A Connecticut District Court recently held that plaintiffs, who brought a subrogation action to recover a judgment entered in their favor in an underlying legal malpractice action against their attorneys, were entitled to litigate coverage issues even though the attorneys’ insurer obtained a default judgment against the attorneys in a separate coverage action.  Victoria Gambino v. American Guarantee & Liability Insurance Co., No. 3:09-CV-304(CFD). For a complete copy of the opinion, please click here.

Plaintiffs were injured in an automobile accident and enlisted the services of a law firm to bring a claim on their behalf.  When the law firm failed to bring a claim or obtain a settlement within the statute of limitations, Plaintiffs sued the law firm and the individual attorneys for malpractice (the “Malpractice Action”).  The Malpractice Action eventually resulted in a stipulated judgment for $75,000 in Plaintiff’s favor.  Before judgment entered in the Malpractice Action, however, the law firm’s insurer (“Insurer”) brought a separate declaratory judgment action to rescind the policy based on misrepresentations in the policy application (the “Coverage Action”).  The Insurer obtained a default judgment against the attorneys and law firm in the Coverage Action.

Plaintiffs brought a subrogation action to enforce the judgment from the Malpractice Action against the Insurer pursuant to Conn. Gen. Stat. § 38a-321, which the Insurer removed to federal court on the basis of diversity jurisdiction.  Plaintiffs argued that because the policy was in effect at the time Plaintiffs’ right of action arose, the default judgment in the Coverage Action did not prevent them from seeking to enforce the policy.  The Insurer contended that because the policy was rescinded, it had the effect of voiding the policy from its inception, and that Plaintiffs were barred by the doctrines of res judicata and collateral estoppel from re-litigating the issue of rescission.

The court held that Plaintiffs’ claim was not barred by res judicata because Plaintiffs were not in privity with the law firm in the Coverage Action and, as a result, their interests were not represented in that action.  In this regard, the court explained that although theoretically Plaintiffs and the attorneys would have had an interest in the policy remaining operative, the attorneys lacked an incentive to defend the rescission action because they were judgment proof and facing harsher penalties, including criminal prosecution.  Similarly, the court found that Plaintiffs’ claim was not barred by collateral estoppel because the rescission issue was not “actually litigated” in the Coverage Action.  Citing the well established principle that an issue is “actually litigated if it is properly raised in the pleadings or otherwise, submitted for determination, and in fact determined,” the court could not characterize the coverage issue as having been litigated because the judgment was obtained by default after one defendant failed to appear and the others, although appearing, did not defend the suit.