An Illinois intermediate court of appeals reversed a trial court and ruled that a professional liability insurer is permitted to amend its complaint to assert a count of restitution to recover defense costs that it paid to defend its policyholder. See Steadfast Ins. Co. v. Caremark Rx, Inc., No. 1-06-1221, 2007 App. LEXIS 550 (App. Ct. 2007).
Steadfast Insurance Company (“Steadfast”) entered into a professional liability insurance contract with Caremark Rx, Inc., and its subsidiary, Caremark, Inc. (collectively “Caremark”). Under the terms of the insurance contract “Steadfast agreed to pay those sums in excess of the policy’s deductible that Caremark might become legally obligated to pay as ‘Damages’ for ‘Claims’ made by reason of any negligent act, error, or omission committed by Caremark arising out of its rendering or failing to render ‘Professional Services’ in the course of business.” The insurance contract excluded claims for intentional, criminal or fraudulent acts. Under the insurance contract, Steadfast agreed to defend any “Claim” against Caremark seeking covered “Damages,” even if the allegations were groundless, false or fraudulent.
In 2002, Caremark was sued in two separate lawsuits. Caremark tendered the defense of these two suits to Steadfast. Steadfast, however, asserted that it had no obligation to defend or indemnify and filed a declaratory judgment action. Caremark counterclaimed for a declaration of coverage and sought attorneys’ fees pursuant to section 155 of the Illinois Insurance Code, claiming that Steadfast’s denial of coverage was vexatious and unreasonable.
Steadfast and Caremark filed crossmotions for summary judgment. The trial court granted summary judgment in favor of Caremark, and denied Steadfast’s cross-motion for summary judgment, holding that Steadfast had a duty to defend Caremark in the two underlying actions. Steadfast appealed, but the trial court refused to stay enforcement of its ruling pending appeal.
The Initial Appeal and Remand
The Appellate Court of Illinois reversed the trial court and held Steadfast did not have a duty to defend or indemnify Caremark and remanded the case to the trial court. On remand, Steadfast then filed a “motion for restitution,” seeking to recover the defense costs it expended in the two underlying actions. The trial court, however, denied Steadfast’s motion, holding that Steadfast’s filing of a declaratory judgment action was the “functional equivalent” of an agreement to defend Caremark under a reservation of rights and concluded that Steadfast could not amend the insurance contract to include a restitution provision by reservation of rights.
The trial court based its decision on the Illinois Supreme Court’s holding in General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 215 Ill. 2d 146, 166, 828 N.E.2d 1092, 293 Ill. Dec. 594 (2005). In General Agents, an insurer provided a defense under a reservation of rights, which asserted that it had the right to recover defense costs if it was determined that the insurer did not owe a defense. The insurer later sought to recover defense costs, but the insurance contract did not contain a provision allowing the insurer to recover defense costs. The Illinois Supreme Court concluded that the insurer could not modify its insurance contract through a reservation of rights letter to allow it to recover defense costs.
Steadfast subsequently filed a “motion for leave to file a second amended complaint, seeking to add a claim for recovery of the defense costs on the basis of restitution, recoupment and/or unjust enrichment.” The trial court denied the motion and Steadfast appealed.
The Appellate Court’s Decision
The appellate court reversed. It determined that the trial court’s reliance on General Agents was misplaced. The appellate court reasoned that “Steadfast did not defend Caremark under a reservation of rights but, rather, it refused to defend and filed a declaratory judgment action.” Therefore, it concluded that Steadfast, unlike the insurer in General Agents, “did not seek to unilaterally alter its policy with Caremark through a reservation of rights letter.”
After noting the fact that Steadfast had no obligation to defend and recognizing case law that requires a party to make restitution if it receives a benefit from an erroneous decree, the appellate court nevertheless held that because Steadfast had not pled a count for restitution it was constrained to affirm the trial court’s decision. The appellate court, however, held that the trial court erred in refusing to permit Steadfast to amend its complaint to include a count for restitution. It then remanded the case for further proceedings consistent with its opinion.
The Steadfast decision signals a willingness of Illinois courts to permit insurers to recover defense costs if they are ordered wrongly to defend a policyholder. It also shows that insurers should be persistent in attempting to recover paid defense costs from policyholders who are not legally entitled to them.
Insurers should also be aware that on the larger question of whether an insurer may recover defense costs from its policyholder for the defense of uncovered claims by reserving its rights to do so, a number of states permit it, and it is an open question in other states.