Federal Abstention in Sixth Circuit Declaratory Judgment Coverage Litigation

By David J. Oberly, Esq.*

As the sophistication and complexity of insurance contracts continues to rise, disputes between insurers and their insureds regarding the existence and/or extent of coverage have become much more commonplace. While the majority of insurance coverage disputes are creatures of state law, the Federal Declaratory Judgment Act, 28 U.S.C § 2201, allows litigants to obtain a judicial determination in federal court regarding the rights and obligations owed by insurers to their insureds in coverage disputes. However, due to the “unique and substantial discretion in deciding whether to declare the rights of litigants” that has been afforded to district court judges, litigating a coverage action in a federal forum is anything but automatic. Rather, the availability of federal declaratory relief is significantly curtailed by the discretionary authority of the federal courts to turn down a lawsuit that is properly in its jurisdiction. Armed with an intricate understanding of this unique procedural aspect of the federal judicial system, insurers can utilize this significant leeway that district courts maintain to pick and choose the requests for declaratory relief that are added to their dockets to steer their coverage disputes directly to their forum of choice.

The Declaratory Judgment Act provides that, “[i]n a case of actual controversy within its jurisdiction, *** any court of the United States, upon the filing of an appropriate pleading, may declare the rights and other legal relations of any interested party seeking such declaration, whether or not further relief is or could be sought.” The Act is an enabling act, which confers discretion on the court rather than an absolute right upon the litigant. The Declaratory Judgment Act’s textual commitment to discretion, and the breadth of leeway that the federal courts have always understood it to suggest, distinguish the declaratory judgment context from other areas of law in which concepts of discretion surface. Federal district courts have “unique and substantial discretion in deciding whether to declare the rights of litigants. “

Importantly, with the Declaratory Judgment Act, Congress created an opportunity, not a duty, to grant relief to qualifying litigants. The exercise of jurisdiction under the Declaratory Judgment Act is not mandatory, and “at times the better exercise of discretion favors abstention.” District courts possess discretion in determining whether and when to entertain an action under the Declaratory Judgment Act, even when the suit otherwise satisfies subject matter jurisdictional prerequisites. With that said, this discretion is not without its limits. Rather, “sound administration of the Declaratory Judgment Act calls for the exercise of judicial discretion, hardened by experience into rule.”

The Sixth Circuit has identified five factors to guide the exercise of discretion. The factors, which come directly from Moore’s Federal Practice, are intended to be helpful guidelines that summarize prior case law. District courts in the Sixth Circuit consider these five non-exclusive factors in the course of exercising their discretion. These factors—often called the Grand Trunk factors, after the case that introduced the list in the Sixth Circuit—are: (1) whether judgment would settle the controversy; (2) whether the declaratory judgment action would serve a useful purpose in clarifying the legal relations at issue; (3) whether the declaratory remedy is being used merely for the purpose of “procedural fencing” or “to provide an arena for a race for res judicata;” (4) whether the use of a declaratory action would increase the friction between our federal and state courts and improperly encroach on state jurisdiction; and (5) whether there is an alternative remedy that is better or more effective.

The Sixth Circuit has often applied the first factor—settling the controversy—to declaratory judgment actions by insurance companies to determine policy liability with inconsistent results. One line of cases holds that this issue is limited to consideration of whether a declaratory relief action will settle the insurance coverage issue not being addressed in the underlying state court action. The other line of cases has required that the declaratory judgment action settle the underlying controversy in state court. Cases fit within one of the two categories based on two factors: (1) whether all parties are joined to both actions; and (2) whether the issues in the federal declaratory judgment action are also before the state court. Declaratory judgment plaintiffs who join all relevant state parties to the federal action may be able to settle the controversy in federal court. Under this scenario, the declaratory judgment is able to resolve all controversies between the federal declaratory plaintiff/insurer, the state court plaintiff injured party and the state court defendant insured. This scenario favors the federal court obtaining jurisdiction where the state court, for its part, is unable to resolve the coverage controversy because the federal plaintiff/insurer is not a party to the state action. When, however, the declaratory plaintiff fails to join a relevant party to the federal declaratory judgment action, the action cannot settle the controversy. In insurance coverage cases, this typically occurs when the declaratory plaintiff/insurer sues only the insured party, omitting the injured party. In that situation, any judgment in the federal court would not be binding as to the state court plaintiff and could not be res judicata in the state court action.

In Western World Ins. Co. v. Hoey, the Sixth Circuit was recently afforded the opportunity to resolve this split, but declined to do so. Rather, it held that district courts could follow either line of cases. The only guidance that the court provided was that “a district court would be wise to decline jurisdiction over a declaratory judgment action if it involved novel, unsettled, or complex issues of state law; if there were evidence of procedural fencing; or if the sought-after declaration would somehow be frivolous or purely advisory.”

The second factor—clarifying the legal relations—is closely related to the first factor and is often considered in connection with it. If, under the first factor, the declaratory judgment will settle the controversy, it will also, almost of necessity, clarify the legal relations at issue. The question is slightly more complicated where the declaratory judgment action does not entirely settle the controversy. In the Sixth Circuit, as with the first factor, a split in precedent exists with respect to the second factor. The first line of cases holds that the district court’s decision must only clarify the legal relationships presented in the declaratory judgment action. By contrast, the second line of cases holds that the district court’s decision must clarify the legal relationships in the underlying state action.

The third factor—procedural fencing—is intended to preclude jurisdiction for declaratory plaintiffs who file their suits for the purpose of acquiring a favorable forum. The Sixth Circuit has instructed, however, that courts should be reluctant to impute an improper motive to a declaratory plaintiff when there is no supporting evidence in the record. At the same time, the Sixth Circuit has agreed with one district court’s conclusion that, although there was no evidence of bad faith filing, because the state court had to consider the same issue raised in federal court, this indicated the declaratory plaintiff’s attempt to obtain a favorable ruling in federal court rather than risk an unfavorable state court result.

The fourth factor—federal/state court friction—concerns whether the use of a declaratory action would increase friction between federal and state courts and improperly encroach upon state jurisdiction. To analyze this factor, the Sixth Circuit has delineated three sub-factors for consideration: (1) whether the underlying factual issues are important to an informed resolution of the case; (2) whether the state trial court is in a better position to evaluate those factual issues than the federal court; and (3) whether there is a close nexus between the underlying factual issues and legal issues and state law and/or public policy, or whether federal common or statutory law dictates a resolution of the declaratory judgment action.

Under the final factor—alternative remedies—the district court evaluates the alternative remedies available to the federal declaratory plaintiff. This factor asks whether there exists an alternative remedy that is better or more effective than the requested declaratory judgment. One of the alternative remedies available is to seek a declaratory judgment in state court. In this regard, the Sixth Circuit has noted its concern regarding declaratory judgments in federal court when the only question is one of state law and when there is no suggestion that the state court is not in a position to define its own law in a fair and impartial manner.

The Sixth Circuit has never indicated how these five Grand Trunk factors should be balanced. With that said, the Sixth Circuit has indicated that district courts should consider three guiding principles: efficiency, fairness and federalism. Courts have never assigned weights to the factors when considered in the abstract, and rightly so—the factors are not, of course, always equal. For example, a relatively efficient declaratory judgment (factors 1, 2 and 5) could very well be inappropriate if hearing the case would be unfair (factor 3) or would offend the bundle of principles generally labeled as “federalism.” Instead, the relative weight of the underlying considerations of efficiency, fairness and federalism, as well as the five more targeted Grand Trunk factors, will depend on the facts of the case.

In the insurance context, district courts routinely adjudicate cases involving insurance carriers seeking a declaratory judgment in federal court regarding the scope of coverage when their insureds have been sued for alleged tort liability in state court. In this context, the Sixth Circuit has repeatedly held that declaratory judgment actions seeking an advance opinion on indemnity issues are seldom helpful in resolving an ongoing action in another court. While there is not a per se rule against exercising jurisdiction in actions involving insurance coverage questions and insurance contract interpretation, the potential danger of federal courts treading on states’ efforts to regulate insurance companies has led the Sixth Circuit to hold on a number of occasions that a district court should have stayed or dismissed complaints as to their underlying state court lawsuits. However, if no significant or unique issues of state insurance law exist, state courts ostensibly have no greater interest in deciding the lawsuit than a federal court, as both courts are equally able to declare the rights and obligations of the parties under the insurance contract.

Insurers must remain cognizant of the ability of federal district courts to exercise their discretion and abstain from exercising jurisdiction over a declaratory judgment action, not only when it institutes litigation seeking a judicial determination as to the rights and obligations owed by it to its insured, but also when the insurer is on the receiving end of a request for declaratory relief filed against it by the insured. When pursuing a declaratory judgment in a federal forum, before filing suit or removing the action from state court, the insurer must ensure that the facts and circumstances of its coverage litigation fit within the contours of the five-factor Grand Trunk test such that a district court will likely find that the exercise of its discretionary jurisdiction is appropriate. Once that determination has been made, the insurer should devise a strategy to take advantage of the federal forum by focusing on framing its issues and claims in a manner that maximizes the likelihood of maintaining federal jurisdiction. On the flipside, when responding to a federal declaratory judgment action—whether it be the result of the insured’s filing of a complaint or the removal of a pending state court action—an insurer who favors litigating the coverage lawsuit in state court should challenge the federal suit through the declaratory judgment abstention doctrine. Done properly, insurers can utilize these abstention principles to pave the way for coverage disputes to be litigated in the forum that increases the chances of obtaining a favorable outcome in a wide range of actions where declaratory relief is sought.

*Dave, an associate in our Cincinnati, Ohio office, can be reached at 513.372.6817 or djoberly@mdwcg.com.

_{Defense Digest, Vol 21, No. 4, December 2015}

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