The Underlying Case: Convolve v. Seagate
In 2000, Convolve, Inc., and the Massachusetts Institute of Technology sued Seagate Technology and other technology companies, claiming $800 million in damages in connection with the alleged infringement of disk drive patents.
At the time, Seagate was insured by liability policies issued by three AIG member companies: National Union Fire Insurance Company of Pittsburgh, Pennsylvania, American International Underwriters Insurance Company (AIU), and American International Specialty Lines Insurance Company (AISLIC) (collectively, the insurers). National Union and AISLIC were obligated to defend Seagate in the Convolve litigation. More particularly, the complaint alleged various acts purportedly undertaken by Seagate that triggered National Union’s duty to defend, including the following:
[B]ased on its press releases, Seagate is claiming that its technology performs the same functions as Convolve’s proprietary technology. However, upon information and belief, plaintiffs’ technology is superior to that of Seagate, notwithstanding that Seagate has misappropriated Convolve’s technology in “developing” S[ound] B[arrier] T[echnology]. The threat of confusion in the marketplace—i.e., that the computer industry will perceive that the two products are identical, when in fact Seagate’s is inferior—threatens irreparable harm to the reputation of plaintiffs’ technology.
Initially, all three insurers denied coverage to Seagate based on the allegations in the underlying complaint. Thereafter, in September 2003, Seagate forwarded to the insurers supplemental interrogatory responses served by Convolve, describing its alleged damages and stating that
[Seagate] also embarked on a campaign to prevent Convolve from successfully and profitably licensing its technologies to others by, inter alia, falsely claiming that Convolve’s innovations were its own and falsely disparaging Convolve’s image and its technologies.
Based on this allegation of “disparagement,” AIU agreed to begin defending the case subject to a reservation of rights. Later, the other insurers were judicially determined to have a duty to defend (and AIU, as an excess insurer, was excused from the defense obligation pending the exhaustion of the primary policies). Because their reservations of rights created a conflict of interest, the insurers provided Seagate with a defense in the litigation pursuant to section 2860 of the California Civil Code , which applies when the provisions of a policy of insurance impose a duty to defend on an insurer and a conflict of interest arises that creates a duty on the part of the insurer to provide independent counsel to the insured. Under this arrangement, the insurers reimbursed Seagate for its defense costs at rates they typically pay in the ordinary course of their business for the defense of similar claims.
The Coverage Litigation
After AIU began defending the Convolve litigation, the insurers filed a declaratory action in 2004, seeking a determination that they had no duty to defend. Early in the coverage litigation, the insurers sought summary judgment on the duty to defend. As determined by the Ninth Circuit in the coverage action, “[b]ecause the duty to defend is broad and the [Convolve case] complaint creates a bare potential for coverage for disparagement, the district court did not err in concluding that the underlying complaint potentially created liability for disparagement thereby giving National [Union] and AISLIC a duty to defend Seagate.” Later, after more protracted litigation in the coverage action, the district court entered judgment that this duty to defend began on November 1, 2000, the date Seagate provided notice of the lawsuit, and ended on July 18, 2007, after Convolve made statements intimating that it was not pursuing disparagement claims.
Relying on this ruling, National Union withdrew its defense of Seagate in the ongoing Convolve litigation while the parties cross-appealed the ruling. During the appeal, the Convolve litigation continued, requiring Seagate to fund its own defense of the litigation. During this period, Seagate’s defense counsel charged rates later determined by National Union to be in excess of the insurer’s panel-counsel rates for similar cases. It is not clear from the recent opinion or the parties’ briefs whether Seagate changed defense counsel or continued using the same lawyers but no longer received the insurer-friendly rates charged by those firms while the insurers were footing the bill.
The district court’s ruling was ultimately reversed on appeal. In an unpublished opinion issued in January 2012, the Ninth Circuit reversed the district court’s judgment, ruling that the district court erred in concluding that the duty to defend terminated in 2007. As a consequence of the appellate ruling, National Union “suddenly found itself five years late on payments for Seagate’s legal defense.”
Vindicated by the appellate decision, Seagate delivered invoices to National Union reflecting the defense costs it incurred from 2007 to 2012, along with a demand for prejudgment interest. National Union paid a portion of the fees and prejudgment interest on those fees, after discounting the invoiced amounts to the rates the insurer pays to attorneys it retains “in the ordinary course of business . . . in similar actions” based on California Civil Code section 2860. As described by National Union’s counsel,
[the] sum represents National Union’s calculation of the amount it owes to Seagate, pursuant to the Ninth Circuit’s Order, on all of the invoices submitted by Seagate for the defense of the Convolve lawsuit dated August 20, 2007 through December 8, 2011. The above sum includes a reduction of the attorney fees in the McDermott, Will & Emery invoices to the rates allowed by National Union, and also includes, pursuant to the Ninth Circuit’s Order, 10% interest from the date of each invoice through October 22, 2012.
Although National Union paid about $33 million in discounted fees, counsel represented at oral argument that the difference between the fees paid and the fees allegedly due is in excess of $20 million.
The Parties’ Competing Interests
Unsatisfied with National Union’s reduced payment and seeking to recover the full amount paid in defense costs, Seagate sought summary judgment on its counterclaim for breach of contract. Unwilling to accede to the insured’s demand for full reimbursement of its expensive legal fees, National Union countered that its withdrawal of the defense was appropriate and that it should not be responsible for Seagate’s decision to use high-priced legal talent.
The insured’s perspective: Seagate moves for summary judgment. Based on the Ninth Circuit’s holding that National Union’s duty to defend remained intact beyond 2007, Seagate argued that the insurer breached the policy’s continuous defense obligation by failing to pay Seagate’s defense costs from 2007 to 2012. Seagate further claimed that the insurer’s discounted payment constituted another breach of the policy in 2012. Once National Union stopped defending, Seagate maintained, section 2860 no longer gave National Union a basis for discounting fees. As a breaching insurer, National Union is not entitled to rely on the protections and limitations of section 2860.
If the policy requires a defense, not defending is a breach. Seagate disputed National Union’s contention that the erroneous lower court ruling converted the insurer’s would-be breach into a non-breach until the ruling was overturned by the Ninth Circuit. Challenging National Union’s authority that its reliance on the lower court’s judgment was appropriate, Seagate cited several cases for the proposition that an insurer would continue to have a defense obligation “until the declaratory judgment itself was final on appeal.”
Indeed, cases considering such an eventuality hold that the insurer is advised to continue to provide a defense until the “judicial determination” becomes final on appeal.
The breaching insurer is not protected by section 2860. Although the existence of a breach has certain legal significance, that question of law is almost completely eclipsed as a practical matter by parties’ real dispute—whether section 2860 of the California Civil Code permits National Union, after withdrawing the defense in reliance on the lower court order, to discount the higher rates Seagate actually paid defense counsel and reimburse those fees at the lower rates typically paid for panel counsel. With a $20 million delta, this issue arguably emerges as the crux of the controversy.
After the Ninth Circuit reversed the lower court, National Union issued payment of Seagate’s defense costs after applying a discount based on section 2860 of the California Civil Code , reimbursing only a portion of the fees Seagate actually incurred. In pertinent part, section 2860(c) provides that the insurer’s obligation “to pay fees to the independent counsel selected by the insured is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.” When an insurer accepts its obligation to defend an insured by reimbursing the insured’s independent counsel, section 2860 protects the insurer from paying rates in excess of panel-counsel rates.
Seagate argued that this provision does not protect National Union once it stopped defending. As support for its position, Seagate relied, in part, on Foxfire, Inc. v. New Hampshire Insurance Co., in which the breaching insurer argued that it should be permitted to reimburse its insured at panel-counsel rates after wrongfully refusing to defend the underlying action. The Foxfire court rejected the argument:
[The insurer]’s first argument—that Foxfire is only entitled to be reimbursed at a rate of pay equal to what [the insurer] would have paid its panel counsel—is without merit, and [the insurer] cites no case law in support of this proposition. It is well established that when an insurance company wrongfully fails to defend an insured, thereby forcing the insured to hire its own counsel, the insurer foregoes any right to control the litigation, and cannot insist that plaintiff use a particular firm.
According to the Ninth Circuit, National Union had an obligation to defend Seagate in the Convolve case from November 1, 2000, to the present, without interruption. When National Union terminated its defense in July 2007 (regardless of the reason), Seagate argued, section 2860 no longer provides a basis for National Union to limit its obligation to reduced, panel-counsel rates.
The insurer’s perspective: National Union responds. Needless to say, National Union took a different view on both issues. Characterizing Seagate’s claim for fees as a “naked attempt to obtain a windfall by avoiding the mandatory arbitration provision of California Civil Code Section 2860,” National Union asked the district court to enter summary judgment against Seagate on the breach of contract claim and order the parties to arbitrate their fee dispute pursuant to section 2860. Framing the issue as one of compliance with the lower court’s “final” order, National Union claimed that it did not breach the policy because it was entitled to—indeed, required to—comply with the district court’s erroneous order.
Focusing on the ultimate consequences, National Union conceded that if it breached the policy by withdrawing the defense, Seagate would be entitled to “reimbursement at the full rates billed by its defense counsel as opposed to the rates the Insurers pay in the ordinary course of business for similar litigation in the same jurisdiction.” A ruling that the insurer breached the policy by terminating defense cost payments, therefore, would create “an unjust windfall” for Seagate by placing it “in a better position as a result of Judge Ware’s erroneous ruling than if Judge Ware had issued a ruling in Seagate’s favor in the first instance”—presumably by requiring National Union to pay higher rates.
National Union’s premise seems to be that it acted appropriately, justifiably relying on the lower court’s erroneous ruling. Therefore, the insurer should not be saddled with the additional cost of Seagate’s “expensive” defense counsel.
The Court Rules: No Breach
Confronted with these arguments, the district court observed that an insurer’s duty to defend ordinarily terminates “upon a judicial determination that the insured does not have a potentially-covered claim” and concluded that the parties were required to “comply” promptly with the judgment once it was entered on the court’s docket absent a stay.
During the pendency of the appeals, Seagate should have been aware that it was retaining expensive counsel at a risk to itself. If Seagate had wanted to change this calculus, it should have made a motion for stay pending appeal.
Effect of the district court’s “final” order. Although both parties knew the lower court’s judgment might be reversed on appeal, the district court’s recent order focuses on the fact that Seagate did not seek a stay of the judgment, which the court characterized as “final.” Because Seagate appealed without seeking a stay of the adverse ruling, the court decided, National Union “was entitled to the benefit of the (erroneous) ruling that there was no longer a duty to defend.” The court reasoned as follows:
To hold that [National Union] was committing a breach of contract all along would convert a final judgment under Rule 54(b) into a provisional one and directly conflict with the principle that absent a stay, a party must comply with a judgment pending appeal. Although [National Union] cross-appealed and chiefly lost, the cross-appeals did not challenge the basic victory that it had already won before Judge Ware.
Focusing on the finality of the judgment, the court found the following analysis persuasive:
[I]t would tip the balance too far in favor of the insured to hold that an insurer must wait for all appeals of a declaratory judgment (relieving it of a duty to defend) to be exhausted before removing its defense of the insured. The fact that the insurer provided a defense for the insured until the time the insurer received a declaratory judgment [o]rder demonstrates to this Court that the insurer adhered to the spirit of the public policy requiring defense of insured persons.
Absence of “Wrongful” Conduct. The court also focused its analysis on the insurer’s lack of culpability, finding that National Union “did not act wrongfully when it chose to rely on the district court’s final judgment.” This absence of “wrongful” conduct appears to have been the driving force underlying the court’s determination that National Union did not commit a breach of the policy when it withdrew its defense of Seagate.
[T]he critical language is “wrongful failure.” It was not wrongful for [National Union] to stop defending Seagate after the district court’s entry of judgment in its favor and therefore there was no breach.
Consequences of the Outcome. After ruling that National Union did not breach the policy by discontinuing Seagate’s defense, the court sought to reconcile its decision with the Ninth Circuit’s determination that the insurer had a continuous duty to defend:
This does not mean that Seagate is not entitled to the benefit of its own bargain. Our court of appeals reversed the prior district court decision and [National Union]’s contractual responsibilities were reinstated retroactively. Reinstatement does not require an additional finding of wrongful breach, however.
Based on its analysis, the court granted National Union’s cross-motion for summary judgment on Seagate’s breach of contract claim, foreclosing judicial relief for the insured.
On February 25, 2013, Seagate appealed the judgment to the Ninth Circuit.
Balancing the Litigants’ Interests
Embedded in this latest Seagate controversy are several issues that merit a careful balancing of the litigants’ interests alongside the expected conscientious legal analysis. Although the central legal issue turns on the existence of a breach, the practical concern driving the most recent development in the Seagate saga is arguably the applicability of section 2860’s rate controls. Because section 2860 does not apply where the insurer has stopped providing a defense, the litigants find themselves arguing the threshold issue of breach.
On a more fundamental level, however, the issues presented in Seagate will arguably require the Ninth Circuit to decide which party will bear the financial impact of a lower court’s erroneous decision on a question of law. When the judgment was appealed, all parties were on notice that the district court’s order might be reversed. Nevertheless, National Union argued persuasively that it should be able to rely on a judgment that its duty to defend had ended. Must an insurer continue providing a defense pending appeal in order to secure the benefit of section 2860 and run the risk that it will not be able to recoup defense costs paid during that period? Insurers can be expected to argue that such a rule unfairly penalizes them for relying on a favorable judgment.
National Union argued, instead, that requiring it to pay Seagate’s actual defense costs at higher than panel-counsel rates would create a windfall to Seagate. This argument appears to conflate the enhanced cost to National Union with unjust enrichment of the insured, ignoring the undisputed fact that Seagate actually spent higher rates for defense counsel.
Consider the insured’s viewpoint. If the court with the last word concludes that the policy required the insurer to defend continuously, the insured will argue that the insurer’s failure to provide the required defense constitutes a breach of the policy. If, as the Seagate court ruled, “the [lower court’s] initial decision in the insurer’s favor does provide insulation against a further claim of breach of contract,” insureds should be expected to argue that the rule deprives them of the full benefit of their bargain—a defense.
When National Union discontinued its defense of Seagate in reliance on the district court’s order, the insured was required to assume financial responsibility for the defense on such terms as it could negotiate. Under the rule articulated by the lower court in Seagate, the insurer reaps the benefit of section 2860, at the expense of the insured, even if it stops defending. The insured bears the full brunt of the lower court’s error, forced to fund its own defense in the face of a very distinct possibility that the insurer will refuse to reimburse the full rates paid by the insured. Alternatively, the court suggests, the insured may pursue a stay of the judgment on appeal, in hopes that the insurer will continue the defense.
Perhaps the most balanced rule is one that minimizes the overall cost. If the insurer continues funding the defense, it accomplishes two things: (1) It avoids a breach—or deviation from the policy terms that has been dubbed “not a breach,” depending on one’s perspective; and (2) it secures the benefit of lower, insurer-negotiated rates. If the insurer ultimately has no duty to defend, overall defense costs that must be assumed by the insured are lower. In Seagate, defense costs would have been reduced by $20 million. If, on the other hand, the court of last resort eventually rules against the insurer, defense costs have been controlled at lower rates and the insurer’s burden is significantly reduced. Although not a perfect win-win, such a rule might be well reasoned.
Keywords: litigation, breach of contract, California Civil Code section 2860, duty to defend, insurance coverage, panel counsel, stay pending appeal, unjust enrichment
Amy Elizabeth Stewart is the founding partner of Amy Stewart PC, Dallas.
 No. C 04-01593 WHA,2013 U.S. Dist. LEXIS 10502 (N.D. Cal. Jan. 25, 2013).
 Convolve, Inc. v. Compaq Computer Corp., No. 00-cv-5141 (S.D.N.Y. 2000).
 AIU and AISLIC are no longer parties to the coverage litigation, and their policies were not at issue in the district court’s most recent ruling, analyzed in this article.
 Original Complaint ¶ 61, Convolve, Inc., No. 00-cv-5141.
 National Union’s & AIU’s Memorandum of Law in Support of Their Cross-Motion for Summary Judgment at 3, Nat’l Union Fire Ins. Co. v. Seagate Tech, Inc., No. C-04-01593 WHA (N.D. Cal. Dec. 13, 2012).
 National Union’s & AIU’s Memorandum of Law in Support of Their Cross-Motion for Summary Judgment at 3, Seagate, No. C-04-01593 WHA.
 Cal. Civ. Code § 2860 (c).
 Nat’l Union Fire Ins. Co. v. Seagate Tech, Inc., 446 F. App’x 653, 655 (9th Cir. 2012).
 Nat’l Union Fire Ins. Co. v. Seagate Tech., Inc., 2013 U.S. Dist. LEXIS 10502, at *2–3 (N.D. Cal. Jan. 25, 2013). See National Union’s & AIU’s Memorandum of Law in Support of Their Cross-Motion for Summary Judgment at 5, Nat’l Union Fire Ins. Co. v. Seagate Tech, Inc., No. C-04-01593 WHA (N.D. Cal. Dec. 13, 2012).
 Nat’l Union Fire Ins. Co. v. Seagate Tech., Inc., 2013 U.S. Dist. LEXIS 10502, at *3 (N.D. Cal. Jan. 25, 2013).
 California Civil Code section 2860 limits the insurer’s obligation to pay legal defense fees to rates the insurer pays to attorneys it retains “in the ordinary course of business . . . in similar actions.” Cal. Civ. Code § 2860.
 Seagate Technology LLC’s Notice of Motion and Motion for Partial Summary Judgment of Breach of Contract Against National Union Fire Insurance Company of Pittsburgh, Pa. at 6, Nat’l Union Fire Ins. Co. v. Seagate Tech, Inc., No. C-04-01593 WHA (N.D. Cal. Dec. 13, 2012).
 Nat’l Union Fire Ins. Co. v. Seagate Tech., Inc., 2013 U.S. Dist. LEXIS 10502, at *4 (N.D. Cal. Jan. 25, 2013).
 Seagate Technology LLC’s Notice of Motion and Motion for Partial Summary Judgment of Breach of Contract Against National Union Fire Insurance Company of Pittsburgh, Pa. at 9, Nat’l Union Fire Ins. Co. v. Seagate Tech, Inc., No. C-04-01593 WHA (N.D. Cal. Dec. 13, 2012).
 Seagate Technology’s Opposition to National Union’s and AIU’s Cross-Motion for Summary Judgment on Seagate Technology LLC’s Counterclaim for Breach of Contract at 3, Seagate, No. C-04-01593 WHA (N.D. Cal. Jan. 10, 2013), citing CNA Cas. of Cal. v. Seaboard Sur. Co., 176 Cal. App. 3d 598, 610 n.6 (1986) (“[E]ven though the insurer received a declaratory judgment in its favor . . . , it was not retroactively relieved of its defense obligations; and it continued to have a defense duty until the declaratory judgment itself was final on appeal.”); Fireman’s Fund Ins. Co. v. Chasson, 207 Cal. App. 2d 801, 807 (1962) (“[O]nce the judgment in the declaratory relief action become final (in this case upon the determination of this appeal), the insurer’s duty to defend such actions shall cease since the duty to defend does not continue beyond the final determination that the claim is not within the coverage of the policy.”).
 Seagate Technology’s Opposition to National Union’s and AIU’s Cross-Motion for Summary Judgment on Seagate Technology LLC’s Counterclaim for Breach of Contract at 3, Seagate, No. C-04-01593 WHA (N.D. Cal. Jan. 10, 2013).
 Cal. Civ. Code § 2860 (c); Michael Taylor Designs, Inc. v. Travelers Prop. Cas. Co. of Am., 761 F. Supp. 2d 904, 914 (N.D. Cal. 2011) (“Section 2860 permits insurers to pay an insured’s independent counsel so-called ‘panel-rates’—those rates ‘actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.’”).
 Seagate Technology LLC’s Notice of Motion and Motion for Partial Summary Judgment of Breach of Contract Against National Union Fire Insurance Company of Pittsburgh, Pa. at 8–9, Seagate, No. C-04-01593 WHA (N.D. Cal. Dec. 13, 2012), citing Michael Taylor Designs, Inc. v. Travelers Prop. Cas. Co. of Am., 761 F. Supp. 2d 904, 914 (N.D. Cal. 2011)(“MTD is correct that an insurer who wrongfully denies coverage may not rely on section 2860 after the fact, once it has agreed to—or been found obligated to—provide a defense.”); Atmel Corp. v. St. Paul Fire & Marine, 426 F. Supp. 2d 1039, 1047 (N.D. Cal. 2005) (explaining that “to take advantage of the provisions of § 2860, an insurer must meet its duty to defend and accept tender of the insured’s defense”); Amato v. Mercury Cas. Co., 53 Cal. App. 4th 825, 831 (1997) (“Where an insured mounts a defense at the insured’s own expense following the insurer’s refusal to defend, the usual contract damages are the costs of the defense.”); Hous. Grp. v. MPA Capital Ins. Co., 193 Cal. App. 4th 1150, 1158 (2011) (holding section 2860(c) is inapplicable when an insurer fails to defend its insured).
 No. C-91-2940 MHP ARB, 1994 WL 361815, at *3 (N.D. Cal. July 1, 1994).
 Foxfire, Inc., No. C-91-2940 MHP ARB, 1994 WL 361815, at *3 (N.D. Cal. July 1, 1994), citing Stalberg v. W. Title Ins. Co., 230 Cal. App. 3d 1223, 1233 (1991).
 Seagate Technology LLC’s Notice of Motion and Motion for Partial Summary Judgment of Breach of Contract Against National Union Fire Insurance Company of Pittsburgh, Pa. at 9, Seagate, No. C-04-01593 WHA (N.D. Cal. Dec. 13, 2012).
 National Union’s & AIU’s Notice of Cross-Motion and Cross-Motion for Summary Judgment on Seagate Technology LLC’s Counterclaim for Breach of Contract at 2–3, Seagate, No. C-04-01593 WHA (N.D. Cal. Dec. 14, 2012).
 Nat’l Union Fire Ins. Co. v. Seagate Tech., Inc., 2013 U.S. Dist. LEXIS 10502, at *5 (N.D. Cal. Jan. 25, 2013).
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *14.
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *5–6.
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *5–6.
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *7, quoting Auto-Owners Ins. Co. v. Potter, 242 Fed. Appx. 94, 97 (4th Cir. 2007).
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *5.
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *11 (emphasis in original).
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *7–8, citing Levy v. Drew, 4 Cal. 2d 456, 459 (1935) (when a judgment is reversed on appeal the appellant is entitled to restitution of all things taken from him under the judgment).
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *15.
 Seagate, 2013 U.S. Dist. LEXIS 10502, at *10 (emphasis in original).