The Court of Appeals for the State of Washington, in its recent decision National Surety Corp. v. Immunex Corporation, 2011 Wash. App. LEXIS 1695 (Wash. App. July 25, 2011), had occasion to consider whether an insurer is entitled to recoupment of defense costs incurred prior to receiving a judgment declaring that it owed no duty to defend.

National Surety insured Immunex under an umbrella and excess liability policy.  Immunex was named as a defendant in a number of suits alleging that it participated in a conspiracy with other prescription drug manufacturers to artificially inflate the average wholesale price of its products.  While the first of the suits was filed in 2001, Immunex did not provide first notice of the suits to National Surety until 2006.  National Surety initially denied coverage based on late notice, but later agreed to provide a defense under a reservation of rights and to seek a declaratory judgment.  Among other things, National Surety reserved its right to recoup defense costs paid in the event it was determined that National Surety had no duty to defend.

Both the trial court and the appellate court agreed that the underlying suits filed against the insured, alleging price discrimination arising out of the insured’s alleged participation in the fraudulent pricing scheme, did not constitute “personal and advertising injury” under the policy, which included the offense of “discrimination.”  While the term “discrimination” was not defined by National Surety’s policy, the appellate court agreed that the underlying suits “originate[d] not from discriminatory actions but from fraudulently inflating” the price of its products.  Although this conduct “might have impacted some consumers more than others, that does not mean the offenses originated from discrimination.”  Thus, the court agreed that National Surety did not have a duty to defend the underlying suits.

While the court held that National Surety had no duty to defend, it disagreed that National Surety was entitled to recoupment of defense costs it had already incurred. The court acknowledged that lack of Washington case law on the issue, but found guidance from the line of cases holding that an insurer has a duty to defend whenever a complaint alleges a potentially covered claim.  While it was ultimately determined that National Surety had no duty to defend, there was no certainty of that outcome until the trial court ruled in National Surety’s favor.  Accordingly, National Surety had a duty to defend from the time the underlying complaint was filed through the time it received summary judgment in the coverage litigation, and as such, it was proper for National Surety to pay defense costs during that period.

The court addressed at length an insurer’s options when it is not clear from the face of the pleading as to whether a defense obligation is triggered.  Under such circumstances, the insurer can deny coverage outright or provide a defense under a reservation of rights and seek a declaratory judgment.  By providing a defense under a reservation of rights, the insurer avoids the potential for having breached any subsequently determined defense obligation.  By opting for the latter, explained the court, the insured is not unjustly enriched by receiving a defense:

… National Surety had the benefit of insulating itself from a bad faith claim and possible coverage by estoppel.  Therefore, the payment of the defense costs is not purely a gratuity to the insured and no unjust enrichment occurs if National Surety covers the cost of defense until the trial court ordered otherwise.

Thus, the court held that an insurer’s reservation of rights to recoup defense costs will not be enforced absent express language in the policy allowing for such relief.