New Jersey Supreme Court Addresses Inter-Insurer Contribution Rights

In a case of first impression, the Supreme Court of New Jersey, in its recent decision in Potomac Ins. Co. of Illinois v. Pennsylvania Manufacturer’s Association Ins. Co., 2013 N.J. LEXIS 847(N.J. Sept. 16, 2013), had occasion to consider the novel issue of whether an “insurer with an obligation to indemnify and defend an insured has a direct claim for contribution against its co-insurer for defense costs arising from continuous property damage litigation.”

The Potomacdecision arose out of an underlying construction defect case brought against Roland Aristone, Inc. (“Aristone”).  Aristone had been hired in 1991 by the Township of Evesham to serve as the general contractor with respect to the construction of a new middle school.  In December 2001, Evasham brought suit against Aristone for alleged construction defects, primarily relating to the school’s roof.  Aristone was insured by five different primary layer general liability insurers during the relevant ten year triggered period: Pennsylvania Manufacturers’ Insurance Company (“PMA”) for two years, Newark Insurance Company (“Newark”) for one year, Royal Insurance Company (“Royal”) for one year, OneBeacon Insurance Company (“OneBeacon”) for one year and Selective Way Insurance Company (“Selective”) for five years.  Selective and OneBeacon agreed from the outset to provide Aristone with a defense in the underlying lawsuit, whereas PMA and Royal/Newark (apparently related companies) denied coverage, thereby prompting Aristone to file suit against those insurers.  PMA eventually settled with Aristone for $150,000 to be used toward Aristone’s settlement of the underlying suit.  In return, Aristone agreed to release PMA from all claims associated with the underlying action.  Days later, the underlying suit was settled for $700,000, with OneBeacon paying $150,000, Selective paying $260,000 and Royal paying $140,000.

Unresolved by the settlement with Evesham was allocation of defense costs.  OneBeacon and Selective paid a combined $528,868 in legal fees and expenses in defending Aristone through resolution of the case.  OneBeacon subsequently demanded that PMA and Royal contribute their proper share of defense costs.  Specifically, OneBeacon argued that under New Jersey law regarding allocation of defense costs for matters involving a continuous trigger, as set forth in cases such as Owens-Illinois Inc. v. United Insurance Co.,138 N.J. 437 (1994), and Carter-Wallace, Inc. v. Admiral Insurance Co., 154 N.J. 312 (1998), the proper allocation of costs, based on the number of years that each insurer was on the risk, was that 50% of total defense costs should be allocated to Selective, 10% should be allocated to OneBeacon, 20% should be allocated to PMA and the remaining 20% should be allocated to Royal/Newark.  While Royal/Newark ultimately settled with OneBeacon, PMA rejected OneBeacon’s demand, arguing among other things, that its release with Aristone precluded OneBeacon’s right to contribution for defense costs.  The matter later was the subject of a three day bench trial that eventually concluded in OneBeacon’s favor.  The trial court agreed that PMA’s settlement with Aristone did not preclude OneBeacon’s contribution claim for defense costs, and thus assigned PMA an allocated share of costs consistent with the approach outlined in Carter-Wallace.  On appeal, the New Jersey Appellate Division acknowledged the lack of New Jersey case law addressing OneBeacon’s right to recover defense costs from PMA.  The court nevertheless relied on California case law, in particular the decision in Fireman's Fund Insurance Co. v. Maryland Casualty Co., 77 Cal. Rptr. 2d 296 (Ct. App. 1998), for the proposition that a coinsurer has a direct right of action against another for defense costs arising out of the same risk. 

On appeal to the Supreme Court of New Jersey, PMA argued that the Appellate Division created a novel cause of action by permitting an insurance company that had already settled with its insured to be sued for a share of defense costs by a co-insurer.  OneBeacon, on the other hand, argued that the decision by the Appellate Division was consistent with decades of New Jersey case law concerning allocation of costs in matters involving a continuous trigger. 

In considering the issue, which it acknowledged was novel, the Supreme Court revisited its decision in Owens-Illinois wherein it adopted a continuous trigger theory for cases involving progressive or individual injury, and wherein it established a pro rata methodology for allocating loss among multiple insurers during the triggered period based on policy limits and years on the risk.  The court noted that its decision in Owens-Illinois “envisioned the litigation of direct claims between co-insurers to ensure that the policyholder's losses would be equitably allocated among its carriers.”  While Owens-Illinoisand its progeny concerned allocation of indemnity amounts among insurers and their respective insured, the court reasoned that it should also apply in the context of claims for reimbursement of defense costs:

We concur with the Appellate Division that recognizing an insurer's cause of action for contribution against a co-insurer for allocation of defense costs comports with Owens-Illinois and its progeny. Although the Court in Owens-Illinois considered an issue not raised by this case -- co-insurers' obligations to indemnify their common insured -- it envisioned a judicial determination of "the portion allocable [to each carrier] for defense and indemnity costs." …  The Court recognized in Owens-Illinois that the insurer's obligation to indemnify the policyholder may engender contribution claims between insurers that share the same insured, independent of any right of subrogation to the claims of the insured. …  Like the obligation to indemnify the insured addressed in Owens-Illinoisand Carter-Wallace, the obligation of successive insurers to pay the policyholder's defense costs can be readily determined by equitable allocation. Absent a right of contribution, a carrier that pays defense costs as they are incurred might alone bear a burden that should be shared. An inequitable allocation of the cost of defense, like an unfair allocation of the obligation to indemnify, may justify a judicial remedy.

The court found several justifications for its holding.  Allowing such a contribution claim, explained the court, fosters a “strong incentive for prompt and proactive involvement of all responsible carriers.”  The court also reasoned that the right to contribution may promote early settlement and create an incentive for insureds to purchase sufficient coverage in every year.  Perhaps just as important to the court is that permitting a contribution claim under the circumstances “serves the principle of fairness recognized in Owens-Illinois.”  In this connection, the court noted that:

… an insurer that refuses to share the burden of a policyholder's defense is rewarded for its recalcitrance, at its co-insurer's expense, unless the insurer who pays more than its share of the costs has an effective remedy. Recognition of an insurer's contribution claim against its co-insurer serves "the demands of simple justice." … In short, an insurer's direct claim for allocation, asserted by an insurer that pays a disproportionate amount of the defense costs against other insurers of the same policyholder, promotes the principles underlying this Court's decisions in Owens-Illinois and Carter-Wallace.

Connecticut Federal Court Split On Recoupment of Defense Costs

In Nationwide Mutual Ins. Co. v. Mortensen, 2011 U.S. Dist. LEXIS 77356 (D. Conn.  July 18, 2011), the United States District Court for the District of Connecticut affirmed its earlier decision that an insurer was not entitled to recoupment of defense costs despite receiving an adjudication that it had no duty to defend.  Nearly one month later, in its recent decision in Scottsdale Ins. Co. v. R.I. Pools, Inc., 2011 U.S. Dist. LEXIS 90380 (D. Conn. Aug. 15, 2011), a different judge from the same federal district court ruled that an insurer is entitled to reimbursement of defense costs under such circumstances.

In both matters, the insurers cited primarily to the 2003 decision by the Connecticut Supreme Court in Security Ins. Co. of Hartford v. Lumbermans Mutual Casualty Co., 826 A.2d 107 (Conn. 2003), in which the court stated that it is proper to “order reimbursement for the cost of defending the uncovered claims in order to prevent the insured from receiving a windfall.”  Lumbermans involved an insured’s asbestos liabilities over a seventeen-year period, several years of which it was uninsured.  The Connecticut Supreme Court held that in light of Connecticut’s pro rata methodology for allocating defense costs, the insured should be required to pay its prorated share of the defense for uninsured periods.

The federal judge in Mortensen limited Lumbermans to its facts, reasoning that recoupment of defense costs was proper in that case since there was no potential for coverage in the uninsured periods.  The Mortensen court distinguished the facts in Lumbermans from those before it, where “there was at least a potential that the defendants’ claims [for breach of contract and trademark infringement] would be covered.”  (Emphasis in original.)   Given this potential for coverage, explained the court, “Nationwide had a temporary duty to defend until a determination on coverage was made,” and as such, it would be improper for Nationwide to recoup its defense costs incurred during this period.  The court further held that absent a policy provision to the contrary, or an explicit assent by the insured, an insurer would never be entitled to recoupment under such circumstances.

By contrast, in the more recent decision in R.I. Pools, a different judge from the same court held that the insurer was entitled to recoupment of defense costs following an adjudication of non-coverage.  Looking to the general liability policy’s supplementary payments provision, the judge concluded that the insurer is entitled to reimbursement of all defense costs associated with defending suits deemed not covered, although it would not be entitled to reimbursement of costs associated with investigating or settling any such suits.  Of note, the judge in R.I. Pools cited only to the Lumbermans decision in support of its holding, and did not address the court’s earlier decision in Mortensen.  Moreover, the judge did not discuss whether the policy must have a recoupment provision or whether the insured must assent to the possibility of recoupment of defense costs.

The contrasting decisions in Mortensen and R.I. Pools makes it very likely this issue will continue to be litigated in Connecticut, at least at the federal level.

Washington Court Holds Insurer Not Entitled to Reimbursement of Defense Costs

The Court of Appeals for the State of Washington, in its recent decision National Surety Corp. v. Immunex Corporation, 2011 Wash. App. LEXIS 1695 (Wash. App. July 25, 2011), had occasion to consider whether an insurer is entitled to recoupment of defense costs incurred prior to receiving a judgment declaring that it owed no duty to defend.

National Surety insured Immunex under an umbrella and excess liability policy.  Immunex was named as a defendant in a number of suits alleging that it participated in a conspiracy with other prescription drug manufacturers to artificially inflate the average wholesale price of its products.  While the first of the suits was filed in 2001, Immunex did not provide first notice of the suits to National Surety until 2006.  National Surety initially denied coverage based on late notice, but later agreed to provide a defense under a reservation of rights and to seek a declaratory judgment.  Among other things, National Surety reserved its right to recoup defense costs paid in the event it was determined that National Surety had no duty to defend.

Both the trial court and the appellate court agreed that the underlying suits filed against the insured, alleging price discrimination arising out of the insured’s alleged participation in the fraudulent pricing scheme, did not constitute “personal and advertising injury” under the policy, which included the offense of “discrimination.”  While the term “discrimination” was not defined by National Surety’s policy, the appellate court agreed that the underlying suits “originate[d] not from discriminatory actions but from fraudulently inflating” the price of its products.  Although this conduct “might have impacted some consumers more than others, that does not mean the offenses originated from discrimination.”  Thus, the court agreed that National Surety did not have a duty to defend the underlying suits.

While the court held that National Surety had no duty to defend, it disagreed that National Surety was entitled to recoupment of defense costs it had already incurred. The court acknowledged that lack of Washington case law on the issue, but found guidance from the line of cases holding that an insurer has a duty to defend whenever a complaint alleges a potentially covered claim.  While it was ultimately determined that National Surety had no duty to defend, there was no certainty of that outcome until the trial court ruled in National Surety’s favor.  Accordingly, National Surety had a duty to defend from the time the underlying complaint was filed through the time it received summary judgment in the coverage litigation, and as such, it was proper for National Surety to pay defense costs during that period.

The court addressed at length an insurer’s options when it is not clear from the face of the pleading as to whether a defense obligation is triggered.  Under such circumstances, the insurer can deny coverage outright or provide a defense under a reservation of rights and seek a declaratory judgment.  By providing a defense under a reservation of rights, the insurer avoids the potential for having breached any subsequently determined defense obligation.  By opting for the latter, explained the court, the insured is not unjustly enriched by receiving a defense:

… National Surety had the benefit of insulating itself from a bad faith claim and possible coverage by estoppel.  Therefore, the payment of the defense costs is not purely a gratuity to the insured and no unjust enrichment occurs if National Surety covers the cost of defense until the trial court ordered otherwise.

Thus, the court held that an insurer’s reservation of rights to recoup defense costs will not be enforced absent express language in the policy allowing for such relief.

Connecticut Court Holds Insurer Not Entitled to Recoupment of Defense Costs

In Security Ins. Co. of Hartford v. Lumbermans Mutual Casualty Co., 826 A.2d 107 (Conn. 2003), the Connecticut Supreme Court held that when an insurer “defends the insured against an action that includes claims not even potentially covered by the insurance policy, a court will order reimbursement for the cost of defending the uncovered claims in order to prevent the insured from receiving a windfall.”  The United States District Court for the District of Connecticut recently had occasion to address the bounds of this rule in Nationwide Mutual Ins. Co. v. Mortensen, 2011 U.S. Dist. LEXIS 77356 (D. Conn.  July 18, 2011).

The insureds in Nationwide were former insurance agents for Nationwide and its affiliated companies.  These individuals also happened to be insured by Nationwide under Business Provider Insurance Policies.  In the underlying suits, Nationwide sued the individuals on several grounds, including breach of contract, breach of fiduciary duty, unfair trade practices and trademark infringement.  These individuals, in turn, sought coverage for the underlying suits under their Nationwide policies.  Nationwide agreed to provide a defense subject to a reservation of rights, including the right to seek recovery of defense costs associated with non-covered claims.  It subsequently filed coverage litigation action against the insureds and successfully obtained a declaratory judgment that it had no coverage obligation with respect to the underlying suits.  In a 2009 decision, however, the court held that Nationwide was not entitled to reimbursement of defense costs incurred prior to the declaratory judgment, explaining that:

It was in Nationwide's own interest to provide a defense under the reservation of rights in order to avoid exposure had the Court held it did have a duty to defend. If the Court were to now allow Nationwide to recoup defense costs, the defendants would be required to pay for the action Nationwide took to protect itself. In these circumstances, in the absence of a policy provision pointed to by Nationwide or active assent to the reservation by the defendants, the reservation of rights letters were not enough to impose a burden on the defendants to reimburse Nationwide for defense costs.  Nationwide Mut. Ins. Co. v. Mortensen, 2009 U.S. Dist. LEXIS 74870 at *18-19 (D. Conn. Aug. 24, 2009).

Nationwide subsequently moved for reconsideration, arguing that decision by the Connecticut Supreme Court in Security Ins. Co. established a general rule that an insurer could recover defense costs associated with non-covered claims.  The Nationwide court disagreed with Nationwide, explaining that Security Ins. Co. should be limited to its facts.  The Security Ins. Co. matter concerned an insured’s asbestos liabilities over a seventeen-year period, several years of which it was uninsured.  The Connecticut Supreme Court held that in light of Connecticut’s pro rata methodology for allocating defense costs, the insured should be required to pay its prorated share of the defense for uninsured periods.  As such, the insurers were entitled to reimbursement of defense costs they had already paid for these periods.  The Nationwide court reasoned that recoupment of defense costs was proper in Security Ins. Co., since there was no potential for coverage in the uninsured periods.  By contrast, explained the court, while it was determined that the underlying suits brought by Nationwide were not covered, “there was at least a potential that the defendants’ claims would be covered.”  (Emphasis in original.)   Given this potential, explained the court, “Nationwide had a temporary duty to defend until a determination on coverage was made,” and as such, it would be improper for Nationwide to recoup its defense costs incurred during this period.