Insurer May Seek Reimbursement from Independent Counsel of Excessive Defense Expenses Given Trial Court’s Duty to Defend Order

Hartford Cas. Ins. Co. v. J.R. Marketing, L.L.C. (2015) ___ Cal. ___.

The California Supreme Court held an insurer can recover allegedly excessive and unnecessary defense expenses directly from its insureds’ independent counsel. The Court reversed a Court of Appeal decision affirming the trial court’s grant of a demurrer. The trial court had concluded the insurer’s right to reimbursement, if any, was from its insureds, not their independent counsel. The Supreme Court disagreed. The insurer was obligated under an enforcement order to pay the insureds’ defense expenses subject to a right to seek reimbursement for “unreasonable and unnecessary” charges after the fact. On the particular facts, and based on principles of restitution and unjust enrichment, the Court concluded the insurer could pursue reimbursement from the law firm.

Hartford Casualty Insurance Company provided liability insurance to J.R. Marketing, L.L.C. and Noble Locks Enterprises, Inc. covering business-related defamation and disparagement claims, among other risks. In 2005, the insureds were named as defendants in lawsuits in California and elsewhere based on alleged defamation and interference with business relationships. The insureds tendered the California action to Hartford, which refused to defend.

After the insureds (through their counsel, Squire Sanders) filed a coverage action against Hartford, Hartford agreed to defend the California action subject to a reservation of rights. Hartford declined to pay already-incurred defense expenses or provide independent counsel under San Diego Federal Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358 (codified at Civil Code section 2860). But the trial court in the coverage action granted the insureds summary adjudication that Hartford owed a duty to defend from the date of tender. The court also concluded Hartford was obligated to provide independent counsel, and the insureds retained Squire Sanders.

The trial court in the coverage action subsequently issued an enforcement order (which Squire Sanders drafted) stating Hartford had breached its duty to defend by failing to pay defense invoices in a timely fashion. The enforcement order precluded Hartford from invoking the rate limitations in Civil Code section 2860, and required Hartford to pay submitted expenses subject to a right to seek reimbursement at the end of the California action of any “unreasonable or unnecessary” expenses.

The California action was resolved in 2009, and Hartford filed a cross-complaint in the coverage action. On a theory of unjust enrichment, Hartford asserted a right to recoup a significant portion of roughly $13.5 million paid to Squire Sanders under the enforcement order. The trial court sustained Squire Sanders’ demurrer to Hartford’s cross-complaint, concluding Hartford only could seek reimbursement from its insureds, not their independent counsel. The Court of Appeal affirmed.

The California Supreme Court granted review to address the narrow question whether an insurer can seek reimbursement of defense expenses directly from independent counsel where the insurer has paid expenses under a court order expressly preserving the insurer’s post-litigation right to recoup “unreasonable and unnecessary” amounts charged.

The Court began with an analysis of its holding in Buss v. Superior Court (1997) 16 Cal.4th 35, which requires an insurer to provide a complete defense to a lawsuit alleging both covered and non-covered claims, subject to the insurer’s right to seek reimbursement of expenses solely allocable to non-covered claims. In such a case, the insured would be unjustly enriched if the insurer had no reimbursement right. But Buss did not consider who is unjustly enriched if independent counsel is allowed to retain payments that were unreasonable or unnecessary to the insureds’ defense.

The Court concluded that, in light of the trial court’s enforcement order, Hartford could pursue Squire Sanders for reimbursement. Assuming Hartford’s position has merit, the firm is the unjust beneficiary of the disputed sums. Nevertheless, the Court emphasized that its conclusion is limited to the unusual facts at issue.

Squire Sanders asserted various objections based on contract law principles, public policy and procedure, all of which the Court rejected. The Court concluded Squire Sanders is not an incidental beneficiary of Hartford’s duty to defend its insureds, with no duty to make restitution. Hartford’s obligation under the enforcement order Squire Sanders prepared was to pay reasonable expenses, subject to an express right to seek reimbursement of unreasonable expenses later. Hartford never agreed to pay whatever Squire Sanders billed, no matter how excessive.

The Court concluded Hartford’s unjust enrichment claim did not interfere with the attorney-client privilege between the insureds and its independent counsel, or with counsel’s right to control the defense. Civil Code section 2860 contemplates that independent counsel will be called upon to justify their fees, and privileged information can be redacted. The Court also rejected the notion that, rather than seeking reimbursement from independent counsel, Hartford should pursue its unsophisticated insureds for allegedly failing to monitor and control their counsel’s fees.

Nor would an unjust enrichment claim against independent counsel violate California’s prohibition against assignment of legal malpractice claims. Hartford seeks to recover overpayments for allegedly excessive and unnecessary work by Squire Sanders, not damages due to the firm’s alleged breach of any duty owed to the insureds.

Click here for the opinion.

This opinion is not final. It may be modified on rehearing or review may be granted by the United States Supreme Court. These events would render the opinion unavailable for use as legal authority.

Under Illinois Law, Nontrivial Possibility of Excess Judgment Creates Conflict Requiring Independent Defense Counsel

In Perma-Pipe, Inc. v. Liberty Surplus Insurance Corp., No. 13-2989, 2014 U.S. Dist. LEXIS 54867 (N.D. Ill. April 21, 2014), the Northern District of Illinois held an insurer breached its duty to defend when it refused to pay for the insured’s independent defense counsel. Although the insurer had waived all coverage defenses, there was a “nontrivial” exposure over the policy limit, which created a conflict of interest under Illinois law.

The insured, Perma-Pipe, was a pipe manufacturer sued for alleged “catastrophic” pipe failures with damages alleged over $40 million.   Liberty issued a commercial general liability (CGL) policy with $1 million per occurrence and $2 million aggregate limits.  Liberty agreed to defend, but reserved rights and allowed Perma-Pipe to select independent defense counsel.  Liberty later withdrew its reservations and retained its own defense counsel. Perma-Pipe sued.

The federal district court, applying Illinois law, found a conflict of interest requiring independent defense counsel.  Because Perma-Pipe was sued for more than $40 million, far above the policy limits, there was “a nontrivial probability” of an excess judgment. While Liberty argued Perma-Pipe had excess coverage, there was no evidence of this in the record.  In any event, the possible existence of excess coverage would not negate the conflict.

While the “nontrivial” excess exposure test may be difficult to apply, that is apparently not the case where the exposure alleged dwarfs the available coverage limits.