms of the disputed insurance policy.” The theories of liability, or the titles given to claims for relief or causes of action, should be immaterial. This concept has long been Wisconsin law, with courts sometimes stating that an insurance policy “does not insure against theories of liability.”

Other Wisconsin decisions similarly have espoused that view of the law. In James Cape, the court of appeals said, “The duty to defend arises from the allegations within the four corners of the complaint. Our focus is on the facts alleged, the incidents giving rise to the claims, not [plaintiff’s] theory of liability.” Wisconsin decisions have followed this maxim so consistently that even a complaint’s use of the word “negligence” or assertion of a negligence cause of action is not enough to outweigh factual allegations of intentional criminal conduct that preclude a duty to defend, so said James Cape: “the factually unsupported use of the term ‘negligence’ in [the] complaint, when measured against the extensive factual allegations of intentional criminal conduct, is insufficient to trigger [the] duty to defend” The supreme court’s Ixthus decision concluded, by contrast, that where a theory of liability, e.g., trademark dilution, does not require proof of intent, the allegations of intent are not significant for duty to defend analysis.

Thus, if the Ixthus decision were accepted at face value, it might now be necessary in determining duty to defend to look not only at all factual allegations, but then consider what subset of them – somewhat like a lesser included offense in the criminal law arena – might prove liability against the defendant. Insurers who receive a tender may now have to contemplate the law, the required elements of a cause of action, and assume only those minimally necessary facts have been alleged and not one fact more. This exercise in considering just some of the alleged facts is contrary to the simple, efficient and long standing application of the four corners rule, which Water Well explained:

We have applied the four-corners rule, without exceptions, in duty to defend cases for so long because it generally favors Wisconsin insureds. The rule ensures that courts are able to efficiently determine an insurer’s duty to defend, which results in less distraction from the merits of the underlying suit.

The four corners rule had required the parties to accept all the complaint allegations as a whole, true and dispositive. The court of appeals recently said “we must consider the complaint as a whole, and we do not isolate singular allegations” when deciding duty to defend. The courts and litigants should resist any effort to use the Ixthus decision to ignore alleged facts. The duty to defend should be based on the whole of what is alleged against an insured, the long held view of the four corners rule, not a select subset of the alleged facts that might be minimally sufficient to prove liability.

So when the insurer wants to challenge duty to defend based on its reading of the facts alleged in the complaint, and seek a declaration based on the four corners rule, what options are available when the underlying dispute is not pending in a Wisconsin Circuit Court, but rather in an arbitration?

II. State ex rel. CityDeck Landing LLC v. Circuit Court for Brown County

In the same month that the Ixthus decision was issued, the Supreme Court addressed the options available to an insurer seeking a duty to defend and indemnify declaration for an arbitration complaint in State ex rel. CityDeck Landing LLC v. Circuit Court for Brown Cty. (“CityDeck”). City Deck concerned insurance coverage for a general contractor and subcontractors in a commercial real estate construction project. The project owner, CityDeck, commenced an arbitration proceeding against the general contractor. The general contractor brought subcontractors into the arbitration. The general contractor also tendered to insurers of subcontractors seeking additional insured coverage.

Society, a liability insurer of one of the subcontractors, commenced a declaratory judgment action against the general contractor, the owner and its putative insured subcontractor. Society moved to stay the parties’ participation in the arbitration pending resolution of insurance coverage issues. No Wisconsin decision directly addressed the appropriate method for postponing decisions on the merits of claims made in an arbitration while insurance coverage disputes were resolved. The Wisconsin Supreme Court has frequently stated its preference for resolution of insurance coverage and duty to defend first, with a stay on proceedings concerning the putative insured’s liability and damages. The parties in at least one published decision involving duty to defend in an arbitration setting stipulated that the declaratory action on insurance coverage should proceed first, suggesting an implicit recognition of Wisconsin law and public policy preference that insurance coverage issues be addressed at the front end of the lawsuit.

The circuit court in CityDeck granted the stay on the arbitration proceeding until coverage was resolved. Society had already moved for summary judgment on insurance coverage, wanting to expedite a resolution.

CityDeck then filed a petition for supervisory writ in the court of appeals. The Wisconsin Court of Appeals construed it as a petition to appeal a non-final order and denied it.

The Wisconsin Supreme Court, however, took the supervisory writ, and concluded that the circuit court was without jurisdiction to stay the arbitration. The Supreme Court concluded:

Nothing in the statutes or the cases authorizes a circuit court to halt a private arbitration so that an insurance company can litigate whether its policy provides coverage to an insured. Although Wisconsin cases do allow insurance companies to bifurcate coverage from liability when both coverage and liability are being decided in the courts, see, e.g., Newhouse by Skow v. Citizens Sec. Mut. Ins. Co., 176 Wis. 2d 824, 836, 501 N.W.2d 1 (1993), no legal authority confers on a circuit court the power to interfere with a liability claim when the parties have contracted to resolve it in arbitration. An insurer may file a declaratory judgment action seeking a coverage determination when the insurer has not been named as a party in a lawsuit involving its insured, see, e.g., Fire Ins. Exch. v. Basten, 202 Wis. 2d 74, 78, 549 N.W.2d 690 (1996), but the declaratory judgment statute does not authorize a circuit court to obstruct a scheduled arbitration over the liability claims pending the circuit court’s coverage determination.

The CityDeck decision leaves insurers wishing to challenge duty to defend but yet wanting to adhere to Wisconsin decisions recommending stay as a preferred method a bit conflicted. The situation is not unlike that in Ixthus where intervention, stay and bifurcation seemed unlikely to be available in the federal court in New York a jurisdiction without the direct action statute and no developed historical familiarity with stays to facilitate coverage decisions. The insurer seeking a duty to defend ruling on an arbitration pleading can be stuck between a rock and hard place. If it commences a declaratory action in circuit court against interested parties in arbitration, then it will not get a stay under CityDeck. It might seek an injunction, but the elements required for such an injunction, including likelihood of success, might be difficult to establish. Alternatively, the insurer could seek to intervene in the arbitration and, if granted, pursue a duty to defend determination from the arbitration panel. Obviously, an insurer has no right to intervene in an arbitration because it typically is not a party to the contract that selected arbitration as a dispute resolution mechanism. Further, the insurer and the insured each possess “the right to have the court resolve the issue of coverage,” and therefore cannot be forced into arbitration. Wisconsin decisions have also recognized the importance of protecting parties from being compelled to arbitrate a dispute they did not agree to arbitrate.

Additionally, insurance coverage issues frequently pose questions of law to be resolved by the circuit court, with full right of appeal on questions of law to the court of appeals and perhaps the supreme court. Arbitration decisions, by contrast, are given deferential review, when reviewed at all, in the courts. The Wisconsin Supreme Court has noted that the scope of judicial review of an arbitration decision is very limited. Arbitrators have comparatively limited experience in addressing insurance coverage and duty to defend. Consenting to them making such decisions poses greater risk of unpredictability. The parties to the dispute have very limited ability to have a wayward decision reversed.

The good news for the insurer challenging duty to defend is that an inability to seek a stay in the arbitration setting is not fatal. Wisconsin decisions plainly allow for separate declaratory judgement actions, and have rejected the assertion that a stay is absolutely required. For example, in Carney v. Village of Darien, the Seventh Circuit Court of Appeals stated an immediate stay was not required, nor was an immediate declaratory judgement action, only that the insurer should request declaratory judgement, and then defend if ordered to do so:

There is clearly no support for appellants’ position that an insurer denying coverage must immediately initiate a declaratory judgment prior to any other party’s filing of such motion. All that is required of the insurer is to seek a court’s determination on the coverage issue, instead of refusing to defend based solely upon its own determination of coverage.

Clearly, the separate declaratory judgment action remains a viable option to address duty to defend, even if the underlying proceeding is an arbitration. The parties to a contract who have chosen arbitration, effectively precluding a stay, cannot complain if the insurer is thereby unable to get a stay.

Author Biography:

Jeff Leavell is a frequent lecturer and author, and has spoken to many Civil Trial Counsel of Wisconsin Conferences and Wisconsin Defense Counsel Conferences over the last two decades. He regularly represents insurers and other parties in duty to defend disputes, in Wisconsin and other states and federal venues. In the Wisconsin Supreme Court 2018-2019 term he argued four cases, including Ixthus and CityDeck.

Mr. Leavell is a Board Certified Civil Trial Specialist by the National Board of Trial Advocacy. He has been elected by his peers as “Superlawyer” every year since 2006. Jeffrey Leavell, S.C. has been recognized annually since 1995 by Martindale-Hubbell in its Bar Register of Preeminent Lawyers. He served on the Board of Governors of the Racine County Bar Association, and is past President of the Racine County Bar Association. He is past President of the Wisconsin Defense Counsel

Jeff Leavell was admitted to the Bar in 1983. He graduated from the University of Chicago, with honors, in 1980, and the University of Wisconsin Law School, J.D., cum laude, in 1983. He was judicial law clerk for the Wisconsin Court of Appeals District IV from 1983-1985.

West Bend Mut. Ins. Co. v. Ixthus Med. Supply, Inc., 2019 WI 19, 385 Wis. 2d 580, 923 N.W.2d 550.

State ex rel. CityDeck Landing LLC v. Circuit Court for Brown Cty., 2019 WI 15, 385 Wis. 2d 516, 922 N.W.2d 832.

Ixthus, 385 Wis. 2d 580.

Id. ¶ 26.

Id. ¶ 5.

Id. ¶¶ 4, 5, 18.

Id. ¶21.

Id. ¶¶ 4, 5, 18, 21, 36.

Plaintiff-Respondent-Petitioner West Bend Mutual Insurance Company’s Supreme Court Brief and Appendix, at p. 5 citing R.11, ¶ 7.

Id. at p. 4 citing R.11, ¶¶ 543, 558-59.

Id. at p. 23, 24 citing R.11, ¶¶ 543, 558-59.

Id. at p. 45 citing R.11, ¶¶ 563, 572, 579, 582, 587, 592, 597, 604, 616, 623, 626, 634, 641.

Ixthus, 385 Wis. 2d 580, ¶ 28. quoting Air Eng’g, Inc. v. Indus. Air Power, LLC, 2013 WI App 18, ¶ 24, 346 Wis. 2d 9, 828 N.W.2d 565.

Id. ¶ 3.

Id.

Id.

Plaintiff-Respondent-Petitioner West Bend Mutual Insurance Company’s Supreme Court Brief and Appendix, at p. 8.

Fire Ins. Exch. v. Basten, 202 Wis. 2d 74, 95, 549 N.W.2d 690 (1996) (“ the plaintiff and any other party who has brought a claim against the insured in the underlying lawsuit, is an ‘interested person’ for purposes of Wis. Stat. § 806.04(11) and required to be made a party to the separate declaratory judgment proceeding.”).

Plaintiff-Respondent-Petitioner West Bend Mutual Insurance Company’s Supreme Court Brief and Appendix, at p. 10 citing R.56, p. 15-16.

See West Bend Mut. Ins. Co. v. Ixthus Med. Supply, Inc., 2018 Wisc. App. LEXIS 355, ¶ 1, 2018 WI App 28, 381 Wis. 2d 472, 915 N.W.2d 456 (unpublished opinion).

Id. ¶¶ 18-20.

Fireman's Fund Ins. Co. v. Bradley Corp., 2003 WI 33, ¶¶ 52-53, 261 Wis. 2d 4, 660 N.W.2d 666 (“the relevant causation issue with regard to insurance coverage is not whether “the injury could have taken place without the advertising,” but “whether the advertising did in fact contribute materially to the injury.”) (quoting R.C. Bigelow, Inc. v. Liberty Mut. Ins. Co., 287 F.3d 242 (2d Cir. 2002)).

Abbott’s Second Am. Compl., R11:104 ¶ 426 R11:7 ¶ 5, found in appendix to Plaintiff-Respondent-Petitioner West Bend Mut. Ins. Co.’s Brief and Appendix, at p. A.

Id. R11 ¶ 15, 385, in Appendix at A59, A87.

Ixthus, 385 Wis. 2d 580, ¶¶ 18, 19, 20, 21.

Plaintiff-Respondent-Petitioner West Bend Mut. Ins. Co.’s Brief and Appendix, at p. 23-24 (citing Abbott’s Second Am. Compl., R:11 ¶¶7, 9, 388, 340, 568, 642).

Id.

Id. (citing Abbott’s Second Amended Complaint, ¶ 389, at Appendix p. A89).

Baumann v. Elliott, 2005 WI App 186, ¶ 12, 286 Wis. 2d 667, 704 N.W.2d 361; see also Callas Enterprises, Inc. v. The Travelers Indem. Co. of Am., 193 F.3d 952, 955 (8th Cir. 1999) (knowledge of falsity exclusion barred coverage because each claim for relief adopted by reference a preceding allegation of the insured’s knowledge) .

James Cape & Sons Co. v. Streu Constr. Co., 2009 WI App 154, 321 Wis. 2d 604, 775 N.W.2d 117.

Id. ¶¶ 12, 17-18.

Ixthus, 385 Wis. 2d 580, ¶¶ 29, 32, 36.

Water Well Sols. Serv. Grp. Inc. v. Consol. Ins. Co., 2016 WI 54, ¶ 20, 369 Wis. 607, 881 N.W.2d at 293.

Doyle v. Engelke, 219 Wis. 2d 277, 284, 580 N.W.2d 245 (1998) quoted in Water Well, ¶ 20.

Bankert v. Threshermen’s Mut. Ins. Co., 110 Wis. 2d 469, 478, 329 N.W.2d 150 (1983).

James Cape, 2009 WI App 154, ¶ 16, 321 Wis. 2d 6054, 775 N.W.2d 117.

Id. ¶ 18; see also C.L. v. School Dist. of Menomonee Falls, 221 Wis. 2d 692, 704-05, 585 N.W.2d 826 (Ct. App. 1998) (facts trumped the legal theories asserted and precluded coverage).

Water Well, 369 Wis. 2d 607, ¶ 25.

Grigg v. Aarrowcast, Inc., 2018 WI App 17, ¶ 46, 380 Wis. 2d 464, 909 N.W.2d 183.

CityDeck, 385 Wis. 2d 516.

Id. ¶ 2.

Id.

Elliott v. Donahue, 169 Wis. 2d 310, 318, 485 N.W.2d 403 (1992) (citing Mowry v. West Bend State Mut. Cas. Co., 129 Wis. 2d 496, 385 N.W.2d 171 (1986)); see also Newhouse v. Citizens Security Mut. Ins. Co., 176 Wis. 2d 824, 836, 501 N.W.2d 1 (1993).

See Family Mut. Ins. Co. v. Am. Girl, Inc., 2004 WI 2, ¶ 18, 268 Wis. 2d 16, 673 N.W.2d 65.

CityDeck, 385 Wis. 2d 516, ¶ 3.

Id. ¶ 4.

Id. ¶ 36.

Estate of Sustache v. Am. Fam. Ins. Co, 2008 WI 87, ¶ 26, 311 Wis. 2d 548, 751 N.W.2d 845.

See, e.g., First Weber Grp., Inc. v. Synergy Real Estate Grp., LLC, 2015 WI 34, ¶ 45, 361 Wis. 2d 496, 860 N.W.2d 498.

Orlowski v. State Farm Mut. Auto. Ins. Co., 2012 WI 21, ¶ 13, 339 Wis. 2d 1, 810 N.W.2d 775 (“The scope of judicial review of an arbitration decision is very limited”).

Id.

Carney v. Vill. of Darien, 60 F.3d 1273, 1277 (7th Cir. 1995).