Under California law, awards of plaintiffs’ attorneys’ fees based on contract, statute, or law qualify as “costs” and may fall within the supplementary payments coverage of a CGL policy. Cal. Code Civ. Proc § 1033.5. If this coverage is part of the insurer’s defense obligation, the carrier must pay such an award outside of its policy limits.

Most CGL policies obligate the insurer to pay in “suits” they defend, “[a]ll costs taxed against the insured in the suit.” Under California law, this provision obligates “the insurer to pay ‘costs’ whenever it must defend the suit, independent of whether those costs would otherwise be covered by way of the insurer’s indemnity obligation.” Prichard v. Liberty Mutual Ins. Co., 84 Cal. App. 4th 890, 895 (2000). This is so because “the supplementary payments provision providing all ‘costs taxed’ is a function of the insurer’s defense obligation, not its indemnity obligation.” Prichard, 84 Cal. App. 4th at 911-12.

In Prichard, the insured was entitled to its claims for costs – including attorneys’ fees –even if it turned out that the insurer could later prove that there was no actual coverage because the court found that the insured’s costs were part of the carrier’s defense obligation. Id. at 912.

The Prichard court rejected the insurer’s challenge to the “fairness” of requiring an insurance carrier to pay all costs in any suit it defends. The insurer suggested that:

the absence of even the possibility of coverage for the causes of action that generated the large costs award is somehow unfair because the insured is getting a benefit he never paid for by being in effect indemnified for exposure on claims the defense of which he never paid a premium for.

Prichard, 84 Cal. App. 4th at 912 n.22. The court dismissed this argument, stating that the problem

is in the insurance contract, not the law . . . If the ISO [ ] forms are written so that attorney fees awarded as part of prevailing party clauses can be considered costs associated with the insurer’s defense obligation, there is nothing we can do about it.

Id. See also Insurance Co. of North America v. National American Ins. Co., 37 Cal. App. 4th 195, 206-07 (1995) (holding that costs awarded against the insured because of prevailing party attorney fee clauses applicable in the underlying litigation were part of the supplementary payments section of the policy and noting that such attorney fees were statutorily defined as costs).

The same reasoning applies to plaintiffs’ attorneys’ fees paid in settlement. Prichard, 84 Cal. App. 4th at 912-13 (rejecting argument that settlement of underlying case was “automatic bar” to any claim for costs “taxed” against the insured and holding “there is no reason that there should be any per se immunity from the supplementary payments obligation”). The California Court of Appeal recently reaffirmed this holding in Employers Mutual Casualty Co. v. Philadelphia Ins. Co., 169 Cal. App. 4th 340 (2008), rejecting the insurer’s argument that “costs taxed cannot include attorney fees paid in settlement.” In upholding the trial court’s award of “costs” to the insured, the court found that “as a matter of public policy and equity our interpretation is sensible. It permits an insured to settle a claim instead of pursuing an action to judgment and risking a greater liability…Public policy encourages settlement.” Id. at 344.

In addition, the Employers Mutual court also rejected the insurer’s argument that its obligation to pay costs taxed against the insured arises only after liability is established in the underlying action. The court found that although the insured did not admit liability as part of the settlement, the settlement agreement established the insured’s liability for the purposes of insurance coverage. Id.

Based on this favorable case law in California, insureds should take the time to carefully examine the basis for any plaintiffs’ attorneys fee award either by judgment or settlement. If such an award qualifies as a “cost,” it may be covered as part of a CGL carrier’s defense obligation and thus paid outside of the available policy limits.