A real estate company's insurer owes no coverage for a $3.4 million settlement resolving an employee's claim that it negligently failed to preserve video evidence of his fall into a sewer pit, an Illinois federal court ruled, rejecting the company's argument that the insurer prejudiced it while providing a defense.

Siding with NorGuard Insurance Co. on Thursday, U.S. District Judge Sunil Harjani first referenced his January ruling that said, at the outset, the insurer owed no defense to MB Real Estate Services Inc. for a spoliation of evidence claim from employee Martin Kraslen under MBRE's employer's liability policy.

In February, MBRE and Kraslen reached a settlement for more than $3.4 million, under which MBRE agreed to pay $325,000 and assigned its insurance rights against NorGuard to Kraslen to recover the remaining sum.

Kraslen had first sued various parties over his fall in state court in April 2018 and eventually lodged his spoliation of evidence claim against MBRE in a September 2021 amended complaint, referred to in court filings as "Kraslen I." He then voluntarily dismissed it, filing another suit in state court solely against MBRE in February 2023, known as "Kraslen II," from which MBRE and Kraslen reached the underlying $3.4 million settlement.

Following Judge Harjani's January decision, he then held a bench trial in July to determine facts over NorGuard's underlying defense of MBRE after the company invoked the doctrine of equitable estoppel. Under the doctrine, a court can bar an insurer from denying coverage if it finds the insurer misled its insured to the insured's detriment.

In particular, MBRE argued that because NorGuard "controlled" the company's defense in Kraslen I, including for a period of time without a reservation of rights, MBRE was prejudiced, thus warranting a finding that NorGuard should be equitably estopped from a coverage denial in Kraslen II. NorGuard has not sought any reimbursement of defense costs or fees it incurred in Kraslen I.

"Although MBRE lacked its own counsel, MBRE was actively aware of and participating in its defense, and at no point before or after the reservation of rights did it object to or express any concerns as to appointed counsel's litigation strategy," Judge Harjani found Thursday.

"Hindsight is twenty-twenty. Simply because MBRE now wishes that it would have acted differently does not establish prejudice," the judge continued. "Equitable estoppel is not a vehicle by which MBRE can now second-guess those decisions by placing all the blame on NorGuard."

According to court filings, Kraslen said he suffered injuries after he fell into a sewer pit in May 2016 at a Chicago hotel while working as chief operating engineer for MBRE, suing various parties in his initial April 2018 suit. Before he directly asserted his spoliation of evidence claim against MBRE in his 11th amended complaint in Kraslen I, filed in September 2021, other underlying defendants had brought MBRE into the dispute in March 2019 via third-party complaint, prompting NorGuard to appoint counsel to defend MBRE.

Per his bench trial findings, Judge Harjani said Thursday that "neither MBRE nor NorGuard considered the spoliation claim brought by Kraslen in Kraslen I to be a serious litigation risk until, at the earliest, January 2022."

NorGuard affirmatively denied coverage to MBRE over the spoliation claim on Feb. 22, 2022, though said it would still defend the company subject to a reservation of rights. A global mediation in Kraslen I was held the day after, which was unsuccessful. During the mediation, Kraslen did not make a demand to NorGuard or MBRE to settle the spoliation claim, though he had previously asked NorGuard to waive MBRE's lien claim on any sums he would recover from the other defendants, which MBRE's underlying counsel refused to do, Thursday's decision said.

NorGuard ultimately chose to replace MBRE's underlying counsel later in 2022. A trial was set for October 2022 in Kraslen I, but Kraslen ultimately voluntarily dismissed that suit on Oct. 18, 2022. He then filed Kraslen II in state court in February 2023, which asserted a single claim of negligent spoliation against MBRE, for which NorGuard denied coverage.

On Thursday, Judge Harjani said to establish equitable estoppel, MBRE must show that NorGuard misled MBRE, that MBRE reasonably relied on the misleading act and that it resulted in prejudice, pointing to the Seventh Circuit's 2019 decision in Essex Insurance Co. v. Blue Moon Lots Condominium Association .

In that case, Judge Harjani said "the insured never lost control of its defense because its counsel controlled the litigation strategy from the start," and the Seventh Circuit further "instructs district courts to analyze whether the insured lost control of the litigation."

"Under Illinois law, the question of prejudice is not whether MBRE could have obtained a better result for itself but whether NorGuard's conduct induced MBRE to surrender its rights to control its own defense," he continued, also citing the Seventh Circuit's 1994 decision in Essex Insurance Co. v. Stage 2 Inc.

As part of its prejudice arguments, MBRE said a NorGuard senior claims representative was informed by MBRE's initial underlying counsel about Kraslen's spoliation claim earlier in October 2021, marking a "critical gap" before Judge Harjani said MBRE and NorGuard considered the claim to be a "serious litigation risk" in January 2022.

Before January 2022, the claim representative and MBRE's initial underlying counsel believed that the spoliation claim was subject to a so-called Kotecki cap, where an employer's or insurer's liability for an employee injury is limited to amounts paid under a corresponding workers' compensation claim. However, they realized the spoliation claim was not covered by the Kotecki cap in January 2022.

"NorGuard did not prevent counsel from their preferred course of action, approved all expenses requested by counsel and did not disrupt the litigation strategy on eve of trial to MBRE's detriment," Judge Harjani found Thursday. "Instead, NorGuard provided an adequate defense, and ultimately Kraslen I was voluntarily dismissed by the plaintiff."

Though the global mediation in Kraslen I failed, Judge Harjani further noted that "MBRE was only one small part, whose role was largely secondary to the negotiations between Kraslen and the direct defendants."

"As Kraslen rejected the direct defendants' offer, without input from MBRE or NorGuard, there was nothing MBRE could have done differently," he said.

Thursday's ruling was not a full win for NorGuard, since the court further partially granted MBRE's motion for sanctions against the insurer for discovery violations. In particular, MBRE said NorGuard's claim notes contained improper redactions, which it said in turn allowed the claims representative to falsely testify about when exactly he knew about the spoliation claim at his deposition.

In its summary judgment bid, NorGuard had argued that it only knew of the spoliation claim until Jan. 31, 2022, which was the date that MBRE and the court relied on in the January summary judgment order.

"While having the notes for summary judgment would not have changed the ultimate outcome, the loss was not harmless," Judge Harjani said Thursday, further rejecting NorGuard's argument that attorney-client privilege justified the redactions.

After MBRE requested the unredacted notes this past March, NorGuard ultimately provided the unredacted notes in April.

While MBRE sought a default judgment against NorGuard, Judge Harjani said Thursday that "such a harsh sanction is not appropriate here," noting that MBRE had access to the unredacted notes for the July bench trial.

He ultimately ordered NorGuard on Thursday to reimburse MBRE for reasonable attorney fees and costs the company incurred between March and April while obtaining the unredacted claim notes and from pursuing its sanctions motions.

Mark Patricoski, an attorney for MBRE, told Law360 that, "with all respect to everyone," they intend to appeal Thursday's ruling next week, saying he believes the court misapplied the Seventh Circuit's holding in the Essex Insurance v. Blue Moon case.

A representative of NorGuard did not immediately respond to a request for comment Friday.

NorGuard is represented by Wendy N. Enerson and Michael J. Weiss of Cozen O' Connor.

MBRE is represented by Mark G. Patricoski and Gregory A. Patricoski of Patricoski Law Offices.

The case is NorGuard Insurance Co. v. MB Real Estate Services Inc. et al., case number 1:22-cv-03007, in the U.S. District Court for the Northern District of Illinois.