Monthly Practice Tip: Is There Hope for Recoupment Claims?
Today, we continue a new feature on our blog: the Monthly Practice Tip, which considers a practical problem faced by claims professionals and outside coverage counsel, presenting a dialogue created by our five editors. This month we look at the ever-challenging problem of recoupment claims.
March is the season of hope. After a long, dreary winter, March is a time of rebirth and possibilities. Even die-hard Chicago Cubs fans have hope (for a while). So this month we’ve chosen to tackle a topic that has always held out hope and promise to insurers yet, while Lucy and Charlie Brown’s football, has often been snatched away. We refer, of course, to recoupment and, more specifically, to whether insurers can recoup costs of defense or settlement payments if they are later found not to have owed coverage.
Recoupment is not the same as allocation. In allocation cases, the insurer is presumed to owe coverage for part of the claim, whether due to injury during its policy period, or, as in so-called “mixed” cases, because some but not all of the counts in the underlying complaint are covered. The issue in allocation cases is whether the insurer is permitted to pro-rate its obligations from the outset to reflect the fact that portions of the underlying claim are not covered.
In most recoupment cases, by contrast, the insurer does not have a duty to defend or indemnify. The issue is whether, notwithstanding the apparent absence of coverage, the insurer nonetheless agreed to provide a courtesy defense or to contribute towards a settlement of the underlying claim, it can recoup monies that it has paid on its insured’s behalf if it later obtains judicial confirmation that it had no contractual duty to do so.
Predictably, these concepts have become muddled in some states. California, in particular, has declared in the Buss line of cases, that insurers may not allocate their defense obligations but may pursue claims for recoupment after the fact if they can prove that certain costs of defense were solely allocable to non-covered counts.
Policyholders have attacked claims for recoupment (and allocation) as being antithetical to insurers’ declared contractual duties. Yet, the recognition of such rights may mitigate the injustice of insurers being forced to defend claims that their insureds never paid premium for, may encourage insurers to agreed to defend and lessen coverage litigation and may actually facilitate the defense and resolution of such claims by ensuring that each party bear responsibility for those claims that are covered (and not).
We first asked our editors whether recoupment was permitted in their states:
California (Sara Thorpe)
California has definitive and strong law on an insurer's right to recoup both defense costs (Buss v. Superior Court, 16 Cal. 4th 35 (1997)) as well as indemnity (Blue Ridge Ins. Co. v. Jacobsen, 25 Cal.4th 489, 22 P.3d 313, 106 Cal. Rptr.2d 535 (2001)). The right is quasi-contractual and equitable in nature. There does not appear to be any reason to distinguish between different types of policies - for purposes of defense costs, it all depends on whether the claim against the insured was potentially covered or not.
Illinois (Shaun Baldwin)
In General Agents Insurance Co. of America v. Midwest Sporting Goods, 828 N.E.2d 1092 (Ill. 2005), the Illinois Supreme Court held that even if an insurer timely and expressly reserves its right to seek recoupment of defense costs and the insured accepts the payments of those defense costs without objection, the insurer is not entitled to recoupment absent an express insurance policy provision to that effect. On the other hand, an insurer can get its money back if it was defending pursuant to an interlocutory court decree that is later reversed. Steadfast Insurance Co. v. Caremark Rx, Inc., 869 N.E.2d 910 (Ill. App. Ct. 2007).
Some newer policies also now feature the Illinois Amendatory Endorsement that ISO promulgated after GAINSCO, which states:
If we initially defend an insured or pay for an insured’s defense but later determine the claim(s) is (are) not covered under this insurance, we will have the right to reimbursement for the defense costs we have incurred.
The right to reimbursement for the defense costs under this provision will only apply to defense costs we have incurred after we notify you in writing that there may not be coverage, and that we are reserving our rights to terminate the defense and seek reimbursement of defense costs.
Massachusetts (Mike Aylward)
Our Supreme Judicial Court ruled in Medical Malpractice Joint Underwriting Association v. Goldberg, 425 Mass. 46, 680 N.E.2d 1121 (1997) that an insurer’s unilateral assertion of a right to reimbursement does not give rise to any obligation on the part of the policyholder absent some express agreement on the part of the insured to do so or a policy provision compelling reimbursement. The court indicated, however, that an insurer could obtain reimbursement for a non-covered settlement, despite its policyholder’s opposition, if it first obtained court approval to proceed. Much of the analysis in Goldberg reflected the court’s view that the insurer settled to protect its own interests. I don’t think that it’s the final word on recoupment, especially in a case where the insured was pressing the insurer to settle a “mixed” claim.
It’s not clear how Massachusetts will address allocation or recoupment in the context of the duty to defend. We’ve only recently had our highest state court ruled that allocation is permitted in long-tail cases, like those involving asbestos and pollution. While Boston Gas Co. v. Century Ind. Co., 454 Mass. 337, 910 N.E.2d 290 (2009) cited supreme court opinions from Connecticut and Vermont that allow allocation, the claims in Boston Gas were only for indemnity, so we really don’t know yet how it will play out with respect to either allocation or recoupment.
As a practical matter, the real issue in these cases is whether the insurer can show that there were discrete expenses solely allocable to non-covered counts—in other words, the Buss test. If that’s true, the insurer has a much better chance of arguing to a court that it shouldn’t have to pay those fees.
New York (Kevin Merriman)
There are only two decisions in New York that squarely address the issue and both have allowed recoupment of defense costs for uncovered claims. In Gotham Ins. Co. v. GLNX, Inc., 1993 WL 312243 (S.D.N.Y. Aug. 6, 1993) (unreported), the insurer issued a reservation of rights letter that explicitly advised the insured that the insurer was reserving the right to seek reimbursement of defense costs if it was later determined that the policy did not cover the loss. The court permitted recoupment of defense costs following a determination that the pollution exclusion barred coverage for the claim because the insured offered no evidence that it refused to consent to the reservation of rights.
A similar result obtained in American Guarantee and Liability Ins. Co. v. CNA Reinsurance Co., 16 A.D.3d 154 (1st Dep’t 2005); however, it does not appear from the decision that the right to recoupment was conditioned on notice to the insured. In American Guarantee, a putative additional insured claimed coverage under an additional insured endorsement that afforded coverage only for the named insured’s negligence. The insurer accepted the additional insured’s defense of the claim subject to a reservation of rights regarding the scope of the coverage afforded by the endorsement. As in GLNX, Inc., the additional insured accepted the defense without objection. The court held that the insurer was entitled to reimbursement for the amount of a post-verdict settlement and defense costs attributable to the finding of liability against the additional insured, though there was no indication that the insurer had expressly reserved the right to recoup defense costs.
Both of these cases involved claims that were determined to be entirely outside of coverage. A recent decision from New York Court of Appeals might support a different outcome, at least for so-called “mixed” actions, in which some claims are determined to be covered and others are not. In Fieldston Property Owners Assn., Inc. v. Hermitage Ins. Co., 2011 NY Slip Op 01361 (Feb. 24, 2011), the court held that a CGL carrier was not entitled to reimbursement of defense costs from a D&O insurer that afforded concurrent coverage for the loss. Although most of the claims were not covered by the CGL policy and were covered by D&O policy, the court found that the CGL insurer’s duty to defend was triggered because the CGL policy covered one of the causes of action. Citing the broad duty to defend, the court concluded that the existence of one covered claim required the insurer to defend the actions in their entirety with no right of recoupment from the D&O insurer for uncovered claims.
Texas (Chris Martin)
In Texas, recoupment is not permitted unless 1) the insurance policy expressly permits it or 2) the insured agrees to it. Excess Underwriters at Lloyd's, London et al vs Frank's Casing, 246 S.W. 42 (Tex. 2008). Few policies provide such rights and most insureds will never agree to it. So, some carriers and certain defense counsel have become very creative in trying to figure out new ways to achieve the same end. Sadly, it has become very frustrating in Texas to obtain recoupment so it has resulted in more coverage cases being filed against insureds so that the carrier has some protection when the inevitable policy limit demands against the insured are made by the underlying claimant.
Oregon (Diane Polscer)
Oregon courts have not specifically addressed whether an insurer can seek recoupment from its insured for either uncovered amounts or for a portion of the defense costs for uncovered claims. In the event an insurer wants to reserve the right to seek recoupment from its insured in any way, it should do so in its initial reservation of rights letter. Without any case guidance, it is difficult to predict whether Oregon would follow the Buss model for allowing an insurer to recover money from its insured. It is at least contemplated, however, that an insurer should be able to recover amounts of an uncovered judgment that an insurer pays on behalf of the insured.
Washington (Diane Polscer)
The issue of whether an insurer can seek reimbursement of defense costs paid, where it is later determined there was no duty to defend, is not completely decided in Washington either. In Holly Mountain Resources, Ltd. v. Westport Ins. Corp., 130 Wn.App. 635, 652, n. 8 (2005), the Washington Court of Appeals suggested that insurers might be allowed to seek recoupment for defense costs in the appropriate case:
If the insurer is unsure of its obligation to defend in a given instance, it may defend under a reservation of rights while seeking a declaratory judgment that it has no duty to defend. A reservation of rights is a means by which the insurer avoids breaching its duty to defend while seeking to avoid waiver and estoppel. "When that course of action is taken, the insured receives the defense promised and, if coverage is found not to exist, the insurer will not be obligated to pay."
However, a well respected treatise on Washington insurance law has since criticized this aspect of Holly Mountain as being inconsistent with the principles stated in Tank v. State Farm, 105 Wn.2d 381 (1986), arguing that “[a] reservation of rights will never allow an insurer to seek retroactive reimbursement for attorney fees and defense costs already incurred by the insurer.” Harris, Washington Insurance Law, Third Edition § 17.01 (Matthew Bender, Rev. Ed. 2010). The Harris treatise on Washington Insurance Law does suggest that recoupment could be allowed if “the insured has signed a non-waiver agreement expressly stipulating that the insurer may seek reimbursement if it is later determined that the insurer never had the duty to defend.”
Q: Is Notice To The Insured A Pre-Condition To Recoupment?
Diane: Although Oregon courts haven’t ruled yet, if the insurer intends to claim this right, it should reserve it from the outset.
Michael: We don’t have much law on this in New England. If this is indeed, an equitable right that the insurer acquires by agreeing to defend, it’s not clear why notice is required. As a practical matter, however, we recommend that this be clearly stated in the RoR just to be safe.
On the other hand, failure to give notice of a right to claim reimbursement for monies paid to help settle a case can be fatal to the insurer’s rights. In a recent Maine case (American National Fire Ins. Co. v. York County, 575 F.2d 112 (1st Cir. 2009)) where the insurer initially raised coverage issues but then agreed to pay for the insured’s settlement without re-stating its right to recover the settlement payments, the First Circuit found that it had waived those rights.
Sara: Not in California.
Chris: Not in Texas either, but as a practical matter, the right is so limited that this issue never arises.
Q: What are the practical differences between allocation and recoupment?
Sara: As a practical matter, recoupment of all of the defense costs paid by the insurer is easier than recouping some. This is because in a "mixed” case, the burden is going to be on the insurer to prove which defense costs are solely allocable to the non-covered claim. The policyholder is not motivated to help sort that out. Defense counsel (especially independent defense counsel) is also not inclined to help out by indicating which tasks are associated with which claim. Expert testimony (whether through claim adjuster, fee auditor, or attorney with similar experience) will usually be required if the insurer hopes to sustain this burden.
Chris: I typcially think of allocation as an issue between carriers while recoupment is limited to the insured. But, some carriers and counsel who work in different states use both terms to refer to the same thing regardless of whether the issue carrier vs carrier or a claim back against the insured. Once the nomenclature is settled, there is no legally significant difference. As it relates to the insured, in my home state, it is exceptionally difficult to obtain because most policies dont have such clauses and most insureds wont agree to allow it.
Q: Is there a downside to having a right to recoup settlement payments?
Michael: Ironically, the answer may be yes. Courts seem more likely to put pressure on insurers to fund settlements—or to sustain bad faith claims if the insurer refuses to settle for policy limits due to coverage concerns—if the insurer has a means of getting its money back later on. The insurer may have less leverage to require the insured to contribute money if the insurer has a remedy for recoupment.
Shaun: There is a potential downside. Under Illinois law, an insurer is only required to pay settlement sums for covered claims. Int’l Ins. Co. v. Rollprint Packaging Products, Inc., 728 N.E.2d 680 (Ill. App. 2000). I would not recommend “advancing sums” for non-covered claims unless the insured expressly agrees that such sums are subject to recoupment.
If the insurer is obliged to front the settlement, it is then forced to assume the risk of the insured’s solvency even if it is successful in getting a ruling that there’s no coverage to say nothing of the additional litigation costs to get the money back. The only leverage to obtain a contribution from the insured is the threat of further litigation in which the insured will have to retain its own counsel to defend it.
And here are some practical tips:
Know Your Jurisdiction
Because the law differs from state to state, it is imperative to know the law. Check the U.S. District Court rulings if you are in federal court. The federal court may view the issue differently than the state court, even if the state's highest court has ruled on the issue.
Understand Coverage
The policyholder and insurer alike must understand the insurance coverage issues. Make sure a complete copy of the policy is available and has been reviewed. Although unlikely, the policy should be reviewed to determine if it has any reimbursement provision. Examine applicable case law on the coverage issues.
Reservation of Rights
What is “adequate” notice may differ depending on the applicable state law. When was the reservation of rights sent? Because of its timing, it may apply to only some of the claim. Did the letter adequately apprise the policyholder of the insurer’s intention to seek reimbursement of defense costs, indemnity and other amounts paid on the policyholder’s behalf. If not, would the policyholder have handled the case differently if so apprised? Check state law on how specific the reservation of the right of reimbursement needs to be, and whether it should be repeated in subsequent letters.
Response to Reservation of Rights
Although a reservation of rights may be unilaterally made in some jurisdictions, the policyholder should consider whether to respond and note objection to the reservation and examine whether the reservation of rights creates conflicts that may entitle the policyholder in some jurisdictions to select counsel of its choice.
Communicating With Insured And Defense Counsel After Reservation
Consideration should also be given to advising the insured and defense counsel in a mixed case, that they should provide clear and specific entries in billings. While this may not be followed by the counsel, it may help later since it will most likely be the insurer’s burden to prove what is attributably to covered and uncovered claims.
Considerations For Settlement Demands
Plaintiff may well tailor the settlement demand to craft the demand only on certain issues for “payment,” but with the release of all claims. This “rationalization” of the demand may have an impact on evaluation and reasonableness for bad faith purposes.
The policyholder, defense counsel, and personal counsel must use extreme care in commenting on settlement demands. There should not be knee-jerk letters to the insurer. On the insurer side, adjusters should be careful about what they comment upon and how they characterize settlement opportunities in their claim notes.
A prudent policyholder might want to pass along the plaintiff’s settlement demand to the insurer with a communication to this effect: “Dear Carrier: Here is a demand from the plaintiff. We leave it to you to protect our interests. We want you to pay everything you are contractually obligated to pay.” In this way, the insurer will have to decide whether the settlement is reasonable under the circumstances even though the policyholder has not demanded that the matter be settled.
Mediation
Mediators need to have a full understanding of the nuances of an insurer’s right (or lack thereof) to reimbursement. If a final resolution and “peace” are the goal, defense counsel and insurers may want to expressly agree to mediate solely on the condition that all rights to reimbursement are waived by all insurers in writing in advance of the mediation. Insurers will want to factor in their reimbursement rights in valuing the claims to be resolved.
Settlement Negotiations
Carriers should be highly sensitive to last minute demands and use reimbursement issues to offset this pressure. Reimbursement equalizes the power considerations in last minute demands.
Coverage Litigation
Finally, consider whether or when to file a Declaratory Judgment action. Know whether the jurisdiction requires one be filed prior to payment of amounts in dispute. Certainly such an action can be filed to apprise the parties of the seriousness of the coverage issue, even if the chances of getting the coverage issue resolved prior to resolution of the underlying dispute is unlikely.
