To give a lawyer answer, “it depends.”  States are split on whether an insurer can recoup defense costs paid where it is ultimately shown that the underlying claims are not covered.  However, there is no authority to suggest that “unreasonable” defense costs cannot be recovered back at any time.

Clawing Back When Defending under a ROR

According to a decision filed on February 9, 2011, in Welch Foods, Inc. v. Zurich American Ins. Co., et al., C.A. No. 09-12087-RWZ (D. Mass.), insurers may not seek to recover defense costs paid under an express reservation of rights which reserved the right to recoup defense costs if the claims were ultimately shown not to be covered.

The court noted that different states had come to different conclusions on the issue. California had concluded – in a matter in which the policyholder and insurer had an express contract calling for the insurer’s reimbursement – that reimbursement of defense costs advanced for claims that are ultimately determined not to be covered are subject to reimbursement. Noting that a contrary decision would allow “the insured…[to] be unjustly enriched,” the Court noted that a California decision hinged on the difference between “potentially” covered claims and claims that were not covered at all:

In an action in which all the claims are at least potentially covered, the insurer has a duty to defend and no right to reimbursement because it was paid premiums and bargained to bear those costs. Conversely, in an action in which none of the claims are even potentially covered, the insurer does not have a duty to defend because no such duty was contracted for, and is entitled to, reimbursement. (See Buss v. Superior Court, 16 Cal. 4th 35, 51, 939 P.2d 766, 769 (Cal. 1997)).

Pennsylvania, the court noted, has a contrary view in which an “insurer has an absolute duty to defend claims that are potentially covered, and this duty is not extinguished by a court’s later determination that the claims are not covered.” The duty to “determine whether a complaint is potentially covered is to be answered by the insurer upon receiving notice of the complaint from the insured, even though an erroneous decision to deny coverage may subject the insurer to liability for breach of contract.” See Order, citing American & Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 2 A.3d 526, 541 (Pa. 2010).

In Welch’s case, the policy was silent as to reimbursement, providing only that the insurer had a duty to defend claims arising under the policy. Noting that the duty to defend is broader than the duty to indemnify, the court ruled that “while the question whether a claim is covered may be difficult, it is the insurer’s duty to make the decision,” as they are “in the business of making this decision.” In denying reimbursement even where the underlying claims were not covered, the court concluded that the insurer “bears the responsibility for making the [coverage] determination, and the concomitant risk if its decision to advance fees is wrong.” Order at 6.

Clawing Back “Unreasonable” Defense Costs

There is no split of authority, albeit, there is no authority to suggest that an insurer cannot clawback “unreasonable” defense costs at any time.   All attorneys – even independent or insured chosen counsel – have an absolute, black letter ethical duty to only charge “reasonable” fees and costs.  Nowhere in any state ethical rules is there an exemption for independent attorneys when it comes to billing reasonable fees and costs for their services.  In fact, if anything there is authority that independent counsel are held to a stricter standard when it comes to billing insurers for their services.  See  Center Foundation v. Chicago Insurance Co., 227 Cal.App. 3d 547, 560 (2nd Dist. 1991) holding that Cumis counsel must engage in “… ethical billing practices susceptible to review at a standard stricter than that of the marketplace.”

Please contact me at jconlon@legalpointsllc.com if you would like more information or an evaluation of whether you have a valid claim to clawback fees paid previously to outside counsel.  Who knows, you may have a fortune sitting around in your closed claims files!