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Insurer May Obtain Reimbursement Of Defense Costs Incurred For Its Insured Where The Policy Never Afforded Potential For Coverage

In Scottsdale Insurance Company v. MV Transportation, the California Supreme Court held that, where an insurer has properly reserved its right to reimbursement, the insurer may obtain reimbursement of its expenses of defending its insured against a third party lawsuit when it is ultimately determined, as a matter of law, that the policy never afforded any potential for coverage and that a duty to defend thus never arose.

In the underlying lawsuit, Laidlaw Transit Services, Inc. ("Laidlaw") sued MV Transportation ("MV") for, among other things, misappropriation of trade secrets, alleging that MV used Laidlaw's confidential, proprietary information to compete unfairly in bidding for and obtaining new service contracts. MV tendered the defense to its insurer, Scottsdale Insurance Company ("Scottsdale"). Scottsdale agreed to provide a defense to MV under a reservation of rights, including the "[t]he right to seek reimbursement of defense fees paid toward defending causes of action which raise no potential for coverage, as authorized by the California Supreme Court in Buss v. Superior Court (Transamerica Ins. Co.) (1997) 16 Cal.4th 35." Laidlaw and MV subsequently settled the suit. The settlement agreement did not require that MV pay any money to Laidlaw. Scottsdale incurred $340,000 in attorney fees and costs in defending MV.

During the course of the underlying Laidlaw litigation, Scottsdale filed a declaratory relief action against MV. After settlement of the underlying action, Scottsdale moved for summary judgment seeking a determination that it owed no legal defense obligations, and seeking reimbursement of the full amount paid for defense costs and fees. The trial court denied Scottsdale's motion for summary judgment and ruled that it had a duty to defend.

Scottsdale appealed. The Court of Appeal found the Scottsdale policy issued to MV never afforded potential coverage of the Laidlaw suit, but nonetheless ruled that Scottsdale could not recover fees and costs previously advanced toward MV's defense. The Court of Appeal reasoned that Scottsdale's defense duty arose and continued until "extinguished" by a judicial determination that no potential for coverage existed. In the Court of Appeal's view, Scottsdale's reimbursement claim was an unavailing attempt to terminate its defense duty "retroactively."

The Supreme Court disagreed, finding that the Court of Appeal erred in its analysis of the reimbursement issue. Previously, in Buss v. Superior Court, 16 Cal. 4th 35 (1997), the Supreme Court confirmed that, in the context of a "mixed" third party action in which potential coverage appears as to some claims but not as to others, an insurer is entitled, under a reservation of rights, to recoup its costs of defending against third party claims that are not potentially covered. The Supreme Court found that Buss's analysis of the reimbursement issue applied equally where the insurer, acting under a reservation of rights, defended an action in which, as it turns out, no claim was ever potentially covered.

In its ruling, the Supreme Court discussed, with approval, Tamrac, Inc. v. California Ins. Guarantee Assn., 63 Cal. App. 4th 751 (1998), a post-Buss decision, in which the Court of Appeal confirmed that, if the insurer is legally uncertain whether any claims in the third party complaint are potentially covered, it may defend the third party action to conclusion under a reservation of its right to reimbursement, and may then recoup all its defense costs if an intervening decision has established, as a matter of law, that the potential for coverage, and thus the duty to defend, never arose.

Buss and Tamrac were based on the principle that an insured pays for, and can reasonably expect, a defense against third party claims that are potentially covered by its policy, but no more. Conversely, the insurer does not bargain to assume the cost of defense of claims that are not even potentially covered. If the opposite were true then the insured, who did not bargain for a defense of noncovered claims, would receive a windfall. Similarly, the Scottsdale Court concluded an insurer under a standard commercial general liability policy, having properly reserved its rights, may advance sums to defend its insured against a third-party lawsuit, and may thereafter recoup such costs from the insured if it is determined, as a matter of law, that no duty to defend ever arose because the third party suit never suggested the possibility of a covered claim.

The Supreme Court's decision in Scottsdale comes as no surprise given the prior opinions in Buss and Tamrac. Indeed, Scottsdale serves not to extend the law, but rather to confirm an insurer's right to reimbursement in these circumstances. However, it should be remembered that the Court stressed the right to reimbursement of defense costs exists where a defense duty never arose in the first place - where there was no potential for coverage. Thus, while it is of benefit in such cases, this Opinion may also provide support for the argument that, if the duty to defend is predicated on a facts which are in dispute, reimbursement will not be allowed and the defense obligation will exist "until the insurer negates all facts suggesting potential coverage." As the Scottsdale Court explained, citing to Buss, "when the [duty to defend] is extinguished by a showing that no claim can in fact be covered, 'it is extinguished only prospectively and not retroactively.'" 16 Cal.3d at 46. Thus, this case confirms that, whether because of policy interpretation or because of facts known at the outset, there is no coverage as a matter of law, and a coverage denial would have been appropriate, the cautious insurer who defends and files suit seeking reimbursement is entitled to reimbursement. However, where the available facts are not so clear, the prudent insurer which defends and files an action to test its obligations may, even if successful, be limited to prospective relief.


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