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Insurance Law

: INSURANCE LAW NOTES

PA Superior Court Denies Insurer Reimbursement of Defense Costs

By Richard Victoria

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The PA Superior Court has held that, in cases where the insurance policy at issue does not provide for reimbursement of defense costs paid by the insurer, an insurer is not entitled to such reimbursement despite the insurer's reservation of rights letter specifically addressing the issue and a later finding of no coverage under the policy.

In American and Foreign Insurance Company, et al. v. Jerry's Sports Center, Inc., et al., No. 1098 MDA 2006, 2008 PA Super 94, the Court addressed the issue of whether an implied contract exists between the insurer and its insured entitling the insurer to recoup costs expended in defending a disputed claim prior to a final judgment on the coverage issue where the relationship between the parties was governed by a written insurance policy that did not grant the insurer the right to recover defense costs. While the insurer argued that: (1) an implied contract for reimbursement was created by its reservation of rights letter in which the insurer expressly reserved the right to seek reimbursement of all defense fees advanced in the event the insurer was determined to have no duty to defend; and (2) that the insured was unjustly enriched, the Court disagreed.

Noting that the issue presented was one of first impression in Pennsylvania courts, the Superior Court examined the law in other jurisdictions and courts, citing with approval the Third Circuit's opinion Terra Nova Ins. Co. Ltd. v. 900 Bar, Inc., 887 F.2d 1213 (3d Cir. 1989), rejecting an insurer's claim for reimbursement. The Court further examined principles of Pennsylvania law concerning an insurer's duty to defend its insured, concluding that "the duty to defend [i]s triggered when a potentially covered claim became apparent to the insurer, as opposed to being triggered later, as when a court determined actual coverage in a subsequent declaratory judgment action" and that "[c]oncluding any differently would eviscerate the longstanding common law rule that the duty to defend is triggered whenever a claim is not just actually covered, but also potentially covered."

The Court also examined the relevant policy language and noted that the insurer not only had a "duty" to defend under the policy, but a "right" to defend as well. Examining the record, the Court determined that the insurer "was preparing for the possibility that a court would later determine there was coverage and, given that the claims may be potentially covered, [the insurer] was exercising its right to defend under the policy." Thus, the insurer's duty to defend was triggered when it was faced with potentially covered claims and when it activated its right to defend under the insurance contract by taking actions such as hiring counsel.

Finally, the Court noted that an insurer benefits from tendering the defense in such cases because it maintains control over the defense and can mitigate any potential future indemnification burdens.

Given these factors, the Court held that a reservation of rights letter does not create an implied contract for reimbursement, that the insured was not unjustly enriched, and that, if the insurer wanted to seek reimbursement of attorneys fees under the circumstances presented, it could have included such a provision in the insurance contract along with its "duty and right to defend."

It also is worth noting that the Superior Court cited with approval the case of LA Weight Loss Ctrs., Inc. v. Lexington Ins. Co., 2006 WL 689109 (Phila. Co. 2006), going so far as to adopt the Common Pleas Court's reasoning.

Thanks to my partner Beth A. Slagle for bringing this case to my attention.

Full post as published by INSURANCE LAW NOTES on May 22, 2008 (boomark / email).