Why it matters: The federal court, applying New York law, held that an energy drink manufacturer’s advertising coverage claim—arising from underlying tort claims alleging that the policyholder’s “all natural” energy drinks in fact contained an illegal and dangerous methamphetamine analog—was excluded, but denied the insurer’s effort to recoup defense costs incurred to date. The policy did not include a recoupment provision and the policyholder had rejected the insurer’s effort to negotiate a recoupment agreement. The insurer argued that the policyholder was unjustly enriched, because it received a partial defense on an uncovered claim, but the court refused to impose by common law a recoupment provision that was included in the policy itself. 

This decision recognizes the breadth of the duty to defend. Policyholders should be careful in placing coverage to avoid, to the extent possible, policies with recoupment provisions, and be wary if an insurer subsequently seeks such an agreement. Policyholders should clearly contest in writing an insurer’s reservation of the supposed right to recoupment. 

Detailed discussion: Policyholder Driven Sports, Inc., produced and sold a pre-workout energy supplement called “Craze.” In 2013, consumers filed multiple class actions against the company alleging that it contained an illegal and potentially dangerous methamphetamine analog. Driven turned to General Star Indemnity Company for coverage under its insurance policy. 

Driven’s insurer, General Star, provided a defense to these claims, subject to a complete reservation of rights, including the asserted right to recoup defense costs paid in the event the claims were determined not to be covered. General Star filed a declaratory judgment seeking a ruling that the claims were not covered based on a “Failure to Conform” exclusion, which applied to advertising injury claims arising out of the failure of products “to conform with any statement of quality or performance made in [Driven’s] ‘advertisement.’ ” Here, the “statement of quality” was “All Natural,” and the alleged violation was in the alleged inclusion in the product of an illegal and dangerous methamphetamine-like substance. 

The insurer also sought to recoup its expenses in defending the underlying lawsuits. Because the policy did not provide for recoupment (and Driven had explicitly rejected such a provision when negotiating the policy), General Star based its claim on a theory of unjust enrichment. 

Finally, in the alternative, General Star sought a ruling that, if it was not entitled to recoupment of paid defense costs, those payments eroded the policy limits. 

U.S. District Court Judge Joseph F. Bianco first decided that the claims were excluded under the “Failure to Conform” exclusion. The court noted by way of example that one complaint cited Driven’s “blatant misrepresentations” of Craze, “which is marketed as containing a natural extract as its active ingredient, when, in fact, it contains illegal analogs to methamphetamine.” A different complaint challenged the failure of Craze to contain only natural ingredients, as promised in Driven’s advertisements. 

All of the allegations were that “Craze’s actual quality (containing a synthetic and potentially dangerous ingredient) did not match its advertised quality (containing only natural ingredients),” the court said, concluding that the alleged misstatements triggered the Failure to Conform exclusion, barring coverage. 

The court was not persuaded by Driven’s argument that the underlying complaints made additional, covered claims, such as disparagement. “[A]s much as defendant attempts to re-brand the underlying claims as advertising injuries, they plainly arise out of how Craze actually performed, which left its consumers exposed to an allegedly dangerous and synthetic substance,” Judge Bianco wrote. 

As to recoupment, the federal court noted that four New York state court cases have permitted recoupment. In two, recoupment was unopposed. In the third case, the court awarded recoupment because there was no evidence that the policyholder refused to consent to the insurer’s reservation of the right to seek recoupment. The federal court noted that there was little analysis in the fourth case, but that the state court there cited only a single case in which the reservation of rights was unopposed. 

“Thus, although some courts have awarded recoupment, it is unclear under New York law whether that remedy is appropriate, or even authorized, under these circumstances, where defendant effectively resisted the idea of recoupment from the very beginning by rejecting plaintiff’s offer of a separate recoupment agreement,” the federal judge explained. 

Because General Star’s argument was not based on a recoupment provision in the policy, the court analyzed the claim under the law of unjust enrichment. New York law generally precludes an unjust enrichment claim as to an issued covered in a contract. The policy obligated General Star to “pay ‘all expenses’ with respect to the underlying lawsuits, and plaintiff did not include a recoupment provision in the Policy.” The court therefore refused to, “in essence, create [a] recoupment agreement and re-write the Policy by relying on a quasi-contract theory, when plaintiff could have addressed recoupment in the Policy, but chose not to.” 

The court further stated that insurers “bear the risk of not providing for recoupment in the Policy itself, and plaintiff is not saved by its later, unilateral reservation of rights,” noting General Star’s awareness of this risk in its attempts to provide for recoupment in a separate agreement after Driven tendered its claims. The policyholder rejected that offer, “and as a matter of equity and good conscience, the Court will not now imply the same agreement into the Policy.” 

Finally, the court also ruled that insurer defense payments reduced the limits of insurance, based on express policy language.

To read the order in General Star Indemnity Co. v. Driven Sports, Inc., click here.