A case published recently by the California Court of Appeal has taken the findings in Buss v. Superior Court (1977) 16 Cal.4th 35 and Aerojet-General Corporation v. Transport Indemnity Company (1997) 17 Cal.4th 38, and expanded an insurer's right to seek reimbursement from an insured for payment of legal fees associated with noncovered claims.
The State of California v. Pacific Indemnity, 98 Daily Journal D.A.R. 5399 (1998), has similar facts to those in the Buss and Aerojet matters. In each case, the insured tendered defense to the insurer for reimbursement. The insurer declined and/or reserved rights, asserting the right to seek indemnification. The insurer held that it had no duty to indemnify based on its assertion that the facts of the case were not covered under its policy of insurance, and/or if there was coverage, it was limited only to a very specific and discrete set of claims or a very specific coverage period which comprised only a small portion of the exposure in the overall litigation.
In the Pacific Indemnity matter, the State of California tendered a claim for property damage caused by toxic contamination. Pacific asserted it was not required to defend the State. Pacific later agreed to defend, however, asserting that their coverage, which extended for only one year of the 43-year period at issue, was so nominal that it should be allowed to apportion defense costs.
Initially, the State was defended by the attorney general's office. They took the position that they were incapable of providing sufficient resources and later retained the law firm of Irell & Manella on a contingency basis.
The State sought reimbursement of attorneys' fees from the attorney general's office at the "market" rate and later from Irell & Manella, based on a contingency contract which provided for reimbursement at twice the firm's normal hourly rates. The State asserted various arguments in support of reimbursement of the fees, which were in excess of $4.5 million.
The court analyzed the facts in the Pacific Indemnity matter, using the earlier findings and argument in both Buss and Aerojet. The court found that Pacific had a clear duty to pay for attorneys' fees for the entire action and should have done so when the matter was tendered. Its failure to do so was a material breach of the insurance contract, and based on this failure, the burden of allocation switched to Pacific. Pacific was unable to meet the burden of proving that the bulk of the legal fees and costs incurred did not relate to defense of covered claims. Since, however, the suit brought by the State was for contract damages (the operative pleadings did not include any cause of action for tort damages), there was no reasonable justification for reimbursement to the State for anything other than the actual attorneys' fees and costs incurred. The contingency contract which would reimburse Irell & Manella at twice their hourly rates was not reasonable, neither was the reimbursement of legal fees to the attorney general's office at anything other than the normal reimbursable rates.
The court reaffirmed the findings in Buss, which stated that an insurer can unilaterally undertake a defense under a reservation of rights. Although the insurer became liable for reasonable attorneys' fees incurred in the defense, the court stated, "We see no reason why it should be required to forfeit whatever right to reimbursement it eventually may be adjudicated to have." The court further found that:
The State is entitled to what it bargained for -- a defense of the entire action that contains potentially covered claims. Pacific Indemnity is obligated to defend the entire action, not just a fraction that is proportionate to its one year of coverage. Because Pacific Indemnity repudiated that obligation, the State is entitled to damages that will make it whole, but no more.
Providing a timely defense to actions tendered where there are potentially covered claims is critical to seeking reimbursement. Advising the insured of a reservation of rights is also important. Finally, taking steps to scrutinize work product and attorney billing to determine services performed and fees for covered versus noncovered claims provides a clear record and assists the court in ordering reimbursement. The burden then lies with the insured to challenge allocation by the insurer, which should be accomplished with the assistance of specialized audit counsel.
Mr.Jardini is a Director of the firm and practices in the firm's Litigation Department. He is President of KPC Legal Audit Services, Inc.
Email: aej@kpclegal.com
Ms. Holmen is a Paralegal with the firm and Senior Auditor with KPC Legal Audit Services, Inc.