By Gary Osborne & Dominic Nesbitt
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Insurers found to have breached their duty to defend "mixed"
actions, containing both covered and non-covered claims, will usually
try to whittle down the damages they owe. One way they do so is by arguing
that they are required to reimburse only the fees and costs incurred to
defend potentially covered claims. They are wrong. This article explains
why California law requires breaching insurers to reimburse the entirety
of the defense fees and costs their insureds were forced to incur, including
those related solely to the defense of non-covered claims.
The
Buss Rule . . .
The California Supreme Court held in
Buss v. Superior Court (1997) 16 Cal.4th 35 [65 Cal.Rptr.2d 366], that an insurer must defend the
entire action against its insured provided
any claim is potentially covered by its policy. (
Id. at 48.) The Court also held that a defending insurer may later seek reimbursement
from its insured of any fees and costs allocated to claims not potentially
covered by its policy.
The
Buss Court explained why a defending insurer is obligated to defend both covered
and non-covered claims. The insurer's duty to defend potentially covered
claims is justified contractually, as an obligation arising out of the
policy. (
Ibid.) On the other hand, the insurer's duty to defend non-potentially-covered
claims cannot be justified contractually, since the insurer never agreed
to defend such claims. Instead, the Court explained, the insurer's
duty to defend non-potentially-covered claims is justified "prophylactically,"
as "an obligation imposed by law in support of the policy." (
Id. at 49.)
The
Buss Court succinctly described the rational for this rule in the following,
much-quoted passage:
To defend meaningfully, the insurer must defend immediately. To defend
immediately, it must defend entirely.
(
Ibid.)
•
As Applied To A Breaching Insurer
While the
Buss Court did not specifically address the question of what liability a breaching
insurer has for defense costs, the answer flows logically from that decision
and the application of basic principles of contract damages: A breaching
insurer has to pay what it should have paid as a defending insurer,
i.e., the entire cost of defense. (
See Archdale v. American International Specialty Lines. Ins. Co. (2007) 154 Cal.App.4th 449, 469 [64 Cal.Rptr.3d 632] ["[T]he injured
party should receive as nearly as possible the equivalent of the benefits
of the contract as he or she would have received, had the performance
been rendered as promised."].)
Breaching insurers will sometimes argue that they can reduce the damages
they have to pay by exercising a "right of reimbursement" pursuant to
Buss. This, however, is clearly wrong. The California Appellate Court addressed
this issue in
State of California v. Pacific Indemnity Co. (1998) 63 Cal.App.4th 1535, 1549 [75 Cal.Rtpr.2d 69]. In
Pacific Indemnity, a breaching insurer was ordered to reimburse the State of California
for defense costs the State had already incurred in ongoing underlying
litigation, and to undertake the State's defense going forward. In
a passage directly contradicting the contention that a breaching insurer
has reimbursement rights, the California Court of Appeal explained:
Buss was premised on a "defend now seek reimbursement later" theory.
By repudiating its duty to defend and providing no defense, Pacific Indemnity
has nothing from which to seek reimbursement.
Buss does not support Pacific Indemnity's theory that the State should contribute
to attorney's fees. To the contrary, it unequivocally holds that the
insurer's duty is to defend the action in its entirety.
(
Id. at 1549, internal citations omitted.)
Moreover, a defending insurer's right of reimbursement is a
conditional right. The
Buss Court made clear that in order for a defending insurer to exercise a claim
for reimbursement it must – and the
Buss Court italicized the word
must – affirmatively reserve its right to do so. (
Buss, supra, 16 Cal.4th at 61, n. 27;
see also Griffin Dewatering Corp. v. Northern Ins. Co. of New York (2009) 176 Cal.App.4th 172, 219 [97 Cal.Rptr.3d 568].) The Court explained
the importance of the insurer's reservation in the following passage:
Through reservation, the insurer gives the insured notice of how it will,
or at least may, proceed and thereby provides it an opportunity to take
any steps that it may deem reasonable or necessary in response--including
whether to accept defense at the insurer's hands and under the insurer's
control [references to earlier footnotes] or, instead, to defend itself
as it chooses.
(
Buss, supra, 16 Cal.4th at 61, n. 27.)
It would be utterly nonsensical if a defending insurer –
which has failed to reserve reimbursement rights – would have to bear the entire costs of defense, while a breaching
insurer –
which has also failed to reserve reimbursement rights – is permitted to allocate between the costs of defending covered
and non-covered claims.
Insurers will sometimes cite the California Supreme Court's decision in
Hogan v. Midland Ins. Co. (1970) 3 Cal. 3d 553 [91 Cal.Rptr. 153] as authority that a breaching
insurer is permitted to allocate between covered and uncovered claims.
Hogan, however, was decided almost 30 years prior to
Buss, and what little was said in
Hogan about allocation was dictum.
Buss, by holding that insurers must provide a complete defense, now serves
as the measuring stick for contractual damages owed by insurers in default
of their defense obligations.
•
Abundant authority endorses the view that a breaching insurer is obligated
to reimburse its insured the cost of defending "non-covered" claims
While no published decision in California since
Buss has squarely addressed the damages owed by an insurer for breach of its
duty to defend a mixed action against its insured, the California Court
of Appeal, several federal district courts, and leading insurance treatises
have all expressed the view that the
Buss rule entitles an insured to recover as contract damages the entirety of
the defense costs it incurred.
A breaching insurer's obligation to reimburse all defense costs, including
those related solely to the defense of non-covered claims, was directly
addressed by the Court of Appeal in a non-insurance case called
Cassady v. Morgan, Lewis & Bockius LLP (2006) 145 Cal.App.4th 220, 236 [51 Cal.Rptr.3d 527]. The
Cassady decision is particularly informative because the appellate panel which
decided it included Justice H. Walter Croskey, who is generally regarded
as the state's leading jurist in the area of insurance law, and who
concurred in the opinion written by Justice Aldrich. The
Cassady court wrote, in relevant part, as follows:
When an insurer
refuses to defend an action in which a potential for coverage exists, the insured
may recover defense costs,
including attorney's fees allocable to the defense of noncovered claims, unless the insurer can prove they were unreasonable or unnecessary.
(
Id., second italics added;
see also Pacific Indemnity,
supra, at 1549.)
Several unpublished decisions from the federal district court have also
addressed the issue and rejected a breaching insurer's attempt to
allocate its insured's defense costs. (See, e.g.
, Electronics For Imaging, Inc. v. Atlantic Mut. Ins. Co. (N.D. Cal. May 14, 2007, No. C 06_03947 CRB) 2007 U.S. Dist. LEXIS 38058,
*7 ["As defendant did not provide plaintiff with a defense, defendant
is liable for plaintiff's costs and fees incurred in defending the
underlying action, including those fees and costs incurred in defending
claims that are not even potentially covered."];
Thane Int'l, Inc. v. Hartford Fire Ins. Co. (C.D. Cal. February 19, 2009, No. EDCV 06_1244 VAP(OPx)) 2009 U.S. Dist.
LEXIS 13696, *16 ["[The insurer's] argument that its duty to
defend should be apportioned with its insured . . . is contrary to California
law."].)
California's leading secondary authority on insurance law is likewise
of the view that a breaching insurer may not allocate defense costs. This
issue is addressed in the following two sections of this treatise:
Damages for breach of duty to defend
Includes defense costs allocable to noncovered claims: The insured may recover its defense costs, including attorney fees allocable
to the defense of noncovered claims . . . .
(Hon. H. Walter Croskey,
et al., California Practice Guide: Insurance Litigation (The Rutter Group 2009)
¶ 7:691.15.)
No allocation between covered and noncovered claims: As long as at least one claim was potentially covered, the insurer owes
a duty to defend the entire action. By refusing to provide a defense,
the insurer becomes liable for defense costs incurred by the insured allocable
to claims
not even potentially covered under the policy. [
State of Calif. v. Pacific Indem. Co. (1998) 63 CA4th 1535, 1548, 75 CR2d 69, 77]
(
Id. at ¶ 12:652, italics in original.)
This view has also been adopted by insurance law authorities outside of
California. (See, e.g., 1-7 New Appleman on Insurance (Law Library Edition)
§ 7.06, n. 365 ["Based on [the
Buss] rationale, in California, at least, the policyholder's recovery where
the insurer does not defend should include reasonable and necessary fees
and expenses to defend against claims within the underlying suit that
are not potentially covered."]; see also Ostrager & Newman, Handbook
on Insurance Coverage Disputes (15th ed. 2010) § 5.05[a] ["An
insurer which breaches its duty to defend will be held liable to pay all
defense costs, regardless of whether all of the claims are covered by
its policy."].)
Thus, while the California Supreme Court has yet to squarely address the
damages owed by a breaching insurer, judges and commentators agree that after
Buss there can be only one logical answer: An insured is owed the entirety
of the defense costs it was forced to incur as a consequence of the insurer's breach.
Moreover, having denied coverage, paid nothing, and failed to reserve a
reimbursement right, a breaching insurer possesses no right of reimbursement.
If it had such a right, it would, anomalously, be in a better position
than a defending insurer which failed to reserve its rights, leading to
an absurd and unfair result, something the law does not countenance.
Conclusion
Thus, under California law, a breaching insurer must reimburse its insured
the entirety of the defense costs incurred – no less than what it
would have owed had it defended – without any right of reimbursement.