You’re a claims manager for an insurance company. An insured is being sued and has tendered its defense under its liability insurance policy with you. The issues in the complaint brought against your insured are complicated. Based on the facts of the complaint, it is not immediately clear whether the allegations are covered by the policy.

In fact, there’s a good chance it won’t be clear, even after considerable factual investigation occurs. As a claims manager, how do you meet your duties to the insured under the policy in this situation while protecting the right of the insurer? Or, perhaps you are the attorney enlisted by the insurance company to offer a coverage opinion and recommendations for next steps. How would you advise the insurer then?

Insurers generally find comfort in the knowledge that, even if they were confronted by a difficult and expensive liability case where coverage was not clear, they could offer their insured a defense under reservation of rights while the insurer continued to investigate the case. In the event that no coverage existed for the claim, the insurer could recoup defense or settlement fees. 

That way, the insured was able to defend itself promptly, the insurance company had time to investigate in good faith without harming the insured, and if there was no coverage, then it was reasonable to require the insurer to repay the defense fees or settlement costs as a benefit the insured had not bargained for in its policy. Some insurers might know that a few outlier courts disallow this approach; however, most relied on the fact that the majority approach allowed recoupment of defense and settlement fees under reservation of rights.

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

A survey of courts around the country shows the majority now refuse to allow insurers to recoup settlement or defense fees for defenses provided under reservation of rights. When did such a shift occur? Furthermore, what are the fundamental differences in the court analyses leading to two drastically different results?

The Presumed “Majority” Position

Even though the California Supreme Court was not the first to hold that insurers could recoup defense fees for a defense provided under 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 is generally considered the exemplar of the “majority” position. Jerry H. Buss and California Sports, Incorporated—collectively called Buss—were the owners of the Los Angeles Lakers as well as the Kings, along with their sports facility. A sports company sued Buss, alleging he had breached a contract relating to the facility. Buss then tendered the defense to his various insurers, all of which denied the claim except Transamerica. 

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

The Supreme Court of California held that if an insurer was tendered a defense including claims covered or potentially covered and claims that were clearly not covered, then the insurer could not be reimbursed for providing a defense under reservation of rights for causes of action that were potentially covered, but could be reimbursed for those that were not covered. It did not bargain to bear those costs.

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

Few Courts Embrace Position Without Notable Limitations

Although 11 federal jurisdictions rely on Buss, those decisions are qualified. Moreover, only 10 courts have embraced it without significant limitations.

The above decision is widely considered the national standard for this issue. In fact, it is routinely referred to by courts as the majority position. However, only seven states have actually come to the same conclusion. For example, Colorado’s 1992 Supreme Court decision HECLA Mining Co. v. N.H. Ins. Co., 811 P.2d 1083, 1089 (Colo. 1991) concluded that an insurer could seek reimbursement of defense costs provided under reservation of rights. The New Jersey Supreme Court held in SL Indus., Inc. v. America Motorists Ins. Co., 607A.2d 1266, 1280 (N.J. 1992) that an insurer can seek reimbursement if it can carry the burden to show defense costs that are allocable to non-covered claims. The Montana Supreme Court allowed reimbursement when the insured did not object to the reservation of rights letter reserving the right. Travelers Cas. & Sur. Co. v. Ribi Immunochem Research, Inc., 108 P.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 court adopted the Buss rationale, concluding that if an insured could not seek reimbursement, the insured would get more coverage than he had bargained to obtain. A superior court in Delaware agreed with Buss in Nationwide Mut. Ins. Co. v. Flagg, 789 A.2d 586, 597 (Del. Super. Ct. 2001), as did a Connecticut appellate court in Security Ins. Co. of Hartford v. Lumbermens Mutual Cas. Co., 826 A.2d 107 (2003). 

Eleven federal courts have adopted the Buss rationale, 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 court would agree with California that the insurer did not bargain to bear the cost of a defense not covered by the contract, and therefore defense fees paid under reservation of rights can be recouped if there is no coverage.The Middle District of Louisiana concluded that the state of New Mexico would reach the same conclusion.In addition, the Sixth Circuit has determined that Michigan, Ohio and Kentucky would agree.

It is important to note that of the 11 federal courts to agree with Buss, six of them explicitly stated that they were doing so because it was the majority rule in the country.The Montana Supreme Court also stated that it adopted Buss because it was the majority position.  Moreoever, five courts—including four of the courts who adopted Busssolely because it was the majority rule—held that reimbursement of defense fees could only be recouped under reservation of rights if the insured did not object to the reservation of rights letter.

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

National Surety v. Immunex and the Rest of the Country

In 2013, the Washington state Supreme Court considered and rejected the Buss approach to reimbursement of defense fees paid under reservation of rights. In National Surety v. Immunex 176 Wn.2d 872 (2013), the Washington Supreme Court considered the case of an insured who was included as a defendant in a large wholesale pricing litigation. As in Buss, most of the insurers involved denied the claim outright, but National Surety filed a declaratory judgment action and provided a defense under reservation of rights.

After the trial court concluded that there was no coverage for the claim, National Surety sought reimbursement of its costs.  The issue reached the state Supreme Court, which held that unless the language of the policy explicitly allows reimbursement of defense fees paid under reservation of rights, no such right to reimbursement exists. The Court also stated that the right to reimbursement should be disallowed on a public policy basis because if the insurer were allowed to recoup all defense costs, its offer to defend under reservation of rights would be self-serving, protecting itself from claims while placing the risk of a determination of lack of coverage solely on insured. Allowing recoupment would allow insurer to claim the benefit of offering a defense 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 that several courts had come to the same conclusion in recent years.  A brief overview of current state and federal law confirms that of the courts to consider the issue, at least half have agreed with the Washington Supreme Court. Not only Washington state, but the Supreme Courts of Pennsylvania, Arkansas, Illinois, Texas and Wyoming have all held that an insurer may not seek reimbursement for a defense provided under reservation of rights.6

Of those courts, all but Arkansas stated that their decision was based on the failure of the policy language to include a right to reimbursement. Arkansas based its decision on the fact that under Arkansas law, attorneys fees are only collectible where expressly allowed by statute, and no statute addresses the situation. Six state courts have disallowed reimbursement of defense fees paid under reservation of rights, and eight federal courts have reached the same conclusion.

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

Seven courts total have denied the right to reimbursement under reservation of rights because the right was not included in the policy. Not all of the courts to deny reimbursement did so based on the policy language. Courts in both Massachusetts and Maryland denied reimbursement on a public policy basis, arguing it would impermissibly narrow the duty to defend. The courts in the Eighth Circuit did so without any analysis at all. 

Eighteen states have not yet considered the issue. Thus far, however, the Eighth Circuit has concluded that all states in its jurisdiction to consider the question would deny reimbursement, and it is reasonable to assume that it would do so for North Dakota and Nebraska as well if the issue is brought to federal court.  Also, while their courts may not have considered the question of reimbursement of defense fees, courts in Alabama, Utah and Kansas have all disallowed reimbursement for settlement costs under reservation of rights, which indicates a strong likelihood that those states would disallow reimbursement of defense costs as well. 

That raises the count to 18 states that have or are likely to deny reimbursement for defense fees paid under reservation of rights, while only 10 states will uphold the right to reimbursement in that scenario even if the insured objects.

So What Should Insurers Do With This Information?

First, insurers should recognize that around the country, the majority of courts already deny reimbursement for fees paid under reservation of rights. Insurers should accept that reality and make future strategic decisions around the assumption that many states will not support an insurer’s attempt to seek such reimbursement unless the right to reimbursement is explicitly included in the policy. Thus, insurers should strongly consider including such a right in future policy iterations.

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

Editing policies to include the right to reimbursement may help curtail litigation in the future, but it will not affect current litigation related to existing policies. How should an insurer handle a questionable third party liability claim, and uphold its duties to the insured while investigating the claim? To forestall insureds from objecting to the right to reimbursement, early correspondence requiring the insured’s signature to document their agreement to the reservation of rights and right to reimbursement will help avoid later claims that the insured did not consent. Insurers may also want to consider an increased reliance on declaratory relief actions early in the investigation to confirm that no duty to defend exists.  Depending on the liability exposure, the cost of the declaratory judgment action could be significantly less than the defense fees and/or settlement fees for the underlying action.

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

Insurers, especially those who insure large, national corporations where suit can be filed in multiple jurisdictions, need to be aware of the changing attitude towards reimbursement of defense fees paid under reservation of rights in different states.  Instituting company-wide policy and claims handling changes now could save an insurer millions of dollars in defense and settlement fees paid under reservation of rights for claims with no coverage.

Footnotes 

[1] Phillips & Assoc. PC v Navigators Ins Co., 764 F. 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 Star Indem.Co., No. A01-0317-CV, 2005 U.S. Dist. LEXIS 46337*8 (D. Alaska Mar. 7, 2005); Capitol Indem. Corp. v. Blazer, 51 F. 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., 927 F. Supp. 190, 194 (M.D. La. 1996).

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

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

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

[6] American and Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 606 Pa. 584, 597 (Pa. 2010); Medical Liability Mutual 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. Pacific Employers Ins. Co., 2 P.3d 510, 513-14 (Wyo. 2000).

[7] Blue Cross of Idaho Health Services, Inc. v. Atlantic Mut. Ins. Co., 734 F. Supp. 2d 1107, 1112-13 (D. Idaho 2010); Westchester Fire Ins. Co. v. Wallerich, 563 F.3d707 (8th Cir. 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); Liberty Mut. Ins. Co. v. FAG Bearings Corp., 153 F.3d 919 (8th Cir. 1998) (applying Missouri law); Medical Protective 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 (4th Cir. 2006) (applying Maryland law); Dash v. Chicago Insurance Co., 2004 WL 1932760 (D. Mass. Aug. 3, 2004).