Opinion ID: 1263554
Heading Depth: 2
Heading Rank: 2

Heading: Whether Westchester is Entitled to Reimbursement of Defense Costs

Text: Because we conclude that Westchester has no duty to defend the Insureds, we must necessarily determine whether Westchester is entitled to reimbursement of defense costs expended in the Fayette lawsuit. The question whether insurers have a right to obtain reimbursement from insureds for funds advanced toward defense of uncovered claims has not been addressed by Minnesota's state appellate courts. Westchester marshals four arguments urging us to conclude that Minnesota courts, like most state courts, would allow reimbursement. Westchester first asserts that, under Minnesota law, an insurer's duty to defend is less broad than in some states. Insurers in Minnesota are not obligated to defend whenever coverage is merely arguable based upon a policy interpretation dispute. Second, Westchester maintains that insurers' reimbursement rights stem from equitable legal principles and not contract terms. Reimbursement, by definition, is only available for the defense of uncovered claims. Third, Westchester states that Minnesota's federal courts have reached conflicting results with respect to insurers' reimbursement rights under Minnesota law and that the better-reasoned decisions recognize a right of reimbursement because it is most consistent with Minnesota law. Finally, Westchester argues that Minnesota's general contract and insurance law is most compatible with the equitable theories that underpin insurers' unilateral reimbursement rights, particularly in cases such as this one in which the insurer did not owe anything under the policy. Nationally, courts are split as to whether an insurer may bring a cause of action against an insured for attorneys' fees and costs expended defending the insured in a different matter. Gen. Star Indem. Co. v. V.I. Port Auth., 564 F.Supp.2d 473, 476 (D.V.I.2008) (citing Perdue Farms, Inc. v. Travelers Cas. & Sur. Co. of Am., 448 F.3d 252, 258 (4th Cir.2006) (acknowledging that jurisdictions differ on the soundness of an insurer's right to reimbursement of defense costs)). [N]umerous courts recognize an insurer's right to reimbursement of defense fees paid where it is determined that the insurer had no duty to defend. Indeed, many cases refer to this holding as the majority position. Westport Ins. v. Ong, No. 1:07CV10 DAK, 2008 WL 892941, at  (D.Utah Mar.28, 2008) (slip op.) (citing St. Paul Fire & Marine Ins. Co. v. Compaq, 457 F.3d 766, 772 (8th Cir.2006) (applying Texas law); United Nat'l Ins. Co. v. SST Fitness Corp., 309 F.3d 914, 921 (6th Cir. 2002) (applying Ohio law); Envirotech Indus., Inc. v. United Capitol Ins., 141 F.3d 1175 (9th Cir.1998) (unpublished); Resure, Inc. v. Chem. Distrib., Inc., 927 F.Supp. 190, 194 (M.D.La.1996) (applying New Mexico law); St. Paul Mercury Ins. Co. v. Med. Lab. Network, Inc., 690 F.Supp. 901, 904 (C.D.Cal.1988); Jim Black & Assoc. v. Transcon. Ins. Co., 932 So.2d 516, 518 (Fla.Dist.Ct.App.2006); Travelers Cas. & Sur. Co. v. Ribi Immunochem, 326 Mont. 174, 108 P.3d 469, 480 (2005); Sec. Ins. Co. of Hartford v. Lumbermens Mut. Cas. Co., 264 Conn. 688, 826 A.2d 107, 125 (2003); Buss v. Superior Court, 16 Cal.4th 35, 65 Cal.Rptr.2d 366, 939 P.2d 766, 778 (Cal. 1997)). Courts that recognize such claims for reimbursement of defense costs generally do so under a quasi-contract theory, allowing recovery to prevent unjust enrichment. Gen. Star Indem. Co., 564 F.Supp.2d at 477. The seminal case allowing reimbursement is Buss; in that case, the California Supreme Court affirmed a ruling that an insurer that issued a standard commercial general liability insurance policy has a right of reimbursement of defense costs for claims not even potentially covered under its policy, explaining that: Under the policy, the insurer does not have a duty to defend the insured as to the claims that are not even potentially covered. With regard to defense costs for these claims, the insurer has not been paid premiums by the insured. It did not bargain to bear these costs. To attempt to shift them would not upset the arrangement. The insurer therefore has a right of reimbursement that is implied in law as quasi-contractual, whether or not it has one that is implied in fact in the policy as contractual. As stated, under the law of restitution such a right runs against the person who benefits from unjust enrichment and in favor of the person who suffers loss thereby. The enrichment of the insured by the insurer through the insurer's bearing of unbargained-for defense costs is inconsistent with the insurer's freedom under the policy and therefore must be deemed unjust. It is like the case of A and B. A has a contractual duty to pay B $50. He has only a $100 bill. He may be held to have a prophylactic duty to tender the note. But he surely has a right, implied in law if not in fact, to get back $50. Even if the policy's language were unclear, the hypothetical insured could not have an objectively reasonable expectation that it was entitled to what would in fact be a windfall. 65 Cal.Rptr.2d 366, 939 P.2d at 776-77 (internal citation omitted). In a related footnote, the court further explained: That the insurer does not have a right of reimbursement express in the policy does not mean that it does not have one implied in law. Rather, that it has an implied-in-law right helps explain why it does not have an express-in-policy one. The former renders the latter unnecessary. This is proved by the fact that, with an implied-in-law right and without an express-in-policy one, insurers have sought, and obtained, reimbursement  and have done so, on the evidence of reported decisions, for much more than a decade. To be sure, an express right could have been introduced into the policy. But that it was not is not dispositive. Id. at 776-77 n. 13 (internal citations omitted). According to the Buss court, in order to obtain a reimbursement of defense costs, an insurer must reserve its rights on this basis. It is not necessary that the insured agree with the insurer's reservation of rights to obtain a reimbursement of defense costs for it to be valid; [b]ecause the right is the insurer's alone, it may be reserved by it unilaterally. Id. at 784 n. 27. In contrast to Buss and the courts relying on its rationale, the most recent decisions reflect the minority position. Westport Ins., 2008 WL 892941, at . These courts have refused to recognize claims by insurers for reimbursement of defense costs expended under a unilateral reservation of rights, absent a provision for such reimbursement in the insurance policy. Gen. Star Indem. Co., 564 F.Supp.2d at 477 (citing Terra Nova Ins. Co., Ltd. v. 900 Bar, Inc., 887 F.2d 1213, 1219 (3d Cir. 1989) ([W]e believe, the Pennsylvania Supreme Court would preclude an insurer who provides a defense under reservation of rights from recovering the cost of that defense from its insured if it is later determined that there is no coverage.); Perdue Farms, 448 F.3d at 258 (holding that, under Maryland law, the insurer had no right to reimbursement for defense costs attributable to non-covered claims); Liberty Mut. Ins. Co. v. FAG Bearings Corp., 153 F.3d 919, 924 (8th Cir.1998) (holding that an insurer was not entitled to reimbursement of defense costs expended prior to the court's determination that there was no duty to defend); LA Weight Loss Ctrs., Inc. v. Lexington Ins. Co., 2003 No. 1560, 2006 WL 689109, at  (Pa.Ct.C.P. Mar. 1, 2006) (holding that an insurer could not sustain a claim for restitution of costs defending uncovered claims based on an unjust enrichment theory); Gen. Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 215 Ill.2d 146, 293 Ill.Dec. 594, 828 N.E.2d 1092, 1102 (2005) (We ... refuse to permit an insurer to recover defense costs pursuant to a reservation of rights absent an express provision to that effect in the insurance contract between the parties.); Shoshone First Bank v. Pac. Employers Ins. Co., 2 P.3d 510, 514 (Wy.2000) (There is no indication in the Policy of any distinction to be made between covered and non-covered claims so far as the defense of those claims is concerned, and we will not permit the Policy to be modified by subsequent letters from the insurer to the insured.)). Courts disallowing such claims for reimbursement generally reason that an insured is not unjustly enriched when an insurer agrees to defend against uncovered claims under a reservation of rights. Id. at 477-78. The Third Circuit explained its reasoning for rejecting a right of reimbursement, stating: A rule permitting such recovery would be inconsistent with the legal principles that induce an insurer's offer to defend under reservation of rights. Faced with uncertainty as to its duty to indemnify, an insurer offers a defense under reservation of rights to avoid the risks that an inept or lackadaisical defense of the underlying action may expose it to if it turns out there is a duty to indemnify. At the same time, the insurer wishes to preserve its right to contest the duty to indemnify if the defense is unsuccessful. Thus, such an offer is made at least as much for the insurer's own benefit as for the insured's. If the insurer could recover defense costs, the insured would be required to pay for the insurer's action in protecting itself against the estoppel to deny coverage that would be implied if it undertook the defense without reservation. Terra Nova, 887 F.2d at 1219-20 (predicting that Pennsylvania law would preclude an insurer that tenders a defense under a reservation of rights and is later deemed to owe no duty to defend from recovering such defense costs from the insured). More recently, the Illinois Supreme Court also rejected a right of reimbursement, explaining: [W]e cannot say that an insured is unjustly enriched when its insurer tenders a defense in order to protect its own interests, even if it is later determined that the insurer did not owe a defense. Certainly, if an insurer wishes to retain its right to seek reimbursement of defense costs in the event it later is determined that the underlying claim is not covered by the policy, the insurer is free to include such a term in its insurance contract. Absent such a provision in the policy, however, an insurer cannot later attempt to amend the policy by including the right to reimbursement in its reservation of rights letter. Gen. Agents, 293 Ill.Dec. 594, 828 N.E.2d at 1103. Conflicting decisions exist within this circuit's district courts as to whether a right to reimbursement for insurers exists under Minnesota law. Compare Knapp v. Commonwealth, 932 F.Supp. 1169 (D.Minn.1996), with Employers Mut. Cas. Co. v. Indus. Rubber Prod., Inc., No. Civ. 04-3839, 2006 WL 453207 (D.Minn. Feb.23, 2006). In Knapp, a diversity case governed by Minnesota law, an insurer sought reimbursement of attorneys' fees and costs for defense under a reservation of rights where there was no coverage or duty to defend. 932 F.Supp. at 1171. The district court acknowledged that Minnesota has not before determined whether or not an insurer may be reimbursed for attorney's fees and costs, when it has been determined that no coverage exists and the insurer undertook the defense under a reservation of rights letter. Id. In granting summary judgment to the insurer on its right to reimbursement, the district court held: [The insured] offers little to dissuade this Court from following those courts that have recognized the rights of insurers to seek reimbursement for its attorney's fees and costs under certain circumstances. California law is persuasive and consistent with earlier Minnesota cases addressing the responsibility of an insurer to meet its duty to defend first and challenge policy coverage questions later. The courts should be consistent in encouraging insurance companies to properly meet their duty to defend its insured against third party claims and minimize unnecessary claims to enforce policy coverage. However, where an insurer has properly met its duty and subsequently successfully challenges policy coverage, it should be entitled to the full benefit of such a challenge and be reimbursed for the benefits it bestowed, in good faith, to its insured. Id. at 1172 (internal citation omitted). The court also addressed the insured's argument that insurance companies are not allowed to require their insured to pay defense costs by unilaterally sending reservation of rights letters unless there is an agreement or understanding with the insured. Id. The court rejected this argument, finding that the language contained in the reservation-of-rights letter sufficiently and specifically reserved the right to seek reimbursement of litigation expenses, finding that the insurer clearly indicated its desire to reserve its right to later seek reimbursement for attorney's fees and costs. Id. According to the court, [the insured's] silence in response to [the insurer's] reservations of rights letter, and subsequent acceptance of the defense provided by [the insurer], constitutes an implied agreement to the reservation of rights. Id. In contrast, in Employers Mutual, the same district court, sitting in diversity and applying Minnesota law, held that no right of reimbursement exists. 2006 WL 453207, at . Relying on a decision from this court issued after Knapp, the district court stated: In [ Liberty Mutual ], the Court determined that the absolute pollution exclusion barred coverage. 153 F.3d [at 923]. In light of the Court's finding of no coverage, the insurer argued it was entitled to reimbursement of all defense costs paid. Applying Missouri law, the Court noted: Although the parties disputed whether the claims were excluded from coverage by operation of the pollution exclusion clause, any uncertainty as to such coverage should be resolved in [the insured's] favor. Therefore [the insurer] remained obligated to defend [the insured] so long as there remained any question as to whether the underlying claims were covered by the policies. Upon such determination that the ... claims ... were excluded from coverage, the district court properly concluded that [the insurer's] duty to defend [the insured] in this action expired. Because we conclude that [the insurer] had a duty to defend [the insured] until such determination was made, we reject [the insurer's] argument that it is entitled to reimbursement of defense costs. Id. at 924. [ See also Gen. Agents, 828 N.E.2d at 1092] (court held it would follow the minority rule which refuses to permit an insurer to recover defense costs pursuant to a reservation of rights absent an express provision to that effect in the insurance contract). While the Eighth Circuit's decision in Liberty Mutual was made pursuant to the law of Missouri as to the scope of the duty to defend, this Court recognizes that Minnesota law has interpreted the duty to defend consistent with Missouri's interpretation. See e.g. Brown v. State Auto. & Casualty Underwriters, 293 N.W.2d 822, 825-26 (Minn.1980) (duty to defend triggered when any part of the claim arguably falls within coverage of policy). This Court will therefore follow the reasoning of the Eighth Circuit in Liberty Mutual and find an insurer is not entitled to the reimbursement of defense costs expended prior to the determination of coverage, unless specifically provided for in the insurance policy. In this case, Employers did include in its reservation of rights letter a right to seek reimbursement of defense costs. However, IRP did not explicitly respond to this reservation, and the CGL policy is silent as to Employers' right to seek reimbursement. Accordingly, the Court will deny Employers' request for reimbursement of defense costs expended prior to the date of this Order. Id. As noted supra, the district court in Employers Mutual relied on this court's holding in Liberty Mutual in reversing its prior position in Knapp. In Liberty Mutual, the district court had determined that although the insurer had an initial duty to defend the insured, such a duty expired upon the determination that the claims against the insured were excluded from coverage by operation of an exclusion clause in the underlying policies. 153 F.3d at 923. Before this court, the insurer argued that it had no initial duty to defend the insured and that it [was] entitled to reimbursement of all defense costs paid. Id. This court rejected that argument, holding that, under Missouri law, the liability insurer remained obligated to defend insured so long as there remained any question as to whether the underlying claims were covered by the policies. Id. In contrast, this court, applying Texas law, has held that an insured entered into a binding agreement that allowed the insurer to reserve the right to recoup defense costs in exchange for the insurer's agreement to forgo its right to veto the insured's choice of defense counsel. St. Paul Fire & Marine Ins., 457 F.3d at 766. In St. Paul, the insurer provided liability insurance to the insured. Id. at 768. After the insured was sued, the insurer sent a letter to the insured, agreeing to defend the insured pursuant to the policy but reserving its right to deny liability under the policy upon any subsequent determination that the underlying lawsuit was not covered. Id. The letter also expressed concern that the insured was retaining defense counsel without the insurer's approval in violation of the terms of the policy. Id. Thereafter, the insurer sent a letter to the insured, recognizing that the insured had continued to retain three law firms of its choice to defend the suit without the insurer's approval. Id. After reiterating its rights under the policy to veto the insured's choice of defense counsel and to pay no defense costs which were unreasonable, the insurer stated its desire to cooperate with the insured to allow the insured to retain its choice of defense counsel. Id. The insurer repeated its earlier reservation of rights to deny all coverage and, in addition, specifically reserved a right to recover any defense costs paid to the insured in the event that the insurer later determined that the claim was not covered. Id. The letter concluded by asking the insured for confirmation that it accepted the offered defense of the underlying claim. Id. No official acceptance occurred, but the insured continued to employ its chosen counsel and began accepting payments from the insurer. Id. On appeal, we found that the insurer's conduct was not unilateral and that Texas law failed to address the situation where the insurer agrees to relinquish another right it has under the policy in return for the reservation of the right to recover. Id. at 773. The insurer's letter contained an offer to forgo its right under the policy to veto the insured's choice of counsel if the insured would agree to reduced coverage of defense costs  and to [the insurer's] reservation of the right to reimbursement of those defense costs upon a subsequent determination that the policy did not cover the claim. Id. According to this court, the insured could have dismissed the three firms it had hired and chosen a firm acceptable to [the insurer], as required by the policy... which would have entitled [the insured] to coverage of 100 percent of its reasonable defense costs. In that case, any attempt by [the insurer] to assert a reservation of rights would have lacked the element of mutual promises necessary to create a bilateral agreement. Id. (internal quotations and citation omitted). But the insured, by continuing to employ its chosen counsel while accepting the insurer's partial defense, accepted the insurer's offer and created a supplemental agreement. Id. In the present case, we hold that Westchester is not entitled to reimbursement of defense costs. First, even if we applied the majority rule, as in Knapp, the Knapp case is distinguishable. In that case, the district court specifically noted that the insured remained silent in response to the insurer's reservation-of-rights letter and subsequently accepted the defense, equating to an implied agreement to the reservation of rights by the insurer. Here, the exact opposite occurred: In response to Westchester's reservation-of-rights letter, the Insureds explicitly rejected such terms in the letter but nonetheless offered to accept Westchester's defense. As a result, when Westchester decided to still tender a defense in spite of the Insureds' rejection of its terms in the reservation-of-rights letter, it was impliedly agreeing to proceed on the Insureds' terms. Second, the instant case is also distinguishable from St. Paul in which this court recognized a right of reimbursement. Unlike in St. Paul, in which the insurer explicitly agreed to forgo another right that it had under the policy in return for the reservation of rights, Westchester never explicitly offered to forgo any right to the Insureds in exchange for tendering a defense. Finally, although Minnesota appellate courts have not announced whether they would permit a right of reimbursement, we find the most recent state and federal court decisions' adoption of the minority position more persuasive. Here, Westchester could have included in the policy an express provision for such reimbursement. Westchester cannot now unilaterally amend the policy by including the right to reimbursement in its reservation-of-rights letter.