A 'Not So' Full Defense

Liability policies typically have a defense obligation and an indemnity obligation. The defense obligation is often as valuable, or more valuable, to the insured as the indemnity obligation. In fact, many courts refer to the defense obligation as “litigation insurance,” protecting the insured from potentially costly litigation. See, e.g., Rubenstein v. Royal Ins. Co. of America, 708 N.E.2d 639, 642 (Mass. 1999); Universal Underwriters Ins. Co. v. Lowe, 761 A.2d 997, 1012 n.15 (Md. App. 2000). Whether the defense obligation is expressed as a duty to defend or a duty to reimburse defense costs, insurers frequently impose major restrictions and limitations relating to the defense costs they will pay. The insurers do this by taking deductions from legal bills based upon the insurer's litigation or billing guidelines, approving rates at amounts less than those charged by defense counsel, and delaying payments of defense costs for unreasonable periods of time. These tactics leave policyholders feeling as though they did not receive the benefit of the insurance with respect to defense coverage and, in some cases, feeling that the defense of a claim is compromised. Fortunately for policyholders, there are ways to combat these practices.

Insurers Usually Insist on Billing Guidelines

Oftentimes after a claim is made, an insurer will accept the defense of the claim subject to a reservation of rights. In doing so, the insurer will for the first time send the policyholder billing guidelines or litigation guidelines. These guidelines are not mentioned in the insurance contract. Insurers insist defense counsel comply with these rules as a pre-condition to paying defense costs. Billing guidelines vary, but many guidelines include limitations regarding the number of attorneys who may attend hearings and depositions, paying for interoffice conferencing among attorneys, the use of online legal research databases, local travel expenses, and clerical or administrative tasks.

Billing guidelines imposed on defense counsel by insurers are often unreasonable and unworkable, especially in large or complicated litigation. Defense counsel complain that guidelines mean the lawyer must litigate the case “on the cheap,” foregoing practices considered both necessary and routine in the ordinary course of litigation. In other words, actual compliance with billing guidelines could mean the client receives only a limited defense and that the client's interests would not be fully represented. In order to not risk everything from reputational damage to potential malpractice liability, many defense counsel incur costs and expenses not allowed by the guidelines and hope the insurer or the policyholder will agree to pay these costs and expenses.

The propriety of billing guidelines has been addressed by state bar associations and courts. Nearly all ethics opinions agree that billing guidelines, at the very least, require a case-by-case analysis to ensure that the guidelines, as applied, do not put the lawyer in a position that compromises the duties he or she owes to his or her client under the state's rules of professional responsibility. Several states have held that certain common billing guidelines so clearly interfere with the professional judgment of the lawyer that it would be per se unethical for a lawyer to follow them, abrogating the need for any case-specific analysis by the lawyer or a governing body.

For example, the Supreme Court of Ohio's Board of Commissioners on Grievances and Discipline, in Opinion 2000-3 (June 2000), clearly stated that certain guidelines per se interfere with a lawyer's professional judgment and are therefore unethical for a lawyer to follow. These include guidelines that require prior approval before performing online legal research, dictate how work is to be allocated among defense team members, require approval before conducting discovery, taking depositions, or consulting with expert witnesses, and guidelines that require the insurer's approval before filing motions and pleadings.

Similarly, the Kentucky Bar Association, in Ethics Opinion KBA E-416 (March 2001), also held that certain billing guidelines were inappropriate for a lawyer to follow. While the committee stated some guidelines would be acceptable, guidelines requiring the insurer to pre-approve discovery requests, legal research, and the filing of motions, and requiring that all investigative work be performed by the insurer or billed out at paralegal rates violated the ethical rules.

The Rhode Island Supreme Court, in Ethics Advisory Panel Opinion No. 99-18 (October 1999), similarly held that a fact-specific determination was unnecessary with certain billing guidelines. The Panel stated that any guidelines which require the insurer's pre-approval for specified legal services such as conducting research, filing counterclaims and motions, visiting accident sites, and conducting depositions, among other activities, infringe upon the attorney-client relationship by “interfering with the independent professional judgment of defense counsel and ultimately with the quality of legal services provided to the insured.” Op. at 1.

The purpose of state bar ethics opinions is to regulate and guide the conduct of members of the bar. While these opinions are useful in defining the professional duties clients may demand from their lawyers, these opinions do not address the contractual relationship between a policyholder and the insurer with respect to the defense coverage.

Several courts have addressed the impact of billing guidelines on the contractual relationship between the insurer and the policyholder. In Nortek, Inc. v. Liberty Mutual Ins. Co., 858 F.Supp. 1231 (D.R.I. 1994), the policyholder argued that the insurer failed to meet its defense obligation by not reimbursing the plaintiff all necessary defense costs. The insurer had accepted its defense obligation subject to billing restrictions:

As set forth in Liberty Mutual's letter of November 14, 1990, the “defense” was made subject to restrictions unilaterally imposed by Liberty Mutual and not found in the Policy. The restrictions included a “cap” of $105 per hour for attorneys fees, $55 per hour for paralegal time, no reimbursement for secretarial overtime, no reimbursement for “meals or over night [sic] trial without pre-approval,” and no reimbursement for any costs, expenses or attorneys' fees that were incurred before Oct. 15, 1990. Id. at 1234, n.3.

The court held that the defendant breached its obligation to defend, in part, by its failure to reimburse the plaintiff policyholder for “all of the reasonable fees and expenses [it] incurred defending itself against all the claims[.]” Id. at 1238-39.

In Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999 (1998), the issue before the court was whether the insurer breached its duty to defend by investigating the purported conflict of interest, and not immediately approving independent counsel. In the opinion, the court took the opportunity to express skepticism toward billing guidelines, noting that “[i]nsurer-imposed restrictions on discovery or other litigation costs may well violate the insurer's duty to defend as well as the attorneys' ethical responsibilities to exercise their independent professional judgment in rendering legal services.” 61 Cal. App. 4th at 1009. The court went on to further elaborate on its view of billing guidelines:

In this regard we question the wisdom and propriety of so-called “outside counsel guidelines” by which insurers seek to limit or restrict certain types of discovery, legal research, or computerized legal research by outside attorneys they retain to represent their insureds. Some guidelines go so far as to call for the use of paralegals, rather than attorneys, to respond to “routine” discovery requests or prohibit the retention of experts or the filing of certain pretrial motions until shortly before trial. Under no circumstances can such guidelines be permitted to impede the attorney's own professional judgment about how best to competently represent the insureds. If the attorney's representation is to be limited in any way that unreasonably interferes with the defense, it is the insured, not the insurer, who should make that decision. Id. at 1009 n. 9 (emphasis in original) (citations omitted).

Thus, courts are in accord with ethics opinions that are wary of billing guidelines that restrict an attorney's professional judgment.

Hourly Rates Significantly Below Market Rates

Insurers that accept the defense of a claim fully and without a reservation of rights typically have law firms they routinely hire to handle such cases. These firms negotiate rates with the insurer based on a large volume of work. The hourly rate is more complicated when the insurer reserves its rights and independent counsel is selected to represent the policyholder. Insurers unilaterally decide the rates they are willing to pay for independent counsel. The rates the insurers propose often are problematic because they are far below the actual billing rates of defense counsel. Policyholders are then forced to either make up the difference in rates themselves, despite having paid for defense coverage, or ask their counsel to write-off the gap between their actual rates and rates approved by the insurer.

The process of selecting defense counsel depends upon many factors, including the complexity of the matter, the expertise required, and the venue of the action. Policyholders often discover, however, that insurers do not analyze these factors. Instead, they simply refuse to pay rates that exceed the levels the insurers typically pay the insurance defense firms they frequently retain in the same jurisdiction. The reality is that reasonable attorneys' fees of independent counsel will often exceed the rates insurers would pay to a firm that does a high volume of insurance defense work for the insurer.

In Watts Water Technologies, Inc. v. Fireman's Fund Ins. Co., 2007 WL 2083769 (Mass. Super. July 11, 2007), the insurer agreed to defend the policyholder under a reservation of rights. The policyholder selected independent counsel and later sought a judicial declaration that “reasonable fees” under the insurance policy included hourly rates which exceeded those typically paid by the insurer. The insurer urged the court to impose a rate restriction similar to those found in the California and Alaska statutes, limiting fees to those “which are actually paid by the insurer to attorneys retained in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.” Slip op. 9 (quoting Cal. Civ. Code '2860 (c) (2007) and citing Alaska Stat '21.89.100 (2007)). The court declined to do so, noting that insurers often pay rates far below what an insured must pay for an adequate defense. The court noted that insurers purchase large quantities of legal services and can therefore negotiate low billing rates with select firms. The court also recognized that, to insurers, the cost savings of low-priced attorneys may outweigh the benefits of more competent representation, whereas to policyholders facing significant liability, the benefits of more competent counsel would surely outweigh the costs. The court reasoned that policyholders should not be bound by the rates insurers normally pay counsel, but rather by the usual price charged for similar services by other attorneys in the same area, and not the “usual price paid by insurance companies.” Id. at *10 (emphasis in original). The court noted the pitfalls of adopting an approach urged by insurers:

For all practical purposes, if the Massachusetts common law were to adopt the standard established by statute in California and Alaska, an insured under a reservation of rights would have to choose between two poor alternatives. It could retain the same law firms retained by insurance companies that handle comparable cases, and attempt to procure the same rates that these firms charge to insurance company clients, thereby severely limiting their choice of counsel. Or it could retain higher priced counsel of its own choice, and pay the difference between the rates charged by those law firms and the rates routinely paid by insurance companies. If the insurer wishes to impose this limitation on its insureds, it may do so by clearly so stating in the insurance policy. If the insurer is unwilling to provide fair notice of this limitation in the policy, it should not look to obtain it through the back door via a common law rule. Id. at *10.

Therefore, if an insurer offers to pay defense counsel only at rates significantly below the rates charged by defense counsel, the insured should check to see if any state statute would support this deduction. If not, most courts would apply a reasonableness test and be guided by what a similarly situated policyholder could obtain in the marketplace. One fertile area for discovery if the issue of reasonableness is litigated may be what rates the insurance company pays attorneys defending the insurance company itself. The newspapers are filled with examples of large, national firms defending insurance companies in connection with the current crisis in the financial markets. These firms have rates that are at the top of the market.

Insurer's Delayed Defense Payments May Adversely Impact the Insured

Another way insurers often diminish their full defense obligation is by delaying the payment of defense costs. Whereas many clients pay legal bills within 30 to 60 days, insurers often pay very slowly, without specifying when bills will be paid. This makes collection and forecasting unpredictable and can seriously damage relations between defense counsel and the insured. When the defense counsel does not know when or if he or she will be paid, counsel naturally may be reluctant to continue incurring expenses. Insurers also sometimes leverage these delinquent payments as a negotiating tool to further reduce legal expenses, drawing out the process to the point that the attorney will “take what he can get,” even further damaging the attorney-client relationship.

Courts have held that insurers have a duty to pay out benefits promptly, including defense costs. Some courts go so far as to require that the insurer pay all defense bills promptly, withholding any challenge as to reasonableness until after the underlying matter has concluded. In J.R. Marketing, L.L.C. v. Hartford Cas. Ins. Co., 2007 WL 4217443 (Cal. App. 1 Dist. Nov. 30, 2007), the court affirmed a trial court order directing the insurer to pay outstanding defense bills immediately and future defense bills within 30 days of receipt in order to satisfy its duty to defend:

[W]here a duty to defend exists, enforcement of that duty necessarily includes directing immediate payment of reasonable and necessary defense bills. (See State of California v. Pacific Indemnity Co., supra, 63 Cal.App.4th at p. 1546; Gray Cary Ware & Freidenrich v. Vigiland Insurance Co., supra, 114 Cal.App.4th at p. 1189; Aerojet-General Corp. v. Transport Indemnity Co., supra, 17 Cal.4th at p. 58). As such, we conclude the trial court's order directing payment of respondents' outstanding and future defense bills was well within its discretion. Indeed, to conclude otherwise would be to render the duty to defend meaningless, because the insured would be deprived of the very benefit of the bargain it sought in purchasing the policy. (Haskel, supra, 33 Cal.App.4th at p. 979 fn.14). And as the trial court correctly noted, any challenge to the reasonableness or necessity of defense bills can await an action for reimbursement following the conclusion of the underlying matter. Slip op. at *10 (emphasis in original).

A Policyholder Does Have Recourse

At the inception of a matter, policyholders should raise specific concerns with guidelines that are objectionable and not simply agree to abide by guidelines that are tendered or rates that are proposed by the insurers. Sometimes a frank discussion at the beginning of a representation can help avoid subsequent disagreements relating to the defense bills.

If the insurer does engage in the tactics described above, policyholders are not without recourse. One option is to meet with senior claims representatives of the insurer. This is a good starting point to demonstrate dissatisfaction with the insurer. And, given that billing guidelines and payment schedules are unilaterally imposed by insurers and not contained in the actual policy, insurers have great flexibility in negotiating with the insured. That said, simply bringing these matters to the attention of senior representatives may well prove insufficient given that these practices may be directed by senior management.

A second option is for the policyholder to initiate proceedings with the appropriate state insurance commissioner. State agencies generally have procedures by which policyholders can file claims or complaints against insurers. The state generally investigates the merits of these complaints and, in some cases, can award relief to the policyholders. However, state commissioners are often limited in the types of relief they can provide and the matters they can decide. For example, some cannot order payment of monetary damages and are limited primarily to declaratory judgments and equitable relief. Some agencies also will not intervene in issues they consider to be factual determinations. Furthermore, policyholders may find that state agency proceedings involve long, drawn-out investigations, that are inherently averse to the policyholder's goal of obtaining prompt payment of the full defense costs owed by the insurer for the underlying litigation. Therefore, it is important for the insured to determine whether the matter is one which the appropriate state insurance commissioner is capable of resolving.

A third option for policyholders is to litigate the matter as the policyholders did in the Nortek, Watts Water, and J.R. Marketing cases. A policyholder has many potential claims against an insurer in these circumstances including claims for breach of contract, declaratory relief, injunctive relief, violation of state insurance practices acts, violations of state business statutes, and bad faith. For example, some state unfair insurance practices acts authorize a private cause of action. These statutes provide for recovery of damages and attorneys' fees. Bad faith also is a powerful claim because an insurer could be liable for punitive or exemplary damages in many states for providing the policyholder with an inadequate defense. Importantly, many jurisdictions will award attorneys' fees the policyholder incurs in forcing an insurer to honor its full defense obligation. McRory v. Northern Ins. Co. of New York, 980 P.2d 736, 738 (Wash. 1999) (quoting Olympic S.S. Co. v. Centennial Ins. Co., 811 P.2d 673 (Wash. 1991)). Therefore, the litigation options are diverse and potentially carry extra-contractual remedies.

Conclusion

In sum, insurers take deductions from defense bills or delay payment of these bills far too frequently. Insurers engage in these tactics with many policyholders, but few actually challenge the insurer's conduct. There are, however, ways to challenge these tactics.

Andrew M. Reidy, a member of this newsletter's Board of Editors, is a partner and Todd L. Brecher is an associate in the Washington, DC, office of Howrey LLP. They represent policyholders in disputes with insurance companies.

Liability policies typically have a defense obligation and an indemnity obligation. The defense obligation is often as valuable, or more valuable, to the insured as the indemnity obligation. In fact, many courts refer to the defense obligation as “litigation insurance,” protecting the insured from potentially costly litigation. See, e.g. , Rubenstein v. Royal Ins. Co. of America , 708 N.E.2d 639, 642 (Mass. 1999); Universal Underwriters Ins. Co. v. Lowe , 761 A.2d 997, 1012 n.15 (Md. App. 2000). Whether the defense obligation is expressed as a duty to defend or a duty to reimburse defense costs, insurers frequently impose major restrictions and limitations relating to the defense costs they will pay. The insurers do this by taking deductions from legal bills based upon the insurer's litigation or billing guidelines, approving rates at amounts less than those charged by defense counsel, and delaying payments of defense costs for unreasonable periods of time. These tactics leave policyholders feeling as though they did not receive the benefit of the insurance with respect to defense coverage and, in some cases, feeling that the defense of a claim is compromised. Fortunately for policyholders, there are ways to combat these practices.

Insurers Usually Insist on Billing Guidelines

Oftentimes after a claim is made, an insurer will accept the defense of the claim subject to a reservation of rights. In doing so, the insurer will for the first time send the policyholder billing guidelines or litigation guidelines. These guidelines are not mentioned in the insurance contract. Insurers insist defense counsel comply with these rules as a pre-condition to paying defense costs. Billing guidelines vary, but many guidelines include limitations regarding the number of attorneys who may attend hearings and depositions, paying for interoffice conferencing among attorneys, the use of online legal research databases, local travel expenses, and clerical or administrative tasks.

Billing guidelines imposed on defense counsel by insurers are often unreasonable and unworkable, especially in large or complicated litigation. Defense counsel complain that guidelines mean the lawyer must litigate the case “on the cheap,” foregoing practices considered both necessary and routine in the ordinary course of litigation. In other words, actual compliance with billing guidelines could mean the client receives only a limited defense and that the client's interests would not be fully represented. In order to not risk everything from reputational damage to potential malpractice liability, many defense counsel incur costs and expenses not allowed by the guidelines and hope the insurer or the policyholder will agree to pay these costs and expenses.

The propriety of billing guidelines has been addressed by state bar associations and courts. Nearly all ethics opinions agree that billing guidelines, at the very least, require a case-by-case analysis to ensure that the guidelines, as applied, do not put the lawyer in a position that compromises the duties he or she owes to his or her client under the state's rules of professional responsibility. Several states have held that certain common billing guidelines so clearly interfere with the professional judgment of the lawyer that it would be per se unethical for a lawyer to follow them, abrogating the need for any case-specific analysis by the lawyer or a governing body.

For example, the Supreme Court of Ohio's Board of Commissioners on Grievances and Discipline, in Opinion 2000-3 (June 2000), clearly stated that certain guidelines per se interfere with a lawyer's professional judgment and are therefore unethical for a lawyer to follow. These include guidelines that require prior approval before performing online legal research, dictate how work is to be allocated among defense team members, require approval before conducting discovery, taking depositions, or consulting with expert witnesses, and guidelines that require the insurer's approval before filing motions and pleadings.

Similarly, the Kentucky Bar Association, in Ethics Opinion KBA E-416 (March 2001), also held that certain billing guidelines were inappropriate for a lawyer to follow. While the committee stated some guidelines would be acceptable, guidelines requiring the insurer to pre-approve discovery requests, legal research, and the filing of motions, and requiring that all investigative work be performed by the insurer or billed out at paralegal rates violated the ethical rules.

The Rhode Island Supreme Court, in Ethics Advisory Panel Opinion No. 99-18 (October 1999), similarly held that a fact-specific determination was unnecessary with certain billing guidelines. The Panel stated that any guidelines which require the insurer's pre-approval for specified legal services such as conducting research, filing counterclaims and motions, visiting accident sites, and conducting depositions, among other activities, infringe upon the attorney-client relationship by “interfering with the independent professional judgment of defense counsel and ultimately with the quality of legal services provided to the insured.” Op. at 1.

The purpose of state bar ethics opinions is to regulate and guide the conduct of members of the bar. While these opinions are useful in defining the professional duties clients may demand from their lawyers, these opinions do not address the contractual relationship between a policyholder and the insurer with respect to the defense coverage.

Several courts have addressed the impact of billing guidelines on the contractual relationship between the insurer and the policyholder. In Nortek, Inc. v. Liberty Mutual Ins. Co. , 858 F.Supp. 1231 (D.R.I. 1994), the policyholder argued that the insurer failed to meet its defense obligation by not reimbursing the plaintiff all necessary defense costs. The insurer had accepted its defense obligation subject to billing restrictions:

As set forth in Liberty Mutual's letter of November 14, 1990, the “defense” was made subject to restrictions unilaterally imposed by Liberty Mutual and not found in the Policy. The restrictions included a “cap” of $105 per hour for attorneys fees, $55 per hour for paralegal time, no reimbursement for secretarial overtime, no reimbursement for “meals or over night [sic] trial without pre-approval,” and no reimbursement for any costs, expenses or attorneys' fees that were incurred before Oct. 15, 1990. Id. at 1234, n.3.

The court held that the defendant breached its obligation to defend, in part, by its failure to reimburse the plaintiff policyholder for “all of the reasonable fees and expenses [it] incurred defending itself against all the claims[.]” Id. at 1238-39.

In Dynamic Concepts, Inc. v. Truck Ins. Exch. , 61 Cal. App. 4th 999 (1998), the issue before the court was whether the insurer breached its duty to defend by investigating the purported conflict of interest, and not immediately approving independent counsel. In the opinion, the court took the opportunity to express skepticism toward billing guidelines, noting that “[i]nsurer-imposed restrictions on discovery or other litigation costs may well violate the insurer's duty to defend as well as the attorneys' ethical responsibilities to exercise their independent professional judgment in rendering legal services.” 61 Cal. App. 4th at 1009. The court went on to further elaborate on its view of billing guidelines:

In this regard we question the wisdom and propriety of so-called “outside counsel guidelines” by which insurers seek to limit or restrict certain types of discovery, legal research, or computerized legal research by outside attorneys they retain to represent their insureds. Some guidelines go so far as to call for the use of paralegals, rather than attorneys, to respond to “routine” discovery requests or prohibit the retention of experts or the filing of certain pretrial motions until shortly before trial. Under no circumstances can such guidelines be permitted to impede the attorney's own professional judgment about how best to competently represent the insureds. If the attorney's representation is to be limited in any way that unreasonably interferes with the defense, it is the insured, not the insurer, who should make that decision. Id. at 1009 n. 9 (emphasis in original) (citations omitted).

Thus, courts are in accord with ethics opinions that are wary of billing guidelines that restrict an attorney's professional judgment.

Hourly Rates Significantly Below Market Rates

Insurers that accept the defense of a claim fully and without a reservation of rights typically have law firms they routinely hire to handle such cases. These firms negotiate rates with the insurer based on a large volume of work. The hourly rate is more complicated when the insurer reserves its rights and independent counsel is selected to represent the policyholder. Insurers unilaterally decide the rates they are willing to pay for independent counsel. The rates the insurers propose often are problematic because they are far below the actual billing rates of defense counsel. Policyholders are then forced to either make up the difference in rates themselves, despite having paid for defense coverage, or ask their counsel to write-off the gap between their actual rates and rates approved by the insurer.

The process of selecting defense counsel depends upon many factors, including the complexity of the matter, the expertise required, and the venue of the action. Policyholders often discover, however, that insurers do not analyze these factors. Instead, they simply refuse to pay rates that exceed the levels the insurers typically pay the insurance defense firms they frequently retain in the same jurisdiction. The reality is that reasonable attorneys' fees of independent counsel will often exceed the rates insurers would pay to a firm that does a high volume of insurance defense work for the insurer.

In Watts Water Technologies, Inc. v. Fireman's Fund Ins. Co., 2007 WL 2083769 (Mass. Super. July 11, 2007), the insurer agreed to defend the policyholder under a reservation of rights. The policyholder selected independent counsel and later sought a judicial declaration that “reasonable fees” under the insurance policy included hourly rates which exceeded those typically paid by the insurer. The insurer urged the court to impose a rate restriction similar to those found in the California and Alaska statutes, limiting fees to those “which are actually paid by the insurer to attorneys retained in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended.” Slip op. 9 (quoting Cal. Civ. Code '2860 (c) (2007) and citing Alaska Stat '21.89.100 (2007)). The court declined to do so, noting that insurers often pay rates far below what an insured must pay for an adequate defense. The court noted that insurers purchase large quantities of legal services and can therefore negotiate low billing rates with select firms. The court also recognized that, to insurers, the cost savings of low-priced attorneys may outweigh the benefits of more competent representation, whereas to policyholders facing significant liability, the benefits of more competent counsel would surely outweigh the costs. The court reasoned that policyholders should not be bound by the rates insurers normally pay counsel, but rather by the usual price charged for similar services by other attorneys in the same area, and not the “usual price paid by insurance companies.” Id. at *10 (emphasis in original). The court noted the pitfalls of adopting an approach urged by insurers:

For all practical purposes, if the Massachusetts common law were to adopt the standard established by statute in California and Alaska, an insured under a reservation of rights would have to choose between two poor alternatives. It could retain the same law firms retained by insurance companies that handle comparable cases, and attempt to procure the same rates that these firms charge to insurance company clients, thereby severely limiting their choice of counsel. Or it could retain higher priced counsel of its own choice, and pay the difference between the rates charged by those law firms and the rates routinely paid by insurance companies. If the insurer wishes to impose this limitation on its insureds, it may do so by clearly so stating in the insurance policy. If the insurer is unwilling to provide fair notice of this limitation in the policy, it should not look to obtain it through the back door via a common law rule. Id. at *10.

Therefore, if an insurer offers to pay defense counsel only at rates significantly below the rates charged by defense counsel, the insured should check to see if any state statute would support this deduction. If not, most courts would apply a reasonableness test and be guided by what a similarly situated policyholder could obtain in the marketplace. One fertile area for discovery if the issue of reasonableness is litigated may be what rates the insurance company pays attorneys defending the insurance company itself. The newspapers are filled with examples of large, national firms defending insurance companies in connection with the current crisis in the financial markets. These firms have rates that are at the top of the market.

Insurer's Delayed Defense Payments May Adversely Impact the Insured

Another way insurers often diminish their full defense obligation is by delaying the payment of defense costs. Whereas many clients pay legal bills within 30 to 60 days, insurers often pay very slowly, without specifying when bills will be paid. This makes collection and forecasting unpredictable and can seriously damage relations between defense counsel and the insured. When the defense counsel does not know when or if he or she will be paid, counsel naturally may be reluctant to continue incurring expenses. Insurers also sometimes leverage these delinquent payments as a negotiating tool to further reduce legal expenses, drawing out the process to the point that the attorney will “take what he can get,” even further damaging the attorney-client relationship.

Courts have held that insurers have a duty to pay out benefits promptly, including defense costs. Some courts go so far as to require that the insurer pay all defense bills promptly, withholding any challenge as to reasonableness until after the underlying matter has concluded. In J.R. Marketing, L.L.C. v. Hartford Cas. Ins. Co., 2007 WL 4217443 (Cal. App. 1 Dist. Nov. 30, 2007), the court affirmed a trial court order directing the insurer to pay outstanding defense bills immediately and future defense bills within 30 days of receipt in order to satisfy its duty to defend:

[W]here a duty to defend exists, enforcement of that duty necessarily includes directing immediate payment of reasonable and necessary defense bills. (See State of California v. Pacific Indemnity Co., supra, 63 Cal.App.4th at p. 1546; Gray Cary Ware & Freidenrich v. Vigiland Insurance Co., supra, 114 Cal.App.4th at p. 1189; Aerojet-General Corp. v. Transport Indemnity Co., supra, 17 Cal.4th at p. 58). As such, we conclude the trial court's order directing payment of respondents' outstanding and future defense bills was well within its discretion. Indeed, to conclude otherwise would be to render the duty to defend meaningless, because the insured would be deprived of the very benefit of the bargain it sought in purchasing the policy. (Haskel, supra, 33 Cal.App.4th at p. 979 fn.14). And as the trial court correctly noted, any challenge to the reasonableness or necessity of defense bills can await an action for reimbursement following the conclusion of the underlying matter. Slip op. at *10 (emphasis in original).

A Policyholder Does Have Recourse

At the inception of a matter, policyholders should raise specific concerns with guidelines that are objectionable and not simply agree to abide by guidelines that are tendered or rates that are proposed by the insurers. Sometimes a frank discussion at the beginning of a representation can help avoid subsequent disagreements relating to the defense bills.

If the insurer does engage in the tactics described above, policyholders are not without recourse. One option is to meet with senior claims representatives of the insurer. This is a good starting point to demonstrate dissatisfaction with the insurer. And, given that billing guidelines and payment schedules are unilaterally imposed by insurers and not contained in the actual policy, insurers have great flexibility in negotiating with the insured. That said, simply bringing these matters to the attention of senior representatives may well prove insufficient given that these practices may be directed by senior management.

A second option is for the policyholder to initiate proceedings with the appropriate state insurance commissioner. State agencies generally have procedures by which policyholders can file claims or complaints against insurers. The state generally investigates the merits of these complaints and, in some cases, can award relief to the policyholders. However, state commissioners are often limited in the types of relief they can provide and the matters they can decide. For example, some cannot order payment of monetary damages and are limited primarily to declaratory judgments and equitable relief. Some agencies also will not intervene in issues they consider to be factual determinations. Furthermore, policyholders may find that state agency proceedings involve long, drawn-out investigations, that are inherently averse to the policyholder's goal of obtaining prompt payment of the full defense costs owed by the insurer for the underlying litigation. Therefore, it is important for the insured to determine whether the matter is one which the appropriate state insurance commissioner is capable of resolving.

A third option for policyholders is to litigate the matter as the policyholders did in the Nortek, Watts Water, and J.R. Marketing cases. A policyholder has many potential claims against an insurer in these circumstances including claims for breach of contract, declaratory relief, injunctive relief, violation of state insurance practices acts, violations of state business statutes, and bad faith. For example, some state unfair insurance practices acts authorize a private cause of action. These statutes provide for recovery of damages and attorneys' fees. Bad faith also is a powerful claim because an insurer could be liable for punitive or exemplary damages in many states for providing the policyholder with an inadequate defense. Importantly, many jurisdictions will award attorneys' fees the policyholder incurs in forcing an insurer to honor its full defense obligation. McRory v. Northern Ins. Co. of New York , 980 P.2d 736, 738 (Wash. 1999) (quoting Olympic S.S. Co. v. Centennial Ins. Co. , 811 P.2d 673 (Wash. 1991)). Therefore, the litigation options are diverse and potentially carry extra-contractual remedies.

Conclusion

In sum, insurers take deductions from defense bills or delay payment of these bills far too frequently. Insurers engage in these tactics with many policyholders, but few actually challenge the insurer's conduct. There are, however, ways to challenge these tactics.

Andrew M. Reidy, a member of this newsletter's Board of Editors, is a partner and Todd L. Brecher is an associate in the Washington, DC, office of Howrey LLP. They represent policyholders in disputes with insurance companies.