Excess Insurers' Duty

to Defend and Indemnify Strategies to Broaden or Limit the Scope of the Excess Insurers Obligations

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WEDNESDAY, DECEMBER 17, 2014

Presenting a live 90-minute webinar with interactive Q&A

Marc S. Mayerson, Principal, The Mayerson Firm, Washington, D.C.

Scott M. Seaman, Partner, Meckler Bulger Tilson Marick & Pearson, Chicago

Excess &Umbrella Insurance:

Working Through ChallengingDefense &Indemnity Issues

Scott M. SeamanMeckler Bulger Tilson Marick &Pearson LLP

123 N. Wacker DriveSuite 1800

-- Chicago, IL 60606Tel: (312) 474-7139Fax: (312) 474-7898

E-mail: scott.seaman(a~mbtlaw.com

TABLE OF CONTENTS

Scott M. Seaman Biography ...................................... A

Allocation of Losses In Complex InsuranceCoverage Claims 3d (Thomson Reuters 2014) SelectPortion of Chapter 12 Defense Costs,Attorney's Fees, and Legal Audits * ............................... B

Allocation of Losses In Complex InsuranceCoverage Claims 3d (Thomson Reuters 2014)Select Portion of Chapter 9Insolvency Of Underlying Insurers * ............................... C

*Excerpted and reprinted with permission from Allocation of Losses inComplex Insurance Coverage Claims by Scott M. Seaman and Jason R.Schulze 3d (Thomson Reuters 2014), available at www.west.thomson.com.O Thomson Reuters. All rights reserved.

~ ~ ~

~B ~ MECKLERBULGERTIL50N

l_..~~._______ MARICK&PEARSON z.Lr~

123 North Wacker DriveSuite 1800Chicago, Illinios 60606

Tel: (312) 474-7139Fax: (312) 474-7898scott. seaman(a~m btlaw. com

Scott M. SeamanPartner

Scott is a partner at Meckler Bulger Tilson Marick &Pearson LLPin Chicago, where he serves on the firm's Executive Committeeand as Chairman of the firm's National Insurance CoverageLitigation and Counseling ~ Practice Group. Scott has hadthe privilege of working with some of the most dedicated andtalented senior management, legal counsel, and insurance andreinsurance claims and litigation professionals in the world and ofbeing counsel in and working on some of the most challengingcontemporary coverage and reinsurance issues confronting theindustry.

For more than twenty seven years, Scott has successfullyrepresented companies in trial courts, appellate courts, andarbitrations across the country in a variety of high stakes matters,including cases and cessions involving general liability coverage(primary, umbrella, and excess), professional liability coverage,first-party property coverage, bad faith and extra-contractualmatters, fee disputes, and facultative and treaty reinsurancecontracts. Scott has served as national coverage counsel as wellas trial and appellate counsel. His advice has been sought onemerging coverage issues and awide-range of case specific andportfolio issues. He has drafted contract language, trainedinsurance and reinsurance professionals, and assisted companiesin evaluating and resolving issues in the claims stage.

Scott also has handled a variety of challenging international,professional liability, tort and product liability, and business andcommercial cases.

Scott is a frequent speaker on insurance, reinsurance, legal, andlitigation matters. He has presented before and on behalf ofvarious organizations, including: American Bar Association;Defense Research Institute; ARIAS US; Bermuda Bar Association;Strafford; Perrin Conferences; Illinois Institute for Continuing LegalEducation; Illinois State Bar Association; Chicago Bar Association;Lorman Education Services; PLRB/LIRB; and West Legalworks.

Scott is a prolific author, writing on a variety of substantive legalissues as well as on litigation practice matters. His treatise

Education:

Loyola University of Chicago School of Law(J.D., magna cum laude, 1987)

Barat College (B.A. 1984)

Admitted to Practice:

Illinois

United States Supreme Court

United States Courts of Appeals (Seventh,Tenth Circuits)

United States District Courts (NorthernDistrict of Illinois, Central District of Illinois,Northern District of Florida)

Admitted Pro Hac Vice in numerousmatters

Professional Activities:

American Bar Association: Tort Trial &Insurance Practice Section (past ViceChair) and Litigation Section (Co-ChairBusiness Interruption Subcommittee ofInsurance Coverage Committee andmember of the Commercial &BusinessLitigation Committees)

ARIAS US

Defense Research Institute: AlternativeDispute Resolution, Insurance, CommercialLitigation, and International LawCommittees; Climate Change LitigationTask Force member; Business Torts SLG

Claims and Litigation Management Alliance(Co-Chair Reinsurance &Run-Off AdvisoryBoard)

Peer Recognitions/Awards:

Martindale &Hubbell — AV Preeminentrating 5.0 out of 5.0 (highest rating for legalability and ethics) (since 1999)

Best Lawyers in America (insurance law)(since 2009).

Illinois Super Lawyers (insurancecoverage, general litigation, businesslitigation) (since 2005)

Leading Lawyers (commercial litigation,insurance coverage, and reinsurance law)(since 2009)

America's Most Honored Professionals(since 2012)

ICFM Leading Lawyers 500 (top 500lawyers in the world) (since 2013)

Chambers USA ranked (since 2009)

Allocation of Losses in Complex Insurance Claims (3d ThomsonReuters 2014) addresses many of the important issues drivingcontemporary insurance claims and coverage litigation andreinsurance cessions and arbitrations. Scott's writings have beenrecognized by courts, insurers, and commentators as authoritativeworks. His writings have been cited by the highest courts of theStates of Arizona, Illinois, Massachusetts, New Jersey, SouthCarolina, and West Virginia and by numerous other state andfederal appellate and trial courts across the country.

Scott has served as counsel in many high profile insurancecoverage cases, including: Owens-Illinois (asbestos reinsurancecase resulting in a landmark allocation ruling by the New JerseySupreme Court); General Electric (asbestos and environmentalcoverage action resulting in landmark number of occurrencesruling by New York's highest court); Liggett (Delaware SupremeCourt decision enforcing tobacco exclusions); Owens-Corning(products coverage, non-products coverage, and asbestosbankruptcy); Dresser/Halliburton (asbestos and toxic tort coverageand bankruptcy); CBS Viacom (environmental); Griffin Dewatering(reversal of $11 million bad faith/punitive damages verdict); andRushing (construction defect coverage action). He also has beencounsel in significant confidential reinsurance arbitrations.

According to Chambers USA (2014): "Scott Seaman is wellrespected for his longtime experience as a litigator, and he hasnotable expertise in complex insurance and reinsurance coveragecases. He is also an expert in bad faith insurance matters. Sourcesdescribe him as a 'terrific lawyer' and as someone who has therespect of the market."

Scott graduated first in his law school class and served as a lawjournal editor.

Prior to joining the firm, Scott was a member of the nationalproduct liability and insurance coverage practice group atSkadden, Arps, Slate, Meagher &Flom LLP.

American College of Coverage andExtracontractual Counsel (foundingfellow)

International Who's Who of Insurance andReinsurance Lawyers

2012 Lawyers World Leading LawyerAward (North America Insurance andReinsurance)

2013 Lawyers World Leading LawyerAward (North America Insurance andReinsurance)

2013 Corporate INTL Legal AwardsInsurance Law -Lawyer of the Year(Illinois)

Intercontinental Finance MagazineContinent Awards Insurance &Reinsurance Litigator of 2013 —NorthAmerica

2014 Insurance Attorney of the Year inIllinois (Corporate InYI Magazine)

2014 Global Law Expert Practice AwardsInsurance Attorney of the Year in Illinois

CorporateLiveWire's 2014 Lawyer ofthe Year —Litigation USA

Corporate~iveWire's Illinois Lawyerof the Year 2013 —Litigation

Illinois Lawyers Auxiliary Scholarship

Loyola Leadership and Service Award

Chief Justice Roger B. Taney Award

Judge John C. Hayes Award

Thomas L. Owens Award

Judge John V. McCormack Award

Community Activities:

Member, National Board of SelectorsJefferson Awards for Public Service (NobelPrize for public and community service)

Chairman of,the Board, Jefferson AwardsChicago

Co-founder Chicago Blood CancerFoundation

Lymphoma Research Foundation:Inaugural Tribute Award Recipient

Chapter 12

Defense Costs, Attorney's Fees, andLegal Audits

5 12:1 Introduction§ 12:2 Defense costs coverage ai d reimbursement§ 12:3 Reasonable defense costs and legal audits

Key~Cite''~: Gases and other legal materials listed in KeyC%ite Scope can beresearched through the KeyCite service on We5tla~c~N'. Use KeyCite Locheck citations for foizn, parallel references, prior and later history, andcomprehensive ci~utor iilFormation, including• citations to other decisi~~nsanti secondary materials.

§ 12:~ Introduction

Treatment of defense costs is an important considerationin the allaeation analysis. Accordingly, this Chapter consid-ers issues of defense cost coverage. It also provides a briefoverview of some issues that may be considered in thecontext of a review of legal fees.

12:2 Defense costs coverage and reimbursement

[a] Primary Insurers' Duty and Right to DefendPrimary liability contracts generally provide that the

insL~rer has the right and the duty to defend the policyholder.The duty to defend is a contractual obligation. Therefore, ifthe contract does not specifically provide f'or a duty to defend,the insui er will have no duty to defend. See, e.g., SphinxI~ztern.., In,c. v. Natiorxa,l Urazo~z FirE Ins. Co. of Pittsburgh,Pa_., 226 F. Supp. 2d 1326 (M.D. Fla. 2002), af~'"d, 412 F.3d1224, 23 I.E.R. Cas. (BNA) 70, 14 A.L.R.6th 871 (11th Cir.2005) (applying Florida law) (holding there is no duty todefend in the absence of an express contract~.ral duty); Lowyv. Travelers Pr•oper~ty & Cas. Co., 20Q0 WL 526702 tS.D. N.Y.2000) (applying New York law) (unpublished opinion) ("inthe absence of a policy ~arovision expressly imposing a deity

397

12i:~. ALLOCATION IN COMPLEX INSURANCE CL.ATIVI5

to defend, New York courts will not find such a duty"); NationalUnion Fire Ins. Co. of Pittsburgh, Pu. u. Ambassador Group,Inc., 157 A.D.2d 293, 556 N.Y.S.2d 549 (1st Dept 1990);Zurich Iris. Co. v. Ra~~mariz Indicstries, Inc., 118 Ill. 2d 23,112 Ill. Dec. 684, 514 N.E,2d 150 (1987).Most courts hold that a primary liability insurer-absent

express policy language to the contrary-must defend its~~olicyholder against a suit or action that states multipleclaims, allegations, or bases for recovery, even if only one ofthose claims or bases is potentially covered under thecontract. See Tran.scon.tznen,tal Ins. Co. v. Insurance Co. ofState of Pennsylvania., 14$ Cal. App. nth 1296, 1303, 56 Cal.Rptr. 3d 491 (4th Dist. 2007); Sachs v. Ar~zerican FamilyMu.t. Iras. Co., 251 P.3d 543, 546 (Colo. App. 2010); Categor3~5 Management Group, LLC v. Companion. Property and Cas.Ilas. Co., 76 So. 3d 20, 23 {Fla. 1st DCA 2011), review denied,97 So. 3d $22 (Fla. 2012); Valley Forge Ins. Co. v. SwiderskzElectro~zics, I~~.c., 223 Ill. 2d 352, 8Q7 III. Dec. 653, 860 N.E.2d307, 314-15 (2006); Aetna Cas. & Szcr~. G'o. v. Continental,Ca.s. Co., 413 Mass. 730, 604 N.E.2d 30, 32, 79 Ed. Law Ptie~~.210 (1992); Amc~ricun Bumper a,nd Mfg. Co. v. Hartford FireIns. Co., 452 Mich. 440, 550 N.W.2d 475, 481(1996); Remodel-ing Dimensr.ons, Inc. v. Integrity Mut. Ins. C,a., 819 N.W.2d602, 616 (Minn, 2012); Town of Mc~.ssena u. HealthcareUnderwriters Mrct. Iras. Co., 98 N.Y.2d 435, 749 N.Y.S.2d456, 779 N.E.2d 167, 172 (2002); City of Sharonville v. Am.Employers Ins. C,o., 109 Ohio St. 3d 186, 2006-Ohio-2180,846 N.E.2d 833, 837 (2006); Zur~i.ch America.~z In.s. Co. v.No1~ia, Inc., 268 S.W.3d 487, 491 {Tex. 2008); Lambe RealtyInv., Inc. v. Allstate Iris. Co., 137 N.C. App. 1, 527 S.E.2d328, 331 (2000); Sc7ztcltze v. Continental Ins. Co., 2000 ND209, 619 N.W.2d 510, 513 (N.D. 2000); Utica Mut. Ins. Co. u.Mi.dler, 1~0 Md. App. 373, 746 A.2d ~J35, 940 (2000); Reinsatr-ar7ce Assn of Minnesota v. Timmer, 641 N.W.2d 302, 307(Minn. Ct. App. 2002); Gregory v. Tennessee Gus Pi~eli.neCu., 948 F.2d 203, 205 (5th Cir. 1991); Western Cas. &Sur.Co. v. 7nternati.onal Spas of Arizona, In.c., 130 Ariz. 76, 634P.2d 3, 6-7 (Ct. App. Div. 1 1981); Horace Munn Ins. Co. v.Peters, 94$ P.2d 8Q, 84, 122 Ed. Law Rep. 813 (Coln. App.1997); Imperial Cas. a~ad I~zdem. Co. z~. State, 246 Conn. 313,714 A.2c~ 1230, 1236 (1998); Continental Cas. Co. a. Alexis I.rZ~cPant Sc7iool Dr,'st., 317 A.2d 101, 103-04 (Del. 1974); Finleyv. Home Ins. C,o., 90 Haw. 25, 975 P.2d 1145, 1150-51 (1998);

398

DF.,FENSE COSTS AND LEGAL AUDITS ~ 1 ~L:~L

First Newton Nat. Barth v. General Cas. Co. of Wisconsin,426 N.W.2d 618, 623 (Iowa 1988).The various rationale offered in support of this general

rule include: the broad language included in the policyregarding the duty to defend; the absence of a reasonablemeans for allocating defense costs between covered and non-covered claims; separate representation for covered and YZon-cavered claims uiay not be reasonable or might produceduplicative and inconsistent rasults; end the failure toprovide a complete defense would violate the policyholder's"reasonable expectations" that the insurer will defend theentire suit. See, generally Windt, Insurance Claims andDisputes: Representation of Insurance Compa~iies andInsureds S 4.13 (1990).However, even in the majority of jurisdictions that require

an insurer to defend the entire action, consideration shouldbe given to whether the language of the policy at issue dif-fers materially from the language in policies involved in de-cisions upon which a jurisdiction's pronouncemexits regard-ing the scope of the duty to defend and recoupment havebee~1 rendered. Many decisions in ruling an the scope of theduty to defend rely upon language ~~roviding that "thecompany shall have the right and duty to defend any suitagainst the insured seeking damages on account of suchbodily injLrry or property darilage, even. if the allcigations offloe suit are groz~ndless, false, or fraudulent ." InNovember 19$5, the italicized laligu~ge was removed fromthe ISO Commercial General Liability Form. The May 1992ISO Commercial General Liability Form, for example,pro~~ides: "we will hive no duty to defend tl~e insured againstany ̀suit' seeking damages for ̀ bodily injury' or ̀ propertydamage' to which this insurance does not apply." The differ-ence in language may not alter the result where a court isreluctant to depart from precedeYit or insofar as the prece-dent is deemed to have a ~~ublic policy component. Nonethe-less, parties should at least consider t}Ze impact of differ-ences in policy language when evaluating the duty to defend.Also keep in mind that a distinct minority of courts haveheld that an insurer may be required to defend only thosecauses of t~ction that are covered by the policy. See, e.b~.,Farmland Mut. Ins. Co. v. Scruggs, 886 So. 2d 714, 719(Miss. 2004).Where an insurer leas both a right and a duty to defend,

1L:2 ALLOCATION IN COMPLEX INSURANCE CLAIMS

the .insurer typically has a right to control the policyholder'sdefense in suits for which the contract potentially providescoverage. The insureY•'s right to control the policyholder'sdefense includes the rigl~t to select defense counsel and toYnake strategic decisions concerning the defense of the suit~~endin~ against the policyholder. See, e.g., Rx.com Inc. v.Hartford Fire Ins. Ca., 426 F. Supp. 2d 546, 559 (S.D. Tex.200G) (applying Texas law) (stating "an insurer's ̀ right todefend' a lawsuit encompasses ̀the a~ithority to select the at-torney who will defend that claim and to make other deci-sions that would Yiormally be vested in the insured as thenamed ~~arty iri the case"); Carolina Cc~s. Ins. Co. v. Bolli~a~,Walter & Gawtha-op, 2Q05 WL 1367096 ~7 (E.D. Cal. 2005)(unpublished opinion) (applying California law) (recognizing"the right and duty to defend affords an insurer the right tocontrol the defense... [andl the right to control the defensegenerally includes the right to select defense counsel"); WellsDairy, Inc. v. Travelers In.d~rn. Co, of Illinni.s, 266 F. Supp.2d 964, 967 (N.D. Iowa 2003) (applying Iowa law) (r~.~lingthat "[wlhe7l an insurer defends an insured, it has controlover the defense and over settlement"); ~iven,s v. Mullikin exrel. Estate of McElwaraey, 75 S.W.3d 3$3, 395 (Tenn. 2002)(noting the ilisurance contract "typically reserves for theinsurer the right to select defense counsel, to guide the liti-gation of the claim, [and] to control decisions regardingsettlement of the claim"); Allied American Ins. Co. v. Ayala,247 Ill. App. 3d 538, 186 Ill. Dec. 717, 616 N.E.2d 1349 {2dDist. 1993); Golden Ea.~le Tns. Co. v. Foremost Ins. Co., 20C~1. App. 4t1~ 1372, 25 Cal. Rptr. 2d 242 (2d Dist. 1993}, asmodified on denial of reh'g, (Jars. 7, 1994). Allowing theinsurer to control the defense of the policyholder protects theinsux•er's financial interests and minimizes unwaz•rantedliability. Arneri.cc~n I+'crmi-ly Mt~t. Ins. C,o. v. t~ H. McNaughton.Builders, In.c., 363 Ill. App. 3d 505, 3U0 Ill. Dec. 234, 843N.E.2d 492 (2d Dist. 2006), appeal denied, 219 Ill. 2d X61,303 Ill. Dec. 831, 852 N.E.2d 238 (206).As discussed in more detail below, where the interests of

the insurer anc~ the policyholder conflict in conzlection withthe defense of a suit, however, courts frequently transformtl~e insurer's right alid duty to defend into an obligation topay defense costs. See, e.~., Marylan.d Cas. Co. v. Peppers, 64Ill. 2d 187, 355 N.E.2d 24 (1976). In such conflict situations,the insurer frequently loses its right to select counsel and to

400

ll~FENSF COS"['S AND LEGAI. AUDITS ,~' 12i:2i

control the policyholder's defense, but retains the obligationto pay the policyholder's selected counsel's reasonable at-torneys' fees. 355 N.E.2d 24; Rx.cona Inc. v. Hartford FireIns. Co., 426 F. Supp. 2d 546 (S.D. Tex. 2006) (applyingTexas law) (finding the p~~esence of a conflict of interestresults in the policyholder being allowed to pick co~.rnsel ofhe~~ own choice at the expense of the insurer); Tr-uvelc~r•sIndem. Co. of Illinois v. Royal Oah Enterprises, Inc., 344 F.Stipp. 2d 1358, 1372 (M.D. Fla. 2004}, aft"ci, 171 Fed. Appx.831 (11th Cir. 2006) (a~~plyin~ I'loricla law) (recognizing asufficient conflict of interest warrants the "iiZsured's reten-tion of its own counsel at the expense of the insurer");Hart fordCus. Ins. Co. v. A & M Associates, Ltd., 200 F. Sapp. 2d 84,90 (D.Fi..I. 2p02) {a~~plying Massachusetts law) (holding that"in these situations of divergent iY~terest... the insured isentitled to control the defense and to secure independentcounsel with reasonable costs [sic] paid by the insurer");Public Service Mut. Ins. Co. v. Goldfarb, 53 N.Y2d 392, 442N.Y.S.2d 422, 425 N,E.2d 810 (1981); Michigan Millers Mzet..Ins. Co. v. Bronson Plating Co., 197 Mich. Ap~~. 482, 496N.W.2d 373 11992), (overruled on other grounds Wzlkie ~.Auto-Owners Ins. Co., 469 Mich. 41, 664 N.W.2d 776 (20Q3).

In the absence of such conflict of interest, generally theinsurer retains the right to select counsel and the policy-halder may retain its own counsel, lout only by paying forsuch counsel. See Train City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co. of'S.C., 433 F.3d 365 (4th Cir. 2005)(holdrng, where nv conflict of interest exists and thepolicyholder does not consent to the couYisel chosen by theinsurer, the policyholder can employ another counsel at itsown cost).A conflict of interest analysis initially depends upon who

is considered to be the client of the insurer-selected counsel.Courts have adopted two divergent approaches regardingwho is the client of the insurer-selected defense counsel.Under ,the one-clsent theory, the defense counsel appointedby the insurer represents only the policyholder. See Metra-pvlitan Life Ins. C,a. v. Aetna Cas.& Su.r. Co., 249 Conn. 36,62, 730 A.2d 51, 65 (1999) (recognizing that, "when aninsr.~rer retains a1i attorney in order to defend a suit againstan insured, the attorney's only allegiance is to the client, theinsured"}; State Farm Fire & Cas. Co. v. Mabry, 255 Va. 286,291, 497 S.E.2d 844, 847 (1998) (finding that "attorney

401

1 ̀L:`L ALLOCATION IN COMPLEX INSURANCE CLAIMS

employed by the insurer to defend tlse insured... ̀ owes theinsured the same duty as if he were privately retained bythe insured"'); Fir2lczy v. Homcz Ins. C,o., 90 Haw. 25, 975 P.2d1145, 112 (1998) (noting that the Hawaii Rules of Profes-sional Condi.~ct dictate that "retained counsel solely repre-sents the insured when a conflict arises between the interestof the ilisurer and the insured").Based upon this attorney-client relationship between the

defense counsel acid the policyholder, the defense counselhired by the insurer awes a duty of loyalty to the ~~olicyholderand represents only the interests of the policyholder. See,e.g., Pine Island Far~tner,s Coop v. Erstad & Rierner; P.A., G49N.W.2d 444, 449 (Minn. 2p02) (holding defense counsel hiredby an insurer to defend a claim against its policyholder "owesa dLYty of undivided loyalty to the insured and m~.rst faith-fully represent the insured's interests"); In. r~e Rules of Profes-szona.l Conduct. and Insurer Imposed Billing Rules andProcedures, 2000 MT 110, 299 Mont. 321, 333, 2 P.3d $06,814 (2000) (holding the "ins~.rred is the sole client of defensecounsel"). A coYiflict analysis does not came into play underthe one-client theory,A conflict of interest analysis with respect to the right to

independent co~.xr~sel may come ilito play, however, inju~•isdictions adhering to the "tri~]artite" relationship theory,In jurisdictions adhering to the two-client theory or the"tri~~artite" relationship, defense counsel is considered to beinvolved in a dual representation of both the policyholderand the insurer. See Arrrtstrong Cleaners, Inc. v. Erie I~zs.Exchange, 364 F. Supp. 2d 797, $06 (S.D. Ind. 2005)(recognizing that the defense counsel selected by the insu~•errepresents the interests of both the policyholder and theinsurer); McCorcrt Co., Inc, v. FPC Properties, I~zc., 386 Mass.145, 434 N.E.2d 1234 (19$2) (noting that defense counsel "isattorney for the insured ~s well as the insurer"); Liebermanv..~mpl~yers Ins. of t~ccicsau, 84 N.J. 325, 338, 419 A.2d 417,424 (19$0) (concluding that "`[i]nsurance defense counselroutinely and necessarily represent two clients: the insurerand the insured"'); Ccyntral. Cab Co. v. Clar•I~e, 259 Md. 542,270 A.2d 662 (1970) (recognizing that counsel chosen by theinsurer represents the policyholder as well as tlis insurer}.Based upon this dual representation, the defense counselowes a dLrty of loyalty to the policyholder ar~d to the insurer.See Gulf Ins. Co. v. Ber•g'er~, Kahn, Shafton, Moss, Figler,

402

DI~:FENSE COSTS AND LEC>'AL AUDITS ~ 1L:`L

Simon &Gladstone, 79 Cal. App. 4th 114, 93 Cal. Rptr. 2d534 (2d Dist. 2000), as modified, (Mar. 17, 2000) (holding theattorney hired by the insurance company to defend an actionagainst the policyholder owes fiduciary duties to thepolicyholder acid to the insurer); Hartford Acc. & In.a'em.. Co.v. Foster, 528 So. 2d 255 (Miss. 1988) (stating "it is the at-torney's ethical obligation to have undiluted loyalty to bothclients"); Naradorf, Inc. v. CNA Ins. Cos., 134 Ill. App. 3d134, 88 Ill. Dec. 968, 479 N.E2d 988 (lst Dist. 1985) (liold-in~ "attorney hired by the insurance company to defend inan action against the insured owed fiduciary duties to twoclients: the insurer and the insured"). Unlike the one-clienttheory, courts that have adopted the two-cliexit theory havefound that the defense counsel's dual duties to both thepolicyholder and insurer may create conflicts of interestunder certain circumstances where the defense is beingprovided slrbject to a reservation of rights.The finding of a conflict of interest sometimes is based on

the perceived risk that the defense attorney's representationof the policyholder somehow will be impaired by his relation-ship with the insurer. The court in Tr•c~velers Indem. Cv. ofIllinois v. Royal Oak Enterprises, Inc., 344 F. Supp. 2d 1358(M.D. Fla. 2004), aff'd, 171 Fed. Appx. 831 (lltlz Cir. 2006)(a~~plying Florida law) explained what is purported to be thepotential problems arising from the insurer's defense undera reservation of rights:

[t]hese courts generally hold that the conflict ofinterest inher-ent in an insurer's defense of a complaint against its insuredcontaining both covered and non-covered claims divides theloyalty of counsel selected and paid by the insurer and createsan unaccept~rble danger that, as counsel for the. insured, i1e~~ould somehow, consciously or unconsciously, skew hisdefense efforts to favor the insurer.

The analysis employed to determine whether a conflict ofinterest exists that would warrant shifting control of counselfrom the insurer to the ~olicyllolder varies by jurisdiction.Many courts haid that the insurer's issuance of a reservationof ri~;lzts letter on its face does not peg- se create a conflict ofinterest that would allow the ~~olicyholder to pick defensecounsel at the ins~.Yrer's expense. See, e.g., Armstrong Clean-ers, In.c. v. Erie Iris. ~xclaange, 364 F. Sapp. 2d 797 (S.D.Ind. 2405) (applying Indiana law) (rejectinb adoption of theper se r~.ile advanced by the policyholder); HK Systems, fnc.

403

S 1`~it`1r ElI.I.00ATION IN COMPLEX INSURAN~JE ~'iLAIMS

v. Admiral Ins. Co., No. 03 C 0795, 2005 WL 1563340, ~~8(E.D. Wis. June 27, 2005) (unpublished opinion) (applyingWisconsin law) (finding the mere reservation of rights doesnot create a conflict automatically); Twin City Fi~~e Ins. Co.v. Ben A~•nal,~?-Sunbelt Bc~aerage Co. of S.C., 433 F.3d 365,327 (4th Cir. 2Q05) (applying South Carolina law) (rejectingthe notion that "reservation of rights letter... creates a peg•se conflict that must be remedied through the insured select-ing counsel and having the insurance companies pay thelegal fees"); ?'rinity Universal Ins. Co. v. Stevens ForestryService, Irac., 335 F.3d 353 (5th Cir. 2003) (applying Louisi-ana law); Jar~aes 3 Corp. a. Truck Ins. Exchange, 91 Cal.App. 4th 1093, 111 Cal. Rptr. 2d 181 (6tli Dist. 2001), asmodified (Aug. 23, 2001} (holding that the Ynere issuance of a.reservation of rights does not entitle the policyholder toselect counsel for its defense); Central Michigan Bd. of Trust-ees v. Employers Rein.suran.ce C.vrp., 117 F. Supp. 2d 627,148 ~d. Law Rep. 271 (E.D. Mich. 2000) (a~~plying Michiganlaw); Grtlf Ins. Co. v. Berger, Kahn, Shafton, Moss, Figler,Simon. &Gladstone, 79 Cal. Asap. 4th 114, 130, 93 Cal..R~~tr.`Ld 534, 545 (2d Dist. 2000), as modified, (Mar. 17, 2000)(holding "not every reservation of rights creates a conflict ofinterest").A minority of courts, however, have found that the

insurer's issuance of a reservation of rights establishes aconflict of interest for purposes of permitting a policyholderto selact counsel. See Herbert A. Sullivan, Inc. v. ITtica Mut.Ins. Ca., 439 Mass. 387, 406-7, 788 N.E.2d 522, 539 (2003)(finding "when an insurer seeks to defend its insured undera reservation of rights, ...the insured Ynay require theinsurer to either relinquish its reservation of rights orrelinquish its defeYise of the ins~rred and reimbLrrse theinsured for its defense costs"); Moeller v. Arnerica.n Guar.a,nc~ Liability Ins. Co., 707 Sa. 2d 1062, 1069 (Miss. 1996), ascorrectecl, (Sept. 19, 1996) (stating "when defending under areservation of rights... not only m~xst the insured be giveYithe opportunity to select his own counsel to defend the claim,the carrier Yizust also pay the legal fees reasonably incurredirl the defense").Courts that have not adopted the per se rule, generally

hold that a conflict of interest must be actual and notpotential in order for tale policyholder to gain the right to~~ick andlor control the defense counsel. See, e.g., Clar•endan

404

D~FF.NS~ COSTS AND LEGAL AUUITS~~ 1 ~L:`L

Nc~t. Irts. Co. v. Iras. Co. of the West, 442 F. Supp. 2d 914(E.D. Cal. 2006) (un~~ublislled opinion) (applying Californialaw) (h.alding "the conflict must be actual aild si;nificant, notmerely potential and theoreticaP'); Twirz City Fire Ins. Co. v.Ben Ar-~aold-Sunbelt Bciverage Ca af' S.C., 433 F.3d 365 (4th.Cir. 2005) (applying South Carolina law); Williams U. Ameri-can Cvic~xtry Ins. Co., 359 Ill. App. 3d 128, 14Q, 295 Ill. Dec.765, 833 N.E.2d 971, 9$1 (1st Dist. 2005}, appeal denied, 217Ill. 2d 595, 300 Ill. Dec. 376, 844 N.E.2cl 48 (2005) (findingan "actual conflict of interest existed" that allowed thepolicyholder to assume cor~tiol over its defense); HK Systems,Inc. v. Admiral Ins. Co., Nn. 03 C 0795, 2005 Vt~L 1563340,'"9 (E.D, Wis. June 27, 2005) (unpublished opinion) (applyingWisconsin law) (recognizing that a "real conflict of interestused on opposing defelzses of insured and insurer requiresthe insurer to give up control" of defense); Travelers Irtdem.Co. of'Zllr_nois v. Royal Oak E~atc}rpriscrs, Inc., 344 F. Supp. 2d1358, 1374 (M.D. Fla. 2004), affil, 171 Fed. Apex. 831 (11thCir. 20UG) (applying Florida law) (holding the insuier wasnot required to relinquish control of the defense where "thei eexistCed] the potential for insurer-selected couxlsei to becomeimpermissibly conflicted in its representation"); GLLIf I7LS. CO.v. Berger, Kahrz, Shaftora, Moss, Figler, Simvn c4i Gla.dston.e,79 Cal. App. 4th 114, 130, 93 Cal. Rptr, 2d 534, 545 (2d Dist.2000), as modified, (Mar. 17, 2000) (noting "the conflict iilustbe significant, not merely theoretical, actual, not merelypotential").Courts have employed dif~'erent tests in determining

whether an actual conflict exists. For example, some courtsconclude that an actual conflict of interest exists only wherethe facts at issue in the underlying litigation are identical totl~e facts shaping the insurer's coverage determination. See,e.g., Clarendon Nat. Ins. Co. v. Ifas. Co. of the West, 442 F.Supp. 2d 914 (E.D. Cal. 2006) (unpublished opinion) (apply-ing California law) (recognizirl~ policyholder does not havethe right to select counsel "where the [coverage) issue is in-dependent of and extrinsic to the issues in the underlyingaction"); Rx.com Inc. u. Hartford Fig~e In.s. Cv., 426 F. S~~pp.2d 546 (S.D. Tex. 2Q~6) (a~~plying Texas law) (holding aconflict of interest did not exist because the policyholder didnot show that "the facts to be decided in the underlyinglawsuit [were] the same facts that would defeat coverage");Ston.eridge I~ev. G"o. v. Essex Iran. Co., 3$2 I11. App. 3d 731,

4OJ

1 ̀1,,:~I, ALLOCATION IN COMPLEX INSUIi,ANCE CLAIMS

742, 888 N.E.2d 633, 645 (2d Dist. 2008) (a conflict existswhere "it appears that factual issues wi11 be resolved in theunderlying suit that allow il~surer-retained counsel to ̀ layt11e groundwork' for a later denial of coverage); AmericanFamily Mut. Ins. Co. v. W.H. McNazcghton Buildcyr•s, Inc.,363 Ill. App. 3(~ JOJ~ 511, 3Q0 Ill. Dec. 234, 843 N.E.2d 492,498 (2d Dist. 2006), appeal denied, 219 Ill. 2d 561, 303 Ill.Dec. 831, 852 N.E.2d 238 (2006} (finding that "if, in theunderlying s~.tit, iYzsurer-retained counsel would lZave the op-portunity to shift facts in a way that takes the case outsidethe scope of the policy coverage, then the insured is riotrequired to defend the underlying suit with insurer-retainedcounsel"); Arm.str~ong Clc~aner•s, Inc. v. Er~r.e Ins. Exchar2ge,364 F. Su~~p. 2d 797 (S.D. Ind. 2005) tap~~lyirig Indiana law)(exarniYiing the "undisputed facts concerning the coverage is-sues (the insurer] has raised and their relationship to thelikely course of the underlying litigation"); Northern Cau.ratyMut. Ins. Co. u. Da.ua.los, 140 S.W.3d 6S<5, 689 (Tex. 2004)(ruling that "when the facts to be adjudicated in the liabilitylawsuit are the same facts upon which coverage depends,the conflict of interest will prevent the insurer from conduct-ing the defense"); Jcrmes 3 Corp. v. Trtcclz Ins. Exclaang~e, 91Cpl. App. 4th 1093, 1102, 111 Cal. Rptr. 2d 181, 187 (6tlzDist. 2001), as modified, (Aug. 23, 2001} (holding• thepolicyholder has no right to choose defense couxisel "wherethe coverage iss~.ie is independent of, or extrinsic to, the is-sues in the underlying action ox' where the damages are or11ypai tially covered by the policy").Other courts regLiire the presentation o£ evidence that the

defense counsel's actions put the inte~•ests of the insurerover the policyholder in order for a conflict to exist. See Travel.-ers Indem.. Co. of Illinois v. Royal Oafv Enterprises, Inc., 344F. Supp. 2d 1358, 1374 (M.D. Fla. 2004), aft°d, 171 Fed. Appx.831 (11th Cir. 200G) (applying Florida law) (holding "theremust be some evidence to suggest that the conflict betweenthe insurer and the insured actually affected counsel's repre-sentation so that it may be said that cauilsel's actionselevated the interests of the insurer over those of his client,the insured"); C.H. Robinson C,o. v. Zzcr-r.ch. American. In,s.Co., 2004 WL 2538468 ~5 (D. Minn. 2Q04) (unpublishedopinion) (applying Minnesota law) (requiring "substantialevidence that actual conflict exists, such as actions that dem-onstrate agreater concern for the insurer's interest than theinsured's interests").

406

OFFENSE COSTS AND LEGAL AUI7STS ~ ~.~L:`Zi

Examples of situations in which courts have found aconflict of interest to exist for purposes of giving thepolicyholder the right to select counsel include the following;(1) the insurer reserves the right to deny coverage basedupon a breach of contract exclusion and the underlying liti-gation raises claims for breach of contract and negligence(HK Systems, Inc. v. Admiral Ins. Co., No. 03 C 0795, 2005WL 15G3340 (E.D. Wis. June 27, 2005) (un~7ublished a~7inion)(applying Florida law)); (2) the same defense counselrepresents two policyholders with diametrically apposedinterests in defending the underlying s~.iit (Wr.11iams v.American Country Iras. Co., 359 Ill. App. 3d 128, 295 Ill. Dec.765, 833 N.E.2d 971 (1st Dist. 2005), appeal denied, 217 Ill.2d 595, 300 Ill. Dec. 376, $44 N.E.2d 48 (2005)); t3) thereservation of nights letter ideistified possible defenses far"expected and intended" exclusion and "occurrence" regtiire-ment where allocation of damages among defendants inunderlying pallutian litigation was determined by the intentof the polluting pax•ties (Armstrong Cleaners, In,c. v. Erzc~ Ins.Exchange, 364 F. Supp. 2d 797 (S.D. Ind. 2005) (a~3plying In-diana law)); (4) the insurer reserved its rights to deny cover-age for damages taking place outside the contract period andthe action involved the issue of when damages took place(American Family Mu.t. Ins. Co. v. W.H. McNa.ug~hton Build-ers, Inc., 363 Ill. App. 3d 505, 300 Ill. Dec. 234, 843 N.E.2d492 (2d Dist. 2006), appeal denied, 219 Ill. 2d 561, 303 Ill.Dec. 831, 852 N.E.2d 238 (2006)); (5) the insurer pursuedsettlement in excess of contract limits without the policyhold-er's consent and left the policyholder exposed to claims bythird parties (Golden Eugle Ins. C,a. v. Fare~nvst Ins. Ca., 20Cal. Akap. 4th 1372, 25 Cal. Rptr. 2d 242 (2d Dist. 1993), asmodified nn denial of reh'g, (Jett. 7, 1~J94)); (6) the insurerprovided insurance coverage to both the plaintiff anddefendant (O'1Vlorrow v. Bora.d, 27 Cal. 2d 794, 167 P.2d 483,163 A.L.R. 894 {1946)); (7) the underlying complaint allegedinjuries based upon the policyholder's alleged intentionalconduct that, if proved, would not be covered by the insur-ance contract (Maryland Ca,s. Co. v. Peppers, 64 Ill. 2d 187,355 N.E.2d 24 (1976)); (8) the resei~vation of rights letter is-sued by the insurer disclaimed coverage for punitive damagerelief raised in the underlying litigation (Nandorf, Inc. v.CNA Ins. Cos., 134 I11. App. 3d 134, $8 Ill. Dec. 9G8, 479N.E.2d 9$$ (1st Dist. 1985)).

407

1LI~L AT~LOCATION IN COMPLPX INSURANCIE CLAIMS

Situations in which courts have found a conflict of interestdoes nat exist inchxde the following: (1) the underlying litiga-tion raised claims against the policyholder that fell withinthe ~~ersonal injury and advertising injury coverage part ofthe insurance contract and the insurer issued a reservationof rights letter emphasizing certain limiting words in the"personal injury" definition (Rx.cvm Inc. v. Hartford Fire Ins.Co., 426 F. Sup~~. 2d 546, 559 (S.D. Tex. 2006) (applyingTexas law)); {2) the policyholder disagreed with the insurer-appointed counsel as to the strategically appropriate venuefor the underlying action (Northern CorLnty Mrct. Ins. Co. v.Davalos, 140 S.W.3d 6$5 (Tex. 2004)); (3) the insurer'sreservation of rights relating to plrnitive damages becamemoot once the insurer offered its contract limits towards asettlement (C.K Robinson Co. u. Zurich American Ins. Co.,2004 WL 2538468 (D. Minn. 2Q04) (applying Minnesota law){unpublished opinion)); (4) the insure~~-selected counselrefused to pursue an affirriiative defense that was requestedby the policyholder (James 3 Corp, v. Truclz Ins. Exchan.~e,91 Cal. App. 4th 1093, 111 Cal. R~~tr. 2d 181 (6th Dist. 2001),as iiladified, (Aug. 23, 2001)); (5) the insurer reserved itsrights to allocate defense casts between covered and non-covered claims (Jcxanes 3 Cor p. v. Truc1~ Ins. Exch.an.ge, 91Cal. Apia. 4th 1093, 111 Cal. R~atr. 2d 181 (6th Dist. 2001),as i7iodified, (Aug. 23, 2001)); (6) the reservation of x•ibhtsletter cited to the absolute ~]ollution exclusion where it wasundisputed in the underlying litigatipn that the petrole~.xmproducts in the policyholder's ruptured pipeline caused thepollution injury and the underlying litigation disp~.rte wasover the cause of the ruptured pipeline (Driggs Corp. v.Peransyluania Mfrs. Assn Ins. Ca., 181 F.3d 87 (4th Cir. 1999)(applying Maryland law) (u~rZpt~blished opinion)).Snme courts recognize that reserving rights to recover

defense costs of non-covered claims may create a conflict ofinterest reasoning that, by reserving rights, the insurerprotects itself against claims for breach of a duty to defendand against waiver and estoppel while also imposing a condi-tion an its defense that was not ba~•gained for, Scie, e.g.,Mor~rone v. Harleysville Mact. Ins. Co., 283 N.J. Super. 411,G62 A.2d 562, 567 (App. Div. 1995) ("the existence of bathcovered and non-covered claims also present a potentialconflict between an insured and iissurer vis-a-vis c~ef'ensestrategy"), citing Bicrd v. Sussex Mut.. Ins. Cn., 56 N.J. 3$3,

408

DEFENSE COSTS AND LFCAL AUDITS ~ 1~I,:~.,

267 A.2d 7 (1970); National Sur. Cori. v. Immzcnex Copp.,176 Wash. 2d 872, 297 P.3d 688, 694 (2013) (hplding aninsurer may not seek to recover defense costs under areservation of rights while the insurer's duty to defend isuncertain). Other coux•ts recognize that an insurer's reserva-tion of its rights to seek reimbursement of defense costs farnon-covered claims does riot create a conflict of interest thatentitled the Policyholder to independent counsel. DynamicConcepts, In.c. v. Tr-uck Ins. Exchange, 61 Cal. App. 4th 999,1000, 71 Cal. Rptr. 2d 8~2 (4th Dist. 1998), as modified,(Mar. 27, 1998); James 3 Co~~. v. Truck Ins. Excha,ngc}, 91Cal. App. 4th 1093, 111 Cal. R~~tr. 2d 181 (6th Dist. 2001),as zlloclified, (Aug. 23, 2001) {reservatiorZ of rights to peekreimbursement of defense costs does not create per se conflictof interest that entitles insured to independent co~rnsel).

An insurer is well-served to consider the impact of areservation of rights not only in terms of avoiding estoppelor waiver of a right or defense, but also in terms of whetherits reseY~~ation places its right to control the defense at risk.In many instances the right to cont~ 01 the defense, drive ef-fective case resolution, and contain costs may be snoreimportant and more achievable than effectuating recoup-ment of a ineaningf'ul amount of defense costs.

It is important to keep in mind that, even were a palicy-holder is entitled to independent counsel, the policyholder islzot always allowed to make the selection. In some st~te~, aninsu~•er is entitled to make the selection, but must selecttruly independent counsel and ii1 other states selection mustbe by mutual agreement.

PriYilary contracts often provide that defense costs are"supplementary" payments that clo not Y•educe the cont~•act'slimits of insLirance. A typical supplemeYitary payments pro-visio77 provides:

SLJPPLEMEIV'PARY PAYMENTS-~.iOVP:ItAGEB A AN77 B

We will pay, with respect to any claim or "suit" we defend:1. All expenses we ii~ct~r.

2. A11 reasonable expenses incurred by the insured at ourrequest to assist us in the investigation or defense of theclaim or "suit," including actual loss of earnings up to$100 per day because of time ofd' i'ro7n work.

409

1 ̀L:L ALLOCATION IN COMPLEX INSURANCE CLAIMS

3. All casts taxed against the insured in the "suit.":~ ~:

These payments will not reduce the limits of insurance.

Some primary contracts specifically provide that defensecost payments reduce the contract's limits of insurance.These contracts often are called "wasting limits" or "exhaust-ing" contracts. Scie Pellett v. Thomas W. Car•larad, Inc., 152S.W.2d 172 (Mo. 1941). For a more detailed analysis of theduty to defend, see genes-ally Meckler Bulger Tilson Marick& Pearson Insurance Law Services, Vol. I, Dzcty tv Defend: AFifty-State Sz~r•vey (April 2d Ed. 2013) (addressiYig the stan-dard for determining the duty to defend, when evideYiceextrinsic to the complaint can be considered, selection ofcounsel, consequences for breach of the duty to defend,recoupment, and other issues).

[b] Right to Reimbursement of Defense Costs

In view of the broad scope of the duty to defend and thepotential adverse consequences for breach of that duty, pri-n~ary insurers often resolve doubts in favor of providing adefense under a reservation of rights, anon-waiver a~ree-ment, and/or by filing an action seeking a declaration that ithas no duty to defend or indemnify the policyholder in con-rlection with the subject claim. IYisl~rers sometimes seek torecover defense costs associated with those claims that arenot potentially covered. This is true where the insu~•erdefends an action that it claims is not covered in its entiretyor «rliere it defends an action involving "mixed claims."

Mixed claims are suits in ~~vhich one or more of the claims{ar some damages or relief sought) against the policyholderare covex•ed aYid one or more of the claims or some elementsof relief are not covered. See, e.g., Buss t~. Superior Court, 16Cal. 4tli 35, 48, 65 Cal. Rptr. 2d 366, 939 P2d 7GG (1997) (amixed claim is one involving bath claims that are potentiallycovered and claims that are not even potentially covered);Texas Assn of Counties County Government Ris1~ Manage-ment Pvol v. Matugor~r~a Cvrcnty, 52 S.W.3d 128, 136 (Tex.2000) (ir1 a mixed action, "some of the claims (are] coveredby the insured's policy axzd some dare] not"); St. Paicl Fireand Marine In.s. Co. v. Compaq Computer Coip., 377 F. Supp.2d 719, 723 (D. A2inn. 2005), aft"d, 457 F.3d 766 (8th Cir.2006) (8th Cir. 2006 (a mixed action is "one which ii~clude[s]

410

DEFENSE COS CS AND LEGAL AUDITS ~ 1~:`Zi

both covered and norl-covered claims"). Mixed claims canarise in a variety of ways, including: some (but not all) claimsfall under an exclusion; both negligent and intentional actsare alleged; potentially covered and non-covered damages orinjuries take place partially within and partially outside ofthe policy period or the coverage territory; or multiplepl~intif~'s or class members are involved and same allegenon-covered injury ar damages.Recoupment, like a pro rata allocation, may help ef~ectu-

ate fairness ar at least ameliorate some unfairness or unjustenrichnlelit. However, recoupment involves reimbursementfor indemnity dollars ~~aid by the insurer on claims notcovered or in defense of claims not even potentially coveredby the i7zsurance contract. Also, in contrast to aproper al-location done at the front end, recoupment is effectuated ~f=ter the insurei has not only honored its obligations to thepolicyholder, but also has advanced benefits to whicls thepolicyholder is not entitled under the insurance contract.Whether driven by altr~.~istic Yiiotives or, much more com-monly, to operate within the framework of the law and toavoid the potential risks associated with a subsequent find-ing of a breach of its obligations, the insurer has done morethan it is required to do and the policyholder has receivedmore than it is entitled to receive.Fundamentally, recoupment is not a Yllatter of contract. It

is a matter of quasi contract, implied contiact—unjustenrichment to the policyholder or unjust impoverishment ofthe insurer. Far this reason, courts that deny insurers theright to recoup in the mixed claims context entirely miss thepoint of recoupmerzt or simply refuse to recogxiize gr~asicontractual rights in the context of a relationship that ispredicated upon an express contY•act.Courts are split as to whether an insurer may seek recoup-

ment from its policyholder of defense costs incurred solely indefending non-covered claims. See Westchester Fire Ins. Co.v. Wallerich, 2007 WL 2821656 (D. Minn. 2007) (slip op.}(recognizing that there is a split among courts and notingthat allowing recoupment appears to be the majority view};General Agents Ins. Co. of America, Irzc. v. Midwest SportingGoods Co., 215 Ill. 2d 146, 293 Ill. Dec. 594, 828 N.E.2d 1092(2005) (identifying the split among courts); LA Weig~h.t LossCenters, Inc'. v. Lexington Ins. Cv., 2 06 WL 689109 (Pa. C.P.2006) (un~~ublishecl opinion) (recognizing the divergent

411

1 ̀LI~L ALLOCATION IIV COMPLEX INSURANCE CLAIMS

viewpoints between courts). With increasing frequency,courts are allowing insurers to recover defense costs fromtheir policyholders iri certain cases. The leading cases onthis issue are from California.One notable decision allowing aYz insurer to recoup costs

incurred in defending non-covered claims is the CaliforniaSupreme Court decision in Buss v. Superior Court, 16 Cal.4th 35, 65 Cal. Rptr. 2d 366, 939 P.2d 766 (1997). In thiscase, the court addressed an insurer's right to obtainreimbursement of defense costs in a "mixed" ~inderlying ac-tion involving both covered and non-covered claims. T11ecourt held that the insurer may obtain reimbursement ofthose defense casts related solely to the non-covered claims.1n that case, H&H Sports, Inc. brought an action against

Jerry Buss and others, alleging several counts, includiYig:breach of contract; breach of the implied covenant of goodfaith and fair dealing; intentional ana negligent interferencewith economic relations; fraud and deceit; and defamation.Buss tendered the defense of this action to his insure~•s.

All of the insurers of Buss denied coverage, except Trarzs-america Insurance Company, ~~hich issued two commercialgeneral liability contracts. Taking the position that the onlycount covered was the single defamation claim, Transainer-ica accepted the defense of the H&H Sports action under areservation of rights, including the right to deny that anycause of action actually was covered and the right to seekreimbursement of defense costs for all non-covered claims.Due to the conflict created by its reservation of'rights, Trans-america agreed to pay for independent Curnis counsel foxBuss. Transamerica paid Buss' independent counsel slightlymore than $1 million in defense costs.Buss eventually settled the H&H Sports suit, ~7ayin~ $8.5

million. Bt1ss there brought an action against Trarzsarnericarequesting a declaration that Transamerica had a duty todefend and contribute to the settlement. Transamerica cross-claimed, seeking a declaration of its right to reimbursementf'or defense GQBtS allocable to all claims other than thecovered defamation cause of action, and its right to refuse tocontribl~te to the settlement. Ultimately, the issue ofreimbursement was presented to the California SupremeCourt.The court characterized the types of claims brought

4 ].2

DEFENSE CO,S:CS AND LF,GAL AUDI'PS ,~'~ ~~Ii:~L

against a policyholder into three categories: covered claims;~~otentially covered claims; and claims that are not poten-tially coveY•ed. The coux•t held that the insurer may not seekreimbursement for costs of defending claims that are coveredor potentially covered bec~~ise the insurer has been paidpremiums by the policyholder for a defense against suchclaiYils. The court noted that, if either the insurance contractitself provides for reimbursement, or if there is a separatecontract supported by separate consideration that providesfor reimbursement, then the insurer is perrnittecl to seekreimblrrsement for the potentially covered claims in theevent that these claims are subsequently determined to benon-covered. 939 P.2d at 775-76.Regarding claims that are not even potentially covered,

the court held that an insurer may seek reir~lbursement ofdefense costs associated with such claims. The court basedits holding upon equitable theories of unjust e7irichment andthe insurer's quasi-contractual implied-in-law right ofreimbursement for defending claims it did not bargain todefend and did not receive premiums to defend. 939 P.2d at776-78. The court held that the insurer may obtain reim-bursement far defense costs that can be allocated solely tothe claims that are not even potentially covered. 939 P.2d at778.The court held that, consistent ~~vith the California Evi-

dence Code Section 500 requirement that the party seekingrelief bears the burden of proof; the insurer bears the burdenof ~~roof on the issue of reimbursement. The burden of proofon the insurer is the civil standard of a "preponderance ofthe evidence." California Evidence Code Section 500. Thecourt rejected and specifically overruled Hogan. v. MidlandNatr:o~aal Ins. Co., 3 Cal. 3d 553, 91 Cal.. Rptr. 153, 47G P.2d825 (1970), which held that an insurer must establish by"undeniable evidence" those defense costs allocable to claimsthat are not even potentially covered in order to obtainreimbursement. The couit reiterated the insurer's obligationis to defend pro~~hylactically both promptly and in their• en-ti~•ety actions containilzg potentially covered and rzan-coveredclaims.The Calif'arnia Court of Appeals in Pr-zclia~•d v. Lzberty

Mut. Ins. Co., 84 Cal. App. 4th 890, 101 Cal. Rptr. 2d 298(4tI~ Dist. 2000), as modified nn denial of reh'g, (Dec. 6, 2000),held that Buss made clear that an insurer did "nothing

413

1`LI~ AT.LOCATION IN COMPLEX INSURANCE CLAIMS

wrong in unilaterally reserving its reimbursement rights ina mixed action." The court held that the "whole point of theBuss case is that an insurer's right to reiYnbursement fordefense CQS~S for claims not even potentially covered ispredicated on a legal right `implied in law as c~uasi-contractual,' not a matter of any agreement between theparties." $4 Cal. App. 4th at 905. The court held that Busswas "very clear that an insu~•er can reserve its reimburse-Yiient right unilaterally and without any agreement." 101Cal. Rptr. 2d at 906.The holding in Buss has been embraced by other courts.

The Florida Court of Appeals held that an insurer wasentitled to ~~eimbursement of costs expended to defend thepolicyholder for claims that were not covered under the in-surance contract. Colon~~ Ins. Co. v. G & E Tires &Service,I~ac., 777 So. 2d 1034 (Fla. Dist. Ct. A~~~~. 1st Dist. 20Q0). Col-ony insured G&E under a garage liability contract thatcontained exclusions for intentional acts, acts by fellow em-ployees, or bodily injury arising out of the course of theemployment. An employee working at G&E allegedly washarassed by other G&E employees. She filed suit againstG&E alleging battery, sexual harassment, invasion ofprivacy, and intentional infliction of emotional distress. 777So. 2d at 1035.G&E tendered the suit to Colony for ~ defense, but Colony

refused the tender. Later, Colony agreed to defend the suitunder ~ reservation of rights, including the right to bereimbursed for defense costs incurred in defending G&E inthe action. Id. In the r•eserv~tion of.' rights letter, Colonystated it was reserving its right to "deny coverage and/ordefense... with respect to defense costs incurred or to beincurred i.n the future, to be reixizbursed and/or obtain an al-location of attorney's fees. . ." 777 So. 2d at 1036. Sonn af-ter Colony agreed to defend G&E, it filed a declaratory judg-ment action disclaiming coverage. At the trial court level,Colony moved for a declaration that it 11ad no obligatioYlunder the insurance contract to either defend or indemnifyG&E. After the trial court granted the motion and foundthat YZo coverage existed under the contract, Colony filed amotion seekilig reirnburseYuerlt of the fees and costs expendedin defending G&E against the underlying suit.In deciding whether to allow the insurer to recoup, the

court cited to Buss v. Superior Court, 16 Cal. 4th 35, 65 Cal.

hi4

DEFENSE COS"['S AND LEGAL AUDITS § 12+:`L

Rptr. 2d 366, 939 P.2d 766 (1997) as persuasive authorityfox the propnsitian that the policyholder did not remitpremiums to the insurer to cover defense of claims that arenot even potentially covered by the insurance contract. Thecourt found that Colony's reservation of rights and appoint-ment of mutually a~'reeable counsel made any claim thatGCE detrimentally relied on the defense it receiveduntenable. Further, the court held that Colony timely andexpressly reserved the right to seek Y•eimbursement of thecosts of defending clearly uncovered claims and that G&Eaccepted the offer. Tl1e court concluded that the case involvedtwo apparently sophisticated I~arties and that G&E acceptedthe defense on the terms set forth by Colony's reservation ofrights letter. Accordingly, the court held that Colony wase~ltitled to reimbursement.Numerous othei decisions have held that an insurer may

obtain reirizbursement of defense costs related to non-coveredclaims. See St.Paul Tire and Marine Iris. Co. v. CompaqCampr.~ter Corp., 457 F.3d 766 (Sth Cir. 2006) (applyingTexas law) (holding that insurer was entitled to recoupmentof defense costs based upon agreement between parties); Jir~zBlack &Associates, Inc. v. Transcontinental Ins. Ca., 932 So.2d 516 (Fla. Dist. Ct. App. 2d Dist. 2000) (holding thepolicyholder accepted the defense provided by the insurerand agreed to the terries of the reservation of rights letter inwhich the insurer stated it would seek reimbursement ofdefense costs for non-covered claims); Certain Underwrr.tersat Lloyd's u. Health Care Mana~eme~it Partners, Ltd., 20Q6WL 2050962 (D. Colo. 2006) (allawi7zg reimbursement ofdefense costs where the court found no duty to defendexisted); Scottsdale Ins. Co. U. MV Transp., 36 Cal. 4tli 643,31 Cal. Rptr. 3d 147, 115 P.3d 460 (2005) (holding aYi insl~rermay uY~ilaterally condition its proffer of a defense upon itsreservation of rights to seek reimbursement of costs advancedto defend claims that are not potentially covered}; CincinnatiIns. Co. v. Cr-an.d Pointe, LLC, 501 F. Sapp. 2d 1145 (E.D.Tenn. 2007) (predicting Tennessee law) (allowing reirnburse-ment of defense costs even if there is not a specific provisionin insurance contract where insurer has made an adequatereservation of rights to seek recoupYllexit); Travelers Cas. &Sur. Co. v. Ribi Immuraochem Research, Inc., 2005 MT 50,326 Marit. 174, 108 P.3d 469, 60 Env't. Rep. Cas. (BNA) 1048(2005) (fincling irZsurer may recoup defense costs expended

~i~

1 ̀L:~L ALLOCATION IN COMPLEX IIVSURANC.E CLAIMS

on behalf of its policyholder for claims that fall outside theinsurance contract); National Uraion Fire Ins, Co. ofPittshurgla, Pa. v. Guan2 Horesing &Urban Renewal Atcthor-ity, 2003 Guam 19, 2003 WL 22497996 {Guam 2003) (unpub-lished opinion) (following Buss and allowing allocation ofdefense costs between covered and non-covered claims);Urzzted Nat. I~as. Co. v. SST Fitness Coip., 309 F.3d 914,2002 Fed. Appx. 0384P (6th Cir. 2002) (applying Ohio law)(holding an insurer is entitled to reimbursement of defensecosts when it had na duty to defend the underlying liti~a-tion); Ranger Iris: Cv. v. Kovach, 1999 WL 1421657 (D. Conn.1999) (applying Connecticut law) (unpublished opinion) (find-in~ the rationale of Bress "very logical arld coYnpelling");Contzrtental Cczs. Co. v. I3oar•d of Educ. of Charles County,302 Md. 516, 489 A.2d 536, 24 Ed. Law Rep. ̀L08 (1985) (al-lowing defense costs to be ap~~ortioned between covered andnon-covered causes of action); Kncz~p v. Commonwealth LandTitle Ins. Co., Znc., 932 F. Su~a~~. 1169 (D. Minn. 1996); Drig~sCorp. v. Pennsylvania Mfrs. Assn Ins. Cv., 181 F.3d $7 (4thCir. 1999) (a~~plying Maryland law) (unpublished o~~iYiion)(allowing reimbursement of expert witness fees); Hecla Mira.Co. v. New Harrtpshzre Ins. Co., $11 P.2d 1083, 33 Lnv't.Rep. Cas. (BNA) 1340 (Colo. 1991); Nationwide Mut. Ins. Co.v. Flcxgg•, 789 A.2d 588, 596-97 (Del. Su~~er. Ct. 2001); SectcrityIns. Ca. of Hartford v. Lu.rnberrnen.s Mut. Ca,s. Co., 264 Cann.6$S, 826 A.2d 107, 124 (2QQ3); Valley Fore Ins. Co. v. HealthCare Management, Partners, Z,td., 616 F.3d 1086 (10th Cir.2010) (applying Colorado law) (affirming insurers' rights toobtain reimbursement for defense costs whe~•e they defendedon reservation of rights inclL~ding the right to obtainreimbursement and where it was ultimately determined thatthey had no duty to defend and rejecting policyholder's argu-ment that insurers must wait until underlying litigation isresolved to seek reimbursement); Hebela v. Healthcare Ins.Co., 370 N.J. Super. 260, 351 A2c1 75, 86 (App. Div. 2004)(right of reimbursement exists because the policyholderwould be unjustly enriched in benefiting by a defense forwhich it did not pay); Dupree v. Scottsdale Ins. Co., 96 A.D.3d546, 947 N.Y.S.2d 428, 429 (1st Dept 2012); R.T. VanderbiltCo., Inc. v, Hartford Acc. & Irtdem. Co., 2013 WL 1112077(Conn. Super. Ct. 2013); Illinois Union Ins. Co. v. NRI Const.In.c., 846 F. Supp. 2d 1366 (N,D. Ga. 2012) (predicting Geor-gia courts would permit recaupment); Great American Insur-

h16

DEFENSE COSTS AND LL'GAI. AL7UI'CS~' 1L:~L

a,nce Co. v. Chang, 2013 WL 5949619 (N.D. Cal. Nov, 6, 2013)(holding ins~.irer is entitled to be reimbursed for nearly$900,000 that it advanced under a reservation of rights forthe costs of defense and site investigation together withprejudgment interest).The Restatement (Third) of Restitution and Unjust Enrich-

7nent also supports the view that insurers should be permit-ted to pursue reimb~.irsement:

If one party to a contract demands from the other a perfor-mance that is riot in fact due by the terms of their agreement,under circumstances making it reasonable to accede to theden7and rather than to insist on an immediate test of thedisputed obligation, the party on whom the demand is mademay render such performance under protest or with reserva-tion of nights, preserving a claim in restitution to recover thevalue of the benefit conferred in excess of the recipient'scontractual entitlement.

Restatement Third, Restitution and Unjust Enrichment~~' 351 at 571. Indeed, the illustration used in tl~e Restate-ment involves an insurer defending claims not even poten-tially covered under a reservation of rights based upon theBuss case.Other courts have not permitted an insurer to seek recoup-

mant of defense costs for certain claims not covered underthe insurance contract. In Shoshone First Bar2k v. PacificEm,~loyers Ins. Co., 2 P.3d 510 (Wyo. 2000), the SupremeCourt of Wyoming was presented with a certified question bythe United States District Court for the District of Wyomingregarding whether Wyoming law recognized a legal o~• equi-table right of an insurer to allocate the costs of defendingnon-covered claims to the ~]olicyholder where there was atleast one covered claim and the insurer was providixig adefense. 2 P.3d at 512.

Pacific is;;ued a commercial general liability contract toShoshone. A fori~Zer director of Shoshone filed a lawsuitagai.rzst Shoshone alleging that his termination constituted abreach of contract, breach of the covenant of goad faith andfair dealing, invasion of privacy, infliction of severe emotionaldistress, and abuse of process. Pacific agreed to defend theshit under a reservation of rights and specifically reservedthe right to allocate to Shoshone the costs of defense relatedto non-covered claims. Pacific undertook the defense becauseone count of the complaint alleged invasion of privacy that

417

1 ̀L:`L ALLOCATION IN COMFLEX INSURANCE CLAIMS

was potentially covered under the liability insurancecontract. The action was settled a71d Pacific sought to re-cover• a portioxi of the defense costs it incurred in defendingShoshone. 2 I'.3d at 513.Although t17e co~rrt recognized that other jurisdictions al-

lowed allocation between the insurer and the policyholder,the court held that, "unless an agreement to the contrary isfound in the policy, the insurer is liable for all of the costs ofdefending the action." 2 P.3d at 514. The col~rt declined tofollow the opinion in Buss, noting that the court in Buss alsofound that there was a "pragmatic difficulty" of an insurerproviding only a "partial defense" to the ~~olicyholder. 2 P.3dat 514.Further, the court reasoned that there was "nn indication

in the policy of any distinction to be made between coveredand norl-covered claims so far as the defense of those claims[was] concerned, and we will not permit the policy to bemodified by subsequent letters from the insurer to theinsured." The court rejected Pacific's contention that itsreservation of rights letter, which specifically reserved theright of x•ecoupmerit, pe~•mitted the insurer to allocate costsbetween covered and non-covered claims. Tl~e court heldthat the insurer was "not permitted to unilaterally modifyand change policy coverage." 2 P.3d at 515. The court heldthat Pacific could have included allocation language iii theinsurance contract but failed to clo so.The Illinois Su~~reme Court reached a similar conclusion

in General Agents Ins. C.o. of Arne -ica, Inc. v. Midwest Spart-ing Goods Co., 215 Ill. 2d 146, 293 Ill. Dec. X94, 828 N.E.2d1092 (2005). In Midwest, Sporting, Gezleral Agents InsuranceCom~~any of America ("Gainsco") ~~rovided general liabilityinsurance to Midwest Sporting Goods Company ("Midwest").The City of Chicago and Cook County brought suit againstMidwest alleging that Midwest created a public nuisance byselling guns to inappropriate purchasers. Midwest tenderedthe suit to Gainsco. It initially denied coverage. However,once an amended complaint was filed, Gainsco agreed to paythe defense costs subject to a reservation of rights. In thereservation of rights letter, Gainsco stated that it agreed toprovide a defense subject to the "right to recoup any defensecosts paid in the event that it is determined that theCompany does not owe the insured a defense in this matter...." 215 Ill. 2d at 148.

~~ra

DEFENSE COSTS AND LEGAL ACIUI'PS ,~'~ 12,:~L

Gainsco then filed a declaratory jud~nnent action seeking adetermination that the suit was not covered and asserting aclaim for recovery of all defense casts. The trial coLirt foundthat Gainsco had nn duty to defend Midwest in the underly-ing litigation aYid later granted Gainscds motion for recoup-lnent of defense costs. The court of appeals af~'irmed the trialcourt's order regLiiring Midwest to reimburse Gainsco for thedefense casts incurred in defending the entire underlyinglitigation.Before the Illinois Supreme Court, Midwest contended

that Gainsco was not entitled to recoupment of the defensecosts because: (1) the insurance contract inchides no provi-sion allowing fog• reimbursement of defense costs; (`L) thereservation of r i~hts letter issued by Gainsco could not cre-ate new rights not contained in the ins~rrance contract; and(3) the theory of unjust enrichment is inapplicable due to thepresence of a written insurance contract bet~~veen Gainscoand Midwest.The Illinois Supreme Court held that a unilateral reserva-

tian of rights letter cannot create rights not contained in theinsurance contract. Relying an Shoshone First Bank v. Pcccr:ficEmployers Iras. Co., 2 P.3d 510 (Wyo. 2000), the courtacknowledged that iYnplying an agreemeYit due to thepolicyholder's acce~atance of the defense provided by the1Tl:5UT~T "eff'ectively places the insured in the position of mak-ing a Hobson's choice between accepting the insurer's ad-ditional conditioYis on its defense or lasing its right to adefense from the insurer ." 215 Ill. 2d at 163. The court fur-ther stated that it could not condone the insu~•er's actions ofunilaterally xilodifying the insurance contract through the is-suance of a reservation of rights letter. The court also agreedwith the Sltoshvne court that the insurer could have includedallocation language in the contract.Gainsco also argued that it was entitled to reimbux•seYi7ent

under• the doctrine of unjust ex7richment. In rejectingGainscds argument, the court noted that arz insurer agreesto defend an underlying lawsuit for the purpose of benefitingthe policyholder and also to avoid tlse risks of exposure thatmay result if the policyholder provides its own. inept defenseof the underlying litigation. The court held that Gainsco wasnot entitled to reimbursement under an unjust enrichmenttheory because tl~e insurer.• undertakes defense of the~~olicyholder to protect itself at least as much as it is protect-

A19

~L:~L ALLOCATION IN COMFLEX INSURANCE CLAIMS

ing its policyholder. 215 Ill. 2d ~t 164. Corrcpare with SteadfastIrts. Co. v. Carerrtark Rx, Inc., 373 Ill. App. 3d 895, 311 Ill.Dec, $97, 869 N.E.2d 910 (lst Dist. 2007}, appeal allowed,225 Ill. 2d 677, 314 Ill. Dec. 837, 875 N.E.2d 1124 (2007)(insurer was allowed to recoup defense costs it paid pursu-ant to an erroneous trial court ruling that the insurer had aduty to defend and indemnify policyholder that was subse-quently ~•eversed in its entirety on appeal).Other courts also have proliibited~ the insurer from recoup-

ing costs incurred to defend non-covered claims. See, e.g.,Pekr,n. Ins. Co. v. Tysa, Inc'., 2006 WL 3827232 (S.D. Iowa2006) (~7redicting Iowa law) (holding reimbursement ofdefense costs not allowed even though insurer reserved theright to recoup); Pe~•due Far•rns, Inc. v. Tr•ar,~elers Cas. AridSurety Co. Of Arrcc~ricu, 448 F.3d 252, 37 Employee BenefitsCas. tBNA) 2621, 11 Wage &Hour Cas. 2d (~3NA) 833 (4thCir. 200G) (applying Marylal~d law) (allowinb reimbrrrsernentof costs expended in defending non-covered claims wouldresult in the narrowing of an insurer's broad duty to defend);Westchester Fire Ins. Co. v. Wallerich, 527 F. Supp. 2d 896(D. Minn. 2007) (predicting Minnesota law} (refusing to al-law reimbursement of defense costs unless this right isspecifically identified in insurance policy because a reserva-tion of rights letter cau only retain those defenses under thepolicy); Employers Nlut,. Cas. Co. v. Industrial RubberProducts, Irac., 2006 WL 453207 (D. Minn. 20Q6) (applyingMinnesota law) (finding an "insurer is not entitled to thereimbursement of defense costs expended prior to the deter-minatioYi of coverage, unless specifically provided for in theinsurance policy"); General Star Indem. Cv. u. Vi~~in IslandsPort Authority, 564 F. Su~~p. 2d 473 (D.V.I. 2008) (deniedreiYnbuY•sement of defense costs paid by an ilzsurer wherethe insurance contract did not specifically provide a right toreimb~rrsement); Medical, Liabilr:ty Mzct.. Ins. Co. v. AlanCurtis Enterprises, Inc., 2008 WL 2205868 (Ark. 2Q08),opinion supplemented an other grounds, on denial of rel~'g,2008 WL 2525818 (Ark. 2008) tdeclining to follow either themajority or minority rule and holding that defense costscould not be recouped because there was not an Arkansasstatute providing for reimbursement under the circum-stances); Bedoya v. Illinois Founders Ins. Co., 293 Ill. App.3d 668, 228 Ill. Dec. 59, 68$ N.E.2d 757 (1st Dist. 1997) (re-fusing to allow ap~~ortionment between covered and non-

4`LO

DEFENSE COSTS AND LEGAL AUDITS ~'~ 12,:`li

covered claims); LA Wezgh.t Loss Centers, Inc. v. LexingtonIns. Co., 2006 WL 689109 (Pa. C.P. 2006) (unpublishedopinion) (following minority view that prohibits an insurerfrom recouping defense costs incurred in defending' non-covered claims absent the presence of ari express right in theinsurance contract); American and Foreig~ra Ins. Co. v. Jerry'sSpvrt Center, Inc., 2 A.3d 526 (Pa. 2010) (insurer thatreceived a declaratory judgment that it had no duty to defendis not entitled to be reimbursed for defense costs absent anexpress provision in the written insurance contract provid-ing f'or reimbursement); Texas Assn of Cozcn.ties CountyGove~•rtmerat Ris~i Management Pool v. Matagorda Cotcnty, 52S.W.3d 128 (Tex. 2000) Qzolding a Unilateral reservation ofrights letter cannot create the right to recoup settlementpayments on non-covered claiYns when such right is notcontained in the insurance contract); Excess Underwriters a.tLloyd's, London, v. Frank's Casing Crew & Ren.tal Tools, Inc.,246 S.W.3d 42 (Tex. 2008) (absent unequivocal consent to al-low reimbursemeYit, an inspirer has no right to seek reiYil-bursemerlt of Uncovered ~~ortion of a claim or suit that itsettles); t~elch. Foods In.c. v. Natzon.al Union Fire Ins. Cv.,2011 WL 576600 (D. Mass. 2011); Nc~.tional Sur•. Corp. U.Irrtmunex Core., 162 Wash. App. 762, 256 P.3d 439 (Div. 12011), review denied, 173 Wash. 2d 100G, 266 P.3d 880{`L012). See also U.S. Fidelity an,d Guaranty Co. v. U.S.Sports Specialty Assn, 2012 UT 3, 270 P.3d 464 (Utah 2012)(holding liability insurer's right to reimbursexnelit foramount paid beyond policy limits was within the subjectmatter of the policy and, therefore, ins~.irer was not perrl~it-ted to seek restit~.ition from ins~.ired based on extra-contractual theory of unjust enrichment).Where the ixisurer is allowed to recoup costs for non-

covered claims, it ~enei ally bears the burden of ~~rovin~ by apreponderance of the evidence both that: (1) the claim is noteven potentially covered, (Colony In.s. Co. v. G & E Tires &Service, In.c., 777 Sa. 2d 1034 (Fla. Dist. Ct. App. 1st Dist.2000)); Aerojet-General Corp. v. Tr•anspo~•t Indern. Co., 17Cal. 4th 38, 70 Cal. Rptr. 2d 118, 948 P.2d 909, 928, 46 Env't.Rep. Cas. (BNA) 1025, 28 Envtl. L. Re~~. 20590 (1997), asmodified nn denial of reh'g, (Mar. 11, 1998)); and (2) thatspecific costs can be allocated solely to causes of action thatare not evert potentially covered (National Urziun Fr.re Ins,Co. of Pittsburgh, Pa. v. Guam Housing & Urbun Renewal

421

1 °L:Ir ALLOCATION IN COMPLEX INSURANCE CLAIMS

Authority, 2003 Guam 19, 2003 WL 22497996 (Guam 2003)(unpublished opinion) (stating the insurer must "identifythose costs which were attributable solely to non-coveredclaims"); Tt•aUele~-s Cas. &Sur. Co. v. RIBI Im.»aunoc~aemResearch, Inc., 326 Mont. 174, 108 P.3d 469 (2005); Buss v.Superior Court, 16 Cal. 4th 35, 6~ Cal. Rptr. 2d 366, 939P.2d 766, 783---4 (1997)). But see Natiarzal Union, Fire Ins,Co. of Pittsburgh, Pu, v. Guam Hot~si.rag &Urban RenewalAuthority, 2003 Guam 19, 2003 WL 22497996 (Guam 2003)(unpublished opinion) (identifying insurer's burden of proofas providing "undeniable evidence supporting allocation").See also LA Saund USA, Irac. u. St. Paicl Fire & Murine Ins.Co., 156 Cal. App. 4th 1259, 67 Cal. Rptr. 3d 917 (4th Dist.2Q07), review denied, (Feb. 27, 2008) (wheie the insurer wasentitled to reimbursement of defense costs and settlementpayment due to the rescission of an insurance contract, eachseparate policyholder is not jointly and severally liable toreimbursement all defense costs and entire indemnitypayment. Therefore, court required insurer to allocatedefense costs and settlement payment amo7zg each ~~articu-lar insured.)Some ,jurisdictions require express language in a reser~va-

tion of rights letter reserving the insurer's right of reimburse-ment for defense costs associated with non-covered claims.See Tra~,~ele~~s Cas. & Sicr. Co. v. Ribi Im~nunocltem Research,Inc., 2005 Mil' S0, 326 Mant. 174, 108 P.3d 469, 60 Env't.Red. Cas. (BNA) 1048 (`L005); Cincinnati Ins. Co. v. GrandPointe, LLC, 501 F. Sl~pp. 2d 1145 (E.D. Tenn. 2007) (predict-in~ Tennessee law) (recognizing reimbursement of defensecosts is available when the~~e is a determination that no dutyto defend or indemnify exists, and an adequate reservationof rights l7as been issuacl?; Seottsclale Iras. Co. v. StellivaraProperties, Inc., 2Q07 WL 2247795 (D. Haw. Aug. 2, 2007)(predicting Hawaii law) (ruling insurer would be entitled toseek reimbursement of defense costs related to claims thatare not even potentially covered where reco'L~pment rightexpressly included in reservation of rights); UnionarnericaIns. Ca Ltd. v. Gcineral Star Indem. Co., 2Q05 WL 757386{p, Alaska 2005) (predicting Alaska law) (predicting theAlaska Supreme Court ~~vould allow reimbursement ofdefense expenses where the insurer had expressly reservedits right to seek reimbursement); National Unio~a Fire Ins,Co. of Pittsburgh, Pa. v. Guam Housing' and Urban Renewal

X22

DEFF,NSF G08T5 AND L~CsAL AUDI'T`S ~ I ~L22r

Auth.o~•ity, 2003 Guam 19, 2003 WL 22497996 (Guam 2003)(unpublished opinion); United Nat. Ins. Co. v. SST FitnessCorp., 309 F.3d 914, 2002 Fed. Appx. 0384P (6t11 Cir. 2002)(applying Ohio law); Bacss v. Superior Cou~~t, 16 Cal. 4th 35,G5 Cal. Rptr. 2d 366, 939 P.2d 766 (1997); Knapp v.Commonwealth Lcr,nd Title Tns. Co., Irac., 932 I'. Supp. 1169(D. Minn. 1996) (applying Minnesota law); Resure, Inc. v.Chemical Distributors, Inc., 927 F. Supp. 190 (M.D. La.1~J96), af~'d, 114 F.3d 1184 (5th Cir. 1997) (applying NewMexico law); Gotha.na Ins. Co. u. GLNX, Inc., 1993 WL312243 (S.D. N.Y. 1993) (unpublished opinion). But seeLea.dville Corp. v. U.S. Fidelity & Guur. Co., 55 F.3d 537, 40Env't. Rep. Cas. (BNA) 2116 (10th Cir. 1995) (applying Colo-rado law) (noting insurer reserved its right to deny coverage,but not noting that tlse reservation of rights letter specifiedthe right to reimbursement). Abankruptcy court stated thatthe right to reirnburseYiierit could be found either in the in-strrance contract itself or in the reservation of rights letter.In re Hansel, 160 B.R. 66 (Bankr. S.D. Tex. 1993). The casesgenerally require that the liability insurer obtain a judicialdetermination of non-coverage in order to recover defensecosts from its policyholder.Insurers should consider the following in conizection with

mixed claims: (1) whether failing to enumerate a particularright, defense, ~r issue is likely to effectuate a waiver oresto~~pel; (2) the likelihood of ultimate success with respectto the right, defense, ar issue; (3) the monetary and strategicsignificaYlce of the right, defense, or issue; (4) the risk thatasserting the right, defense, or issue will create a conflictand empower the policyholder to select inde~~endent counsel;{5) the monetary and ether costs associated with losingcontrol of the defense; (6) the likelihood of recouping defensecosts and the amount likely to be reimbursed in view of theburden of showing that costs relate solely to uncoveredclaims; and (7) the costs of pursuing recou~ment. Often, theloss of control of the defense and the increased costs associ-ated with independent counsel outweigh the preservation ofa partic~~lar right, defense, or issue. AccoY•dingly, a deliber-ate decision not to reserve a right or defense even if it meansforgoing the right to recoup defense costs may be the properdecision.As discussed above, recoupment is a Yiiatt~r of quasi

contract and equity. Mpst of the courts that deny insurers

423

1LtS ALLOCATION IN COMPS,EX INSLJRAN~JE CLAIMS

the right to .recoup in the mixed claims context da so underthe guise of refusing to re-write the insurance contact or atleast point to the absence of any contractual provisionregarding reimbursement. As a result of some court rulingsholdinb that an insurer is not entitled to recoup monies fromthe policyholder absent an express policy provision, some in-surance contracts now expressly provide for rights ofreimbursement. In sixch instances, of course, the right toreimbursement is contractual.An Illinois Amendatory ISO Endorsement promulgated af-

ter the Illinois Supreme Court decision in General AgentsIris. Co. of Am.eri.ca, Irac. v. Midwest Sportr.ng~ Goods Co., 215Ill. 2d 146, 293 Ill. Dec. 594, 828 N.E.2d 1082 (2005)provides:

If'we i~litially defend an insured or pay for an insured's defensebut later determine that claiin(s) is (are) clot coti~ered underthis insurance, we will have the right to reimbursement forthe defense costs we have incurred.The right to reiinbursemetYt for the defense costs under thispi•ovisioii will only apply to defense costs we ha~~e incurred af-ter eve notify you in writing that there may not be coverage,and that we are reservinb our rights to teriuinate the defenseand seek reimbursement of defense costs.

Prospectively, an insurer can better protect itself byincluding an appro~~riate provision or endorsement expresslyentitling it to reimbursement of costs spent defending non-covered claims.

[e] Recoupment of Settlement Amounts Associatedwith Non-Covered ClaimsBefore returning to the subject of defense costs, we briefly

address the issue of recoupuient of indemnity dollars.Conceptually, an insurers' right to recolrp indemnity pay-ments associated with non-covered claims should be evenmore straightforward and the standard more favorable toinsrxrers than recoupment of defense costs. The duty toindemnify is narrower than the duty to defend, involvingonly claims actually (as opposed to potentially) covered. Pay-ments on ,judgments ar in settlemeY~t generally take place ata time after the claix~~s have beers subjected to greaterscrutiny, after evaluation, and even after a ,judgment orverdict is entered in the underlying action. Indeed, manycourts have held that, where an insurer defends a suit under

424

DEFENSE CAS"['S AND LEGAL ALJDI'i`S ~ 1L:`L

a reseY-~~ation of rights, it may recover settlement paymentsif it is later determined in a declaratory ,judgment actionthat the underlying claims are not covered by the policy.

California has awell-established body of law allowing forreimbursement of indemY~ity payments. For example, in BlueRidge Ins. Co. v. Jacobsen, 25 Cal. 4th 4$9, 502-03, 106 Cal.Rptr. 2d 535, 22 P.3d 313 (2001), opinion after certifiedquestion answered, 10 Fed. Apex, 563 (9th Cir. 2001) thecourt relied upon the reasoning in Buss arzd recognized aninsurer's right to obtain reiYnbursement for non-coveredclaims included within a reasonable settlement payment. Toobtain reimbursenYent, the insurei must:

(1) send ~ timely and express reservation of rights (includingthe right to seek such reimbursement]; (2} expressly notify thepolicyholders of the insurer's intent to accept a proposed settle-ment offer; and (3) expressly offer to the policyholders thatthey may assume their own defense when the insurer gildinsureds disagree whether to accept the proposed settlement.

Id. at 502. See also Marizel American Ins. Co. v. G.L.Anderson Ins. Ser•z~icczs, Irac., 715 F. Supp. ̀Ld 1068, 1074(~.D. Cal. 2010) (citing Blue I~id~e); Burlington Ins. Co. u.Devdhara, 2009 WL 2901624 (N.D. Cal. 2009) (holding thatinsurers have aquasi-contractual right to seek reimburse-ment for settlements made for uncovered claims); Phillips &Associates, P.C. v. Navigators Ins. Co., 764 F. Supp. 2d 1174(D. Ariz. 2011); American. Mvc~rn Home Ins. Ca. v. Fahmian,194 Cal. App. 4th 162, 124 Cal. Rptr. 3d 456 (4th Dist. 2011)(insurer may obtain reimbursement of settleYnent from.policyholder even though insurer entered into settlementwithout giving policyholder a st~f~icient amount of time to re-spond to settlement offer).

Recently, in Park Townsend, LLC v. Clarendon AmericaIns. ~'v., 916 F. Sapp. 2d 1445 (N.D. Cal. 2013), the courtrecognized the insurer was entitled to seek reimbursementof settlement amounts associated with non-covered claims.When the insurer, Clarendon, reserved its rights to seekfuture reimbursement of settlement amounts of rion-coveredclaims, the policyholder protested and sought a declaratoryjudgment that the insurer was required to fully indemnifythe insured in the underlying action.

Clarendon recognized its duty to defend and did notdispute that some of tl7e damages in the uYiderlying action

425

1 ̀Z~:2i AS.LOCATION IN COMPLEX INSURANCE CLAIMS

wee e covered under its policy. It did dispute, however, the~~olicyholder's assertion that it sought to have the insuredcontribute to the settlement. Instead, Clarendon, in reserv-in~ its rights, intended to bring a separate action foxreimbursement for non-covered damages in the event itsettled the underlying action. The caurt recognized this ap-proach is permitted by California law. Citing Blue Ridge, thecourt explained that "[t]he rationale behind permitting aninsurer's reimbursement is to prevent unjust enrichment onthe ~~art of the insured." Park Townsend, LLC, 916 F. Sup~~.2d at 1051. Where Clarendon made a timely and expressreservation of rights upon agreeing to defend the policy-holder, informed the policyholder of its interest in settle-ment and offered the policyholder the opportunity to assumetheir own defense should the parties disagree about whetherClarendon should accept the pro~~osed settlement, the courtfound that Clarendon's reservation of rights did not appearto be forcing the policyholder to contribute toward the costsof settlement. The co~.irt concluded that Clarendon's reserva-tiori of rights and interest in seeking future reimbursementfar nan-co~lered costs did not amount to misconduct.Park Townsend reaffirms that, at least under California

law, an insurer is entitled to reserve its rights for futurereimbursement of settlement amounts associated with non-covered claii~is, so long as the insurer follows the stepsoutlined in Blue Ridge. When such steps are taken, a courtwill view the insut~er's actioxis as reasonable aYzd not an at-tem~~t at forcing the insured to contribute toward thesettlement.Other courts also have allowed an iYlsurer to seek reim-

burseinent of indemnity payments pursuant to a unilateralreservatioYi ofrights. Travelers Property Cas. Co. of An2e1•icav. Hillericla & Bradsby Co., Inc., 598 F.3d 257, 201Q-1 TradeCas. (CCH) ~ 76984 (6th Cir. 2010) (applying Kentucky law)(a right to reimbursement arose under an implied-in-lawcontract theory in light of the insurer's explicit reservationof rights, including notification of the right to seek reimburse-ment, acid the policyholder's cont~•ol of the defelise and settle-meilt ~~rocess); Cincinnati Ins. Co. u. Grand Pointe, LLC, 501F. Supp. 2d 1145 {E.D, Tenn. 2007) (insurer may recoupsettlement payments from policyholder where court hascancl~.~ded that there is no duty to defend); AmericanGuarantee and Liability Tns. Co. v. CNA Reinsurance Co., 16

426

DEFF.NS~ ~iOSTS AND I.ECxAL AUDITS fi 12:2i

A.D.3d 154, 791 N.Y.S.2d 525 (1st Dept 2005) (where insurerreserved right to reimbursement, and it was subsequeYltlyestablished that there was no additional insured coverage,insurer was entitled to reimbui sement of settlement costspaid on behalf of additional insured); Medr.cal ~Vlalprar~ticeJain.t Underwriting Assn of Mtrssachusetts v. Goldberg, 425Mass. 46, 680 N.E.2d 1121 (1997) (suggesting an insurercould obtain reimbursement for anon-covered settlement ifit first obtained court approval).Courts in other jurisdictions have refused to allow an

insurer to obtain reimbursement unless there is a specific~~rovision in the policy, a written agreement from theinsured, or a court order requiring such reimbursement. See,e.g., American Modern Hnme Ins. Co. v. Reeds at Bcryvi.ewMobile Home Pariz, LLC, 176 Fed. Appx, 363, 9-10 (4th Cir.2006) (unpublished opinion) (insurer does not have right toreimbursement despite assertion of such right in reservationof rights); Houston Cas. Co. v. Sprint Nextel Corp., 2010 WL4852649 (E.D. Va. 2010) (rejecting insurer's unilateral at-tem~~t to recoup settlement ~~ayment where policyholder didYiot consent to such recoupment); Utica Mtct. Iris. Co. v. Rehmarzd Haas Co., 6$3 F. Supp. 2d 3G8 (E.D. Pa. 2p10) (applyingPennsylvania and Iilinais law) (insurer was not entitled toreimbursement of settlement costs from policyholder, absentexpress ag-reemer~t providing for sucli reimbursement); Ameri-can Motorist Ins. Co. v. Custor~z Kubber Extrusions, Inc.,2006 WL 2460$61, ~~7-$ (N.D. Ohio 2006); Coregis In.surar2ceCo. v. Law 4f~ices of Car•~le F. Kafrissefz, P.C., 140 F. Supp.2d 461, 463-66 (E.D. Pa. 2001} (absent fraud by the policy-holder, settlement by insurer constituted a "voluntary pay-ment" not subject to reimbursement); Excess Uradercvt•iters atLloyd's, Landon v. Frcxnk's Casing Crery & RentaZ Tvols, In.c.,246 S.W.3d 42 (Tex. 200$) (absent unequivocal consent fromthe insured to allow reimbursement, an insurer was notentitled to reimbursement of uncovered portion of a claim orsuit that it settled); Steadfast Ins. Co. v. Sheridan Children'sHealthcare Services, Inc., 34 F. Sapp. 2d 1364, 1366-67 (S.D.Fla. 1998) (settlement by insurer precluded an action againstpolicyholder for reimbursement); Medical Malpractice pointUn.derivriting Assn of Massachusetts v. Goldberg, 4`L5 Mass.46, G80 N.E.2d 1121, 1128-29 (1997); Mou~at Azry Zns. Co v.Due La,w Firm, 668 So. 2d 534, 538 (Ala. 1995) (rejected by,I31ue Ridge Ins. Co. v. Jacobsen, 25 Cal. 4th 489, 106 Cal.

427

~`li:~. ALLOCATION IN COMPLF,X INSURANCE CLAIMS

Rptr. 2d 535, 22 P.3d 313 (2001)) (in order to preserve itsright to be reimbursed far settlement payments, insurerm~.~st obtain either a written agreement with insured or acourt order); and U.5'. I+'id. &Guar. Co. v. U.S. SportsSpecialty Ass'rz, 270 P.3d 464, 468 (Utah 2Q12) (statiYig that"an insurer's right to reimbursement from an insured mustbe expressly provided iYi an insurance policy before it carp beenforced").A divided Texas Supreme Court, on rehearing of a prior

decision, held that an excess insure• was not entitled toreimbursement for settlement payments from the policy-holder unless the ~~olicy so ~~rovides or unless the policyholderhas coYiseYited to the right to reimbursement. Excess Under-wri.ters cct Lloyd's, London v. Franh's Casing Crew & Renta.lTools, Inc., 246 S.W.3d 42 (Tex. 2008). The ruling vacated anearliei decision in which the court had ruled that reimburse-meilt was appropriate where it was slibseq~rently determinedthat the claims against the insured were not covered. SeeExcess Un.deru~riters ut Lla,~~d's, London v. Frank's CasingCrew &Rental Tools, Inc., 4$ Tex. Sup. Ct. J. 735, 2005 WL1252321 (Tex. 20Q5}, opinion withdrawn and superseded,246 S.W.3d 42 (Tex. 2008). On rehearing, the high court re-af~irmed the rule set forth in Texas Assn of Cotcnties CountyGouerramerat Ris7~ Manccg~ement Pool u. Matagorda County, 52S.W.3d 128 (Tex. 2000).Where the policyholder and insurer can agree upon the

amount of the payment relating to covered claims and theamount attributable to the uncovered claims, the simplestapproach is for each to fund their respective portions of thesettlement. Alternatively, the inslrrer could reach an agree-ment with the policyholder whereby the policyholder agreesto reimburse the insurer for whatever amount is agreed torelate to the non-covered claims o~• subsequently determinedto relate to the non-covered claim. A separate agr•eemeYit toreimburse settlement payments has been held to beenforceable. Rc~uco D.S., Inc. v. Govern.~nent, Employees Iris.Co., 791 F. Supp. 1254, 1272, 1275-77, 1279 (N.D. Ohio1991), af~'d, 968 F2d 1216 (6th Cir. 1992}, published in fullat, 984 F.2r~ 154 (6th Cir. 1992) and aff'd, 984 F.2d 154 (6thCir. 1992). See also T.H.E. Ins. Co. v. Larsen Inter~modalServices, Inc., 242 F.3d 667, 676 (5th Cir. 2001).Babcock &Wilcox Co. a. Am,erica~z Nucica~- Instc~~ers, 2p13

PA Super 174, 76 A.3d 1 (2013), appeal granted in part, 84

4`L8

DEFENSE COSTS AND LEGAL AUDITS ~ 1 ̀I~:`L

A.3d 699 {Pa. 2014) (unp~.iblished opinion) is an interestingrecent decision. In this case, the intermediate Pennsylvaniaappellate court was presented witl~ the issue of whether apolicyholder that settled within policy limits but without theconsent of its insurer was able to seek reimbursement forthe settlement despite the insurer's continued defense of thepolicyholder and the presence of a "conseYlt to settlement"clause in the policy. Initially, the trial court appliedPennsylvania's bad faith standard, finding that the insurerwas only obligated to indemnify the policyholder if it declinedto settle in bad faith. 76 A.3d at "`3-4. B~.tt, upon rehearing,the trial court came to the opposite conclusion, holding that,where an insurer defends under a reservation of rights it isthe essential equivalent of denying a defense and requiresthe insurer to reimburse the insured as long as the settle-ment was fair and reasonable. 76 A.3d at ~~4.The appellate court took a different approach—one not

previously recognized uncler Pennsylvania case law. It heldthat a policyholder has twa options when its insurer ~f~ers adefense under a reservation of rights. It may accept thedefense, remain bound by all policy provisions, and allow theinsurer to retain fii11 control of the defense. 76 A.3d at "17.In this scenario, the policyholder's only recourse against theinsurer is a bad faith action. 76 A.3d at *17. Alternatively,the policyholder may decline the ins~.irer's defense and~~rocure its own defense. 76 A.3d at ̂ `18. Under this option,the policyholder retains coYitrol over the defense and is ableto litigate in the manner it deems best. If coverage is found,the policyholder is able to recover defense and settlementcosts from the insurer. 76 A.3d at ̂ ~1$. Based an this ruling,insurers in Pennsylvania now risk losing control of thedefense any time they issue a reservation of rights whilestill remaining liable to indeYnnify the insured for r eason-able settlements or judgments of covered claims.Many courts have ruled that the policyholder bears the

burden of apportioning a settlement or verdict betweenCOVBTed and non-covered claims. See, e.g., MedMczrc Cas. Iras.Co. v. Forcrst Healthca,rcz, Inc., 359 Ark. 495, 199 S.W.3d 58,61, 34 Employee Benefits Cas. (BNA) 1084 12004); PerdueFauns, Irtic. v. Travelers Cas. And Stcr•ety Co. 4f' America,448 F.3d 252, 263, 37 Employee Benefits Cas. (BNA) 2621,11 Wage &Hour Cas. 2d tBNA) $33 (4th Cir. 2006) (whereallocation of a settlement between covered and noncovered

429

1`L:~ ALLOCATION IN COMPLEX INSURANCE CLAIMS

claims must be resolved through litigation, the burden is onthe policyholder to prove the amount attributable to coveredclaims); Fi.ess v. State Farm Lloyds, 392 F.3d 802, $07 (5thCir. 2004), certified question accepted, (Jan. 21, 2005) andcertified question answered, 202 S.W.3d ?44 (Tex. 2006}(holding that "the policyholder bears the burden of present-ing evidence that will allow a trier• of fact to segregate thecovered losses from non-covered losses"); Raychem Corp. v.Fec~er•al Ins. Co., 853 F. Supp. 1170, 1175-76, Fed. Sec. L.I~.ep. (CCH) Y 98223 (N.D. Cal. 1994) (holding that thepolicyholder bears the burden of proving allocation of settle-ment liability between insured and uninsured parties, es~~e-cially when the insured controlled its own defense); KellerIndustries, fnc. a. Er~aployers Mut. Liability Ins. Co. ofWisconsin., 429 So. 2c~ 779, 780 (Fla. 3d DCA 1983) (holdingthat "the ~aarty claiming coverage .. . ha[s] the burden . .to apportion damages and show that the settlement, or por-tians thereof, re~~resentec~ costs that fell within the coverageprovisions").Other courts apply a shifting burden of prow£ Some courts

first require the insurer to show that at least some claims ordamages are not covered before placing the burden on thepolicyholder to prove what portion of the settlement iscovered. Canti~ten_tccl Cas. Co. v. Ctznacliun Universal Ins.Co., 924 F.2d 370, 376, 65 Ed. Law Rep. 340, 54 Fair Ernpl.Prac. Cas. (BNA) 1606, ~5 Empl. Prac. Dec. (CCH) P 40524(1st Cir. 1991). Other decisions initially place the burden onthe policyholder to show that coverage exists for some claimsand thexi shift the burden to the insurer to show "l7ow mlrchof the damage was caused by anon-covered cause." ImperialTra.dir2g Co., In,c. v. Travelers Property Cas. Co. of'Amer~zccr,,638 F. Supp. 2d 692, 694 (E.D. La. 2009).

Still other decisions holcl that, where the insurer controlsthe defense, it assumes the bu~~den of apportioning any judg-ment or settlement between covered and non-covered claims.Forest Health Care, Inc., 199 S.W.3d at 61-62, In AtctarrcaxHyundai South, L,L.C. v. Zurich American Ins. Co., 720 F.3d798, 807 (10th Cir. 2013), the court shifted the k~urden ofproving allocation from the ~~olicyholder to the insurer, hold-ing that "where bath covered and noncovered causes of ac-tion are alleged, the insurer —assuming it is in char ~e of theinsured's defense —must request a special verdict todisentangle the facts relevant to its indemnification of the

434

DL~"FENSE COSCS AND LEGAL ACJDITS~'' 12i:2i

insured," (citing Ma.grat~m Foods, Irxc. v. Cnntinentul Cas.Co., 36 P.3d 1491, 1498, 9 I.E.R. Cas. (BNA) 1601 (10th Cir.1994)). The court reasoned that, if the burden were placedon the policyholder to apportion a settlement or judgmentwhile the insurer controlled the defense, " ̀the insurer couldobtain for itself an escape from responsibility merely by fail-ing to request a special verdict or special inte~•rogatories.' "Autornccx, 720 F.3d at 808 (quoting Magnurra Foods, Inc., 36F.3d at 1498). The same reasoning would apply to requirethe policyholder to bear the burden of proof when it is con-trol.ling the defense directly or through independent counsel.Camden-Clary Mer~aor•ial Hose. Assn. v. St. Patel. Fire andMa,rirae Ins. Co., 224 W. Va. 228, 682 S.E.2d 566, 576 (2009)(holding the policyholder has the burden of proof to establishpY•oper allocation between covered claims and non-coveredclaiYns if the policyholder has controlled the defense of theunderlying claims). See also Raychcrm Corp. u. Fea'erul Iras.Co., $53 F. Supp. 1170, 1175-76, Fed. Sec. L. Rep. (CCH) P98223 (N.D. Cal. 1994) (court gave extra weight to the factthat the policyholder controlled its own defense in decidingto place the burden of allocation oYi the insured).The insurer.• may also bear the burden of allocating be-

tween covered and non-covered claims if it wrongfully re-fuses to defend the policyholder. See Ligrcar Liu,bility JointUradercvriting Assn of Massachusetts v. Hermitage Ins. Co.,419 Mass. 316, 644 N.E2d 964, 969, 44 A.L.R.5th 787 (1995)(holding that, where an insurer breaches its duty to defendand some claixils are covered and others are not, the iris~~rerhas the burden of proving allocation). However, not everycourt takes this approach. See Kc}ller- Industries, Inc. v.Employers Mut. Liability Ins. Co. of ~~isconsin, 429 So. 2d779, 780-81 (Fla. 3d DCA 1983) tholding that, even thoughthe insurer breached its duty to defend, it did not have topay a settlemexlt where rio coverage existed ar~d the partyclaiming coverage had the burden of allocating damages andshowing that the settlement represented costs that fellwithin the coverage ~~ravided by the ~~olicy).Even where the Policyholder has selected counsel, the

insurer still has certain rights and its role should not belimited to paying the bi11s. For exariiple, the Cccmis CounselStatute in Califorliia px•ovides:

(a) If the provisions of ~ policy of insurance impose a duty to

431

1 ̀L:`L ALLOCATION TN COMPLEX INSi1RANCE CLAIMS

defend upon an insurer and a conflict cif interest arises whichcreates a duty on the paz-t of the insurer t.o provide indei~en-dent counsel to the insured, the insurer shall provide indepen-dent counsel to represent the insured unless, at the time theinsured is informed that a possible conflict may arise or duesexist, the insured expressly waives, in writing, the right to in-dependent counsel. An insurance contract may contain a pro-vision which sets forth the method of selecting that counselconsistent with this section.(bl For purposes of this section, a conflict of interest does notexist as to allegations or facts in the litigation for which theinsurer denies coverage; however, when an insurer reservesits rights on a given 'issue and the outcome of that coverage is-sue can be controlled by coui~5el first retained by the insurerfor the defense of the claim, a conflict of interest may exist. Nnconflict o£ interest shall be deemed to exist as to allegations ofpuiritive damages or be deemed to exist solely because aninsured is sued for an amount iii excess of the insurance policylimits.(c) When the insured has selected independent coansel to rep-resent llim or her, the insurer may exercise its right to requirethat the counsel selected by the insured possess certain mini-mum qualifications which may include that the selectedcounsel have (1) at least five years of civil litigation practicewhich includes substantial defense experie~ice in the subjectat issue in the litigation, and (2) errors and omissionscoverage. The insurer's obligation to pay fees to the indepen-dei~t counsel selected by the insured is limited to the ratewhich are actually paid by the insurer to attorneys retainedby 'it in the ordinary course of business in the defense of simi-lar actions in the community ~,vhere the claim arose or is beingdefended. This subdivision does not invalidate other differentor additional policy provisions pertaining to attorney's fees arproviding for methods of settlement of disputes concerningi;hose fees. Any dispute concei•niil~ attorney's fees noi; resolvedby these methods shall be resolved by final and bindingarbitration by a single neutral arbitrator selected by the pai•-ties to the dispute.(d) When independent counsel has been selected by theinsured, it shall be the duty of that counsel and the insured todisclose to the insurer all information coiicernin~ t ie actioizexcept privileged materials relevant to coverage disputes, andtimely to inform and consult with the ins~~rer on all mattersrelating; to the action. Any claim of privilege asserted is subjectto in camera review in the appropriate law and motion depart-tnent of the superior court. Any information disclosed by theitYsured or by independent counsel is not a waiver of the privi-le~e as to any other party.(e) The insured may waive its ribht to select independent

432

DEFENSE COSTS AND LEGAL AUDITS ~ I~.,:~L

counsel by signing the following statement: "I have been ad-vised and informed of my right to select independent counselto represent me in this lawsuit. I have considered this matterfully and freely waive my right to select independent counselat this time. I authorize my insurer to select ~ defense at-torney to represent me in this lawsuit."(f~ Where the insured selects independent counsel pursuant tothe provisions of this sectioi7, both the counsel provided by theinsurer and independent counsel selected by the insured 511x11be allo«red to participate in all aspects of the litigation.Counsel shall cooperate fully in i;he eYclian~e of informationthat is consistent with each counsePs ethical and legal obliga-tion to the insured. Nothing iii this section shall relieve theinsured of his or her duty to cooperate with the insurer underthe terms of the insuraxice contract.

Cal. Civ. Code § 28G0

[c] Excess Insurers and the Duty to ReimburseDefense CostsIn contrast to the ~~rimary insurer, the excess insurer

rarely undertakes to defend the policyholder. Because thecost of defending a liability lawsuit can be significant, thenature and extent of the excess insurer's defense obligationhas been extensively litigated.

[1] Excess Insurer Generally Has No Duty toDefend

As a general matter, an excess insurer has r10 duty todefend a policyholder absent express contract language tothe contrary. See, e.g., Powerine Uil Co., In,c. v. Super°ivrCourt, 37 Cal. 4th 377, 404, 33 Cal. Rptr. 3d 562, 118 P.3d589, 606, 61 Endt. Rep. Cas. (BNA) 1202, 35 Envtl. L. Rep.20176 (2005), as modified, (Oct. 26, 2005) and as modified,(4ct. 27, 2005) (recognizing that "excess/umbrella policies donot as a matter of course contain a duty to defend"); Roya:lIns. Co. vf'Arne~•ica v. Laurelton Welding Service, Inc., 2004WL 1336324 (E.D. Pa. 20Q4) (applying Pennsylvania andNew Jersey law) (unpublished opinion) (finding that "pri-mary insurer has the duty to defend the insured while theexcess insurer has no such duty"); Sawyer v. Westcheste~-Fire I~as. Co., 2002 WL 31579159 (Cal. A~3p. 2d Dist. 2002)(unpublished opinion) (Nov. 20, 2002) and as modified ondenial of i eh'g, (Dec. 19, 2002) (un~~ublished opinion) (stat-ing the parties must "look to the specific language of theexcess policy to ascertain the existence of a duty to defend");

433

1L:~L ALIACATION IN COMPLEX INSURANCE CLAIMS

Notional Union Fire Ins. C.o. of PittsUur-gh, Penn. u. Travel-ers Ins. Co., 214 F.3d 1269, 1273 (11th Cir. 2000) ta~~plyin~Florida law) (holding excess liability insurer's duty to defend"depend[ed] solely on how that duty [was] defined by theterms of the excess insurance contract"); Firernan.'s FundIris. Co. v. TIC Ins. Co., 14 S.W.3d 230 (Mo. Ct. App. W.D.2000) (finding "if thex•e is nn language requiring tlse insurerto defend, there is Y7o duty to defend"); clones v. SouthernNlc~ri~ae & Aviatzon Underwriters, Inc., $88 F.2d 358 {5th Cir.1989) ("(w]e do nat see how Underwriters could havebreached a duty to defend when their policy certificates didnot impose a contractual duty to defend"); Institute of Lo~zdonIlnderwriter~s v. First Horizon Iris. Co., 972 F.2d 125 (5thCir. 1992) (applying Louisiana law); Cooper Laboratories,In.c. u. International, Sicrplzcs Li~aes Ins, Cv., 802 F.2d 667 (3dCir. 1986) (applying Louisiana law) ("duty to defend is amatter of contract"); All-Star' I~as. Corp. v. Steel Bc~r, Inc.,324 F. Su~~p. 160 (N.D. Incl. 1971) ("[the Yiature of theinsurer's duty to defend is purely contractual"); Car~r~oresel,Cor2cessions, Inc. v. Florida Ins. Guczr. Assn„ 483 So. 2d 513{Fla. Dist. Ct. App. 3d Dist. 1986) ("Caan insurer's duty todefend arises solely from the language of the insurancecontract"); Tschimperle u. Aetna Cas. &Sup•. C~., 529 N.W2d421 (Minn. Ct. App. 1995) ("[t]he duty to defend is contrac-tual in nature"); Crvrvn Center Redevelopment Cvrp. v.Occidental Fire & Cas. Co. of North Carolina, 716 S.W.2d348 (Mo. Ct. App. W.D. 1986) ("[t)he duty of an insurer todefend is contractual, and if there is no contract to defendthere is no duty to defend"); Chicugv & E. I. R. Co. u. RciserveIns. Co., 99 Ill. App. 3d 433, 54 Ill. Dec. 564, 425 N.E.2d 429(1st Dist. 1981) ("[wJe find na basis f'ox• disregax•ding thelanguage and imposirl~ upo~i the insurers a duty to defendthe policyholder which the insurers did not undertake iYi tl~einsurance policies"); Occideratul Fire &Ctrs. Co. of NorthCarolina a. Underrvriter•s at Lloyd's, London, 19 Ill. App. 3d265, 311 N.~.2d 330 (1st Dist. 1974); Er~ascnr, Inc. v. AllianceIns. Grozap, 804 S.W.2d 195 (Tex, l~pp. Houston 14th Dist.1991) (Bolding that following form excess contracts incorpo-ration of unde~•lying contract terms did not create a duty todefend); Ticor Title Ins. Co. v. Employe~.s Iris. of Wausau, 40C;al. App. 4th 1699, 48 Cal. Rptr. 2d 368, 373 (1st Dist. 1995)("[i]n the absence of contract language to the contrary, theexcess carrier has no right o~• duty to participate ir1 thedefense until the primary policy limits are exhausted").

434

I~~FENSE COSTS AND LECAI. AUUITS~~ 1~.+:~.+

Nonetheless, a distinct minority of courts leave held that,if an insurance contract does not contain a provision negat-ing an insurer's duty to defend (z.e., if the contx•act is silent),the excess insurer may, under certain circumstances, be ob-ligated to defend. See Legacy Vulcan Corp. v. Superior• C.oacrt,185 Cal. App. 4th 677, 110 Cal. Rptr. 3d 795 (2d Dist. 2010),review denied, (Sept. 7, 2010); Jahnsa~z Controls, Irac, v.Londo~a Market, 2010 WI 52, 325 Wis. 2d 176, 784 N.W.2d579, 71 Env't. Rep. Cas. (BNA) 1251 (2010); TIG Ins. Co. v.Eagle, IrT-c., 2007 WL 561153 (E.D. La. March 19, 2007) (rul-ing aggregate excess insurer 11ad a duty to defend policy-halder where (1) the underlying primary contract wasproperly exhausted, (2) the claim fell ~~vithin the terms of t17eexcess contract, (3) the excess contract followed form to theunderlying primary contract, which incl~.rded a defense p~•o-vision, and (4) the excess contract did not include a pr ovisionnegating defense cost coverage); Cadet. Mfg. Co. v. ArrtericanIns. Co., 391 F. Supp. 2d 884, 891 (W.D. Wash. 2005) (apply-ing Washington law) (Balding that aYz excess insurer.• wi11have a duty to defend the policyholder where "tl) the claimis covered under the laY~g~.rage of the excess policy; (2) theexcess policy does not expressly eliminate any defense obli~a-tion; and {3) the coverage and obligations of the underlyinginsurer have been validly exhausted"); t~eyerhaeuser Co. v.Comrnercial Il~aion Ins. Co., 142 Wash. 2d 654, 690, 15 P.3d115, 134 (2000), as amended, (Jan. 16, 20Q1) (holding excessinsurer is required to defend where the "excess policy doesnot expressly eliminate any defense obligation"); Aetna Cas.& Sccrety Co. v. Certazn Underwriters, 56 Cal. App. 3d 791,129 Cal. Rptr. 47 (2d Dist. 1976) ("the law imposed animplied obligation to defend where it is not ex~~ressly andclearly omitted from the particular risk"); Underwritc~r~s a,tLloyds v. Denali Seafoods, Inc., 729 F. Supp. 721 (W.D.Wash. 1989), aft"d, ~J27 F.2d 459, 1991 A.M.C. 3000 (9th Cir.1991) (ap~~lying Washington law) (finding an insurer hasduty to defend the policyholder against any alleged claimthat potentially falls within the scope of coverage); PhoenixPhase I Assocr.ates v. Ginsberg, Curen & Mer~r•itt, 27 OhioApp. 3d 240, 50Q N.E.2cl 365 ($th Dist. Cuyahoga County1985) (applying California Law); Hartford Accident &Indemnity Co. v. Stcperior Court, 23 Cal. App. 4th 1774, 29Cal. Rptr. 2d 32 (1st Dist. 1994); Interstate Fire & Cas. Co.v. Stuntman Inc., 861 F.2d 203 (9th Cir. 1983) (applying

435

1 ̀L:~L ALLOCATION IN CQMPLEX INSURANCE CLAIMS

California law); Gross v. Llvyds of Lgr2don In.s. C,o., 121 Wis.2d 78, 358 N.W.2d 266 (1934) (finding that, because any lim-itatiolis on the insurer's duty to defend is in the nature of anexclusion, the defense coverage clause must clearly expressthe limitation), overruled in part on other grounds, Matthiesenv. Continental Cus. Co., 193 Wis. 2d 192, 532 N.W.2d 729(1995}. But see Cotter Carp. v. American Errrpire Su~plzcsLines Iris. Co., 90 P.3d 814 (Colo. 2004), as moclified on denialof rel~'g, (June 7, 2004) (stating excess insurers had no dutyto defend because the contracts included language specifi-cally disclaiming such duty); Chubb /Pacific Indernni.ty Groupv. Ins. Co. of North Americo, 188 Cal. App. 3d 691, 233 Cal.Rptr. 539 (2d Dist. 1987) (recognizing language of excesscontract sufficiently excluded duty to defend).

[2] Excess Insurer's Right to AssociateAlthough excess insurance contracts ordinarily do not

contain a duty to defend, most provide that the excessinsurer has the "option" to participate or the right to "associ-ate" in the defense of laws~.iits pending against thepolicyholder. These provisions are iY~tended to allow theexcess insurer, if it chooses, to became involved in activelydefending lawsuits that could involve its layer of coverage.The option to defend, far example, may be exercised by insur-ers in situations where there is significant exposux•e in excessof the underlying limits and the policyholder and theunderlying insurer are not xi~ounting a strong defense. An-other instance in which an excess insurer may wish toexercise its right to associate in the defense is where theinsured or primary insurers are insolvent and there is a riskof a default ,judgment impacting the excess izisurer's limits.Most courts have held that, even where an excess insur-

ance contract allows the insurer the right or option to defendlawsr.~its, the insrxrer does not thereby have a duty to defendthe policyholder. See, e.g., Gener•ul Motors Accepturace Corp.v. Nationwide Ins. Co., 4 N.Y.3d 451, 796 N,Y.S.2d 2, 828N.E.2d 959 {2005); Ins. Co. of the tiVest v. County of McHenry,No. 02 C 2291, 2002 WL 1$03743 (N.D. Ill. Aug. 6, 2002)(un~~ublished opinion); Institute of London Underwriters v.Fzr~st Horizon In.s. Co., 972 F,2d 125 (5th Cir. 1992) (apply-ing Louisiana law); Can.tinental Cas. Co. v. Pittsbu~•ghCvrn,ing Carp., 917 F.2d 297 (7th Cir. 1990) (applyingPennsylvania law); Home Iris. Co. v. American Horne

436

DEFENSE COSTS AND L~Gl3L ALJUITS § 12:~I+

Products Corgi., 902 F.2d 1111 (2d Cir. 1990) (applying NewYork law); Outboard Marine Corp. v. Liberty Mut. In.s. Co.,536 F.2d 730 (7th Cir. 1976); Schwinn Cycling &Fitness,Inc. v. Hat-tford Acc. and Indem. Co., $63 r. Su~~p. 784 (N.D.Ill. 1994) (applying Illinois law); B & D Ap~raisuls v.Gaudette Machinery Movers, Inc., 752 I+. Supp. 554 (D.R.I.1990) (applying Rhode Island law); Lazzara ail Co. v. Colurn-hia Ca~s. Co., 683 I~~. Supp. 777, 1988-2 Trade Cas. (CCH) P68217 (M.D. Fla. 1988), af~'d, 868 F.2d 1274 (11th Cir. 1989){~~~plying Florida law); Liberty Mut. Ins. Co. v. Paci f c Iradem.Co., 579 F. Stipp. 140 (W.D. Pa. 1984); ChubblPucific Indem.Group v. Ins. Co. of North. America, 188 Cal. App. 3d 691,233 Cal. Rptr, 539 t2d Dist. 1987); Corrahusker A,;r. Ass'rz,Inc. v. Equitable General I~zs. Co., 223 Neb. 61$, 392 N.W.2d366 (1986); Zc~borac v. Amer-icttn. Cas. Co. af' Reading, Pa.,663 F. Supp. 330 (C.D. Ill. 1987) (applying Illinois law);Chicago & E. I. R. C,o. v. Reserve Ins. Co., 99 Ill. App. 3d433, 54 Ill. Dec. 564, 425 N.E.2d 429 (lst Dist. 1981).Simply stated, the option to defend lawsuits against the

policyholder is included for the protection of the excessinsurer and does not give rise to a duty to defend thepolicyholder.

[3~ Duty to Reimburse Defense CostsAlthough excess insurance contracts ordinarily do not

impose a duty to defend, depending upon the language of thecontract, under certain circumstances, an excess insurermay ba obligated to reimburse the policyholder for defelisecosts. The duty to defend and the duty to reimburse are twodistinct obligations. See Federal Ins. Co. v. Kvzlo~oski, 18A.D.3d 33, 792 N.Y.S.2d 397, 34 Employee Benefits Cas.(BNA) 2678 (1st Dept 2005); Lowy a. Truaelers Property &Cas. Co., 2000 WL 5267Q2 (S.D. N.Y. 2000) (ap~~lying NewYork law) (unpublished opinion); American Cas. Ca. ofReading', Fennsylvania v. Rahn, 854 F. Sup~~. 492 (W.D.l~2ich. 1994) (applying Michigan law) ("Cdluty to defendclauses and reimbursement clauses are two different things[andJ the fact that the insurance cornpariy has agreed to re-imburse the defense costs of the policyholder does not createa duty to defend on the part of the iYisurance cori~parly.");Save Mart Sz~permarkets v. Underwriters ut Lloyd's London,843 F. Supp. 597, 72 Fair Empl. Prac. Cas. (BNA) 831 (N.D.Cal. 1994) ("an obligation to reimburse is not determinative

437

1L:~L ALLOCATION IN COMPLEX INSURAT~TCE CLAIMS

of an obligation to defend"); Baard of Trustees af'Michib~anState University v. Continerata.Z Cas. Co., 730 F. Supp. 1408(W.D. Mich. 1990) (applying Michigan la«); FMC Corp. v.Plaisted and Companies, 61 Cal. App. 4th 1132, 72 Cal. Rptr.2d 467 (6th Dist. 1998), as modified on denial of reh'g, (Mar.27, 1998); Z{'edera.l Ins. Co, v. St. Paul Fire & Ma.rine Ins.Co., 638 So. 2d 1132 (La. Ct. App. 1st Cir. 1994); Zaborac v.American Ca.s. C~. of Readin~~, Pa., G63 F. Supp. 330 (C.D.Ill. 1987) (applying Illinois law) ("the fact that tl~e insuraxicecompany has agreed to reimburse the policyholders for lossesdoes not c~ eate a duty to defend an the part of the insurancecompany"). Accordingly, an insurer may assume a duty toreiYiiburse defense costs ~~vithout ha~~ing a duty to defend.

Im~~ortantly, where an excess insurance contract providesfor reimbursement of defense costs generally the onlyreiinbt~rsable expenses are those associated with "covered"claims as apposed to "potentially covei ed" claims. See, e.g.,City of Burlington v. Association of Gas & Elec. Ins. Services,Ltd., 170 Vt. 35$, ?51 A.2d 284 (2Q00) (finding it was ap-~~ropriate for excess insurer to allocate defense costs andsettlement payment between covered and non-coveredclaims); Stonewall Ins. Co. v. Ashestns Claims MccnagemeratCorp., 73 F.3d 1178 (2d Cir. 1995), opinion modified on denialof reh'g, $5 F.3d 49 (2d Cir. 1996) (applying Texas and NewYork law); Matte.~~ af' Celatex Carp., 152 B.R. 661 (Bankr.M.D. Fla. 1993) (a~~plying Florida, Illinois, and Ohio law) ("ifthe [policyholder] is not liable on the underlying claim, therehis been no occurrence covered under the policy and, thus,the excess insurer is under no obligation to indemnify (thepolicyholder] f'oY• anything, including defense costs associatedwith defending the underlying claim"); FMC Corp. v. Plaistedand Companies, 61 Cal. App. 4th 1132, 72 Cal. RptY. 2d 467(Gth Dist. 1998), as modified on denial of reh'g, (Mar. 27,1998); In r-e Kenai Corp., 136 B.R. 59 (S.D. N.Y. 1992) (ap-plying New York law) ("[u]nlike duty to defend policies,which require the insurer to defend claims even if they areoY~ly arguably entitled to coverage, policies requiring theinsurer to reimburse damages and defense costs related towrongful acts entitle the insurer to costs only when theunderlyiYig claims are covered by the policy"); Nurthlan.dCccs. Co. v. HBE Corp., 160 F. Supp. 2d 134$, 1360 (M.D.Flaw. 2001) (applying Florida, No~~th Carolina, and P~nnsyl-vania law).

<~38

DEP`ENSE COSTS AND LT`GAL AUI3ITS ~ 1`L:rL

A recent New Jersey appellate court decision did not liYnitthe insurers' obligation to reimburse defense costs to defensecosts associated with covered claims. In IMO In.dicstries Inc.v. Transamerica Corp., 2014 WL 4810Q47 (N.J. Super. Ct.App. Div. 2014), some insuiers challenged the trial court'sruling that defense costs incurred by the policyholder IMOin connection with "uncovered" asbestos claims are r•ecover-able under "ultimate net loss" policies that limit defensereimbursement to costs paid as a consequence of a coveredoccurrence. Essentially, the trial co~rrt and appellate divisionagreed with IMO that tl~e excess insurers' policies pY~omiseto pay for the costs of defending liabilities arising fromcovered "occ~.irrences," not covered "claims," and Owens-Illi-nois defines an "occurrence" to be the decision to manufactureasbestos-containing products, not the exposure of a specificclaimant to an asbestos ~~raduct. According to the court,

the excess insurers' obligation to cover IMO's ultimate netlosses, which include defense costs, was triggered when IMOmanufactured and sold asbestos-containing products andclaimants became injured by those products. IMO's decision totrade in such products resulted in IMO ~ayin~ damages toclaii7iants f'ollowin,; litigation or settlement. Under the termsof the excess insurance policies, LMI anti ACE are required toindemnify IMO f'or the sums it expended in defending all thoseclaims.The conclusion that the excess insurers must reimburse IMOfoi• defense costs even if some of them were incurred to defenduncovered claims is also compelled by another aspect of Owens—Illiraor.s. As i:he [special allocation mastery noted, the need tosegregate end classify defense costs according to each individ-ual claim would greatly complicate the already complex alloca-tioi7 process. Challenges among the parities as to whether par-ticular claims were covered ar uncovered would increaselitigation and require additional judicial attention. The reasonthe Court developed the pro-rata methodology was to reducethe litigation costs and judicial inefficiencies attendant toresolving insurance coverage f'ar long-term environsnentaidamages. Owens—Itl.inois, supra, 138 N. J. at 474, 650 A.2d974. Adopting the process that the excess insurers suggestwould directly contravene those objectives.

2014 WL 4810047 at ~~27. The rationale supporting this deci-sion appears to be unique to New Jersey.Unlike the duty to defend, the obligation to reimburse

does not arise until coverage for a given claim is established.Luther a. Fidelity &Deposit Co. of Maryland, 679 F. Supp.

439

1`L:2. ALLOCATION IN COMPLEX INSUR/iNCE CLAIMS

1092 (S.D. Fla. 1986) (applying Florida law} (holding, wherethe contract gave the insurer "option" of advancing defensecosts, the insurer was not obligated to do so px•ior to finaldisposition of any claim); American Excess Ins. Co. v. MGMCra,nd Hotels, In.c., 102 Nev. 601, 729 P.2d 1352 (1986) (find-ing an excess insurer is not obligated to reimburse defensecosts acid legal expenses falling within its layer of coverageuntil all of the liability claims arising out of occurrence havebeen resolved).

[A] Consent RequirementMarcy excess and umbrella insurance contracts expressly

require the policyholder to obtain the insurer's consent priorto incurring defense costs where the policyholder seeks cover-age for such defense costs under the excess insurancecontract. Some courts have construed such consent provi-sions narrowly such that prior consent is not necessary. See,e.g., North Rive• Ins. Co. v. CIGNA Reinszcran.ce Co., 52 F.3d1194 (3d Cir. 1995) (applying Ohio law) {ruling consentcondition applied only ~~vlzere coYisent has been reasonablywithheld); Coastal Zrora Wor•Jzs, Inc. v. Petty Ray Geophysical,Div. of Gevsvrc~•ce, In.c., 783 F.2d 577, 1987 A.M.C. 571 (5thCir. 198G) (applying Texas law) (construing written consentrequirement as not providing an insurer with the option todefend, but rather with a right to be notified before costs areincurred).Other courts have enforced such provisiolis as requiring

actual consent from an insurer as a ~~recondition to coverageof defense costs. For example, the United States Court ofAp~~eals for the Second Circuit in Ston.ewaZl In.s. Cn. v.Asbestos Clairrts Man,age~nent. Cvrp., 73 F.3d 1178 (2d Cir.1995), opinion modified on denial of reh'g, 85 F.3d 49 (2dCir. 1996) (applying Texas and New York law), rejected apolicyholder's contention that a "mutual consent" conditiononly permitted aYi insurer to deny ulireasonable or excessivedefense costs incurred an behalf of the policyholder. TliecoY~tract at issue provided, iY~ pertineYzt part:

In the event expense and/or costs in con~~ectian with any claimor suit is incurred jointly by mutual consent of the Companyand of the Insured or Primary Insurer, the Company, in adcli-tion to its limits of liability .. .shall be liable for na greaterproportion of such expense and/or costs than the amotmt pay-able by the Company under this Policy bears to the total losspayment.

440

DEFENSE COSTS AND LEGAL AUUI7`S ~'~ 12:2+

In support of its holding, the Second Circait reasoYied:

[W]e agree with the District Court that, pursuant to this pro-vision, the insurer has no duty to defend or pay costs, but oi11yhas the right to do so at its own election. The insurer canpermit the [policyholder's] defense to proceed and take thechance that the CpUlicyholderJ ~~ill exceed the limits of other li-ability coverage, or participate in the defense and agree to payall or part of the defense costs incurred. The consent provisiondoes not require the insurer to inclemnif'y [tlie. policyholder] fordefense costs unless the parties mutually agree beforehand tothis arran~csment.

73 F.3d at 1219.The Staneu~all decision is consistent with several cases

interpreting similar contract language as requiring aninsurer's consent as a precondition to payi7zg costs and reject-ing the notion that there is an implied reasonablenessrequirement in the consent provision. For example, in CrotunCenter Redeveloprrtent Corp. v. Occidental 1~'ire & Cas. Co. ofNorth Carolzna, 716 S.W.2d 348 (1l~0. Ct. App. W.D. 1986),the contract at issue limited the insurer's liability to paydefense costs to those incuried with its consent. The courtremanded the case for entry of judgment in the insurer'sfavor after finding no evidence that the insurer had consentedto incur defense casts. The court reasoned:

(T]he obligation of . [the insurer) to pay clef'ense costs isneither fixed nor absolute. The obligation is plainly stated that. • [the 'insurer] will pay costs which may be incurred by theinsured with the consent of ... [the insurer]. Thus, the entireobligation is conditioned on the consent of . [the insurer]and not simply the procedure by which the obligation is car-ried out.

716 S.W.2d at 356.Similarly, in Chesapeal~e &Ohio R,y. Co. v. Certain Under-

rvrite~-s at Lloyd's, London, 834 F. Sapp. 456 (D.D.C. 1993),off d in part, redd in part on other grounds, 82 F.3d 478(D.C. Cir. 1996) (applying Virginia law), t11e court addressedthe validity of a contract term providing "that r10 legal castsor expenses shall be inc~.lrred witl~ol~t t11e consent of theinsurer." The court conclucled that "fulnder the plain andunambiguous language of these provisions, the duty todefend is conditioned on . . . Ctlle insurer's] giving consent."834 F. S~.rpp. at 461. Because it was undisputed that theinsurer had not given its consent, the court entered sum-

441

S 1~i12i ALLOCATION IN COMPLEX INSURANCE CLAIMS

wary j~.ldgment irz favor of the iYisurer. See also Gerxeral Acc.In.s. Co. of America v. American Ins. Co., 2000 WL 92097(E.D. Pa. 2000) (unpublished opinion) (applying Pexznsylva-nia law) (holding that an excess insurer is not required to re-imburse pro rata share of defense costs because the excesscontract requires written consent before the policyholderincurs defense expenses); Truck Ins. Exchange v. UnigardIns. Ca., 79 Cal. App. 4th 9G6, 94 Cal. Rptr. 2d 516 (2d Dist.2000) (noting that "the deity to cont~•ibute to Ldefense] costswould arise only if (the policyholder] obtained [the excessinsurer's] writteYi consent to incLir costs"); AstenJohrzsorz v.Columbia Cas. Co., 483 F. Sapp. 2d 425, 480 (E.D. Pa. 2Q07),judgment aff"d in part; redd in part on other grounds, 562F.3d 213 (3d Cir. 2009) (finding "the policy only requrres theins~.~rer to pay the defense cpsts it consents to"); Pline SafetyAppliances C~. v. AIU Ins. Co., 2014 WL 605753 (Del. Supr.Ct. Jan. 21, 2014) (finding policies clearly only cover defensecounsel to which insurer consisted, rejecting ~~olicyhalder'sattempt to impose a reasonableness requirement on refusalto consent, and rejecting attempt to proofer expert testimonyan alleged custom and practice on any requirement ofreasonableness); Botany Bay Marina, Inc. v. Great AmericanIns. Co., 760 F. Supp. $$ (D.S.C. 1991) (applying South Car-olina law) (stating there is no coverage for defense costsabsent the insurer's consent); Occiden.ta,l Fire & Ca,s. Cv. ofNorth Carolina v. Underwriters at Lloyd's, London, 19 Ill.App. 3d 265, 311 N.E.2d 330 (1st Dist. 1974) (recognizingthat the insurer's prior written consent was required foxcosts to be payable); Driggs Corp. v. Pennsylva-nra Mfrs. AssnIns. Co., 181 F.3d 87 (4tli Cir. 1999) (uYipublished opinion)(a~~plyin~ Maryland law) (ruling the insurer is entitled to re-cover $150,000 paid to experts where the policyholderretained expert prior to obtaining consent).Properly understood, provisions providing for reimburse-

ment of defense costs incurred with the insurer's consent ex-ist for the protection of the insurer, where the insurerbelieves incurring defense costs will protect its exposure forincleinnity losses; such provisions are not f'or the benefit ofthe policyholder. Accordingly, the excess insurer should beable to give consent for defense costs land pay a portion ofsuch casts in accordance with the contract) or withholdconsent (and not be liable for defense costs) in accordancewith its unilateral wishes or interests.

442

D~F~NST) ~OSTS AND I.L;GfiL AiJDITS fi 12:`1.+

[B] Whether "Defense Costs" Are Includedwithin the Definition of "Loss"

Many excess insurance contracts contain definitions of"lass" or "ultimate net loss" that specifically exclude costsand legal expenses. Most courts that have add~•essed the is-sue have held that such contracts unambiguously excludecoverage for legal expenses. Seri TIG Iris. Co. v. Nar•th Ameri-ca.n Van Lines, Inc., 170 S.W.3d 264 (Tex. Ap~~. Dallas 2005)(finding definition of "ultimate net loss" in excess contractexcluded defense costs); Hercules, Inc. v. AIU Ins. Co., 784A.2d 481 (Del. 2001) (holding that excess contract defining"Ultimate Net Lnss" to exclude all expe~Yses and casts didnot cover the policyholder's defense costs); Continental C,as.Co. v. Pittsburgh Corning Corp., 917 F.2d 297 (7th Cir. 1990)(applying Pennsylvania law); Home In.s. Cv. v. Amc~riecr,raHome Prods. Corp., 902 F.2d 1111 (2d Cir. 1990) (applyingNew Yark law}; Chesapeal~e & Ohiv Ry. v. Ce~~tain, ZTnder-writers at Lloyd's London, No. 85-3162, (D.D.C. Oct. 16,1991); United States Gypsum Co. v. Continental Cas. Co.,No. 83 L 53328, (Ill. Cir. Ct. Jan. 8, 1990). Bict see A~iliutedFM Ins. Co. v. Owens-Corrtzr2g Fiberglas Corp., 16 F.3d 6$4,1994 Fed. Appx. 0047P (6th Cir. 1994) (applying Ohio law)(reversing summary judgment in favor of the insurer andremanding for consideration of extrinsic evidence).

In Can.tinentul, Cas. Co. v. Pzttsburgh. Corning Cvrp., 917I'.2d 297 (7th Cir. 1990) (applying Pennsylvania law), an up-per layer excess insLYrer contended that it was not obligatedto pay defense costs incurred by its policyholder, PPGIndL~stries, in connection with thousands of asbestos bodilyinjury lawsuits. Z'he excess contract insured against "loss,"which was defined to exclude expenses and costs fromcoverage. Tlse excess contract incorporated by reference theinsuring agreement of the underlying primary insurance,which covered allocated expenses including defense costs.1989 WL 106468 (N.D. Ill. 19$9). PPG recognized thatdefense expenses were excluded from the excess contractthrough the definition of "loss." Yet, it argued that Continen-tal nevertheless eras obligated to "follow the form" of theunderlying primary insurance and pay defense costs. It thenargued that this obligation to reimburse defense expenseswas outside of and in addition to the expressed limits ofliability.

Continental advanced three arguments in support of its

443

1 ̀L:~Ir ALLOCATION IN COMPLEX INSURANCE CLAIMS

position that its carltract did nat cover PPG's defense casts.first, it contended that its insuring agreement coverecl only"LOSS," t~1c`~t ~~IOSS" WaS C~Bf7210C~ c1S "SUTYIS jl`d1C~ 1I1 S2tt18I118I1t Of

losses for which the insured is liable," and that the "naturalunderstanding" of "sums paid in settlement of lasses . .cannot coYnprehend lawyer's fees." Second, noting that thedefinition of "loss" expressly exch~ded "costs" and that "costs"were defined to include "legal expenses," the insurerreasoned that "law,yers fees are the most coYnmonly under-stood form of ̀legal expenses' and thus, must be excludedfrom the definition of loss." Third, Continental emphasizedthat the cai~tract allowed it to participate in the defense ofclaims "likely to involve this policy." ContiYiental argued thatto impose an absolute duty in the face of such languagewould reYider the condition meaningless.The district court rejected PPG's ar~~.iments and g~•anted

summary judgment to ContiYzeiltal, holding that the excessinsurance contract did not include any part of defense costswithin its terms of coverage. The court reasoned that thedefiziition of "loss" in file excess contract could YZot reason-~bly be construed to include defense costs: "Ctlhe commonunderstanding is that the sums paid in settlement of lossesare those amounts paid to satisfy the liability assertedagainst the insured, not the costs of the insured's defense."1989 WL 106468 at 6. The United States Co~irt of Appealsfor the Seventh Circuit affirmed, rea~orling that "[the]indemnification is limited to loss, loss excludes costs, costsinclude legal ex~~enses, so legal expenses are excluded fromcoverage." 917 F.2d at 298.Similarly, the United States District Court for the

Southern District of New York, interpreting aY~ excesscontract with language excluding "costs and expenses" fromthe definition of"loss," 11e1d that the contract plainlyexcluded defense costs. Home Iras. Co. v. American HomeProducts Corp., 665 F. Supp. 193 (S.D. N.Y. 1987), judgmentaf~'d in part, rev'd iri part an other grounds, 902 F2d 1111(2d Cir. 1990) (applying New York 1aw). In so holding, thecourt stated:

Although (the policyholder] labors mightily to obfuscate theplain language of the Home excess policy, it is clear to me thatneither the legal fees incurred nor the interest that ac-cuinulated after judgments are covered by the policy. The plainlanguage of the Home excess policy specifically excludes them.Thus, there is nothing more to be said on this point.

444

DEFENSE COSTS AND L~CxAL AUUI'~`S ~ 1L:`l+

665 F. Supp. at r96. The United States Court of Appeals forthe Second Circuit affirmed this portion of the district court'sdecision. Home Ins. Co. v. Amer-zcan Home Products Corp.,665 F. Supp. 193 (S.D. N.Y. 1987), judgment af~'d in part,redd in part on other grounds, 902 F.2d 1111 (2d Cir. 1990)(a~~plying• New York law).Where an excess insurance contract provides coverage fox•

defense costs, reference to the contract is requii ed todetermine whether such costs are payable within thecontract's stated limits of liability or in addition to the limitsof liability. Most of the excess or umbrella contracts thatcover defense costs do sa within limits. Such contracts areoften referred to as "wastilig limits" contracts. In otherwords, they cover defense costs, but payment of defense costsserve to waste or reduce the stated limits of liability.

[4] Umbrella Insurer's Obligation to DefendLawsuits "Not Covered" by Primary Insurance

Some umbrella contracts obligate the insL~rer to defendlawsuits that are covered under the umbrella contract butnot under the primary contract. The broader coverage of ~numbrella contract, includiri~ the umbrella insurer's defenseobligation, may apply to risks that are excluded by or arenot within the scope of the underlying coverage or to thoserisks which fall within the .mare expansive coverage of theumbrella contract. See Home Iras. Co. v. National U~zion FireIris. of Pittsburgh, G58 N.W.2d 522 (Minn. 2003), as modifiedon denial of reh'g, (Apr. 3, 2003) (finding an umbrella insurerwas liable to pay the defense expenses associated with claimsbeyond the reach. of the primary contract but within theumbrella contract's scope); Continental Cas. Co. U. RoperCorp., 173 Ill. App. 3d 76Q, 123 Ill. Dec. 360, 527 N.E.2d 998(1st Dist. 1988); Arnerica.n States Ins. Co. v. Maryland Cas.Ca., 427 Pa. Super. 17~, 628 A.2d 880 {1993) (r~.~ling areumbrella insurer was required to defend where the umbrellacoYztract provided coverage for areas not covered by primarycontract); National Uniora I+ire Ijas. Co. u. Glenview Pur•kDi.st., 230 Ill. App. 3d 578, 171 Ill. Dec. 780, 594 N.E.2d 1300(lst Dist. 1992), aff'cl in part, redd in part on other grounds,158 Ill. 2d 116, 198 Ill. Dec. 428, 632 N.E.2d 1039 (1994)(finding umbrella insurer was required to defend claim orsuit to which no primary insixrance applied); Hockey v. NewHam~ashire Ifas. Co., 922 T~'.2d 1476 (10th Cir. 1991) (a~~~~ly-

~~J

X2:5 ALLOCATION IN COMPLEX INSURANCE CLAIMS

ing Wyoming law); Americttn Motorists Ins. Cv. a. Tra.rze Co.,544 F. Supp. 669 (W.D. Wis. 1982), af~'d, 718 F.2d 842 (7thCir. 1983) (applying Wisconsin law).One situation in the past where the umbrella insurers

s~~pplemerital defense obligation could arise was in thecontext of a claim within the scope of the umbrella coveragefor "personal injury" or "advertising liability," but outsidethe scope of the primary general liability primary coveragethat provide coverage on a "bodily injury" basis.

Generally, courts have rejected policyholders' argumentsthat the mere exhaustion of a primary layer of coverage bythe ~~ayinent of claims gives rise to an umbrella insurer'sdefense obligation. For instance, in Contincznta,l Cas. C,a. v.Roper Corp., 173 Ill. App. 3d 760, 123 Ill. Dec. 360, 527N.E.`Ld 998 (1st Dist. 198$), the ilisurer agreed to indemnifythe policyholder with respect to any occ~.irrence or type ofdamages (i.e., punitive damages) "not covered" by theunderlying insurance. The palicyholdea• argued that theCoverage B part of the umbrella contract covered theunder lying claim because the lawsuit fell under the terms oftl~e underlying prixizary contract and would lave been paidbut for the e~austion of the primary limits. The court heldthat the "not covered" language "refers to the fact of cover-age, not to the extent of coverage under that policy." 527IV.E.2d at 1003. Because "both the type of occurrence riskand the type of damage risk had been assumed by theunderlying ins~.irer," all risks were "covered" even thoughpayment was not made by the primary ins~.rrer because theprimary limits had been exhausted. 527 N.E.2d at 1003. Seealso Native American, Arts, Inc. v. Hartford Cas. Ins., No. 03C 7233, 2004 WL 2065065 (N.D. Ill. Sept. 10, 2004) tap~~ly-ing Illinois law) (unpublished opinion) (finding regardless af'whether the limits of the primary contract were exhausted,an umbrella insurer did not have a duty to defend theunderlying occurrence due to application of an exchision inthe umbrella contract); Far•tin v. Hartford Un.der•wri.ter-s Ins.Co., 20Q5 WL 1Q83800 (Conn. Super. Ct. 2005) (unpublishedopinion) (bolding that the umbrella contract languagedictated that the umbrella insurer had a duty to defend thepolicyholder in a lawsuit that was "covered by the terms andconditions of the [umbrellal policy, but not covered as war-ranted by the underlying policy"); Garmany v. Mzssion. Ins.Co., 785 F.2d 941 (11th Cir. 1986) (applying Georgia law)

h46

DEFENSE COSTS AND LECAI, AUDITS ~ 12+:`Z

(stating the term " ̀not covered' speaks only to the fact ofcoverage under the underlying policy, not to the extent ofcoverage under that policy") (emphasis in original); SeatsIn.c. a. Nutr~aeg Ins. Co., 178 Wis. 2d 219, 504 N.W.2d 613(Ct. App. 1993) (ruling that an umbrella liability contractrequired the policyholder to keep underlying comprehensivegeneral liability contract in force; inclusion of self-insuredretention in contract's declarations was not an indicationthat the policyholder would only have been liable for amountof self-insured retention); American Special Risk Ins. C~. v.A-Best Products, In.c., 975 F. S~.rpp. 1019 (N.D. Ohio 1997),af~'cl, 1G6 F.3d 1213 (6th Cir. 1998) (applying Ohio law) (llold-ing in context of asbestos claims that "not covered" relates tothe scope of risk undertaken by the primary insurer, not itsexhaustion status); Freimzcth. v. Glens Falls Ins. Co., 50Wash. 2d 621, 314 P.2d 468 (1957) (ruling "coverage" meanst11e risks that a insurance contract covers); Traders StateBarak, Glerz Elder, Kan. v. Contirz.ental Ins. Ca., 448 F.2d 280(1Qth Cir. 1971) (applying Kansas law); Seubaugh v. Sisk,413 S.W.2d 602 (Mo. Ct. App. 1967); D'Angelo u. CornellPaperboard Pr~vducts Co., 59 Wis. 2d 46, 207 N.W.2d $4G(1973); Hotcsing~ Group v. California Ins. Guar•untee Assn., 47Cal. App. 4t11 528, 56 Cal. Rpt7-. 2d 378 (4th Dist. 1996), asmodified on denial of reh'g, (July 23, 1996)

In Jostens, Znc. v. Mission Ins. Co., 387 N.W.2d 161 (Minn.1986}, the court addressed the situation where both a pri-maryand an umbrella insurer arguably had a duty to defendthe ~.~Yiderlying lawsuit. The policyholder tendered thedefense of a wrongful discharge suit to its primary andumbrella insurers, both of which declined to defend the suit.In a subsequent suit by the policyholder to iecover itsdefense and settlexiient costs from these insurers, the Min-nesota Supreme Court ruled:

C4V]11ere an umbrella policy is involved, as bet~~~een theuiiderlyin~ insurer and the umbrella insurer, the t~nderlyii~ginsurer slYall be lial.~le for the entire defense costs except as tothose costs that the underlying insurer can show were f'ordefendiizg claims covered only under the umbrella insurer's"braider" or primary coverage.We believe this ~•ule will encoui°age two insurers, whentendered a defense, to resolve promptly the duty to defend is-sue either by some cooperative arrangement between them, orby ~ declaratory judgment action, or by some otlYer means.

447

1 ̀li:2i ALLOCATION IN COMPLEX INSURANCP CLAIMS

~~Vhen ~n Lmlbrella carrier is involved, our rule assibns more ofthe risk of liability for defense costs to the underlying carrier,which, because it bargained for the primacy coverage, seemsappropriate.

387 N.W.2d at 167. Thus, an uYizbrella insurer's obligation todefend only arises where the primary insurance does notprovide coverage. See cr.lso Barrett Paving Materials, Inc. v.Continental Ins. Co., 2005 WL 2877742 (D. Me. 2005), reportand recommendation adopted, 200G WL ̀L87951(D. Me. 2006)(applying Maine law) (unpublished opinion) (holding that"umbrella [coYztract] is said to ̀ drop down' to provide priYnarycoverage where the underlying policy provides no coverageat all"); Scvtt,'s Liquid Gold, Iric. v. Lexington Irrs. Co., 293F.3d 1180 (10th Cir. 2002) (applying Colorado law} (rulingtl~e "not covered" clause in umbrella contract, dictates thatumbrella insurer "is to provide far risks not insured againstby the underlying insLtY•ances"); Fidelity &Deposit C.u. ofMar3~land v. Hartford Cas. Ins. Co., 189 F. Strpp. 2d 1212 (D.Kan. 2002) (applying Kalisas law) (noting the L1nlbrellacontract language dictated that the umbrella insurer had aduty to defend the policyholder «hen the underlying insur-ance did not apply); Metlife Capital Carp. v. Westchester FireIns. Co., 224 F. Sapp. 2d 374 (D.P.R. 2002) (applying PuertoRico law) (holding the umbrella insurer is required to " ̀dropdown' and provide horizontal co~~erage only when no cover-age is ~~rovided for the type of occurrence at issue under thepriYiiary policy"); Hocker v. New Hampshi~•cy Ins. Ca., 922F.2d 1476 (10th Cir. 1991) (applying Wyoming law) (holding,based on contract langl~age, that umb~~ella insixrer owed dutyto defeY~d oYzce primary insurer refused to defend); Cranfar~dIns. Cn., Irac. v. Allwest Ins. Co., 645 F. Sapp. 144Q (N.D.Cal. 1986) (applying California law) (finding based oncontract language, the umbrella insurer owed defense whereit was aware of possibility that claim was excluded from pri-mary contract)..But see Hawkins Chem.icad, Inc. v. WestchesterFire £ris. Co., 159 F.3d 348, 29 Envtl. L. Rep. 20309 (8th Cir.1998) (applying Minnesota law).Courts generally have rejected policyholders' q~~ests for ~

defense under supplemental defense provisions in umbrellacontracts based upon the contention that claims are notcovered by reason of a primary insurer's insolvency. See, e.g.,North American Capacity In.s. Co. v. Claremont Liabr.lr.ty Ins.Co., 177 Cal. App. 4th 272, 99 Cal. Rptr. 3d 225 (2d Dist.

448

DF.FENSF COS"[`S AND L~GAI. AUUI'T`S~' 12:3

2009) (umbrella iYzsurer did not drop down to defend or coverlosses that were "the subject of the underlying primarypolicy, but which were not covered under the primary policydue to insured's failure to comply with cont~•actor's warrantyendorsement and, under California rule ofhorizontal exhaus-tion, all primary insurance must be exhausted before excessinsurer must drop down to defend an insured); Barrett,Pa.ving~ Materials, I~ac. v. Continental In.s. Co., 2005 WL2877742 (D. Me. 2005), report and recomineridation adopted,2006 WL 287951 (D. Me. 2006) (applying Maine law} (un-pt~blished opinion) (finding the umbrella insurer was notrequired to "drop down" and defend the policyholder due tothe primary insurer's insoh~ency); ZJ.S. Fir-c~ Ins. Co. v.Colerrcan, 754 S.W.2d 941(Mo. Ct. App. E.D. 1988); GuarantyNaf,. Ins. Ca. v. Ba3~side Resort, Inc., 635 F. Supp. 1456(D.V.I. 1986); Continental Cas. Co. v. Roper Corp., 173 Ill.App. 3d 7G0, 123 Ill. Dec. 360, 527 N.E.2d 998 (1st Dist.19$$); Mission Nut. Ins. Co. v. Dulve Transp. Co., Inc., 792F.2d 550 (5th Cir. 1986) (applying Lo~iisiana law); Ar1~rvrightBoston Manufacturers Mut. Itas. Co. v. Aries Marine Corp.,932 F.2d 443 (5th Cir. 1991} (applying Texas law); Highla.nr~?sIns. Co. v. Gerber Products Co., 702 F. Supp. 109 (D. Md.1988); U.S. Fire Ins. Co. v. Colemcr.n, 754 S.W.2d 941 (Mo.Ct. App. E.D. 1988).Some courts have held that, when tl7e umbrella iusl~rer is

required to defend claims within the scope of the umbrellapolicy and not ~~ithin the scope of primary coverage, thecosts it incurs in defending are supplemental even whendefense costs are included within the definition of "ultimatenet loss." See, e.g., l'la.net Ins. Co. v. Mead Reirasura.nce Corp.,789 F.2d 668 (9th Cir. 1986); Grunewuld chi Adums ~Tewelers,Inc. v. Lloyds of London, 145 Ariz. 190, 700 P.2d 8$8 (Ct.App. Div. 2 1985).

§ 12:3 Reasonable defense costs and legal audits

Many times the insurer is paying the legal fees of counseldefending the policyholder in the underlying action. Thismay be the case where an insurer with a duty to defend isproviding a defense to the policyholder. Alternatively, aninsurer may be paying independent couY~sel selected by arfor the policyholder where a potential conflict exists in accor-dance with decisions such as San Diego Navy Federal CreditUnion v. Ctcmis Ins. Society, Inc., 162 Cal. App. 3d 358, 20$

449

Chapter 9

Insolvency of Underlying Insurers—(The Issue of "Drop Down") and theImpact of the Policyholder'sBankruptcy On Insurers

§ 9:1 Introduction

~~' 9:2 Insolvency of underlying insurers—The issue of

"drop down„

§ 9:3 Impact of the policyholder's bankruptcy on

insurers

HeyCite"`~: Cases and other legal materials listecl in KeyCite Scope can be

researched tihrou~;h ttie KeyCite sex•rice nn Westla~c~"", Use KeyC.ite to

check citations for foi7n, parnllel references, prior end liter history, andcomprehensive cit.r~tor iiifbrmatiotY, including citations to otiher decisions

and secondai;y materials.

§ 9:1 Intraductinn

Where orie or more of the insurers issuing coverage to thepolicyholder is insolvent, issues arise as to whether the

policyholder or other insurers mrxst bear the conseq~.~ences of

the insolvency. The presence of insolvent insurers could

cause the policyholder to advocate an "all sums" allocation

so that it may "select around" insolvent periods. Tliepolicyholcler also may argue that other insurers should "drop

down" where an underlying iYisurer is insolvent. In recent

years, particlrlarly in the context of asbestos bankruptcies,efforts have been made to use the bankruptcy of the policy-holder as a means to accelerate insurer obligations and tootherwise adversely ixnpact the rights of insurers. Tlzischapter examines the impact on allocation clue to theinsolvency of bankrrtptcy of parties to the insuraYicecontracts.

283

9:~, ALLOCATION IN COMPLEX INSURANCE. CLAIMS

~~' 9:2 Insolvency of underlying insurers—The issue of"drop down"

Allocation issues may arise where the policyholder doesobtain underlying insurance, but the insurer selected by thepolicyholder becomes insolvent by the time the subject claim.is presented. As a result of several insurance companyinsolvencies in recent years, there has been considerable lit-i~ation over the issue of whether an excess insurer has anobligation to "drop down" and assuule the obligations or po-sition of an underlying insurer that has become insolvent.Absent an express undertaking in the excess insurance

Conti act, an excess insurer should nat be held to be a guarari-tar of the solvency of another insurer that was selected bythe policyholder and, i1i fact, was a competitor of the insurer.Accordingly, excess insurers argue that, merely by virtue ofproviding coverage over an iilsolverzt insurer, they shouldnot be liable for the "gap" in coverage. Indeed, excess insur-ance is priced based upon the insurer's exposure being iYiexcess of the underlying coverage or self-insured retentionthat the policyholder represents as being in force. Thefinancial responsibility of the underlying insurers properlyrests with the policyholder, not with the excess insurer.Nonetheless, ~~olicyholders often contend that excess insur-ers should "drop down" to fill any gaps. Sec' generally, An-notation, Primary insurer's insolvency as affecting excessinsurer's liability, 85 A.L.R.4th 729 (1999 R Supp. 2006).The majority of courts to address the issue have held that

an excess insurer is not required to "drop down" where anunderlying insurer is insolvent. Some courts have reliedupon the nature of excess insurance in holding that there isno "drop down" obligation. See, e.g., Ca~ztinentt!-Z Marble &Cran.ite v. Canal Ins. Co,, 7$5 F.2d 125$ (5th Cir. 198G)("Imposing t11e duty of indeYnnification an Canal tivould, ineffect, transmogrify the policy into one guaranteeing thesolvency of wizatever primary insurer the insured mightchoose . . (The policyholder's] proposed rule would requireinsurance companies to scrutinize one another's financialwell-being before issuing secondary policies. The insuranceworld is complex enol~gh; to impose this additional burden. ..would Dilly further our legal system's lamentable trendof complicating commercial relatioliships and transactions");American Re-Insu.ra.nce Co. v. SGB ~Iniversal Builders

284

INSOLVENCY OF UNDERI.YINC INSL7RE1tS5~~ ~:`L

Supply In.c., 141 Misc. 2d 375, 532 N.Y.S.2d 712, 715 (Sup.19&~) ("Excess liability insurance is a low-cost method of _providing extended protection where primary (and second-ary) insurance leaves off; its premiums do not reflect the as-sumptioi7 of risk of the primary carrier's insolvency. It wouldseem that they do not even reflect the cost of scrutinizingthe financial condition of the primary providers. Those risksand costs are better left with the purchaser of the primarypolicy"). See ttlso H.B. Fuller' C,o. v. U.S. Fire Ins. C,o., 2011WL 2884711 (D. Minn. 2011) (noting that the MinnesotaSupreme Co~~rt had "repeatedly found that insureds areresponsible for uninsured periods" and thus, holding thatthe policyholder must contribute to the allocation whereinsurers are insolvent); Sotcth.ern. Silica of Louisiana, Inc. v.Louisiana Ins. Gzcar-. Assn, 979 So. 2d 460 (La. 2008) Qiold-ing that solvent i7~surers were not required to fill the gapcreated by insurer's insolvency and pay more than their~~rorated share of defense and indemnity for Silica claims);Wzcrth u. Ideal ltlu.t. In.s. Co., 34 Ohio App. 3d 325, 518N.E.2d 607, 610 (12th Dist. Warren County 1987) tholding~n excess insurance does not "dr.op down" where primaryinsux er is insolvent, because to hold otherwise would "placethe risk of loss for securing an insoh~ent insurer not on theinsurance purchaser, who purchased the policy, but on theexcess coverage provide~~, wl7o never contracted to cover s~.~cha continency"). But see California Ins. Co. v. Stzmson.Lz~mbcir~ Co., 325 Fed. Appx. 496 (9th Cir. 2009} (applyingOregon law) (holding that policyholder was not res~~onsiblefor payment of share of defense costs where one ins~.irer wasinsolvent).In addressing these "drop down" issues, most courts look

to the specific language in the excess insurance contract todeteruline whether there is an nbligatian for the excessirzst~rer to drop down. In particular, courts often considerspecific provisions, such as "other insurance," "maintenanceof underlying coverage," a7zd "limits of liability" provisions.The fallowing is an explanation of these provisions and howthey impact the "drop down" issue.[a] Coverage in excess of a stated amount ar "ap-

plicable" insuranceWhere the limits of liability provision of an excess insur-

ance contract provides coverage in excess of a stated amountar in excess of "ap~~licable" underlying insurance, most courts

285

9:`L ALLOCATION IN CdMPLFX INSURANCJE CLAIMS

have held that the excess insurance contract does xzot "dropdown." See, e.g. , Arkwright-Boston Mfrs. Mut. Ins. Co. v.Aries Marine Corp., 932 F.2d 442, 19 Fed. R. Serv. 3d 1290(5th Cir. 1991) (applying Texas law) (concluding that uncol-lectibility of the underlying insurance due to the primaryinsurer's insolvency did not cause the retained limit to "dropdowrZ"); Lum.ar Marine, Inc. v. Iras. Co. of North America,910 F.2d 1267, 1994 A.M.C. G00 (5th Cir, 1990) (applyingLouisiana law); Molina v. U.S. Fire Ins. C,a., 574 F.2d 1176(4th Cir. 1978) (holding that excess insurer was required topay only ultimate net loss in excess of contract limits of pri-mary coverage); Canal Ins. Co. v. Mon.tello, Inc., 2013 WL6732G58 (N.D. Okla. 2013) (applying Oklahoma law) (hold-ing that excess insurers do not have an obligation to"d~•opdown" under bath excess arzd umbt•ella policy languagestating coverage is provided in excess of specified underlyinglimits); Part, of Seattle v. A~~z. Nat'l, Fire Ins. Co., No C96-4340(W.D. Wash., Jan. 27, 1998), reported i.ra Mealey's Ins. Lit.Rep., Vol. 12, #14 (Feb. 10, 1998) at p. 13; Rc}vco D.S., Inc. v.Government Employees Ins. Co., 791 ~'. Supp. 1254 (N.D.Ohio 19~J1), af~'d, 968 F.2d 1216 (6th Cir. 1992j, published infull at, 984 F.2d 154 (6th Cir. 1992) (holding that excessinsurers do .not have ~ duty to "drop down" absent expresslanguage to that effect); High.lcxnds Ins. Co. v. GerberProducts Co., 702 F. Supp. 109 (D. Md. 1988) (stating thatexcess insurers ordinarily are not required to provide "dropdown" coveY•age in the event of ixisoh~ency of underlyinginsurers); Alabama Ins. Gacar. Assn v. Ki~ader-Care, Inc., 551So. 2d 286 (Ala. 1989); Denny's, Inc. v. Ch.icug'o Ins. Co., 234Cal. App. 3d 1786, 286 Cal. Rptr. 507 (2d Dist. 1991); PlaytexFP, Inc. v. Colccmbia Ca.s. Ca., G22 A.2d 1074 (Del. Super.Ct. 1992); La. Ins. Guar. Assn. v. Interstate Fire & Cas. Cti.,630 So. 2d. 759 (La. 1994); Domi.ngue r,~. Reliance Ins. Co.,619 So. 2d 122U (La. Ct. App. 3d Cir. 1993); Gibson v. Krei.hs,538 So. 2d 1057 (La. Ct. A~~p. 4th Cir. 1989), writ denied,541 So. 2d 856 (La. 1989); Massachusetts Bay Transp.Authority v. Allian.z Ins. Co., Inc., 413 Mass. 473, 597 N.E.2d439 (1~J92) (holding that excess contract providing thatinsurer's obligation did not attach until "amount of ap-plicable underlyilig limit was paid by or on behalf of theinsured" did not "drag down" to replace uncollectible underly-ing coverage); Vzclzodil v. Lexington. Iras. Ca., 412 Mass. 132,587 N.E.2d 777 (1992) (finding that excess insurer will pay

286

INSOLVENCY OF UNDERLYING INSURERS ~ ~:~.+

excess of commitments made by underlying insurers regard-less of solvency); Central Waste Systems, IItC. v. Granite StateIns. Co., ̀ L31 Neb. 640, 437 N.W.2d 496 (1989); ArnbczssadvrAssociates v. Corcoran, 168 A.D.2d 281, 562 N.Y.S.2d 507(1st Dept 1990), af~'d, 79 N.Y.2d 871, 581 N.Y.S.2d 276, 589N.E.2d 1255 (1992); S't. Vincent's Hose. &Medical Center v.Ins. Cv. of'North Amc}r•ica, 117 Misc. 2d 665, 457 N.Y.S2d670 (Sup. 1982); Steyr-Daimler-Pccch A.G. v. Allstate Ins.Co., 151 A.D.2d 942, 543 N.Y.S.2d 538 (3d Dep't x989).

~ b] Coverage in excess of "collectible" or "recover-able" insuranceCourts have reached differing x esults orl the "drop down"

obligation where the contract is excess of "collectible" or "re-coverable" insurance. Same courts have held there is a "dro~~down" obligation where the excess contract provides that itis excess of "collectible" or "recoverable" underlying limits.See, e.g., Sife~-s v. General Marine Catering Co., 892 F.2d 386(5th Cir. 1990), opinion modified on reh'g, 897 F.2d 1288(5th Cir. 1990) (applying Louisiana law); Reserve In.s. Co. v.Pisciotta., 30 Cal. 3d 800, 180 Cal. R,ptr. 628, 640 P2d 764{1982) (finding that excess contract included risk of primaryinsurer's insolvency where excess insurer assumed liabilityfor any excessive "amount receivable"); Coca Cola BottlingCo. v. Colicnzbia Casualty In.s. Co., 11 Cal. App. 4th 1176, 14Cal. Rptr. 2d G43 (4th Dist. 1992) (stating that "amount re-coverable" is ambiguous; thus, excess insurer was requiredto "drop down" and cover risk for insolvent ilzsurer); DonaldB. MacNeul, Inc. v. Interstate Fi~•e c~ Cas. Co., 132 Ill. App.3d 564, 87 Ill. Dec. 794, 477 N.E.2d 1322 (1st Dist. 1985)(holding that the contract language was ambiguous andconstrued it against the insurer; "[tlhe fact that defendantoffered its excess policy at a .reduced rate does not changethe interpretation of the entire contract"); Gulezittn v.Lincoln Ins. Co., 399 Mass. 606, 50G N.E.2d 123 (19$7);Ceerdes v. St. Paul Fire c~ Marine Ins. Co., 128 Mich. App.730, 341 N.W.2d 195 (1983); Atctoridad de Acuecluctos yAlcantarillados v. Librotex, Inc., 141 D.P.R. 375, 1996 JTS107, 1996 WL 940315 (P.R. 1996), on reconsideration, 142D.P.I.. 820, 1997 JTS 41, 1997 WL 1$9490 (P.R. 1997).

In contrast, other courts have held that the terms "collect-ible" or "recoverable" must be read in conjunction with otherprovisions referencing underlying insurance or other insur-ance clauses and have held that there is no "d~•op dawn"

287

~:~, ALLOCATION TN COMPLEX INSITRANCE CLAIMS

obligation. See, e.g., Tr•arasco Exploration Cv. v. PacificEmplo,~~ers Ins. Co., 869 F.2d 862 (5th Cir. 1989) (finding thecollectibility requir.~ement is confined to non-scheduled insur-ance; otherwise, contract would have read "an amount equalto tl7e limits of liability of any collectible ~.~nderlying insur-ance"); Premco~• USA, Inc. v. American Home Assurance Co.,400 F.3d 523 (7th Cir. 2005) tapplying Illinois law) (holdingthat the amount recoverable language was not ambiguouswhen viewed in light of the definition of "ultimate net loss,"the retained limit language and an endorsement prohibitingan increase in the liability of tl7e excess insurer in the eventthe primary insurer was insolvent); Shapiro v. AssociatedIntern. Ins. Co., 899 F2d 1116 (11th Cir. 1990) (applyingFlorida law); Canal Ins. Co. v. Montello, Irac., 2013 WL6732658 (N.D. Okla. 2013) (applying Oklahoma law); Eng. v.Reliance Ins. Ca., No. CV0200796065 (Conn. Super. Ct., Feb.24, 2004), reported ira Mealey's Ins. Lit. Rep. Insolv., Vol. 16,#1 (May 20, 20Q4) at p. 14; Kelly v. Weil, 563 So. 2d 221 (La.1990) (explaining the collectibility requirement is limited tonon-scheduled insurance); Lindsey v. Poole, 579 So. 2c1 1145(La. Ct. App. 2d Cir. 1991), writ denied, 588 So. 2d 100 {La.1991}; Fred tiVelaer, Inc. v. Granite Stute Trts. Co., $29 S.W.2d589 (Mo. Ct. App. E.D. 1992) tholding that "collectible" modi-fies only the phrase "other underlying insurance"); U.S. FireIns. C.o. v. Coleman, 754 S.W.2d J41 (Mo. Ct. App. E.D. 198$}(balding that "collectible" modifies only the phrase "any otherinsurance" and not the phrase "the underlying policies");Ambassador Associates v. Corcoran, 168 A.D.2d 281, 562N.Y.S.2d 507 (1st Dept 1990), af~'d, 79 N.Y.2d 871, 5$1N.Y.S.2d 276, 589 N.E2d 125$ (1992); North Carolina Ins.Guar. Ass'ra v. Century Inc~errt. Co., 115 N.C. App. 175, 444S.E.2d 464, 470 (1994) (holding that "amount recoverable"provision is unaYiibiguous in requiring t11at underlying in-surance be unrecoverable because of payment of claims, notinsolvency); Ho/~man Const. Co. of Alaska. v. Fred S. Names& Co. of Ore~~on, lOG O.r. App. 329, 8U7 P.2d 80$ (1991),af~'d, 313 Or. 464, 836 P.2d 703 (1992) (holding that amountrecoverable refers to the limits, because the loss payableclause provides that the excess insurer has no liability until

the policyholder or the underlying iY~s~.irer "shall live paidthe amount of the underlying limits").

[e] Exhaustion clausesWhere the excess insurance contract provides that the

28s

INSOLVENCI OF' UNDERLYING INSURERS ~ ~:`~

excess contract will continue in force as underlying ins~.ir-ance in the event of the "exhaustion" or "reduction" of thelimits of liability under tl~e underlying contract, the excessinsurer generally will not be regl~ired to "drop down" if theexlla~istion clause provides that exhaustion will only resultby reason of losses actually paid thereunder. See, e.g., FederalIns. Co. v. Sr-iva,stava, 2 F.3d 98 (5th Cir. 1993) (applyingTexas law); Mission Nat. Ins. Co. v. Du1~e Transp. Co., Inc.,792 F.2d 550 (5t11 Cir. 1986) ("Duke argues that the underly-ing ~~olicy is exhausted because Northwest is unable to payany claims utsder the policy; however, the policy specificallyprovides that it functions as the underlying insurance onlywheYi the exhaustion occurs by reason of losses paid underthe policy"); New Process Baking Co. v. Federal Ins. Co., 923F.2d 62 (7t17 Cir. 1991) (applying Illinois law); Zurzch, Iris.Co. v. Heil Co., 815 F2d 1122 (7th Cir. 1987) (stating thatcontract lang~ua~e means exhaustion by .reason of losses paidunder the underlying contract); Interco Inc. v. National Sur.Carp., 900 F.2d 1264, 16 Fed. R. Sere. 3d 393 (8th Cir. 1990)("it is clear that the parties intended ̀ exhausted' to meanpayment and not insolvency"}; Guar. Nat. Ins. Cv. a. BaysideResort, Inc., 635 F. Sapp. 1456 (D.V.I. 1986); Alabama. Ins.Cuar. Assn v. Kinder-Care, Inc., 551 So. 2d 286 (A1a. 1989);Span, Inc. u. Associated Internat. Ins. Co., 227 Cal. App. 3d463, 277 Cal, Rptr. 8`L8 (2d Dist. 1991), reh'g denied andopinion modified, (FeU. 27, 1991} (finding that this languageprecludes are obligation of arz excess insurer to "drop down"upon the primary insurer's insolvency); ZI.S. b'i.re Ins. Co.,Inc. v. Capital Ford Truck Sales, Irac., 257 Ga. 77, 355 S.E.2d428 (1987); Massachusetts Bay Trarasp. Authority v. AllianzIns. Co., Inc., 413 Mass. 473, 597 N.E.2d 439 (1992); Steyr-Dai»zler-Pzcch A.G. v. Allstate In.s. Co., 151 A,D.2d 942, 543N.Y.S.2d 538 (3d De~~'t 1989); City of Seattle v. CertainUncleru~rzters at Lloyd's of Lorrc~on., No. ~J7-2-15939 (Wash.Super. Ct. Jan. 28, 1998), reported ira Mealey's Ins. Lit. Rep.,VoI. 12, #19 (March 17, 1998) at p. 4. See also Federal.-Mogul,U.S. Asbestos Personal Injury Tricst v. Continental Cas. Co.,666 F.3d 384 (6th Cir. 2011) (holding, ul~der Michigan law,that an umbrella policy is not required to respond until theexha~.~stion of both the listed underlying policy as well as"any other underlying insurance collectible by the insured").

A minority of col~rts lave Held that excess contractscontaining similar exhaustion clauses are required to "drop

289

9:`L ALLOCATION IN COMPLEX INSURANCE CLAIMS

down." Fedcir~al Ins. Cv. v. Scursella Bros., In.c., 931 F.2d 599(9th Cir. 1991) (finding language ambiguous under Washing-ton law); Hoc~l~er v. Nciw Hampshire Ins. Co., 922 F.2d 1476(10th Cir. 1991) ("First State policy explicitly addresses thepossibility that the primary insurer will wroYigfully denycoverage for occurrences that it had warranted would beco~~ered by its primary policy. The excess carrier miist thendrop down and provide a defense"); Fageol Truck & Coa:chCo. v. Pacific Indem. Co., 18 Cal. 2d 748, 117 P.2d 669 (1941);Massachusetts Irasu.rers InsolUerzcy b'und v. Continental Cas.Co., 399 Mass. 598, 5Q6 N.E.2d 118 (19$7}; NorthmeadvwTennis Club, Ir1:c. v. Noi•tlteastern Fire Ins. Co. of Penrasyluaraia,2G Miss. App. Ct. 329, 526 N.E.2d 1333 (1988). The dif~er-ence in results sometimes can be explained by the specificcontract language at iss~ie in the litigation.

[d] Maintenance clauses

Maintenance of underlying insurance clauses also havebeen relied upon by courts as evincing an intention that theexcess insurance contract does not "drop down." See, e.g.,Alabama Ins. Guar. Assn u. Kinder-Care, Inc., 551 So. 2d

286 (Ala. 1989); Eng. v. Reliance} Ins. Co., No. CV0200796065(Conn. Super. Ct., Feb. 24, 2004), ~•epor•ted in Mealey's Ins.

Lit. Rep. Iilsol~~., Vol. 16, #1 (May 20, 2004) at p. 14; Playtex

FP, In.c. v. Colzcmbza Cas. Co., 622 A.2d 1074 (Del. Super.

Ct. 1992); Domingue v. Legion Inderrc. Co., 9~8 So. 2d 1213

(La. Ct. App. 3d Cir. 2006); Donain~'tce v. Reliance Iras. Co.,

619 So. 2d 122U (La. Ct. App. 3d Cir. 1993); Massachusetts

Ba.y Transp. Authority v. Allzanz Ins. Co., Inc., 413 Mass.

473, 597 N.E.2d 439 (1992); Steyr-Daimler-Push A.G. v.Allstate Irzs. Co., 151 A.D2d 942, 543 N.Y.S.2d 538 (3d Dep't

1989); Allegheny Pittsburgh, Coal Co. v. North River Iris. Co.,No. 698 of 1995 (Pa. Corn. Pl. Oct. 23, 1996), reported raz

Mealey's Ins. Lit. Rep., Vol. 11, #3 (Nov. 12, 1996) at p. 9(finding nn "drop down" based upon language of maintenance

clause).

Zurich In.s. Co. v. Hezl Ca., 815 F.2d 1122 (7th Cir. 1987)provides awell-reasoned discussion of the "drop down" issue.

The Court of Appeals for the Seventh Circuit rejected the~~olicyholder's "drop down" argument on several bases. First,

the co~irt fa~.~nd that the insolveYicy of a primary insurer is

not an "occurrence" covered by an umbrella contract. 815F2d at 1 24. See also Radiator• Specialty Ca. v. First State

Ins. Co., 651 F. Supp. 439 tW.D. N.C. 1987), af~'d, 836 F.2d

290

INSOLVENCY OF UNDERI.XING INSURERS ~ ~:.`~

193 (4th Cir. 19$7) (per curiam). Second, the court notedthat the contract's "limits of liability" language clearlyprovided that the umbrella contract applied only in excess ofthe limits of the primary contract, regardless of ti~vhether theprimary insurer was soh~elit. 815 F.2d at 1125. Third, thecourt pointed out that the umbrella contract's "maintenance"cla~~se "places the burden on [the policyholder) to maintainthe underlying insurance in force as collectible." Finally, thecourt found that the comparatively lower premium chaff gedfor excess coverage reflected the insurer's intent not to "dropdawn." 815 F.2d at 1126.

[e] Anti-drop down previsionsIn respoYise to insurer• insolvency and co~.trt rulings on the

"dro~~ down" issue, excess insurance contracts of more recentvintage sometimes include an insolvency clause that ex-pressly provides that insolvency of an underlyixzg insurerdoes not result in any "dro~~ down" obligation. See, e.g.,P7~em,cor USA, Inc. v. Amerr,can Hume Assurance C.o., 400F.3d 523 (7th Cir. 2005), as amended an reh'g, (A~~r. 21,2005) tap lying Illinois law) (holding that endorseYiient stat-ing that liability under the contract "should not be increased`by the refusal or inability of ar~y underlying insurer to pay,tivhether by Reasons of Insolvency, Bankruptcy, or otherwise. .'." rendered the a7iiount recoverable language unambigu-ous); McGirt v. Royal Zns. Co. of America, 399 F. Supp. 2d655 (D. Md. 2005) (applying Maryland law); Eng. v. ReliancciI7LS. CO., No. CVp200796065 (Conn. Su~~er. Ct., Feb. 24,2044), reported in. Mealey's Ins. Lit. Rep. Insohl., Vol. 16, #1(May 2p, 2004) at p. 14; Liraa.res a. Louisiana. Dept. of Transp.and Develvpmen,t, 582 So. 2d 879 (La. Ct. App. 4th Cir. 1991);Robiclzaux v. Randolph, 555 So. 2d 581 (La. Ct. App. 1st Cir.1989), writ gianted, 556 So. 2d 1288 (La. 1990) acid writdenied, 559 So. 2d 127 (La. 1990) and judgment aff'd, 563So. 2d 226 (La. 1990).

§ 9:3 Impact of the policyholder's bankruptcy oninsurers

7'he insolvency of underlying insurers must be distin-guisl~ed from the bankruptcy or insolvency of thepolicyholder. By o~~eration of law in iilany states, an insurer'sobligation to pay claims is not relieved by the policyholder'sinsolvency or bankruptcy. See, e.g., Cal. Ins. Code

291