Recent Developments in Recouping Defense Costs
The majority view in Nautilus. On March 11, 2021, the Nevada Supreme Court addressed a certified question from the Ninth Circuit concerning an insurer’s right to reimbursement in Nautilus Insurance Co. v. Access Medical, LLC. The Ninth Circuit presented the following certified question to the Nevada Supreme Court:
Is an insurer entitled to reimbursement of costs already expended in defense of its insureds where a determination has been made that the insurer owed no duty to defend and the insurer expressly reserved its right to seek reimbursement in writing after defense has been tendered but where the insurance policy contains no reservation of rights?
The Nevada Supreme Court ruled 4–3 that yes, an insurer can recoup restitution when a party to a contract performs an obligation in dispute and under protest and a court later determines that the insurer did not have an obligation to perform under the contract. Nautilus cited Buss and is consistent with that reasoning.
The respondent in Nautilus, Access Medical, LLC, was facing 31 claims by a former business partner, Ted Switzer, including a claim for “interference with prospective economic advantage.” The respondent tendered defense to its insurer, Nautilus Insurance Co. The insurer was required under the policy to defend the respondent against “any ‘suit’ seeking . . . damages” because of a “personal and advertising injury,” “arising out of . . . [o]ral or written publication, in any manner, of material that slanders or libels a person or organization.” The insurer initially declined to defend the suit but then defended the suit while expressly reserving its rights to withdraw from coverage and recoup defense costs if a court determined that the insurer had no duty to defend. The insurer’s declaratory judgment action eventually was heard by the Ninth Circuit on appeal, and the Ninth Circuit affirmed that the insurer did not have a duty to defend.
The Nevada Supreme Court accepted the Ninth Circuit’s holding that the insurer did not have a duty to defend and analyzed only the consequences of this determination. The court concluded that because the Ninth Circuit ruled that the insurer does not have a duty to defend, the insurance contract between the insurer and respondent is inapplicable. The Nevada Supreme Court analyzed whether the insurer’s claim for unjust enrichment had any merit. A claim for unjust enrichment has three elements: “the plaintiff confers a benefit on the defendant, the defendant appreciates such benefit, and there is acceptance and retention by the defendant of such benefit under such circumstances that it would be inequitable for him to retain the benefit without payment of the value thereof.” The first two elements of an unjust enrichment claim applied, and the court analyzed whether equity required the policyholder to pay back the insurer. Using the Restatement (Third) of Restitution and Unjust Enrichment as support, the Nevada Supreme Court found that “[w]hen time is precious, it makes sense for the parties to decide quickly what to do, and to litigate later who must pay.” Moreover, the court found that an insurer risks unbounded liability for refusing to defend a suit and losing the coverage determination that it is reasonable to initially pay to defend while determining coverage later. The Nevada Supreme Court concluded that an insurer can recover restitution when it clearly reserves its rights in writing and a court determines that the insurer has no contractual duty to defend.
The minority view in Nautilus. Three justices on the Nevada Supreme Court dissented in Nautilus, reasoning that the insurance policy did not have a provision that allowed the insurer to seek reimbursement. The dissent points to Nevada’s precedent, which does not allow a party to recover under unjust enrichment when there is an express written contract. In Nautilus, there was an express written contract between the insurer and the respondent, and the written contract did not provide a remedy for reimbursement. The fact that the insurance contract did not provide the particular remedy that the insurer seeks does not nullify the fact that the insurance contract governs. Last, in addressing the majority’s equity argument for unjust enrichment, the dissent stated, “[C]oncerns of equity and fairness weigh against reimbursement, because an insurer benefits unfairly if it can hedge on its defense obligations by reserving its right to reimbursement while potentially controlling the defense and avoiding a bad faith claim.”
Courts in other states, consistent with the dissent in Nautilus, hold that insurers cannot seek reimbursement when the insurance policy does not explicitly include a right to reimbursement. This question was examined by the Illinois Supreme Court in General Agents Insurance Co. of America, Inc. v. Midwest Sporting Goods Co., a case in which the insurer chose both to defend under a reservation of rights to seek reimbursements and to file for a declaratory judgment that there was no coverage. Illinois took the minority view on this issue by not allowing “an insurer to receive reimbursement of its defense costs even though the underlying claim was not covered by the insurance policy and the insurer had specifically reserved its right to reimbursement.” The Illinois Supreme Court concluded that it would go against public policy to allow an insurer to unilaterally modify a contract through a reservation of rights letter and allow it to seek reimbursements for defense costs when a court later determines there was no duty to defend.
Increasingly, many types of policies include allocation provisions specifically requiring an attempt to agree on a division of costs and providing for the insurer to attempt to recoup such costs in the event the parties cannot agree. These clauses vary widely, and insurers will likely be more successful pursuing reimbursement under such policies than under policies without allocation clauses. For policyholders, they can mean agreeing to an insurer’s proposed allocations early in the case, often without the benefit of coverage counsel and before the merits of the case are truly understood. For example, an allocation of one-third of all fees because one out of three causes of action is not covered may sound reasonable but can be disadvantageous where those claims are in the alternative and substantially overlap and may not hold up as pleadings are amended and discovery develops the merits of the claims.
Even where the insurer has specifically reserved the right to reimbursement of defense costs in its reservation of rights letter, in a jurisdiction where reimbursement is allowed, it is rare that reimbursement from the insured is actually pursued (let alone awarded). The reasons for this include collectability concerns, ongoing relationships with large insureds, as well as the hurdles to proving reimbursement. In mixed actions, such as in Buss, the insurer must bear the burden to prove which (if any) fees are solely allocable to uncovered claims. The Buss court recognized that this burden “if ever feasible, may be extremely difficult” and, hence, will only be pursued in “apparently exceptional cases.” As in indemnity situations, the presumption is that unless the insurer can prove the fees were more than they would otherwise have been in the absence of the covered claim, this burden cannot be met. This is a factual issue that often turns on the defense bills; so the ability of the insurer to seek reimbursement may turn on the specificity (or lack thereof) in defense counsel’s time entries. It also poses logistical difficulties: The defense counsel may become a witness. Where defense counsel was independent or no tripartite relationship exists, that creates privilege issues. In a tripartite relationship, counsel’s loyalties are divided, adding another level of complexity.
Timing is also an issue. Under Buss, the insurer should wait until the conclusion of the underlying case to seek reimbursement. However, in some jurisdictions, a failure to promptly seek declaratory relief may preclude a recovery of fees: In states where the duty to defend can be terminated only prospectively, it would be inconsistent to allow an insurer to wait until the case is over and then seek to recoup fees. Where the basis for reimbursement is not confined to the initial pleadings but is instead based on developments in the litigation, the question of when the right to reimbursement would date from, and whether it could be retroactive, also remains to be seen.
Another level of complexity is added when there are multiple insureds being defended. Even where multiple insureds received policy benefits to which they were not entitled, subjecting them to liability for reimbursement, “it does not follow that all . . . insureds should be jointly liable for reimbursing the entire amount of those costs.” As an equitable restitution remedy, it must be for an equitable share. Thus, insurers should also consider the relative benefits to each insured before attempting recoupment where there are multiple insureds.
There is no one-size-fits-all answer for insurers seeking to recover indemnity or defense payments. These determinations are jurisdiction-specific and fact-driven. However, it is clear that most jurisdictions allow insurers to attempt to recover for adverse outcomes from defense counsel under a theory of malpractice, whether or not the insurer had any engagement with the defense counsel. Furthermore, while the majority of states allow insurers to unilaterally reserve rights and recover defense costs in the event the insurer can prove the claims were uncovered, a significant minority refuse to allow the insurer to do so—a minority that may gain further traction in many jurisdictions.