Liability Insurer Recovers Defense Costs Paid for Uncovered Claims
September, 2004
In General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods, 812 N.E.2d 620 (Ill. App. 2004), a case of first impression and a split decision, a majority of the Illinois Appellate Court ordered an insured (Midwest) to reimburse its liability insurer (Gainsco) for costs paid to defend Midwest for claims not covered by Gainsco’s policy. The majority’s holding is expressly based upon the circumstances presented, where Midwest accepted defense payments knowing Gainsco intended to seek recovery of such costs if the underlying claims were ultimately found to fall outside of coverage.
Facts
The underlying nuisance suit was filed against Midwest in connection with gun sales to inappropriate purchasers. Gainsco denied coverage, but agreed to defend Midwest under a reservation of rights, including the right to recoup any defense costs paid if it was determined that Gainsco did not owe a defense in the matter. Gainsco filed a declaratory judgment action claiming it owed no duty to defend or indemnify Midwest.
A summary judgment ruling in favor of Gainsco was affirmed on appeal. Gainsco then sought to recoup the defense costs it previously paid to Midwest’s counsel. The trial court awarded the costs to Gainsco and Midwest appealed. The decision was affirmed.
Analysis
The majority found Gainsco’s payments of defense costs were not made pursuant to its insurance policy, but rather as an accommodation pending litigation to determine whether Gainsco actually owed Midwest a defense. Midwest accepted the conditions placed on the accommodation by accepting the checks it received. The majority found this arrangement similar to an accommodation upheld in City of Chicago v. McKechney, 68 N.E. 954 (1903), an Illinois Supreme Court case involving a construction contract. The majority also cited several out-of-state decisions and Grinnell Mut. Re. v. Shierk, 996 F.Supp. 836 (S.D. Ill. 1998), a case which predicted Illinois would follow California decisions which have allowed insurers to recoup defense costs after reserving the right to do so.
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 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.
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. 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.
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