On March 7, 2013, Washington State’s highest court dealt a blow to liability insurers seeking to recover defense costs for uncovered claims.  The court, in a 5-4 decision available here, held that where an insurer elects to defend its insured under a reservation of rights, it cannot force the insured to remit those defense costs if a court later determines that the insurer had no duty to defend.

The case, National Surety Corporation v. Immunex Corporation, stemmed from governmental investigations and lawsuits into Immunex’s manipulation of the price of its drugs. Immunex was alleged to have reported inflated wholesale drug prices, which, in turn, allowed the providers of those drugs – doctors, hospitals, and pharmacies – to receive Medicare reimbursements in amounts greater than what they actually paid.

Immunex tendered defense of the lawsuits to National Surety in October 2006, claiming that the suits were covered “under the umbrella insurance ‘Coverage B,’ which applied to cover ‘injury…arising out of…[d]iscrimination.”  In a March 2008 letter, National Surety agreed to defend Immunex under a reservation of rights and pay defense costs as of October 2006.  National Surety also indicated in the letter that it would pursue a declaratory judgment action to determine whether or not there was indeed a duty to defend. 

National Surety’s letter further stated that it “reserves the right to recoup the amounts paid in defense if it is determined by a court that there is no coverage or duty to defend.”National Surety then proceeded with a declaratory judgment action.  In April 2009, the trial court held that there was no coverage because the underlying complaints did not arise out of “discrimination,” but that National Surety nonetheless bore responsibility for defense costs incurred until the April 2009 ruling.  Both the Court of Appeals and the Washington Supreme Court affirmed.

Writing for the majority, Justice Stephens held as follows:

It is the insurer that decides whether to defend (with or without a reservation of rights) before any judicial determination of coverage. Providing a defense benefits the insurer by giving it the ability to monitor the defense and better limit its exposure. When an insurer defends under a reservation of rights, it insulates itself from potential claims of breach and bad faith, which can lead to significant damages, including coverage by estoppel. In turn, the insured receives the benefit of a defense until a court declares none is owed. Conversely, when an insurer declines to defend altogether, it saves money on legal fees but assumes the risk it may have breached its duty to defend or committed bad faith.

We reject National Surety’s view that an insurer can have the best of both options: protection from claims of bad faith or breach without any responsibility for the costs of defense if a court later determines there is no duty to defend. This “all reward, no risk” proposition renders the defense portion of a reservation of rights defense illusory. The insured receives no greater benefit than if its insurer had refused to defend outright.

[…]

We hold that insurers may not seek to recoup defense costs incurred under a reservation of rights defense while the insurer’s duty to defend is uncertain. Accordingly, National Surety may be held responsible for the reasonable defense costs incurred by its insured until the trial court determined National Surety had no duty to defend.

In reaching this decision, the Court declined to follow states like California (Buss v. Superior Court), Colorado, Connecticut, and Florida, among others, where insurers are entitled to recoup defense costs where a duty to defend never existed.

Writing for the four dissenters, Justice Wiggins observed that the majority was bucking the rule prevailing in most states:

the majority fails to acknowledge that its rule – that insurers may never recoup defense costs paid under a reservation of rights even when it is later determined that the insurer owed no duty to defend – is the minority view. The majority does not mention that a majority of American courts have allowed insurance companies to recoup reservation-of-rights defense costs and overlooks the leading theory, unjust enrichment, that most of these jurisdictions…have invoked to justify insurer recoupment.

The dissent further argues that “Washington courts should make individualized determinations on the recoupment issue by balancing the equities of each case.”

The Immunex decision will surely be welcomed by insureds.  Insurers in Washington electing to defend under a reservation of rights while also pursuing a declaratory judgment action will now have no right to recoup any defense costs advanced prior to a declaration of non-coverage.  The Immunex decision is thus likely to incentive insurers to proceed as quickly as possible with their declaratory judgment actions, while providing the opposite incentive for insureds.