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Insurance Law

SNR Denton on Insurer Recoupment of Noncovered Defense Costs and Settlements

   By William Barker, Partner, SNR Denton

A recurring issue in the law of liability insurance is whether an insurer that has provided a defense under a reservation of rights (including a reservation of the right to recoup the cost of that defense if a court finds there was no duty to defend) can in fact recover its defense costs.  On two consecutive days in August, the Tenth Circuit predicted that Colorado law would allow such a recovery, and the Pennsylvania Supreme Court refused to allow such a recovery.  This commentary critically reviews those decisions and other recent decisions on this issue and argues that recoupment should be permitted under the law of unjust enrichment.

The commentary describes the issue as follows:

Liability insurers are frequently called upon to defend suits against their insureds when it is questionable whether there is actually a duty to defend.  The consequences of an unjustified refusal to defend can be quite unpleasant, so insurers often defend when they believe there is no duty to do so, but fear that a court might disagree.  In such circumstances, they would like to be able to obtain reimbursement (sometimes called recoupment) of the amounts they expend on defense if they later establish that no defense was owed.

Similarly, an insurer defending a case with potential for a judgment in excess of policy limits is often faced with a demand that it settle for or within policy limits, even though it questions whether the claims that would be settled are actually covered by the insurance policy.  But, in many jurisdictions, failure to settle might expose the insurer to liability for the full judgment, if that judgment turns out to be covered.  The insurer would like to have the option of settling the claim against the insured and then, if it can establish lack of coverage, recouping the payment from the insured.

The commentary reviews the two newest cases and two leading anti-recoupment cases.  Relying on the new Restatement (Third) of Restitution and Unjust Enrichment, it shows that lack of any coverage establishes a prima facie claim for unjust enrichment, so long as the insurer has properly reserved the right to seek recovery.  It examines and rejects reasons advanced in some of the cases for questioning the justice of that conclusion.  It also examines and rejects suggestions that uncertainty about existence of a duty to defend requires the insurer to defend until that question is adjudicated.  As the commentary concludes:

The Pennsylvania court in Jerry’s Sports Center, and other anti-recoupment courts that rely on similar analysis have confused the “potential for coverage,” as defined in Lee and its progeny, with the risk that coverage will be found.  Certainly, that perceived risk will sometimes induce an insurer to offer a defense under reservation when, in fact, there is no potential for coverage and no duty to defend.  But there is no basis in the contract language to find a duty to defend based on the risk that coverage might be found if there is no actual potential for coverage that would create a duty to defend regardless of the perceived risk.  So, this basis for antirecoupment decisions is unsound and ought not to be followed.

Establishment of a prima facie claim for unjust enrichment is only the beginning of the unjust enrichment analysis.  The commentary notes that “‘[t]he restitution claim to recover a payment in excess of an underlying liability … meets an important limitation in the voluntary payment rule.’”  Under that rule, “‘“[m]oney voluntarily paid on a claim of right, with full knowledge of all the facts, in the absence of fraud, deception, duress or compulsion, cannot be recovered back merely because the party at the time of payment was ignorant or mistook the law as to his liability.”’”  The commentary explains why the voluntary payment rule ordinarily does not bar recoupment of noncovered defense or settlement costs. subscribers can access the complete commentary, SNR Denton on Insurer Recoupment of Noncovered Defense Costs and Settlements. Additional fees may be incurred. (approx. 26 pages)

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William Barker is the co-author of New Appleman Insurance Bad Faith Litigation, Second Edition.

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