Insured's reimbursement of insurer's defense expenses: some practical steps.

• Author: Wall, Dennis J.

If there is a judicial determination of noncoverage, insurers stand to get reimbursement, but there are pitfalls to be avoided

COURTS are allowing liability carriers to recover their defense expenses from their own insureds in certain cases. The approach taken in this article is a practical one, examining alike the reported cases that allow or reject reimbursement. The practitioner can pull from those cases the practical steps courts have looked for when they have faced the issue.

SEPARATE RECOVERY FOR SETTLEMENT OR INDEMNITY PAYMENTS

Courts that deal with the issue of the recovery by an insurer of its defense expenses from its insured are often careful to distinguish the fact that they are dealing with the issue of insureds' reimbursement of insurers' defense expenses. Cases that deal with insureds' reimbursement to their insurance carrier of payments made by the carriers in settlement or indemnity generally require four things: (1) an agreement by the carrier with the insured. (2) reserving the defense of noncoverage, (3) full recovery of a reasonable settlement made by the insurer on behalf of the insured with the injured claimant, and (4) the carrier's subsequent establishment of noncoverage.(1)

Such cases include at least one holding that the requirement of an "agreement" was satisfied where the insured refused to agree but its insurance carrier obtained court approval to make the settlement. The carrier in that case was entitled to seek reimbursement.(2) The practical steps necessary for an insurance carrier to obtain reimbursement from its insured of defense expenses, are different.

CAUSES OF ACTION

In general terms, it is useful to examine the available causes of action by looking first at cases allowing various causes of action and then at cases not allowing them. In cases allowing recovery for defense expenses, the insurers' chosen cause of action most often has been "reimbursement,"(3) The "reimbursement" cause of action has allowed recovery of some significant sums, varying, for example, from the recovery in California state court of $14,294.45 in 1981.(4) to the recovery of $96,627.00, again in California state court in 1994.(5) to the recovery in federal court in California in 1988 of $495,754.13.(6)

In addition, there is some authority allowing recovery in a suit "for declaratory relief and restitution of the sums it [a general liability insurer] paid in defending and settling" the underlying liability suit.(7) There is also some authority that Texas law may allow a cause of action for such "reimbursement" if it is stated in the insurance policy, or arguably if such a fight is clearly stated in a reservation of rights letter and the record reflects "an agreement or understanding that the insured would reimburse if later it was determined that there was no duty to defend."(8)

There may also be a possibility of recovery under a theory of "recoupment" under Pennsylvania law, a U.S. district court noted in a case that apparently did not directly involve the issue of reimbursement. The court's decision in Federal Insurance Co. v. Susquehanna Broadcasting Co.(9) apparently allowed the recovery of defense expenses in that case, but only after the underlying liability case had terminated. The court stated:

We note that the claim for counsel fees is for fees

expended in defense of non-covered claims so the

merits of this claim are not connected to the early

failure to assert the damages defense. The two issues

are simply not relevant to each other. What is

important is that plaintiff did defend under a

reservation of rights. We do note our agreement

with defendant that plaintiff is not entitled to

reimbursement of any of its defense costs incurred

until the time of the termination of the Fishel

[underlying] action. See Terra Nova Insurance Co. v.

900 Bar, Inc., 887 F.2d 1213 (3d Cir. 1989). We

will therefore enter judgment in favor of defendant

on Count III of the complaint.(10)

It is not clear from the opinion what "Count III of the complaint" alleged exactly, but it appears to have alleged the cause of action for "recoupment" of defense expenses.

Causes of action not allowed because they were held to be legally unavailable to liability insurance carriers seeking reimbursement of defense expenses from their insureds, included "equitable restitution" under California law.(11) the "equitable doctrine of quasi-contract or restitution" under California law.(12) and a declaratory judgment for "recovery" of defense expenses in federal court in Pennsylvania.(13)

This article focuses on the practical steps that recur most frequently in the cases requiring insureds to reimburse their liability insurers for defense expenses, as well as the consequences in cases denying recovery when those practical steps have not been taken. The legal bases for recovery of defense expenses have been discussed in the legal literature, including by some of the more preeminent minds in the insurance bar.(14)

JUDICIAL DETERMINATION OF NO COVERAGE

Every case located on this issue to date has held that regardless of other facts, a liability carrier must obtain a judicial determination that it had no coverage in order to recover its defense expenses from its insured.(15)

This mandates obvious wisdom on the part of liability carriers and their counsel. Since a judicial determination of no coverage is required, in cases where coverage questions do not have a chance of being determined in favor of the carrier, there does not appear to be much reason to raise the issue and argue over something that is a loser in the first place. To the contrary, there may be a downside risk of triggering allegations of unfair claim settlement practices at common law or under statutes in a given jurisdiction.(16)

Regardless of unfair claim practices or other extracontractual damages allegations, it simply makes no sense to spend time and effort in a cause which has no merit. In cases in which coverage questions are clearly in favor of the insured and against the carrier, the idea of recovering defense expenses from the insured is not worth pursuing by the carrier and its counsel.

Obversely, where time allows additional facts to be discovered or circumstances change, which increase the chances of prevailing on coverage issues, liability carriers and their coverage counsel must be adroit. They must be alert to the presence of such changing circumstances and newly learned facts. This should not impose much additional burden, if any.

Many jurisdictions follow the rule that the duty to defend in the first place continues until all covered claims have been eliminated. The flip side of that statement is that when covered claims later appear to be noncovered, a basis may develop for issuing a supplemental reservation of rights due to the changed information or circumstances, so long as the law of the given jurisdiction permits a reservation of rights under such circumstances.(17)

In Buss v. Superior Court.(18) the California Supreme Court held that there is no potential for reimbursement of clearly covered claims. However, where a liability insurer provides a defense to the entire action, it may recover defense costs allocable solely to noncovered claims for which there never was a potential for coverage. Liability insurers and their coverage counsel therefore should be alert to the possibilities in which the carrier may seek reimbursement of those defense costs which could be allocated exclusively to noncovered claims.

When carriers are required to defend claims including some which are not covered, because some claims have been alleged that are covered, the carriers should be allowed to reserve the right to be reimbursed for defense expenses attributable exclusively to defense of the noncovered counts or claims.

RESERVATIONS OF RIGHTS

The general state of the law in this area in California was stated in Gossard v. Ohio Casualty Group of Insurance Cos.: "In California, it is well established that reimbursement is available to an insurer if it has either secured a nonwaiver agreement from the insured or made an adequate reservation of rights."(19) Gossard and the case it relies on, Val's Painting & Drywall Inc. v. Allstate Insurance Co.,(20) are the only two cases found to date in which "nonwaiver agreements" have been discussed, even theoretically. The remainder of the case law addresses situations in which carriers have employed reservations of rights, including of the right to seek reimbursement of defense expenses later when there is a judicial determination of no coverage.

In most if not all of the cases, the courts have summarized the situation as follows: The liability carrier has agreed to provide a defense for the insured, subject to a reservation of the carrier's right to assert that it did...