National Insurance Law Forum : Insurance Litigation Lawyer & Attorney : National Insurance Law Forum : Insurance Coverage, Bad Faith Litigation

 
In American & Foreign Ins. Co. v. Jerry’s Sports Center, No. J-48-2009 (Pa. August 17, 2010), a gun shop was sued by the NAACP seeking to enjoin a public nuisance that the insured and others allegedly created by failing to prevent the illegal sale of firearms. Royal agreed to defend the case and hired defense counsel on behalf of the insured but did so under a comprehensive reservation of rights, including the right to recoup its costs of defense if it was later owed not to owe coverage. Royal thereafter filed an action for declaratory relief, in which the Court of Common Pleas ruled that the NAACP suit did not seek damages for any “bodily injury” suffered by the plaintiff. After this finding was affirmed in 2004 by the Pennsylvania Superior Court, the trial court further ruled that Royal was entitled to recoup $309,126 that it had paid to defense the case. On appeal, however, the Superior Court ruled that Royal had no such right. Royal appealed to the Supreme Court of Pennsylvania.

In affirming the Superior Court’s ruling that liability insurers have no right of recoupment, the Pennsylvania Supreme Court aligned itself with General Agents Ins. Co. v. Midwest Sporting Goods, 215 Ill. 2d 146, 828 N.E.2d 1092 (2005) (GAINSCO) where, under nearly identical facts, the Illinois Supreme Court had ruled that an insurer cannot recover defense costs pursuant to a reservation of rights absent an express provision to that effect in the insurance contract between the parties.

Further, as with GAINSCO, the Pennsylvania Supreme Court declared that the NAACP suit at least potentially set forth a claim for “bodily injury” triggering the insurer’s duty to defend. The court emphasized the fact that Royal’s claim personnel had never explicitly disclaimed any duty to defend and had, indeed, proceeded as if the claim triggered its duty to defend. As a result, it found that the trial court’s subsequent determination that Royal did not have a duty to defend did not have retroactive effect.

It would seem that this ruling that Royal had a duty to defend would have been the end of the story as, absent proof that discrete portions of the defense were solely attributable to non-covered causes of action a la Buss, no court has allowed an insurer to recoup costs of defense that it was contractually obligated to pay. Nevertheless, the Pennsylvania Supreme Court proceeded to address the equitable theories that other courts have adopted in permitting a right to recoup the cost of defending law suits that were found not to trigger an insurer’s defense duty. Thus, various courts have ruled an insured that receives a defense to claims that are not covered is unjustly enriched. Alternatively, some courts have permitted recovery on the grounds of quantum meruit or have found that an implied in fact contract is created when the insured accepts a defense on the basis of a reservation of rights that includes an asserted right to recoupment.

In this case, however, the Pennsylvania court ruled that Royal could not manufacture a right to recoupment by issuing a reservation of rights where no such right was contained in the policy itself. Further, the court held that the insured was not unjustly enriched by accepting the defense of a suit that was later found to fall outside of its insurance coverage. Indeed, the court found that the insured had little alternative, as rejecting the insurer’s proferred defense might have been treated as a breach of the insured’s duty to cooperate. There was also benefit to Royal as, in defending, the insurer was able to use it own chosen defense counsel, implement its own audit and litigation management procedures, protect against indemnity exposures and avoid bad faith claims.
A concurring opinion by Justice Saylor suggested that, in appropriate circumstances, an implied in fact contract might be created by the insured’s acceptance of the insurer’s defense that would allow a right of recoupment. He concluded, however, that the better course of action would be for insurers to explicitly include such provisions in their policies to give the insured advance notice

While the Pennsylvania court embraced the Illinois Supreme Court’s opinion in GAINSCO, the U.S. Court of Appeals for the Tenth Circuit took the opposite view, predicting that the Colorado Supreme Court would reject GAINSCO and would allow recoupment under such circumstances.
In Valley Forge Ins. Co. v. Health Care Mgt. Partners, Ltd., No. 09-1251 (10th Cir. August 16, 2010), a long-term care facility was sued by the federal for submitting fraudulent Medicare claims. CNA and Zurich denied that these claims were covered under their professional liability policies but nonetheless agreed to defend under a reservation of rights pending the outcome of a DJ filed to resolve their claimed obligations. The carriers’ position was sustained by the federal district court in Colorado and, on appeal, by the Tenth Circuit. See, Zurich-American Ins. Co. v. O’Hare Regional Center for Rehabilitation, 529 F.3d 916 (10th Cir. 2008). On remand, the District Court ruled in 2009 that Zurich and CNA were entitled to recoup all of the defense costs that they had paid in the interim.

On appeal to the Tenth Circuit, the insured argued that an insurer could not manufacture a right to recoupment that does not appear in its policy. Further, the insured argued that a trial was, in any event, necessary to determine what fees were recoverable.

In rejecting these arguments and affirming the insurers’ right of recoupment, the Tenth Circuit predicted that the Colorado Supreme Court would not follow GAINSCO. In particular, the court found guidance in the opinions of the state Supreme Court in cases such as Hecla Mining v. N.H. Ins. Co., 811 P.2d 1083 (Colo. 1991) and Cotter Corp. v. American Empire Surplus Lines Ins. Co., 90 P.3d 814 (Colo. 2004), in which insurers were directed to defend under a reservation of rights, even if a defense duty was not apparent from the underlying complaint. While acknowledging that the discussion of a right to recoupment in Hecla and Cotter might be mere dicta, the court held that these opinions were a sufficient basis under diversity rules for predicting that the Colorado Supreme Court would allow recoupment even where such a right is not set forth in the insurance contract itself.

The Tenth Circuit also declined to hold that an insurer must wait until the conclusion of the underlying law suit before presenting a claim for reimbursement of defense costs. This is indeed the procedure that the California Supreme Court set forth in Buss. Unlike California, however, Colorado allows insurers to bring an action for declaratory relief to determine their coverage duties ven while the underlying suit is still pending so long as the coverage issues are independent of the underlying liability claims and can be resolved without prejudicing the insured’s position in the underlying suit.

The Tenth Circuit declined to define the doctrinal basis for permitting recoupment, declaring that where the right derives in equity (unjust enrichment), contract (implied in fact) or just as a matter of public policy, Colorado clearly permits recoupment of defense costs.

Further, the court rejected the insured’s argument that disputed issues of fact remained with respect to how much the insurers could lawfully recoup or that certain of the defense costs at issue were excessive and unreasonable and thus beyond what any insured should be expected to pay for. The court held that the insureds had failed to present credible evidence disputing the reasonableness of these costs.

Neither of these opinions breaks significant new ground in the on-going battle over the issue of recoupment. Even so, there are a few interesting take-aways.

First, it remains the case that those courts whose states are most lenient in finding a duty to defend are also most likely to recognize recoupment as a palliative remedy for the insurer that is forced, often as a matter of public policy, to defend suits that on their face do not create a potential for coverage.

Second, a right to recoupment is only likely to arise if the insurer had no duty to defend. This is not to be confused with the separate issue of allocation, where defense costs are pro-rated at the outset of the litigation, or Buss, where the insurer must pay 100% of defense costs while the litigation is on-going but may be entitled to recoup some of its defense costs after the fact.

Finally, it is apparent from these and past cases that the manner in which claims are presented and defended can have an impact on the outcome of the parties’ rights. There seems little doubt that the Pennsylvania Supreme Court’s analysis of this issue was influenced by the fact that Royal took equivocal positions with respect to its claimed coverage obligations yet insisted that the case be defended through counsel of its own choosing, subject to its own litigation management procedures.

In the earliest Minnesota case to address this issue, a federal district court ruled in Knapp v. Commonwealth Land Title Insurance Co., 932 F. Supp. 1169 (D. Minn. 1996) that a title insurer could recoup defense costs that it had paid pending a determination that it did not, in fact, owe coverage for the underlying title dispute. The court focused on the fact that the insurer had expressly reserved a right of recoupment when it agreed to defend and that the insured had not protested this claimed right. The court concluded, “Under these circumstances, the Court finds it appropriate to determine that Knapp’s silence in response to Commonwealth’s reservations of rights letter, and subsequent acceptance of the defense provided by Commonwealth, constitutes an implied agreement to the reservation of rights.”

The Eighth Circuit seemed to follow this line of reasoning a decade later in a Texas case. Despite the insured’s argument that Texas law, as exemplified by the Texas Supreme Court’s opinion in Matagorda County v. Texas Association of Counties Risk Management Pool, 52 S.W.3d 128 (Tex. 2000) precludes insurers from unilaterally asserting a right to recoupment of defense costs, the Eighth Circuit ruled in St. Paul Fire & Marine Ins. Co. v. Compaq Computer Corp., 457 F.3d 766 (8th Cir. 2006) that St. Paul’s assertion of a right to recoupment was not “unilateral” but rather was impliedly agreed to by Compaq when it accepted St. Paul’s partial payment of its defense costs after the insured itself had demanded a defense beyond that provided for under the policy. As a result, the court found that the insured had, in effect, created a supplemental agreement that required payments beyond those contemplated in the original agreement but that also gave St. Paul both rights asserted in the reservation of rights letter pursuant to which it had agreed to make any such payments.

Since then, however, it appears that the Eighth Circuit has gotten cold feet (or been taken aback by emerging case law in other jurisdictions rejecting a right of recoupment). In any event, the court’s recent opinion in Westchester Fire Ins. Co. v. Wallerich, No. 07-3624 (8th Cir. April 24, 2009) declined to find a right of recoupment and narrowly distinguished Knapp and Compaq.
In Wallerich, a directors and officers carrier agreed to provide a defense under a reservation of rights but stated that it would seek reimbursement for any sums advanced if a court later ruled that it did not have a duty to defend. Westchester Fire proceeded to bring a DJ and ultimately obtained a ruling that the “insured v. insured” exclusion in its policy precluded any duty to defend. The Minnesota District Court ruled that Westchester Fire was entitled to recoup the defense costs that it had paid in the interim.

On appeal, the Eighth Circuit affirmed the lower court’s ruling that Westchester Fire had no duty to defend but rejected its claims to recoup defense costs.. The court took note of the split in authority around the country and the growing number of courts that have rejected the insurers’ position and concluded that it was persuaded by the more recent state and federal court opinions from other jurisdictions that have adopted the “minority” position barring reimbursement for defense costs.
The court also distinguished the facts in Knapp and Compaq. In particular, the Eighth Circuit emphasized that Wallerich had not acquiesced in the insurer’s assertion of this right and, indeed, had loudly protested at the time that it should not have to repay Westchester Fire.

Under the circumstances, the court ruled that Westchester’s decision to still go forward with a defense despite the insured’s rejection of the terms in its reservation of rights letter constituted an implied acceptance of the insured’s terms. Furthermore, unlike Compaq, the court held that the insurer had never explicitly agreed to forego any rights that it otherwise had in return for tendering a defense.

Is Wallerich a complete repudiation of Compaq or just a refinement of the court’s earlier analysis in a different fact pattern where the insured’s objection at the time invalidates the “implied in fact” contract that insurers have argued to advantage in other cases.

From the author’s own point of view, the defense cost recoupment cases are much more difficult to prove than is the case where an insurer agrees to pay a settlement on its insured’s behalf and later seeks repayment after it is held not to owe coverage. The real issue with the defense cost recoupment cases is that courts are increasingly viewing these claims as subverting the promise to defend set forth in the policy’s insuring agreement. What value is the duty to defend, so goes this argument, if the insurer demands its money back later?

In fact, there is real merit to insurer arguments for recoupment where the absence of a defense obligation is apparent on the face of the pleadings or uncontroverted facts and the defense being provided to the insured is truly a “courtesy” defense that may minimize any liability that the insured may otherwise face. Where an insurer does have a duty to defend, however, it may only recoup defense costs that are attributable to non-covered claims (as in Buss) or that were incurred after it was found not to owe a defense.

In 2004, York County was sued by three inmates of the York County Jail for strip searches that the plaintiffs claimed had violated their constitutional rights. York County tendered the defense of this case to American National and other insurers that had provided Law Enforcement Liability insurers that have provided LEL coverage to it during the period in question. American National agreed to defend under a reservation of rights noting the fact that its policy in question contained a $5,000 “per claim” deductible. A dispute arose between the parties as to whether this deductible applied to each individual class member or, as the insured contended, applied to its claim for coverage as a whole.

Despite this reservation, American National ultimately agreed to contribute $750,000 towards a package settlement of the claims. At the time, its agreement to contribute was not explicitly tied to any claim to reimbursement reflecting its position with respect to the $5,000 “per claim” deductible. Thereafter, American National sought to recover its settlement contribution, noting that it was undisputed that none of the members of the underlying class action had been subjected to strip searches during its policy nor had any of the claimants who were approved to payments from the class action settlement fund obtained recovery in excess of $5,000 per claimant.

In the ensuing coverage litigation, Judge Singal agreed with American National that the policy deductible was unambiguous and applied individually to each underlying claimant. The court ruled, however, that the application of this deductible to American National’s contribution to settlement was far from clear given the size and makeup of the class and the numerous parties participating in funding the settlement. Further, the district court held that American National had no right to recover back these payments as York County had proved that there was a binding agreement between it as of 2004 without any reservation to recoup these sums.
Alternatively, the district court held that York County had proved the affirmative defense of equitable estoppel that it had relied to its detriment on American National’s agreement to contribute these sums without any right to recoupment. The district court concluded that it was “unreasonable for [American National] as the insurer to ‘gamble’ in this manner without explicitly disclosing its position to the insured, who, in the absence of any such disclosure, reasonably believed that its own $50,000 contribution to the York County class action settlement fund was the maximum extent of its payment under the terms of the settlement.”

The district court held that accord and satisfaction would not exist so as to create a contract if American National had explicitly reserved its rights regarding the deductible at the time that the parties were agreeing on the various contributions to the settlement or, later, when it tendered its settlement contribution. The court took note of the fact, however, that American National had last pressed the issue of its deductible months earlier and had not sought clarification as to how the deductible would be reimbursed or reiterated its reservation of rights during the final stages of the settlement discussions, a period of time when it was well aware of its insured’s position that the County’s maximum contribution would be capped at $50,000.

As to the issue of estoppel, the court ruled that American National’s conduct was, in fact, unreasonable, not because of its willingness to contribute $750,000 but because of its failure to alert its policyholder that this sum was not the contribution it appeared to be. Rather, the district court concluded that American National had evolved its strategy of seeking recoupment after the fact without appropriate disclosure to its policyholder who had in the interim justifiably and detrimentally relied on the insurer’s “misleading offer.”

Judge Singal’s order did not reach the crucial question of whether an insurer ever has a right to recoup settlement payments. Courts around the country have reached different conclusions on this issue although most have ruled as a matter of equity that if an insurer funds a settlement at the request of the insured for which it is later held not to owe coverage, an insurer is entitled to recoupment and the insured would otherwise obtain a windfall. Compare. Blue Ridge Ins. Co. v. Jacobsen, 25 Cal.4th 489, 22 P.3d 313, 106 Cal. Rptr.2d 535 (2001)(right to recoupment) with Excess Underwriters at Lloyd’s, London v. Frank’s Casing Crew and Rental Tools, No 02-0730 (Tex. February 1, 2008)(no right).

In all of these cases, however, courts have emphasized the need for transparency and, in particular, for disclosure of the insurer’s intent to seek contribution. Without such an explicit assertion, few courts will uphold or imply a right to recovery.
 

In this latest case, the Pennsylvania Superior Court ruled in American & Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 2008 PA Super. 1994 (Pa. Super. May 5, 2008), that a trial court erred in holding  that Royal was entitled to reimbursement for the cost of defending various class action gun cases that it was later held not to have any obligation to defend because the NAACP case did not allege or involve “bodily injury.”

Whereas the trial court had found that an implied contract existed between the parties in light of the fact that the insured had accepted Royal’s defense pursuant to a reservation of rights letter that included an asserted right to recoupment of fees, the Superior Court held that such an analysis undercut the focus of the duty to defend on the possibility of coverage as distinguished from such facts as might ultimately be adjudicated.

The appellate court also took note of the fact that it was Royal’s suggestion that the insured retain independent counsel as opposed to participating in a joint defense involving multiple defendants that would have resulted in substantially lower legal costs to the policyholder. Where the insurer had a contractual duty to defend and had obtained various benefits by exercising that right to defend, the Superior Court refused to find that an implied contractual right to reimbursement existed or that the insured was unjustly enriched by the defense that Royal had provided so as to entitle Royal to reimbursement of attorney’s fees under a theory of quantum meruit.

Plainly the outcome of this case was influenced by its unique facts.  At the same time, the court was clearly persuaded by the Illinois Supreme Court's 2005 opinion in Gainsco (which also involved recoupment claims in the context of the NAACP gun suits).  It will be interesting to see whether the case proceeds to the Pennsylvania Supreme Court.