Insurer Obligations To Fund Defense/Settlements/Judgments
I. DEFENSE FEE REIMBURSEMENT
A. Recovery of Pre-Tender Defense Fees in the Underlying Action
Some states addressing pre-tender fee recovery issues allow policyholders to recover fees expended prior to notifying their insurer of the claim. Recovery will be limited, however, by factors, such as an insurer's proof that its vital interests were prejudiced by the late notice, due to the voluntary payment provisions, lack of timely notice, and rules regarding waiver.
Courts favoring recovery of pre-tender fees have cited the reasonableness of a policyholder's response to the suit against them and the lack of prejudicial harm to the insurer caused by the lack of notice of the claim while the fees were being incurred. When policyholders have acted reasonably in spite of their late notice, and an insurer does not incur a larger burden because of the delay in notification, pre-tender fee recovery has been granted as part of an insurer's obligation to defend the policyholder. • Sherwood Brands, Inc. v. Hartford Accident & Indemnity Co., 347 Md. 32, 698 A.2d 1078 (1997)
The Maryland Court of Appeals, Maryland's highest court, held that when a duty to defend arises, the insurer is liable for pre-tender fees. The court found that a duty to defend is created when an insured claim is filed or an insured event occurs. The court held that if an insurer breaches that duty, the insurer is then liable for "all damages incurred by the [policyholder] as a result of that breach," including pre-tender fees.
B. Post-Tender Defense Fees
Ultra Coachbuilders, Inc. v. General Security Ins. Co., 229 F. Supp. 2d 284, 286 (S.D.N.Y. 2002) (The court found, “[when] the insurer has breached its duty to defend, it is the insured that must carry the burden of proof on the existence and amount of the . . . expenses, which are then presumed to be necessary as defense costs, and it is the insurer that must carry the burden of proof that they are in fact unreasonable or unnecessary." Applying blended rate averages for Partners and Associates, the court found that billing rates charged to be within the 75% of the AIPLA Survey were reasonable. The same was true of the fees themselves where "the services were rendered [by Knobbe, Martens, et al.] under exigent circumstances, involved the factual and legal complexities of trademark cases, were performed with skill and dispatch, and resulted in a substantial victory, successfully defended on appeal and of great importance to the client.
C. Right to Independent Counsel
Right Not Created
Johnson v. Continental Cas. Co., 788 P.2d 598, 363 (Wa. App. 1990) (Not all reservation of rights create a conflict of interest. The court stated “[i]n Washington, there is simply no presumption, as Johnson urges, that a reservation of rights situation creates an automatic conflict of interest. Therefore, the insurer has no obligation before the fact to pay for its insured's independently hired counsel. Any breach of the ‘enhanced obligation of fairness’ in a reservation of rights situation might lead to after-the-fact liability of the insurer, retained defense counsel, or both.”)
• James 3 Corp. v. Truck Ins. Exch., 91 Cal. App. 4th 1093 (2001)
The court found that refusal to pursue affirmative defense, prosecute counterclaims or to seek reimbursement of defense costs allocable to noncovered claims does not create a conflict. A conflict may arise nonetheless (1) where the insurer insures both the plaintiff and the defendant (a fact which may require discovery to reveal); (2) the insurer has filed suit against the insured whether or not related to the lawsuit the insurer is obligated to defend.
Right Created
• San Diego Federal Credit Union v. Cumis Ins. Soc'y, Inc., 162 Cal. App. 3d 358, 371, 28 Cal. Rptr. 494 (1984)
The court found that independent counsel is triggered where a conflict of interest arises because appointed defense counsel could conduct defense to shift liability from the insurer (i.e. intentional acts) to the policyholder so as to avoid a covered indemifiable loss.
• Nelson Elec. Contr. v. Transcontinental Ins., 660 N.Y.S.2d 220, 222 (1997)
The court stated, "Where, as here, the interests of the insured are at odds with those of its insurer, the former is entitled to select independent counsel to conduct the defense."
D. Interim Fee Agreements
The standard for independent counsel rates is reasonableness. The burden of proving a fee charged by an attorney is unconscionable or unreasonable rests upon the party asserting such fees are unconscionable or unreasonable.
If an insurer appoints "audit" counsel, its access to material should be limited to noncoverage related items. Policyholder counsel should request that the insurance company set forth the basis for audit counsel's investigation and review, including the assumptions upon which "audit counsel" relies in conducting its review.
A written contract should be entered into between independent counsel and the insurer governing the criteria to be employed by the insurer including: review of outside attorneys' fees; A mechanism for the resolution of future fee disputes. Such as: The rate payable to independent counsel, the period of time from receipt of invoice to payment; format of billing; format of reporting to the insurer, policyholder's right for specific identification of items disputed by the insurer, and like items should be identified where the insurer retains "audit counsel." The agreement should address an interim blended or capped rates subject to a right to agree to disagree about and to address reasonableness (tasks selected, time accrued for tasks, case staffing) as fees accrue.
E. Recovery of In-House Fees and Investigative Costs
• PLCM Group, Inc. v. Drexler, 22 Cal. 4th 1084, 1093-94 (2000)
The court found that "A corporation represented by in-house counsel is in an agency relationship, i.e., it has hired an attorney to provide professional legal services on its behalf. . . . The fact that in-house counsel is employed by the corporation does not alter the fact of representation by an independent third party. Instead, the payment of a salary to in-house attorneys is analogous to hiring a private firm on a retainer. The superior court calculated the attorney fees to be awarded PLCM based on their market value, specifically, the reasonable inhouse attorney hours multiplied by the prevailing hourly rate in the community for comparable legal services."
F. Recovery of CounterClaim Fees
Where defense of counterclaim requires prosecution of plaintiff's claims, they are recoverable.
Great West Casualty Co. v. Marathon Oil Co., 2003 U.S. Dist. LEXIS 11805, at *8 (N.D. Ill. (E. Div.) July 11, 2003) (The court found that "‘Defense' is about avoiding liability. Claims and actions seeking third-party contribution and indemnification are a means of avoiding liability just as clearly as is contesting the claims alleged to give rise to liability." )
Ultra Coachbuilders, Inc. v. General Sec. Ins. Co., 229 F. Supp. 2d 284 (S.D.N.Y. 2002) (“The counterclaims, alleging unfair competition and interference with competitive advantage, were used to argue (albeit unsuccessfully) that the injunction application was barred by the doctrine of unclean hands, . . . and were thus ‘inextricably intertwined with the defense of [defendant's] claims and necessary to the defense of the litigation as a strategic matter.'”)
TIG Ins. Co. v. Nobel Learning Communities, Inc., 2002 U.S. Dist. LEXIS 10870, at *41 (E.D. Pa. June 18, 2002) ("As the prosecution of the affirmative claims was essential to the defense against the counterclaim, it was logically encompassed by TIG's duty to defend Nobel.")
• KLA-Tencor Corp. v. Travelers Indem. Co., 2004 U.S. Dist. LEXIS 15376 (N.D. Cal. Aug. 4, 2004)
The court noted that "‘reasonable and necessary costs of defending a lawsuit are recoverable if the insurer breaches its duty to defend.' Barratt Am., Inc. v. Transcont. Ins. Co., 102 Cal. App. 4th 848, 860, 125 Cal. Rptr. 2d 852 (2002)"). Affirmative claims for patent infringement were answered by a disparagement counterclaim conjoined with a patent infringement count as well as other uncovered claims. The issue was whether all attorneys fees incurred by the counter defendant, including those arguably in connection with KLA's affirmative pursuit of its patent claims, were defense related and therefore recoverable:
To satisfy the ‘reasonable and necessary' test, fees and costs of an insured must meet three requirements: (1) the challenged costs and fees must relate to an action conducted within the temporal limits of Travelers' duty to defend; (2) the challenged costs and fees must relate to a reasonable and necessary effort to avoid or minimize liability; and (3) the challenged costs and fees must be reasonable and necessary for that purpose. See Barratt, 102 Cal. App. 4th at 858 (citing Aerojet, 1Cal. 4th at 60-63). Id at. 21-22
The court found that it was unreasonable to charge the insurer for the cost incurred in the defense of the ‘406 patent infringement claim, because as they were unnecessary to Thermo Waves disparagement allegations, even though they might provide some information on damages sought for same. The court criticized the cursory deposition testimony and lack of substantive fact record which impacted its ability to find that the prosecution of KLA's affirmative IP claims and the defense of the disparagement claims were "inextricably intertwined."
G. Insurer Guidelines
• In the Matter of the Rules of Professional Conduct and Insurer Imposed Billing Rules and Procedures, 2 P.3d 806, 814-17 (Mont. 2000)
Defense counsel who submit to insurer-imposed requirements of prior approval for depositions, legal research, employment of experts and preparation of motions "violate their duties under the Rules of Professional Conduct"). In Dynamic Concepts, Inc. v. Truck Insurance Exchange, 71 Cal. Rptr. 2d 882, 889 & n.9 (Ct. App. 4thDist. 1998), the court stated,
Insurer-imposed restrictions on discovery or other litigation costs may well violate the insurer's duty to defend as well as the attorneys' ethical responsibilities to exercise their independent professional judgment in rendering legal services. . . . Under no circumstances can such guidelines be permitted to impede the attorney's own professional judgment about how best to competently represent the insureds.
H. Insurer Requests For Information to Assess Defense Fees And Settlement Opportunities
• In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289, 303 (6th Cir. 2002)
The court discussed in detail the
attorney-client privilege [which] is a matter of common law right, "the oldest of the privileges for confidential communications known to the common law." Upjohn [Co. v. United States,] 449 U.S. [383] at 389, 101 S. Ct. [677] at 682 [(1981)]. It is not a creature of contract, arranged between parties to suit the whim of the moment. [Emphasis added.]
The Columbia/HCA Healthcare court then surveyed federal case law on the issue of whether it is possible to have any selective waiver of the attorney-client privilege as some courts had suggested. The Sixth Circuit entirely rejected the idea of selective waiver. The court stated, "[A]fter due consideration, we reject the concept of selective waiver, in any of its various forms." Id. at 302. [Emphasis added.]
The court then applied the same bright line test to the waiver of attorney work-product privilege as it does to the waiver of attorney client privilege:
These and other reasons "persuade us that the standard for waiving the work-product doctrine should be no more stringent than the standard for waiving the attorney-client privilege" - once the privilege is waived, waiver is complete and final. Id. at 307. [Emphasis added.]
Courts have held that because of the privilege's adverse effect on the full disclosure of the truth, it must be narrowly construed and is therefore often found to be waived. Underwater Storage, Inc. v. United States Rubber Co., 314 F. Supp. 546, 547 (D.D.C.1970). An intent to waive one's privilege is not necessary for such a waiver to occur. Id., at 549. Waiver of the attorney-client or the work product privilege can be found from a failure assert it. Daniels v. Hadley Memorial Hospital, 68 F.R.D. 583, 587 (D.D.C.1975). In fact the privilege can be lost even where the disclosure was accidental.
All involuntary disclosures, in particular, through the loss or theft of documents from the attorney's possession, are not protected by the privilege, on the principle . . . that . . . the law . . . leaves to the client and attorney to take measures of caution sufficient to prevent being overheard by third persons. The risk of insufficient precautions is upon the client.
8 Wigmore, Evidence § 2325 (McNaughton rev. 1961) [Emphasis added.]
Within the Sixth Circuit, cases suggest that express or implied waiver of privilege can be found from many circumstances, including "‘a client's disclosure to a third party of communications made pursuant to the attorney-client privilege . . .'" Travelers Cas. & Sur. Co. v. Excess Ins. Co., 197 F.R.D. 601, 606 (S.D. Ohio, 2000), disclosure of an attorney's letter to the client's insurer for the purpose of obtaining coverage, Gomez v. Towne Bancorp, 2000 U.S. Dist. LEXIS 12060, *4 (N.D. Ohio, 2000), allowing an expert witness to read a document provided by the client, Amway Corp. v. P&G, 2001 U.S. Dist. LEXIS 5317 * 4 (W.D. Mich., 2001), and failure to provide a sufficiently detailed privilege log, Carfagno v. Jackson Nat'l Life Ins. Co., 2001 U.S. Dist. LEXIS 1768 *7 (W.D. Mich., 2001). Significantly, United States v. Skeddle, 989 F. Supp. 905, 911 (N.D. Ohio, 1997) held no privilege applied to a letter from an insured's outside counsel to an attorney for the liability insurer.
I. Recovery of Prejudgment Interest on Unpaid Fees
• Ultra Coachbuilders, Inc. v. General Security Ins. Co., 229 F. Supp. 2d 284, 289 (S.D.N.Y. 2002)
The court found that "Ultra is entitled to . . . pre-judgment interest on those fees and costs, at 10% per annum, from the date of each invoice until the date of the judgment."
J. Recovery of Coverage Fees Incurred in a Coverage Action
• Concept Enterprises, Inc. v. Hartford Ins. Co. of the Midwest, No. CV 00-7267 NM (JWJx), 2001 U.S. Dist. LEXIS 6901 (C.D. Cal. May 22, 2001)
The Court ruled that Hartford's failure to reimburse 100% of the reasonable defense fees incurred, as well as its demand that its insured allocate its defense fees incurred between covered trade dress and uncovered patent infringement claims was a breach of the duty of good faith and fair dealing, justifying a finding of bad faith as a matter of law. Under California law, Hartford therefore had to pay all reasonable attorneys' fees incurred by coverage counsel in proving that Hartford's duty to defend extended to the complete lawsuit.
• McRory v. Northern Ins. Co., 980 P.2d 736, 138 Wn.2d 550, 555 (Wn. 1999)
The court stated, "In every case, the conduct of the insurer imposes upon the insured the cost of compelling the insurer to honor its commitment. . . . We believe that an award of fees is required in any legal action where the insurer compels the insured to assume the burden of legal action, to obtain the full benefit of his insurance contract."
II. OBTAINING SETTLEMENT AUTHORIZATION FOR REIMBURSEMENT
A. A Settlement Is Subject to Reimbursement Based on a Potentiality Standard and It Does Not Require Proof of a Right to Indemnity
An insurer's obligation to fund a settlement flows from the duty to defend as an implied contractual covenant and is implicated by a "potential" not "actual" coverage as is the case for a judgment which requires proof of an insurer's duty to indemnify its insured based on the manner in which liability attaches. Recovery of monies paid in settlement does not implicate indemnity issues because there is no adjudication of liability. Aerojet General Corp. v. Transport Indem. Co., 17 Cal. 4th 38, 76 n.29 (1997). Analyzing potential coverage based on the claims asserted but not proven against the insured suffices to trigger a right to reimbursement of defense fees, since that is all that can be assessed where there is no adjudication against the insured. Zurich Ins. Co. v. Killer Music, 998 F.2d 674, 679 (9th Cir. (Cal.) 1993).
Much like the rules applicable to an insurer's duty of defense, the rules applicable to an insurer's duty of settlement significantly favor obligating an insurer to fund settlements. It is critical to note that the duty to settle cannot be equated with an insurer's obligation to indemnify the insured for a judgment. Whereas questions of indemnity turn exclusively on what is (or is not) actually covered, these considerations play no part in evaluating an insurer's settlement obligation.
B. Insurers Cannot Avoid Funding a Reasonable Settlement Based on Coverage Disputes
Coverage issues such as allocation between covered and uncovered claims cannot be properly considered when evaluating and effectuating settlement of a suit against the insured. If the proposed settlement is reasonable, the insurer must agree to fund the entire amount. It cannot seek to allocate amongst the claims; it cannot force the insured to contribute to the settlement, see Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718, 731, 117 Cal. Rptr. 2d 318, 328 (2002) ("[I]nsurer potentially can be liable for unreasonably coercing an insured to contribute to a settlement fund, even though (by definition) there is no excess judgment where a case is settled.").
An insurer cannot wait around in the hopes that a better deal will be forthcoming – it must take the settlement and reserve whatever rights of reimbursement it may possess. In a mixed action involving both covered and uncovered claims, the insurer must fund the entire settlement but, as with defense costs, may reserve the right to seek reimbursement for the uncovered portions of the settlement once the underlying suit has been concluded. See Blue Ridge Ins. Co. v. Jacobsen, 25 Cal. 4th 489, 502 (2001).
C. Insurer Obligations to Pay Settlement Costs Where a Business Tort Lawsuit Asserts Potentially Covered Claims
1. Where the Insurer Defends
An insurer who fulfills its defense obligations has the right to approve and participate in any settlements entered into by its insured. In the absence of bad faith, the insurer will not necessarily be liable for the entire settlement so long as potentially covered claims were asserted at the time of settlement makes the most sense. Pershing Park Villas Homeowners Ass'n v. United Pac. Ins. Co., 219 F.3d 895, 902 (9th Cir. (Cal.) 2000). This rule is consistent with the law that governs when an insurer denies a defense and seeks to obtain reimbursement for that portion of the defense fees which it claims are uncovered claims. Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718, 728 (2002). In those few jurisdictions that have recognized an insurer's right to reimbursement, a refusal to defend deprives the insurer of any right to seek allocation of defense fees. Amato v. Mercury Cas. Co., 53 Cal. App. 4th 825, 835 (1997); Samson v. Transamerica Ins. Co., 30 Cal. 3d 220, 237 (1981) ("It is well established in California that "an insurer that wrongfully refuses to defend is liable on the judgment . . . .").
HA 2003, Inc. v. Federal Ins. Co., 310 B.R. 710, 723-24 (N.D. Ill. (E. Div.) 2004 (“The general rule in Illinois is that if an insurer does not breach the insurance contract, the insured must get the insurer's approval before settling the case. . . . However, the majority of courts addressing this issue convincingly holds that the rules change once an insurer reserves its rights and takes a position that coverage does not apply. The only Illinois court addressing this specific issue has adopted the majority approach. Commonwealth Edison Co. v. Nat'l Union Fire Ins. Co., 323 Ill. App. 3d 970, 985, 752 N.E.2d 555, 567, 256 Ill. Dec. 675 (2001), held that when an insurer that defended while reserving its right to contest coverage lost the right to consent to a settlement. The court quoted extensively from Cay Divers, Inc. v. Raven, 812 F.2d 866 (3rd Cir. 1987), which held that, by providing the insured with independent counsel while reserving a right to contest coverage, an insurer renounces control of the litigation and thrusts responsibility for the litigation on the insured, who is then free to enter into a reasonable settlement. . . . Although the facts of Commonwealth Edison are more complex, and involve a relinquishment of control by the insurance carrier because of a conflict of interest between two insureds, the court's holding is a clear acceptance of the majority view addressed below.”)
2. Where the Insurer Does Not Defend
Insurers who refuse to defend will often contest their duty to reimburse policyholders for amounts paid in satisfaction of settlement agreements. On the other hand, if a court finds a policy excluded any coverage, it will not construe either the refusal to indemnify a judgment, or reimburse monies paid in settlement as a "source of bad faith liability."
Courts generally distinguish between insurer's good faith and bad faith refusals in this context. An insurer who wrongfully denies its obligations under the policy is liable for all damages incurred by the insured as a result of the breach. Isaacson v. California Ins. Guarantee Assn., 44 Cal.3d 775, 793-94 (1988). Such damages include the amount of the judgment or reasonable and noncollusive settlement under a commercial general liability policy. Similarly, some of the asserted claims are potentially covered as of the date of settlement, the insurer is obligated to pay the entirety of a reasonable settlement under the law. In Adolfo House Distribution Corp. v. Travelers Property & Casualty Ins. Co., 165 F. Supp. 2d 1332, 1343 (S.D. Fla. 2001), the court found the insurers obligated to reimburse the full amount of the settlement paid where potential coverage existed at the time of settlement as to some of the claims asserted.
An insurer cannot attack its insured's settlement of an underlying lawsuit simply because the insured paid no money toward the settlement. Johansen v. California State Auto. Asso. Inter-Insurance Bureau, 15 Cal. 3d 9, 15 (1975); Hamilton, 27 Cal. 4th at 728. Where the issues upon which coverage depends were not raised in the underlying action, they may be the subject of post- settlement coverage litigation. Pruyn v. Agricultural Ins. Co., 36 Cal. App. 4th 500, 514, n.15 (1995).
Much like the rules applicable to an insurer's duty of defense, the rules applicable to an insurer's duty of settlement significantly favor obligating an insurer to fund settlements. In Johansen v. California State Auto. Ass'n, 15 Cal. 3d 9, 16, 123 Cal. Rptr. 288, 292 (1975), the court ruled that an insurer cannot consider coverage issues in evaluating the reasonableness of a settlement opportunity. Coverage issues such as allocation between covered and uncovered claims cannot be properly considered when evaluating and effectuating settlement of a suit against the insured. If the proposed settlement is reasonable, the insurer must agree to fund the entire amount. It cannot seek to allocate amongst the claims; it cannot force the insured to contribute to the settlement; it cannot wait around in the hopes that a better deal will be forthcoming – it must take the settlement and reserve whatever rights of reimbursement it may possess. Hamilton 27 Cal. 4th at 731 ("[I]nsurer potentially can be liable for unreasonably coercing an insured to contribute to a settlement fund, even though (by definition) there is no excess judgment where a case is settled.").
Recently, the Illinois Supreme Court held that a nondefending insurer owed payment of a reasonable settlement in a case in which an insured settled a case and in consideration assigned its rights to the underlying plaintiff. In Guillen v. Potomac Ins. Co. of Ill., 203 Ill. 2d 141 (Ill. 2003), the Court found that the assignment created a contractual liability on the insured and was not a release, thus while the insured did not face personal exposure the payment obligation was not negated. Id. at 160-161.
In dicta, the Court explained that once an insurer breaches its duty to defend, and insured may agree to settle the case and seek indemnification from the insurer, and the insurer would be limited in its disputing of liability if there was no assignment, and the insured had a legal obligation to pay the settlement amount.
D. Structuring Settlements to Maximize Recovery of Insured Proceeds
1. Reasonableness of the Settlement
Even if the insurer improperly refuses to reimburse its insured for monies paid in settlement, it is not estopped from contesting the reasonableness of the settlement agreement. Courts differ in their allocation of the burden of proof as to reasonableness, applying one of two approaches. Under the first approach, "a reasonable settlement made by the insured to terminate the underlying claim against him may be used as presumptive evidence of the insured's liability claim, and the amount of such liability." Killer Music, 998 F.2d at 679.
In applying this approach, some courts use a two pronged test to determine reasonableness. First, they examine the record to determine whether the settlement was made in reasonable anticipation of personal liability. Where the exposure faced by an insured is sufficient to justify the amount paid in settlement, the payment is presumptively reasonable, irrespective of whether aspects of the exposure would not fall within coverage. Second, they look to the policy limit to determine whether the settlement was for a reasonable amount. If the settlement figure exceeds the policy limits, courts may require a showing that the insurer breached its duty of implied good faith and fair dealing to establish a right to recovery of same. Johansen, 15 Cal. 3d at 15.
2. Allocation of Settlement Between "Covered/Uncovered" Claims in Mixed Actions
• Vargas, et. al. v. Hudson County Bd. of Elections, et. al., 949 F.2d 665, 674 (3rd Cir. (N.J.) 1991)
Under a distinct approach, reasonableness is always an issue of fact which must be proved by the insured assuming the claims settled were clearly within coverage. The court noted, "The insured has the burden of producing evidence showing that the settlement was prima facie reasonable. . ."
• Flodine v State Farm Ins. Co., 2003 U.S. Dist. LEXIS 4006, (N.D. Ill, 2003)
The court found that nondefending insurer had indemnity obligation (as a result of a settlement) because of estoppel (citing Employers Ins. v. Ehlco Liquidating Trust, 186 Ill. 2d 127, 150-51 (1999). The court then determined the settlement was reasonable by evaluating the details of the settlement.
Courts have [established] the general rule that an insurer will be liable for the full amount of an insured's settlement , as long as that settlement was made in reasonable anticipation of personal liability and the settled amount was reasonable . . . . Id. * 30.
The "litmus test" for deciding whether a settlement was reasonable is "what a reasonably prudent person in the position of the [insured] would have settled for on the merits of plaintiff's claim. (citing Guillen) Id.*37.
3. Impact of the "Voluntary Payments" Provision Where an Insured Tenders the Defense then Negotiates a Settlement on Its Own
When a "voluntary payments" provision is present in a policy, absent insurer consent or the insurer's denial of a defense, an insured must loose policy benefits by failing to keep the insurer fully apprized of pertinent facts it seeks to evaluate in determining whether the insurer will contribute to or fund settlement.
• Low v. Golden Eagle Insurance Co., 110 Cal. App. 4th 1532 (2003)
The insured was barred from seeking reimbursement from a defending insurer where it failed to apprize it of the settlement, even if its terms were reasonable and noncollusive.
• Servpro-Domesticare of Anderson Hills, Inc. v. Grange Mut. Cas. Co., 1985 WL. 7739 *2 (Ohio App. Sept. 23, 1985)
The rule changes where an insurer participating in the insureds defense refuses to participate in its settlement. The court stated:
Generally, where the insurance company denies liability for a claim or refuses to defend its insured, the insured may make a reasonable settlement or compromise with the claimant absent the insurer's consent without losing its right to recover on the policy. 59 Ohio Jurisprudence 3d (1985) 61, Insurance, Section 1030.
• Ferrando v. Auto-Owners Mut. Ins. Co., 781 N.e.2d 927, 947 (Ohio 2002)
The court found that a voluntary payment provision is no impediment to holding an insurer liable for a reasonable settlement where "the insurer failed to respond within a reasonable time to a request for consent to the settlement offer, or unjustifiably withheld consent. . ."
E. Settlements Which Grant Affirmative Business Rights May Not Be Recoverable
1. Settlements which Confer Business Rights on Alleged Infringers Through License Provisions May Require Allocation Where a Business Benefit Is Conferred on the Settling Party
Settlements should recite that monies paid are for past damages. If a prospective license fee is negotiated, and ongoing use of products or services covered by the license will occur, some allocation of settlement payments to that business benefit should be made. Absent a conferral of business benefits to the insured, a nondefending insurer or an insurer who refuses to fund a reasonable settlement may be liable for the full amount of a settlement even if it includes uncovered claims.
• Zurich Ins. Co. v. Killer Music, 998 F.2d 674, 679 (9th Cir. (Cal.) 1993)
The court stated, "We recognize that the settlement agreement represents, in part, an exchange of cash consideration for the rights to Pfeifer's songs, not simply compensation for damages from copyright infringement." As a result, on remand, the court required the separation of the award into the "compensation" for rights to songs and the damages from copyright infringement. Critically, the policyholder acknowledged the viability of the underlying plaintiff's copyright by seeking to license the right to play songs subject to copyright protection.
• Platinum Technology, Inc. v. Federal Ins. Co., 282 F.3d 927 (7th Cir. (Ill.) 2002)
The court found that the license components of a technology transfer in association with a settlement were a benefit that accrued to the insured which was chargeable to the insurer. The court ruled that Platinum purchased the "Platinum" trademark, worth $4 million in the settlement/ assignment agreement, and that this $4 million cash payment was not made as part of a reasonable settlement agreement to relieve Platinum of its liability from trademark infringement.
2. Settlements That Reflect Affirmative Claims for Damages Against Underlying Plaintiffs May Unnecessarily Vest Insurers with Subrogation Rights That Preclude the Insured's Full Settlement Reimbursement
• TIG Ins. Co. v. Nobel Learning Communities, Inc., No. 01-4708, 2002 U.S. Dist. LEXIS 10870, at *41 (E.D. Pa. June 18, 2002)
The court found that fees incurred in prosecution of counterclaims against the underlying plaintiff, as well as those expended in defending the copyright infringement claims were compensable. Critically, however, once compelled to pay all defense fees including those related to prosecution, the recitals in the settlement agreement provided a pathway to the insurers to recover such fees. Thus, in TIG, the court awarded a "setoff to the extent of $175,000 against Nobel's post-counterclaim fees, costs and expenses." Id. at *42-43. The court therefore found that there was a right by the carrier to offset this portion of the sum from the settlement agreement against their defense obligation to avoid "double recovery" to the insured.
• Flodine dba Natural Wonders v. State Farm Ins. Co., 2003 U.S. Dist. LEXIS 4006 (N.D. Ill. (E. Div.) March18, 2003)
The settlement entered into by Flodine and NAA was intended to settle an actual (and still viable) dispute between them. Therefore, State Farm had a duty to indemnify Flodine for the settlement of those claims even though State Farm was unaware of the settlement. Because State Farm breached its duty to defend Flodine with respect to the IACA and non-IACA claims, it could not rely on policy defenses.
III. INDEMNIFICATION FOR DAMAGE EXPENSES
A. Judgment Maybe Subject to Indemnity Where Potentially Covered Claims Are Asserted Through Motion for Summary Judgment
U.S. Fire Ins. Co. v. Green Bay Packaging, Inc., 66 F. Supp. 2d 987, 998-99 (E.D. Wis. 1999) (“A duty to indemnify exists if acts occur that are insured against. Where a claim consists of a variety of acts, some of which are covered and others that are not, it is well settled that resulting liability falls within the terms of the Insurance policy unless the uncovered risk is the sole cause of damages. . . . Only if the damage award was totally unrelated to the conduct within the coverage of the insurance policy will the insurer not be liable. . . . the insurer has a duty to indemnify.”)
B. Judgment for Disgorgement of Ill-Gotten Gain May Not Be Subject to Indemnity
The duty to defend and indemnify under the "advertising injury" provisions of the CGL policy is only for "sums for which the policyholder shall become legally obligated to pay for damages." A suit for purely equitable relief does not give rise to a duty to defend because it is not a lawsuit seeking damages. For this reason, the California Supreme Court denied indemnity to Bank of the West for claims asserted against it under the Unfair Business Practices Act. The court stated, "one may not insure against the risk of being ordered to return money or property that has been wrongfully acquired. Such orders do not award ‘damages' as that term is used in insurance policies." Bank of the West, 2 Cal. 4th at 1266 (citation omitted).
C. Duty to Indemnify Is Determined Based on Facts of Underlying Case
• Hyman v. Nationwide Mut. Fire Ins. Co., 304 F.3d 1179 (11th Cir. (Fla.) 2002)
The insured was found liable for violating section 43(a) of the Lanham Act, codified at 15 U.S.C.S. § 1125(a), by using artwork from a competitor's brochures in the insured's advertisements and by using model numbers similar to the competitor's to designate the insured's products. The jury found that the insured acted willfully. The assignee claimed that the insurer was obligated to provide indemnity for the judgment under the "advertising injury" provision of the policy, but the district court found no coverage. The appellate court found that the insured's trade dress infringement amounted to a misappropriation of advertising ideas or style of doing business and therefore constituted advertising injury. There was a causal connection between the advertising injury and the insured's advertising activity, as the advertisements were central to the infringement claim. The court stated, "An insurer's duty to indemnify is ordinarily determined by analyzing the policy coverages based on the actual facts of the underlying case." Thus, the insurer was obligated to indemnify the insured.
IV. BREACH OF THE DUTY OF GOOD FAITH AND FAIR DEALING
A. Unreasonable Failure to Defend
To be liable for breach of the covenant of good faith and fair dealing in providing policy benefits ("bad faith") the insurer must unreasonably fail to provide policy benefits that are due, not simply breach the insurance contract or take an erroneous position. For example, "[a]n insurer's breach of the duty to defend is actionable as breach of contract; [but] where the refusal to defend is unreasonable, it is actionable as a tort." Tradewinds Escrow, Inc. v. Truck Ins. Exch., 97 Cal. App. 4th 704, 712 (2002). Depriving an insured of policy benefits is another way of defining a breach of the covenant of good faith and fair dealing. Barney v. Aetna Cas. & Sur. Co., 185 Cal. App. 3d 966, 978 (1986).
B. Inadequate or Inordinately Long Insurer Investigations
An insurer commits bad faith when it fails to investigate evidence which supports the claim of its insured. "[A]n insurer may breach the covenant of good faith and fair dealing when it fails to properly investigate its insured's claim." Egan v. Mutual of Omaha Ins. Co., 24 Cal. 3d 809, 817 (1979). "[T]he insurer's implied covenant of good faith and fair dealing, its fiduciary duties to the insured, and its statutory duty to engage in fair business practices all encompass a duty to investigate . . . ." Frommoethelydo v. Fire Ins. Exchange, 42 Cal. 3d 208, 218-19 (1986).
In Tibbs v. Great American Ins. Co., 755 F.2d 1370, 1375 (9th Cir. (Cal.) 1985) the insurer was found to have breached its duty of good faith and fair dealing when it failed to adequately investigate the claims and disregarded advice of its own employees. When told that the state court judge thought there was a duty to defend, the insurer's chief in-house counsel said, "F____ the Judge."
Insurers are permitted a reasonable time to investigate. However, "[a] carrier is subject to tort liability for bad faith only where it unreasonably fails to provide benefits due under the policy or the law. . . . [I]nsurers are entitled to a reasonable period of time to analyze a situation requiring a coverage decision." Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999, 1010 (1998). Where an insurer never agreed to defend or reimburse fees incurred by independent counsel during the pendency of the underlying action, it cannot take advantage of the safe harbor offered in Dynamic Concepts.
C. Denials of Settlement or Defense Without Adequate Factual or Legal Basis
An insurer commits bad faith when it relies upon a justification for which there is no evidentiary basis. For example, in Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847, 882 (2000) bad faith was established when the insurer asserted reliance on an exclusion ("faulty workmanship") for which it 3had no evidence and had not "articulated any factual theory for claiming the exclusion."
V. CONCLUSION
The coverage savvy claimants as well as policyholders can use insurance as a powerful tool for successfully attaining the intellectual property litigants objectives. Effective use of this "tool," however, requires careful planning and implementation of a well-designed litigation plan that accurately reflects the intricacies of coverage law. As such, successfully navigating the coverage waters to reach the desired destination may require the guidance of an experienced hand. In most instances, the benefits of obtaining external coverage expertise will far outweigh the incremental increase in litigation costs and should be seriously considered by coverage-savvy intellectual property counsel.
A. Recovery of Pre-Tender Defense Fees in the Underlying Action
Some states addressing pre-tender fee recovery issues allow policyholders to recover fees expended prior to notifying their insurer of the claim. Recovery will be limited, however, by factors, such as an insurer's proof that its vital interests were prejudiced by the late notice, due to the voluntary payment provisions, lack of timely notice, and rules regarding waiver.
Courts favoring recovery of pre-tender fees have cited the reasonableness of a policyholder's response to the suit against them and the lack of prejudicial harm to the insurer caused by the lack of notice of the claim while the fees were being incurred. When policyholders have acted reasonably in spite of their late notice, and an insurer does not incur a larger burden because of the delay in notification, pre-tender fee recovery has been granted as part of an insurer's obligation to defend the policyholder. • Sherwood Brands, Inc. v. Hartford Accident & Indemnity Co., 347 Md. 32, 698 A.2d 1078 (1997)
The Maryland Court of Appeals, Maryland's highest court, held that when a duty to defend arises, the insurer is liable for pre-tender fees. The court found that a duty to defend is created when an insured claim is filed or an insured event occurs. The court held that if an insurer breaches that duty, the insurer is then liable for "all damages incurred by the [policyholder] as a result of that breach," including pre-tender fees.
B. Post-Tender Defense Fees
Ultra Coachbuilders, Inc. v. General Security Ins. Co., 229 F. Supp. 2d 284, 286 (S.D.N.Y. 2002) (The court found, “[when] the insurer has breached its duty to defend, it is the insured that must carry the burden of proof on the existence and amount of the . . . expenses, which are then presumed to be necessary as defense costs, and it is the insurer that must carry the burden of proof that they are in fact unreasonable or unnecessary." Applying blended rate averages for Partners and Associates, the court found that billing rates charged to be within the 75% of the AIPLA Survey were reasonable. The same was true of the fees themselves where "the services were rendered [by Knobbe, Martens, et al.] under exigent circumstances, involved the factual and legal complexities of trademark cases, were performed with skill and dispatch, and resulted in a substantial victory, successfully defended on appeal and of great importance to the client.
C. Right to Independent Counsel
Right Not Created
Johnson v. Continental Cas. Co., 788 P.2d 598, 363 (Wa. App. 1990) (Not all reservation of rights create a conflict of interest. The court stated “[i]n Washington, there is simply no presumption, as Johnson urges, that a reservation of rights situation creates an automatic conflict of interest. Therefore, the insurer has no obligation before the fact to pay for its insured's independently hired counsel. Any breach of the ‘enhanced obligation of fairness’ in a reservation of rights situation might lead to after-the-fact liability of the insurer, retained defense counsel, or both.”)
• James 3 Corp. v. Truck Ins. Exch., 91 Cal. App. 4th 1093 (2001)
The court found that refusal to pursue affirmative defense, prosecute counterclaims or to seek reimbursement of defense costs allocable to noncovered claims does not create a conflict. A conflict may arise nonetheless (1) where the insurer insures both the plaintiff and the defendant (a fact which may require discovery to reveal); (2) the insurer has filed suit against the insured whether or not related to the lawsuit the insurer is obligated to defend.
Right Created
• San Diego Federal Credit Union v. Cumis Ins. Soc'y, Inc., 162 Cal. App. 3d 358, 371, 28 Cal. Rptr. 494 (1984)
The court found that independent counsel is triggered where a conflict of interest arises because appointed defense counsel could conduct defense to shift liability from the insurer (i.e. intentional acts) to the policyholder so as to avoid a covered indemifiable loss.
• Nelson Elec. Contr. v. Transcontinental Ins., 660 N.Y.S.2d 220, 222 (1997)
The court stated, "Where, as here, the interests of the insured are at odds with those of its insurer, the former is entitled to select independent counsel to conduct the defense."
D. Interim Fee Agreements
The standard for independent counsel rates is reasonableness. The burden of proving a fee charged by an attorney is unconscionable or unreasonable rests upon the party asserting such fees are unconscionable or unreasonable.
If an insurer appoints "audit" counsel, its access to material should be limited to noncoverage related items. Policyholder counsel should request that the insurance company set forth the basis for audit counsel's investigation and review, including the assumptions upon which "audit counsel" relies in conducting its review.
A written contract should be entered into between independent counsel and the insurer governing the criteria to be employed by the insurer including: review of outside attorneys' fees; A mechanism for the resolution of future fee disputes. Such as: The rate payable to independent counsel, the period of time from receipt of invoice to payment; format of billing; format of reporting to the insurer, policyholder's right for specific identification of items disputed by the insurer, and like items should be identified where the insurer retains "audit counsel." The agreement should address an interim blended or capped rates subject to a right to agree to disagree about and to address reasonableness (tasks selected, time accrued for tasks, case staffing) as fees accrue.
E. Recovery of In-House Fees and Investigative Costs
• PLCM Group, Inc. v. Drexler, 22 Cal. 4th 1084, 1093-94 (2000)
The court found that "A corporation represented by in-house counsel is in an agency relationship, i.e., it has hired an attorney to provide professional legal services on its behalf. . . . The fact that in-house counsel is employed by the corporation does not alter the fact of representation by an independent third party. Instead, the payment of a salary to in-house attorneys is analogous to hiring a private firm on a retainer. The superior court calculated the attorney fees to be awarded PLCM based on their market value, specifically, the reasonable inhouse attorney hours multiplied by the prevailing hourly rate in the community for comparable legal services."
F. Recovery of CounterClaim Fees
Where defense of counterclaim requires prosecution of plaintiff's claims, they are recoverable.
Great West Casualty Co. v. Marathon Oil Co., 2003 U.S. Dist. LEXIS 11805, at *8 (N.D. Ill. (E. Div.) July 11, 2003) (The court found that "‘Defense' is about avoiding liability. Claims and actions seeking third-party contribution and indemnification are a means of avoiding liability just as clearly as is contesting the claims alleged to give rise to liability." )
Ultra Coachbuilders, Inc. v. General Sec. Ins. Co., 229 F. Supp. 2d 284 (S.D.N.Y. 2002) (“The counterclaims, alleging unfair competition and interference with competitive advantage, were used to argue (albeit unsuccessfully) that the injunction application was barred by the doctrine of unclean hands, . . . and were thus ‘inextricably intertwined with the defense of [defendant's] claims and necessary to the defense of the litigation as a strategic matter.'”)
TIG Ins. Co. v. Nobel Learning Communities, Inc., 2002 U.S. Dist. LEXIS 10870, at *41 (E.D. Pa. June 18, 2002) ("As the prosecution of the affirmative claims was essential to the defense against the counterclaim, it was logically encompassed by TIG's duty to defend Nobel.")
• KLA-Tencor Corp. v. Travelers Indem. Co., 2004 U.S. Dist. LEXIS 15376 (N.D. Cal. Aug. 4, 2004)
The court noted that "‘reasonable and necessary costs of defending a lawsuit are recoverable if the insurer breaches its duty to defend.' Barratt Am., Inc. v. Transcont. Ins. Co., 102 Cal. App. 4th 848, 860, 125 Cal. Rptr. 2d 852 (2002)"). Affirmative claims for patent infringement were answered by a disparagement counterclaim conjoined with a patent infringement count as well as other uncovered claims. The issue was whether all attorneys fees incurred by the counter defendant, including those arguably in connection with KLA's affirmative pursuit of its patent claims, were defense related and therefore recoverable:
To satisfy the ‘reasonable and necessary' test, fees and costs of an insured must meet three requirements: (1) the challenged costs and fees must relate to an action conducted within the temporal limits of Travelers' duty to defend; (2) the challenged costs and fees must relate to a reasonable and necessary effort to avoid or minimize liability; and (3) the challenged costs and fees must be reasonable and necessary for that purpose. See Barratt, 102 Cal. App. 4th at 858 (citing Aerojet, 1Cal. 4th at 60-63). Id at. 21-22
The court found that it was unreasonable to charge the insurer for the cost incurred in the defense of the ‘406 patent infringement claim, because as they were unnecessary to Thermo Waves disparagement allegations, even though they might provide some information on damages sought for same. The court criticized the cursory deposition testimony and lack of substantive fact record which impacted its ability to find that the prosecution of KLA's affirmative IP claims and the defense of the disparagement claims were "inextricably intertwined."
G. Insurer Guidelines
• In the Matter of the Rules of Professional Conduct and Insurer Imposed Billing Rules and Procedures, 2 P.3d 806, 814-17 (Mont. 2000)
Defense counsel who submit to insurer-imposed requirements of prior approval for depositions, legal research, employment of experts and preparation of motions "violate their duties under the Rules of Professional Conduct"). In Dynamic Concepts, Inc. v. Truck Insurance Exchange, 71 Cal. Rptr. 2d 882, 889 & n.9 (Ct. App. 4thDist. 1998), the court stated,
Insurer-imposed restrictions on discovery or other litigation costs may well violate the insurer's duty to defend as well as the attorneys' ethical responsibilities to exercise their independent professional judgment in rendering legal services. . . . Under no circumstances can such guidelines be permitted to impede the attorney's own professional judgment about how best to competently represent the insureds.
H. Insurer Requests For Information to Assess Defense Fees And Settlement Opportunities
• In re Columbia/HCA Healthcare Corp. Billing Practices Litig., 293 F.3d 289, 303 (6th Cir. 2002)
The court discussed in detail the
attorney-client privilege [which] is a matter of common law right, "the oldest of the privileges for confidential communications known to the common law." Upjohn [Co. v. United States,] 449 U.S. [383] at 389, 101 S. Ct. [677] at 682 [(1981)]. It is not a creature of contract, arranged between parties to suit the whim of the moment. [Emphasis added.]
The Columbia/HCA Healthcare court then surveyed federal case law on the issue of whether it is possible to have any selective waiver of the attorney-client privilege as some courts had suggested. The Sixth Circuit entirely rejected the idea of selective waiver. The court stated, "[A]fter due consideration, we reject the concept of selective waiver, in any of its various forms." Id. at 302. [Emphasis added.]
The court then applied the same bright line test to the waiver of attorney work-product privilege as it does to the waiver of attorney client privilege:
These and other reasons "persuade us that the standard for waiving the work-product doctrine should be no more stringent than the standard for waiving the attorney-client privilege" - once the privilege is waived, waiver is complete and final. Id. at 307. [Emphasis added.]
Courts have held that because of the privilege's adverse effect on the full disclosure of the truth, it must be narrowly construed and is therefore often found to be waived. Underwater Storage, Inc. v. United States Rubber Co., 314 F. Supp. 546, 547 (D.D.C.1970). An intent to waive one's privilege is not necessary for such a waiver to occur. Id., at 549. Waiver of the attorney-client or the work product privilege can be found from a failure assert it. Daniels v. Hadley Memorial Hospital, 68 F.R.D. 583, 587 (D.D.C.1975). In fact the privilege can be lost even where the disclosure was accidental.
All involuntary disclosures, in particular, through the loss or theft of documents from the attorney's possession, are not protected by the privilege, on the principle . . . that . . . the law . . . leaves to the client and attorney to take measures of caution sufficient to prevent being overheard by third persons. The risk of insufficient precautions is upon the client.
8 Wigmore, Evidence § 2325 (McNaughton rev. 1961) [Emphasis added.]
Within the Sixth Circuit, cases suggest that express or implied waiver of privilege can be found from many circumstances, including "‘a client's disclosure to a third party of communications made pursuant to the attorney-client privilege . . .'" Travelers Cas. & Sur. Co. v. Excess Ins. Co., 197 F.R.D. 601, 606 (S.D. Ohio, 2000), disclosure of an attorney's letter to the client's insurer for the purpose of obtaining coverage, Gomez v. Towne Bancorp, 2000 U.S. Dist. LEXIS 12060, *4 (N.D. Ohio, 2000), allowing an expert witness to read a document provided by the client, Amway Corp. v. P&G, 2001 U.S. Dist. LEXIS 5317 * 4 (W.D. Mich., 2001), and failure to provide a sufficiently detailed privilege log, Carfagno v. Jackson Nat'l Life Ins. Co., 2001 U.S. Dist. LEXIS 1768 *7 (W.D. Mich., 2001). Significantly, United States v. Skeddle, 989 F. Supp. 905, 911 (N.D. Ohio, 1997) held no privilege applied to a letter from an insured's outside counsel to an attorney for the liability insurer.
I. Recovery of Prejudgment Interest on Unpaid Fees
• Ultra Coachbuilders, Inc. v. General Security Ins. Co., 229 F. Supp. 2d 284, 289 (S.D.N.Y. 2002)
The court found that "Ultra is entitled to . . . pre-judgment interest on those fees and costs, at 10% per annum, from the date of each invoice until the date of the judgment."
J. Recovery of Coverage Fees Incurred in a Coverage Action
• Concept Enterprises, Inc. v. Hartford Ins. Co. of the Midwest, No. CV 00-7267 NM (JWJx), 2001 U.S. Dist. LEXIS 6901 (C.D. Cal. May 22, 2001)
The Court ruled that Hartford's failure to reimburse 100% of the reasonable defense fees incurred, as well as its demand that its insured allocate its defense fees incurred between covered trade dress and uncovered patent infringement claims was a breach of the duty of good faith and fair dealing, justifying a finding of bad faith as a matter of law. Under California law, Hartford therefore had to pay all reasonable attorneys' fees incurred by coverage counsel in proving that Hartford's duty to defend extended to the complete lawsuit.
• McRory v. Northern Ins. Co., 980 P.2d 736, 138 Wn.2d 550, 555 (Wn. 1999)
The court stated, "In every case, the conduct of the insurer imposes upon the insured the cost of compelling the insurer to honor its commitment. . . . We believe that an award of fees is required in any legal action where the insurer compels the insured to assume the burden of legal action, to obtain the full benefit of his insurance contract."
II. OBTAINING SETTLEMENT AUTHORIZATION FOR REIMBURSEMENT
A. A Settlement Is Subject to Reimbursement Based on a Potentiality Standard and It Does Not Require Proof of a Right to Indemnity
An insurer's obligation to fund a settlement flows from the duty to defend as an implied contractual covenant and is implicated by a "potential" not "actual" coverage as is the case for a judgment which requires proof of an insurer's duty to indemnify its insured based on the manner in which liability attaches. Recovery of monies paid in settlement does not implicate indemnity issues because there is no adjudication of liability. Aerojet General Corp. v. Transport Indem. Co., 17 Cal. 4th 38, 76 n.29 (1997). Analyzing potential coverage based on the claims asserted but not proven against the insured suffices to trigger a right to reimbursement of defense fees, since that is all that can be assessed where there is no adjudication against the insured. Zurich Ins. Co. v. Killer Music, 998 F.2d 674, 679 (9th Cir. (Cal.) 1993).
Much like the rules applicable to an insurer's duty of defense, the rules applicable to an insurer's duty of settlement significantly favor obligating an insurer to fund settlements. It is critical to note that the duty to settle cannot be equated with an insurer's obligation to indemnify the insured for a judgment. Whereas questions of indemnity turn exclusively on what is (or is not) actually covered, these considerations play no part in evaluating an insurer's settlement obligation.
B. Insurers Cannot Avoid Funding a Reasonable Settlement Based on Coverage Disputes
Coverage issues such as allocation between covered and uncovered claims cannot be properly considered when evaluating and effectuating settlement of a suit against the insured. If the proposed settlement is reasonable, the insurer must agree to fund the entire amount. It cannot seek to allocate amongst the claims; it cannot force the insured to contribute to the settlement, see Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718, 731, 117 Cal. Rptr. 2d 318, 328 (2002) ("[I]nsurer potentially can be liable for unreasonably coercing an insured to contribute to a settlement fund, even though (by definition) there is no excess judgment where a case is settled.").
An insurer cannot wait around in the hopes that a better deal will be forthcoming – it must take the settlement and reserve whatever rights of reimbursement it may possess. In a mixed action involving both covered and uncovered claims, the insurer must fund the entire settlement but, as with defense costs, may reserve the right to seek reimbursement for the uncovered portions of the settlement once the underlying suit has been concluded. See Blue Ridge Ins. Co. v. Jacobsen, 25 Cal. 4th 489, 502 (2001).
C. Insurer Obligations to Pay Settlement Costs Where a Business Tort Lawsuit Asserts Potentially Covered Claims
1. Where the Insurer Defends
An insurer who fulfills its defense obligations has the right to approve and participate in any settlements entered into by its insured. In the absence of bad faith, the insurer will not necessarily be liable for the entire settlement so long as potentially covered claims were asserted at the time of settlement makes the most sense. Pershing Park Villas Homeowners Ass'n v. United Pac. Ins. Co., 219 F.3d 895, 902 (9th Cir. (Cal.) 2000). This rule is consistent with the law that governs when an insurer denies a defense and seeks to obtain reimbursement for that portion of the defense fees which it claims are uncovered claims. Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718, 728 (2002). In those few jurisdictions that have recognized an insurer's right to reimbursement, a refusal to defend deprives the insurer of any right to seek allocation of defense fees. Amato v. Mercury Cas. Co., 53 Cal. App. 4th 825, 835 (1997); Samson v. Transamerica Ins. Co., 30 Cal. 3d 220, 237 (1981) ("It is well established in California that "an insurer that wrongfully refuses to defend is liable on the judgment . . . .").
HA 2003, Inc. v. Federal Ins. Co., 310 B.R. 710, 723-24 (N.D. Ill. (E. Div.) 2004 (“The general rule in Illinois is that if an insurer does not breach the insurance contract, the insured must get the insurer's approval before settling the case. . . . However, the majority of courts addressing this issue convincingly holds that the rules change once an insurer reserves its rights and takes a position that coverage does not apply. The only Illinois court addressing this specific issue has adopted the majority approach. Commonwealth Edison Co. v. Nat'l Union Fire Ins. Co., 323 Ill. App. 3d 970, 985, 752 N.E.2d 555, 567, 256 Ill. Dec. 675 (2001), held that when an insurer that defended while reserving its right to contest coverage lost the right to consent to a settlement. The court quoted extensively from Cay Divers, Inc. v. Raven, 812 F.2d 866 (3rd Cir. 1987), which held that, by providing the insured with independent counsel while reserving a right to contest coverage, an insurer renounces control of the litigation and thrusts responsibility for the litigation on the insured, who is then free to enter into a reasonable settlement. . . . Although the facts of Commonwealth Edison are more complex, and involve a relinquishment of control by the insurance carrier because of a conflict of interest between two insureds, the court's holding is a clear acceptance of the majority view addressed below.”)
2. Where the Insurer Does Not Defend
Insurers who refuse to defend will often contest their duty to reimburse policyholders for amounts paid in satisfaction of settlement agreements. On the other hand, if a court finds a policy excluded any coverage, it will not construe either the refusal to indemnify a judgment, or reimburse monies paid in settlement as a "source of bad faith liability."
Courts generally distinguish between insurer's good faith and bad faith refusals in this context. An insurer who wrongfully denies its obligations under the policy is liable for all damages incurred by the insured as a result of the breach. Isaacson v. California Ins. Guarantee Assn., 44 Cal.3d 775, 793-94 (1988). Such damages include the amount of the judgment or reasonable and noncollusive settlement under a commercial general liability policy. Similarly, some of the asserted claims are potentially covered as of the date of settlement, the insurer is obligated to pay the entirety of a reasonable settlement under the law. In Adolfo House Distribution Corp. v. Travelers Property & Casualty Ins. Co., 165 F. Supp. 2d 1332, 1343 (S.D. Fla. 2001), the court found the insurers obligated to reimburse the full amount of the settlement paid where potential coverage existed at the time of settlement as to some of the claims asserted.
An insurer cannot attack its insured's settlement of an underlying lawsuit simply because the insured paid no money toward the settlement. Johansen v. California State Auto. Asso. Inter-Insurance Bureau, 15 Cal. 3d 9, 15 (1975); Hamilton, 27 Cal. 4th at 728. Where the issues upon which coverage depends were not raised in the underlying action, they may be the subject of post- settlement coverage litigation. Pruyn v. Agricultural Ins. Co., 36 Cal. App. 4th 500, 514, n.15 (1995).
Much like the rules applicable to an insurer's duty of defense, the rules applicable to an insurer's duty of settlement significantly favor obligating an insurer to fund settlements. In Johansen v. California State Auto. Ass'n, 15 Cal. 3d 9, 16, 123 Cal. Rptr. 288, 292 (1975), the court ruled that an insurer cannot consider coverage issues in evaluating the reasonableness of a settlement opportunity. Coverage issues such as allocation between covered and uncovered claims cannot be properly considered when evaluating and effectuating settlement of a suit against the insured. If the proposed settlement is reasonable, the insurer must agree to fund the entire amount. It cannot seek to allocate amongst the claims; it cannot force the insured to contribute to the settlement; it cannot wait around in the hopes that a better deal will be forthcoming – it must take the settlement and reserve whatever rights of reimbursement it may possess. Hamilton 27 Cal. 4th at 731 ("[I]nsurer potentially can be liable for unreasonably coercing an insured to contribute to a settlement fund, even though (by definition) there is no excess judgment where a case is settled.").
Recently, the Illinois Supreme Court held that a nondefending insurer owed payment of a reasonable settlement in a case in which an insured settled a case and in consideration assigned its rights to the underlying plaintiff. In Guillen v. Potomac Ins. Co. of Ill., 203 Ill. 2d 141 (Ill. 2003), the Court found that the assignment created a contractual liability on the insured and was not a release, thus while the insured did not face personal exposure the payment obligation was not negated. Id. at 160-161.
In dicta, the Court explained that once an insurer breaches its duty to defend, and insured may agree to settle the case and seek indemnification from the insurer, and the insurer would be limited in its disputing of liability if there was no assignment, and the insured had a legal obligation to pay the settlement amount.
D. Structuring Settlements to Maximize Recovery of Insured Proceeds
1. Reasonableness of the Settlement
Even if the insurer improperly refuses to reimburse its insured for monies paid in settlement, it is not estopped from contesting the reasonableness of the settlement agreement. Courts differ in their allocation of the burden of proof as to reasonableness, applying one of two approaches. Under the first approach, "a reasonable settlement made by the insured to terminate the underlying claim against him may be used as presumptive evidence of the insured's liability claim, and the amount of such liability." Killer Music, 998 F.2d at 679.
In applying this approach, some courts use a two pronged test to determine reasonableness. First, they examine the record to determine whether the settlement was made in reasonable anticipation of personal liability. Where the exposure faced by an insured is sufficient to justify the amount paid in settlement, the payment is presumptively reasonable, irrespective of whether aspects of the exposure would not fall within coverage. Second, they look to the policy limit to determine whether the settlement was for a reasonable amount. If the settlement figure exceeds the policy limits, courts may require a showing that the insurer breached its duty of implied good faith and fair dealing to establish a right to recovery of same. Johansen, 15 Cal. 3d at 15.
2. Allocation of Settlement Between "Covered/Uncovered" Claims in Mixed Actions
• Vargas, et. al. v. Hudson County Bd. of Elections, et. al., 949 F.2d 665, 674 (3rd Cir. (N.J.) 1991)
Under a distinct approach, reasonableness is always an issue of fact which must be proved by the insured assuming the claims settled were clearly within coverage. The court noted, "The insured has the burden of producing evidence showing that the settlement was prima facie reasonable. . ."
• Flodine v State Farm Ins. Co., 2003 U.S. Dist. LEXIS 4006, (N.D. Ill, 2003)
The court found that nondefending insurer had indemnity obligation (as a result of a settlement) because of estoppel (citing Employers Ins. v. Ehlco Liquidating Trust, 186 Ill. 2d 127, 150-51 (1999). The court then determined the settlement was reasonable by evaluating the details of the settlement.
Courts have [established] the general rule that an insurer will be liable for the full amount of an insured's settlement , as long as that settlement was made in reasonable anticipation of personal liability and the settled amount was reasonable . . . . Id. * 30.
The "litmus test" for deciding whether a settlement was reasonable is "what a reasonably prudent person in the position of the [insured] would have settled for on the merits of plaintiff's claim. (citing Guillen) Id.*37.
3. Impact of the "Voluntary Payments" Provision Where an Insured Tenders the Defense then Negotiates a Settlement on Its Own
When a "voluntary payments" provision is present in a policy, absent insurer consent or the insurer's denial of a defense, an insured must loose policy benefits by failing to keep the insurer fully apprized of pertinent facts it seeks to evaluate in determining whether the insurer will contribute to or fund settlement.
• Low v. Golden Eagle Insurance Co., 110 Cal. App. 4th 1532 (2003)
The insured was barred from seeking reimbursement from a defending insurer where it failed to apprize it of the settlement, even if its terms were reasonable and noncollusive.
• Servpro-Domesticare of Anderson Hills, Inc. v. Grange Mut. Cas. Co., 1985 WL. 7739 *2 (Ohio App. Sept. 23, 1985)
The rule changes where an insurer participating in the insureds defense refuses to participate in its settlement. The court stated:
Generally, where the insurance company denies liability for a claim or refuses to defend its insured, the insured may make a reasonable settlement or compromise with the claimant absent the insurer's consent without losing its right to recover on the policy. 59 Ohio Jurisprudence 3d (1985) 61, Insurance, Section 1030.
• Ferrando v. Auto-Owners Mut. Ins. Co., 781 N.e.2d 927, 947 (Ohio 2002)
The court found that a voluntary payment provision is no impediment to holding an insurer liable for a reasonable settlement where "the insurer failed to respond within a reasonable time to a request for consent to the settlement offer, or unjustifiably withheld consent. . ."
E. Settlements Which Grant Affirmative Business Rights May Not Be Recoverable
1. Settlements which Confer Business Rights on Alleged Infringers Through License Provisions May Require Allocation Where a Business Benefit Is Conferred on the Settling Party
Settlements should recite that monies paid are for past damages. If a prospective license fee is negotiated, and ongoing use of products or services covered by the license will occur, some allocation of settlement payments to that business benefit should be made. Absent a conferral of business benefits to the insured, a nondefending insurer or an insurer who refuses to fund a reasonable settlement may be liable for the full amount of a settlement even if it includes uncovered claims.
• Zurich Ins. Co. v. Killer Music, 998 F.2d 674, 679 (9th Cir. (Cal.) 1993)
The court stated, "We recognize that the settlement agreement represents, in part, an exchange of cash consideration for the rights to Pfeifer's songs, not simply compensation for damages from copyright infringement." As a result, on remand, the court required the separation of the award into the "compensation" for rights to songs and the damages from copyright infringement. Critically, the policyholder acknowledged the viability of the underlying plaintiff's copyright by seeking to license the right to play songs subject to copyright protection.
• Platinum Technology, Inc. v. Federal Ins. Co., 282 F.3d 927 (7th Cir. (Ill.) 2002)
The court found that the license components of a technology transfer in association with a settlement were a benefit that accrued to the insured which was chargeable to the insurer. The court ruled that Platinum purchased the "Platinum" trademark, worth $4 million in the settlement/ assignment agreement, and that this $4 million cash payment was not made as part of a reasonable settlement agreement to relieve Platinum of its liability from trademark infringement.
2. Settlements That Reflect Affirmative Claims for Damages Against Underlying Plaintiffs May Unnecessarily Vest Insurers with Subrogation Rights That Preclude the Insured's Full Settlement Reimbursement
• TIG Ins. Co. v. Nobel Learning Communities, Inc., No. 01-4708, 2002 U.S. Dist. LEXIS 10870, at *41 (E.D. Pa. June 18, 2002)
The court found that fees incurred in prosecution of counterclaims against the underlying plaintiff, as well as those expended in defending the copyright infringement claims were compensable. Critically, however, once compelled to pay all defense fees including those related to prosecution, the recitals in the settlement agreement provided a pathway to the insurers to recover such fees. Thus, in TIG, the court awarded a "setoff to the extent of $175,000 against Nobel's post-counterclaim fees, costs and expenses." Id. at *42-43. The court therefore found that there was a right by the carrier to offset this portion of the sum from the settlement agreement against their defense obligation to avoid "double recovery" to the insured.
• Flodine dba Natural Wonders v. State Farm Ins. Co., 2003 U.S. Dist. LEXIS 4006 (N.D. Ill. (E. Div.) March18, 2003)
The settlement entered into by Flodine and NAA was intended to settle an actual (and still viable) dispute between them. Therefore, State Farm had a duty to indemnify Flodine for the settlement of those claims even though State Farm was unaware of the settlement. Because State Farm breached its duty to defend Flodine with respect to the IACA and non-IACA claims, it could not rely on policy defenses.
III. INDEMNIFICATION FOR DAMAGE EXPENSES
A. Judgment Maybe Subject to Indemnity Where Potentially Covered Claims Are Asserted Through Motion for Summary Judgment
U.S. Fire Ins. Co. v. Green Bay Packaging, Inc., 66 F. Supp. 2d 987, 998-99 (E.D. Wis. 1999) (“A duty to indemnify exists if acts occur that are insured against. Where a claim consists of a variety of acts, some of which are covered and others that are not, it is well settled that resulting liability falls within the terms of the Insurance policy unless the uncovered risk is the sole cause of damages. . . . Only if the damage award was totally unrelated to the conduct within the coverage of the insurance policy will the insurer not be liable. . . . the insurer has a duty to indemnify.”)
B. Judgment for Disgorgement of Ill-Gotten Gain May Not Be Subject to Indemnity
The duty to defend and indemnify under the "advertising injury" provisions of the CGL policy is only for "sums for which the policyholder shall become legally obligated to pay for damages." A suit for purely equitable relief does not give rise to a duty to defend because it is not a lawsuit seeking damages. For this reason, the California Supreme Court denied indemnity to Bank of the West for claims asserted against it under the Unfair Business Practices Act. The court stated, "one may not insure against the risk of being ordered to return money or property that has been wrongfully acquired. Such orders do not award ‘damages' as that term is used in insurance policies." Bank of the West, 2 Cal. 4th at 1266 (citation omitted).
C. Duty to Indemnify Is Determined Based on Facts of Underlying Case
• Hyman v. Nationwide Mut. Fire Ins. Co., 304 F.3d 1179 (11th Cir. (Fla.) 2002)
The insured was found liable for violating section 43(a) of the Lanham Act, codified at 15 U.S.C.S. § 1125(a), by using artwork from a competitor's brochures in the insured's advertisements and by using model numbers similar to the competitor's to designate the insured's products. The jury found that the insured acted willfully. The assignee claimed that the insurer was obligated to provide indemnity for the judgment under the "advertising injury" provision of the policy, but the district court found no coverage. The appellate court found that the insured's trade dress infringement amounted to a misappropriation of advertising ideas or style of doing business and therefore constituted advertising injury. There was a causal connection between the advertising injury and the insured's advertising activity, as the advertisements were central to the infringement claim. The court stated, "An insurer's duty to indemnify is ordinarily determined by analyzing the policy coverages based on the actual facts of the underlying case." Thus, the insurer was obligated to indemnify the insured.
IV. BREACH OF THE DUTY OF GOOD FAITH AND FAIR DEALING
A. Unreasonable Failure to Defend
To be liable for breach of the covenant of good faith and fair dealing in providing policy benefits ("bad faith") the insurer must unreasonably fail to provide policy benefits that are due, not simply breach the insurance contract or take an erroneous position. For example, "[a]n insurer's breach of the duty to defend is actionable as breach of contract; [but] where the refusal to defend is unreasonable, it is actionable as a tort." Tradewinds Escrow, Inc. v. Truck Ins. Exch., 97 Cal. App. 4th 704, 712 (2002). Depriving an insured of policy benefits is another way of defining a breach of the covenant of good faith and fair dealing. Barney v. Aetna Cas. & Sur. Co., 185 Cal. App. 3d 966, 978 (1986).
B. Inadequate or Inordinately Long Insurer Investigations
An insurer commits bad faith when it fails to investigate evidence which supports the claim of its insured. "[A]n insurer may breach the covenant of good faith and fair dealing when it fails to properly investigate its insured's claim." Egan v. Mutual of Omaha Ins. Co., 24 Cal. 3d 809, 817 (1979). "[T]he insurer's implied covenant of good faith and fair dealing, its fiduciary duties to the insured, and its statutory duty to engage in fair business practices all encompass a duty to investigate . . . ." Frommoethelydo v. Fire Ins. Exchange, 42 Cal. 3d 208, 218-19 (1986).
In Tibbs v. Great American Ins. Co., 755 F.2d 1370, 1375 (9th Cir. (Cal.) 1985) the insurer was found to have breached its duty of good faith and fair dealing when it failed to adequately investigate the claims and disregarded advice of its own employees. When told that the state court judge thought there was a duty to defend, the insurer's chief in-house counsel said, "F____ the Judge."
Insurers are permitted a reasonable time to investigate. However, "[a] carrier is subject to tort liability for bad faith only where it unreasonably fails to provide benefits due under the policy or the law. . . . [I]nsurers are entitled to a reasonable period of time to analyze a situation requiring a coverage decision." Dynamic Concepts, Inc. v. Truck Ins. Exch., 61 Cal. App. 4th 999, 1010 (1998). Where an insurer never agreed to defend or reimburse fees incurred by independent counsel during the pendency of the underlying action, it cannot take advantage of the safe harbor offered in Dynamic Concepts.
C. Denials of Settlement or Defense Without Adequate Factual or Legal Basis
An insurer commits bad faith when it relies upon a justification for which there is no evidentiary basis. For example, in Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc., 78 Cal. App. 4th 847, 882 (2000) bad faith was established when the insurer asserted reliance on an exclusion ("faulty workmanship") for which it 3had no evidence and had not "articulated any factual theory for claiming the exclusion."
V. CONCLUSION
The coverage savvy claimants as well as policyholders can use insurance as a powerful tool for successfully attaining the intellectual property litigants objectives. Effective use of this "tool," however, requires careful planning and implementation of a well-designed litigation plan that accurately reflects the intricacies of coverage law. As such, successfully navigating the coverage waters to reach the desired destination may require the guidance of an experienced hand. In most instances, the benefits of obtaining external coverage expertise will far outweigh the incremental increase in litigation costs and should be seriously considered by coverage-savvy intellectual property counsel.
