     Case: 11-31134   Document: 00512065053    Page: 1   Date Filed: 11/27/2012




        IN THE UNITED STATES COURT OF APPEALS
                 FOR THE FIFTH CIRCUIT  United States Court of Appeals
                                                 Fifth Circuit

                                                                   FILED
                                                             November 27, 2012

                                No. 11–31134                   Lyle W. Cayce
                                                                    Clerk

TIM SOSEBEE; MARK WRITESMAN; DALE PATILLO,

                                          Plaintiffs - Appellees
v.

STEADFAST INSURANCE COMPANY,

                                          Defendant - Appellant



                Appeal from the United States District Court
                    for the Eastern District of Louisiana


Before JONES, GARZA, and PRADO, Circuit Judges.
GARZA, Circuit Judge:
      Appellant Steadfast Insurance Co. (“Steadfast”) appeals from the district
court’s order denying Steadfast summary judgment and granting summary
judgment to Appellees Sosebee, Writesman, and Patillo (“Sosebee”). The district
court held Steadfast waived its coverage defense. We REVERSE and render
summary judgment in favor of Steadfast.
                                          I
      Tim Sosebee, Mark Writesman, and Dale Patillo were passengers on a
chartered fishing boat insured by St. Paul Fire when they were involved in an
accident with a utility boat owned by non-party Harvest Oil (“Harvest”) and
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                                  No. 11–31134

insured by Steadfast Insurance Company (“Steadfast”). One week after the
accident St. Paul Fire initiated a declaratory judgment action against Sosebee
and the owner and operator of the fishing boat. Sosebee filed a third-party
complaint against Harvest, alleging substantial personal injuries. Harvest
answered the complaint on December 3, 2008 through Slattery, Marino &
Roberts, its corporate counsel.
      After Steadfast became aware of the accident and the lawsuit, Harvest
received a letter, dated February 23, 2009, titled: “Reservation of Rights: Please
read carefully.” The letter is on the letterhead of Zurich North America, and is
signed, “Sincerely, Zurich American Insurance Company.” The letter contains
the name Zurich American Insurance Company (“Zurich”) five times and the
name Steadfast two times. The letter refers to Sosebee’s complaint and third-
party complaint against Harvest in the 2008 case, cites the Steadfast policy
number, quotes the watercraft exclusion in the policy, and states the exclusion
“might apply.” The parties do not dispute that the plain language of the
watercraft exclusion quoted in the letter would exclude coverage for Sosebee’s
claims. The letter requests additional information regarding the ownership and
length of the vessel involved in the accident. The letter states Zurich will
“proceed with investigation of the case and allegations subject to a full
Reservation of Rights.”
      Zurich is a separate insurance company, and both Zurich and Steadfast
are members of Zurich North America. Zurich North America handles insurance
claims for its member companies, including Zurich and Steadfast. At the time
of the accident Harvest had a comprehensive general liability policy and an
umbrella policy with Steadfast, as well as a commercial auto liability policy with


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                                         No. 11–31134

Zurich.
       On March 31, 2009 Saratoga Resources, Inc., a Texas corporation and sole
member of Harvest, filed for bankruptcy under Chapter 11.1                           Harvest is
represented in its bankruptcy case by its own counsel. At the time Harvest filed
for bankruptcy, all of the twenty largest unsecured claims against Harvest were
for “Vendor/Trade Debt”, not tort liability. Creditors have a total of 207 claims
against Harvest, totaling $226,754,130.85 in secured claims and $20,592,114 in
unsecured claims. Harvest’s personal property totals $25,659,388 and its real
property totals $146,118,745. On August 9, 2009, Sosebee filed a claim against
Harvest in the bankruptcy case for an amount “to be determined.” Harvest
immediately filed an objection to Sosebee’s claim. The court has not yet held an
adversary proceeding to quantify Sosebee’s claim.
       On April 14, 2009, Harvest filed a notice of filing of bankruptcy in
Sosebee’s case against Harvest. On April 22, 2009, Harvest moved to change its
counsel from Slattery, Marino & Roberts to a firm employed by Steadfast,
Anderson, Stephens & Grace (hereinafter Stephens & Grace). On the same day
the court held a status conference with the parties and stayed and
administratively closed the case because of Harvest’s bankruptcy filing.
       On June 17, 2009, Sosebee filed this suit against the owner and operator
of the boat, St. Paul, and Steadfast, alleging substantial personal injuries.
Sosebee did not include Harvest in this suit because Harvest had filed for


       1
         Pursuant to FED. R. EVID. 201(b), we are entitled to take judicial notice of adjudicative
facts from reliable sources “whose accuracy cannot reasonably be questioned.” But “[i]f the
court takes judicial notice before notifying a party, the party, on request, is still entitled to be
heard.” FED. R. EVID. 201(e).



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bankruptcy.    Stephens & Grace, the same firm employed by Steadfast to
represent Harvest in the 2008 case, represented Steadfast in this case. Stephens
& Grace also represented a Harvest employee in a deposition taken by the owner
and operator of the fishing boat. In its initial answer to the complaint Steadfast
asserted no affirmative defenses and made no mention of the watercraft
exclusion. When Sosebee asked Steadfast to produce any insurance policies that
would provide coverage for Sosebee’s injuries, Steadfast produced its primary
and umbrella policies.      At this time Steadfast was unaware that its policy
excluded coverage because three separate Steadfast insurance adjusters
mistakenly interpreted Steadfast’s policy as covering Harvest’s claim. The court
set a trial date for October 18, 2010, and then granted motions to continue the
trial to August 15, 2011.
      On September 29, 2010, Sosebee received leave to file a first amended
complaint, adding a claim against Steadfast under Harvest’s umbrella policy.
On April 1, 2011, after an insurance adjuster discovered Steadfast’s policy
excluded coverage, Steadfast filed an answer to the amended complaint,
asserting for the first time the watercraft exclusion.
      On April 14, 2011, the district court granted Steadfast’s motion to
substitute new counsel in place of Stephens & Grace. Stephens & Grace sent a
letter to Harvest on April 21, 2011 stating that:


            As you know, this firm was assigned to represent [Harvest]
      and [Steadfast] in the Sosebee Writesman and Patillo suit pending
      in the United States District Court for the Eastern District of
      Louisiana. The lawsuit has been proceeding forward against
      Steadfast only under the direct action statute after the notice of
      bankruptcy of Harvest. Steadfast has decided to assert policy


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      defenses and they have reassigned their defense . . .
            WE WILL NO LONGER REPRESENT HARVEST OR
      STEADFAST IN THIS MATTER. WE STRONGLY URGE YOU TO
      CONSULT YOUR OWN ATTORNEY TO PROTECT YOUR
      INTERESTS.

      On April 19, 2011, Sosebee moved to strike Steadfast’s amended answer,
arguing Steadfast did not assert the watercraft exclusion in a timely manner.
The district court denied the motion on the basis that the amended answer was
not so untimely as to prejudice Sosebee. The district court continued the trial
date to permit Sosebee to take discovery related to the watercraft exclusion.
      In a deposition in this case, Harvest’s designated representative, Brian
Daigle, testified that the entire time Stephens & Grace represented Harvest,
Harvest was unaware that Steadfast intended to invoke the exclusion.2 Mr.


      2
          The relevant portion of Mr. Daigle’s deposition is excerpted below:
                Q. Now did Steadfast Insurance Company ever send you a reservation
                of rights letter similar to the one that Zurich American Insurance
                Company sent you?
                A. No.
                ...
                Q. Did Steadfast Insurance Company ever inform you that they were
                reserving their rights to coverage on this particular claim?
                A. The only letter I received was from Zurich right there.
                Q. Okay. At some point, did Harvest Oil eventually learn that Steadfast
                was being sued directly by the plaintiffs in this case on this particular
                claim?
                A. At some point, yeah.
                ...
                Q. So if we talked about earlier May 1st of 2008 is when the accident
                occurred– at any point in 2008, did Steadfast inform Harvest that this
                particular accident may not be covered under its policies?
                A. Not that I’m aware of.
                Q. Okay. At any point in 2009, did Steadfast inform Harvest that this
                accident may not be covered under its policies?
                A. No.

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Daigle testified Harvest was under the impression the February 23, 2009
reservation of rights letter related to Harvest’s policies with Zurich, not
Steadfast. Mr. Daigle further testified Steadfast never informed Harvest that
Steadfast contested coverage for Sosebee’s claim.
      Steadfast moved for summary judgment arguing because Steadfast did not
owe coverage to Harvest, Sosebee cannot recover from Steadfast. Sosebee moved
for summary judgment arguing Steadfast waived its coverage defense. Holding
Steadfast waived its right to assert the watercraft exclusion as a defense, the
district court denied Steadfast summary judgment and granted summary
judgment for Sosebee. Steadfast appealed.
                                                II
      To determine whether Steadfast waived its coverage defense the district
court applied a two-prong test, asking (1) whether Steadfast’s conduct was so
inconsistent with asserting the exclusion as to induce a reasonable belief that
Steadfast relinquished its right to assert the exclusion, see Steptore v. Masco



            Q. At any point in 2010, did Steadfast inform Harvest that this accident
            may not be covered under its policies?
            A. No.
            ...
            Q. At any point during that process of assisting in coordination of
            depositions, did anyone from Steadfast Insurance Company or their
            attorneys inform you that this claim might not be covered?
            A. No.
            ...
            Q. Had Steadfast brought this coverage issue to Harvest’s attention any
            time between 2008 and 2011, what if anything would have Harvest
            done?
            A. We would have immediately contacted our corporate attorneys first.

      Daigle Dep. 45:17–51:14, July 20, 2011.


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Constr. Co., 643 So. 2d 1213, 1216 (La. 1994); Emery v. Progressive Cas. Ins. Co.,
49 So. 3d 17, 21 (La. App. Ct. 2010), and (2) whether Steadfast’s inconsistent
conduct prejudiced Harvest. Scottsdale Ins. Co. v. Gulf Sea Temporaries, Inc.,
No. 98-1364, 1999 WL 130633, at *5 (E.D. La. Mar. 10, 1999). On appeal
Steadfast contends the district court erred in answering both prongs
affirmatively and holding Steadfast thereby waived its coverage defense.
Sosebee contends the district court erred in holding Steadfast’s February 23,
2009 letter was a valid reservation of rights. Sosebee contends Steadfast never
reserved its right to assert the exclusion as a coverage defense.
      We review the district court’s grant of summary judgment de novo. Am.
Nat’l Gen. Ins. Co. v. Ryan, 274 F.3d 319, 323 (5th Cir. 2001). “The district
court’s interpretation of an insurance contract is a question of law that we also
review de novo.” Id. Summary judgment is appropriate only if the evidence in
the record shows “there is no genuine dispute as to any material fact and the
movant is entitled to judgment as a matter of law.” FED. R. CIV. P. 56(a). The
parties agree Louisiana law governs the dispute.
                                            III
      Steadfast contends it properly reserved its rights to assert the watercraft
exclusion as a defense to coverage.         We address the issue of Steadfast’s
reservation of rights letter before the question of waiver because under
Louisiana law waiver of noncoverage defenses is automatic and requires no
showing of prejudice where the insurer assumed the insured’s defense without
first issuing a reservation of rights letter. See Steptore, 643 So. 2d at 1216.
      Sosebee contends the district court erred in holding Steadfast’s February
23, 2009 letter reserved its rights under the watercraft exclusion. Sosebee


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contends Steadfast’s letter to Harvest on February 23, 2009 failed to reserve
Steadfast’s rights under the policy for two reasons. First, Sosebee asserts Zurich
authored the letter and reserved Zurich’s rights rather than Steadfast’s rights.
Sosebee maintains the references to Zurich are not mere typographical errors.
At the time of the boat accident, Harvest had policies with both Steadfast and
Zurich. Sosebee thus maintains that the letter did not sufficiently apprise
Harvest of which insurer was waiving its rights with respect to which policy.
Second, Sosebee cites a Sixth Circuit case for the proposition that a reservation
of rights that only refers to an investigation of an accident will not function as
a reservation of rights with respect to a defense of the matter. Transamerica
Ins. Group v. Beem, 652 F.2d 663, 666–67 (6th Cir. 1981).        According to the
court in Transamerica, if the initial letter does not mention a defense, the
insurer must issue a second reservation of rights letter if it undertakes to defend
the insured. Id.
      Under Louisiana law, an insurer can waive any provision of an insurance
contract even if it has the effect of bringing within coverage risks originally
excluded under the policy. Steptore, 643 So. 2d at 1216. If an insurer with
knowledge of facts indicating noncoverage assumes an insured’s defense without
first reserving its rights to assert a noncoverage defense, the insurer waives its
right to assert the defense. Id. If an insurer assumes an insured’s defense with
knowledge of facts indicating noncoverage without first obtaining a non-waiver
agreement, the insured may assume the insurer is acting in the insured’s best
interest with respect to coverage defenses the insurer has seemingly
relinquished. Arceneaux v. Amstar Corp., 66 So. 3d 438, 451 (La. 2011). Thus,
“the insurer’s notice of its intent to avail itself of the defense of noncoverage


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must be timely.” Scottsdale, 1999 WL 130633, at *3. Courts must apply waiver
principles stringently to prevent conflicts of interest between insurer and
insured that could potentially affect legal representation. Steptore, 643 So. 2d
at 1216. Courts should not, however, require overly technical or talismanic
language for insurers to effectively reserve their rights. See F.D.I.C. v. Duffy, 47
F.3d 146, 151 (5th Cir. 1995) (rejecting assertion that insurer must state in
reservation of rights that insurer “reserved its rights to void the policy”).
      Steadfast reserved its watercraft exclusion defense through its letter to
Harvest on February 23, 2009. The letter unambiguously refers to the policy
that Steadfast issued to Harvest, cites the watercraft exclusion in the policy, and
reserves rights under the exclusion. Even though Steadfast’s February 23, 2009
letter to Harvest was on Zurich’s letterhead, Zurich signed it, and the letter
mentioned Zurich’s name multiple times, the letter nevertheless put Harvest on
notice that Steadfast was reserving its rights under the policy listed in the letter.
The letter referred to the policy issued by “Steadfast Insurance Company” and
listed the policy number and dates of coverage. The letter reproduced verbatim
the watercraft exclusion from Steadfast’s policy. The letter did not include any
reference to policies issued by Zurich and the letter referenced the lawsuit
against Harvest by name. The letter stated Zurich would proceed with the
“investigation of the case and allegations subject to a full [r]eservation of
[r]ights.” Because Louisiana follows a functional approach to the reservation of
rights and we have rejected requirements for technical language, see Duffy, 47
F.3d at 151, the fact that Steadfast did not explicitly state it was reserving its
rights with respect to the defense of Harvest did not render the reservation of
rights void once Steadfast undertook to defend Harvest. Therefore, Sosebee’s


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                                  No. 11–31134

contention that Steadfast failed to reserve its rights with respect to the
watercraft exclusion is without merit.
                                              IV
      Because we hold Steadfast validly reserved its right to assert the
watercraft exclusion, we must now address whether Steadfast waived its
reservation of rights. Though Steadfast concedes Sosebee has standing under
the Louisiana Direct Action Statute to raise the issue of waiver, our waiver
analysis is complicated by the fact Harvest, not a party to this case, is currently
in bankruptcy. Moreover, Harvest was in Chapter 11 bankruptcy at all times
relevant to Sosebee’s claim that (1) Steadfast engaged in conduct inconsistent
with asserting a noncoverage defense and (2) Steadfast’s inconsistent conduct
prejudiced Harvest. The Louisiana Direct Action Statute explicitly states that
when an insured is in bankruptcy, an injured person or his survivors may bring
an action directly against the insurer without joining the insured. LA. REV.
STAT. § 22:1269(B)(1) (Supp. 2012). We have held a direct action claimant may
assert waiver even where the insured is not a party to the litigation and has
received a discharge in bankruptcy. Duffy, 47 F.3d at 149–50; F.D.I.C. v. Duffy,
835 F. Supp. 307, 308, n.1 (E.D. La. 1993), aff’d, 47 F.3d 146 (5th Cir. 1995)
(“Duffy received a discharge in bankruptcy, which relieved him of any potential
liability . . . . Hence the sole defendant remaining in this proceeding is Duffy’s
alleged insurer”). Whether an insurer may waive its coverage defenses through
its conduct in a direct action suit in which the insured is not a party while the
insured is in bankruptcy is, however, a question of first impression.
                                              A
      In order to determine if Steadfast waived its noncoverage defenses vis-à-


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vis Harvest through its conduct in this case we must we must examine (1) the
protections Louisiana Direct Action statute provides to Sosebee and (2) the
protections the Bankruptcy Code provides to Harvest while it is in Chapter 11
bankruptcy.
      The purpose of Louisiana’s Direct Action statute is to safeguard the rights
of injured persons. Duffy, 47 F.3d at 150. The Louisiana direct action statute
creates a “contractual relationship which inures to the benefit of any and every
person who might be negligently injured by the insured as completely as if such
injured person had been specifically named in the policy.” Id. (quoting Shockley
v. Sallows, 615 F.2d 233, 238 (5th Cir. 1980)). Section 655 of Title 22, Louisiana
Revised Statutes, provides in part:
        A. No policy or contract of liability insurance shall be issued or
        delivered in this state, unless it contains provisions to the effect
        that the insolvency or bankruptcy of the insured shall not release
        the insurer from the payment of damages for injuries sustained or
        loss occasioned during the existence of the policy . . .

        B. (1) The injured person or his survivors or heirs . . . shall have
        a right of direct action against the insurer within the terms and
        limits of the policy . . . however, such action may be brought
        against the insurer alone only when at least one of the following
        applies:
             (a) The insured has been adjudged bankrupt by a court of
             competent jurisdiction or when proceedings to adjudge an
             insured bankrupt have been commenced before a court of
             competent jurisdiction . . . .

LA. REV. STAT. § 22:1269 (Supp. 2012). The plain language of the statute evinces
Louisiana’s intent for the insolvency of the insured not to “release the insurer
from the payment of damages” to injured parties. Id. Section 22:1269 is crafted
to protect Louisiana’s vital interest in liability insurance that covers injuries to

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people in the state. Watson v. Emp’rs Liab. Assur. Corp., 348 U.S. 66, 73 (1954).
The Supreme Court held even where an insurance contract expressly prohibited
direct actions before a determination of the insured’s liability, Louisiana’s
interest in protecting injured parties under Section 22:1269 overrode
Massachusetts’s interest in enforcing its contract rules. Watson, 348 U.S. at
72–73 (holding Louisiana direct action did not deny due process to foreign
liability insurer even where contract of insurance prohibited direct action and
was drafted and executed in Massachusetts).
      The Louisiana Supreme Court has held that “the direct action statute does
not create an independent cause of action against the insurer, it merely grants
a procedural right of action against the insurer where the plaintiff has a
substantive cause of action against the insured.” Descant v. Adm’rs of Tulane
Educ. Fund, 639 So. 2d 246, 249 (La. 1994). Under Section 22:1269, insurers may
raise any defenses that arise from the nature of the obligation, that are personal
to the insurer, or “that are common to all the solidary obligors.” Id. 249–50.
Insurers may not, however, raise defenses to liability that are personal to the
insured, such as the fact the insured is in bankruptcy. Id. at 250 n.9. Thus, if
there is coverage for Sosebee’s claim, the fact Harvest is in bankruptcy should not
affect Steadfast’s obligation to pay on the claim. This does not mean Steadfast
may not raise the fact Harvest is in bankruptcy as a defense to waiver. The
question of waiver is, of course, antecedent to coverage.
      Because Harvest has been in Chapter 11 bankruptcy at all times relevant
to Sosebee’s claim of waiver, we must consider how the protections of bankruptcy
might affect our waiver analysis. Chapter 11 provides robust protections to
debtors while bankruptcy is ongoing, but strikes “a balance between a debtor’s


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interest in reorganizing and restructuring its debts and the creditors’ interest in
maximizing the value of the bankruptcy estate.” Florida Dept. of Revenue v.
Piccadilly Cafeterias, Inc., 554 U.S. 33, 51 (2008) (internal citations omitted).
Unlike Chapter 7 bankruptcy, the goal of which is liquidation of the debtor’s
assets, Pioneer Inv. Servs. Co. v. Brunswick Assocs. Ltd., 507 U.S. 380, 389
(1993), the goal of Chapter 11 bankruptcy is to marshall the debtor’s resources
“to provide the best possible opportunity for a successful rehabilitation which will
ultimately redound to the benefit of all creditors.” In re Colortex Indus., Inc., 19
F.3d 1371, 1377 (11th Cir. 1994); accord Pioneer Inv. Servs., 507 U.S. at 389.
      When a debtor files for bankruptcy, an estate is created under 11 U.S.C.
§§ 541, 541(a) (2006). Except as otherwise provided in the statute, the estate
includes “all legal or equitable interests of the debtor in property as of the
commencement of the case.” 11 U.S.C. § 541(a)(1). We have held that while
insurance policies are generally property of the estate, the proceeds of liability
insurance policies, unlike first party policies, generally are not.
             [The] definition [of the bankruptcy estate] is intended to be
      broadly construed, and courts are generally in agreement that an
      insurance policy will be considered property of the estate. Insurance
      policies are property of the estate . . . . Any rights the debtor has
      against the insurer, whether contractual or otherwise, become
      property of the estate.
             Acknowledging that the debtor owns the policy, however, does
      not end the inquiry. The question is not who owns the policies, but
      who owns the liability proceeds . . . .
             The overriding question when determining whether insurance
      proceeds are property of the estate is whether the debtor would have
      a right to receive and keep those proceeds when the insurer paid on
      a claim . . . .
             Examples of insurance policies whose proceeds are property of
      the estate include casualty, collision, life, and fire insurance policies


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                                  No. 11–31134

      in which the debtor is a beneficiary. Proceeds of such insurance
      policies, if made payable to the debtor rather than a third party such
      as a creditor, are property of the estate and may inure to all
      bankruptcy creditors. But under the typical liability policy, the debtor
      will not have a cognizable interest in the proceeds of the policy. Those
      proceeds will normally be payable only for the benefit of those harmed
      by the debtor under the terms of the insurance contract.

In re Edgeworth, 993 F.2d 51, 55–56 (5th Cir. 1993) (footnotes and internal
quotation marks omitted); accord In re Sfuzzi, Inc., 191 B.R. 664, 666 (Bankr.
N.D. Tex. 1996) (holding liability insurance proceeds not property of bankruptcy
estate). Only in the limited instance of a mass tort action where hundreds or
thousands of claims against the debtor’s insurer might exhaust insurance
proceeds and thus threaten the debtor’s estate over and above limits of liability
insurance policies have courts held the proceeds of liability insurance policies are
property of the bankruptcy estate. E.g., MacArthur Co. v. Johns-Manville Corp.,
837 F.2d 89, 92 (2d Cir. 1988), (“Manville’s insurance policies and their proceeds
were substantial property of the Manville estate which will be diminished if and
to the extent that third party direct actions against the insurance carriers result
in plaintiffs’ judgments.”) (internal citation and quotation marks omitted);
Edgeworth, 993 F.2d at 56 n.21 (“In the mass tort context, the decisions by
several courts to include the proceeds as property of the estate appear to be
motivated by a concern that the court would not otherwise be able to prevent a
free-for-all against the insurer outside the bankruptcy proceeding.”). At the time
Harvest filed for bankruptcy, all of the twenty largest unsecured claims against
Harvest were for “Vendor/Trade Debt”, not tort liability. Sosebee’s personal
injury claim against Harvest is the result of an isolated accident to which the
mass tort precedents are inapplicable. There is no evidence that numerous tort


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                                  No. 11–31134

claims threaten the limits of Harvest’s liability insurance or that Steadfast needs
to be protected from a siege of tort claims under Harvest’s policy. Therefore, the
proceeds of the policies at issue in this case are not the property of Harvest’s
bankruptcy estate.
      Because liability insurance proceeds are generally not property of the
bankruptcy estate, if a direct action claimant succeeds in obtaining a judgment
against an insurer, the claimant recovers from the insurer directly rather than
from the bankruptcy estate. See Landry v. Exxon Pipeline Co. 260 B.R. 769, 779
(Bankr. M.D. La. 2001).
      [R]ecovery against the Insurers causes a dollar for dollar reduction
      of any obligation on the part of [the debtor] to repair any damage
      suffered by the Plaintiffs. In turn, the value of the remaining
      claims against the assets of [the debtor] increases by the amount of
      the diminished liability of [the debtor]. Recovery against the
      Insurers lessens the sum total of claims for which the estate is or
      may be liable, while at the same time potentially increases the pro
      rata recovery of creditors that are situated, as a matter of priority,
      the same as the Plaintiffs’ claims (or that are situated in a position
      of lesser priority), but are not afforded by applicable
      non-bankruptcy law the right to liability insurance coverage.

Id. Thus, in this direct action case Sosebee is seeking recovery from the proceeds
of the insurance policy, not from Harvest’s bankruptcy estate.
      Pursuing a direct action claim against a liability insurer is not the only
recovery option available to a personal injury claimant when the insured is in
bankruptcy: a personal injury claimant may make a claim against the debtor in
the bankruptcy case. See Sikes v. Global Marine, Inc., 881 F.2d 176 (5th Cir.
1989). Sosebee has also filed a claim against Harvest in the bankruptcy case.
If, as in this case, the debtor objects to the claim, the court must quantify the
claim by lifting the bankruptcy stay so that a personal injury action may

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                                  No. 11–31134

proceed. See, e.g., id. (lifting bankruptcy stay to permit personal injury action
to proceed). To discourage forum shopping and prevent a party “from receiving
a windfall merely by reason of the happenstance of bankruptcy,” state law
applies in the adversary proceeding unless an overriding bankruptcy policy
requires otherwise. Butner v. United States, 440 U.S. 48, 55 (1979) (citing Lewis
v. Mfrs. Nat’l Bank, 364 U.S. 603, 609 (1961)). If the personal injury claimant
succeeds in proving the debtor is liable on the claim and there is liability
insurance coverage, the insurer will pay the claimant directly, rather than the
bankruptcy estate. See Landry, 260 B.R. at 800. The money paid under the
liability policy is the money of the insurance company. Id. If, however, the court
finds the debtor is liable but there is no insurance coverage, the claimant must
seek a payout from the bankruptcy estate. See Fogel v. Zell, 221 F.3d 955, 960
(7th Cir. 2000) (citing 11 U.S.C. § 101(10)) (tort victim is creditor of bankruptcy
estate if victim had claim against bankruptcy estate that arose no later than the
filing of petition). Because tort victims are only unsecured creditors, they are
disadvantaged vis-à-vis the debtor’s secured creditors who have a higher priority
in the payout. See 11 U.S.C. §§ 725–26, 507 (2006); see, e.g., In re Chance Indus.,
Inc., 367 B.R. 689, 696 (Bankr. D. Kan. 2006) (“No funds were recovered and
available for distribution to unsecured creditors.”). Thus, if there is no coverage
for Sosebee’s claim, Sosebee must seek a payout from the bankruptcy estate. In
Harvest’s bankruptcy, the claims against the estate amount to tens of millions
of dollars more than the assets of the estate, and the amount Harvest owes to
secured creditors dwarfs the amount Harvest owes to unsecured creditors. If
there is no coverage, Sosebee may receive only a fraction of the amount Harvest
owes it from the bankruptcy payout. Conversely, if there is insurance coverage,
Sosebee would be able to recover the judgment amount directly from Steadfast,

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                                 No. 11–31134

see Landry, 260 B.R. at 800, leaving more money in the bankruptcy estate for
Harvest’s other creditors.
      When a debtor files for bankruptcy under Chapter 11, an automatic stay
goes into effect under 11 U.S.C. § 362 and suspends nonbankruptcy courts’
authority to continue judicial proceedings then pending against the debtor
including

      (1) the commencement or continuation. . . [of a] proceeding against
      the debtor that was or could have been commenced before the
      commencement of the case . . .
      (3) any act to obtain possession of property of the estate or of
      property from the estate or to exercise control over property of the
      estate
      (6) any act to collect, assess, or recover a claim against the debtor
      that arose before the commencement of the case under this title
11 U.S.C. § 362. This stay goes into effect without any action required by the
bankruptcy court. 3 Collier on Bankruptcy, ¶ 362.02 (Alan N. Resnick & Henry
J. Sommer eds., 16th ed. 2011). Parties need not receive formal service of
process in order to be subject to the stay. Id. Unless a court grants relief from
the stay, the stay continues until the property at issue is no longer property of
the bankruptcy estate or until the bankruptcy case is closed or dismissed. 11
U.S.C. § 362(c).
      The automatic stay does not generally apply to third parties such as
debtors’ codefendants or guarantors, Travelers Indem. Co. v. Bailey, 557 U.S.
137, 166 (2009) (Stevens, J., dissenting), but some courts have held the stay
applies to the debtor’s insurers. 3 Collier on Bankruptcy, ¶ 362.03 (Alan N.
Resnick & Henry J. Sommer eds., 16th ed. 2011).            In MacArthur Co. v.
Johns-Manville Corp., the Second Circuit held the liability insurance proceeds
constituted property of the estate and therefore actions by third parties against

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                                   No. 11–31134

debtor-insurers were automatically stayed when the debtor filed its bankruptcy
petition.   837 F.2d at 92 (citing In re Johns-Manville Corp., 40 B.R. 219
(S.D.N.Y. 1984). Where a court finds insurance proceeds to be property of the
bankruptcy estate the automatic stay will apply to direct actions against
insurers, see 11 U.S.C. § 362(3), but where the proceeds of the insurance policies
are not property of the bankruptcy estate, direct actions against insurers will not
be affected by the stay. See 11 U.S.C. § 362. Therefore, because the proceeds
from Steadfast’s policy are not property of Harvest’s bankruptcy estate, the
automatic stay does not apply to the direct action in this case. Because the
automatic stay did, however, apply to Sosebee’s claim against Harvest in the
2008 case, that case has remained stayed since Harvest filed for bankruptcy and
the court cannot lift the stay until the bankruptcy court closes or dismisses
Harvest’s bankruptcy case.
                                         B
      Also relevant to Sosebee’s claim of waiver is the possible res judicata or
collateral estoppel effect a judgment in this case would have on Sosebee’s claim
in the bankruptcy case.
      Federal courts look to the law of state in which the federal diversity court
sat to determine the preclusive effect of a federal diversity judgment. Hartsel
Springs Ranch of Colo., Inc. v. Bluegreen Corp., 296 F.3d 982, 986 (10th Cir.
2002). If claim preclusion applies in a bankruptcy case the judgement in the
prior action would be dispositive as to the existence and amount of the debtor’s
obligation to the particular creditor, see, e.g., In re Comer, 723 F.2d 737, 739–40
(9th Cir. 1984), but not as to the dischargeability of the debt. Brown v. Felson,
442 U.S. 127, 129 (1979). “The four prerequisites for the application of res
judicata are: (1) the parties must be identical in both suits, or in privity; (2) the

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                                  No. 11–31134

prior judgment must have been rendered by a court of competent jurisdiction; (3)
there must be a final judgment on the merits; and (4) the same claim or cause
of action must be involved in both cases.” Schneidau v. Vanderwall, 17 So. 3d
61, 64 (La. Ct. App. 2009); LA. REV. STAT. ANN. § 13:4231. In this case Harvest
is not a party, so for claim preclusion to apply there must be privity between
Steadfast and Harvest. Louisiana courts have interpreted privity to mean “a
person whose liability is purely derivative from the act of another person, or a
person who is the primary actor in creating this kind of liability, such as in cases
of employer-employee and lessor-lessee relationships.” Baker v. Wheless Drilling
Co., 303 So. 2d 511, 515 (La. Ct. App. 1974). Insurers may be in privity with the
insured when the injured party sues the under the Louisiana Direct Action
Statute, but only where the policy limits are not exceeded and the interests of
the insurer and the insured are aligned. See Cornish v. Freeman, 451 So. 2d
148, 150 (La. Ct. App. 1984); Roland v. Owens, 786 So. 2d 167, 170 (La. Ct. App.
2001) (“The insured and the insurer not only share the same quality as parties,
but in essence their identities are virtually merged into one, to the extent of the
policy limits.”) (emphasis added) (internal citation and quotation marks
omitted). Because Steadfast has asserted policy defenses in this case, there is
no credible argument that the interests of Harvest and Steadfast are sufficiently
aligned to establish privity for purposes of res judicata. Thus, claim preclusion
will not apply to Sosebee’s claim against Harvest in the bankruptcy case.
      Issue preclusion will likewise not bar Harvest from relitigating the issues
decided in this case in the bankruptcy case. Louisiana requires four elements
to be met “before an earlier valid and final judgment will preclude relitigation
of an issue: (1) the parties must be identical; (2) the issue to be precluded must
be identical to that involved in the prior action; (3) the issue must have been

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                                  No. 11–31134

actually litigated; and (4) the determination of the issue in the prior action must
have been necessary to the resulting judgment.” Sevin v. Parish of Jefferson,
632 F. Supp. 2d 586, 594–95 (E.D. La. 2008) (internal citations and quotation
marks omitted). Because Steadfast and Sosebee are not identical parties,
collateral estoppel will not prevent relitigation of the waiver issue in the
adversary action. Unlike the federal issue preclusion rules, Louisiana still
requires mutuality for issue preclusion. Williams v. City of Marksville, 839 So.
2d 1129, 1132 (La. Ct. App. 2003). Therefore, neither claim preclusion nor issue
preclusion will prevent Harvest from relitigating the issues decided in this case.


                                        C
      Waiver requires (1) misleading conduct on the part of the insurer and (2)
prejudice to the insured. Emery, 49 So. 3d at 21; Scottsdale, 1999 WL 130633,
at *5. The burden of proving waiver is on the party claiming waiver. Duffy, 47
F.3d at 150.
                                         i
      Steadfast contends the district court erred in holding Steadfast’s conduct
was so inconsistent with asserting the exclusion as a defense as to reasonably
lead Harvest to believe Steadfast relinquished its right to assert the exclusion.
Steadfast claims it never informed Harvest it was withdrawing its reservation
of rights or covering Sosebee’s claims. Steadfast admits three of its insurance
adjusters misinterpreted Steadfast’s policy as covering Harvest’s claims, but
maintains Steadfast never communicated the mistaken interpretation to
Harvest. Steadfast maintains Louisiana case law has restricted waiver to cases
where the insurer fails to issue a reservation of rights before providing a defense
to the insured.

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                                 No. 11–31134

      Steadfast extensively relies on F.D.I.C. v. Duffy, 47 F.3d 146 (5th Cir.
1995) for the proposition that an insurer cannot waive its reservation of rights
through delay in asserting policy defenses against the injured party. In Duffy,
we examined the issue of whether an insurer waived its defense that the policy
was void ab initio. Id. at 150. Steadfast cites language from Duffy for the
proposition that waiting four years after the grounds for a defense arises to
assert a noncoverage defense does not place an insurer in danger of waiving its
reservation of rights. Duffy does not support this proposition. The insurer in
Duffy waited four years to raise its affirmative defense because the court
dismissed the suit sua sponte before the insurer had the opportunity to file
responsive pleadings. F.D.I.C. v. Duffy, 835 F. Supp. 307, 325 (E.D. La. 1993),
aff’d, 47 F.3d 146 (5th Cir. 1995). The insurer only had the opportunity to assert
its noncoverage defense four years later on remand, at which time the insurer
immediately filed responsive pleadings denying coverage. Id. Therefore Duffy
does not support Steadfast’s contention that voluntarily waiting years to assert
a noncoverage defense in a direct action suit could never waive an otherwise
valid reservation of rights.
      In Steptore, the Louisiana Supreme Court held that for an insurer to waive
a provision of an insurance contract through its inconsistent conduct the insurer
must either have “an actual intention to relinquish the right” or the conduct
must be “so inconsistent with the intent to enforce the right so as to induce a
reasonable belief that the right has been relinquished.” Steptore, 643 So. 2d at
1216; Emery, 49 So. 3d at 21 (rejecting contention that insured could not waive
coverage defense through subsequent conduct after issuing reservation of rights
letter). An insurer may waive a reservation of rights unintentionally, even


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                                  No. 11–31134

without explicitly withdrawing its reservation of rights. Steptore, 643 So. 2d at
1216.
        Sosebee’s claim of waiver revolves entirely around Steadfast’s conduct in
this suit, to which Harvest is not a party. Both parties are in agreement that
Steadfast’s delay in asserting the watercraft exclusion as a defense in this case
was the result of multiple Steadfast policy adjusters misreading the policy.
Steadfast did not act with a knowing intention to relinquish its right to assert
the watercraft exclusion.
        Because Steadfast had no intention to relinquish its right to assert the
exclusion, we must examine whether Steadfast’s conduct was sufficiently
inconsistent with asserting the exclusion to induce a reasonable belief in Harvest
that Steadfast had relinquished its right to assert the exclusion. Louisiana law
implies a subjective and an objective component to this inquiry. See Arceneaux,
66 So. 3d at 450–51 (holding waiver requires “conduct so inconsistent with the
intent to enforce the right so as to induce a reasonable belief that the right has
been relinquished.”) (emphasis added). The requirement that the insured’s
belief be reasonable forms the objective component of the inquiry. The subjective
component of the inquiry requires the insurer’s conduct to actually induce or
cause the insured’s belief that the insurer relinquished its right.
        Regarding the objective component, Sosebee alleges Steadfast’s conduct in
this case was inconsistent with an intention to assert the watercraft exclusion
as a defense vis-à-vis Harvest.      In Steadfast’s initial answer to Sosebee,
Steadfast pled no affirmative policy defenses. Only after its right to amend its
answer as a matter of course passed, see FED. R. CIV. P. 15(a)(1), did Steadfast
move to amend its answer to add policy defenses. When Sosebee asked Steadfast
to produce any insurance policies that would provide coverage for Sosebee’s

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                                        No. 11–31134

injuries, Steadfast produced the applicable policies covering Harvest. Although
a judgment in this case would have no preclusive effect in the bankruptcy case,
Harvest might have viewed failure to timely assert the watercraft exclusion in
this case as inconsistent with an intention to assert the exclusion as a defense
in future litigation.3 Whether Steadfast’s actions in this case are sufficiently
inconsistent with asserting the watercraft exclusion as a defense to satisfy the
objective test is a close question. We need not resolve this question because the
subjective component of our inquiry clearly does not support a claim of waiver.
       Regarding the subjective component, the deposition testimony of Harvest’s
representative, Brian Daigle, never references Steadfast’s conduct in this case
as a reason for Harvest’s belief that Steadfast was not asserting policy defenses.
Mr. Daigle suggests Harvest believed Steadfast was covering Sosebee’s claim
because (1) it read the February 23, 2009 reservation of rights letter as only
pertaining to Harvest’s policies with Zurich and (2) Steadfast never informed
Harvest that Steadfast would not be providing coverage for Sosebee’s claim. Mr.
Daigle did not claim Steadfast employees informed Harvest that Steadfast would
be covering Sosebee’s claim, only that Steadfast employees never informed
Harvest that Steadfast would not be covering Sosebee’s claim. As discussed in
our analysis of the February 23, 2009 reservation of rights letter, that letter



       3
        Taking such an inconsistent position could give rise to a claim of judicial estoppel. See,
Rissetto v. Plumbers & Steamfitters Local 343, 94 F.3d 597, 600 (9th Cir. 1996) (“Judicial
estoppel . . . precludes a party from gaining an advantage by taking one position, and then
seeking a second advantage by taking an incompatible position.”). We have no occasion here
to guess what advantage Steadfast might have gained by intentionally failing to assert the
watercraft exclusion in this case, losing, and then raising the exclusion in the bankruptcy case.
We make this point only to acknowledge that Steadfast failing to timely assert the watercraft
exclusion in this case could induce a belief that it did not intend to raise the exclusion as a
defense in future litigation.

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                                  No. 11–31134

references Harvest’s policy with Steadfast by number and reproduces verbatim
the text of the watercraft exclusion. In this letter Steadfast properly reserved
its rights to assert the watercraft exclusion as a defense. Once Steadfast
reserved its rights under the watercraft exclusion, it did not need to again
inform Harvest that it might not be covering Sosebee’s claim. Mr. Daigle’s
deposition strongly suggests that it was a careless reading of the reservation of
rights letter, rather than Steadfast’s conduct in this case that misled Harvest as
to coverage. To establish waiver Louisiana requires that the insured be misled
about coverage because of the insurer’s inconsistent conduct. See Arceneaux, 969
So. 2d at 767 (citing Steptore, 643 So. 2d at 1216). Mr. Daigle’s deposition
testimony was sufficiently clear on this point as to leave no issue of material fact
in dispute: Harvest’s understanding that Steadfast would cover Sosebee’s claim
was not related to Steadfast’s conduct in this case. Thus, the district court erred
in granting summary judgment to Sosebee and in denying to summary judgment
to Steadfast.
                                         ii
      Even if Sosebee had produced sufficient evidence of inconsistent conduct
to survive summary judgment, Sosebee produced no evidence that Steadfast’s
conduct in this case prejudiced Harvest.
      Steadfast contends the district court erred in holding Steadfast’s conduct
prejudiced Harvest. In support of this contention Steadfast states that Harvest
was never a defendant in this case and Sosebee’s case against Harvest is stayed
pending the resolution of Harvest’s bankruptcy case. Steadfast maintains its
conduct could not have prejudiced Harvest when Sosebee has no active lawsuits
pending against Harvest. Steadfast stresses Harvest provided the information
with respect to the vessel involved in the accident prior to the time Steadfast

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                                  No. 11–31134

assumed Harvest’s defense. Thus, Steadfast asserts the documents and fact
witnesses Harvest provided to Steadfast after Steadfast assumed its defense did
not give Steadfast any information Steadfast could use against Harvest.
      The party asserting waiver must prove the insurer’s inconsistent conduct
prejudiced the insured. Scottsdale, 1999 WL 130633, at *5. If the injured party
raises the issue of waiver pursuant to a claim under the Louisiana Direct Action
statute, the relevant question remains whether the insurer’s conduct prejudiced
the insured. See Todd v. Steamship Mut. Underwriting Ass’n, No. 08-1195, 2011
WL 1226464, at *6 (E.D. La. Mar. 28, 2011) (citing LA. REV. STAT. § 22:1269(B)(1)
(2009)) (holding direct action plaintiff has no independent cause of action against
insurer but merely stands in shoes of insured). The question of whether an
insurer’s conduct prejudiced the injured party is irrelevant to the question of
whether the insurer waived its reservation of rights vis-à-vis the insured.
      This appeal raises the question of whether the party asserting waiver may,
under Louisiana law, prove prejudice to the insured without showing actual
harm. Louisiana case law addressing the prejudice prong of waiver does not
clarify whether the insured must have detrimentally relied on the insurer’s
misleading conduct to prove prejudice. Cf. Tudor Ins. Co. v. First Advantage
Litig. Consulting, LLC, No. 11 CIV. 3567 KBF, 2012 WL 3834721, at *11
(S.D.N.Y. Aug. 21, 2012) (citing Federated Dep’t. Stores, Inc. v. Twin City Fire
Ins. Co., 28 A.D. 3d 32, 37 ( N.Y. App. Div. 2006))(“Moreover, ‘a key element of
common-law estoppel’ is a showing by the insured of prejudice, or detrimental
reliance, from the belated disclaimer.”); Pennsylvania Nat. Mut. Cas. Ins. Co. v.
Kitty Hawk Airways, Inc., 964 F.2d 478, 480 (5th Cir. 1992) (requiring insured
show actual harm to prove prejudice under Texas law). In Arceneaux, the court


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                                      No. 11–31134

discusses but does not decide whether actual harm is required to prove the
insured was prejudiced. 969 So. 2d at 767 (citing 14 Couch on Ins.3d §§
202:67-69) (some jurisdictions hold “the loss of the right of the insured to control
and manage the defense is, in itself, prejudice without any further proof.”)
(internal quotation marks omitted). Keeping in mind this ambiguity, the central
point of our prejudice inquiry is whether insurer’s conduct interfered with the
insured’s rights. Lee R. Russ, et. al, 14 Couch on Ins. § 202:70 (3d ed. 2008).
(“Whether specific detriments, or combinations thereof, constitute prejudice is
extremely fact specific, rendering it difficult or impossible to provide any black
letter rules of law. Practitioners must review each factual pattern to determine
whether the insurer’s actions or inactions interfered with the insured’s rights.”).
       Louisiana case law suggests there are two ways to prove an insurer’s
misleading conduct prejudiced the insured. First, an insurer may prejudice an
insured by depriving the insured of the opportunity to assume and manage its
own defense. Arceneaux, 66 So. 3d at 452. Louisiana case law does not clearly
define the contexts in which this form of prejudice may occur.4
           [A]n insurers actions in continuing to defend an insured after it
           acquired information relevant to a potential defense against
           coverage, may be thought to imply an acknowledgment of
           coverage despite that defense. The jurisprudence has found an
           insurers belated disclaimer prejudicial because the insured lost
           its opportunity to assume and/or manage its own defense as a
           direct result of its reliance on the insurers assumption of the
           defense. However, there are no universally accepted rules.

Arceneaux v. Amstar Corp., 969 So. 2d at 768 (internal citations omitted).


       4
        The two instances in which Louisiana case law mentions this form of prejudice are in
contexts where the insurer never issued a reservation of rights. Arceneaux, 66 So. 3d at 452;
Arceneaux, 969 So. 2d at 768.

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                                 No. 11–31134

Second, an insurer prejudices an insured if the insured was actually harmed by
the insurer’s inconsistent conduct. See Scottsdale, 1999 WL 130633, at *5. In
Scottsdale the insured’s claim of waiver was not based on delay in asserting a
policy defense, but based on a claimed conflict of interest. Id. at *4. The court
held the insurer indeed created a conflict of interest by retaining the same
attorney to represent itself and the insured even though the insurer raised policy
defenses. Id. at *5. Nevertheless the court held the insured was not prejudiced
by this conflict of interest because the insurer also defended the claim on the
merits and there was no evidence that the settlement was unfair to the insured.
Id.

        Sosebee failed to show evidence either of Arceneaux or “real harm”
prejudice. Steadfast did not deprive Harvest of the opportunity to assume and
manage its own defense. Stephens & Grace did not begin representing Harvest
until after the district court stayed Sosebee’s claim against Harvest pursuant to
11 U.S.C. § 362. This case remained stayed the entire time Stephens & Grace
was representing Harvest. While it is true that Sosebee has filed a claim against
Harvest in the bankruptcy case that may evolve into an adversary proceeding,
Harvest’s own counsel represents Harvest in the bankruptcy case. Further,
neither claim preclusion nor issue preclusion will apply to prevent relitigation
in the impending adversary proceeding of the coverage issue or the merits of
Sosebee’s claim against Harvest. Therefore, Harvest will have an opportunity
to defend itself both from Sosebee’s personal injury claim and Steadfast’s claim
of waiver. The only evidence Sosebee provided of prejudice to Harvest was that
Harvest cooperated with Steadfast to aid Steadfast in defending Sosebee’s claim
against Steadfast by making its personnel available to Steadfast for questions,


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                                 No. 11–31134

allowing Stephens & Grace to represent a Harvest employee in a deposition
taken by the owner and operator of the fishing boat, and providing discovery
material to Steadfast as an aligned party rather than as an adversarial party.
Sosebee provided no evidence that any of these actions actually harmed Harvest
or will somehow detrimentally effect Harvest in its attempt to reorganize or in
its future negotiations with Sosebee as unsecured creditor in the bankruptcy
case. In short, Sosebee did not provide evidence that any of the aid Harvest
provided to Steadfast in this case actually harmed Harvest’s interests. We do
not have occasion to hold that if an insured is in Chapter 11 bankruptcy it may
never be prejudiced by an insurer’s conduct in a direct action suit. We do,
however, hold Sosebee did not provide evidence that Harvest was actually
prejudiced by Steadfast’s inconsistent conduct in this case. Thus, the district
court erred in denying summary judgment to Steadfast and granting summary
judgment to Sosebee.

                                      V

      For these reasons, we REVERSE and render summary judgment for
Steadfast.




                                      28
