Opinion ID: 160773
Heading Depth: 3
Heading Rank: 1

Heading: The state court case

Text: The underlying state court action began in the Travis County, Texas probate court following the death of Mr. Hempel’s mother, Ada Mudge, in 1991. The dispute concerned Ada Mudge’s rights under the will of her late husband Daniel Mudge, who died in 1959. The principal asset of Mr. Mudge’s estate was 23,400 shares of common stock in what later became the Tandy Corporation. Daniel Mudge’s will directed his estate to be divided between Ada Mudge and Mr. Mudge’s two daughters from a previous marriage, Francis Graham and Virginia Tauche. The will appointed Eugene Graham, Mr. Mudge’s son-in-law as executor, directed him to establish two trusts (an “Annuity Trust” and a “Residuary Trust”), and appointed Mr. Graham as trustee. 6 Under the will, the Annuity Trust was to be funded with one third of “any and all stocks, bonds, and like securities of every nature and description.” Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. VIII, at 2342. The will directed the trustee to pay to Ada Mudge during her lifetime “all income as may be derived from the dividends from such securities.” Id. The Residuary Trust was to be funded with “the rest, residue, and remainder” of the estate. Id. The will directed the trustee to pay to Ada Mudge, Francis Graham, and Virginia Tauche one-third of the rents and profits from the Residuary Trust during Ada Mudge’s lifetime. Eugene Graham did not comply with the terms of the will. Rather than creating two trusts and designating Ada Mudge as a life beneficiary, he created only one trust and distributed two-thirds of the stock held by the estate to the two daughters. He also converted 5,000 of the 7,800 shares of remaining stock into debentures. Mr. Graham died in 1964, and the Bernallilo County, New Mexico District Court appointed First National Bank of Albuquerque (the Bank) as the successor trustee. The court appointed Mr. Westerfield as the attorney for the trust. Eventually, in Feburary 1976, the Bank created two trusts—the Annuity Trust and the Residuary Trust. See id. at 2354. Following Ada Mudge’s death in 1991, the Bank filed a petition seeking instructions regarding the proper distribution of the Annuity Trust and Residuary 7 Trust assets. The case was transferred to the Bernallilo County District Court. Mr. Hempel responded to the Bank’s petition and asserted counterclaims and crossclaims against the Bank, Mr. Westerfield, Francis Graham, and the estate of Virginia Tauche. Mr. Hempel alleged that these parties had participated in the wrongful appropriation of trust assets in contravention of Daniel Mudge’s will. He asserted claims for breach of fiduciary duty, negligence, gross negligence, tortious interference, fraud, conversion, legal malpractice, breach of contract, and prima facie tort. He also asserted various equitable claims seeking an accounting of the trust assets and a return of property to Ada Mudge’s estate. Mr. Hempel’s allegations against Mr. Westerfield encompassed a period of more than twenty-five years, from before Eugene Graham’s death in 1964 until 1991. According to Mr. Hempel, Mr. Westerfield knew about Eugene Graham’s misappropriation of trust assets before the court appointed him as attorney for the trust, but he failed to inform Ada Mudge, thereby breaching his duty to her as a beneficiary. Subsequently, Mr. Westerfield filed petitions with the court without notice to Mrs. Mudge. Mr. Hempel alleged that these petitions distorted the terms of the trusts and led the court to authorize distributions of trust assets inconsistent with the terms of the will. Mr. Hempel further maintained that on several occasions Mr. Westerfield sent Mrs. Mudge misleading waivers and releases that purported to surrender any future claims for money from the trusts. According to 8 Mr. Hempel, Mr. Westerfield persuaded Mrs. Mudge to sign these waivers and releases in exchange for additional distributions from the trusts. These documents did not inform Mrs. Mudge of her actual rights under the trusts. Mr. Westerfield had insurance coverage with various insurers, including CNA, St. Paul, Home Insurance Company (Home), and Ranger Insurance Company (Ranger). He requested the insurers to provide a defense to Mr. Hempel’s lawsuit. Home and St. Paul agreed, but CNA refused to provide coverage. CNA maintained that the Mr. Hempel’s allegations fell within its policies’ exclusions for “dishonest, fraudulent, criminal, or malicious act[s] or omission[s].” See Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. VI, at 1646. As to one of its policies, CNA further maintained that there was no coverage because Mr. Hempel’s action had not been filed within “fifteen years of the end of the annual policy period, in which the act, error or omission occurred.” Id. In a separate ruling that is not directly at issue in these appeals, the federal district court concluded that CNA breached its duty to defend Mr. Westerfield. The court reasoned that Mr. Hempel had made allegations that “could be categorized as either fraudulent wrongdoing, excluded from coverage . . . , or professional negligence, an insurable risk.” Id. vol. I, at 262. It noted that Mr. Hempel had asserted claims for negligence, gross negligence, legal malpractice, 9 and breach of contract and that his factual allegations comported with those legal theories. Home retained Briggs Cheney to represent Mr. Westerfield in the Hempel litigation. After conducting discovery, Mr. Cheney concluded that “[t]here clearly exist circumstances which I believe can create liability for Mr. Westerfield, the bank, and the daughters and I think the court will so find.” Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. VI, at 1625. To Mr. Cheney, the central issue in the case was the determination of the amount of damages to which Ada Mudge’s estate was entitled and the determination of which parties should be held responsible for them. The damages issue turned on the interpretation of Daniel Mudge’s will. As noted above, the will provided that, during her lifetime, Ada Mudge was entitled to “all income as may be derived from the dividends from . . . securities” held in the Annuity Trust and one-third of the “rents and profits” from the Residuary Trust. See Aplt’s App. (case nos. 97-2190, 2194, 2195) vol. VIII, at 2342. Since Daniel Mudge’s death in 1959, the primary trust asset—the Tandy Corporation shares— had multiplied through various stock dividends and stock splits, and the formation of subsidiary entities that had also issued stock splits. The question for the parties was whether these various stock dividends, stock splits, and stock spinoffs should be treated as “income . . . derived from the dividends from . . . 10 securities” and “rents and profits,” id. —to which Ada Mudge’s estate would be entitled—or alternatively, as principal (i.e., part of the trust corpus)—to which the daughters would be entitled. The parties consulted experts who reached contrasting conclusions as to the value of Ada Mudge’s rights in the trusts. Mr. Hempel’s attorney, John McKetta, first considered the calculations of a Texas accountant named Thomas Glass. Mr. Glass had determined that assets to which Ada Mudge was entitled under the Annuity Trust and Residuary Trust approximated $17,600,000. Mr McKetta also considered alternative calculations using assumptions more favorable to Mrs. Mudge’s rights (e.g., that the first trustee had wrongfully converted 5,000 shares of stock to which Mrs. Mudge was entitled). Under these alternative calculations, Mrs. Mudge’s estate was entitled to $27,964,836 in trust assets. Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. III, at 645. Then, in 1993, Mr. McKetta retained another expert, New Mexico accountant Thomas Gilmore. Mr. Gilmore developed a series of alternative scenarios concerning the rights of Ada Mudge’s estate in the trusts. The scenarios varied in their treatment of stock dividends, splits, and spinoffs. Under Mr. Gilmore’s scenarios, the amounts to which the estate was entitled ranged from $3,711,837 to $35,936,566. Id. at 648. In contrast, Mr. Cheney consulted experts who arrived at a much lower 11 valuation of Mrs. Mudge’s interest in the two trusts. In defending Mr. Westerfield, Mr. Cheney was able to identify New Mexico legal authorities that provided substantial support for the theory that the stock splits were generally treated as principal under New Mexico’s statutory law. He contacted experts who agreed to testify at trial that treatment of the stock splits as principal was warranted. In light of this information, Mr. Cheney advised Home that Mr. Hempel was severely overvaluing his claims. He reported that his own defense expert had calculated damages in a range of “a best case basis of approximately $443,000 and a worst case basis of $2.8 million.” Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. VI, at 1696. Mr. Cheney stated that Mr. Hempel was incorrect in arguing that splits and dividends constituted items of income payable to Ada Mudge and that he believed that Mr. Westerfield would prevail on that point at trial. Mr. Cheney also stated that Mr. Westerfield could argue that, to the extent that Ada Mudge had been injured by the misappropriation of trust assets, the damages should be paid by the two daughters, because they had received the profits and earnings that should have gone to her. B. The agreement not to execute on Mr. Westerfield’s assets 12 In the months preceding the March 1994 trial, the parties engaged in extensive settlement negotiations. In November 1993, Mr. Hempel made a global settlement demand of $5.5 million in exchange for a release of all claims against all parties–the Bank, Mr. Westerfield, the two daughters, and the two daughters’ trusts. That settlement offer was not accepted. About a week before the trial, Mr. Westerfield hired another attorney, Floyd Wilson, as personal coverage counsel. At that point, Mr. Wilson and Mr. Hempel’s attorney, Mr. McKetta, began to discuss the idea of agreeing to an uncontested trial. In particular, Mr. Wilson and Mr. McKetta discussed a settlement plan under which, in exchange for cash payments to Mr. Hempel by certain of Mr. Westerfield’s insurers, those insurers would be released from any further obligations under their policies, but Mr. Westerfield would not obtain a release of his liability to Mr. Hempel. Instead, Mr. Hempel would be permitted to proceed with his claims against Mr. Westerfield. Mr. Westerfield would receive a covenant not to execute upon his personal assets and would assign his claims against any insurer unwilling to participate in the settlement. As a result of this assignment, Mr. Hempel could attempt to recover from Mr. Westerfield’s insurers the judgment that he obtained in the state court trial against Mr. Westerfield. Mr. Wilson and Mr. McKetta also discussed the possibility of an agreement under which Mr. Westerfield would retain a ten percent interest in the recovery from the 13 bad faith actions. Around March 15, 1994, Mr. Wilson and Mr. McKetta entered into a written settlement agreement on behalf of their clients. Under the agreement, Mr. Hempel executed a covenant not to execute on a judgment against Mr. Westerfield, although he did not agree to release Mr. Westerfield from liability. Mr. Westerfield assigned to Mr. Hempel 90% of the proceeds of the bad faith lawsuit that Mr. Westerfield agreed to pursue against the non-settling insurers after the entry of judgment in the state court. Mr. Cheney explained the agreement to his client in the following terms: By this settlement, we have tacitly agreed not to defend the action. In fact, it is not necessarily in your best interests to do so as it may impact negatively on subsequent actions against non-settling or non- participating Westerfield professional liability insurance carriers . . . . . . . it is understood that I will not actively defend you in this matter. I am operating on your instructions not to actively defend . . . To that end, I . . . will not take actions to minimize any judgment which may be entered. Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. VI, at 1684; see also CNA Br. in Chief at 8 (emphasis added). After negotiating the agreement, Mr. Hempel settled claims against both the Bank (for $1,150,000) and against the Mudges’ two daughters ($650,000 for both of them). The daughters agreed not to take an active role in the state court trial. 14 C. The settlements with Home and St. Paul Mr. Hempel’s and Mr. Westerfield’s lawyers also explored settlement of claims pursuant to specific insurance policies. In particular, on March 15, 1994, Mr. McKenna sent the following letter to Mr. Cheney: Dear Briggs, Hempel offers to settle with Westerfield for the coverage year time period afforded by the Ranger policy for $1,000,000–well under the $5 mm policy limits, This offer expires 5 p.m. Th. 3-17-94 Mike McKetta 7 p.m. 3-15-94 Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. II, at 457. Mr. Cheney conveyed this note to the Ranger (which had issued an excess liability policy to Mr. Westerfield in the amount of $5,000,000 for the period of December 5, 1975 through January 5, 1977). Initially, Ranger proposed a counteroffer of $500,000. However, on March 17, 1994, Ranger agreed to pay the $1,000,000 sum that Mr. McKetta had demanded in the March 15, 1994 letter. On March 18, 1994, Mr. McKetta made a written $300,000 settlement offer to St. Paul in the following terms: “[t]his settlement demand is made on behalf of Hempel to settle claims against Westerfield to the extent of coverage under the following St. Paul policies for payment of the amounts indicated: (1) 583JE7440 $300,000.” Id. at 459. Mr. McKetta said that the offer would expire on March 15 21, 1994. St. Paul accepted the offer and agreed to pay $300,000 to Mr. Hempel on the policy. The parties entered into a formal agreement on March 21, 1994. Apparently, neither Mr. Hempel, nor Mr. Westerfield, nor their attorneys had advised St. Paul of the settlement with Ranger. It is that failure to disclose the Ranger settlement that St Paul now alleges to be fraudulent. D. The lost policy A dispute also arose about whether the Insurance Company of North America (INA) had issued a policy (GLP 090925) to Mr. Westerfield. The only reference to the existence of that policy is contained in an addendum to an INA excess insurance policy. The addendum listed policies held by Mr. Westerfield and described the period of coverage provided by the disputed GLP policy as from January 1, 1968 to January 1, 1969. It described the policy in the following terms: Professional Liability Bodily Injury liab $100,000 each person $300,000 each occur Property damage liab $50,000 each occurance [sic] Aplts’ App. (case nos. 97-2136, 2147) vol. I, at 109. INA presented testimony from one of its agents, B.H. Kinney, regarding the significance of the addendum. Mr. Kinney stated that the GLP policy provided 16 general liability coverage for certain of Mr. Westerfield’s commercial properties and that the policy did not afford professional liability coverage, despite the contrary indication in the addendum. He also stated that the coverage limits listed in the addendum, specifically the split limits for personal injury or property damage, were inconsistent with professional liability coverage. The record also indicates that, in the years following the policy period, Mr. Westerfield never identified or listed the GLP policy on applications for additional professional insurance. E. The state court trial The state court trial was held on March 22, 1994 before Judge Phillip Ashby. At the beginning of the proceedings, the lawyers representing Messrs. Hempel and Westerfield informed the judge that they had reached a settlement under which a judgment would be entered against Mr. Westerfield. Mr. Cheney (Mr. Westerfield’s lawyer) further explained that the judgment would be “not recourse against Mr. Westerfield personally” and that “there is an assignment of proceeds of claims against . . . nonsettling carriers, which will be pursued by Mr. Hempel and Mr. Westerfield.” Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. VII at 2061. He added that he had been instructed not to expend any further efforts to defend Mr. Westerfield, not because “[Mr.] Westerfield would not like 17 to defend his interest . . . [but] because he’s not in a position to do so.” Id. The parties offered the written settlement agreement between Messrs. Hempel and Westerfield into evidence. The judge indicated that, as he understood the trial, “the whole purpose of this is to allow the Hempels to get a judgment which would allow them to seek whatever remedies they wish against the other [nonsettling] carriers.” Id. at 2062. On behalf of Mr. Hempel, Mr. McKetta called four witnesses. In response, Mr. Cheney did not conduct cross examination, did not call any witnesses on behalf of Mr. Westerfield, and did not make an opening statement or a closing argument. Mr. McKetta began with Forrest Smith, a New Mexico attorney who had worked as the head of a trust department of a bank in Santa Fe and who testified as an expert witness. Mr. Smith explained that he had reviewed the pleadings and evidence in the case, including the will of Daniel Mudge, orders of the probate court, files maintained by the Bank (as trustee of the Residuary and Annuity trusts), and various accountings performed by the Bank and the executor of the Mudge estate. Based on this evidence, Mr. Smith stated that Eugene Graham, the Bank, and Mr. Westerfield had all breached their fiduciary duties to Ada Mudge as a beneficiary of the trusts. As to Mr. Westerfield, Mr. Smith explained that his 18 actions following his appointment as the attorney for the trustee bank in 1964 revealed a conflict of interest: Mr. Westerfield had acted in furtherance of the interests of two of the beneficiaries (Mrs. Graham and Mrs. Tauche) rather than in the interests of all of the beneficiaries, including Ada Mudge In certain instances, Mr. Westerfield had learned of improper distributions of trust assets to Mrs. Graham and Mrs. Tauche, but he had failed to disclose these distributions to Ada Mudge and had also failed to protect her interests by seeking to recover these assets for the trusts. He agreed that Mr. Westerfield’s failure to disclose this information “result[ed] in a continued failure for Ada Mudge during her lifetime to continue to enjoy the substantial benefits that Daniel Mudge had designed under his . . . trusts for her.” Id. at 2153. Next, Mr. McKetta called Mr. Hempel and his wife. They both testified about their reliance on Mr. Westerfield in the management of the trusts. Finally, Mr. McKetta called Mr. Gilmore, the certified public accountant, who testified as to the damages sustained by Mrs. Mudge as a result of improper actions of Mr. Graham, the Bank, and Mr. Westerfield. For each of the trusts, Mr. Gilmore offered five different methods for calculating damages. The methods differed in their treatment of the stock dividends, stock spin-offs, and stock splits that constituted trust assets. In particular, the methods varied in whether these categories of assets were treated as income or as principal. For 19 example, Mr. Gilmore’s first method treated stock dividends as income and spinoffs and splits as principal. The second method treated stock dividends and splits as principal and spinoffs as income. Mr. Gilmore also based his calculations under each method on different interest rates. Thus, he arrived at differing dollar figures using the first method (dividends as income; spinoffs and splits as principal) by performing the calculations under a fifteen percent interest rate, a twelve percent rate, a nine percent rate, and so forth. He also made differing assumptions about whether 5,000 shares of stock (removed from the trusts by Mr. Graham) should be included in the calculations. Significantly, Mr. Gilmore did not offer an opinion as to which method was the proper one. At the conclusion of the evidence, Judge Ashby concluded that “there was clear legal malpractice . . . and breach of fiduciary duty by Mr. Westerfield.” Id. at 2235-36. He added that he did not understand why the problems in the trust were not corrected in the 1960s and that “at least as early as 1975, the bank itself and the trust attorney became aware of the problem and they went to some lengths to conceal matters.” Id. at 2235. Judge Ashby then asked Mr. McKetta which of Mr. Gilmore’s methods of calculating damages he believed to be proper. Mr. McKetta informed the judge that the proposed findings had employed the first method and that was his 20 recommendation. Judge Ashby accepted that recommendation, but indicated that the fifteen percent interest rate proposed by Mr. McKetta was too high. Instead, he ruled that interest should be calculated at nine percent. Based on these rulings, Mr. McKetta submitted proposed findings of fact and conclusions of law, which Judge Ashby adopted. The judge concluded that Mr. Graham and the Bank had committed willful breaches of trust, that Mr. Westerfield had knowingly participated in the bank’s breaches of trust, and that Mr. Westerfield’s conduct from 1964 through 1991 constituted negligence and was the proximate cause of the losses suffered by Ada Mudge. Based on Mr. Gilmore’s first method and on Mr. McKetta’s recommendation, the judge determined that the estate of Ada Mudge had sustained $29,431,851 in damages. From that amount, he offset $3,050,000 that Mr. Hempel had previously received on behalf of the estate in settlements with other parties. Accordingly, the court entered judgment in favor of Mr. Hempel and against Mr. Westerfield for $26,381, 851. Id. at 2247. F. The federal district court’s rulings
In the instant case, the federal district court ruled as a matter of law that the parties to the state court lawsuit had engaged in collusion. See Continental 21 Casualty Co. v. Westerfield , 961 F. Supp. 1502, 1507-09 (D.N.M. 1997). In support of this ruling, it cited several characteristics of the state court proceeding: (1) the fact that “the presiding judge did not perceive the commonality of interest in the supposedly adverse parties appearing before him and that failing to actively defend could actually serve to benefit [Mr.] Westerfield financially;” id. at 150708; (2) Mr. Cheney’s failure to present various colorable defenses; (3) the fact that Mr. McKetta negotiated settlements with the remaining defendants other than Mr. Westerfield, thereby “eliminat[ing] any chance that Judge Ashby would hear any evidence or argument contrary to that presented by [Mr.] Hempel in his prima facie case on liability and as to damages;” id. at 1508; and (4) the fact that Mr. McKetta submitted proposed findings and conclusions (ultimately adopted by Judge Ashby) that assessed damages for the period from 1964 to 1983, thus eliminating the possibility of that any of Mr. Hempel’s damages would be attributed to the period after 1983—when one of the settling insurers had provided coverage. Accordingly, the court concluded: “To fail to find collusion in fashioning an unreasonable settlement under these circumstances would be to authorize manipulation which compromises the integrity of the adversary system.” Id. at 1509. Nevertheless, in this ruling, the district court stopped short of finding that the collusive state court judgment relieved the insurers of all obligations. Instead, 22 it said, the import of its summary judgment ruling on the collusion issue was that Messrs. Hempel and Westerfield “were not entitled to any res judicata or collateral estoppel effect as to the state court proceeding.” Id. Thus, the duty to defend the state court lawsuit and the duty to indemnify the judgment remained at issue in the case.
Upon further briefing, the district court ruled that the insurers were entitled to judgment as a matter of law “that the collusive settlement agreement extinguished any obligations owed to [Mr.] Westerfield under their respective contracts of insurance.” Aplts’ App. (case nos. 97-2190, 2194, 2195) vol. IX, at 2869-70. The court reasoned that the combination of Mr. Hempel’s covenant not to execute on Mr. Westerfield’s assets with Mr. Westerfield’s retention of ten percent of the proceeds of the bad faith claims that he assigned to Mr. Hempel transformed the Hempel-Westerfield agreement “from a shield into a sword.” Id. at 2869. The elimination of any actual risk from a judgment against him in the state court proceedings extinguished the insurers’ obligations to him under the subject policies.
23 The district court granted summary judgment against St. Paul and in favor of Messrs. Hempel and Westerfield on St. Paul’s claim that the two men had fraudulently induced St. Paul into entering into a separate settlement for $300,000. The court found no evidence in the record that Mr. McKetta’s March 15, 1994 offer pertained to the coverage provided by St. Paul. It also concluded that the letter did not express the final understanding of the parties.
Finally, the court granted summary judgment to INA on Mr. Westerfield’s claim for coverage under the lost policy. Noting that “New Mexico law requires the insured to bear the burden of establishing the existence and terms of a lost insurance policy,” the court concluded that Mr. Westerfield had provided no evidence regarding the policy’s terms. See Aplts’ App. (case nos. 97-2136, 2147) vol. II, at 490 (citing Harden v. St. Paul Fire & Marine Ins. Co. , 178 P.2d 578, 579 (N.M. 1947)).