The California Supreme Court has revisited the issue of a liability insurer's right to seek reimbursement from its insured for costs expended defending non-covered claims. The Court holds that when the insurer notifies the insured that it may seek reimbursement and then obtains a determination that there is not, and never has been, a potential for coverage under the policy, the insured can be required to reimburse all defense costs paid by the insurance company from the inception of the claim.
In the case before the Court, Scottsdale Insurance Company insured MV Transportation. MV was sued by Laidlaw Transit Services, which claimed that MV -- with the help of a number of former Laidlaw officers and employees -- had engaged in an array of unfair and unlawful competitive practices. MV sought a defense from Scottsdale, relying on a 9th Circuit decision that had found that trade secret misappropriation could be covered under the rubric of "advertising injury." Scottsdale disagreed with that analysis, but it agreed to provide a defense. The defense was provided subject to an explicit reservation of Scottsdale's right to seek recovery of all defense costs that could be attributed to non-covered claims.
- Scottsdale relied on the state Supreme Court's1997 decision in Buss v. Superior Court, in which the Court first recognized an insurer's right to obtain reimbursement of defense costs to the extent those costs could be shown to relate entirely to claims that were never potentially covered. A liability insurer must defend any claim that raises a potential for an award of covered damages, the Court reasoned in Buss, but it is not required to defend claims that are conclusively shown to have contained no such potential and -- having "done the right thing" by defending those non-covered claims along with the potentially covered claims -- is entitled to recover those expenses from the insured, which would otherwise receive a windfall.
While defending MV against Laidlaw, Scottsdale filed an action seeking a declaratory judgment to determine whether any portion of the MV/Laidlaw litigation was potentially covered under its policies. While the declaratory judgment action was pending, the MV/Laidlaw action was settled. Scottsdale continued forward with its action, only to have the trial court rule that Scottsdale did owe a duty to defend. Scottsdale appealed. The Court of Appeal's decision was a case of "good news/bad news" for the insurer: the Court agreed with Scottsdale that there was never any potential for coverage for any of the Laidlaw claims, but held that its determination of non-coverage did not operate retroactively and that Scottsdale could not recoup any of the costs that it had expended prior to obtaining the Court of Appeal's ruling in its favor -- which is to say, since the underlying case has been fully litigated and resolved by this point and all of the related defense costs have already been paid, that Scottsdale wins but recovers nothing. (I, for one, do not envy the attorney who was chosen to report that result to the client . . . )
Scottsdale, unsurprisingly, petitioned the Supreme Court for review. The Supreme Court, much to the relief of Scottsdale and its counsel, not only granted review, it effectively expunged the "but" from the Court of Appeal's decision. Justice Baxter, writing for a unanimous 6-member Court [Justice Brown having been recently elevated to the D.C. Circuit] sums it up as follows:
The third party action ended in settlement. Thereafter, in the insurance action, the superior court found a potential for coverage, but the Court of Appeal ultimately disagreed. For reasons of law, the Court of Appeal held that the allegations in the third party’s complaint never triggered any possibility of coverage under Scottsdale’s policies. Nonetheless, the Court of Appeal concluded that Scottsdale was not entitled to reimbursement. The Court of Appeal reasoned, in essence, that its no-potential-coverage determination 'extinguished' Scottsdale’s defense duty only from that time forward. Hence, the Court of Appeal determined, Scottsdale could not 'retroactively' recover defense costs expended before its duty was 'extinguished.'
We disagree. By ruling, as a matter of law, that the third party action never presented any possibility of coverage by Scottsdale’s policies, the Court of Appeal established not that the duty to defend was thereupon prospectively 'extinguished,' but that it never arose. Therefore, Scottsdale may recover amounts it expended in defending the insured under its reservation of rights. To the extent the Court of Appeal held otherwise, its judgment must be reversed.
(Italics in original.) Or, to state it as a quasi-syllogism
- If there is a potential for coverage, the insurer must defend
- If there is no potential for coverage, the insurer need not defend
- If there was never a potential for coverage, the insurer never needed to defend,
AND THEREFORE
- All expenses incurred in defending a never-covered claim are recoverable by the insurer.
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The decision in Scottsdale Insurance Company v. MV Transportation (July 27, 2005), Case No. S123766, can be accessed at these links in PDF and Word formats.
[Note: Links expire approximately 120 days following issuance of the opinions; the opinions should still be accessible thereafter by substituting "archive" for "documents" in the URL.]
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