Opinion ID: 2575976
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Heading Rank: 6

Heading: Scottsdale's right to reimbursement.

Text: Scottsdale advanced fees and costs to defend MV against the Laidlaw suit, but did so under a reservation of rights. By a letter dated March 15, 2000, counsel for Scottsdale informed MV's general counsel that, although Scottsdale did not believe Laidlaw's claims fell within the scope of its policies' advertising injury provisions, Scottsdale would provide a defense subject to various reservations of rights. These included [t]he right to seek a declaration of [Scottsdale's] rights and duties under its [p]olicies regarding its defense and/or indemnity obligations, and [t]he right to seek reimbursement of defense fees paid toward defending causes of action which raise no potential for coverage, as authorized . . . in Buss [, supra, ] 16 Cal.4th 35, 65 [65 Cal.Rptr.2d 366, 939 P.2d 766]. . . . Scottsdale thus served notice that it might seek to recover defense fees and costs already expended if it were later determined that Scottsdale had owed MV no defense. As we explained in Buss, supra, 16 Cal.4th 35, 65 Cal.Rptr.2d 366, 939 P.2d 766, the insurer may unilaterally condition its proffer of a defense upon its reservation of a right later to seek reimbursement of costs advanced to defend claims that are not, and never were, potentially covered by the relevant policy. Such an announcement by the insurer permits the insured to decide whether to accept the insurer's terms for providing a defense, or instead to assume and control its own defense. ( Id., at p. 61, fn. 27, 65 Cal.Rptr.2d 366, 939 P.2d 766.) [3] Despite its conclusion that the Scottsdale policies never afforded any potential coverage of the Laidlaw claims, and despite Scottsdale's explicit reservation of its reimbursement rights, the Court of Appeal held that Scottsdale may not recover the costs it advanced to defend MV in the Laidlaw action. The Court of Appeal based this ruling on the premise that a judicial no duty determination extinguishes the duty to defend only prospectively and not retroactively. ( Buss, supra, 16 Cal.4th 35, 46, 65 Cal.Rptr.2d 366, 939 P.2d 766; see Aerojet-General, supra, 17 Cal.4th 38, 58, 70 Cal.Rptr.2d 118, 948 P.2d 909.) Thus, the Court of Appeal reasoned, if the insurer wishes to limit its liability for defense costs, it either must adopt the risky strategy of refusing a defense outright, thus exposing itself to a bad faith suit by the insured, or must seek, during the pendency of the third party action, to terminate its defense duty from that time forward by proving no potential for coverage. MV and its amicus curiae advance the same premise here. [4] They urge as follows: In a CGL policy, the insured purchases a guarantee that the insurer will absorb all costs of defending the insured against a third party action that includes one or more potentially covered claims, and that it will continue to do so until the third party action is concluded or the insurer can establish that no claim is even potentially covered. Under this bargain, the insurer bears the entire risk of its incorrect decision to provide or withhold a defense. Thus, if the insurer wrongly concludes that no duty to defend has arisen, and therefore declines the insured's tender of defense, the insured may recover its damages in contract and tort. On the other hand, if the insurer seeks to avoid that pitfall by assuming the costs of the insured's defense, those costs cannot be shifted back to the insured, even if the insurer reserved its rights and a court later determines, as a matter of law, that there was never any potential coverage. We disagree with this analysis. We are persuaded that an insurer, having reserved its right to do so, may obtain reimbursement of defense costs which, in hindsight, it never owed. Buss, supra, 16 Cal.4th 35, 65 Cal.Rptr.2d 366, 939 P.2d 766, succinctly explained the scope of the contractual right to a defense that the insured purchases with its premiums. [T]he insurer's duty to defend runs to claims that are . . . potentially covered, in light of facts alleged or otherwise disclosed. [Citations.] ( Id., at p. 46, 65 Cal.Rptr.2d 366, 939 P.2d 766, italics added.) This duty, having arisen, is discharged when the action is concluded. [Citation.] It may be extinguished earlier, if it is shown that no claim can in fact be covered. [Citation.] If it is so extinguished, however, it is extinguished only prospectively and not retroactively: before, the insurer had a duty to defend ; after, it does not have a duty to defend further. [Citations.] ( Ibid., italics added.) Thus, the insurer's duty to defend arises whenever the third party complaint and/or the available extrinsic facts suggest, under applicable law, the possibility of covered claims. In such circumstances, if the insured tenders defense of the third party action, the insurer must assume it. The duty to defend then continues until the third party litigation ends, unless the insurer sooner proves, by facts subsequently developed, that the potential for coverage which previously appeared cannot possibly materialize, or no longer exists. The insurer must absorb all costs it expended on behalf of its insured while the duty to defend was in effecti.e., before the insurer established that the duty had ended. ( Montrose, supra, 6 Cal.4th 287, 295-304, 24 Cal.Rptr.2d 467, 861 P.2d 1153; see also, e.g., Haskel, Inc. v. Superior Court (1995) 33 Cal.App.4th 963, 977, 39 Cal.Rptr.2d 520 ( Haskel ); Hartford Accident & Indemnity Co. v. Superior Court (1994) 23 Cal.App.4th 1774, 1780-1781, 29 Cal.Rptr.2d 32.) However, we have made clear that where the third-party suit never presented any potential for policy coverage, the duty to defend does not arise in the first instance, and the insurer may properly deny a defense. Moreover, the law governing the insurer's duty to defend need not be settled at the time the insurer makes its decision. As several courts have explained, subsequent case law can establish, in hindsight, that no duty to defend ever existed. If the terms of the policy provide no potential for coverage, . . . the insurer acts properly in denying a defense even if that duty is later evaluated under case law that did not exist at the time of the defense tender. [Citations.] ( Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, 26, 44 Cal.Rptr.2d 370, 900 P.2d 619, italics added; see also Hameid, supra, 31 Cal.4th 16, 20-21, 30, 1 Cal.Rptr.3d 401, 71 P.3d 761; McLaughlin v. National Union Fire Ins. Co. (1994) 23 Cal.App.4th 1132, 1151, 29 Cal.Rptr.2d 559 [duty to defend did not arise in first instance where only potential for liability turned on legal question later resolved in insured's favor]; State Farm Mut. Auto. Ins. Co. v. Longden (1987) 197 Cal.App.3d 226, 233, 242 Cal.Rptr. 726 [same].) These principles are equally true where, as here, the insurer does not deny a defense at the outset, but instead elects to provide one under a reservation of its right to reimbursement. By law applied in hindsight, courts can determine that no potential for coverage, and thus no duty to defend, ever existed. If that conclusion is reached, the insurer, having reserved its right, may recover from its insured the costs it expended to provide a defense which, under its contract of insurance, it was never obliged to furnish. In Buss, supra, 16 Cal.4th 35, 65 Cal.Rptr.2d 366, 939 P.2d 766, we confirmed an insurer's entitlement, under a reservation of rights, to recoup its costs of defending against third party claims that are not potentially covered. Buss addressed an insurer's rights and obligations with respect to a mixed third party action, in which potential coverage appears as to some claims, but not as to others. In such circumstances, Buss noted, the insurer must defend the entire mixed action. ( Id., at pp. 48-49, 65 Cal.Rptr.2d 366, 939 P.2d 766.) This is so, Buss explained, because the contractual duty to defend the potentially covered claims immediately and meaningfully implies the prophylactic duty to defend entirely, without pausing to parse among potentially covered and clearly uncovered claims. ( Id., at p. 49, 65 Cal.Rptr.2d 366, 939 P.2d 766.) Nonetheless, we held that the insurer, having reserved its rights, may recover its costs of defense attributable to the claims for which there was no potential coverage. ( Id., at pp. 50-53, 65 Cal.Rptr.2d 366, 939 P.2d 766.) The Court of Appeal, echoed here by MV and its amicus curiae, reasoned that Buss's reimbursement analysis applies only to mixed actions, where the insurer must defend even clearly uncovered claims and has no option to deny a defense at the outset, or to minimize its liability by seeking a prompt judicial declaration that it has no duty to defend. We are not persuaded. Though Buss itself involved a mixed action, Buss's analysis of the reim bursement issue applies equally where the insurer, acting under a reservation of rights, defended an action in which, as it turns out, no claim was ever potentially covered. As Buss explained, the duty to defend, and the extent of that duty, are rooted in basic contract principles. The insured pays for, and can reasonably expect, a defense against third party claims that are potentially covered by its policy, but no more. Conversely, the insurer does not bargain to assume the cost of defense of claims that are not even potentially covered. To shift these costs to the insured does not upset the contractual arrangement between the parties. Thus, where the insurer, acting under a reservation of rights, has prophylactically financed the defense of claims as to which it owed no duty of defense, it is entitled to restitution. Otherwise, the insured, who did not bargain for a defense of noncovered claims, would receive a windfall and would be unjustly enriched. ( Buss, supra, 16 Cal.4th 35, 47-52, 65 Cal.Rptr.2d 366, 939 P.2d 766.) Buss itself made clear that this analysis does not apply only when the insurer was forced, in a mixed action, to defend noncovered claims along with those that were potentially covered. On the contrary, Buss indicated it was simply extending well-settled law to mixed actions. Thus, Buss declared: As to . . . claims that are not even potentially covered, . . . the insurer may . . . seek reimbursement for defense costs. Apparently, all the decisional law considering such claims in and of themselves so assumes. (See, e.g., Hogan v. Midland National Ins. Co. [(1970)] 3 Cal.3d [553,] 563-564 [91 Cal.Rptr. 153, 476 P.2d 825]; American Motorists Ins. Co. v. Allied-Sysco Food Services, Inc. [(1993)] 19 Cal.App.4th [1342,] 1355-1356 [24 Cal.Rptr.2d 106]; Reliance Ins. Co. v. Alan [(1990)] 222 Cal.App.3d [702,] 708-710 [272 Cal.Rptr. 65]; Insurance Co. of the West v. Haralambos Beverage Co. [(1987)] 195 Cal.App.3d [1308,] 1322-1323 [241 Cal.Rptr. 427]; Travelers Ins. Co. v. Lesher [(1986)] 187 Cal.App.3d [169,] 203 [231 Cal.Rptr. 791]; Western Employers Ins. Co. v. Arciero & Sons, Inc. (1983) 146 Cal.App.3d 1027, 1028-1029, 1032 [194 Cal.Rptr. 688]; Walbrook Ins. Co. Ltd. v. Goshgarian & Goshgarian (C.D.Cal.1989) 726 F.Supp. 777, 781-784 [applying California law]; Omaha Indem. Ins. Co. v. Cardon Oil Co. (N.D.Cal.1988) 687 F.Supp. 502, 504-505; affd. (9th Cir.1990) 902 F.2d 40, 1990 WL 55904 [same]; accord, Ins. Co. North America v. Forty-Eight Insulations [(6th Cir.1980)] 633 F.2d [1212,] 1224-1225 [applying Illinois and New Jersey law, but speaking generally].) So it has been held: `California law clearly allows insurers to be reimbursed for attorney's fees' and other expenses `paid in defending insureds against claims for which there was no obligation to defend.' ( Omaha Indem. Ins. Co. v. Cardon Oil Co., supra, 687 F.Supp. at p. 504.) ( Buss, supra, 16 Cal.4th 35, 50-51, 65 Cal.Rptr.2d 366, 939 P.2d 766, italics added; accord, Truck Ins. Exchange v. Superior Court (1996) 51 Cal.App.4th 985, 994, 59 Cal.Rptr.2d 529 [if insurer defends under reservation of right to seek reimbursement of defense and indemnity costs, it may seek reimbursement for payments expended if noncoverage is ultimately proven]; Frank and Freedus v. Allstate Ins. Co. (1996) 45 Cal.App.4th 461, 474, 52 Cal.Rptr.2d 678 [law permits insurer to condition acceptance of defense on later right to contest coverage or seek reimbursement of defense costs].) As Buss further noted, [n]ot only is it good law that the insurer may seek reimbursement for defense costs as to the claims that are not even potentially covered, but it also makes good sense. Without a right of reimbursement, an insurer might be tempted to refuse to defend an action in any partespecially an action with many claims that are not even potentially covered and only a few that arelest the insurer give, and the insured get, more than they agreed. With such a right, the insurer would not be so tempted, knowing that, if defense of the claims that are not even potentially covered should necessitate any additional costs, it would be able to seek reimbursement. ( Buss, supra, 16 Cal.4th 35, 52-53, 65 Cal.Rptr.2d 366, 939 P.2d 766.) Though these comments were made in the context of mixed actions, they apply equally here. An insurer facing unsettled law concerning its policies' potential coverage of the third party's claims should not be forced either to deny a defense outright, and risk a bad faith suit by the insured, or to provide a defense where it owes none without any recourse against the insured for costs thus expended. The insurer should be free, in an abundance of caution, to afford the insured a defense under a reservation of rights, with the understanding that reimbursement is available if it is later established, as a matter of law, that no duty to defend ever arose. [5] In Tamrac, Inc. v. California Ins. Guarantee Assn. (1998) 63 Cal.App.4th 751, 74 Cal.Rptr.2d 338 ( Tamrac ), a post- Buss decision, the Court of Appeal confirmed that if the insurer is legally uncertain whether any claims in the third party complaint are potentially covered, it may defend the third party action to conclusion under a reservation of its right to reimbursement, and may then recoup all its defense costs if an intervening decision has established, as a matter of law, that the potential for coverage, and thus the duty to defend, never arose. ( Id., at pp. 757-758, 74 Cal.Rptr.2d 338.) Tamrac expressly rejected the insured's argument, similar to that made by MV here, that a determination of noncoverage operates prospectively only. The insured, said Tamrac, misplaces reliance on cases where there was factually a potential for coverage which imposed the duty to defend, and the insurer subsequently developed facts showing there was no duty in the particular circumstances. In those situations the insurer's duty to defend ceases prospectively from the subsequent determination but not retroactively to the beginning. [Citations.] Here, . . . as a matter of law there was never a potential for coverage. ( Tamrac, supra, 63 Cal.App.4th 751, 758, 74 Cal.Rptr.2d 338.) We find this analysis persuasive. [6] The instant Court of Appeal suggested that an insurer uncertain of its defense obligations might initially assume the defense, then seek to stop the bleeding by obtaining a prompt, though prospective, extinguishment of its duty to defend. But where, as here, there was never a duty to defend, this limited remedy provides the insured more, and the insurer less, than the parties' bargain contemplated. Moreover, as Scottsdale and its amici curiae point out, it also forces the insurer to commence litigation of defense and coverage issues, and to press for early resolution of those issues, while the third party litigation is still pending. However, this is a tactic which, in many cases, the insurer is not allowed to pursue, and in general should be discouraged for policy reasons. When an insured calls upon a liability insurer to defend a third party action, the insurer as a general rule may not escape the burden of defense by obtaining a declaratory judgment that it has no duty to defend. Were the rule otherwise, the insured would be forced to defend simultaneously against both the insurer's declaratory relief action and the third party's liability action. Because the duty to defend turns on the potential for coverage, and because coverage frequently turns on factual issues to be litigated in the third party liability action, litigating the duty to defend in the declaratory relief action may prejudice the insured in the liability action. To prevent this form of prejudice, the insurer's action for declaratory relief may be either stayed [citation] or dismissed [citation]. ( Montrose, supra, 6 Cal.4th 287, 305, 24 Cal.Rptr.2d 467, 861 P.2d 1153 (conc. opn. of Kennard, J.); see also, e.g., David Kleis, Inc. v. Superior Court (1995) 37 Cal.App.4th 1035, 1044-1045, 44 Cal.Rptr.2d 181; Haskel, supra, 33 Cal.App.4th 963, 979 & fn. 15, 39 Cal.Rptr.2d 520.) Indeed, [i]t is only where there is no potential conflict between the trial of the coverage dispute and the underlying action that an insurer can obtain an early trial date and resolution of its claim that coverage does not exist. [Citation.] ( Haskel, supra, 33 Cal.App.4th 963, 979, 39 Cal.Rptr.2d 520; see Montrose Chemical Corp. v. Superior Court ( Canadian Universal Ins. Co. ) (1994) 25 Cal.App.4th 902, 910, 31 Cal.Rptr.2d 38.) The Court of Appeal's analysis contravenes these sound rules and policies. Unlike the Court of Appeal, we decline to require an insurer uncertain about the law relevant to its coverage and defense obligations to engage its insured in a futile two-front war. ( Montrose Chemical Corp. v. Superior Court ( Canadian Universal Ins. Co. ), supra, 25 Cal.App.4th 902, 910, 31 Cal.Rptr.2d 38.) MV urges that, by limiting its reservation of reimbursement rights to those authorized . . . in Buss,  supra, 16 Cal.4th 35, 65 Cal.Rptr.2d 366, 939 P.2d 766, Scottsdale did not clearly signal its intent to seek reimbursement outside the context of a mixed action. We disagree. As we have seen, Buss simply applied to mixed actions the general premise that an insurer may obtain reimbursement for defending claims or suits as to which it never owed a duty of defense. The language of Scottsdale's reservation of rights was amply sufficient to preserve its reimbursement rights here. Accordingly, we conclude that an insurer under a standard CGL policy, having properly reserved its rights, may advance sums to defend its insured against a third-party lawsuit, and may thereafter recoup such costs from the insured if it is determined, as a matter of law, that no duty to defend ever arose because the third party suit never suggested the possibility of a covered claim. Such is the case here. It follows that, insofar as the Court of Appeal denied Scottsdale's right to reimbursement, its judgment should be reversed.