Insurers: Can You Get Your Defense Dollars Back?
July 2005
Buss v. Superior Court,
65 Cal. Rptr. 2d 366 (Cal. 1997), permitted an insurer to obtain reimbursement
from its insured of defense costs incurred in defending noncovered claims asserted
against the insured. If your state law allows an insurer to obtain reimbursement
of the costs of defending claims that are not even potentially covered under
the policy from the insured, your state relies on Buss.
Similarly, if your jurisdiction does not permit reimbursement of the cost of
defending claims, your state distinguishes Buss.
by R. Steven
Rawls *
Butler Pappas
Weihmuller Katz Craig, LLP
Very few states have expressly decided this issue. If your state hasn't taken
a position, an examination of Buss and the states
that have done so may help you determine how an insurer should probably proceed
and the potential defenses available in the event the insurer does not proceed
appropriately.
Buss v. Superior Court
H&H Sports, Inc. filed suit against Jerry Buss and Buss-related entities
alleging 27 causes of action related to Buss's unilateral termination of several
contracts with H&H Sports. Buss tendered the defense of the action to his insurers,
all of whom denied coverage except Transamerica Insurance Company. Transamerica
accepted the defense under both the comprehensive general liability and commercial
general liability policies issued to Buss based on the single claim for defamation
alleged by H&H Sports.
Transamerica reserved its rights to deny coverage and for reimbursement or
an allocation of defense costs if the defamation claim proved not to be covered.
Transamerica agreed to pay for Buss's independent counsel as well because of
the reservation of rights and conflict. Buss and Transamerica eventually entered
into a separate agreement where Buss agreed to reimburse Transamerica if a court
ordered a pro rata allocation of defense costs. Buss settled the action with
H&H Sports with no contribution from Transamerica. Transamerica paid over $1
million in defense costs of which, according to its expert, between $21,720
and $55,767.50 were attributable to the defamation claim. Buss, 65 Cal. Rptr. 2d at 370.
Buss filed suit for contribution to the settlement and breach of Transamerica's
defense obligation and Transamerica cross-claimed for reimbursement. The Supreme
Court of California began its analysis by reviewing California insurance law.
The policy language must be given its plain meaning and where it is unclear,
it must be read "in the sense that satisfies the hypothetical insured's objectively
reasonable expectations." Buss, 65 Cal. Rptr.
2d at 372-3.
The court then examined the differences between the insurer's indemnity obligation
(arising only after liability is established and only for claims that have been
proved to be actually covered) and its defense obligation. The court recognized
that an insurer's duty to defend is broader than the duty to indemnify as it
runs to claims that are merely potentially covered as opposed to an insurer's
obligation to pay only those claims that are actually covered.
The court explained: "the insurer's duty to defend runs to claims that are
merely potentially covered, in light of facts alleged or otherwise disclosed.
[The duty] entails ... the mounting a funding of a defense in order to avoid
or ... minimize liability." Id. at 373.
The insurer's defense obligation arises as soon as the action is tendered and
ends when the action is concluded but may be extinguished earlier "if it is
shown that no claim can in fact be covered." Id. However, if extinguished early, it is only prospective; that is, until it is
decided that no claim is, in fact, covered, the insurer's defense obligation
persists.
The defense obligation is contractual, arising expressly from the policy
language, resting "on the fact the insurer has been paid premiums by the insured
for a defense." Buss, 65 Cal. Rptr. 2d at 774.
The court then recognized that the freedom from defending actions where none
of the claims is even potentially covered is also contractual and implied from
the policy language resting "on the fact that the insurer has not been paid
premiums by the insured for a defense." Id. The court then reiterates that, in a mixed action (one alleging claims that
are potentially covered and others that are not) the insurer is obligated to
defend the action in its entirety: "[t]o defend meaningfully, the insurer must
defend immediately. To defend immediately, it must defend entirely. It cannot
parse the claims, dividing those that are at least potentially covered from
those that are not." Id. This obligation
does not arise out of the contract but, rather, is "an obligation imposed by
law in support of the policy." Buss, 65 Cal.
Rptr. 2d at 775.
Thus, in an action with both covered and noncovered allegations, the insurer
may not seek reimbursement of defense costs incurred in defending claims potentially
covered under the policy because the insurer has a duty to defend these claims
and has received a premium for doing so. However, if the policy provides for
reimbursement of these claims or if the parties to the insurance contract had
entered into a separate agreement with separate consideration, the insured might
then seek reimbursement for potentially covered claims. See Buss, 65 Cal. Rptr. 2d at 776. The court further
explained that an insurer cannot reserve its right to reimbursement for the
cost of defending potentially covered claims because "it has no such ‘right'
to ‘reserve' ... even if the insured agrees to the ‘reservation.'" Id.
As to claims brought in a mixed action that are not even potentially covered,
"the insurer may seek reimbursement for defense costs." Id. Under the policy, the insurer has no
obligation to defend uncovered claims and has not been paid a premium for doing
so and "did not bargain to bear these costs." Id. This "right of reimbursement" is "implied in law as quasi-contractual, whether
or not it has one that is implied in fact in the policy as contractual." Id. According to the Buss court, if the insurer was not entitled to
reimbursement, the insured would be unjustly enriched under the law of restitution.
"The 'enrichment' of the insured by the insurer through the insurer's bearing
of unbargained-for defense costs is inconsistent with the insurer's freedom
under the policy and therefore must be deemed 'unjust.'" Buss, 65 Cal. Rptr. 2d at 777.
The Buss court concludes by holding that an
insurer defending a mixed action may seek reimbursement of "defense costs that
can be allocated solely to the claims that are not even potentially covered." Buss, 65 Cal. Rptr. 2d at 778. It is only as
to these solely uncovered claims that the insurer has not been paid a premium,
thus, even costs that can be allocated jointly to potentially covered claims
and those not covered cannot be recovered. Further, the insurer must prove,
by a preponderance of the evidence, which expenses are attributable to solely
noncovered claims. SeeBuss,
65 Cal. Rptr. 2d at 778-9. Finally, in a footnote, the court explains that this
right to reimbursement, to the extent implied in law as quasi-contractual, must be reserved and, to the extent it is
implied in fact in the policy as contractual, should be reserved. SeeBuss,
65 Cal. Rptr. 2d at 784 n.27.
States Recognizing Insurer's "Right to Reimbursement"
States following Buss that recognize the insurer's
right to reimbursement do so only for claims which are not covered under the
policy and where the insurer timely and expressly reserves its right to seek
reimbursement. See e.g., Colony Ins. Co. v. G&E Tires & Service, Inc.,
777 So. 2d 1034 (Fla. Dist. Ct. App. 2000). In relying on basic contract law,
the Colony court explained that G&E accepted
Colony's offer of a defense with a reservation of the right to seek reimbursement,
therefore, G&E "manifested acceptance of the terms upon which Colony's offer
to pay for the defense was tendered." Colony,
777 So. 2d at 1039. Thus, because Colony's offer to pay for defense costs was
conditioned on its right to seek reimbursement for defending any uncovered claims,
G&E's acceptance of the defense as described by the reservation of rights included
an acceptance of Colony's "right to reimbursement." See also Security
Ins. Co. of Hartford v. Lumbermens Mut. Cas. Co., 826 A.2d 107 (Conn.
2003) (recognizing an insurer's right to reimbursement).
Capitol Indemnity Corp. v. Blazer, 51 F. Supp.
2d 1080 (D. Nev. 1999), explains that "[t]he right to reimbursement does not
arise unless there is an understanding between the parties that the insured
would be required to reimburse the insurer for monies expended in providing
a defense." Blazer, 51 F. Supp. 2d at 1090. Thus,
only if the insured is notified and has a clear understanding of the insurer's
right to seek reimbursement for the costs of investigation and/or defense of
noncovered claims does the right to reimbursement arise.
Importantly, even states that recognize the right to reimbursement deny the
insurer that right if the insurer initially breaches its duty to defend. See e.g., Jostens,
Inc. v. CNA Insurance/Continental Cas. Co., 403 N.W.2d 625 (Minn. 1987), overruled on other grounds;Northern
States Power Co. v. Fidelity & Cas. Co. of N.Y., 523 N.W.2d 657 (Minn.
1994) (defense costs could not be separated by claimants or time periods and
that the insurer initially breached its duty to defend); Flannery v. Allstate Ins. Co., 49 F. Supp. 2d
1223 (D. Colo. 1999), and Dash v. Chicago Ins. Co.,
No. Civ. A. 00-11911-DPW, 2004 WL 1932760 (D. Mass. Aug. 23, 2004) (reimbursement
disallowed where the insurer originally breached its duty to defend).
States That Don't Recognize Insurer's "Right to Reimbursement"
In Shoshone First Bank v. Pacific Employers Insurance
Co., 2 P.3d 510 (Wyo. 2000), the Supreme Court of Wyoming decided, as
a matter of first impression, that "unless an agreement to the contrary is found
in the policy, the insurer is liable for all of the costs of defending the action." Shoshone, 2 P.3d at 514. In declining to allow
an action for reimbursement, the Supreme Court of Wyoming looked to the language
of the policy and relied on the principle that ambiguities in the policy are
to be construed in favor of the insured. The court explained, "Pacific's failure
to treat with the allocation of defense costs in the policy results in an assumption
by the insured that Pacific will pay the full cost of the defense. We construe
the policy in favor of Shoshone to that end." Id.
Although the Shoshone court recognizes the
problems associated with adopting a policy allowing allocation of defense costs
among claims, including inefficiency as disputes among members of the defense
team arise and inconsistency of result, the court bases its declination to allow
such a claim on the policy language.
- The Policy required Pacific to defend Shoshone in any suit and not simply
for specific claims. There is no indication in the Policy of any distinction
to be made between covered and noncovered claims so far as the defense of
those claims is concerned, and we will not permit the Policy to be modified
by subsequent letters from the insurer to the insured.
Shoshone, 2 P.3d at 515. Consequently, the
court goes on to reject what it characterizes as an attempt to modify the policy
by Pacific: "[i]n light of the failure of the policy language to provide for
allocation, we will not permit the contract to be amended or altered by a reservation
of rights letter." Id. at 516.
Characterizing this as the minority position, the states of Texas and Illinois
and the Third Circuit Court of Appeals have rejected the Buss "right to reimbursement" in favor of an
analysis that precludes an insurer from recovering defense costs pursuant to
a reservation of rights absent an express provision in the insurance policy. SeeTexas Ass'n of
Counties Gov't Risk Management Pool v. Matagorda County, 52 S.W.3d 128
(Tex. 2000); General Agents Ins. Co. of America, Inc.
v. Midwest Sporting Goods Co., No. 98814, 2005 WL 674685 (Ill. Mar. 24,
2005) (denying reimbursement due to absence of a policy provision and public
policy); and Terra Nova Ins. Co. v. 900 Bar, Inc.,
887 F.2d 1213 (3d Cir. 1989).
These courts distinguish the notion that a reservation of rights letter is
a separate agreement allowing an insurer to recoup defense costs and that it
merely preserves the insurer's existing defenses under the policy. SeeMidwest
Sporting Goods, 2005 WL 674685 at *10-*11. See also Timberline
Equipment Co., Inc. v. St. Paul Fire & Marine Ins. Co., 576 P.2d 1244
(Or. 1978) (finding the insurer liable for the total amount of defense costs
in a mixed action). Accord Medical Protective Co. v.
McMillan, No. Civ. A. 501CV00073, 2002 WL 31990490 (W.D. Va. Dec. 16,
2002).
Can You Predict What Your Jurisdiction Will Do?
Jurisdictions that allow an insurer to recover the costs of defending claims
not potentially covered under the policy require that the insurer timely notify
its insured of the insurer's intention to seek reimbursement. The insurer can
do so through a reservation of rights or a separate reimbursement agreement.
Those jurisdictions that do not recognize this "right" do so based on the absence
of express policy language allowing the insurer to seek reimbursement. Cases
from jurisdictions that do not permit Buss-style
reimbursement suggest that an express policy provision allowing reimbursement
would be upheld.
If your jurisdiction has not yet addressed this issue, these cases may help
establish a framework in which to evaluate the potential of seeking reimbursement.
First, the insurer must defend if a claim is potentially covered by the policy.
Second, the insurer must notify the insured that, in conjunction with its defense,
it is specifically reserving the right to seek reimbursement for defense costs
incurred in defending claims not even potentially covered under the policy.
Third, the insurer bears the burden of allocating the defense costs between
covered and uncovered claims, with any indivisible defense costs taxed against
the insurer. Finally, even when the insurer acts in accord with this framework,
your state may nonetheless preclude reimbursement absent a policy provision
expressly permitting reimbursement.
*Contributing author Rebecca
C. Appelbaum is an associate with Butler Pappas Weihmuller Katz Craig, LLP,
practicing in the areas of third-party coverage and third-party liability defense.
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