Daily Journal

Insurance companies hate paying to defend claims they believe may not be covered - especially where the defense fees are significant. But when they do pay for the defense of claims they feel they should not have to defend, insurance companies can reserve the right to seek reimbursement from their insureds. These reimbursement claims are increasingly common, and insurers are stretching the boundaries of these actions. Indeed, some are even filing suits against those who were never parties to the insurance contract, and who have no relationship at all to the insurer.

Are an insurer's direct claims against such independent counsel or uninsureds ever justified? A case pending before the state high court may answer that question. Hartford Casualty Insurance v. J.R. Marketing, S211645.

Suppose an insurer is defending a potentially covered lawsuit but suspects that its insured may have made fraudulent representations to secure the policy in the first instance. Generally, the insurer will be unable to litigate a coverage suit before the underlying suit is finished, especially if there are disputed issues of fact which overlap the factual issues in the underlying suit. Such coverage suits would be stayed to avoid prejudice to the insured, who would otherwise be facing a two-front war. Montrose Chem. Corp v Superior Court, 6 Cal. 4th 287 (1993). In the meantime, the defending insurer may pay millions in defense fees. Yet the insured may not have money to refund the defense payments if a reimbursement claim is successful.

Even in these unusual circumstances, is there justification for a direct action for recovery of the funds paid to independent Cumis counsel? (So-called because of the Court of Appeal decision establishing the right of California policyholders to employ independent counsel: San Diego Federal Credit Union v. Cumis Ins. Society, 162 Cal. App. 3d 358, 364 (1984). The right to independent counsel was later codified at Civil Code Section 2860.)

No, there isn't.

Cumis counsel only represents the insureds; they have no attorney-client relationship with the insurers themselves, and thus can have no obligations to the insurer. By allowing insurers to sue Cumis counsel, a court would be creating a legal obligation running from the counsel to the insurer. A Cumis counsel with obligations its client's insurer is no longer the "independent" counsel envisioned by the Cumis court. That case was decided precisely to prevent insurers from compelling their insureds to accept a defense by attorneys beholden to the insurer.

There is no reason the insurers should not be limited to whatever remedies they may have against their own insureds, including rescission, restitution and damages. After all, the underwriting risk assumed by the liability insurer was freely undertaken, based on the submitted application for insurance. The insurer was free to ask any questions and conduct any inspections of the potential risk.

And yet in Hartford Casualty, which is fully briefed and awaiting a date for oral argument, the issue raised is whether an insurance company forced to pay for Cumis counsel can later sue that same counsel to get back fees the insurance company believes were "unreasonable or unnecessary." Or is the insurance company limited to suing its insured to get back such "unreasonable or unnecessary" fees?

The Court of Appeal in Hartford Casualty had affirmed the dismissal of insurer Hartford's reimbursement claims against both the Cumis counsel and an individual who was not an insured, but who Hartford was compelled to defend pursuant to prior court rulings.

After Hartford initially refused a defense, the insured, J.R. Marketing, filed a bad faith suit. Hartford agreed to defend thereafter, but not from the date of tender and only with its panel counsel. However, the trial court later ordered Hartford to defend from the date of tender and to pay for Cumis counsel. The decision was affirmed on appeal, and Hartford was ordered to pay all fees through the conclusion of the underlying litigation, subject only to reimbursement if Hartford could show the bills were unreasonable or unnecessary.

Hartford brought suit against J.R. Marketing, the Cumis counsel and the uninsured individual asserting causes of action for reimbursement, rescission and unjust enrichment. The trial court sustained all the defendants' demurrers on unjust enrichment. The court also sustained the Cumis counsel's and uninsured individual's demurrers on all claims and dismissed them from the lawsuit. Hartford appealed the dismissals.

The Court of Appeal affirmed dismissal of the claims against the Cumis counsel, holding that, "it is clear California law bars an insurer, like Hartford, in breach of its duty to defend from thereafter imposing on its insured its own choice of defense counsel, fee arrangement or strategy. This court now takes the law one slight step forward by holding Hartford likewise barred from later maintaining a direct suit against independent counsel for reimbursement of fees and costs charged by such counsel for crafting and mounting the insureds' defense where Hartford considers those fees unreasonable or unnecessary.

"To hold otherwise would effectively afford the insurer that has waived ... protections ... through its own wrongdoing more rights in a fee dispute with independent counsel than an insurer that has not waived such protections. Specifically, while the insurer in compliance with its duty to defend would be limited ... to arbitrating a fee dispute, the insurer in breach of its duty could bring the fee dispute to court."

As to Hartford's effort to recover from the uninsured individual, the Court of Appeal found that Hartford failed to cite to relevant authority for its direct action and failed to allege any fees or costs which were incurred solely for the defense of this uninsured. Both of these failures could not be remedied, and were fatal to Hartford's appeal.

This is a matter that has attracted amicus briefing from the insurance industry as well as from the policyholder side. The state Supreme Court will likely address this small step forward made by the Court of Appeal, and in doing so hopefully will clarify the boundaries applicable to reimbursement claims.