“No-Recoupment” Default Rule in Restatement of the Law: Liability Insurance Cited by Illinois Court in Support of Ruling Dismissing Insurer Recoupment Claim
In Gilbane, Inc. v. Liberty Ins. Underwriters, Inc., (case no. 2016‑CH‑15163) a Cook County, Illinois court dismissed an insurer’s claim for recoupment of a $7.5 million settlement payment from its policyholder based on the equitable theory of unjust enrichment. The insurance policy at issue did not contain a provision addressing the recoupment of indemnity payments. The dispute was governed by Rhode Island law, which did not have any case authority directly on point. In reaching its ruling, the Illinois court cited with approval to RLLI §21 (Insurer Recoupment of the Costs of Defense) and §25 (The Effect of a Reservation of Rights on Settlement Rights and Duties) within Draft no. 4 of the RLLI. While acknowledging that the RLLI was not binding, the Illinois court stated that “this comprehensive Restatement of the Law describes the recent trend and default rule to disallow reimbursement [of insurer payments] absent a provision in the insurance policy or contract between the parties.” The Illinois court concluded that “[t]his is consistent with Illinois law and how the Court thinks Rhode Island’s highest court would rule” (internal citations omitted).
Gilbane is another example of a court looking to the recently-adopted RLLI for support where there is no binding case law on point. In August of this year, a Delaware state court, applying Tennessee law, cited to the RLLI in connection with its ruling on, ironically, another insurer recoupment claim based on principles of unjust enrichment. Catlin Specialty Ins. Co. v. CBL & Assocs. Props., 2018 Del. Super LEXIS 342 (Del. Super. Ct. Aug. 9, 2018). The Catlin court reached the opposite conclusion from the Gilbane court, holding that the insurer in question did have a right to recoup defense costs from its policyholder after securing a determination that it had no duty to defend the underlying claim in question. The Catlin court noted that RLLI reflected a recent shift by courts against allowing recoupment absent a policy provision permitting the same. Nevertheless, the Catlin court also observed that Tennessee courts had not adopted the RLLI recoupment rule. The Catlin court ultimately found, based on examination of Tennessee unjust enrichment case authority, that Tennessee law supported the insurer’s claim.
Although they reached divergent conclusions, the Illinois court in Gilbane and the Delaware court in Catlin share a common thread: both courts applied the law of a jurisdiction other than the one in which they were sitting. And this common thread may explain, at least in part, these divergent rulings. More specifically, the Gilbane and Catlin rulings were both consistent with the law of the jurisdictions in which they were sitting. The Illinois Supreme Court rejected an insurer recoupment claim in General Agents Ins. Co. v. Midwest Sporting Goods, 215 Ill.2d 146 (2005), ruling that an insurer may not unilaterally reserve a right to seek reimbursement. By contrast, and as the Catlin court acknowledged, Delaware is among the states that allow insurer recoupment claims. Nationwide Mut. Ins. Co. v. Flagg, 789 A.2d 586, 597 (Del. Super, Ct. 2001).
It appears that the Gilbane court’s citation to the RLLI “no recoupment” default rule was an instance of a court using the RLLI to buttress a conclusion it was likely to have reached even in the absence of the RLLI. However, the explicit reference by the Gilbane court to the Restatement’s “default rule” of no recoupment is concerning because close examination of RLLI §25 reveals that the rule largely reflects the Reporters’ aspirational views as to what the law on recoupment should be, not the law as it currently stands. This deviates from the core objective of Restatements, which are in the words of the American Law Institute (ALI), “[p]rimarily addressed to courts” and “aim at clear formulations of common law and its statutory elements, and reflect the law as it presently stands or might be appropriately stated by a court.” The Gilbane court appeared to accept as accurate the RLLI’s broad statement regarding purported “recent trends” amongst courts regarding insurer recoupment claims. But this broad description is misleading when the comments to the Rule are examined in depth. The comments to §25 state that the default rule is analogous to the default rule followed in RLLI §21 for defense costs. Although the rule in §21 purports to follow what is characterized as an emerging state-court majority rule regarding recoupment of defense costs, the comments admit that “about half of the state courts that have considered this issue, and a majority of the federal courts making Erie predictions, have held to the contrary, based on a theory of unjust enrichment.” And the comments to §25 acknowledge that most states have not addressed recoupment in the context of indemnity claims.
The Reporters further acknowledge that the no-recoupment default rule as to insurance settlement payments is contrary to the general principles of unjust enrichment articulated in the Restatement Third, Restitution and Unjust Enrichment (Restatement of Unjust Enrichment).
- § 35 PERFORMANCE OF DISPUTED OBLIGATION (1) If one party to a contract demands from the other a performance that is not in fact due by the terms of their agreement, under circumstances making it reasonable to accede to the demand rather than to insist on an immediate test of the dispute obligation, the party on whom the demand is made may render such performance under protest or with reservation of rights, preserving a claim in restitution to recover the value of the benefit conferred in excess of the recipient’s contractual entitlement.
The RLLI Reporters gloss over this clear inconsistency with a sweeping reference to “special insurance law reasons” discussed in RLLI §25, comment “c.” However, close examination reveals that most of the proffered reasons appear to spring not from existing law but from the Reporters’ own beliefs as to what constitutes “special insurance law reasons.” The Reporters conclude, without reference to specific legal authority, that the current practice in most liability insurance markets is for insurers not to seek recoupment and that a no-recoupment rule is “most consistent with the parties’ reasonable expectations.” Ignoring the plain language of the Restatement of Unjust Enrichment, the RLLI Reporters also criticize the argument that a no-recoupment rule would provide insureds with coverage that the policy language does not. The Reporters assert that the omission of policy language addressing recoupment of non-covered settlements supports the need for a default rule, but they do not explain why a departure from the Restatement of Unjust Enrichment (which does not require specific contractual language) is necessary in the insurance context. The Reporters also argue that allowing an insurer to seek recoupment would create a moral hazard on the part of insurers by incentivizing insurers to settle more actions “and to work less hard to keep the settlements low.” The Reporters cite to no legal or other authority in support of this position while simultaneously acknowledging that their default rule could increase risks to the insured and also implicated relevant empirical questions that have no easy answer.” In sum, the special insurance law reasons articulated by the Reporters tilt heavily towards advocacy by the Reporters themselves.
With the Reporters’ advocacy and aspirations now encapsulated under the rubric of “special insurance law reasons,” the Reporters conclude that principles of extra-contractual performance and unjust enrichment contained in the Restatement of Unjust Enrichment disappear because “insurance law is understood to include a no-recoupment default rule.” Further extending this circular reasoning, the Reporters conclude that when an insurer pays a non-covered settlement under a policy that does not include a no-recoupment provision, it is not performing beyond its contractual obligations because the insurers’ contractual obligations include a no recoupment rule.
In sum, RLLI §25 modifies the law on recoupment rather than reflecting where it currently stands. In so doing, the RLLI misleads and does a disservice to its primary intended audience—the courts.
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[The views expressed herein are solely those of the author. Mr. Zimmerman devotes his practice to insurance coverage, bankruptcy and other commercial litigation issues and is a senior shareholder and member of the Board of Directors of Clausen Miller]