You're a claims manager for an insurance company. An insured isbeing sued and has tendered its defense under its liabilityinsurance policy with you. The issues in the complaint broughtagainst your insured are complicated. Based on the facts of thecomplaint, it is not immediately clear whether the allegations arecovered by the policy.

In fact, there's a good chance it won't be clear, even afterconsiderable factual investigation occurs. As a claims manager, howdo you meet your duties to the insured under the policy in thissituation while protecting the right of the insurer? Or, perhapsyou are the attorney enlisted by the insurance company to offer acoverage opinion and recommendations for next steps. How would youadvise the insurer then?

Insurers generally find comfort in the knowledge that, even ifthey were confronted by a difficult and expensive liability casewhere coverage was not clear, they could offer their insured adefense under reservation of rights while the insurer continued toinvestigate the case. In the event that no coverage existed for theclaim, the insurer could recoup defense or settlementfees.

That way, the insured was able to defend itself promptly, theinsurance company had time to investigate in good faith withoutharming the insured, and if there was no coverage, then it wasreasonable to require the insurer to repay the defense fees orsettlement costs as a benefit the insured had not bargained for inits policy. Some insurers might know that a few outlier courtsdisallow this approach; however, most relied on the fact that themajority approach allowed recoupment of defense and settlement feesunder reservation of rights.

At some point during the last 10 years, the majority viewchanged. The problem is that no one seemed to notice.

A survey of courts around the country shows the majority nowrefuse to allow insurers to recoup settlement or defense fees fordefenses provided under reservation of rights. When did such ashift occur? Furthermore, what are the fundamental differences inthe court analyses leading to two drastically different results?

The Presumed “Majority” Position

Even though the California Supreme Court was not the first tohold that insurers could recoup defense fees for a defense providedunder reservation of rights once it determined no coverage existed,its decision in Buss v. Supreme Court, 16 Cal. 4th 35 (CA)(1997) remains the most well-known case to so hold. Also, it isgenerally considered the exemplar of the “majority” position. JerryH. Buss and California Sports, Incorporated—collectively calledBuss—were the owners of the Los Angeles Lakers as well as theKings, along with their sports facility. A sports company suedBuss, alleging he had breached a contract relating to the facility.Buss then tendered the defense to his various insurers, all ofwhich denied the claim except Transamerica.

Under reservation of rights, Transamerica agreed to provide adefense while it investigated the claim. After a settlement of $8million and more than a million dollars in legal fees, Transamericaeventually concluded there was no coverage for the claim.Transamerica then sought reimbursement for the defense fees itpaid, along with a declaration that it was not responsiblefor contributing to the settlement.

The Supreme Court of California held that if an insurer wastendered a defense including claims covered or potentially coveredand claims that were clearly not covered, then the insurer couldnot be reimbursed for providing a defense under reservation ofrights for causes of action that were potentially covered, butcould be reimbursed for those that were not covered. It did notbargain to bear those costs.

“The insurer therefore has a right of reimbursement that isimplied in law as quasi-contractual, whether or not it has one thatis implied in fact in the policy as contractual,” the court held.The insurer can receive reimbursement for any defense fees clearlyallocable solely to non-covered causes of action.

Few Courts Embrace Position Without NotableLimitations

Although 11 federal jurisdictions rely on Buss, those decisionsare qualified. Moreover, only 10 courts have embraced it withoutsignificant limitations.

The above decision is widely considered the national standardfor this issue. In fact, it is routinely referred to by courts asthe majority position. However, only seven stateshave actually come to the same conclusion. For example, Colorado's1992 Supreme Court decision HECLA Mining Co. v. N.H. Ins.Co., 811 P.2d 1083, 1089 (Colo. 1991) concluded that aninsurer could seek reimbursement of defense costs provided underreservation of rights. The New Jersey SupremeCourt held in SL Indus., Inc. v. America Motorists Ins.Co., 607A.2d 1266, 1280 (N.J. 1992) that an insurer can seekreimbursement if it can carry the burden to show defense costs thatare allocable to non-covered claims. The Montana Supreme Courtallowed reimbursement when the insured did not object to thereservation of rights letter reserving the right. TravelersCas. & Sur. Co. v. Ribi Immunochem Research, Inc., 108P.3d 469, 480 (Mont. 2005)

In Florida, in Colony Ins. Co. v G&E Tires &Service, 777 So. 2d 1034 (FL App. 2000), an appellate courtadopted the Buss rationale, concluding that if an insuredcould not seek reimbursement, the insured would get more coveragethan he had bargained to obtain. A superior court in Delawareagreed with Buss in Nationwide Mut. Ins. Co. v.Flagg, 789 A.2d 586, 597 (Del. Super. Ct. 2001), as did aConnecticut appellate court in Security Ins. Co. of Hartford v.Lumbermens Mutual Cas. Co., 826 A.2d 107 (2003).

Eleven federal courts have adopted the Bussrationale, anticipating that the state courts would agree.District courts in Arizona, South Dakota, Hawaii, Tennessee,Alaska, Nevada, and New York have all agreed that their state courtwould agree with California that the insurer did not bargain tobear the cost of a defense not covered by the contract, andtherefore defense fees paid under reservation of rights can berecouped if there is no coverage.1 The Middle District ofLouisiana concluded that the state of New Mexico would reach thesame conclusion.2 In addition, the SixthCircuit has determined that Michigan, Ohio and Kentucky wouldagree.3

It is important to note that of the 11 federal courts to agreewith Buss, six of them explicitly stated that they weredoing so because it was the majority rule in thecountry.4 The Montana Supreme Courtalso stated that it adopted Buss because it was themajority position. Moreoever, five courts—including four ofthe courts who adopted Busssolely because it was themajority rule—held that reimbursement of defense fees could only berecouped under reservation of rights if the insured did not objectto the reservation of rights letter.5

If the insured did object in one of these jurisdictions, and theinsurer provided a defense despite the objection instead of filinga declaratory judgment action, then the insurer made the decisionto provide a defense and cannot seek reimbursement. So while 18state and federal courts permit an insurer to seek defense fees fornon-covered causes of action defended under reservation of rights,only 12 of them allow the insurer to do if the insured objects tothe attempt. Two additional courts only adopted Bussbecause it was the majority position adopted nationwide.

National Surety v. Immunexand the Rest of the Country

In 2013, the Washington state Supreme Court considered andrejected the Buss approach to reimbursement of defense fees paidunder reservation of rights. In National Surety v. Immunex176 Wn.2d 872 (2013), the Washington Supreme Court considered thecase of an insured who was included as a defendant in a largewholesale pricing litigation. As in Buss, most of theinsurers involved denied the claim outright, but National Suretyfiled a declaratory judgment action and provided a defense underreservation of rights.

After the trial court concluded that there was no coverage forthe claim, National Surety sought reimbursement of its costs. The issue reached the state Supreme Court, which held that unlessthe language of the policy explicitly allows reimbursement ofdefense fees paid under reservation of rights, no such right toreimbursement exists. The Court also stated that the right toreimbursement should be disallowed on a public policy basis becauseif the insurer were allowed to recoup all defense costs, its offerto defend under reservation of rights would be self-serving,protecting itself from claims while placing the risk of adetermination of lack of coverage solely on insured. Allowingrecoupment would allow insurer to claim the benefit of offering adefense while shouldering no costs with that decision.

Six States And Eight Federal Jurisdictions Reject Buss;Four More Likely to Follow

In its decision the Washington Supreme Court mentioned thatseveral courts had come to the same conclusion in recentyears. A brief overview of current state and federal lawconfirms that of the courts to consider the issue, at least halfhave agreed with the Washington Supreme Court. Not only Washingtonstate, but the Supreme Courts of Pennsylvania, Arkansas, Illinois,Texas and Wyoming have all held that an insurer may not seekreimbursement for a defense provided under reservation ofrights.6

Of those courts, all but Arkansas stated that their decision wasbased on the failure of the policy language to include a right toreimbursement. Arkansas based its decision on the fact that underArkansas law, attorneys fees are only collectible where expresslyallowed by statute, and no statute addresses the situation. Sixstate courts have disallowed reimbursement of defense fees paidunder reservation of rights, and eight federal courts have reachedthe same conclusion.

Eight federal courts, interpreting the laws of Idaho, Minnesota,Iowa, Maryland, Massachusetts, Georgia, Missouri, and Virginia,have also refused to allow reimbursement.7 The decisions based onGeorgia and Idaho law also denied reimbursement because of the lackof policy language authorizing it.

Seven courts total have denied the right to reimbursement underreservation of rights because the right was not included in thepolicy. Not all of the courts to deny reimbursement did so based onthe policy language. Courts in both Massachusetts and Marylanddenied reimbursement on a public policy basis, arguing it wouldimpermissibly narrow the duty to defend. The courts in the EighthCircuit did so without any analysis at all.

Eighteen states have not yet considered the issue. Thusfar, however, the Eighth Circuit has concluded that allstates in its jurisdiction to consider the question would denyreimbursement, and it is reasonable to assume that it would do sofor North Dakota and Nebraska as well if the issue is brought tofederal court. Also, while their courts may not haveconsidered the question of reimbursement of defense fees, courts inAlabama, Utah and Kansas have all disallowed reimbursement forsettlement costs under reservation of rights, which indicates astrong likelihood that those states would disallow reimbursement ofdefense costs as well.

That raises the count to 18 states that have or arelikely to deny reimbursement for defense fees paid underreservation of rights, while only 10 states will uphold the rightto reimbursement in that scenario even if the insured objects.

So What Should Insurers Do With ThisInformation?

First, insurers should recognize that around the country, themajority of courts already deny reimbursement for fees paid underreservation of rights. Insurers should accept that reality and makefuture strategic decisions around the assumption that many stateswill not support an insurer's attempt to seek such reimbursementunless the right to reimbursement is explicitly included in thepolicy. Thus, insurers should strongly consider including such aright in future policy iterations.

While there is no evidence that California courts willre-evaluate their stance on the issue, anything could happen in thefuture if the nation continues to shift to a denial ofreimbursement rights. And Nevada is one of the jurisdictions thatexplicitly adopted reimbursement under reservation of rightsbecause it was the “majority position.” There is no way to know ifcourts will continue to permit reimbursement if they become awareof the national move away from permitting reimbursement.

Editing policies to include the right to reimbursement may helpcurtail litigation in the future, but it will not affect currentlitigation related to existing policies. How should an insurerhandle a questionable third party liability claim, and uphold itsduties to the insured while investigating the claim? To forestallinsureds from objecting to the right to reimbursement, earlycorrespondence requiring the insured's signature to document theiragreement to the reservation of rights and right to reimbursementwill help avoid later claims that the insured did not consent. Insurers may also want to consider an increasedreliance on declaratory relief actions early in the investigationto confirm that no duty to defend exists. Depending on theliability exposure, the cost of the declaratory judgment actioncould be significantly less than the defense fees and/or settlementfees for the underlying action.

This also protects the insurer from the all-too-common scenariowhere even if the insurer can seek reimbursement for defense orsettlement fees, the insured is not in a position to repay thosefees. Thus, even in “safe” jurisdictions like California where theability to seek reimbursement is clear, it can behoove the insurerto quickly ask the courts to adjudicate coverage before the insurerinvests large amounts of money in a defense or settlement.

Insurers, especially those who insure large, nationalcorporations where suit can be filed in multiple jurisdictions,need to be aware of the changing attitude towards reimbursement ofdefense fees paid under reservation of rights in differentstates. Instituting company-wide policy and claims handlingchanges now could save an insurer millions of dollars in defenseand settlement fees paid under reservation of rights for claimswith no coverage.

Footnotes

[1] Phillips & Assoc. PC v Navigators Ins Co., 764F. Supp. 2d 1174 (D Ariz. 2011); Auto-Owners Ins. Co. v.Prairie Auto Group, Inc., 2008 U.S. Dist. LEXIS 45327, *9 (D.S.D. June 10, 2008); Scottsdale Ins. Co. v. Sullivan Prop.Inc., 2007 WL 2247795 (D. Hawaii 2007); : Cincinnati Ins.Co. v. Grand Pointe, LLC, 501 F. Supp. 2d 1145, 1151-52 (E.D.Tenn. 2007); UnionAmerica Ins. Co. v. General StarIndem.Co., No. A01-0317-CV, 2005 U.S. Dist. LEXIS 46337*8 (D.Alaska Mar. 7, 2005); Capitol Indem. Corp. v. Blazer, 51F. Supp. 2d 1080, 1090-91 (D. Nev. 1999); Gotham Ins. Co. v.GLNX, Inc., 1993 WL 312243 (S.D.N.Y. Aug. 6, 1993).

[2] Resure, Inc. v. Chemical Distributers, Inc., 927F. Supp. 190, 194 (M.D. La. 1996).

[3] Budd v. Travelers Indem. Co., 820 F.2d 787(6^th Cir. 1987); United Nat'l Ins. v. SSTFitness, 309 F.3d 914 (6^th Cir. 2002);Travelers Prop. Cas. Co. v. Hillerich v. Bradsby Co., 598F.3d 257, 268 (6th Cir. 2010).

[4] See the Sixth Circuit decisions in Ohio and Kentucky, andthe district court decisions in Nevada, Alaska, Tennessee, andHawaii.

[5] See the New Mexico, Montana, Alaska, Ohio and Nevadadecisions above.

[6] American and Foreign Ins. Co. v. Jerry's Sport Center,Inc., 606 Pa. 584, 597 (Pa. 2010); Medical LiabilityMutual Ins v Alan Curtis Enterprises, 373 Ark. 525 (Ark.2008); Gen Agents Ins Co of Am v Midwest Sporting Goods,215 Ill. 2d 146 (Ill. 2005); Excess Underwriters at Lloyd's v.Frank 's Casing Crew & Rental Tools, Inc., 246 S.W.3d 42(Tex. 2006); WYOMING: Shoshone First Bank v. PacificEmployers Ins. Co., 2 P.3d 510, 513-14 (Wyo. 2000).

[7] Blue Cross of Idaho Health Services, Inc. v. AtlanticMut. Ins. Co., 734 F. Supp. 2d 1107, 1112-13 (D. Idaho 2010);Westchester Fire Ins. Co. v. Wallerich, 563 F.3d707 (8thCir. 2009) (Insurance Co., 2004 WL 1932760 (D. Mass. Aug.3, 2004); Transportation Insurance Co. v. Freedom Electronics,Inc. 264 F. Supp. 2d 1214, 1221 (N.D. Ga. 2003); LibertyMut. Ins. Co. v. FAG Bearings Corp., 153 F.3d 919(8^th Cir. 1998) (applying Missouri law); MedicalProtective Co. v. McMillan, 2002 WL 31990490 (W.D. Va. Dec.16, 2002) applying Minnesota law); Pekin Ins. Co. v. Tysa,Inc., No. 3:05-cv-00030, 2006 U.S. Dist. LEXIS 93525 (S.D.Iowa Dec. 27, 2006); Perdue Farms, Inc. v. Travelers Cas. &Sur. Co. of Am., 448 F.3d 252, 258 (4^th Cir. 2006)(applying Maryland law); Dash v. Chicago Insurance Co.,2004 WL 1932760 (D. Mass. Aug. 3, 2004).