Insurers may assert that they have a right to be reimbursed by their policyholders for defense fees if a court later rules that the insurer had no such duty to defend, says Linda D. Kornfeld, the managing partner of Dickstein Shapiro L.L.P.'s Los Angeles office who represents policyholders in complex coverage matters. However, policyholders can protect themselves from such insurer efforts through several steps, including expressly objecting to reservation-of-rights letters that raise the reimburse-ment issue, she says.

Insurers that defend lawsuits against their policyholders under commercial general liability policies often reserve a “right to reimbursement.” That is, insurers assert that they may “get back” defense dollars they paid should a court later decide that the underlying lawsuit did not trigger the duty to defend. This, of course, can create problems for policyholders, particularly when the underlying lawsuit is expensive and the insured is not financially prepared to repay the amounts “advanced” by the insurer.

Policyholders should not presume that an insurer's asserted right to reimbursement is legally enforceable.

Despite some insurers' stance, no “majority” of states ever provided this right. Indeed, many states have not ruled on the issue. A growing majority of others explicitly prevent insurers from obtaining “reimbursement,” even if a court holds that no duty to defend ever existed. The rationale of the courts is fair and consistent with actual insurance policy language.

In many jurisdictions, when a policyholder seeks a defense for underlying litigation, the insurer may accept coverage, deny coverage, or defend pursuant to a reservation of rights and file a lawsuit regarding its duty to defend. These options come with benefits and consequences for the insurer.

If the insurer denies coverage, it may avoid paying for the claim. If its coverage evaluation is wrong, it may be exposed to allegations of breach of contract and bad faith. If the insurer defends and files suit, it may seek to protect itself from bad faith, but it must pay for the insured's defense until a court rules against the duty to defend. Insurer reimbursement efforts seek a result with zero risk—the insurer seeks to avoid bad faith exposure by advancing defense costs, without bearing the risk of actually and unconditionally paying for the defense. All reward and no risk for the insurer is not a just result.

CGL policies usually do not include language that allows insurers to obtain reimbursement of defense fees paid with respect to uncovered claims. Insurers do, however, include such language in other types of policies. An insurer should not be allowed after the fact, and post-claim, to use a reservation-of-rights letter to establish reimbursement rights that are not contained in the insurance contract, but could have been.

Courts also should reject these efforts based on recent case law.

In General Agents Insurance Co. of America Inc. vs. Midwest Sporting Goods Co., the Illinois Supreme Court in 2005 said: “The fact that the trial court ultimately found that the underlying claims against Midwest were not covered by the (General Agents) policies does not entitle (General Agents) to reimbursement of its defense costs.”

In Nationwide Mutual Insurance Co. vs. Bruce Mortensen et al, a Hartford, Conn., federal judge ruled in August 2009 that “Nationwide cannot recoup expenditures made in fulfilling its promises to defend pursuant to the reservation-of-rights letters. It was in Nationwide's own interest to provide a defense under the reservation of rights...to avoid exposure had the court held it did have a duty to defend...In the absence of a policy provision...or active assent to the reservation by the (policyholders), the reservation of rights letters were not enough to impose a burden on the (policyholders) to reimburse Nationwide.”

Also last August, a Washington state judge held that even if an underlying claim did not trigger the duty to defend and the insurer defended pursuant to a reimbursement reservation, the insurer was required to pay the reasonable defense dollars the policyholder incurred prior to the court's ruling against the duty to defend.

Insurers rely on cases such as the 1997 California Supreme Court ruling in Jerry H. Buss et al. vs. Superior Court of Los Angeles County and Transamerica Insurance Co. to argue that if no potential for coverage ever existed, reimbursement is proper. Even if the Buss decision could be argued to support this insurer argument, the decisions by the “new majority” courts do not. Additionally, even if a “potential for coverage” is necessary to overcome insurer reimbursement efforts, an insurer's agreement to defend pursuant to a reservation of rights is evidence of that “potential.” An insurer likely would not defend if it believes no court could find a potential for coverage.

Policyholders can seek to protect themselves from such insurer efforts. For example, in many instances, policyholders should expressly object to reservation-of-rights letters that raise the reimbursement issue. This may assist policyholders in overcoming later insurer arguments that the policyholder impliedly acquiesced to the insurer's use of its reservation-of-rights letter to modify its policy to include a reimbursement right not included in the policy. Additionally, even if a court rules against the duty to defend, policyholders should rely on, among other cases, the new majority cases to require insurers to pay for defense fees incurred before the court rules.

Linda Kornfeld is managing partner of Dickstein Shapiro L.L.P.'s Los Angeles office and represents policyholders in complex coverage matters. Ms. Kornfeld was been named by Business Insurance in 2007 as one of the 50 Women to Watch in Insurance. The California Daily Journal has named her as one of the top 100 women lawyers in the state. She also is recognized as one of Southern California's top 50 women lawyers by Southern California Super Lawyers.