Expert Commentary

Federal Preemption in Favor of a Risk Retention Group

Risk retention groups (RRGs) are insurers of last resort created by federal statute to provide coverages not available under state statutes. As a result, the RRG founding papers and policy wording will always preempt state law concerning the policy.


Claims Practices
October 2016

In Attorneys Liab. Protection Soc'y, Inc. v. Ingaldson Fitzgerald, P.C., 2016 U.S. App. LEXIS 17396 (9th Cir. Alaska Sept. 23, 2016), Attorneys Liability Protection Society (ALPS) appealed from a trial court's grant of summary judgment to Ingaldson Fitzgerald, P.C., which denied ALPS reimbursement of defense fees expended in an underlying insurance litigation.

The Facts

ALPS is an RRG chartered in Montana. Ingaldson is a law firm located in Alaska. ALPS provided Ingaldson's malpractice insurance coverage from April 29, 2007, to April 29, 2008.

Ingaldson's policy with ALPS insured the firm against claims arising from "an act, error, or omission in professional services that were or should have been rendered by [Ingaldson]." The policy expressly excluded from coverage any claims arising from conversion or disputes over fees. The policy also required Ingaldson to reimburse ALPS for fees and costs that ALPS incurred in defending noncovered claims.

In 2008, the bankruptcy trustee for the bankrupt estate of a former client of Ingaldson, in conjunction with another former client of the firm, brought a claim against Ingaldson in the US Bankruptcy Court for the District of Alaska. The suit concerned Ingaldson disbursing from and withdrawing fees and costs against a $150,000 retainer. The former client and the trustee sought recovery of that retainer and asserted claims against Ingaldson for, among other things, restitution, disgorgement, and conversion.

Ingaldson notified ALPS of the underlying suit. ALPS accepted Ingaldson's tender of the defense in the underlying suit, but did so with the caveat that ALPS "reserved 'all rights.'" ALPS also asserted that the claims in the underlying suit sought restitution that was not within the policy's definition of covered "damages" and that the policy did not cover claims related to disputes over fees, dishonest or criminal acts, or the conversion of funds in client trust accounts. ALPS specifically reserved the right to reimbursement for the portion of fees incurred in the defense of claims that were deemed not covered under the policy.

Ingaldson retained independent counsel to defend it in the bankruptcy litigation, and ALPS paid the fees charged by that counsel. The bankruptcy court twice granted partial summary judgment against Ingaldson.

On September 23, 2011, ALPS filed an action in federal district court seeking a declaration that the ALPS policy did not cover the claims against Ingaldson and that ALPS had no obligation under the policy to provide an appeal bond in the underlying suit. ALPS also sought to recover the expenses it incurred providing a defense to Ingaldson.

The district court determined that the policy did not cover the claims in the underlying suit. It also concluded that ALPS had no obligation to provide an appeal bond. Nevertheless, the district court determined that ALPS was not entitled to reimbursement of the expenses it incurred defending Ingaldson in the underlying suit. While the policy provided ALPS with a right to reimbursement, the reimbursement provision did not comply with Alaska insurance law and, the trial court concluded, was therefore unenforceable. Alaska Statute § 21.96.100(d) provides that, in furnishing the insured with independent counsel, an insurer "shall be responsible only for the fees and costs to defend those allegations for which the insurer either reserves its position as to coverage or accepts coverage."

The Ninth Circuit Court of Appeals certified two questions concerning interpretation of Alaska law to the Alaska Supreme Court.

  • Does Alaska law prohibit enforcement of a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending claims under a reservation of rights, where (1) the insurer explicitly reserved the right to seek such reimbursement in its offer to tender a defense provided by independent counsel, (2) the insured accepted the defense subject to the reservation of rights, and (3) the claims are later determined to be excluded from coverage under the policy?
  • If the answer to Question 1 is "yes," does Alaska law prohibit enforcement of a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending claims under a reservation of rights, where (1) the insurer explicitly reserved the right to seek such reimbursement in its offer to tender a defense provided by independent counsel, (2) the insured accepted the defense subject to the reservation of rights, and (3) it is later determined that the duty to defend never arose under the policy because there was no possibility of coverage?

The Alaska Supreme Court answered "yes" to each question.

Analysis

The court needed to decide whether the Liability Risk Retention Act of 1986 (LRRA) preempted Alaska Statute § 21.96.100(d)'s prohibition on reimbursement of fees and costs incurred by an insurer defending a noncovered claim.

In ALPS's chartering state, Montana, insurers are permitted to seek reimbursement of fees expended defending a noncovered claim pursuant to a reservation of rights. The Ninth Circuit concluded that Alaska Statute § 21.96.100(d)'s prohibition on reimbursement of fees and costs incurred by an insurer defending a noncovered claim offended the LRRA's broad preemption language and that no exception applied to save the law.

The court said that LRRA leaves regulation of an RRG to the state where the RRG is chartered and broadly preempts "any [nonchartering] State law, rule, regulation, or order to the extent that such law, rule, regulation, or order would … make unlawful, or regulate, directly or indirectly, the operation of a risk retention group." 15 U.S.C. § 3902(a)(1).

Statute § 21.96.100(d) places a restriction on Alaska contracts that is "not contemplated by the LRRA, and that is not [precluded] by all other states."

Federal statutes allow nonchartering states to restrict the types of insurance coverage, such as for punitive damages or intentional conduct, that may be provided in the state. The district court's interpretation would permit that statute to overtake the broad preemption scheme. If the district court's interpretation were correct, nonchartering states could simply "prohibit" coverage that did not comply with every aspect of state insurance law. The district court's interpretation, that nonchartering states could fashion their insurance laws in a way to ensure they fall into an exception, thereby always avoided preemption. The Ninth Circuit did not believe Congress intended such a result.

The Ninth Circuit reversed the district court's order precluding ALPS from recovering fees and costs incurred defending Ingaldson in the underlying dispute.

Conclusion

Federal law about RRGs is different from state insurance law. Since RRGs are often insurers of last resort, the LLRA allows the chartering state to control what is written and prohibits a state from limiting what the RRG policy states. States have no right to control an RRG or limit what it does in a state that did not charter the RRG.

© 2016 Barry Zalma, Esq., CFE


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