New York Federal Court Refuses Reimbursement of Insurer Defense Costs
Illinois Appellate Court Highlights Low Threshold Governing Insurers’ Duty to Defend
California Appellate Court Holds That Section 2860’s Rate Limitation Does Not Apply Retroactively
New York Federal Court Refuses Reimbursement of Insurer Defense Costs
A federal court applying New York law recently considered a fundamental question that arises in insurance coverage litigations: when is an insurer entitled to recoup its costs in defending an insured against claims that ultimately are found to be outside the coverage of the insurance policy at issue? As New York state courts have yet to answer this question definitively, the opinion of the U.S. District Court for the Eastern District of New York in General Star Indemnity Co. v. Driven Sports, Inc. may turn out to be an important one for coverage actions governed by New York law.
The case centered on a dispute over potential coverage for Driven Sports, Inc., a manufacturer and seller of a pre-workout energy supplement called “Craze.” The court concluded that an exclusion in Driven Sport’s liability policy barred coverage for all of the claims alleged in three underlying lawsuits. Although the insurer had defended all of the claims, the court refused to permit the insurer to recoup the costs it incurred in defending the actions prior to the court’s declaration of no coverage.
In reaching this decision, the court noted that the insurer had asked Driven Sports to sign a “non-waiver and defense funding agreement,” under which Driven Sports “would agree to repay any defense expenses in the event that it is finally determined that such amounts are not covered under the Policy.” Although the insured declined to sign the agreement, the insurer agreed to defend the insured against the underlying actions, unilaterally reserving the right to seek recoupment of defense costs in the event the claims were ultimately determined not to be covered. These circumstances proved significant. The court noted that while four earlier New York decisions had allowed an insurer to recoup defense costs, none of them involved a circumstance where the insured had explicitly rejected a separate recoupment agreement. The court held that no provision in the policy explicitly granted the insurer the right to such recoupment, and that the insurer’s defense obligations were governed by the policy’s “supplementary payments” provision, which expressly stated that the insurer “will pay,” with respect to any suit against an insured, “all expenses we incur.” The court, therefore, rejected the insurer’s bid to recoup the costs incurred to defend non-covered claims.
In reaching this decision, the court observed that the insurer could have provided for a separate right of recoupment in the policy, but did not do so. Accordingly, the court held that the insurer could not effectively re-write the policy by unilaterally reserving a right to recoupment that was not provided for in the insurance contract. In addition, the court concluded that allowing the insurer to recoup defense costs in these circumstances would improperly make the duty to defend co-extensive with the duty to indemnify, and would thus run afoul of well-established New York authority holding that the duty to defend is broader than the duty to indemnify. In the court’s view, allowing the insurer to recoup its defense costs “would effectively require that insurers only defend to the same extent that they must ultimately indemnify.”
Notably, none of the underlying claims in Driven Sports were covered. The case thus does not address the question of whether an insurer has a right to partial recoupment in cases involving both covered and non-covered claims (a so-called “mixed” action). Nonetheless, with respect to the basic question of whether an insurer may seek reimbursement of defense costs for non-covered claims under New York law, insurers should familiarize themselves with the Driven Sports decision, as this case underscores how difficult it may be under New York law for a defending insurer to get its defense costs back – particularly where the policy does not provide an explicit right to recoupment.
The decision is General Star Indemnity Co. v. Driven Sports, Inc., No 14-CV-3579 (JFB)(ARL) (E.D.N.Y. Jan. 23, 2015) and is available for download here.
Illinois Appellate Court Highlights Low Threshold Governing Insurers’ Duty to Defend
A recent Illinois appellate decision, Illinois Tool Works Inc., et al. v. Travelers Casualty and Surety Co., et al., re-affirms one of the long-held principles governing a liability insurer’s coverage obligations: to defend its insured against underlying claims even when such claims are, on their face, groundless, false or fraudulent. The Illinois appellate court ruled on January 13, 2015 that a defendant in multiple toxic tort lawsuits was entitled to a defense by its liability insurer, even though the underlying allegations against the insured were, by all objective standards, groundless.
The insured, Illinois Tool, a manufacturer of tools and other equipment, was insured by Travelers and Century Indemnity Company from 1971 to 1987. In 1993, Illinois Tool acquired Miller Electric, a company involved in the distribution of welding products. Miller Electric’s products utilized various harmful materials, including asbestos, benzene and manganese. Thereafter, both Illinois Tool and Miller Electric were named in numerous toxic tort lawsuits alleging injuries arising out of exposure to Miller Electric’s products. Because Illinois Tool was not in the welding business prior to 1993, it was able to defeat the claims against it on motions to dismiss or on summary judgment. Illinois Tool then sought to hold its insurers under the 1971 through 1987 policies liable for its defense costs. The insurers, however, disclaimed any defense obligation. They argued that they could not possibly have a duty to defend Illinois Tool because it only entered the welding product market in 1993, which was six years after the expiration of the last policy at issue.
In the ensuing declaratory judgment action, the trial court found for Illinois Tool, and the appellate court affirmed. The appellate court conceded that while Illinois Tool was “unlikely to actually be found liable in the underlying suits,” the court’s primary focus must be on “whether the facts pled by the underlying plaintiffs, if true, would potentially bring the claims within coverage.” Concluding that it “must even consider false and groundless allegations,” the court held that it was “clear” the insurers had a duty to defend. Because the underlying complaints alleged that Illinois Tool made or distributed harmful materials during the insurers’ policy periods – even though, as a factual matter, that could not have been the case – the insurers’ duty to defend was, in fact, triggered. To hold otherwise, the court reasoned, would impermissibly equate the duty to defend with the obligation to indemnify.
The court also found that under Illinois law, the insurer’s independent knowledge of facts extrinsic to the complaint which will ultimately defeat coverage “does not negate [the insurer’s] duty to defend in the first place if the complaint, on its face, presents a claim potentially within the insurance policy’s coverage.” The court thus reaffirmed the rule that an insurer may only refuse to defend the insured “if the allegations of the underlying complaint preclude any possibility of coverage.” Characterizing the duty to defend as “litigation insurance,” the court held that the insurers were obligated to defend Illinois Tool against the underlying lawsuits, “however groundless.”
Illinois Tool thus appears to represent the outer boundary of the duty to defend. Many general liability policies, like the ones at issue in Illinois Tool, require the insurer to defend the insured against allegations which are groundless, false or fraudulent. Not all states, however, prohibit the use of extrinsic evidence to inform whether there is any possibility of coverage for the underlying claims, for purposes of analyzing the insurer’s potential duty to defend. It is thus critical for the insurer to ascertain the rules followed by the jurisdiction whose law will apply in the event of questions pertaining to the duty to defend.
The decision is Illinois Tool Works Inc., et al. v. Travelers Casualty and Surety Co., et al., No. 1-13-2350 (Ill. App., 1st Dist., 2nd Div. Jan. 13, 2015) and is available for download here.
California Appellate Court Holds That Section 2860’s Rate Limitation Does Not Apply Retroactively
Addressing an important question under California’s “independent counsel” statute, California Civil Code Section 2860, a California appellate court in City Art, Inc., et al. v. Superior Court of the State of California (Travelers Property Casualty Co. of America) recently held in favor of the insured. This decision holds that an insurer which initially denies a duty to defend, but then later agrees to appoint independent counsel pursuant to Section 2860, may not apply Section 2860’s rate limitation retroactively to defense costs incurred prior to its change of heart.
In the underlying suit, a publishing company brought a wide-ranging complaint alleging more than a dozen causes of action against City Art. City Art tendered the complaint to its liability insurer, Travelers, which denied any duty to defend under the policy and continued to do so while the case went on for nearly three years. Eventually, however, Travelers reversed course, and agreed to pick up the costs incurred by City Art’s independent defense counsel, subject to a full reservation of the insurer’s rights.
Under Section 2860(c), when independent counsel is appointed by a carrier for its insured, the carrier’s obligation to pay independent counsel fees 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.” In this case, however, Travelers’ decision to provide City Art with independent defense counsel came nearly three years after counsel had been retained. Nonetheless, Travelers invoked Section 2860 in an attempt to limit its obligation for the fees previously charged by defense counsel, prior to Traveler’s agreement to defend under a reservation of rights.
In response, City Art sued Travelers, seeking a declaration that Section 2860’s rate limitation did not apply until Travelers began “adequately funding” the insured’s defense. Although the trial court rejected City Art’s claim, holding that the statutory rate limitation becomes effective when the duty to defend is triggered, not accepted, the appellate court reversed. It held that Section 2860 requires the carrier to honor its duty to defend before the rate limitation provision can come into play. That the carrier would have defended under a reservation of rights, if it had timely defended, was deemed irrelevant. A carrier that breaches its duty to defend, the court reasoned, cannot invoke the benefit of Section 2860 for the time period during which it failed to provide a defense. Rather, the insurer must pay the usual measure of damages for its breach of the duty to defend – that is, the reasonable attorney’s fees that the insured actually incurred in defending the lawsuit itself. The court further observed that allowing carriers to take retroactive advantage of Section 2860’s rate limitation provision would encourage them to reject their defense obligations for as long as possible, secure in the knowledge that they could later retroactively invoke the statutory rate limitations.
In light of this case, insurers deciding whether to defend an insured in California pursuant to a reservation of rights, thus implicating the insured’s right to independent counsel, must carefully consider the ramifications of delaying their acceptance of the duty to defend. Under City Art, doing so will prevent the carrier from invoking the benefits of Section 2860’s rate limitation if the duty to defend is subsequently assumed, subject to a reservation of rights.
The case is City Art, Inc., et al. v. Superior Court of the State of California (Travelers Property Casualty Co. of America), Case No. B256132, (Cal. Ct. App., 2d Dist. Dec. 9, 2014) and is available for download here.
