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Washington Supreme Court holds liability insurers defending under a “reservation of rights” cannot unilaterally condition the defense on recouping their defense costs in the event a court ultimately finds no coverage.

Mar 7, 2013

In National Surety Corp. v. Immunex Corp., the Washington Supreme Court held, in a 5-4 majority opinion, that a liability insurer cannot unilaterally condition the defense it affords its insured under a “reservation of rights” on the insurer’s recoupment of defense costs in the event there is a finding of no coverage.  Absent policy provisions to the contrary, the insurer can only avoid or limit its exposure to defense costs in situations involving late tender by the insured that result in “actual and substantial prejudice” to the insurer.  As such, once a liability insurer accepts its insured’s tender of defense under a reservation of rights, the insurer’s duty to fund the defense continues until a court says there is no coverage and the insurer may not seek reimbursement of defense costs incurred prior to the court’s coverage ruling.

 The duty to defend is broader than the duty to indemnify and affords the insured the benefit of a defense not only against claims for which coverage is ultimately found, but also against “colorable claims” that might trigger coverage.  The court in Immunex emphasized the insured isn’t the only party to the insurance contract that benefits from such an arrangement.  The insurer benefits as well.  For example, the insurer can monitor the defense and contain its exposure, potentially “walk away” from the defense if a court finds no coverage, and otherwise “insur[e] itself” against claims of breach of contract, waiver, coverage by estoppel, and other extra-contractual claims that may arise if it instead denied coverage outright.  Citing out-of-state cases, the court held it would constitute an impermissible “unilateral modification” of the insurance contract for an insurer to condition a defense afforded under a reservation of rights on its recoupment of defense costs retroactive to the date it started funding the defense. 

 The court thus held a judicial determination of no coverage will only have prospective application to absolve the insurer of defense obligations “from that point forward.” And because both parties to the insurance contract benefit from the insurer’s provision of a defense under a reservation of rights, the majority discounted the dissent’s assertion that the insured would be “unjustly enriched” if the insurer paid for the entire defense up until there was a determination of no coverage.

 The dissent criticized the majority for relying upon distinguishable out-of-state cases and ignoring the unjust enrichment rationale that informs the “majority rule” among American jurisdictions–also adopted by the Restatement (Third) of Restitution and Unjust Enrichment—which permits restitution to a liability insurer who fronts defense costs for ultimately uncovered claims.  It discounted the majority’s “mutual benefit” argument, noting a liability insurer does not “benefit” by merely complying with the insurance contract and Washington “decisional law” when offering to front defense costs the insurer would only owe if a court ultimately found the claims are covered.  Last, the dissent objected to the majority’s “sweeping and categorical” rule that, as a matter of law, insurers may never recoup defense costs under a reservation of rights, instead urging that Washington courts should be permitted to make “individualized determinations” in each case as to whether the “equities” involved support the insurer’s claim for reimbursement.

 Immunex modifies previous Washington law and may run contrary to the expectations liability insurers have as to what their rights are when affording a defense under a reservation of rights.  Nevertheless, under Immunex, when a liability insurer accepts its insured’s tender of defense under a reservation of rights, it is surrendering any right to reimbursement even if a court later finds no coverage and the insurer erred on the side of caution to give its insured more than the insurance contract arguably required.

 You can view the majority and dissenting opinions here:

 March 7, 2013 – 86535-3 – National Surety Corp. v. Immunex Corp.