Gateway Residences at Exch., LLC v. Ill. Union Ins. Co.

PUBLISHED

UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT

No. 18-1491

GATEWAY RESIDENCES AT EXCHANGE, LLC,

Plaintiff − Appellant,

v.

ILLINOIS UNION INSURANCE COMPANY, d/b/a ACE American Insurance
Company, d/b/a ACE Environmental, d/b/a Ace USA, d/b/a ACE USA Companies,

Defendant – Appellee.

Appeal from the United States District Court for the Eastern District of Virginia, at
Alexandria. Liam O’Grady, District Judge. (1:17-cv-00629-LO-JFA)

Argued: December 12, 2018 Decided: February 28, 2019

Before AGEE, DIAZ, and HARRIS, Circuit Judges.

Affirmed by published opinion. Judge Diaz wrote the opinion, in which Judge Agee and
Judge Harris joined.

ARGUED: C. Thomas Brown, SILVER & BROWN, Fairfax, Virginia, for Appellant.
Douglas Aaron Winegardner, SANDS ANDERSON, PC, Richmond, Virginia, for
Appellee. ON BRIEF: Eric B. Lawson, SILVER & BROWN, Fairfax, Virginia, for
Appellant.
DIAZ, Circuit Judge:

Having been awarded more than $900,000 for a contractor’s faulty workmanship,

Gateway Residences at Exchange, LLC, sued to collect the judgment from the

contractor’s liability insurer, Illinois Union Insurance Company. The relevant policy,

however, covered only claims reported to the insurer during the policy period, and that

policy expired 19 months before Illinois Union learned about Gateway’s claim.

That should end this case. But Gateway claims it may nonetheless recover on the

policy because, by Virginia statute, Illinois Union waived certain defenses by failing to

promptly inform Gateway of its coverage denial. See Va. Code Ann. § 38.2-2226. The

district court was unpersuaded and, for reasons that follow, we affirm.

I.

A.

This insurance dispute started with two broken generators in an Alexandria,

Virginia, apartment complex. Gateway, the building’s owner, had hired a local

contractor, Mechanical Design Group (MDG), to provide various engineering and design

services. Among MDG’s jobs was to install two “life and safety power generators” in the

garage. J.A. 208. MDG apparently didn’t install the generators very well, though, for

when they started up in August 2014, they caught fire, wrecking the generators and

delaying the 217-unit building’s opening.

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 Blaming MDG for the damage, Gateway demanded that its contractor “cure the

negligent design and installation” of the generators. J.A. 209. But it didn’t sue MDG, at

least initially. And in September 2014, MDG went out of business.

Before starting work on the Gateway project, MDG had bought liability insurance

from Illinois Union. Under the policy, Illinois Union had agreed to indemnify MDG for

legal claims that might arise from the Gateway job. The front page of the policy advised

that it provided liability coverage “ON A CLAIMS-MADE AND REPORTED

BASIS,” meaning that it covered “ONLY CLAIMS FIRST MADE AGAINST THE

INSURED AND REPORTED TO THE INSURER, IN WRITING, DURING THE

POLICY PERIOD.” J.A. 256 (typeface in original). To further stress the point, the

policy made it a “condition precedent to coverage” that any claim be reported to the

insurer during the policy period. J.A. 259. The policy period began on February 1, 2014,

and ended one year later on February 1, 2015. 1

MDG apparently never told Illinois Union about Gateway’s potential claim before

its insurance policy expired in 2015. Instead, Illinois Union first heard about the

generator incident on September 6, 2016, after Gateway notified MDG’s insurers that it

intended to sue. Ten days later, Gateway sued MDG in Virginia state court alleging

negligence and breach of contract.

1
The policy also provided a 60-day “extended reporting period,” subject to
various conditions. J.A. 269. These provisions have no bearing on this appeal.

3
 In early October 2016, MDG learned that Illinois Union had denied it coverage for

Gateway’s claim. The denial letter, sent by Chubb North American Claims “on behalf

of” Illinois Union, 2 explained that because the claim was first reported in September

2016 there was “no coverage for this matter as no claims were made and reported during

the policy period.” J.A. 294, 296. A couple of weeks later, Gateway’s counsel received a

copy of Illinois Union’s denial letter from MDG’s insurance broker. Chubb, however,

didn’t contact Gateway directly about its coverage denial until January 23, 2017.

In the meantime, Gateway’s lawsuit against MDG proceeded in state court. MDG

never appeared, so the court entered a default judgment awarding Gateway $910,148 in

damages and $22,580 in costs and attorneys’ fees.

B.

Having obtained this judgment, Gateway filed the present lawsuit seeking to

collect from Illinois Union under MDG’s liability policy. Gateway first sued in Virginia

state court, but Illinois Union removed the case to the U.S. District Court for the Eastern

District of Virginia, invoking that court’s diversity jurisdiction. (Gateway is a citizen of

Virginia and Maryland, whereas Illinois Union is a citizen of Pennsylvania and Illinois.)

Gateway moved unsuccessfully to remand. See Gateway Residences at Exch., LLC v. Ill.

Union Ins. Co., No. 1:17-cv-629, 2017 WL 7805743, at *2 (E.D. Va. Sept. 11, 2017).

Following discovery, the district court granted summary judgment to Illinois

Union because its policy didn’t cover claims first reported after the policy period ended

2
Illinois Union’s parent company, ACE USA, merged with Chubb in 2016.

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in February 2015. The court also rejected Gateway’s contention that Illinois Union had

waived this noncoverage argument because it gave Gateway untimely notice of its denial.

Gateway Residences at Exch., LLC v. Ill. Union Ins. Co., No. 1:17-cv-629,

2018 WL 1629107, at *2–4 (E.D. Va. Apr. 3, 2018). This appeal followed.

II.

Gateway challenges the district court’s refusal to remand the case and its entry of

judgment in Illinois Union’s favor. We have reviewed both issues de novo and find no

error.

A.

Gateway first argues that the district court lacked subject matter jurisdiction and

should have remanded this case to Virginia state court. It contends that the present suit is

a “direct action” against an insurer and that Illinois Union therefore assumes the

citizenship of its insured under 28 U.S.C. § 1332(c)(1). Were that true, the court would

lack diversity jurisdiction because both Gateway and Illinois Union’s insured, MDG, are

citizens of Virginia. We disagree, however, that Gateway’s lawsuit is a “direct action.”

Federal courts have original jurisdiction over suits for more than $75,000 between

“citizens of different States.” 28 U.S.C. § 1332(a)(1). For diversity jurisdiction

purposes, a corporation is a citizen of any state in which it is incorporated, plus the state

or foreign country “where it has its principal place of business.” Id. § 1332(c)(1). But

§ 1332(c) has an extra citizenship rule for insurance companies. Namely:

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 [I]n any direct action against the insurer of a policy or contract of liability
insurance . . . to which action the insured is not joined as a party-defendant,
such insurer shall be deemed a citizen of . . . every State and foreign state of
which the insured is a citizen.

Id. § 1332(c)(1)(A). In other words, if a plaintiff brings a “direct action” against a

wrongdoer’s liability insurer, the insurer assumes the citizenship of the insured. Kong v.

Allied Prof’l Ins. Co., 750 F.3d 1295, 1299 (11th Cir. 2014).

On its face, this language sweeps broadly, potentially covering any lawsuit in

which a third party sues a liability insurer over its insured’s conduct. But the unanimous

understanding of our sister circuits has been that “direct action” as used in § 1332(c) has

a much narrower meaning. Specifically, it refers to a suit in which the plaintiff sues a

wrongdoer’s liability insurer without joining or first obtaining a judgment against the

insured. Kong, 750 F.3d at 1300; accord Hyland v. Liberty Mut. Fire Ins. Co., 885 F.3d

482, 484–85 (7th Cir. 2018); Rosa v. Allstate Ins. Co., 981 F.2d 669, 675 (2d Cir. 1992);

Beckham v. Safeco Ins. Co. of Am., 691 F.2d 898, 901–02 (9th Cir. 1982); see Velez v.

Crown Life Ins. Co., 599 F.2d 471, 473 (1st Cir. 1979); Henderson v. Selective Ins. Co.,

369 F.2d 143, 149 (6th Cir. 1966); see also 7A Couch on Insurance § 107:4 (3d ed.

updated 2018) (collecting additional cases).

Section 1332(c)’s legislative history strongly supports this reading. In 1964,

Congress added language to the diversity jurisdiction statute to address “direct action”

lawsuits allowed by the laws of Louisiana and Wisconsin. See S. Rep. No. 88-1308, at

1–2 (1964); see also Velez, 599 F.2d at 473. Under these laws, a plaintiff may sue a

tortfeasor’s liability insurer without joining the tortfeasor as a defendant and establish

6
both the insured’s liability and the insurer’s obligation in a single suit. See La. Stat. Ann.

§ 22:1269(B); Wis. Stat. Ann. § 632.24. Such statutes often created federal diversity

jurisdiction when the insurer’s citizenship was different from the plaintiff’s. And as a

result, what were essentially tort disputes between local residents would end up in federal

court. See H.R. Rep. No. 88-1229, at 1–2 (1964); cf. Lumbermen’s Mut. Cas. Co. v.

Elbert, 348 U.S. 48, 56–57 (1954) (Frankfurter, J., concurring) (bemoaning “direct

action” forum-shopping). In response, Congress amended § 1332(c) to provide that the

defendant insurer adopts the insured’s citizenship in such cases, thereby destroying

diversity and ensuring that the merits of the tort claim would be resolved in state court.

Given this provision’s background, we agree with the Eleventh Circuit that the

“key feature” of a direct action is “the plaintiff’s ability to skip suing the [tortfeasor] and

sue directly his insurance carrier.” Kong, 750 F.3d at 1300–01 (internal quotation marks

omitted). When a plaintiff must either join the local tortfeasor or first obtain a separate

judgment against it, the lack of diverse citizenship forces the state tort claim into state

court. It’s only when the plaintiff skips this step and sues the insurer directly that the

concerns behind Congress’s “direct action” amendments are implicated. See Kong, 750

F.3d at 1300–01 (no direct action when plaintiff sued insurer after obtaining judgment

from insured); Hyland, 885 F.3d at 485 (same).

Under this definition, Gateway’s lawsuit is not a direct action. Virginia doesn’t

have a direct action statute but instead requires a third-party claimant to first obtain a

judgment against the insured. The claimant may then sue the insurer on the policy to

collect the judgment. Va. Code Ann. § 38.2-2200; Richmond, Fredericksburg, &

7
Potomac R.R. Co. v. Hughes-Keegan, Inc., 152 S.E.2d 28, 33–34 (Va. 1967). And that is

just what happened here. Gateway obtained a default judgment against MDG in state

court then sued to collect that judgment under Illinois Union’s liability policy. Gateway

did not (and could not) skip the tortfeasor, the insured. Its present lawsuit is therefore not

a direct action within the meaning of § 1332(c)(1).

Gateway’s arguments do not persuade otherwise. First, it notes that we have

previously used the words “direct action” to describe, under Virginia law, a lawsuit

against an insurer to enforce a judgment against its insured. See Morrel v. Nationwide

Mut. Fire Ins. Co., 188 F.3d 218, 221–22 (4th Cir. 1999). But in Morrel, we used “direct

action” in the generic sense of a lawsuit filed against an insurer. We did not consider

whether such a suit fits the technical meaning of § 1332(c). Second, Gateway points us

to a sprinkling of district court cases holding that suits like this one are direct actions

because they essentially do “in two steps” what Louisiana’s and Wisconsin’s statutes “did

in one.” See, e.g., Sherman v. Pa. Lumbermen’s Mut. Ins. Co., 21 F. Supp. 2d 543, 544–

45 (D. Md. 1998) (quoting Prendergast v. All. Gen. Ins. Co., 921 F. Supp. 653, 655 (E.D.

Mo. 1996)). But these cases, as the weight of contrary circuit precedent shows, are

plainly wrong. It is precisely the first step of suing the insured tortfeasor (or, for that

matter, the simultaneous step of joining it as a party) that funnels the tort suit into state

court and thus eases Congress’s jurisdictional and forum-shopping concerns.

This lawsuit, in sum, is not a direct action for purposes of § 1332(c)(1), and

Illinois Union therefore does not adopt MDG’s Virginia citizenship. Because this lawsuit

8
instead pits a Virginia plaintiff against an Illinois defendant, the district court had

diversity jurisdiction and rightly refused to remand to state court.

B.

On the merits, the district court awarded summary judgment to Illinois Union

because its policy covered only claims made and reported during the policy period and

Gateway’s claim wasn’t reported until well after the policy had expired. Gateway’s main

contention on appeal is that, under a Virginia statute, Illinois Union waived that argument

by failing to inform Gateway of its coverage denial within 45 days of receiving the claim.

Illinois Union, in response, says the relevant statute doesn’t apply in this case.

Gateway’s waiver argument invokes Virginia Code Section 38.2-2226. Under this

statute, an insurer that wants to defend against a third-party claimant based on its

insured’s breach of the underlying policy must notify the claimant of that intention.

Specifically, it provides that:

Whenever any insurer on a policy of liability insurance discovers a breach
of the terms or conditions of the insurance contract by the insured, the
insurer shall notify the claimant or the claimant’s counsel of the breach.
Notification shall be given within forty-five days after discovery by the
insurer of the breach or of the claim, whichever is later.

Va. Code. Ann. § 38.2-2226. Failure to give the required 45 days’ notice “will result in a

waiver of the defense based on such breach to the extent of the claim by operation of

law.” Id.

The statute’s text makes two things clear: it covers denials based on the insured’s

“breach” of the terms and conditions of the policy and applies to arguments properly

characterized as waivable “defenses.” Courts have therefore rightly held that that the

9
statue (or its precursor) doesn’t apply when an insurer denies coverage because the claim

falls outside the scope of policy coverage. See Cheatham v. NGM Ins. Co., No.

3:12cv263-HEH, 2013 WL 509049, at *5 (E.D. Va. Feb. 11, 2013); Berry v. State Farm

Mut. Auto Ins. Co., 340 F. Supp. 228, 231 (E.D. Va. 1972); Jackson v. Middleton, 90 Va.

Cir. 279, 2015 WL 10765161, at *3–4 (Va. Cir. Ct. 2015). The argument that a claim is

outside the scope of coverage is not about an insured’s “breach” of contract. A “breach”

assumes a legal duty on the insured’s part, but the insured obviously has no legal duty to

incur covered claims. Likewise, a denial based on scope of coverage is not a “defense,”

as a “defense” presupposes the insurer’s existing obligation to provide coverage.

With this understanding, we conclude that the statute doesn’t apply in this case.

Illinois Union hasn’t denied coverage because of MDG’s breach. Rather, it asserts—

correctly—that the present claim is simply not covered by the policy.

As the policy’s bold, all-caps preface makes clear, Illinois Union sold MDG a

“claims-made-and-reported” policy. This is a type of “claims-made” policy, which

differs from an ordinary “occurrence” policy in the type of risk it insures. An occurrence

policy insures against a specific occurrence (say, a car accident or building fire), and

usually doesn’t depend on when the claim itself is filed. In contrast, under a claims-made

policy, the making of the claim itself is the peril being insured. First Am. Title Ins. Co. v.

Cont’l Cas. Co., 709 F.3d 1170, 1174 n.2 (5th Cir. 2013). Coverage usually attaches to a

claim made during the policy period regardless of when the events underlying the claim

took place. Id. See generally 7 Couch, supra, § 102:22 (describing different liability

policies).

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 Claims-made-and-reported policies, like the one Illinois Union sold MDG, are a

distinct brand of claims-made policies. A claims-made-and-reported policy usually

“requires the claim both be made against the insured and reported to the insurer during

the policy period.” Sherwood Brands, Inc. v. Great Am. Ins. Co., 13 A.3d 1268, 1282

(Md. 2011). If no claim is reported, no coverage is triggered, even if the events

underlying the claim took place during the policy period. And after the policy expires,

“the insurer’s potential liability ends.” T.H.E. Ins. Co. v. P.T.P. Inc., 628 A.2d 223, 227

(Md. 1993) (quoting St. Paul Fire & Marine Ins. Co. v. House, 554 A.2d 404, 418 (Md.

1989) (Murphy, C.J., dissenting)).

We do not think Virginia Code Section 38.2-2226 applies when, as here, an

insurer denies coverage under a claims-made-and-reported policy because no claim was

reported during the policy period. Illinois Union’s potential liability under this policy

ended when it expired in February 2015, so the policy simply can’t cover a claim first

reported to the insurer a full 19 months later in September 2016. Illinois Union is

therefore not raising a “defense based on [an insured’s] breach.” Va. Code. Ann. § 38.2-

2226. There was no “breach” because, after February 2015, there was no policy to be

breached; there is no “defense” because, after February 2015, Illinois Union had no

coverage obligation to defend against. See T.H.E., 628 A.2d at 227, 230 (holding, under

similar Maryland statute, that denial of claim made after expiry of claims-made-and-

reported policy “resulted from the terms of coverage” and “is not attributed to a ‘breach’”

by the insured); Minn. Lawyers Mut. Ins. Co. v. Baylor & Jackson, PLLC, 531 F. App’x

312, 325 (4th Cir. 2013) (Thacker, J., dissenting) (“If [the act triggering coverage]

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occurred after the expiration of the liability policy . . . there is simply no policy which the

insured can breach when it fails to notify the insurer of the claim.”). Because Illinois

Union’s argument is based on noncoverage, and not on MDG’s breach, Section 38.2-

2226 does not apply. 3

Besides being textually awkward, Gateway’s reading of Section 38.2-2226 would

have the policy embrace claims it was never intended to cover. In a claims-made-and-

reported policy, the condition that claims be reported during the policy period is an

essential part of the bargain between insurer and insured. See Chas T. Main, Inc. v.

Fireman’s Fund Ins. Co., 551 N.E.2d 28, 29–30 (Mass. 1990). For the insurer, claim-

triggering reporting allows it to “close its books on a policy at its expiration and therefore

attain a level of predictability unattainable under standard occurrence policies.” First

Am., 709 F.3d at 1175 (internal quotation marks omitted). In exchange, the insurer may

accept a lower premium from the insured than it would for an occurrence policy with

enduring liability. Id.; Stine v. Cont’l Cas. Co., 349 N.W.2d 127, 131 (Mich. 1984).

3
Gateway puts heavy stock in Section 38.2-2226’s use of the phrase “terms or
conditions” and language in Illinois Union’s policy that makes reporting a claim during
the policy period a “condition precedent to coverage.” J.A. 259 (emphasis added). But
Gateway’s focus on this single word ignores the broader statutory language. The statute
applies only to “conditions” that can plausibly be “breached,” and where the breach of
such conditions could rightly be understood as a “defense” to coverage. That is not true
about the reporting condition in a claims-made-and-reported policy. See Sherwood
Brands, 13 A.3d at 1288 (where notice of claim under claims-made policy occurs only
after expiration, “this non-occurrence of the condition precedent to coverage is not a
‘breach of the policy’”).

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 Applying Section 38.2-2226 as Gateway urges, however, would expand the policy

to confer benefits that MDG didn’t pay for and that Illinois Union never agreed to

provide. Though Virginia’s legislature clearly designed Section 38.2-2226 to override

certain defenses, we doubt it intended the statute to effectively rewrite basic coverage

terms of insurance contracts. Cf. Burns v. Int’l Ins. Co., 929 F.2d 1422, 1424–25 (9th

Cir. 1993) (declining, for this reason, to apply a similar California rule to a claims-made

policy); Zuckerman v. Nat’l Union Fire Ins. Co., 495 A.2d 395, 405–06 (N.J. 1985)

(same under New Jersey law).

Gateway’s effort to shoehorn this dispute into Section 38.2-2226 misconstrues the

insurance contract at issue. Gateway says its demand on MDG in August 2014 triggered

coverage under the policy and obligated MDG to report that claim to its insurer. MDG’s

failure to make that report, Gateway says, was a “breach of the reporting condition.”

Appellant’s Br. at 30. But under Illinois Union’s claims-made-and-reported policy, the

act triggering coverage was not Gateway’s 2014 demand, as Gateway claims, but rather

the communication of that claim to Illinois Union, which didn’t happen until well after

the policy expired.

This case might come out quite differently had MDG reported Gateway’s demand

in 2014, or had MDG instead bought an occurrence policy. In those scenarios, coverage

under the policy would likely have been triggered, leaving Illinois Union to defend,

perhaps, because MDG didn’t give prompt enough notice or failed to fully cooperate with

the insurer. In similar circumstances, courts have required notice under the statute at

issue. See Morrel, 188 F.3d at 226–27 (insurer waived defense based on insured’s failure

13
to assist); Fed. Ins. Co. v. Nationwide Mut. Ins. Co., 448 F. Supp. 723, 725–26 (waived

defense based on insured’s failure to notify “as soon as practicable”). But those are not

the facts of this case. Here, MDG bought a claims-made-and-reported policy and

reported no claim to Illinois Union during the policy period. MDG did not “breach” the

policy by not reporting Gateway’s 2014 demand any more than one breaches a fire

insurance policy by incurring damage from a flood.

Applying the text of the statute to the policy terms MDG and Illinois Union agreed

to, we hold that Section 38.2-2226 does not apply to Illinois Union’s denial of coverage.

Illinois Union may therefore deny Gateway coverage despite allegedly failing to give

notice. And since the policy by its clear terms does not cover Gateway’s post-

termination claim, summary judgment for Illinois Union was proper. 4

III.

We hold that the district court had subject matter jurisdiction and properly

awarded summary judgment in Illinois Union’s favor. The judgment of the district court

is therefore

AFFIRMED.

4
Given our holding, we do not decide whether Illinois Union complied with
Virginia’s notice statute because Gateway received actual (though indirect) notice of the
denial less than 45 days after making its claim.

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