Downey, Michael v. State Farm Fire

In the
United States Court of Appeals
For the Seventh Circuit

No. 00-3473

Michael Downey,

Plaintiff-Appellee,

v.

State Farm Fire & Casualty Co.,

Defendant-Appellant.

Appeal from the United States District Court
for the Central District of Illinois.
No. 98-1118--Michael M. Mihm, Judge.

Argued March 29, 2001--Decided September 17, 2001

Before Easterbrook, Rovner, and Diane P.
Wood, Circuit Judges.

Easterbrook, Circuit Judge. Michael
Downey lives on a hill in Peoria,
Illinois. His back yard runs downward at
a 35 angle, creating a dangr of soil
erosion that could compromise the
foundation of his house. A retaining wall
supported the soil, but in February 1997
heavy rain washed away the wall and much
of the soil that it had been retaining.
This in turn caused the house’s
foundation to shift and become unstable.
Fortunately (or so he thought) Downey had
purchased flood insurance. State Farm
Fire & Casualty Co., from which Downey
bought the policy, paid to fix cracks in
the foundation but denied indemnity for
the expense of stabilizing the house to
ward off collapse. Injury caused by the
failure of the retaining wall, State Farm
asserted, is excluded from coverage.
State Farm lost in the district court and
on appeal challenges the district judge’s
interpretation of the policy. Before
reaching the merits, however, we must
consider both subject-matter and
appellate jurisdiction.
Our ears pricked up at the assertion
that this suit belongs in federal court,
for a contract dispute between two
private parties typically does not arise
"under the Constitution, laws, or
treaties of the United States", 28 U.S.C.
sec. 1331, and the complaint does not
allege diversity of citizenship. State
Farm’s brief asserts that federal-
question jurisdiction exists but does not
explain why; Downey concurred in State
Farm’s presentation. Because the
presentations at oral argument were
unilluminating, we directed the parties
to file supplemental memoranda addressing
jurisdictional issues. Their responses
focus on the nature of the insurance.
Downey bought his policy through the
National Flood Insurance Program (nfip),
codified at 42 U.S.C. sec. sec. 4001-4129.
This national system of flood insurance
for residents of high-risk areas
regulates the transactions between Downey
and State Farm, and the parties offer
three reasons why the upshot is a
question within federal jurisdiction.

State Farm points to an explicit grant
of jurisdiction in 42 U.S.C. sec. 4053:

[U]pon the disallowance by any such
company or other insurer of any such
claim . . . the claimant, within one year
after the date of mailing of notice of
disallowance or partial disallowance of
the claim, may institute an action on
such claim against such company or other
insurer in the United States district
court for the district in which the
insured property or the major part
thereof shall have been situated, and
original exclusive jurisdiction is hereby
conferred upon such court to hear and
determine such action without regard to
the amount in controversy.

Although Downey is a "claimant" and State
Farm an "insurer", Downey’s action
against State Farm is not a "claim" under
sec. 4053--State Farm looked at the wrong
part of the statute. When Congress
created the nfip it gave the program’s
administrator two ways to execute the
program and discretion to choose between
them. The first method, the "Industry
Program," allows a pool of private
insurers to underwrite flood insurance
with financial backing from the
government. See 42 U.S.C. sec. sec. 4051-
56. The "Government Program," the second
option, allows the government to run the
nfip itself--offering federally
underwritten policies-- with the
potential for administrative assistance
from private insurers. See 42 U.S.C.
sec. sec. 4071-72. See Edward T.
Pasterick, The National Flood Insurance
Program, in Howard Kunreuther & Richard
J. Roth, Sr., eds., Paying the Price: The
Status and Role of Insurance Against
Natural Disasters in the United States
(1998), for an explanation of the nfip. In
1977 the Secretary of Housing and Urban
Development, who ran the nfip at the time
(it has since been taken over by the
Federal Emergency Management Agency),
decided that the Industry Program was
unworkable and ended it. He then
implemented the Government Program, which
has continued to the present. Section
4053, the grant of jurisdiction to which
State Farm points, enables only claims
brought "under this part"--the nfip as run
under the Industry Program. State Farm,
then, is 24 years too late to take
advantage of sec. 4053. Courts
occasionally make the same error. See
Froelich v. Catawba Insurance Co., 10 F.
Supp. 2d 597 (W.D. Va. 1998); Gagliardi
v. Omaha Property & Insurance Co., 952 F.
Supp. 212 (D. N.J. 1997). Like the
eleventh circuit, Newton v. Capital
Assurance Co., 245 F.3d 1306 (2001), we
avoid this pitfall.

Downey observes that the Government
Program has its own jurisdictional
provision, 42 U.S.C. sec. 4072:

In the event the program is carried out
as provided in section 4071 of this
title, the Director [of fema] shall be
authorized to adjust and make payment of
any claims for proved and approved losses
covered by flood insurance, and upon the
disallowance by the Director of any such
claim . . . the claimant . . . may
institute an action against the Director
on such claim in the United States
district court for the district in which
the insured property or the major part
thereof shall have been situated, and
original exclusive jurisdiction is hereby
conferred upon such court to hear and
determine such action without regard to
the amount in controversy.

Yet this section allows only "an action
against the Director". Downey sued State
Farm. He might have thought that State
Farm is the only proper defendant: In
1983 fema created the Write-Your-Own
Program (wyop), which allows private
insurers to issue and administer flood-
risk policies under the Government
Program. The private insurers also defend
suits arising from the policies. 44
C.F.R. sec. 62.23(d). Perhaps Downey
figured that, because he contracted with
State Farm, he had to sue State Farm.
Neither party appears to have noticed 44
C.F.R. sec. 62.22, which permits suits
against the Director of fema arising from
decisions made by wyop insurance
companies. This regulation effectively
allows a direct action against the person
who is ultimately responsible, rather
than the wielder of delegated authority.
But Downey sued State Farm rather than
the Director and is stuck with that
choice. Section 4072 does not mention the
wyop or indicate that anyone other than
the Director may be sued under this grant
of jurisdiction.

Nonetheless, Downey insists, with the
support of Van Holt v. Liberty Mutual
Fire Insurance Co., 163 F.3d 161 (3d Cir.
1998), that, because "a suit against a wyo
company is the functional equivalent of a
suit against fema", we should look past
the caption of this case and pretend that
the Director is the defendant. This
position is not without force: fema
provides a standard text for all nfip
policies and forbids wyop companies from
making changes; fema’s interpretations of
the policy bind all wyop participants;
fema decides what rates may be charged;
all premiums are remitted on to fema
(minus a small fee); if wyop companies pay
out on a claim they get reimbursed by
fema; likewise with litigation costs. See
generally 42 U.S.C. sec. 4081; 44 C.F.R.
sec. sec. 62.23-62.24. So although private
insurers issue the policies, fema
underwrites the risk. The insurance
companies handle administrative business
for fema by selling policies and
processing claims but do little else
(unlike the Industry Program, where the
private companies underwrite the risks).
Arrangements like this make sense. fema
likely is unsuited to tasks such as
selling insurance and collecting fees,
and even less adept at processing
individual claims for flood damage. By
purchasing the services of a more
efficient claims processor, fema saves
money. We see a similar structure in the
Medicare program: Health care providers
seek reimbursement, not directly from the
government but from "fiscal
intermediaries"--usually private
insurance companies--that act as the
claims processor in the government’s
stead. See Your Home Visiting Nurse
Services, Inc. v. Shalala, 525 U.S. 449
(1999).

In a sense, then, State Farm is a place-
holder for fema, but does this fact have
jurisdictional significance? Downey might
have something if for jurisdictional
purposes courts typically look to see who
will be affected by a decision; but we
don’t. This would be clear enough in an
ordinary tort dispute between two
Illinois citizens. If the plaintiff in
such a suit agreed to pay any proceeds
from the judgment to an out-of-state
insurance company (who, let’s say, in
return agreed to pay his medical bills),
would a court peek behind the formality
of the non-diverse parties and recognize
that those who truly have something to
gain or lose--the insurance company and
the Illinois defendant--are diverse?
Surely not. Nor do courts look past
corporate form to the citizenship of the
shareholders or other investors. There is
a special rule for administrators of
estates, 28 U.S.C. sec. 1332(c)(2), but
normally the status of the named litigant
governs--provided that the litigant is an
entity rather than a name for an
unincorporated association such as a
partnership. See Carden v. Arkoma
Associates, 494 U.S. 185 (1990); Indiana
Gas Co. v. Home Insurance Co., 141 F.3d
314 (7th Cir. 1998). For example, the
citizenship of a trustee rather than the
trust beneficiary is dispositive under
sec. 1332. Navarro Savings Association v.
Lee, 446 U.S. 458 (1980). Downey cannot
escape the same conclusion: Although a
judgment against State Farm may come out
of the federal treasury--creating a
federal interest--the only litigants are
in the private sector. Because we see no
good reason to disregard not only the
identity of the litigants but also the
fact that sec. 4072 is limited to suits
against the Director, we decline to adopt
Van Holt’s reasoning. (For purposes other
than jurisdiction the economic incidence
of the decision sometimes matters.
Compare Montana v. United States, 440
U.S. 147 (1979) (for purposes of claim
preclusion courts may look behind the
nominal parties to a suit), with Regents
v. Doe, 519 U.S. 425 (1997) (for purposes
of sovereign immunity courts should look
exclusively at the parties).)

This is not the end of the
jurisdictional inquiry, however.
Sometimes the federal interest in a
controversy is so dominant that federal
law applies--activating federal-question
jurisdiction under sec. 1331--even if the
national government is not a party. See
National Farmers Union Insurance Cos. v.
Crow Tribe of Indians, 471 U.S. 845
(1985). The fifth circuit has held, see
West v. Harris, 573 F.2d 873 (1978), that
because the nfip is a federal program,
uniform judicial interpretations of the
standard insurance policies are
necessary. Every other circuit that has
considered this issue has followed West’s
approach either explicitly or implicitly.
See Linder & Associates, Inc. v. Aetna
Casualty & Surety Co., 166 F.3d 547 (3d
Cir. 1999); Flick v. Liberty Mutual Fire
Insurance Co., 205 F.3d 386 (9th Cir.
2000); Newton, supra (11th Cir.). Cf.
Atlas Pallet, Inc. v. Gallagher, 725 F.2d
131 (1st Cir. 1984); Leland v. Federal
Insurance Administrator, 934 F.2d 524
(4th Cir. 1991); Berger v. Pierce, 933
F.2d 393 (6th Cir. 1991); Nelson v.
Becton, 929 F.2d 1287 (8th Cir. 1991). We
assumed the same result in Sodowski v.
National Flood Insurance Program, 834
F.2d 653 (7th Cir. 1987), and now so
hold.

In 1978, when West was decided, most
judges assumed a nation-wide program
automatically leads to federal common
law. Atherton v. FDIC, 519 U.S. 213
(1997), has complicated matters. Atherton
considered the question whether federal
law provides the standard of care in
derivative litigation involving the
directors and officers of a federally
chartered lending institution. Although a
federal statute was also at issue, the
Court first considered and rejected the
proposition that federal common law could
displace the state rule for the internal
affairs of corporate entities, holding
that, although an imperative of
uniformity is enough to call for federal
common law, the federal nature of a
program alone does not demonstrate a need
for uniformity. That analysis applies
equally here. Neither the parties to this
appeal nor any case we could find
articulate any reason for uniformity of
interpretation other than the very one
Atherton rejected. None even takes notice
of Atherton.

Not proscribed by Atherton is a narrower
ground for applying federal common law.
Clearfield Trust Co. v. United States,
318 U.S. 363 (1943), establishes that,
when the duties or rights of the United
States are at stake under a federal
program, that federal interest requires
the application (and if necessary the
creation) of federal law. For example,
United States v. Kimbell Foods, Inc., 440
U.S. 715 (1979), considered what law
governs the priority of liens that secure
federal agencies’ loans to private
parties. The Court reasoned, citing
Clearfield Trust, that the liens
implicated the agencies’ rights under
federal programs created by "specific
Acts of Congress", which meant that
federal law had to apply--though the
Court then borrowed that federal law from
state law. See also United States v.
Little Lake Misere Land Co., 412 U.S. 580
(1973). Typically the United States is a
party to disputes that call for federal
law under the approach of Clearfield
Trust. See, e.g., Priebe & Sons v. United
States, 332 U.S. 407 (1947); United
States v. Standard Oil Co., 332 U.S. 301
(1947). But there is no reason to view
that condition as a necessity. If fema
were the defendant in our case, we would
have no doubt that federal law applied:
Just like the agencies in Kimbell Foods,
fema runs a federal program, and because
it bears the risk on all nfip contracts,
fema’s duties are at issue whenever an nfip
policy is interpreted. Replacing "fema"
with "State Farm" in the caption of the
case changes nothing; a judgment against
State Farm and a judgment against fema
have identical effects: fema pays. And
though we were concerned with the formal
parties to this action when we
interpreted sec. 4072, here we are
concerned with the federal interest
invoked by the dispute’s subject matter.

The federal interest is no less here
than in Turner/ Ozanne v. Hyman/Power,
111 F.3d 1312 (7th Cir. 1997), which
applied federal common law to a dispute
between two contractors in a construction
project for the United States Postal
Service. Hyman/Power, the general
contractor, agreed in its contract with
the usps to indemnify the agency for any
on-the-job injuries. Turner/Ozanne, the
usps’s on-site overseer for the project,
then sought indemnification from
Hyman/Power on the theory that as a
"representative" of the usps it should be
treated as the usps. Although the dispute
affected only private rights--the Postal
Service had nothing to lose or gain--we
held that, because Turner/Ozanne invoked
a protection it had negotiated with the
United States and because both parties
were involved in an ongoing federal
project, a federal question was present.
Today’s disagreement presents both
characteristics-- Downey contends that he
bought protection from the government
through a federal program--and here the
government coffer is at risk. That is
enough to justify the application of
federal law to the dispute, which means
that subject-matter jurisdiction arises
under sec. 1331.

Having assured ourselves that this
dispute was properly before the district
court, we now must inquire whether State
Farm can ask us for relief. In two orders
the district court held that the policy
covers Downey’s claim. At this point only
the calculation of damages remained for
the district court to accomplish. State
Farm then offered to allow judgment in
Downey’s favor in the amount of
$186,360.54. See Fed. R. Civ. P. 68.
Downey accepted, and at the parties’
joint request the district court then
entered a final judgment against State
Farm expressly reserving "State Farm’s
right to pursue an appeal from the
[liability] orders of this Court".

An agreement among the parties to enter
a judgment may create nothing adverse
from which to appeal. How can State Farm
contend that it is aggrieved by a
judgment that it consented to? Appeals
are taken not from issues but from
judgments. See California v. Rooney, 483
U.S. 307 (1987). Parties often stipulate
to issues such as damages once the
district court resolves liability, but an
agreement on a specific issue differs
from asking the court to enter judgment,
which winds up the case itself. In
criminal cases courts allow conditional
guilty pleas (with the district judge’s
consent) followed by appeal on a reserved
issue, because Fed. R. Crim. P. 11(a)(2)
expressly allows such a tactic, but the
civil rules do not have a parallel
provision. One might think, therefore,
that if a judgment is not contested in
the district court then the adversarial
process has ended and the court of
appeals has no role to play.
 Yet for jurisdictional purposes there is
no distinction between "consent" and
"adversarial" judgments. Judgments are
judgments, and any party can appeal as of
right from a final decision adverse to
his interests. So says 28 U.S.C.
sec. 1291, which allows appeal from "all
final decisions of the district courts".
Finality is the necessary and sufficient
condition. Distinguishing between final
judgments entered with the consent of
both parties and final judgments entered
against one party’s wishes would create
an extrastatutory condition on appeal.
This has little to recommend it, and the
possibility has been rejected by the
Supreme Court. See Pacific R.R. v.
Ketchum, 101 U.S. 289, 295 (1880).
Ketchum interpreted an earlier version of
the statute, but the critical language
has survived. See INB Banking Co. v. Iron
Peddlers, Inc., 993 F.2d 1291 (7th Cir.
1993), applying Ketchum to the current
version of sec. 1291.

State Farm is not home free, however.
Although the Supreme Court has held that
"consent judgments" are final and
appealable under sec. 1291 (so appellate
jurisdiction is secure) the Court has
added that the act of giving consent
usually waives the consenting party’s
right to review, leading to affirmance
"without considering the merits of the
cause." Nashville, Chattanooga & St.
Louis Ry. v. United States, 113 U.S. 261,
266 (1885). See also Swift & Co. v.
United States, 276 U.S. 311 (1928);
United States v. Babbitt, 104 U.S. 767
(1882); Association of Community
Organizations for Reform Now v. Edgar, 99
F.3d 261 (7th Cir. 1996). Waiver affects,
not a court’s power to hear the case, but
whether as a practical matter it has any
job to do. So did State Farm waive its
right to appellate consideration? Both
the Offer of Judgment and the district
court’s judgment reserved State Farm’s
right to challenge the liability
determination. A reservation of rights is
incompatible with waiver. See Cutting v.
Jerome Foods, Inc., 993 F.2d 1293 (7th
Cir. 1993); Hudson v. Chicago Teachers
Union, 922 F.2d 1306 (7th Cir. 1991).
Almost every circuit that has considered
the issue has held that an express
reservation of the right to appeal avoids
waiver of contested issues that had been
resolved earlier in the litigation. See
BIW Deceived v. Local S6, 132 F.3d 824
(1st Cir. 1997); Keefe v. Prudential
Property & Casualty Insurance Co., 203
F.3d 218 (3d Cir. 2000); Cohen v.
Virginia Electric & Power Co., 788 F.2d
247 (4th Cir. 1986); Slaven v. American
Trading Transportation Co., 146 F.3d 1066
(9th Cir. 1998); Mock v. T.G. & Y. Stores
Co., 971 F.2d 522 (10th Cir. 1992);
Shores v. Sklar, 885 F.2d 760 (11th Cir.
1989) (en banc). Only the fifth circuit
gives no effect to an express reservation
of appellate rights. See Amstar Corp. v.
Southern Pacific Transport Co., 607 F.2d
1100 (5th Cir. 1979). Amstar, however,
offered no explanation of its holding and
so gives us no reason to doubt our own
conclusion: State Farm preserved its
rights, and we may reach the merits.

The parties came to blows over many
issues in the district court, but on
appeal only one dispute remains: Does
Downey’s nfip policy cover the cost of
shoring up the soil around his house
after the retaining wall failed at the
task? The 1997 storm (which the parties
now agree caused a "flood" under the
policy) washed away the retaining wall
and a lot of soil. According to David
Maurer, a structural engineer whose
opinion State Farm does not contest, this
removal of soil from the northwest corner
of the house led to cracks in the
foundation and caused the western
exterior wall to tilt outward. Because
that wall bears the weight of the second
story bedroom, the tilt created, in
Maurer’s opinion, a "danger of partial
collapse unless the movement [was]
stopped." Maurer recommended the changes
that Downey implemented and for which he
now seeks reimbursement-- installing
gabion baskets and rocks in the hillside
and injecting grout into the ground
underneath the house. State Farm paid to
fix the cracks in the house but insists
that rendering the house stable and safe
for occupancy is outside the scope of the
contract.

The nfip policy covers only Downey’s
"dwelling" and explicitly excludes from
coverage "[f]ences, retaining walls,
seawalls, bulkheads, wharves, piers,
bridges, and docks." (Emphasis added.)
State Farm argues that this clause
relieves it of obligation to indemnify
not only damage to a retaining wall but
also damage to a house caused by damage
to a retaining wall. The district court
found little to support this reading.
Neither do we. The policy covers "any
loss [to the dwelling] in the nature of
actual loss of or physical damage,
evidenced by physical changes, to the
insured property . . . which is directly
and proximately caused by a flood".
(Emphasis deleted.) State Farm does not
contend that the "physical changes" to
the house were not symptomatic of
"physical damage" and likewise makes no
argument that the flood was not a
proximate cause of that damage. End of
story. If there is physical damage to the
house, and that damage was caused by a
flood, how can the policy not provide
coverage? State Farm does not contend
that the repairs Downey made were
unjustifiable or excessive (for the
parties settled all disputes about the
amount of indemnity, if any is
available). The retaining-wall exclusion
is irrelevant. It puts no limitation on
what types of flood damage to a house are
covered. Had Downey installed a new
retaining wall, the policy would not
cover the expense. But he didn’t; he
fixed his house.

This understanding still leaves meaning
in the retaining-wall exclusion: If the
flood caused damage to the retaining wall
with no loss of stability to the house,
the policy would not cover the loss. If
the retaining wall had supported a barn
rather than Downey’s bedroom, the policy
would not cover the loss. Remember that
this policy is a standard form for use by
all nfip participants. It must, therefore
address as many complications as
possible; not all provisions will be
relevant to every property owner. So the
exclusion has plenty of work to do--just
not in this situation. There is, however,
no more work for us to do: the repairs
Downey undertook to stabilize his house
are covered by the policy, and State Farm
must pay up. The parties settled all
other differences in the district court.

Affirmed