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Liability Insurer Allowed to Recoup Attorney Fees From Its Own Insured After paying for Defense of Lawsuit

12/06/2014 | Winter 2014 Newsletter
You sent the claim/suit papers seeking personal injuries and property damage immediately to your liability insurer, and the insurer sent back a lengthy letter agreeing to defend, reserving its rights, appointing defense counsel, and quoting liber­ally from the policy. Somewhere in the letter, the insurer wrote that if the claim were ultimately found not to be covered by the policy, the insurer reserved the right to seek the defense costs from you.

Don’t ignore this warning! An attorney learned this expensive lesson after his malpractice insurer recovered from him over $165,000 in defense costs for a claim ultimately not covered by his policy. Certain Underwriters at Lloyd’s v. Lacher & Lovell-Taylor, P.C., (New York Appellate Division First Department, December 5, 2013).

A liability insurance policy has two parts: defense and indemnity. The defense part is litigation insurance. The insurer agrees to defend the insured from baseless and fraudulent claims, in return for a premium. On what basis can the insurer recover more than the premium from an insured? New York law has not yet articulated a basis for this, but over the past two decades lower court decisions have allowed this result. Typically, the insured receives a reservation of rights letter and, happy to have the insurer paying for the defense, ignores the boilerplate. Case law seems to be saying that by acquiescing in the insurer defending a claim clearly not covered by the policy while allowing the insurer to reserve its right to recoup defense costs, the insured has consented to repay defense costs if the claim is ultimately found not to be covered. There was an implied contract.

There is a nationwide debate on whether a liability insurer can recoup its defense costs from an insured. California allows this when the claim is clearly not within the liability policy. Other states do not allow this, arguing that the insurer is changing the policy retroactively without obtaining approval from state insurance departments. Still other states require the insurer to include language in a policy reserving the right to recoup. Many directors and officers policies contain such language. Some insurers argue that the insured is unjustly enriched because the insured received a benefit for which equity and good conscience require payment. There are other factors involved, e.g., the size and nature of the insured, whether there is a good faith basis for contending that the claim is covered by the policy.

The better course is to review carefully the reservation of rights letter when received, and if you have any questions about what it means, consult with your insurance professional or else an attorney experienced in insurance coverage. Don’t be caught short.

About the author: Eugene H. Goldberg is an associate at Gallet Dreyer & Berkey LLP. He handles complex litigation involving construction matters, insurance coverage, professional malpractice claims involving architects and engineers, surety bond claims, and general liability claims. He also drafts and negotiates contracts relating to the construction industry. Mr. Goldberg has published numerous articles in legal journals, and is the former editor of the New York State Bar Association Construction and Surety Division Newsletter. Mr. Goldberg can be reached at ehg@gdblaw.com.