What happens when a claim is tendered for defense and it has 20 causes of action, only one of which is potentially covered by the policy? It may be a claim "thrown in" to try to trigger coverage (e.g., false imprisonment in a corporate disagreement, defamation in patent litigation, or negligence in a contract dispute). Under California law, if there is a duty to defend one aspect of the case, there is a duty to defend the entire case. Hogan v. Midland Nat. Ins. Co., 3 Cal.3d 553, 563 (1970). Defense costs are bound to be substantial. What can an insurer do in that situation?
If the correct steps are taken to preserve the right of reimbursement, and the amounts incurred defending noncovered claims can be determined, the insurer can obtain reimbursement of the amounts it pays to defend the noncovered claims. This assumes, of course, that the insured is financially able to reimburse those amounts.
Reimbursement of indemnity payments
In California, an insurer can obtain reimbursement from its policyholder of amounts it pays to settle on behalf of its policyholder. See, e.g., Johansen v. Calif. State Auto. Assoc., 15 Cal.3d 9, 19 (1975). This is because the duty to indemnify is narrower than the duty to defend and only exists if there is actual coverage for the claim. Id. at 12. This right arises because of the duty of good faith and fair dealing implied in all contracts that places an obligation on insurers to settle claims for a reasonable amount within policy limits if given the opportunity to do so (as is discussed above). Id. at 15-16. However, what if the settled claim is not covered by the policy?
In Johansen, the insurer faced a choice of paying a settlement within policy limits or declining to do so on the basis there was no coverage for the claim. California's highest court held the choice exists but if it chooses to deny the claim, the insurer does so at its own risk. Id. at 12. Conversely, if the insurer pays the settlement, the insurer has the right to seek reimbursement of the settlement from its policyholder if it is later determined there was no coverage for the claim. Id. at 19. Thus, the California Supreme Court put the burden on the insurer to protect the policyholder's interests in the first instance, but recognized that if there were in fact no coverage for the clam, the insurer should not be made to pay for something for which it received no premium and which it did not intend to cover.
This right to seek reimbursement of indemnity amounts exists if the claims are later found not to be covered by the policy. Blue Ridge Ins. Co. v. Jacobsen, 25 Cal.4th 489 (2001). The right of reimbursement of indemnity need not be stated in the policy. Id. at 504.
Right to recover defense costs
While the duty to defend is broader than the duty to indemnify, it is not unlimited. Waller v. Truck Ins. Exchg., 11 Cal.4th 1, 19 (1995). The duty to defend is still proscribed by the coverage purchased – "it is measured by the nature and kinds of risks covered by the policy." Id.
In California, when an insurer adequately reserves its rights to seek reimbursement of defense costs, and establishes there was never any potential for coverage under the policy, it is entitled to seek reimbursement of amounts paid in defense costs. See, Walbrook Ins. Co. Ltd. v. Goshgarian & Goshgarian, 726 F.Supp. 777 (C.D. Cal. 1989) (right to seek reimbursement of all defense costs); Buss v. Superior Court, 16 Cal.4th 35 (1997) (right to reimbursement of those defense costs incurred for noncovered claims); Scottsdale Ins. Co. v. MV Transportation, 36 Cal.4th 643 (2005) (right to reimbursement of all defense costs).
The seminal case in California on this topic is the Buss decision. In that case, the California Supreme Court held that the right to reimbursement of defense costs arises out of the insurance contract although it need not be set forth in the insurance policy. Buss, 16 Cal.4th at 51, fn. 13. The right exists as an implied contractual obligation and under equitable concepts of unjust enrichment. Id. at 51. Premiums have been paid and the insurer agreed to provide coverage, including the mounting and funding of a defense, but based on the policy's parameters. Id. at 47-48. An insurer has no duty to pay for defense of claims that are not even potentially covered by the policy, and therefore the insurer should have the right to be reimbursed for amounts paid for a defense that was not owed. Id. at 48. Otherwise, the policyholder receives more than that for which it bargained. Id. at 51.
Having a right to reimbursement of defense costs, in the California court's opinion, motivates the correct behavior on the part of insurance companies. That is, the policyholder receives an immediate defense, even if later it must reimburse its insurer for a defense that the policy did not provide because there was no potential for coverage of the claim. Scottsdale, 36 Cal.4th at 660; Buss, 16 Cal.4th at 52-53.
Buss involved Jerry Buss, the owner of the Los Angeles Lakers pro-basketball team. He was sued by H & H Sports, Inc. for 27 causes of action arising out of a number of business disputes. Among the causes of action was one for defamation. Buss' insurer, Transamerica Insurance Company, determined that none of the causes of action were covered except, potentially, the defamation claim. In agreeing to defend Buss, Transamerica reserved its rights to reimbursement for defense costs incurred defending claims unrelated to the defamation claim.
The case eventually settled, with both Buss and Transamerica contributing to that settlement. Buss sued Transamerica, alleging Transamerica had breached its duty to defend and indemnify by not paying for the entire settlement. Transamerica filed a cross-complaint, requesting a declaration that it had a right to obtain reimbursement of amounts paid to defend and indemnify claims not covered by its policy, and a right not to contribute to the settlement of noncovered claims.
Buss filed a motion for summary judgment against Transamerica arguing that "the insurer could not obtain reimbursement for defense costs from an insured unless it could prove by 'undeniable evidence' that certain costs could be allocated solely to claims that were not even potentially covered?" The trial court denied the motion and Buss filed a petition for writ of mandate in the California Court of Appeal. The Court of Appeal denied the petition, and Buss appealed to the California Supreme Court.
The California Supreme Court accepted review and held that an insurer may seek reimbursement from the insured for defense costs after the insurer defends a "mixed" action – that is, one that involves both claims potentially covered by the policy and claims not covered by the policy. In reaching this decision, California's highest court held that this was both consistent with the insurance policy and with the behavior courts expect from insurers. An insurer has a duty to defend claims potentially covered by the policy and no duty to defend claims not covered by the policy. Buss, supra, 11 Cal.4th at 46-47, citing Montrose Chemical Corp. v. Sup. Ct. (1993) 6 Cal.4th 287, 295; Hogan, supra, 3 Cal.3d 553. If the action had not included potentially covered claims, the insurer would not have any duty to defend. Buss, supra, 11 Cal.4th at 47. But if any aspect of the case is potentially covered, than the insurer has a duty to defend the entire case. Id. at 47-48.
The insurer should defend immediately and entirely, but at the end of the day the insurer should not be required to defend claims not covered by the policy. Thus, the insurer should be permitted to seek reimbursement from its policyholder of the amounts associated with defending claims not covered by the policy. Id. at 49-53.
While Buss involved a "mixed" claim (that is, one that involved both a potentially covered claim and many claims not covered by the policy), the right of reimbursement exists when an insurer defends an insured against claims, none of which are covered by the policy. See Scottsdale supra, 36 Cal.4th 643, 653, 663; Golden Eagle Ins. Corp. v. Cen-Fed, Ltd., 148 Cal.App.4th 976, 988-989 (2007).
Reserving the right
The right to reimbursement must be preserved. Buss, supra, 16 Cal.4th at 61. The right is the insurer's right, and therefore can be unilaterally reserved. Id. at fn. 26.
Of course that is not the end of the story. In order to obtain reimbursement, there is the challenge of having a solvent insured with resources to repay the amounts, the ability to demonstrate which of the defense costs were incurred solely for the noncovered claim, and a successful action for a determination that no duty to defend was owed as to those claims. To be in the best position to obtain that recovery, it is important to get on the bus early in the journey in order to assure that the proper steps are taken to preserve, protect, and advance the interest in getting money back in connection with claims that should not have been defended.