United States: Insurers Continue Attempting to Recoup Defense Costs: One Win, One Loss

As discussed in our last insurance recovery alert, insurers around the country continue seeking ways to recoup the fees and costs spent defending their insureds for uncovered claims. Two more courts have weighed in on the issue.

U.S. Court of Appeals for the 10th Circuit

The U.S. Court of Appeals for the 10th Circuit, applying Colorado law, recently ruled that an insurer can recoup defense costs. In Valley Forge Insurance Company v. Health Care Management Partners, Ltd., 2010 U.S. App. LEXIS 17098 (10th Cir. Aug. 26, 2010), the policyholder received a reservation of rights letter offering a defense, but reserving the right to recoup defense costs. The court notes that Health Care Management never objected to the reservation of rights letter.

During the defense of the underlying case, all three insurers filed a declaratory judgment action against their insured to deny their duty to defend and recoup defense costs. While noting that the right to recoup defense costs was not a provision of the insurance policy, the 10th Circuit, nevertheless, found that Colorado state law allowed recoupment. As the court noted in its opinion, "Regardless whether the Colorado courts situate the rule in equity, contract, policy, rule of court, or someplace else – whatever doctrinal pigeonhole best fits – one thing is clear: Colorado permits insurers to recoup defense costs in the circumstances before us."

U.S. District Court for the Eastern District of Virginia

In an even more recent Order, the U.S. District Court for the Eastern District of Virginia, applying Washington state law, ruled that an insurer does not have the right to recoup defense costs. (Zurich American Insurance Co. v. Public Storage, et al., Civil Action No. 1:09cv1394 (E.D. Va. Sept. 17, 2010) (J. Ellis). In this case the insurer, Zurich, also attempted to reserve a right of recoupment in its reservation of rights letter.

Recoupment was not part of the insurance contract. Judge Ellis noted in his Order, "Zurich has not cited a single case, nor has one been found, where Washington courts have allowed insurers to recoup defense costs for uncovered claims. As a court sitting in diversity, it is inappropriate to blaze a new trail in Washington insurance law for which there is absolutely no invitation in the prior cases."

As noted in the last alert, policyholders must remain hyper vigilant to this issue, and never let a reservation of rights letter asserting a right to recoup defense costs go unanswered. As courts around the country remain divided over this issue, it is critical to also understand a specific state's law addressing recoupment and be ready to address it.

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