### In the 

# United States Court of Appeals For the Seventh Circuit

____________________ No. 14

- 3341

E DWARD T. J OYCE & A SSOCIATES , P.C., Plaintiff

- Appellant
,

v

.

P ROFESSIONALS D IRECT I NSURANCE C OMPANY , Defendant

- Appellee

.

____________________ Appeal from the United States District Court for the Northern District of Illinois , Eastern Division

. No. 13 CV 2475

— Charles R. Norgle
, Judge

.

____________________
A RGUED A PRIL 16, 2015

— D ECIDED M ARCH 21, 2016

____________________

Before B AUER , E ASTERBROOK , and S YKES , Circuit Judges

. S YKES , Circuit Judge

. The Illinois law firm of Edward T. Joyce & Associates, P.C.
, purchased professional

- liability insurance from Professionals Direct Insurance Com pany , a Michigan

- based insurer

. In 2007 t he Joyce fir m won a large damages award for a class of securities

- fraud plaintiffs and hired another law firm to sue to collect the money from the2 No. 14

- 3341

defendant’ s insurers. Some of the class members t hought the Joyce firm should have handled this aspect of the litigation itself under the terms of its contingency

- fee agreement . The class members too k the firm to arbitration over the extra fees incurred in the satellite collection litigat ion

. Professionals Direct paid for the Joyce firm’s defense in the arbitration . But when t he arbitrator found for the clients and ordered the firm t o reimburse some of the fees they had paid , the insurer refused the firm’s demand for indemnif ic ation. The Joyce firm initiat ed c overage litiga tion in state
court , which the insurer promptly removed to federal court

. Ruling on cross

- motions for summary judgment, t he district judge sided with the insurer, concluding that the arbitration award was a “sanction” un der the insurance policy’s excl usion (o), which excludes coverage for “fines, sanctions, penalties , punitive damages or any damages resulting from the multiplication of compensatory damages.”

We affirm
, though on a different rationale. The arbitr ation awa rd was not functionally a sanction , so e xclusion (o) does not apply. But another provision in the p olicy excludes

“ claim [ s ] for legal fees , costs or disbursements paid or owed to you.” Because t he arbitration award adjusted the atto rney’s fees owed to the firm in the underly ing securities

- fraud class action , th e “legal fees” exclusion applies. I. Background

P rofessionals Direct issued a professional

- liability in su rance policy to the Joyce firm promising to pay “ all sums which you [the firm] become legally obligated to pay as damages because of any claim or claims first made againstNo. 14

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you.” 1 The policy defines “ claim ” as “a demand or suit for money or services you receive, including any arbitration proceedings .” Eligible claims a re those “aris[i ng] out of the rendering of or the failure to render professional services .” And “p rofessional ser vices ” include “services you [ the Joyce firm ] render in a lawyer

- client relationship as a lawyer, mediator, arbitrator, notary public, administrator, conserv ator, receiver, executor, guardian, trustee, or in any similar fiduciary capacity.”

“D amages ” are defined as “monetary judgments, awards or settlements unless otherwise excluded .” (Emphasis added

. ) To that end, the policy lists 27 exclusions, two of which are relevant here . Exclus ion (o) excludes coverage for “any claim for fines, sanctions, penalties, punitive damages or any damages resulting from the multiplication of compensatory damages .” Exclus ion (p) ex cludes coverage for “an y claim for legal fees, costs or disb ursements paid or owed to you.”

A . The Securities

- Fraud Class Action

In 2002 a class of plaintiffs retained the Joyce firm to prosecute a securities

- fraud action against EPS Solu tions Corporation and Enterprise Profit S olutions Corporation (collectively, “EPS”). Under t he retainer agree ment, the Joyce firm would receive a $200,000 flat fee and 25% of any award or settlement
, plus reimbursement of costs

. The agreement permitted the Joyce firm to retain local coun sel outsi de Illinois if the firm deemed such assistance necessary, with

1 B olded words appear as they do in the policy and are terms specially defined in section (D) of the p olicy.4 No. 14

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any resulting third

- par ty legal fees to be treated as costs under the agreement.

In 2007 the Joyce firm won a substantial arbitration award against EPS. By that point, however, EPS had become insolvent , and its insurers were t he only source of funding to collect on the award

. This is where the dispute between the firm and its client s arose. T he Joyce f irm thoug ht it had fully satisfied its oblig ations under the terms of the original retainer agreement by securing the arbitration award . The firm recommended the retention of Morgan, Lewis & Bockius LLP , a California law firm, to handle the collection litigation ag ainst EPS’s insu rers. The clients, however

— or at least a large subset of the class that later pursu ed a claim against the Joyce firm

— thought the firm should have continued to represent them under the terms of the original retainer agreement. Regardless, th e Joyce firm arranged for Morgan Lewis and later Reed Smith LLP to pursue the insurance litigation. Because of its “intimate knowledge of the facts and legal th eories ,” the Joyce firm assisted in the litiga tion on an hourly

- fee basis, with payment deferred until and only if there was an actual recovery. The case ultimately settled when EPS’s insurers agreed to pay $8

. 6 million

. B . The Arbitration Demand by the Class Members In January 2011 Walter Duemer, a plaintiff in the se cur ities

- fraud class action , filed a d emand for a rbitration against the Joyce firm on behalf of roughly 90% of his fellow plai ntiffs

. He a lleg ed claims for breach of fiduciary duty, wron gful conversion of client trust funds, and breach of contract. The cla ims centered on the Joyce firm ’s ret ention of theNo. 14

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Morgan Lewis and Reed Smith firms to handle the satellite litigation against EPS’s insurers

. 2 The Joyce firm denied any wrongdo ing and retained counsel to defend it in the arbitr ation
, forwarding counsel’s invoices to P rofessional D irect for payment

. T he insurer agreed to pay for the firm ’s defense under a reservation of rights and paid the invoices as they were submitted . (There were two exceptions, which we’ll discuss later.)

Th e arbitrator rejected the conversion and breach

- of

contract claims but found the Joyce firm liable for breach of fiduci ary duty in the manner in which it had arrange d for the two outside firms to handle the satellite litigation

. More

s pecifically, the arbitrator found t hat the Joyc e firm did not make “up front full disclosure about the change in legal representation” and that the new fee arrangement “was presented [to the cl ients ] as already accomplished,” sugges ting “an element of undue influence about the purported negoti ation o f a new fee agreement.” As a remedy, the arbitrator sought to unwind some of the additional attorney’s fees incurred by the Duemer claimants in the satellite litigation

. The arbitrator ordered the Joyce firm to remit the $405,674.87 in fees it had charged fo r consultative work with Morgan Lewis and Reed Smith. And because the original retainer agreement had called for a 75/25 client/attorney split of any recovery yet the clients had footed the entire bill for the satellite litigation , the arbitrator

2 The arbitration demand also challenged the acceptance of a settlement offer of $8.6 million

— $400,000 below the $9 million threshold authorized by the plaintiffs. This claim was not part of the arbitrator’s final award and is immaterial to this appeal.6 No. 14

- 3341

also ordered the Joyce firm to pay 25% of the fees charged by Morgan Lewis and Reed Smith . T his a dd ed $150,127.15 to the award

. Finally
, the arbitrator ordered the firm to pay $72,725.45 to offset the costs incurred in the arbitration. The Joyce firm unsuccessf ully challenged the arbitration award in Illinois state court on grounds unrelated to this appeal

. The firm was thus on the hook for $628 ,527.47. At this point P rofessionals D irect balked and refused to pay the award , relying on exclusions (o) and (p) in t he policy (among other policy defenses)

. The Joyce firm filed suit in state court seeking a declar ation that the insurer had breached its duty to indemnify.
P rofessionals D irect removed the action to federal court based on diversity jurisdiction

. See 28 U. S.C. § 1332. On

cross

- motions for summary judgment, t he district court honed in on the arbitrator’s use of the word “sanction” to describe the final award against the Joyce firm . Since “claims for ... sanctions” are expressly excluded from coverage under exclusion (o) of the policy , the judge held that the insurer owed no indemnification duty and entered summary judgment for P rofessionals D irect

. This appeal by the Joyce firm followed.

II. Discussion The primary question in this case is how to classify the arbitration award won by the Duemer claimants: I s it a sanction, the return of disputed fees, or simply damages? If the award qualifies as a sanction
, then exclusion (o) knocks out coverage. If the award is an adjustment of disputed legal fees, then exclu sion (p) applies and the result is the same. IfNo. 14

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the arbitrator awarded ordinary compensatory damages, then Professionals Direct may be required to pay.

W e review de novo the district court’s ruling on cross

motions for summary judg ment

. Dunnet Bay Constr. Co. v. Borggren , 799 F.3d 676, 688 (7th Cir. 2015). Because this case is in federal court under diversity jurisdiction, Illinois substa ntive law controls

. A. Estoppel

A s a threshold matter
, the Joyce firm a sserts that P rofe ssional D irect is estopped from r elying on any policy excl usions because it reneged on its duty to defend in the arbitr ation . U nder Illinois law “an insurer’ s duty to defend under a liability insurance policy is so fundamental an obligation that a breach of that duty constitutes a repudia tion of the contract.” Emp ’ rs Ins. of Wausau v. Ehlco Liquidating Tr

. , 708 N.E.2d 1122, 1135 ( Ill. 1999). A breach of the duty t o defend estops the insurer from raising policy defenses to
coverage. Id

. The district judge declined to address th e estoppel a rg ument because it was underdeveloped and therefore waived.
T he Joyce firm challenges that conclusion on appeal.

W e don’t need to address waiver because the estoppel argument is so obviously meritless. An insur ance company has two options when an insured requests a defense and the insurer disputes cover age : T he insurer can “(1) defend the suit under a reservation of rights or (2) seek a declaratory judgment that there is no coverage.” Id . P rofessionals D irect elected the first option. T he Joyce fi rm had retained counsel of its choosing for the arbitration , and u nder a reservation of8 No. 14

- 3341

rights, P rofessionals D irect a greed to reimburse defense
costs

. I t followed through on this reimbursement promise

. The Joyce firm’s estoppel argument rests entirely on the timing of two of the reimbursement payments. T he firm asserts that after the arbitrator issued his final award
, Profe ssionals Direct claimed it had no further responsibility for defense costs and left two outstanding invoices unpaid

. Multiple p hone calls and e

- mails followed, and t he firm threat ened litigation . Professionals Direct then paid the two outstanding invoices , belatedly , a few weeks later

. The Joyce firm contends that th is brief delay in payment
amounts to a breach of the duty to defend. T here’s no su pport for this argument. T o the contrary, i n Santa's Best Craft, L.L.C. v. Zurich Am erican Ins urance Co.
, 941 N.E.2d 291 ( Ill. App. Ct. 2010), the Illinois Appellate Court express ly d eclined to find a breach of an insurer’s duty to defend based solely on “the amount of time between the insured's submi ssion of expenses ... and its subsequent receipt of rei mbursement
, ” i d. at 300. So even if properly preserved , the estoppel argument plainly fails . Because t here was no failure to defend
, Professionals Direct is not estopped from raising its policy defenses to coverage

. B. Exclusion (o)

As we’ve explained
, exclusion (o) knocks out coverage for “any claim for fines, sanctions, penalties, punitive da mages or any damages resulting from the m ultiplication of compensatory damages.” The district judge classifie d the arbitration award as a “sanction” and thus concluded that exclusion (o) applies

. T h e judge’s reasoning re st s heavily on the la nguage used by the Illi nois courts in their rulingsNo. 14

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reje cting the Joyce firm’s challenge to the arbitration award

. Because th e state courts occasionally used the word “san ction” to describe the award, the judge evidently thought himself bound by th at label.

But t he character of the award was not at issue in the
state

- court proceedings , which fo cused narrowly on whether the dispute was subject to arbitration and whether the arbitrator exceeded his authority. It’s t rue that the Illinois Appel late Court’s decision use s the word “sanctions” three
times

— each time closely mi rroring language found in the arbitrator’s award. Duemer v. Edward T. Joyce & Assocs

. , P.C.
, 995 N.E.2d 321, 326 (Ill. App. Ct. 2013). But this perfunctory repetition of the arbitrator’s termi nology doesn’t determine the proper characterization o f the award

. Nor does the arbitrator’s occasional use of the word “sanction” conclusively resolve the matter. Indeed, t he arbitrator used a bevy of different terms to describe the award , inc luding “damages,” “disgorgement
, ” the “equit able result
, ” “remedy, ” and the “final awar d” (among other terms). In the end, w h a t the arbitrator called the award is less important than what was actually alleged and proved, what was awarded, and why. See Cont'l Cas. Co. v. Donald T. Bertucci, Ltd. , 926 N.E.2d 833, 842 ( Ill. App. Ct. 2010) ( e xplaining that Illinois courts “compare the language of the policy with the facts alleged in the complaint, rather than examine whether the client has pled any particular theory of relief”). Exclusion (o) lists “sanctions” alongside “fin es,” “pena lties,” “punitive damages , ” and “ damages resulting from the multiplication of compensatory damages ”

— all terms that describe penalties rather than compensatory remedies. The10 No. 14

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arbitration award, on the other hand, is crafted as a remedy for the Joyce firm’s breach of fiduciary duty in connection with its handling of the reten tion of the outside firms for the collection litigation against EPS’s insurers

. The arbitrator sought to make the clients whole for a portion of the extra fe es they incurred in the satellite litigation. To be sure, the arbitrator rooted his holding in part on an ethics rule that carr ies the threat of sanctions. Specifically, he noted that “the Joyce law firm violated Rule 1.5c of the 1990 Illinois Rules of Pr ofessional Conduct by entering into a verbal agreement for a contingent fee engagement, even though this was a contingent hourly fee and not your stan dard ‘percentage of recov ery’ contingent fee agreement.” But the power to issue sanctions for violation of the Rules of Professional Conduct belongs exclusively to the Illinois Supreme Court and to any in ferior courts acting with its bless ing. Lustig v. Horn , 732 N.E.2d 613, 620 ( Ill. App. Ct. 2000) (“ Courts other than the su preme court may adjudicate
matters touching on attorney discipline only when acting as agents of the supreme court u pon direct order of that
court. ... [A] denial of attorney [ ’s ] ... fees, imposed solely as a sanction for unprofessional conduct on his part, would constitute an impermissible inf ringement on the exclusive power of the supreme court

... to adjudicate disciplinary
matters. ” ). This narrow aspect of the arbitrator’s decision doesn’t determine the character of the award.

The arbitrator used a variety of different terms to d escribe the award to the Duemer claimants , b ut the label ultimately doesn’t matter. Because the award is functionally and in substance a remedy for the firm’s fiduciary breach

— and not a sanction

— exclusion (o) does not apply

.No. 14

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C. Exclusion (p)

The stronger argument agai nst cover age is that the arb itrat or’s award falls within exclusion (p), which excludes coverage for “any claim for legal fees ... owed to ” the firm.
T he request for relief in the arbitration demand fits squarely within this exc lusion

. T he Duemer claimants so ught “ relief for legal fees wrongfully collected under Contingency Fee Agreements signed by each of Claimants and Respondent in connection with Respondent’s agreement to provide legal services to investigate and prosecute any and all claims which Claimants might have in connection with the pu rch ase of EPS stock.” (E mphasis added

. ) T his straightforward request grows a bit murki er in the “ [p] rayer” for relief
, which more broadly asks for “[a]ctual damages as dete rmined by the Arbitrator

. ” Still, t he award fashioned by the arbitrator adjusted the legal fees recovered by the Joyce firm in the underlying securities

- fraud action

. That brings excl usion (p) into play.

Recall that the arbitration award had three components: (1) $405,674.87 to be remitted fro m the Joyce firm to th e Duemer claimants for the hourly fees they paid to the firm for its consultancy with Morgan Lewis and Reed Smith; (2) $150,127.15 from the Joyce firm to offset 25% of the legal fees paid by the claimants directly to Morgan Lewis and Reed Smith; and (3) $72,725.45 to cover arbitration costs. The
costs are not at issue here

. T he first component of the award straightforwardly qua lifies as a “claim for legal fees ... paid or owed to [ the firm ]” within the meaning of exclusion (p) bec a u s e t he claimants were seeking and received remittance of fees they had paid12 No. 14

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direct ly to the Joyce firm

. This part of the award is plainly excluded from coverage.

T he second component of the award is somewhat more difficult to classify. It isn’t directly a n ord er for reimburs ement of legal fees paid to the Joyce firm . A fter all, the Duemer claim ants had paid the $150,127.15 to the two outside law firms

. But substance is what matters here , and in su bstance th is part of the arbitrator ’s award reduced the fees the Joyce firm was entitled to recover from the proceeds of the settlement with EPS’s insurers

. In other words , the arbitrator adjusted the legal fees owed to the firm for its work in the underlying securities

- fraud arbitration, lopping off an
amount equal to its share of the fees the Duemer claimants paid to the two outside firms. So although it’s a closer que stion, we conclude that this part of the award , too, falls within exclusion (p) and is excluded from coverage

. 3

3 P rofessionals Direct also argues that the arbitration award falls outside the basic grant of coverage in the policy because t he award did not “arise out of the rendering of or the failure to render professional services. ” That s trikes us as a stretch . T he a rbitrator found the Joyce firm liable for breach of fiduciary duty arising directly out of the attorney

- client relationship with the plaintiff class

. Professionals Direct cites Continental Casualty Co. v. Donald T. Bertucci, Ltd. , 926 N.E.2d 833 (Ill. App. Ct. 2010), but that case is distinguishable; it involved a pure billing dispute that

arose after litigation concluded and the attorney

- client relationship ended.
Professionals Direct also argues that the second component of the arbitration award

— the order that the firm reimburse the Duemer claimants for 25% of the fees paid to the two outside firms

— is uninsur able restitution under Illinois law. See Local 705 Int’ l Bhd

. of Teamsters Health & Welfare Fund v. Five Star Manag ers, LLC , 735 N.E.2d 679 (Ill. App. Ct. 2000) (explaining that “disgorgement or restitution of fees do notNo. 14

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A ccordingly, al though we part co mpany with the district court on which of the two exclusion s applies, we agree that the arbitra tion award i s excluded from the policy’s coverage and Professionals Direct owe s no duty to indemnify.

A FFIRM ED

.

constitute insurable damages ... as a matter of Illinois law”). We don’ t need to address this argument because we’ve already concluded that this part of the award amounts to a claim for legal fees and is therefore excluded from coverage by exclusion (p).