A Breaching Insurer May Recover Unreasonable Fees Directly From Independent Counsel, Says California Supreme Court

Matthew C. Lovell and Seth J. Manfredi

August 27, 2015

The California Supreme Court has ruled in Hartford Casualty Insurance Company v. J.R. Marketing, L.L.C., 190 Cal. Rptr. 3d 599 (Cal. 2015), that an insurer that pays its insured’s defense fees, in compliance with a court order that reserved the insurer’s right to recover unreasonable amounts billed by counsel -- has a right to seek reimbursement directly from independent counsel.  According to the court, independent counsel had “provide[d] no convincing reason why they should be absolutely immune from liability for enriching themselves” by collecting fees for unreasonable and unnecessary services.  The court emphasized that its holding was narrow, and expressly left several questions unanswered.

Background

Several general propositions of California insurance law form the background for the court’s decision.  An insurer with a duty to defend has an obligation to pay “reasonable and necessary” defense costs.  Aerojet-General Corp. v. Transport Indem. Co. 17 Cal.4th 38, 60 (1997).  Where there is a conflict of interest between insurer and insured because of the nature of the rights the insurer reserves, the insured has the right to select its own counsel, pursuant to California Civil Code section 2860.  Under Section 2860, disputes about independent counsel’s rates and fees must be arbitrated.  Under California law, an insurer has the right to later seek reimbursement for amounts that were not potentially covered by the policy.  Buss v. Superior Ct., 16 Cal.4th 35 (1997).

The Case

In J.R. Marketing, the insurer (Hartford) initially refused to defend its insureds against various lawsuits.  The insureds sued Hartford, which agreed to defend, but refused to pay for independent counsel.  The trial court granted the insureds summary judgment, ruling Hartford was required to defend and pay for independent counsel (Squire Sanders, now known as Squire Patton Boggs).  The trial court entered a subsequent order (drafted by Squire and approved by the court) (“the Order”) enforcing Hartford’s duty to defend, ordering Hartford to pay all outstanding attorneys’ fees, and prohibiting Hartford from relying on the rate provisions of Section 2860(c) because Hartford initially breached the duty to defend.  However, the Order also expressly reserved Hartford’s right to seek reimbursement of unreasonable and unnecessary legal charges after the underlying lawsuits had concluded.

After the underlying actions resolved, Hartford filed a cross-complaint against the insureds and Squire, alleging Squire had “padded” its bills.  Squire filed a demurrer, which the trial court sustained and the Court of Appeal affirmed, holding Hartford did not have a right to directly sue independent counsel for reimbursement of unreasonable fees.

The Supreme Court’s Holding

The California Supreme Court reversed, holding that when an insurer is ordered to pay all fees billed by independent counsel with only a post-litigation right to challenge unreasonable billings, and the Order does not specify against whom reimbursement can be sought, the insurer has a right to seek reimbursement directly from independent counsel.

The court rejected Squire’s contention that it was immune to restitution claims because it was merely the incidental beneficiary of Hartford’s duty to defend its insureds.  The court reasoned that Hartford only had an obligation to pay reasonable defense costs, and was seeking reimbursement for unreasonable defense costs.  Further, Squire submitted bills to Hartford and obtained payment subject to the express provision in the Order that such bills must be reasonable, and that Hartford could later obtain reimbursement for unreasonable charges.

The court also rejected Squire’s argument that a dispute over fees affects independent counsel’s judgment and loyalties, frustrating public policy.  In doing so, the court noted that attorneys represent their clients in numerous settings where they have to later justify their fees to third parties (e.g., class-action settlements).  Moreover, arbitration under Section 2860(c) specifically addresses disputes about independent counsel’s fees and provides for resolution of those disputes.  Further, the court dismissed Squire’s argument that any financial responsibility for the allegedly excessive billing should fall first on the insureds.  The court noted that the insureds paid to receive a defense of potentially covered claims, not face additional rounds of litigation and possible monetary exposure for the conduct of their lawyers.

The court’s holding was expressly limited to the unique procedural history of the case, including that the insurer had breached its duty to defend.  In addition, the court specifically declined to address the related issues of: (1) whether, absent the Order’s express provision authorizing Hartford to seek reimbursement for excessive fees, an insurer that breaches its defense obligations has any right to recover excessive fees it paid independent counsel; (2) whether a dispute over allegedly excessive fees is more appropriately decided through a court action or Section 2860 arbitration; and (3) when fee disputes ought to be decided relative to the underlying litigation.

If you would like to discuss the practical effects of the California Supreme Court’s opinion, please contact the lawyers at Nicolaides Fink Thorpe Michaelides Sullivan LLP.

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