When a liability insurer provides a defense subject to a reservation of rights, it seeks to preserve its own rights, while avoiding prejudice to the insured in the underlying claim. If the insurer ultimately wins the coverage battle, it can try to recover the cost of the defense it provided. Whether it can succeed is a question that different states answer in a wide variety of ways.
In New York, insurers can recoup defense costs by establishing a lack of coverage. E.g., Dupree v. Scottsdale Ins. Co., 96 A.D.3d 546, 546, 947 N.Y.S.2d 428, 429 (1st Dept. 2012). In California, insurers can also recover defense costs, but only if they can show the claims they defended were “not even potentially” entitled to coverage. Buss v. Superior Court, 16 Cal.4th 35, 939 P.2d 766, 775-77 (1997); Axis Surplus Ins. Co. v. Reinoso, 208 Cal.App.4th 181, 188 , 145 Cal.Rptr.3d 128 (Cal. Ct. App. 2012). Florida has a similar rule. Certain Interested Underwriters at Lloyd’s v. Halikoytakis, No. 8:09-CV-1081-T-17TGW (M.D. Fla. Dec. 21, 2011). In Illinois, insurers generally cannot recover defense costs, but it might be possible to do so if there is a provision to that effect in the policy itself. General Agents Ins. Co. of America v. Midwest Sporting Goods Co., 215 Ill.2d 146, 162-63, 828 N.E.2d 1092, 1102 (2005).
Statutes in California and Alaska add an additional wrinkle to this issue: They provide that a reservation of rights can create a “conflict of interest” that requires the insurer to provide its insured with independent counsel. If it later turns out that the insured is not entitled to coverage, a federal court in Alaska has found that the insurer is still responsible for the cost of the independent defense.
Attorneys Liability Protection Society, Inc. v. Ingaldson & Fitzgerald, P.C., No. 3:11-cv-00187-SLG (D. Alaska, Dec. 21, 2012), grew out of a bankruptcy proceeding in which the debtor sought the return of a retainer it had paid to its law firm. The law firm demanded coverage under a liability policy, the insurer issued a reservation of rights, and the firm hired independent defense counsel. After the bankruptcy proceeding ended with summary judgment against the law firm, on grounds that fell within the policy’s express exclusions, the insurer sought to recover the costs of the defense.
Alaska’s statute on independent counsel states that insurers are not responsible for the costs of defending allegations for which coverage is properly denied, but that they “shall be responsible” for the defense of allegations “for which the insurer either reserves its position to coverage or accepts coverage.” The insurer argued that the latter term obligates insurers to pay for counsel while the reservation is in place, but not to forego reimbursement, once it has been determined that they had no duty to defend. Although a 2005 decision from the District of Alaska appeared to support the insurer’s position, the court now rejected it. It further held that the statute had not been pre-empted by the federal Liability Risk Retention Act.
The insurer also sought to rely on a provision in the policy that expressly permitted it to seek reimbursement for the cost of non-covered claims. The court rejected that argument, as well. The provision might have been effective in Illinois, but another Alaska statute requires that policy provisions at variance with the state’s mandates must be construed as if they complied with Alaska law.