A word to the wise about recoupment of defense costs

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Print this page by Collin Hite

An ongoing battle continues around the country between insurance companies and policyholders over an insurer’s right to recoup defense costs. The debate began in 1997 when the issue was first raised in a California lawsuit. Buss v. Superior Ct., 16 Cal.4th 35, 939 P.2d 766 (1997).  In that case the California Supreme Court held that “California law clearly allows insurers to be reimbursed for attorneys’ fees” and other expenses “paid in defending insureds against claims for which there was no obligation to defend.”  In most instances, the insurer must issue a reservation of rights letter specifically reserving its right to recoupment.  Ever since the Buss decision insurers have continued to expand this ruling to other states with a varying degree of success.

In the recent case of State Farm Fire & Casualty Company v. Wier, 2012 WL 5279790 (Cal. Ct. App. Oct. 26, 2012)., the California courts have revisited the issue.  Once again the policyholders lost the argument against recoupment in a bizarre set of circumstances in which litigation spanned 13 years.

The policyholders were former State Farm agents.  They took proprietary customer information with them when they left State Farm’s employment.  The agents then used that information to solicit State Farm customers through direct mailings.  State Farm, not surprisingly, sued the agents to stop the poaching.  The agents, who were insured by State Farm, tendered the lawsuit and requested a defense.  In short, State Farm was being asked to defend its former agents against its own lawsuit.

State Farm agreed to provide a defense under a reservation of rights.  Subsequently, the California Supreme Court took up a case where the question revolved around “whether taking a competitor’s customer list and soliciting customers from it gives rise to a duty to defend under a CGL [commercial general liability] policy’s ‘advertising injury’ provisions.”  This was the exact issue State Farm was facing with in its lawsuit against its former agents in providing them a defense.  State Farm, realizing that the Court could find in favor of no coverage, issued a supplementary reservation of rights letter and noted its right to recoup defense costs.

State Farm guessed correctly.  The California Supreme Court ruled that there was no coverage under the advertising injury provisions.  State Farm then filed a lawsuit against its former agents for full recoupment of costs incurred after it issued its supplementary reservation of rights letter since the “hindsight ruling” found no coverage at all.  The appellate court ruled, “If the law regarding coverage of a claim changes in the insurer’s favor, the insurer never had a duty to defend, and is entitled to seek recoupment of any defense costs it paid, as long as it has reserved its right to do so.”  The agents jointly owed more than $700,000 in defense costs to reimburse State Farm for defending them.

The right to recoup attorneys’ fees and expenses in defense of an insured is guaranteed to remain a hot topic in 2013 as this case proves.  Policyholders must be vigilant to insurers seeking recoupment and tackle the problem head on to avoid owing a huge amount for reimbursement down the road.  A proactive strategy is especially critical in states that have not addressed the recoupment issue yet, such as Virginia.  No doubt insurance companies are likely to use this latest opinion to continue their push for an expanded right of recoupment from their customers.

Collin Hite is the leader of the Insurance Recovery Group in Hirschler Fleischer’s Richmond office. He handles insurance recovery and coverage litigation nationally in the areas of business interruption, all risk, construction, business torts, products liability, directors’ and officers’ liability, employee dishonesty, intellectual property, environmental matters and bad faith claims.

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