Insurer Loses on Attempt to Recoup Defense Costs

August 19, 2010

Insurers around the country continue to seek ways to recoup the fees and costs spent defending their insureds for uncovered claims. This issue basically started in the Buss v. Superior Court decision in California where an insurer unilaterally sought to recoup defense costs when it had not reserved such a right in a reservation of rights letter or in the policy. These days, it is certainly not uncommon to see insurers insert such a right in a reservation of rights letter regardless of the state’s law on the issue. The hope is that down the road the law may change in the carrier’s favor.

The Pennsylvania Supreme Court just addressed this issue in American and Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 2010 Pa. LEXIS 1803 (Penn. Aug. 17, 2010). The insurance company attempted to claim that the insured owed the insurer for reimbursement of defense costs expended by the insurer on behalf of the insured under a reservation of rights. The insurance policy at issue did not specifically provide for this recoupment of defense costs.

Instead, the insurer argued that its reservation of rights letter created the right to recoup defense costs by indicating that the insured provided the defense under a full reservation of its rights, including such recoupment. At trial, the insurer claimed that the insured must reimburse the defense costs based on an unjust enrichment theory.

The Pennsylvania Supreme Court held that the insurer had no right to recoupment of defense costs based on the policy. Further, an insurer “cannot employ a reservation of rights letter to reserve a right it does not have pursuant to the contract.” The court also held that the insurer owes a duty of defense when the possibility for coverage exists. Because the insurer initially provided the defense pursuant to its own interests, the insurer made the initial decision that the possibility for coverage existed under the terms of the contract and the contents of the underlying complaint.

Just because a court later ruled that no possibility for coverage existed under the contract, the insurer’s initial determination that such a possibility existed created its duty to defend against the claims. If the insurer did not believe that a possibility of coverage existed, it would never have provided a defense in the first place. As such, the court rejected the claim for the recoupment of defense costs.

Policyholders must remain vigilant to this issue and never let a reservation of rights letter asserting rights to recoup defense costs go unanswered. Failure to respond to such a claim may create a waiver or estoppel argument for the insurer.

For more information on this issue and how McGuireWoods’ Insurance Coverage Team can assist policyholders, please contact the authors.