Why it matters: A legal malpractice insurer forfeited its right to recoup a $10 million malpractice settlement by waiting three years after the malpractice claim was filed to reserve its right to recoup, an Atlanta federal district court determined. The law firm asserted that Twin City Fire Insurance had failed to properly reserve its right to deny coverage and to claim recoupment before paying the settlement amount. The court found that Twin City failed to take the necessary and “proper and safe course of action” by providing proper notice of its reservation of rights, taking appropriate measures in the underlying litigation to protect the insured from prejudice, and seeking immediate declaratory relief, including a stay of the underlying case pending final resolution of the declaratory judgment coverage action. Twin City, however, waited three years, until the last day of a 30-day settlement window in the underlying case, to attempt to reserve its rights and file a declaratory action. Too little, too late, the court said, leaving the insurer unable to seek recoupment of the $10 million settlement paid.

Detailed Discussion

In the fall of 2009, a bank hired Hartman Simons & Wood LLP to draft a guaranty release agreement as part of a real estate transaction. The guaranty release was to release the bank’s interest in a single property, but the? counter party and other entities argued that the release extended to a broad array of obligations to the bank.

A state court subsequently entered judgment against the bank on the scope of the release. The bank filed a malpractice claim against the law firm and demanded indemnification for its losses, which it estimated exceeded $60 million.

Three years into the litigation, the bank offered to settle the malpractice suit for $10 million, the amount of the law firm’s malpractice policy limits with Twin City – but only if payment was made within 30 days. The law firm asked Twin City to fund the settlement.

Twin City responded by disputing that it had any coverage obligations and informed the law firm that it intended to accept the bank’s demand, and asked the law firm to contribute to the settlement or execute a nonwaiver agreement that would allow Twin City to pursue recoupment against the law firm. The firm declined to accept the nonwaiver agreement. Twin City proceeded to fund the settlement under a full reservation of rights and on the same day filed a declaratory and recoupment action against Hartman Simons.

In its lawsuit against the law firm, Twin City requested recoupment of the $10 million settlement payment or, in the alternative, an order allocating the costs based on the presence of covered and noncovered claims and/or covered and noncovered defendants.

The Georgia federal court held that Twin City had forfeited its right to recoup or allocate. Although Hartman Simons notified Twin City within weeks of the bank’s malpractice lawsuit, the insurer waited almost three years to reserve its rights regarding coverage.

Under Georgia law, insurers may not give policyholders unilateral notice of a reservation of rights and proceed with a complete defense of the claim absent the express or implied consent of the insured. If an insurer is put on notice of grounds for coverage and the insured refuses to consent to a defense under a reservation of rights, the court spelled out exactly what the insurer must do to reserve its rights: the insurer must give the insured “proper, unilateral notice of [the insurer’s] reservation of rights,” take the “necessary steps to prevent the main case from going into default or to prevent the insured from being otherwise prejudiced,” and “seek immediate declaratory relief including a stay of the main case pending final resolution of the declaratory judgment action.”

Twin City failed to take the required steps. “Instead, Twin City waited nearly three years, until after the bank had submitted a settlement demand with a 30-day time limit. Then, on the very day the settlement demand was to expire, and after it had already decided to pay the demand, Twin City for the first time sought to reserve its claimed right to seek allocation and recoupment,” the court said.

This “last minute, unilateral reservation of rights after its insured had declined to contribute to a settlement” did not follow the “proper and safe course of action,” the court explained.

“The insurer’s options did not include settling the case, regardless of whether the settlement occurred before or after filing a declaratory judgment action,” he said. “By proceeding to settle the underlying claim before obtaining a final judgment determining its obligations, Twin City…short circuited the process and thereby waived any right to seek reimbursement from its insureds.”

To read the decision in Twin City Fire Insurance v. Hartman Simons & Wood LLP, click here.