Insurer Not Entitled to Reimbursement of Defense Costs Incurred While Defending Non-Covered Claims
April, 2005
In General Agents Ins. Co. of America, Inc. v. Midwest Sporting Goods Co., et al., 2005 WL 674685 (Ill. 2005), the Illinois Supreme Court reviewed whether an insurer was entitled to reimbursement of the amounts paid for the defense of its insured in an underlying lawsuit where it was later determined that the insurer had no duty to defend.
Facts
The City of Chicago and Cook County sued Midwest for creating a public nuisance by selling guns to inappropriate purchasers. Midwest tendered its defense to its liability insurer, General Agents Insurance Company of America (“Gainsco”). Gainsco denied coverage but defended under a reservation of rights. Within its reservation of rights letter, Gainsco stated that it was providing a defense:
without waiving any of its rights and defenses, including the right to recoup any defense costs paid in the event that it is determined that the Company does not owe the Insured a defense in this matter.
Gainsco also filed a declaratory judgment action against Midwest. The trial court found in favor of Gainsco on the coverage issue and Gainsco then sought to recoup the amounts it paid for Midwest's defense. The trial court ruled for Gainsco and ordered Midwest to reimburse Gainsco for Midwest's defense costs. The appellate court affirmed; however, the Illinois Supreme Court subsequently reversed, finding that an insurer is not entitled to seek reimbursement from its insured unless the policy specifically provides for such reimbursement.
Analysis
Illinois Appellate Court
Midwest argued that Gainsco paid defense costs pursuant to the insurance contract and the contract contained no provision allowing Gainsco to recover these defense costs. The appellate court relied upon a 1903 decision wherein the parties entered into an express agreement to dispute payment under a contract while continuing to perform certain obligations under the contract. In City of Chicago v. McKechney, 205 Ill. 372 (1903), the parties to the contract made a new arrangement for resumption of work pending a final determination of the parties' rights in a lawsuit. The appellate court found that Gainsco offered a similar accommodation pending litigation to determine whether Gainsco owed Midwest the cost of defending the underlying lawsuit. The appellate court also relied in part upon the California decision of Buss v. Superior Court, 16 Cal. 4th 35, 939 P. 2d 766, 65 Cal. Rptr. 2d 366 (1997). In Buss, a dispute arose over the payment of defense costs following a tender. The insured and insurer entered into a formalized written agreement regarding the dispute of defense costs. After a finding of no coverage, the court in Buss ordered the insured to reimburse the insurer for the defense costs.
The appellate court ruling in General Agents was a case of first impression which resulted in a split decision. A majority of the Illinois Appellate Court ordered Midwest to reimburse Gainsco for expenses incurred in the defense of Midwest for claims not covered by the policy. The majority's holding was expressly based upon the fact that Midwest accepted the defense payments with the knowledge that Gainsco intended to seek recovery of the costs if the underlying claims were ultimately found to fall outside of coverage.
The majority suggested that if Midwest had refused to accept a defense on the conditions imposed by Gainsco, it could have forced Gainsco to either defend without a right of reimbursement, or to deny coverage entirely and risk a loss of policy defenses if a court later found it in breach of its insurance contract. The majority also found this arrangement similar to an accommodation upheld in the 1903 decision. The majority also cited several out-of-state decisions, as well as Grinnell Mut. Re. v. Shierk, 996 F.Supp. 836 (S.D. Ill. 1998), a case which predicted Illinois would follow the California Buss decision allowing insurers to recoup defense costs after reserving the right to do so.
The dissent opined that the majority's decision was not supported by Illinois case law and pointed to various cases from other jurisdictions which supported the opposite conclusion. The dissent also disagreed with the majority's suggestion that Midwest could have refused the defense under the terms offered as “wrong,” and opined that the burden instead was on Gainsco to file a declaratory action before agreeing to defend.
Illinois Supreme Court
On review in the Illinois Supreme Court, Midwest argued that the threat of reimbursement would place too much power in the hands of the insurer and that an insured would not have any finality as to defense costs. The Supreme Court found that the defense was not the product of an agreed “accommodation” between the insured and the insurer as addressed in the 1903 McKechney decision. Instead, it was an insurer imposing a right to reimbursement unilaterally.
Midwest argued that Gainsco failed to establish any legal basis that would entitle it to an award of reimbursement of defense costs and that the policy contained no provisions allowing Gainsco to recover defense costs. Midwest also argued that the reservation of rights letter could only reserve the rights contained within the insurance policy and could not create new rights.
Gainsco relied in part upon the California decision in Buss which permits an insurer to recovery defense costs from an insured. Buss has been relied upon by numerous jurisdictions across the country. The Illinois Supreme Court found that, in general, the jurisdictions allowing reimbursement of defense costs based the right on a contract implied in fact or law, or a finding that the insured was unjustly enriched when its insurer paid defense costs for claims that were not covered by the insured's policy. While acknowledging that, if Illinois adopted Gainsco's argument, Gainsco would be entitled to reimbursement, the Supreme Court concluded that the decisions refusing to allow reimbursement were more persuasive and more on point with Illinois case law than the cases cited by Gainsco.
For example, in Shoshone First Bank v. Pacific Employers Ins. Co., 2 P.3d 510, 514 (Wy. 2000), the court declined to allocate costs between covered and uncovered claims and held that “unless an agreement to the contrary is found in the policy, the insurer is liable for all the costs of defending the action.” This same reasoning was adopted in: First Ins. Co. of Hawaii, Inc. v. State, 665 P.2d 648, 654 (Hawaii 1983) (insurer could have included allocation language in its policy, but it failed to do so); Texas Ass'n of Counties Government Risk Management Pool v. Matagorda County, 52 S.W.3d 128 (Tex. 2000) (absent provision providing for reimbursement, a unilateral reservation of rights letter cannot create rights that do not appear in the policy); and Terra Nova Ins. Co. v. 900 Bar, Inc., 887 F.2d 1213 (3d Cir. 1989).
Based upon this reasoning, the Illinois Supreme Court held that:
As a matter of public policy, we cannot condone an arrangement where an insurer can unilaterally modify its contract, through a reservation of rights, to allow for reimbursement of defense costs in the event a court later finds that the insurer owes no duty to defend.
With this holding, Illinois joined the minority of jurisdictions prohibiting an insurer from recovering defense fees from an insured for matters not covered under the policy.
Learning Point:
When preparing reservation of rights letters for liability carriers, counsel should include a reservation of the right to seek reimbursement of any defense costs paid for uncovered claims in those jurisdictions permitting the recovery of defense costs. If an insured agrees to the arrangement, the carrier may be able to obtain reimbursement if a court finds it owed no duty to defend the underlying claims. If an insured refuses to accept a defense under such a reservation of rights, the insurer should consider filing a declaratory judgment action, so as to avoid any claim of estoppel as to its coverage defenses.
In those jurisdictions that do not permit an insurer to recover defense costs incurred in defending an insured for non-covered matters, the reservation of rights should be carefully drafted in order to avoid any claims of bad faith. The filing of a declaratory judgment action should be considered if a possibility of limiting a defense obligation exists. •
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