In Security Ins. Co. of Hartford v. Lumbermans Mutual Casualty Co., 826 A.2d 107 (Conn. 2003), the Connecticut Supreme Court held that when an insurer “defends the insured against an action that includes claims not even potentially covered by the insurance policy, a court will order reimbursement for the cost of defending the uncovered claims in order to prevent the insured from receiving a windfall.”  The United States District Court for the District of Connecticut recently had occasion to address the bounds of this rule in Nationwide Mutual Ins. Co. v. Mortensen, 2011 U.S. Dist. LEXIS 77356 (D. Conn.  July 18, 2011).

The insureds in Nationwide were former insurance agents for Nationwide and its affiliated companies.  These individuals also happened to be insured by Nationwide under Business Provider Insurance Policies.  In the underlying suits, Nationwide sued the individuals on several grounds, including breach of contract, breach of fiduciary duty, unfair trade practices and trademark infringement.  These individuals, in turn, sought coverage for the underlying suits under their Nationwide policies.  Nationwide agreed to provide a defense subject to a reservation of rights, including the right to seek recovery of defense costs associated with non-covered claims.  It subsequently filed coverage litigation action against the insureds and successfully obtained a declaratory judgment that it had no coverage obligation with respect to the underlying suits.  In a 2009 decision, however, the court held that Nationwide was not entitled to reimbursement of defense costs incurred prior to the declaratory judgment, explaining that:

It was in Nationwide's own interest to provide a defense under the reservation of rights in order to avoid exposure had the Court held it did have a duty to defend. If the Court were to now allow Nationwide to recoup defense costs, the defendants would be required to pay for the action Nationwide took to protect itself. In these circumstances, in the absence of a policy provision pointed to by Nationwide or active assent to the reservation by the defendants, the reservation of rights letters were not enough to impose a burden on the defendants to reimburse Nationwide for defense costs.  Nationwide Mut. Ins. Co. v. Mortensen, 2009 U.S. Dist. LEXIS 74870 at *18-19 (D. Conn. Aug. 24, 2009).

Nationwide subsequently moved for reconsideration, arguing that decision by the Connecticut Supreme Court in Security Ins. Co. established a general rule that an insurer could recover defense costs associated with non-covered claims.  The Nationwide court disagreed with Nationwide, explaining that Security Ins. Co. should be limited to its facts.  The Security Ins. Co. matter concerned an insured’s asbestos liabilities over a seventeen-year period, several years of which it was uninsured.  The Connecticut Supreme Court held that in light of Connecticut’s pro rata methodology for allocating defense costs, the insured should be required to pay its prorated share of the defense for uninsured periods.  As such, the insurers were entitled to reimbursement of defense costs they had already paid for these periods.  The Nationwide court reasoned that recoupment of defense costs was proper in Security Ins. Co., since there was no potential for coverage in the uninsured periods.  By contrast, explained the court, while it was determined that the underlying suits brought by Nationwide were not covered, “there was at least a potential that the defendants’ claims would be covered.”  (Emphasis in original.)   Given this potential, explained the court, “Nationwide had a temporary duty to defend until a determination on coverage was made,” and as such, it would be improper for Nationwide to recoup its defense costs incurred during this period.