United States: California Supreme Court Allows Insurer To Seek Reimbursement Of Excessive Legal Fees Directly From Cumis Counsel Under Narrow Facts Of Case

Hartford Casualty Ins. Co. v. J.R. Marketing, L.L.C., California Supreme Court Case No. S211645 (Filed August 10, 2015):

In JR Marketing, the California Supreme Court held that a liability carrier could seek reimbursement of excessive legal fees incurred defending the insured directly from Cumis counsel. The Court repeatedly emphasized, however, that its holding was limited to the narrow facts of the case, thus leaving many pertinent questions unanswered.

The insurer, Hartford Casualty Insurance Company ("Hartford"), issued one commercial general liability ("CGL") policy to Noble Locks Enterprises, Inc., effective from July 28, 2005, to July 28, 2006, and a second CGL policy to J.R. Marketing, L.L.C. (collectively the "Insureds"), effective from August 18, 2005 to August 18, 2006. The policies provided defense and indemnity to the Insureds, and their members and employees, against business-related tort claims. In September 2005, an action was filed in Marin County Superior Court against the Insureds and several individuals alleging, among other things, intentional misrepresentation, breach of fiduciary duty, defamation, and conspiracy (the "Marin Action").

On September 26, 2005, the Insureds tendered the defense to Hartford. Hartford denied any duty to defend or indemnify on the grounds that the acts complained of occurred prior to the policies' effective dates, and that certain defendants named in the lawsuit were not covered under the policies. The Insureds and several individual defendants filed a coverage action against Hartford (the "Coverage Action").

On January 19, 2006, Hartford agreed to defend the Insureds and several individual defendants, subject to a reservation of rights. However, Hartford still refused to pay for any defense costs incurred prior to that date, and also refused to provide independent counsel in place of panel counsel. In July 2006, the trial court in the Coverage Action found that Hartford had breached its duty to defend the Marin Action on the date first tendered, and that Hartford was required to furnish independent counsel (or Cumis counsel) pursuant to California Civil Code Section 2860 ("Section 2860). Squire Sanders was hired to serve as Cumis counsel.

In September 2006, the trial court issued an enforcement order (the "Order"), requiring Hartford to pay all past and future defense costs in the Marin Action. The Order, which was drafted by Squire Sanders, further stated that Squire Sanders's bills had to be "reasonable and necessary," and that, because of Hartford's prior breach, Hartford would be precluded from "invoking the rate provisions of Section 2860." Finally, the Order stated that, "[t]o the extent Hartford seeks to challenge fees and costs as unreasonable or unnecessary, it may do so by way of reimbursement after resolution of the [Marin Action]."

After the Marin Action concluded, Hartford filed claims against, among others, Squire Sanders, asserting, under restitution and unjust enrichment theories, that Hartford was entitled to reimbursement of a significant portion of defense fees incurred in defending individuals not entitled to coverage under either CGL policy. Hartford also asserted that Squire Sanders's services and the costs thereof were excessive, unreasonable, and unnecessary. Squire Sanders demurred, arguing that direct actions for reimbursement against Cumis counsel are disallowed. The trial court and appellate court agreed with Squire Sanders. The matter was appealed to the California Supreme Court.

The California Supreme Court reversed finding that Hartford could maintain an action for reimbursement directly against Squire Sanders. The Supreme Court reasoned that it was Squire Sanders (and not the Insureds) who would be unjustly enriched if allowed to retain payments that were unreasonable and unnecessary for the Insureds' defense:

As applied here, accepting for the sake of argument that Squire Sanders's bills were objectively unreasonable and unnecessary to the insured's defense in the underlying litigation and that they were not incurred for the benefit of the insured, principles of restitution and unjust enrichment dictate that Squire Sanders should be directly responsible for reimbursing Hartford for counsel's excessive legal bills.

(italics in original).

In its decision, the Supreme Court emphasized that its holding "hinge[d]" on the particular facts of the case, thereby limiting its ruling to the "unusual" scenario here where there was an Order that i) required Hartford to pay for "reasonable and necessary" costs of Cumis counsel; and ii) provided that Hartford had a right to reimbursement where such costs were not reasonable or necessary.

Thus, according the Court, the terms of the Order itself removed from consideration (and thus the Court did not decide) the questions of: (1) whether an insurer who breaches its defense obligations has any right to recover from anyone excessive fees paid to Cumis counsel; (2) whether such disputes should be required to be resolved by arbitration pursuant to Section 2860 (as was precluded by the terms of the Order here), and (3) whether resolution of such a fee dispute should be resolved after or before the conclusion of the underlying litigation (as the Order specified here that such a dispute could only be resolved after resolution of the Marin Action).

In the Concurring Opinion, Justice Liu notes that the Court's holding is premised on the dual assumption that Squire Sanders's bills were objectively unreasonable and unnecessary to the Insureds' defense in the underlying litigation and that they were not incurred for the benefit of the Insureds. Justice Liu expresses his view that the Court leaves open the possibility that some portion of Squire Sanders's allegedly unreasonable fees were incurred for the benefit of J.R. Marketing. Thus, to the extent this is true of any of the fees Hartford seeks to recover, such fees necessarily fall outside the scope of the Court's ruling in his opinion.

Further, Justice Liu explains that Section 2860 promotes collaboration among the insurer, insured and independent counsel. He posits that this exchange of information reduces the risk that a fee dispute will serve as a mechanism by which the insurer seeks to influence the judgments of Cumis counsel. However, unlike the usual Cumis scenario, here, Hartford breached its duty to defend. Thus, according to Justice Liu, in circumstances such as those presented here, an insurer seeking reimbursement from Cumis counsel for excessive fees should have to demonstrate the following: i) that counsel misled the insured in the representation, ii) acted without the insured's express or implied authorization, iii) contravened the insured's instructions; or iv) otherwise acted in a manner with little or no benefit to the insured.

The JR Marketing decision leaves much to be determined by future cases, although, arguably, it provides a foothold for insurers to argue that reimbursement actions may be maintained directly against Cumis counsel generally.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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