A common question in insurance coverage litigation is whether the injured plaintiffs in the underlying litigation are necessary parties to the coverage case. A recent, detailed opinion from Judge Fox in the Eastern District of North Carolina squarely deals with this issue and lays out a roadmap for dealing with the issue in future cases. Judge Fox concludes that the underlying plaintiffs are not necessary parties to the coverage action. Whether the plaintiffs from the underlying litigation are necessary to the insurance coverage action - between the defendant from the underlying action and its insurance company - has broad implications for many procedural questions, as well as strategic implications.
In Scottsdale Ins. Co. v. B&G Fitness Center, Inc., 2015 WL 4641530 (Aug. 4, 2015 E.D.N.C.), the defendant had been sued by five plaintiffs in two separate lawsuits regarding alleged surreptitious video recording in the tanning bed area of a gym (the “Underlying Actions”). Scottsdale, the insurer, then filed a declaratory judgment action in federal court, seeking a declaration that there was no coverage under its insurance policy for the torts alleged in the Underlying Actions.
The defendant, the policyholder gym who had been sued in the Underlying Actions, moved to dismiss the case under Federal Rule of Civil Procedure 12(b)(7) for the failure to join the five individual plaintiffs from the Underlying Actions as co-defendants, arguing that these were necessary parties to the insurance declaratory judgment action under Rule 19.
The Court first explained that whether a party is indispensable under Rule 19 requires a two-step inquiry. The party must be “necessary” under Rule 19(a) and if the “necessary” party cannot be joined, the party has to be determined to be “indispensable” under Rule 19(b). The moving party – here, the gym defendant – bears the burden of showing that the missing party is indispensable. The gym argued that the underlying plaintiffs were both necessary and indispensable because under Rule 19(a)(1)(B)(i) they claimed an interest in the action and that interest would be defeated or impeded by the failure to join them to the coverage action.
Judge Fox concluded that the underlying plaintiffs were, “at best, incidental beneficiaries to the insurance contract at issue” and because they were not parties to the insurance contract and did not already have a judgment against the gym, they lacked standing to have the insurance contract construed. See also, Whittaker v. Furniture Factory Outlet Shops, 145 N.C. App. 169, 172 (2001). “Without having obtained a judgment or settlement against [the gym], the third party claimants have no legal rights under the insurance contract. Because the third party claimants lack a recognized legal interest in this action, they cannot be necessary parties.” B&G Fitness Center, Inc., at *4. Judge Fox further concluded that, even if the plaintiffs from the Underlying Actions had an interest in the coverage litigation, it was aligned with the gym – they both were seeking insurance coverage under the Scottsdale policies – and thus the gym would adequately represent the interests in maximizing the insurance recovery available for the plaintiffs. In other words, only “when the insured was not actively defending the lawsuit” or is subject to a default judgment is it proper to hold that the absent third-party is indispensable. Id. at *5. But as a normal matter, “the insured’s position protects the interest of the absent party because both parties want the insurance to be viable.” Id.,citing CFI Wis. Inc. v. Hartford Fire Ins. Co., 230 F.R.D. 552, 554 (W.D. Wis. 2005).
The question of whether underlying plaintiffs must be joined in the coverage action has to be considered in every coverage action. And, the outcome of this determination may be different in different jurisdictions. There are a number of federal cases from other jursidictions which hold that absent third-party tort plaintiffs are required to be joined under Rule 19. B&G Fitness is ongoing and it remains to be seen whether Judge Fox’s decision will be appealed or reviewed by the Fourth Circuit.
This question also has major implications for whether the coverage action can even succeed in federal court. Sometimes, a single federal district court may not be able to obtain personal jurisdiction over (1) the insurer, (2) the insured, and (3) the underlying tort plaintiffs. Even if a federal district court has adequate personal jurisdiction, insurance coverage litigation in federal court is typically premised on diversity jurisdiction under 28 U.S.C. § 1332. In some cases, that diversity jurisdiction only exists in the absence of the underlying plaintiffs; i.e., if the underlying plaintiffs have to be joined as indispensable parties under Rule 19, and joinder destroys diversity, then the coverage action can only be litigated in state court. Those facts typically arise when the policyholder sues the insurance company, joining the underlying tort plaintiffs as defendants in the coverage action. Of course in that case, the insurance company could move to have the parties re-aligned to reflect the true adverse interests in the suit, in which case diversity may exist. See, e.g., Earnest v. State Farm Fire and Cas. Co., 475 F.Supp.2d 1113, 1117 (N.D. Ala 2007).