Written by David O’Neill, JD
Director of Investigations, PolicyFind
The California Supreme Court recognized an insurer’s right to recoup defense costs for claims proven to be non-covered in its 1997 holding in Buss v. Superior Court.1 Finding precedent in state law for the rule that an insurer’s duty to defend in a commercial general liability (“CGL”) insurance policy is indeed broader than its duty to indemnify, the Supreme Court singled out an issue before it as one of first impression. The issue to be determined was whether the insurer’s costs in exercising its duty to defend could be passed to the policyholder should claims defended later be determined to include those for which coverage did not apply.
Basing its decision on contractual principles, the Buss court opined that because the insurer had defended potentially uncovered claims, the policyholder had received a benefit for which it had not bargained. It found that the insurer’s right to recoup these defense dollars was implied in law even if not expressly stated in the insurance contract.
In reliance on Buss, insurers have made standard the drafting of reservation of rights letters that stipulate their right to reimbursement for defense costs for potentially coverable claims that later are determined to be outside of coverage. In the past decade, some courts have found that a policyholder’s acceptance of a defense under the terms of such reservation of rights letters amounted to the acceptance of new contract terms, extending rights to insurers in addition to those rights expressed in the policy language itself.
While Buss continues as precedent in California, recently courts have chosen not to extend its ruling or have distinguished it on its facts. Also courts of first impression in other states that historically looked to California court opinions for guidance in insurance matters are also opting not to board the Buss. These have included Alabama, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Minnesota, Mississippi, Missouri, Pennsylvania, Virginia, Washington, and Wyoming.
In its 2005 decision in the General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co.2 case, the Illinois Supreme Court reversed lower court decisions based on Buss. A gun dealer’s general liability insurance policy language had not included a provision allowing its insurer to recompense itself for defense expenditures later found uncovered, and the Supreme Court refused to find these rights to recoupment in the insurer’s reservation of rights letter.
Here the Illinois court looked to Wyoming and Hawaii for its inspiration. It found that the Wyoming decision in Shoshone First Bank v. Pacific Employers Insurance Company3 in which an insurer’s claim that its reservation of rights letter gave it a right to reimbursement not expressed in the policy had been denied. The Shoshone court had looked to Hawaii for its reasoning, finding language in the opinion in First Insurance Co. of Hawaii v. State4 for its rule.
“The insurer is not permitted to unilaterally modify and change policy coverage. We agree with the Supreme Court of Hawaii that a reservation of rights letter does not relieve the insurer of the costs incurred in defending its insured where the insurer was obligated, in the first instance, to provide such a defense.”
Similarly, the Pennsylvania Supreme Court found in its 2010 Am. & Foreign Ins. Co. v. Jerry’s Sport Ctr., Inc. ruling5 that allowing an insurer to use a reservation of rights letter to reserve a right not in the policy language was “tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract.” The court held that the insurer could not obtain reimbursement of defense costs for a claim for which the court later determined there had been no duty to defend even with a reservation of rights letter.
More recently, the Supreme Court of Washington observed that more recent decisions by state courts of first impression had rejected the notion that an insurer can have protection from claims of bad faith or breach without any responsibility for the costs of defense if a court later determines there is no duty to defend. In its 2013 en banc decision in National Surety Corporation v. Immunex Corporation,6 it took note of Buss but turned away from it, finding that “this all reward, no risk proposition renders the defense portion of a reservation of rights defense illusory. The insured receives no greater benefit than if its insurer had refused to defend outright.”
Based on this trend in other states, it would seem that the influence of the Buss decision is waning. Watching what deference upcoming state court decisions give to the Buss line of cases should be a good determiner of whether the insurer’s reliance on reservation of rights letters for its right to recoup will continue or diminish.
1. Buss v. Superior Court, 939 P.2d 766 (Cal. 1997).
2. General Agents Ins. Co. of Am. Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092, 1102 (Ill. 2005).
3. Shoshone First Bank v. Pacific Employers Insurance Co., 2 P.3d 510, 514 (Wy. 2000).
4. First Insurance Co. of Hawaii, Inc. v. State, by Minami, 66 Haw. 413, 665 P.2d 648, 654 (1983).
5. Am. & Foreign Ins. Co. v. Jerry’s Sport Ctr., Inc., 2A.3d 526, 545 (Pa 2010)
6. National Surety Corporation v. Immunex Corporation, 176 Wash.2d 872, 297 P.3d 688 (Wash. 2013).