Opinion ID: 164354
Heading Depth: 2
Heading Rank: 3

Heading: MCCC's Reimbursement of its Insureds' Attorney Fees Incurred in Underlying Tort Actions

Text: 77 ERC does not dispute that it must partially reimburse MCCC for amounts that MCCC paid its insureds for their defense costs in the underlying tort actions (in which MCCC should have provided a defense and did not). The parties dispute what the amount of the reimbursement should be. The specific disagreement is whether the insureds' attorney fees constitute loss under the Agreement, or merely claim expenses. Under the Agreement ERC reimburses MCCC at a different rate for loss than for claim expenses. We hold that MCCC's payment of an insured's attorney fees in defending a third-party claim is a claim expense under the Agreement. ERC need only reimburse MCCC at the contractual proportionate rate. 78 The relevant portion of the loss definition provides: 79 The word loss shall mean only such amounts: 80 .... 81 paid by [MCCC] for punitive, exemplary, or compensatory damages awarded to the insured and arising out of the conduct of MCCC in the investigation, trial, or settlement of any claim or failure to pay or delay in payment of any benefits under any policy.... 82 Article VIII, ¶¶ (c)(1), (c)(2), App. 600. There are two requirements for a payment to constitute loss. First, the payment must be for punitive, exemplary, or compensatory damages. Second, it must aris[e] out of the conduct of MCCC in the investigation, trial, or settlement of any claim or failure to pay or delay in payment of any benefits.... Here, the amounts paid do not arise out of MCCC's conduct. 83 The amounts at issue are fees for attorneys to represent the insureds in the underlying tort litigation. These fees were a consequence of the underlying litigation, not of any conduct by MCCC. Whatever MCCC's conduct had been in the investigation, trial, or settlement of the claim, attorneys would be needed to represent the insured in the tort action. Perhaps the fees for attorneys to defend the tort actions would have been less if MCCC had hired and paid for the attorneys (because of lower hourly rates, more efficient conduct of the defense, or even earlier resolution by settlement), but the fees might also have been greater (higher hourly rates, greater willingness to play hard ball, etc.). Regardless, the payments to attorneys for the insured in the tort action do not arise out of the conduct of MCCC. Rather, they arise out of the fact that a third party sued the insured. 84 We are reinforced in this interpretation of the Agreement by the observation that adopting MCCC's interpretation—that the payments constitute loss—would create a perverse incentive for MCCC when the loss would otherwise approach the $300,000 retention threshold. There is no dispute that if MCCC had provided attorneys to defend its insureds in the underlying tort actions, the fees and expenses it incurred would have been treated under the Agreement as claim expenses. ERC would have been required to reimburse MCCC for these claim expenses at the contractual proportionate rate, once the loss exceeded $300,000. In other words, MCCC would receive, at most, partial payment from ERC. A loss, however, is fully reimbursable by ERC (once the $300,000 threshold is passed). Thus, if MCCC is correct that payment to the insured for hiring its own attorneys is a loss, then MCCC would have a financial incentive to refuse to pay for a defense of its insureds. It would usually end up paying less out-of-pocket (after reimbursement from ERC) if it paid its insured for having hired an attorney than if it hired an attorney itself to represent the insured. This is a highly unlikely intent of the parties, and the result might well violate public policy favoring the honoring of insurance contracts because MCCC could be induced to refuse to provide an attorney for its insured. 85 We therefore reverse the district court and hold that MCCC's payments of its insureds' attorney fees incurred in the underlying tort actions should be treated as claim expenses.