States continue to disagree about whether an insurer that defends its insured in a lawsuit can reserve a right to recoup its defense costs from the policyholder if the carrier wins a declaratory judgment that it owed no duty to defend. Courts in New York and Nevada recently took opposite positions on the issue, but both cited an article that described a simple policy language-based approach policyholders can urge to resolve the issue in their favor.
The California Buss case permitted recoupment
The California Supreme Court issued a famous opinion favoring recoupment in Buss v. Superior Court, 939 P.2d 766 (Cal. 1997). It held an insurer has an implied in law right to seek recoupment to avoid unjustly enriching its policyholder if the insurer establishes that a suit’s claims were not even potentially covered. The court said recoupment would not disturb the parties’ arrangement because standard insurance policies do not obligate the insurer to bear those costs.
The Illinois General Agents case refused recoupment absent a policy recoupment provision
Although the Buss decision gained followers in other states, some courts disagreed with it. A prominent dissenter was the Illinois Supreme Court. In General Agents Insurance Co. v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Ill. 2005), it held that an insurer cannot reserve a right to recoupment unless its policy expressly provides for recoupment. The court said policy rights cannot be enlarged by reservation and refusing recoupment is fair because insurers defend to reduce the risk of a large judgment they might have to cover.
The Buss Stop article claimed the supplementary payments provision defeats recoupment
An article examining the Buss and General Agents decisions advocated the latter’s express provision requirement but proposed a reason the court had not discussed. See Angela R. Elbert & Stanley C. Nardoni, Buss Stop: A Policy Language Based Analysis, 13 Conn. Ins. L.J. 61 (2006–2007). The article maintained that contrary to the Buss court’s reasoning, standard liability policies prohibit recoupment by their supplementary payments provisions, in which insurers promise: “We will pay, with respect to any claim or ‘suit’ we defend: 1. All expenses we incur.” Id. at 94-95.
The New York Gjonaj Realty decision stressed the supplementary payments provision to refuse recoupment
After the Buss Stop article was published, some courts cited it and pointed to the supplementary payments provision in refusing recoupment. In General Star Indemnity Co. v. Driven Sports Inc., 80 F. Supp. 3d 442, 460-61 (E.D.N.Y. 2015), for example, a federal district court observed that provision meant the policy at issue was not “silent concerning who bears the costs of legal representation” once an insurer agrees to defend.
More recently, the Second Department of the New York Supreme Court’s Appellate Division pointed to the supplementary payments provision in refusing recoupment. In American Western Home Insurance Co. v. Gjonaj Realty & Management Co., 138 N.Y.S.3d 626, 628 (App. Div. 2020), it held that an insurer was not “entitled to recover from the insureds the defense fees and costs incurred on their behalf” before winning a summary judgment of no duty to defend a suit on late notice grounds. Citing Driven Sports, the court reasoned that the policy “obligates the insurance company at its own cost to defend the insureds until a judicial determination … that the underlying action was not covered by the policy.” Id. at 634.
The Nevada Supreme Court declined to examine policy language in allowing recoupment in Nautilus
In what appears to be the latest precedential state court decision to confront the subject, Nautilus Insurance Co. v. Access Medical, LLC, 482 P.3d 683, 685-86 (Nev. 2021), the Supreme Court of Nevada answered “yes” to a certified question that asked: “Is an insurer entitled to reimbursement of costs already expended in defense of its insureds where a determination has been made that the insurer owed no duty to defend and the insurer expressly reserved its right to seek reimbursement in writing after defense has been tendered but where the insurance policy contains no reservation of rights?”
The court aligned itself “with the approach in California” established in Buss. Id. at 689. Although the Nautilus court mentioned the Buss Stop article, it “decline[d] to consider specific insurance policy language that was not included in the certifying order.” Id. at 689-90.
A scholar criticizing Nautilus has urged the supplementary payments provision to defeat recoupment
A prominent law professor who has written extensively on insurance law has just taken the Nevada Supreme Court to task for failing to consider the impact of the supplementary payments provision. In A Deeper Dive Into Nautilus: Differentiating Insurer Efforts to Recover Defense Costs and Assessing Recoupment in the Wake of the ALI Restatement, 57 Tort & Ins. L.J. 57, 90 (2022), Professor Jeffrey W. Stempel chided the Nautilus court for citing the Buss Stop article without recognizing that it “skewers the rationale of recoupment” the court adopted.
According to Professor Stempel, “Applying the textualist mode of construction usually favored by insurers, there is no question that policy language logically precludes recoupment,” and “the typical ‘supplementary payments’ provisions of a general liability policy promise payment of defense costs without restrictive recoupment language.” Id. at 67. He further said that the Buss Stop article’s “argument against recoupment based on the Supplementary Payments provision of typical general liability policies … has been insufficiently appreciated by commentators and courts,” and “[d]uring the twenty years of recoupment litigation, the supplementary payments provision has been too often overlooked–a sin the Nautilus majority perpetuated even as it was citing an article making this very point.” Id. at 90, 92. In line with Professor Stempel’s analysis and opinions such as Driven Sports and Gjonaj Realty, a policyholder facing a claim for defense cost recoupment in a jurisdiction that has not definitively taken a position on the issue should keep the supplementary payments provision in mind as a possible solution.