California Supreme Court Permits Insurer To Seek Reimbursement Of Unreasonable And Unnecessary Defense Fees Directly From Insured’s Independent Counsel

California Supreme Court Permits Insurer To Seek Reimbursement Of Unreasonable And Unnecessary Defense Fees Directly From Insured’s Independent Counsel

08.14.2015

In a case attracting nationwide attention, Hartford Cas. Ins. Co. v. J.R. Marketing, L.L.C., 2015 WL 4716917 (August 10, 2015), in a narrowly tailored opinion, the California Supreme Court held that an insurer may seek reimbursement of “unreasonable and unnecessary” defense expenses directly from independent counsel, rather than its insured, where the insurer paid counsel’s fees pursuant to a court order preserving the insurer’s right to recover such sums.

Hartford’s insureds were sued for defamation and other claims.  Hartford denied the insureds’ tender of the underlying lawsuit but, in resulting coverage litigation, Hartford was held to owe a duty to provide a defense to the insureds through independent counsel.  The trial court also found that because Hartford breached its duty to defend, it was precluded from invoking the provisions of California’s independent counsel statute, Civil Code § 2860, including its hourly fee rate cap.  However, the trial court’s enforcement order stated that Hartford could challenge independent counsel’s fees and costs as unreasonable or unnecessary by way of a reimbursement action after the underlying lawsuit concluded.  Independent counsel charged $13.5 million in defense fees in the underlying suit, which Hartford paid pursuant to the enforcement order.

Once the underlying suit was resolved, Hartford filed a complaint against independent counsel for reimbursement of substantial fees and costs.  Independent counsel moved to dismiss Hartford’s claims against it, arguing that because an insurer’s right of reimbursement depends upon the contractual relationship between insurer and insured, Hartford had no cognizable claim against it.  The trial court and Court of Appeal agreed, finding Hartford could only seek reimbursement from the insureds, not their independent counsel.

However, the California Supreme Court disagreed and reversed, while repeatedly emphasizing that its decision was limited to the facts of this case.  Its decision was grounded, in part, upon the equitable principle that one who has been unjustly enriched by another may be required to pay restitution, even if no contract expressly or impliedly imposes such a duty.  Thus, while the insurance policy was a contract between Hartford and the insureds, the fact that independent counsel was not a party to the policy did not bar Hartford’s claims.

The Court cited its decision in Buss v. Superior Court, 16 Cal.4th 35 (1997), which held that when an insurer has met its duty to defend a “mixed” action encompassing both covered and noncovered claims under a general liability policy, the insurer is entitled to restitution from the insured for those fees that were solely attributable to defending claims that clearly were not covered by the policy.  The Court reasoned that it would be unjust for the insured to retain the benefit of the insurer paying for a defense that is beyond the scope of the insurance contract.

The J.R. Marketing Court observed that the difference in the case before it was that if independent counsel’s bills were unreasonable and unnecessary to the insured’s defense, they were not incurred for the benefit of the insured, and principles of restitution and unjust enrichment dictated that independent counsel should be directly responsible for reimbursing Hartford for counsel’s excessive bills.

The Court observed that Hartford’s duty to pay for independent counsel was not unlimited under the enforcement order and that under the ethical rules governing attorney conduct generally, citing California Rules of Professional Conduct, Rule 4-200(A), the duty “did not ultimately extend beyond the duty to pay the reasonable costs of the defense.”  That Rule states:  “A member shall not enter into an agreement for, charge, or collect an illegal or unconscionable fee.”

The Court rejected independent counsel’s argument that permitting Hartford to file a direct action against it would frustrate public policy, including the purposes of Section 2860.  While Section 2860 confers independence upon an insured and independent counsel in the defense of cases falling within the statute’s purview, the Court stated “such independence is not inconsistent with an obligation of counsel to justify their fees.”

The Court thus concluded that Hartford could pursue a reimbursement action against independent counsel, and in that action, Hartford will bear the burden of showing counsel’s fees were “objectively unreasonable at the time they were incurred, under the circumstances then known to counsel.”

As noted above, the Opinion was by its terms “limited.”  The Court “express[ed] no view as to what rights an insurer that breaches its defense obligations might have to seek reimbursement directly from [independent] counsel in situations other than the rather unusual one [] in this case.”  The “unusual” situation was the enforcement order, upheld on appeal and final, that barred Hartford from limiting counsel’s hourly rates as provided under Section 2860 but nevertheless provided that counsel’s bills must be “reasonable and necessary” and that Hartford could challenge the bills in a subsequent reimbursement action.  The Court did not address whether the lower courts were correct in ruling that Hartford was not permitted to take advantage of Section 2860, including with respect to independent counsel’s fees incurred after the enforcement order was entered.  The Court also did not address whether the fee dispute must be resolved by arbitration as specified by Section 2860 or litigated while the underlying suit was pending or after it was concluded.  Perhaps more important was another question the Court did not decide – whether an insurer that is not in breach and does not have an order like the enforcement order in J.R. Marketing could seek reimbursement of “excessive fees” from independent counsel.

An insurer is more likely to confront these undecided issues than the ones actually resolved by the Court.  Thus, the decision itself provides limited guidance.  Indeed, policyholder counsel are focusing on the restrictive nature of this ruling.  On the other hand, the Court cited law, such as the ethical rules governing attorney conduct generally that constrain independent counsel from charging “illegal or unconscionable” fees, which will form the backbone of support for claims by insurers.  Unfortunately, that may be of little help, and the undecided issues will likely remain points of contention and undecided for some time. 

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