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Ellis v. Arrowood Indemnity Co.

United States District Court, E.D. Kentucky, Southern Division, Pikeville

June 23, 2014

JAMES A. ELLIS, et al., Plaintiff,
v.
ARROWOOD INDEMNITY COMPANY, Defendant.

MEMORANDUM OPINION & ORDER

AMUL R. THAPAR, District Judge.

When a Kentucky judicial commission concluded that Judge Joseph F. Bamberger had engaged in unethical behavior while on the bench, its decision set in motion an unintended cascade of events. Among the casualties was a settlement agreement between plaintiffs James A. Ellis and his architecture firm (collectively, the "Ellis Parties") and two law firms that once represented them. Eight years later, a resolution remains elusive for the parties, now joined by defendant Arrowood Indemnity Company ("Arrowood"). Seeking to bring matters to a close, the Ellis Parties and Arrowood have filed cross-motions for summary judgment. For the reasons discussed below, the Court will grant the Ellis Parties' motion and deny Arrowood's motion.

BACKGROUND

The story begins with a malpractice claim. The Ellis Parties sued two law firms, seeking money damages for their failure to pursue various causes of action. Ellis v. Caudill, No. 2006-SC-660, 2007 WL 1790397, at *1 (Ky. June 21, 2007). The presiding state court judge, Judge Bamberger, divided the case into two phases, holding a jury trial over the issue of damages first. Id. The jury found that if the case had been litigated, the Ellis Parties could have achieved a verdict of at least three million dollars. Id. Soon thereafter, the defendants moved for a new trial, citing evidence that Judge Bamberger and the Ellis Parties' trial consultant had an impermissibly close relationship. Id. Judge Bamberger recused himself, and the parties eventually settled all matters and signed a written agreement (the "Settlement Agreement"). Id. at 2. Arrowood's predecessor distributed $3.965 million (the "settlement funds") to the Ellis Parties pursuant to the Settlement Agreement. Id .; see R. 81-3. But new and even more damning evidence of a business relationship between Judge Bamberger and the trial consultant soon emerged. Ellis, 2007 WL 1790397, at *2. A new judge, Judge John David Caudill, took over, and in 2006 he set aside the Settlement Agreement to protect the integrity of the judicial process. Id.; R. 81-5. The court ordered the parties to participate in mediation, R. 81-5; see R. 82-11, to no avail. Eventually, in 2012, the Ellis Parties and the law firms finally reported that they had reached some sort of settlement. R. 81-9. Arrowood and the Ellis Parties dispute the terms of this settlement.

In late 2012, citing Arrowood's alleged refusal to permit the parties to reach a settlement, the Ellis Parties sued Arrowood for bad faith and deceptive trade practices in violation of the Kentucky Unfair Claims Settlement Practices Act ("UCSPA"). R. 1-1 at 7-9. After removing the case to federal court on diversity grounds, R. 1, Arrowood eventually filed two counterclaims, R. 8; R. 28. In its first counterclaim for restitution, Arrowood alleges that the Ellis Parties never returned the settlement funds-despite having no legal right to the funds after Judge Caudill set aside the Settlement Agreement. R. 28 at 12. Arrowood also argues that the parties never subsequently reached a settlement that would entitle the Ellis Parties to retain the funds. Id. at 12-13. Arrowood's second counterclaim is for breach of contract, based on the same facts. Id. at 13-15.

DISCUSSION

After completing the bulk of discovery, the parties filed cross-motions for summary judgment. R. 81; R. 82. Arrowood moved for summary judgment on the merits of its counterclaims and the Ellis Parties' bad faith claims. R. 81-1. The Ellis Parties, for their part, proposed three grounds for summary judgment on Arrowood's counterclaims: Kentucky's applicable statutes of limitations, the doctrine of laches, and Arrowood's lack of standing to file its counterclaims. R. 82-1 at 9. The motions present highly interrelated arguments; for example, the substance of the Ellis Parties' motion for summary judgment also appears in their response to Arrowood's motion for summary judgment. For this reason, the Court will consider both motions simultaneously.

I. Judge Caudill's Order Held that the Settlement Agreement Was Void Ab Initio.

The outcome of several of the parties' grounds for summary judgment hinges on one key question: What was the legal effect of Judge Caudill's decision to set aside the Settlement Agreement? The state court's order contains little explanation. It says only that "the integrity of the judicial process requires that [the] dismissal order be vacated, that the settlement agreement [be] set aside, and that the jury verdict reached in November 2004 be set aside." R. 82-11 at 3. The puzzle is, essentially, whether Judge Caudill declared the contract void ab initio or merely terminated a valid contract when he "set aside" the Settlement Agreement. Kentucky precedent indicates that Judge Caudill's order had the former effect.

The Court has not uncovered a clear statement by the Kentucky courts of the legal consequences of "setting aside" a settlement agreement. An investigation of Kentucky case law shows that setting aside a settlement agreement is extremely rare, except in the realms of family law and workers' compensation.[1] In those fields, the Kentucky courts appear to use the term to describe the act of throwing out a settlement agreement because no true meeting of the minds ever occurred-essentially a finding that the settlement agreement was void from the outset. E.g., Kendrick v. Bailey Vault Co., Inc., 944 S.W.2d 147, 150 (Ky. Ct. App. 1997) (setting aside a settlement agreement due to mutual mistake or constructive fraud). Of course, family law and workers' compensation are governed by specialized statutory schemes, which affect how Kentucky courts treat settlement agreements in those contexts. See, e.g., Ky. Rev. Stat. ยง 403.180 (permitting courts to find divorce-related settlement agreements unconscionable). The Court must therefore draw on other, more generally applicable evidence to interpret Judge Caudill's order.

In the absence of settlement-specific cases to provide guidance, basic principles of contract law, as applied to the circumstances of this case, must govern. See Humana, Inc. v. Blose, 247 S.W.3d 892, 895 (Ky. 2008) ("Settlement agreements are a type of contract and therefore are governed by contract law." (internal quotation marks omitted)). Under Kentucky law, courts may hold contracts or contractual provisions void and unenforceable if they violate public policy. Wehr Constructors, Inc. v. Assurance Co. of Am., 384 S.W.3d 680, 688 (Ky. 2012); see also S.J.L.S. v. T.L.S., 265 S.W.3d 804, 821 (Ky. 2008) (collecting cases). The legislature is chiefly responsible for establishing public policy, but in the absence of a legislative decree the courts may also adopt and apply public policy principles. Wehr Constructors, 384 S.W.3d at 687-88. A contract that "seriously offends... public policy" is "void ab initio. " Commonwealth v. Whitworth, 74 S.W.3d 695, 700 (Ky. 2002) (citing Black's Law Dictionary 1568 (7th ed. 1999)).

Judge Caudill's order, as best construed, fits this mold. The order reflects a policy of preventing judicial bias and misconduct from affecting the rights of innocent parties appearing before the Kentucky courts. As the order stated, Judge Bamberger's conduct- which violated the Canons of Judicial Conduct-cast "reasonable doubt on his capacity to act impartially as a judge" and "gave the appearance of impropriety." R. 82-11 at 2 (quoting a ruling by the Judicial Retirement and Removal Commission). This so tainted the "settlement born from a bifurcated trial over which Judge Bamberger presided" that "the integrity of the judicial process" required the court to set aside both the jury verdict on damages and the Settlement Agreement. Id. at 3. In other words, even if the parties properly negotiated at arms' length and reached an agreement containing terms that might otherwise be fair, the unethical judicial backdrop against which they negotiated rendered the Settlement Agreement unenforceable. And, based on the principles of Kentucky law discussed above, this meant that the Settlement Agreement was never enforceable, even if the parties initially believed they were operating under a binding contract.

II. Arrowood's Breach of Contract Claim Fails Because No Contract Between the Parties Exists.

Due to the result just reached, Arrowood's breach of contract counterclaim must fail. Under Kentucky law, to prove breach of contract, a plaintiff must demonstrate: (a) The existence of a contract, (b) a breach of one of the contract's terms, and (c) damages flowing from the breach of the contract. Adler v. Elk Glenn, No. 12-85, 2013 WL 6632057, at *1 (E.D. Ky. Dec. 17, 2013) (citing Barnett v. Mercy Health Partners-Lourdes, Inc., 233 S.W.3d 723, 727 (Ky. Ct. App. 2007)). Arrowood's theory is this: The Ellis Parties breached the Settlement Agreement when they withdrew their promise to release Arrowood from ...


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