Case Briefs

The Ongoing Debate Regarding Recoupment of Defense Costs

On Aug. 17, 2010, the Supreme Court of Pennsylvania issued its decision in American and Foreign Insurance Co. v. Jerry's Sport Center, Inc., No. 88 MAP 2008, 2010 WL 3222404 (Pa. Aug. 17, 2010). The Pennsylvania high court held that when an insurance policy does not expressly provide for recoupment of defense costs, a unilateral reservation of rights letter citing the intent to seek reimbursement does not entitle the insurer to recoup from the policyholder costs the insurer spent defending an underlying suit prior to obtaining a declaratory judgment that no duty to defend existed. The court did not reach the issue of recoupment of indemnity costs in this case. Just a day earlier, however, the U.S. Court of Appeals for the Tenth Circuit in Valley Forge Ins. Co. v. Health Care Mgt. Partners, Ltd., No. 09-1251 (10th Cir. Aug. 16, 2010), predicted that Colorado would allow recoupment of defense costs by insurers, underscoring the ongoing debate on this question throughout the country.

In Jerry's Sport Center, the insurer provided commercial liability primary and umbrella insurance coverage to the policyholder, a firearm wholesaler-distributor. In 2001, the policyholder was named as a defendant in a lawsuit against firearms wholesalers and distributors.

The suit sought both injunctive relief and monetary relief to establish an educational and regulatory fund. The insurer accepted defense of the policyholder subject to a reservation of rights, including the right “to seek reimbursement for any and all defense costs ultimately determined not to be covered.” The insurer later filed an action seeking a declaratory judgment that it had no duty to defend or indemnify the policyholder.

A Pennsylvania trial court found that the suit was not covered because the remedy that the underlying suit sought was not an award of damages for bodily injury. After prevailing on appeal in the declaratory judgment action, the insurer sought reimbursement of defense fees expended on the policyholder's behalf from the date it filed the declaratory judgment action. The trial court found that the insurer was entitled to restitution based on a theory of unjust enrichment, but an intermediate appellate court reversed. The Supreme Court of Pennsylvania agreed to hear the insurer's appeal, and in its recent decision found that the insurer was not entitled to recoup defense costs based on a unilateral reservation of rights letter.

The Supreme Court of Pennsylvania noted that many jurisdictions that have addressed the issue do allow insurers to recoup defense costs based on a reservation of rights letter, citing Buss v. Superior Court, 939 P.2d 766 (Cal. 1997). The court also noted that there was conflicting authority, citing Terra Nova Insurance Company, Limited v. 900 Bar, Inc., 887 F.2d 1213 (3d Cir. 1989) and General Agents Insurance Company of America, Incorporated v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Ill. 2005). The court stated that it found the latter line of cases “more consistent with the broad duty to defend under Pennsylvania law.”

The Pennsylvania high court stated that an insurer must decide in the first instance whether a claim falls or potentially falls within the scope of its policy, and should deny a defense if it believes there is no possibility of coverage so that the policyholder can control its own defense without breaching the insurance contract. Moreover, the court concluded that if the insurer is unsure about coverage, it should provide a defense and seek a declaratory judgment. According to the court, however, a declaratory judgment for the insurer does not “retroactively eliminate the insurer's duty to defend the insured during the period of uncertainty.”

According to the court, an insurer “cannot employ a reservation of rights letter to reserve a right it does not have pursuant to the contract.” Since the policy itself did not provide for a right of reimbursement, the court stated that permitting the insurer to reserve the right to reimbursement through a reservation of rights letter, without more, “is tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract.” Moreover, the court also rejected the insurer's unjust enrichment argument. It stated that the insurer had the right to defend the insured, which allowed it to control the defense to protect itself against potential indemnity exposure. The court stated that the insurer's retention of defense counsel meant that the policyholder “would have been at risk of breaching the insurance contract if it had rejected [the insurer's] defense and it was later determined that the claim was covered,” and that the policyholder “was obliged to cooperate” with the insurer in defending the underlying suit. While the policyholder “had no reasonable alternative” except to accept the defense, the insurer was able to monitor defense expenses and enforce its billing guidelines. Further, the insurer was “protecting itself from the potential of a bad faith claim.”

Justice Thomas G. Saylor of the Supreme Court of Pennsylvania concurred separately, noting some differences with the majority's treatment of unjust enrichment and interpretation of contract law principles in the context of reservation of rights letters, but ultimately agreeing that an insurer should ground a reservation of rights in a policy provision.

Courts across the country are divided on the right of insurers to recoup the costs of defending a claim which a court later determines in a declaratory judgment action is not covered by the insurance policy terms. Indeed, just the day before the Jerry's Sport Center ruling was issued, the U.S. Court of Appeals for the Tenth Circuit in Valley Forge Ins. Co. v. Health Care Mgt. Partners, Ltd., No. 09-1251 (10th Cir. Aug. 16, 2010), predicted that Colorado would allow recoupment of defense costs by insurers where the insurance policy was silent on recoupment, tying the right to reimbursement to the insurer's reservation of a recoupment claim when it provides a defense, not to any provision in the insurance contract itself. These rulings make clear that the debate over insurers' rights to recoup defense costs ' as well as indemnity amounts ' that the insurer advanced in an uncertain coverage setting will continue to be litigated under the individual law of each state.

Victory for Policyholders Facing Securities Claims

A recent federal court decision, applying Massachusetts law, represents a significant victory for policyholders facing securities claims. In Genzyme Corp. v. Federal Ins. Co., 2010 U.S. App. LEXIS 21079 (1st Cir. Mass. Oct. 13, 2010), the U.S. Court of Appeals for the First Circuit ruled that public policy does not preclude insurance coverage for a settlement negotiated by a company accused of favoring one class of shareholders over another. Although Genzyme lacked entity coverage for itself due to a specific exclusion in its policy, the court found that the amounts paid in settlement to indemnify Genzyme's officers and directors were insurable and covered losses.

In 2003, Genzyme undertook a share exchange transaction whereby holders of its Biosurgery Division stock exchanged their shares for Genzyme's General Division's stock. 2010 U.S. App. LEXIS 21079, *4-5. The share exchange was unpopular and led to shareholder lawsuits alleging that Genzyme, its board of directors and its officers had improperly favored General Division shareholders over Biosurgery Division shareholders. Id. at *5-6. After Genzyme settled the claims, it sought to recover a portion of the settlement from its D&O insurer Federal Insurance Company (“Federal”). Federal denied coverage arguing that the settlement was an uninsurable loss.

The court concluded that public policy did not bar coverage for Genzyme's securities settlement. Id. at *16. Under Massachusetts law, public policy precludes insurance coverage only for intentionally committed wrongful acts that are also done “deliberately or intentionally, in the sense that the actor knew the act was wrongful” or “with a specific intent to do what the law forbids.” Id. The court reminded that courts cannot create a public policy bar not otherwise found in Massachusetts law. Id. at *18-19. Because there were no allegations of an intentionally and knowingly wrongful act, public policy did not prohibit coverage for Genzyme's settlement.

The court also rejected the notion that Genzyme's settlement was uninsurable as somehow a disgorgement of ill-gotten gains. Genzyme received nothing in the share exchange transaction ' it had merely issued additional shares of stock. Id. at *19-21. Having received nothing, Genzyme could not be compelled to disgorge anything. Id. at 21.

Despite these favorable policyholder findings, the court nevertheless concluded that Genzyme itself was not entitled to coverage for the settlement. Its policy contained an express “Bump-Up” clause, stating that Federal would not be liable for “that part of Loss, other than Defense Costs ' which is based upon, arising from, or in consequence of the actual or proposed payment by any Insured Organization of allegedly inadequate or excessive consideration in connection with the purchase of securities issued by [Genzyme].” Id. at 24-25. The court found this clause applied to the class action plaintiffs' claims against Genzyme because the share exchange involved a “purchase” of securities. Id. at 25-29.

The Bump-Up clause did not, however, bar coverage for those portions of the settlement resolving claims against Genzyme's officers and directors. Id. at *29-32. The court therefore remanded the matter for allocation of the settlement between covered claims against the officers and directors and uncovered claims against Genzyme.

The first Case Brief was contributed by Laura A. Foggan, a partner at Wiley Rein LLP who regularly represents insurers in a wide variety of coverage and other matters, and Parker Lavin, an associate in the insurance practice at the firm. Foggan is a member of this newsletter's Board of Editors. Alissa Pyrich, an associate at McCarter & English, LLP, contributed the second case brief.

The Ongoing Debate Regarding Recoupment of Defense Costs

On Aug. 17, 2010, the Supreme Court of Pennsylvania issued its decision in American and Foreign Insurance Co. v. Jerry's Sport Center, Inc. , No. 88 MAP 2008, 2010 WL 3222404 (Pa. Aug. 17, 2010). The Pennsylvania high court held that when an insurance policy does not expressly provide for recoupment of defense costs, a unilateral reservation of rights letter citing the intent to seek reimbursement does not entitle the insurer to recoup from the policyholder costs the insurer spent defending an underlying suit prior to obtaining a declaratory judgment that no duty to defend existed. The court did not reach the issue of recoupment of indemnity costs in this case. Just a day earlier, however, the U.S. Court of Appeals for the Tenth Circuit in Valley Forge Ins. Co. v. Health Care Mgt. Partners, Ltd., No. 09-1251 (10th Cir. Aug. 16, 2010), predicted that Colorado would allow recoupment of defense costs by insurers, underscoring the ongoing debate on this question throughout the country.

In Jerry's Sport Center, the insurer provided commercial liability primary and umbrella insurance coverage to the policyholder, a firearm wholesaler-distributor. In 2001, the policyholder was named as a defendant in a lawsuit against firearms wholesalers and distributors.

The suit sought both injunctive relief and monetary relief to establish an educational and regulatory fund. The insurer accepted defense of the policyholder subject to a reservation of rights, including the right “to seek reimbursement for any and all defense costs ultimately determined not to be covered.” The insurer later filed an action seeking a declaratory judgment that it had no duty to defend or indemnify the policyholder.

A Pennsylvania trial court found that the suit was not covered because the remedy that the underlying suit sought was not an award of damages for bodily injury. After prevailing on appeal in the declaratory judgment action, the insurer sought reimbursement of defense fees expended on the policyholder's behalf from the date it filed the declaratory judgment action. The trial court found that the insurer was entitled to restitution based on a theory of unjust enrichment, but an intermediate appellate court reversed. The Supreme Court of Pennsylvania agreed to hear the insurer's appeal, and in its recent decision found that the insurer was not entitled to recoup defense costs based on a unilateral reservation of rights letter.

The Supreme Court of Pennsylvania noted that many jurisdictions that have addressed the issue do allow insurers to recoup defense costs based on a reservation of rights letter, citing Buss v. Superior Court , 939 P.2d 766 (Cal. 1997). The court also noted that there was conflicting authority, citing Terra Nova Insurance Company, Limited v. 900 Bar, Inc. , 887 F.2d 1213 (3d Cir. 1989) and General Agents Insurance Company of America, Incorporated v. Midwest Sporting Goods Co. , 828 N.E.2d 1092 (Ill. 2005). The court stated that it found the latter line of cases “more consistent with the broad duty to defend under Pennsylvania law.”

The Pennsylvania high court stated that an insurer must decide in the first instance whether a claim falls or potentially falls within the scope of its policy, and should deny a defense if it believes there is no possibility of coverage so that the policyholder can control its own defense without breaching the insurance contract. Moreover, the court concluded that if the insurer is unsure about coverage, it should provide a defense and seek a declaratory judgment. According to the court, however, a declaratory judgment for the insurer does not “retroactively eliminate the insurer's duty to defend the insured during the period of uncertainty.”

According to the court, an insurer “cannot employ a reservation of rights letter to reserve a right it does not have pursuant to the contract.” Since the policy itself did not provide for a right of reimbursement, the court stated that permitting the insurer to reserve the right to reimbursement through a reservation of rights letter, without more, “is tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract.” Moreover, the court also rejected the insurer's unjust enrichment argument. It stated that the insurer had the right to defend the insured, which allowed it to control the defense to protect itself against potential indemnity exposure. The court stated that the insurer's retention of defense counsel meant that the policyholder “would have been at risk of breaching the insurance contract if it had rejected [the insurer's] defense and it was later determined that the claim was covered,” and that the policyholder “was obliged to cooperate” with the insurer in defending the underlying suit. While the policyholder “had no reasonable alternative” except to accept the defense, the insurer was able to monitor defense expenses and enforce its billing guidelines. Further, the insurer was “protecting itself from the potential of a bad faith claim.”

Justice Thomas G. Saylor of the Supreme Court of Pennsylvania concurred separately, noting some differences with the majority's treatment of unjust enrichment and interpretation of contract law principles in the context of reservation of rights letters, but ultimately agreeing that an insurer should ground a reservation of rights in a policy provision.

Courts across the country are divided on the right of insurers to recoup the costs of defending a claim which a court later determines in a declaratory judgment action is not covered by the insurance policy terms. Indeed, just the day before the Jerry's Sport Center ruling was issued, the U.S. Court of Appeals for the Tenth Circuit in Valley Forge Ins. Co. v. Health Care Mgt. Partners, Ltd., No. 09-1251 (10th Cir. Aug. 16, 2010), predicted that Colorado would allow recoupment of defense costs by insurers where the insurance policy was silent on recoupment, tying the right to reimbursement to the insurer's reservation of a recoupment claim when it provides a defense, not to any provision in the insurance contract itself. These rulings make clear that the debate over insurers' rights to recoup defense costs ' as well as indemnity amounts ' that the insurer advanced in an uncertain coverage setting will continue to be litigated under the individual law of each state.

Victory for Policyholders Facing Securities Claims

A recent federal court decision, applying Massachusetts law, represents a significant victory for policyholders facing securities claims. In Genzyme Corp. v. Federal Ins. Co., 2010 U.S. App. LEXIS 21079 (1st Cir. Mass. Oct. 13, 2010), the U.S. Court of Appeals for the First Circuit ruled that public policy does not preclude insurance coverage for a settlement negotiated by a company accused of favoring one class of shareholders over another. Although Genzyme lacked entity coverage for itself due to a specific exclusion in its policy, the court found that the amounts paid in settlement to indemnify Genzyme's officers and directors were insurable and covered losses.

In 2003, Genzyme undertook a share exchange transaction whereby holders of its Biosurgery Division stock exchanged their shares for Genzyme's General Division's stock. 2010 U.S. App. LEXIS 21079, *4-5. The share exchange was unpopular and led to shareholder lawsuits alleging that Genzyme, its board of directors and its officers had improperly favored General Division shareholders over Biosurgery Division shareholders. Id. at *5-6. After Genzyme settled the claims, it sought to recover a portion of the settlement from its D&O insurer Federal Insurance Company (“Federal”). Federal denied coverage arguing that the settlement was an uninsurable loss.

The court concluded that public policy did not bar coverage for Genzyme's securities settlement. Id. at *16. Under Massachusetts law, public policy precludes insurance coverage only for intentionally committed wrongful acts that are also done “deliberately or intentionally, in the sense that the actor knew the act was wrongful” or “with a specific intent to do what the law forbids.” Id. The court reminded that courts cannot create a public policy bar not otherwise found in Massachusetts law. Id. at *18-19. Because there were no allegations of an intentionally and knowingly wrongful act, public policy did not prohibit coverage for Genzyme's settlement.

The court also rejected the notion that Genzyme's settlement was uninsurable as somehow a disgorgement of ill-gotten gains. Genzyme received nothing in the share exchange transaction ' it had merely issued additional shares of stock. Id. at *19-21. Having received nothing, Genzyme could not be compelled to disgorge anything. Id. at 21.

Despite these favorable policyholder findings, the court nevertheless concluded that Genzyme itself was not entitled to coverage for the settlement. Its policy contained an express “Bump-Up” clause, stating that Federal would not be liable for “that part of Loss, other than Defense Costs ' which is based upon, arising from, or in consequence of the actual or proposed payment by any Insured Organization of allegedly inadequate or excessive consideration in connection with the purchase of securities issued by [Genzyme].” Id. at 24-25. The court found this clause applied to the class action plaintiffs' claims against Genzyme because the share exchange involved a “purchase” of securities. Id. at 25-29.

The Bump-Up clause did not, however, bar coverage for those portions of the settlement resolving claims against Genzyme's officers and directors. Id. at *29-32. The court therefore remanded the matter for allocation of the settlement between covered claims against the officers and directors and uncovered claims against Genzyme.

The first Case Brief was contributed by Laura A. Foggan, a partner at Wiley Rein LLP who regularly represents insurers in a wide variety of coverage and other matters, and Parker Lavin, an associate in the insurance practice at the firm. Foggan is a member of this newsletter's Board of Editors. Alissa Pyrich, an associate at McCarter & English, LLP, contributed the second case brief.