A liability carrier claims a policy does not require it to defend a particular lawsuit. A federal district court agrees, and the insurer stops providing a defense. Five years later, a Court of Appeals reverses. Did the insurer breach its insurance contract? In what appears to be a case of first impression, a federal court in California has said “no,” because holding otherwise would “tip the scales too far in favor of the insured.”
Seagate Technology, Inc., was sued in New York in 2000. Seagate’s liability insurer provided a defense, but, in 2004, it filed a declaratory judgment action in the Northern District of California, arguing that it had no duty to defend. The district court eventually found that the insurer owed a defense only for the period from November 1, 2000, through July 18, 2007. Relying on that judgment, the insurer stopped paying defense costs in 2007.
In 2012, the district court’s declaratory judgment was reversed. Seagate presented the insurer with a bill for five years of attorneys’ fees, plus prejudgment interest. Citing California Civil Code Section 2860, which provides that an insurer is obligated to pay only those rates that it pays to the attorneys it retains “in the ordinary course of business . . . in similar actions,” the insurer reduced Seagate’s bill by about $20 million. Seagate argued that the appellate decision converted the insurer’s failure to pay defense costs after 2007 into a breach of contract nunc pro tunc to 2007, and, therefore, that the insurer was not entitled to rely on Section 2860.
In National Union Fire Ins. Co. of Pittsburgh, Pa. v. Seagate Technology, Inc., No. C 04-01593 WHA (N.D. Cal. Jan. 25, 2013), the court rejected Seagate’s position. Finding an absence of authority directly on point, the court nevertheless concluded that “application of general principles provides a clear result.” It explained that the prior order was entered under Rule 54(d); that it was a final order for purposes of res judicata and collateral estoppel; and that, absent a stay, parties must generally comply with such orders while an appeal is pending. Seagate did not seek a stay pending the appeal, and its insurer was therefore entitled to the benefit of the ruling that there was no duty to defend–even if that ruling was erroneous. The court explained that Seagate would still obtain the benefit of its bargain, because its insurance benefits would be reinstated from 2007, but that the insurer did not breach its contract with Seagate by relying on a judgment in its favor. Accordingly, the insurer was entitled to reduce the payment of legal fees, based on Section 2860.
The court was careful to distinguish this case from one in which an insurer refuses to defend an insured and then obtains a judgment in its favor, only to see that judgment reversed. Under those circumstances, the prior favorable ruling provides no insulation to the insurer that denied the tendered defense and knowingly gambled that it would be vindicated by the courts. Here, the insurer’s decision to stop defending its insured was based on a court’s judgment, and such a decision is not “wrongful,” nor is it a breach.