In St. Paul Fire and Marine Insurance Co. v. National Union Fire Insurance Co. of Pittsburgh, PA, No. 16-12015 (11th Cir. May 29, 2018), a battle between excess and primary carriers, the Eleventh Circuit applied the so-called “realignment doctrine” to long-running coverage litigation and held that the district court never had jurisdiction over the matter in the first place.

The underlying dispute arose out of several explosions at an Imperial Sugar Co. refinery in Port Worth, Georgia that killed 14 and wounded 36 workers. The workers and their families filed tort and workers’ compensation claims against Imperial.

Three subsidiaries of American International Group, Inc. ­— National Union Fire Insurance Co., American Home Assurance Co., and New Hampshire Insurance Co. ­(collectively, “AIG”) — provided Imperial with a $26 million general liability policy and an unlimited workers’ compensation policy. St. Paul Fire & Marine Insurance Co. and American Guarantee & Liability Insurance Co. provided excess coverage to Imperial on top of the AIG general liability policy.

AIG globally settled 41 of the 67 claims against Imperial for about $28.5 million. AIG paid 90 percent of the global settlements (approximately $25.5 million) under the general liability policy and 10 percent (approximately $3 million) under the workers’ compensation policy.

St. Paul and American Guarantee contended that by allocating the global settlements in this manner, AIG prematurely exhausted the $26 million general liability policy and improperly exposed the excess policies. According to St. Paul and American Guarantee, AIG should have allocated more of the settlement to the workers’ compensation policy — which was unlimited — and reduced its contributions under the general liability policy — which was capped at $26 million. Thus, St. Paul and American Guarantee argued that AIG breached its duty to Imperial by exposing Imperial to undue excess liability based on the allocation.

St. Paul, as the alleged subrogee of Imperial, sued AIG and American Guarantee in the United States District Court for the Northern District of Georgia, seeking a declaration that it was entitled to recoup its settlement and defense costs due to AIG’s allegedly improper exhaustion of the general liability policy. Federal jurisdiction was based on diversity of citizenship. The parties’ citizenships were arranged as follows in St. Paul’s complaint:

In its answer, American Guarantee admitted essentially all of St. Paul’s allegations. American Guarantee also made a cross-claim against the AIG subsidiaries requesting the same relief as St. Paul based on the same allegations.

While the cross-claim potentially destroyed diversity and, therefore, federal jurisdiction, American Guarantee contended that the district court had supplemental jurisdiction over the cross-claim pursuant to 28 U.S.C. § 1367(a), which provides that “district courts shall have supplemental jurisdiction over all other claims that are so related to claims in the action within such original jurisdiction that they form part of the same case or controversy under Article III of the United States Constitution.” Importantly, there must be a claim within the action that confers original jurisdiction before a court can exercise supplemental jurisdiction.

After over two years of discovery, AIG moved for summary judgment, arguing that there was an absence of evidence to support St. Paul’s and American Guarantee’s claims. The district court granted AIG’s motion, and St. Paul and American Guarantee appealed to the Eleventh Circuit.

After St. Paul voluntarily dismissed its appeal, the Eleventh Circuit sua sponte directed the remaining parties to file supplemental briefs addressing whether the court had jurisdiction to hear the appeal. The parties agreed that the court had supplemental jurisdiction under 28 U.S.C. 1367(a). They argued that St. Paul’s original complaint conferred diversity jurisdiction on the district court because citizenship was diverse and the amount in controversy was met. Thus, according to both American Guarantee and AIG, supplemental jurisdiction over American Guarantee’s cross-claim was proper because it formed “part of the same case or controversy” as St. Paul’s original claim.

The Eleventh Circuit disagreed, holding that the district court did not have supplemental jurisdiction over American Guarantee’s cross-claim because it did not have diversity jurisdiction over St. Paul’s original complaint. Relying on the jurisdictional principle known as the “realignment doctrine,” the court held that it was the district court’s duty to look beyond the pleadings and realign the parties to reflect their interests in the litigation. This is because the “parties themselves cannot confer diversity jurisdiction upon the federal courts by their own designation of plaintiffs and defendants.”

While St. Paul named American Guarantee as a defendant in its complaint, the court held that the realignment doctrine should have been applied because St. Paul and American Guarantee were actually on the same side of the controversy. According to the court, both American Guarantee and St. Paul sought a declaration that AIG had improperly exhausted the general liability policy, and both asserted the same facts, pursued the same legal theories, and, importantly, raised no claims against each other. Indeed, the court noted that the two excess insurers’ interests were “completely coextensive.”

After realigning American Guarantee as plaintiff, the court found that diversity was destroyed from the outset of the litigation because American Guarantee (the realigned plaintiff), National Union, American Home, and New Hampshire (the defendants) were all citizens of New York. And because the district court never had diversity jurisdiction over St. Paul’s complaint, it could not exercise supplemental jurisdiction over American Guarantee’s cross-claim because there was no original jurisdiction to which supplemental jurisdiction could attach. Thus, the Eleventh Circuit vacated the district court’s judgment and remanded with instructions to dismiss.

This holding illustrates an important lesson for insurers and all litigants in federal court — subject-matter jurisdiction cannot be waived and cannot be conferred upon the courts by the parties’ own designation. So, before filing a declaratory judgment action in federal court, insurers and others should ensure that diversity jurisdiction exists, and should consider the fact that courts may look beyond the pleading as framed by the parties, and assess the possibility that the parties’ interests may not be aligned in the manner originally pled in a way to ensure diversity jurisdiction.