Defense Digest 9/08: Pennsylvania Superior Court Denies Right To Reimbursement Of Defense Costs Paid Under A Reservation Of Rights
By William J. McPartland, Esq.*
Pennsylvania - Coverage/Reservation Of Rights
Earlier this year the Pennsylvania Superior Court issued their opinion in American and Foreign Insurance Company v. Jerry's Sport Center, Inc., 2008 Pa.Super. 94 (Pa.Super. 2008), addressing the validity of a provision in a reservation or rights letter regarding the right to seek reimbursement of defense costs advanced when it was later determined that the insurer had no duty to defend.
In May of 2001, Jerry's Sport Center was named as a defendant in a civil action brought by the National Association for the Advancement of Colored People ("NAACP") and the National Spinal Cord Injury Association ("NSCIA") against several firearms wholesaler-distributors for negligence in the marketing and distribution of handguns. Jerry's provided notice to its commercial liability insurers, American and Foreign Insurance, Royal Insurance Company of America, Safeguard Insurance Company, and Royal Indemnity Company (collectively "Royal"). Upon receipt of notice of the suit, Royal retained counsel to defend Jerry's and informed their president that it was more appropriate to have independent counsel in the action rather than participate in a group or joint defense with the other gun distributors named in the lawsuit.
By letter dated June 15, 2001, Royal confirmed its conversations with Jerry's regarding the retention of defense counsel and stated that it was examining coverage issues related to the policy Jerry's had with Royal. In that letter, Royal advised Jerry's that it was providing them with a defense under a full reservation of rights, including the right to seek reimbursement of all defense fees advanced in the event that it was determined that Royal had no duty to defend Jerry's in the action. Royal also advised Jerry's that they had the right to retain their own counsel to consult with the counsel provided by Royal.
On or about September 7, 2001, Royal informed Jerry's in writing of its final determination that Royal had no duty to defend or indemnify them in the NAACP/NSCIA action. Royal also advised them that they would be commencing a declaratory judgment action seeking a judgment that Royal had no duty to defend or indemnify Jerry's. In the interim, Royal stated that it would continue to advance the costs of defense in the action and that in the event it was successful in its declaratory judgment action, it might also seek reimbursement of any defense costs advanced after the date of the final coverage determination.
Throughout the course of the NAACP/NSCIA action, Royal paid for the defense costs. Their adjuster reviewed each bill to determine if it reflected the strategy discussed with counsel, if the hourly charges were reasonable, and whether the bills were fair and reasonable.
On July 16, 2002, Royal filed a motion for summary judgment in the declaratory judgment action requesting that the court declare that it was under no duty to defend or indemnify Jerry's and that Royal was entitled to reimbursement of fees and costs paid in the defense of the NAACP/NSCIA action. On February 25, 2003, the trial court granted Royal's motion for summary judgment finding that Royal had no duty to defend or indemnify Jerry's because the policy covered damages for bodily injury and the suit sought injunctive relief and a monetary fund to educate, supervise and regulate gun dealers. However, the court did not indicate that it was granting reimbursement of the attorney's fees paid by Royal. Jerry's filed an appeal to the Superior Court, which affirmed and concluded, like the trial court, that the complaint did not trigger coverage as it did not seek compensation for bodily injury. The Superior Court did not indicate whether it was remanding or relinquishing jurisdiction.
On May 11, 2004, Royal filed a motion in the trial court seeking reimbursement of defense costs in the amount of $317,540.29. On August 11, 2004, the trial court entered an order finding that an implied contract existed between the parties and that Jerry's was unjustly enriched by Royal's payment of defense costs. It also scheduled a hearing for the court to take evidence on the issue of quantum meruit as to the defense costs. The court then entered a verdict in the amount of $309,215.86, plus six percent interest per annum, which totaled $345,819.14.
On appeal, the Superior Court found that insurers cannot receive reimbursement under such circumstances, absent an express provision in the insurance contract. To allow Royal to receive reimbursement of fees based on a reservation of rights letter would constitute an impermissible unilateral modification of the insurance contract. The court focused on the language of the insurance policy providing Royal with a right to defend its insured. By undertaking the defense of Jerry's, Royal benefited by preserving control of the defense and its ability to take actions to mitigate any future indemnification responsibilities. Because Royal derived these benefits and exercised its right to defend, the trial court erred when it found an implied contract, that Jerry' was unjustly enriched, and that Royal was entitled to reimbursement of defense costs. The court held that if Royal wanted to seek reimbursement of attorney's fees under these circumstances, it could have included such a provision in the insurance policy along with its duty and right to defend. However, where the insurance contract is silent on the issue, permitting reimbursement of defense costs expended by the insurer prior to a court's determination of no coverage or no duty to indemnify would result in a retroactive erosion of the breadth of the duty to defend.
* William is an associate in the Pittsburgh, Pennsylvania, office. He can be reached at (412) 803-1145 or at wjmcpartland@mdwcg.com.
