When an Insured's Defense and Prosecution Costs Overlap

By Dominic S. Nesbitt

It is a common refrain heard from liability insurers that the “duty to defend” in California does not encompass the prosecution of an insured’s own affirmative claims. However, as with many issues having to do with insurance, the law is not that simple.

Although it is true that a defending insurer in California has no per se duty to prosecute claims on behalf of an insured, a defending insurer very clearly does owe a duty to pay any and all fees and costs that satisfy California law’s definition of a “defense cost.” Moreover, where an insured is both defending against claims and concurrently prosecuting its own claims (e.g., in a cross-complaint), an insurer has a duty to pay the insured’s “defense costs” regardless of whether they also serve some dual purpose, such as benefiting the prosecution of the insured’s affirmative claims.

1. Defense Costs: The Aerojet Test

In Aerojet-Gen. Corp. v. Transp. Indem. Co., 17 Cal. 4th 38 (1997), the California Supreme Court established the following three-part test to determine those fees and costs an insurer must pay in fulling its duty to defend:

"First, the [fee or expense] must be conducted within the temporal limits of the insurer’s duty to defend, i.e., between tender of the defense and conclusion of the action. Second, the [task] must amount to a reasonable and necessary effort to avoid or least minimize liability. Third and final, the [fee or expense associated with the task] must be reasonable and necessary for that purpose." Id. at 61.

2. Defense Costs That Do “Double Duty” As Prosecution Costs

The California Supreme Court made clear in Aerojet that, provided an insured can establish that a particular fee or expense meets the definition of a “defense cost,” it is irrelevant that the fee or expense also serves some dual purpose. So in Aerojet, it was held that site investigation expenses may qualify as defense costs even though they may also have been response costs under CERCLA. Id.; see also Barratt American, Inc. v. Transcontinental Ins. Co., 102 Cal. App. 4th 848, 860 (2002) (expenses incurred by an insured to perform repair work on homes might qualify as recoverable defense costs provided they met the Aerojet criteria).

This rule that defense expenses may serve some dual purpose applies to fees and costs which do “double duty” as both defense and prosecution expenses. Provided such fees and costs are “reasonable and necessary” to the insured’s defense, then the insurer must pay them as defense expenses, and this is true even though they may also benefit the prosecution of the insured’s affirmative claims. See State v. Pacific Indemn. Co., 63 Cal. App. 4th 1535, 1548-49 (1998) (defense costs included tasks involved in prosecuting that were inextricably linked to those involved in defending counterclaims); KLA-Tencor Corp. v. Travelers Indemn. Co., 2004 U.S. Dist. LEXIS 15376 *23 (N.D. Cal. August 4, 2004) (acknowledging that the defense of a disparagement lawsuit might encompass the prosecution of a separate patent lawsuit);Adobe Systems, Inc. v. St. Paul Fire & Marine Ins. Co., 2007 U.S. Dist. LEXIS 83648, *27 (N.D. Cal. November 5, 2007) (“even though an insured initiates a lawsuit, that fact does not automatically preclude coverage for defense-type legal fees and expenses where the insured is resisting a contention of liability for damages.”); Larkin v. ITT Hartford, 1999 U.S. Dist. LEXIS 9960, *20 (N.D. Cal. June 29, 1999) (recognizing that attorney’s fees in prosecuting a lawsuit may have been reasonable and necessary to the insured’s defense of a separate action); United Coastal Ins. Co. v. Strategic Organizational Systems Int’l, Inc., 1992 U.S. App. LEXIS 11621, *18 (9th Cir. May 13, 1992) (explaining that, where insurer had a duty to defend one lawsuit but not others and “[s]ome expenses . . . overlap between the three lawsuits,” insurer was not prejudiced by paying for these overlapping costs because “the mere fortuity that the same defense measure proved of use in another lawsuit does not by itself relieve [insurer] of its duty to pay”); Ultra Coachbuilders, Inc. v. General Security Ins. Co., 229 F. Supp. 2d 284, 289 (S.D.N.Y., 2002) (fees incurred in asserting counterclaims “intextricably intertwined” with the defense) (applying California law);3-17 New Appleman on Insurance Law Library Edition § 17.07 (“Reimbursable defense fees incurred to minimize or eliminate liability may include the cost of . . . prosecuting cross-claims . . .”).

3. Aerojet’s “Double Duty” Rule Is Consistent With Other Apportionment Rules

Aerojet’s “double duty” rule means that a liability insurer cannot water down its contractual duty to defend simply because some collateral advantage is conferred on the insured, such as aiding the prosecution of the insured’s affirmative claims. This rule parallels other common law rules of apportionment applicable in other contexts. See e.g., Reynolds Metals Co. v. Alperson, 25 Cal.3d 124, 129-130 (1979) (“Attorney’s fees need not be apportioned when incurred for representation on an issue common to both a cause of action in which fees are proper and one in which they are not allowed.”).

Therefore, when confronted with the refrain “the duty to defend does not encompass prosecution costs,” policyholders should be mindful of the California Supreme Court’s decision in Aerojet, as well as the other authorities cited above. Provided that the fees and costs satisfy California law’s definition of “defense costs,” then an insurer owing a duty to defend must pay them. This is true even when such fees and costs also do “double duty” as prosecution costs.

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