United States: Attorneys Liability Protection Society, Inc. V. Ingaldson Fitzgerald, P.C.

In Attorneys Liability Protection Society, Inc. v. Ingaldson Fitzgerald, P.C., 838 F.3d 976 (9th Cir. 2016), the Ninth Circuit Court of Appeal, in ruling on cross-appeals from a grant of summary judgment, reversed the district court's order denying Attorneys Liability Protection Society ("ALPS"), a risk retention group ("RRG"), reimbursement of defense costs, affirmed the district court's conclusion the underlying claims were not covered, and remanded to the district court for further proceedings.

ALPS provided malpractice insurance coverage to Ingaldson Fitzgerald, P.C. ("Ingaldson"), a law firm located in Alaska.

Ingaldson's policy with ALPS insured the firm against claims arising from "an act, error or omission in professional services that were or should have been rendered by [Ingaldson]." The policy expressly excluded from coverage any claims arising from conversion or disputes over fees. The policy also required Ingaldson to reimburse ALPS for fees and costs that ALPS incurred in defending non-covered claims.

Two former clients of the firm (one brought by a bankruptcy trustee on behalf of the bankruptcy estate of a former client) brought a claim against Ingaldson concerning Ingaldson "disbursing from and withdrawing fees and costs against a $150,000 retainer," seeking recovery of that retainer and asserting causes of action for, inter alia, restitution, disgorgement, and conversion.  

Ingaldson notified ALPS of the suit, and ALPS accepted the tender of defense under a reservation of rights, on the basis that (1) the allegations of the suit did not appear to be based on professional services within the policy's coverage, (2) the suit sought restitution, which was not within the definition of covered damages, and (3) the policy did not cover disputes over fees, dishonest or criminal acts, or conversion from client trust accounts. ALPS specifically reserved the right to reimbursement for the portion of fees incurred in defense of claims deemed not covered under the policy. Ingaldson retained independent counsel, and ALPS paid the fees charged by that counsel. The underlying bankruptcy court twice granted partial summary judgment against Ingaldson. ALPS then initiated this action, seeking a declaration that the ALPS policy did not cover the claims against Ingaldson and ALPS had no obligation to provide an appeal bond in the underlying suit. ALPS also sought to recover the expenses it incurred in defending Ingaldson.

The district court determined that the policy did not cover the claims in the underlying suit. It also concluded that ALPS had no obligation to provide an appeal bond. Nevertheless, the district court determined that ALPS was not entitled to reimbursement of the expenses it incurred defending Ingaldson in the underlying suit. The district court reasoned that while the policy provided ALPS with a right to reimbursement, the reimbursement provision did not comply with Alaska insurance law and was therefore unenforceable. Specifically, the district court concluded that the reimbursement provision was inconsistent with Alaska Statute § 21.96.100(d), which provides that in furnishing the insured with independent counsel, an insurer "shall be responsible only for the fees and costs to defend those allegations for which the insurer either reserves its position as to coverage or accepts coverage." The district court determined that "Alaska law prohibits the inclusion of a right to reimbursement in insurance policies in the state and does not allow ALPS to provide insurance policy coverage that contradicts that prohibition." The district court rejected ALPS's argument that the LRRA [the Liability Risk Retention Act of 1986] preempted Alaska Statute 21.96.100(d).

ALPS appealed. It argued that the district court erred for three reasons: (1) Alaska law does not prohibit an insurer from enforcing a contractual right to reimbursement of defense costs for noncovered claims; (2) the underlying suit was never potentially covered by the ALPS policy; and (3) an interpretation of Alaska Statute § 21.96.100 that prohibited an insurer from including a reimbursement provision in an insurance policy would be preempted by the LRRA.

Ingaldson cross-appealed the district court's ruling that the ALPS policy did not cover the claims against Ingaldson in the underlying suit. Ingaldson argued that ALPS is estopped from denying coverage under Alaska law because it did not attend settlement sessions and therefore breached the covenant of good faith and fair dealing.

The Ninth Circuit certified two questions to the Alaska Supreme Court concerning interpretation of Alaska law:

1.   Does Alaska law prohibit enforcement of a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending claims under a reservation of rights, where (1) the insurer explicitly reserved the right to seek such reimbursement in its offer to tender a defense provided by independent counsel, (2) the insured accepted the defense subject to the reservation of rights, and (3) the claims are later determined to be excluded from coverage under the policy?

2.   If the answer to Question 1 is "Yes," does Alaska law prohibit enforcement of a policy provision entitling an insurer to reimbursement of fees and costs incurred by the insurer defending claims under a reservation of rights, where (1) the insurer explicitly reserved the right to seek such reimbursement in its offer to tender a defense provided by independent counsel, (2) the insured accepted the defense subject to the reservation of rights, and (3) it is later determined that the duty to defend never arose under the policy because there was no possibility of coverage?

The Alaska Supreme Court answered "yes" to each question, undermining the first and second bases for ALPS's appeal. Attorneys Liab. Prot. Soc'y, Inc. v. Ingaldson Fitzgerald, P.C., 370 P.3d 1101, 1112 (Alaska 2016).

The Ninth Circuit addressed ALPS's third argument (preemption) and Ingaldson's cross-appeal.

The Court noted that Montana, ALPS's chartering state, permits an insurer to seek reimbursement of fees expended defending non-covered claims, while Alaska Statute § 21.96.100(d) does not. The Court then "must decide whether the LRRA preempts Alaska's prohibition."

When considering whether the LRRA preempts a state law, we first determine whether the challenged aspect of the state law offends the LRRA's broad preemption language. [Citation.] If so, we consider whether one of the LRRA's exceptions, which are contained in §§ 3902(a)(1) and 3905, applies to save the state law. [Citation.] If no exception applies, the law is preempted.

We conclude that § 21.96.100(d)'s prohibition on reimbursement of fees and costs incurred by an insurer defending a non-covered claim offends the LRRA's broad preemption language and that no exception applies to save the law.

The LRRA leaves regulation of an RRG to the state where the RRG is chartered, and broadly preempts "any [non-chartering] State law, rule, regulation, or order to the extent that such law, rule, regulation, or order would . . . make unlawful, or regulate, directly or indirectly, the operation of a risk retention group." 15 U.S.C. § 3902(a)(1).

Section 21.96.100(d) places a restriction on Alaska contracts that is "not contemplated by the LRRA, and that is not [precluded] by all other states." [Citation.] Although ALPS is permitted by its chartering state, Montana, to require reimbursement of fees and costs incurred defending non-covered claims, ALPS would not be permitted to include such a provision in a contract issued in Alaska. Section 21.96.100(d) therefore "regulates" ALPS's operations in Alaska and impermissibly conflicts with the LRRA.

There is no exception that applies to save § 21.96.100(d) from preemption. The exceptions announced in § 3902(a)(1) concern unfair claim settlement laws, false practices laws, taxes levied against other insurers, registration requirements, and financial stability regulations. None of these permits the regulation of the substantive terms of policies issued by an RRG. The only substantive policy term a non-chartering state may require is a notice to the insured that RRGs are not subject to all of the insurance laws of the non-chartering state. [Citation.]

The Court disagreed with the district court's conclusion that Section 3905(c) saves the Alaska statute from preemption. Section 3905(c) states: "The terms of any insurance policy provided by a risk retention group or purchased by a purchasing group shall not provide or be construed to provide insurance policy coverage prohibited generally by [the] State . . . whose law applies to such policy." The Court determined that, following the district court's interpretation, "non-chartering states could fashion their insurance laws in a way to ensure they fall into this exception, thereby always avoiding preemption. We do not believe Congress intended such a result."

The Court rejected Ingaldson's argument on cross-appeal that ALPS is estopped from denying coverage "because ALPS failed to attend settlement conferences," thereby breaching the implied covenant of good faith and fair dealing. The Court found there was "no indication that Ingaldson was prejudiced by ALPS's failure to attend settlement sessions," a necessary element for a finding of estoppel. The Court noted: "ALPS informed Ingaldson from the outset that it intended to assert coverage defenses, provided independent counsel to Ingaldson, and acted consistently with its view that coverage did not exist."

The Court reversed the district court's order precluding ALPS from recovering defense fees and costs, affirmed the district court's holding the claims were not covered, and remanded for further proceedings. 

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