Case Notes

The discussion continues herein.

The Appeal

Hartford appealed, asserting that Squire Sanders, not J.R. Marketing, had been unjustly enriched by overcharging Hartford for the defense. The Court of Appeals affirmed the ruling against Hartford and in favor of Squire Sanders. The Court of Appeals concluded that allowing Hartford to seek reimbursement directly from Squire Sanders would frustrate the Cumis scheme generally because counsel chosen by the insureds answer solely to the insureds and are free from any insurer involvement in counsel's approach to the defense. Additionally, the Court of Appeals stated that Squire Sanders had conferred a benefit on J.R. Marketing, not Hartford. Accordingly, it is J.R. Marketing, and not Squire Sanders, from whom Hartford must seek reimbursement.

The Supreme Court accepted Hartford's appeal as follows:

We granted Hartford's petition for review, which raised a narrow question:

May an insurer seek reimbursement directly from counsel when, in satisfaction of its duty to fund its insureds' defense in a third-party action against them, the insurer paid bills submitted by the insureds' independent counsel for the fees and costs of mounting this defense, and has done so in compliance with a court order expressly preserving the insurer's post-litigation right to recover “unreasonable and unnecessary” amounts billed by counsel?

The California Supreme Court noted that Hartford paid defense expenses pursuant to a court order that required Hartford to pay Squire Sanders' bills promptly, but also required that such bills be “reasonable and necessary,” and that after conclusion of the underlying litigation, Hartford had the right to seek reimbursement of any amounts it deemed excessive. The order did not specify from whom Hartford must obtain any reimbursement. Hartford seeks reimbursement from Squire Sanders based on equitable principles of restitution and unjust enrichment. The court noted that an individual who has been unjustly enriched at the expense of another may be required to make restitution, the law implies such obligation even if no contract exists between the parties.

Examining the holdings in Buss (Buss v. Superior Court, 16 Cal. 4th 35, 49 (1997), the California Supreme Court noted that when an insurer has met its obligation to defend an action that includes both covered and uncovered claims, the insurer is entitled to restitution from the insured for those fees and costs solely attributable to defending uncovered claims. This makes sense, as the insurer never bargained to bear the cost of defending uncovered claims, and the insured never paid premiums or reasonably expected to receive a defense for such claims. If an insurer was required to absorb the cost of defending claims it never agreed to defend, the insured would be unjustly enriched at the insurer's expense. In Buss , however, the court did not confront the question as to who is unjustly enriched if Cumis counsel is allowed to retain payments that were unreasonable and unnecessary for the insured's defense against any claim. Accordingly, the question addressed in J.R. Marketing is premised on the assumption the defense fees were excessive and unnecessary and were not incurred for the benefit of the insured.

Squire Sanders raised two types of objections to the proposition that a direct action by Hartford for unjust enrichment could lie against Squire Sanders as Cumis counsel. First, Squire Sanders argued that restitution cannot be sought for a benefit “incidentally” conferred by another while the other was performing a pre-existing duty or protecting his own interest. Said differently, Hartford contracted with J.R. Marketing to pay defense costs potentially covered under the policy, and Squire Sanders was merely the “incidental” beneficiary of Hartford's performance of this obligation. In response, the Callifornia Supreme Court stated as follows: “We are not persuaded that the incidental benefits principle applies to the facts Hartford has alleged. The logic underlying this principle is straightforward: equity does not create a duty to pay for a benefit one neither sought nor had the opportunity to decline, and over which one had no control.” The court went on the state that Hartford did not voluntarily pay the alleged unreasonable and unnecessary overcharges out of any interest extraneous to the benefit conferred upon Squire Sanders. Furthermore, the overpayments were not merely an “incidental” benefit to Squire Sanders.

Next, Squire Sanders objected on public policy grounds. Essentially, it argued that to allow a “breaching insurer” such as Hartford to assert a direct right of action against Cumis counsel would contravene the purposes of the Cumis rule. Such a direct claim would interfere with the insured's attorney-client privilege and the insured's right to control its defense presented by the Cumis counsel. Squire Sanders argued that Cumis counsel's undivided loyalty to the insured would be unduly compromised if Cumis counsel faced the prospect of an insurer's lawsuit challenging, in hindsight, the reasonableness of the defense expenses.

The court was not convinced by this argument. While Cumis counsel must retain the necessary independence, such independence is not inconsistent with the obligation to justify fees. The court compared this obligation with cases brought under fee shifting statutes, class action settlements, probate and bankruptcy.

Squire Sanders also argued that because the attorney-client relationship is exclusively between Cumis counsel and the insured, it is J.R. Marketing alone that had the authority and responsibility to monitor and control defense expenses. Squire Sanders went on to argue that if J.R. Marketing failed to do so, then J.R. Marketing should suffer the consequences of such failure. The court found that such argument “all but ignores the realities of cases like the one before us.” The insureds were not sophisticated, frequent litigators with any experience monitoring defense counsel. Moreover, there's no indication that J.R. Marketing expected they would have to finance separate litigation against Squire Sanders to recover any funds J.R. Marketing would be ordered to pay to Hartford as a result of Squire Sanders' unreasonable billing.

Next, Squire Sanders argued that its due process rights would be affected if Hartford were allowed to recover directly from Squire Sanders. In particular, its due process rights would be violated if J.R. Marketing refused to waive attorney-client privilege, thus preventing Squire Sanders from effectively defending against Hartford's claim for reimbursement. The court held that: “An objective assessment of the litigation as a whole to determine whether counsel's bills appear fundamentally reasonable is unlikely to involve an examination of individual attorney-client communications or the minute details of every litigation decision.” The court went on to say that if there was any privileged information needed for the evaluation, it could be redacted. Here, the court made a number of assumptions which are ripe for challenge in subsequent, similar cases.

Last, Squire Sanders argued that allowing Hartford to seek direct reimbursement from Cumis counsel would contravene California's prohibition on the assignment of legal malpractice claims. The court was not persuaded by this argument and instead accepted Hartford's response that it does not seek to stand in J.R. Marketing's shoes to assert a claim that counsel violated a duty to J.R. Marketing by performing deficiently. Furthermore, Hartford does not seek to gain from a claim that by its nature belongs uniquely and personally to J.R. Marketing. On the contrary, Hartford is seeking to recover monies it paid to Squire Sanders pursuant to a court order for services to J.R. Marketing.

Finally, in its conclusion, the court pointed out the irony of the fact that Squires Sanders sought to avoid enforcement of an order it drafted:

We emphasize that this conclusion is a limited one, and a particularly apposite one given the history of this litigation. The trial court's 2006 enforcement order plainly permits Hartford to pursue someone for reimbursement of allegedly excessive legal charges. … Taking the 2006 enforcement order as we find it, we conclude that equitable principles of restitution and unjust enrichment dictate that Hartford may seek reimbursement for the allegedly unreasonable and unnecessary defense fees directly from Squire Sanders. … Squire Sanders drafted the very order that expressly preserved Hartford's right to pursue reimbursement for excessive fees and grounded that reimbursement right in principles of restitution and unjust enrichment.

Conclusion

While this case certainly serves as a warning to Cumis counsel with respect to billing practices, it likely also will change the negotiations with respect to payment of Cumis counsel and/or reimbursement for overbilling as well as agreements regarding assertion or waiver of the attorney-client privilege in reimbursement disputes.

' Jessica F. Pardi, Morris, Manning & Martin

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