Washington Federal Court Enforces Endorsement Allowing Insurer to Recoup Defense Costs for Uncovered Claims

Quarterly Newsletter Winter 2019

In 2013, the Washington Supreme Court rendered a decision in Nat’l Sur. Corp. v. Immunex Corp., 297 P.3d 688, 691 (Wash. 2013) that an insurer could not seek recoupment of defense costs incurred for uncovered claims when it defended an insured under a reservation of rights.  While the Immunex decision rejected the attempt to recoup defense costs, that Court specifically noted that the policy at issue did not include a provision allowing an insurer to recoup such costs.  Thus, the Court held that the insurer could not reserve a right to recoup defense costs that was not specifically provided for in the policy.  The Immunex decision left open the issue of whether an insurer could recoup defense costs when a policy specifically provided such a right.

On an issue of first impression, a Washington federal judge recently ruled that an insurer can recoup defense costs when the policy contains an endorsement that provides such a right.  In Massachusetts Bay Ins. Co. v. Walflor Industries, Inc., 2019 WL 1651659 (W.D. Wash, April 17, 2019), Judge James Robart held that an insurer is entitled to reimbursement of the monies it has already paid to defend the insureds in the underlying lawsuit because the policy provided such a right and because the claims against the insureds in the underlying lawsuit were not covered under the policy.

The underlying lawsuit arose out of a business dispute from an alleged breach of a distributorship agreement by selling trade-name-marked products to multiple parties in the United States and Canada resulting in millions of dollars of lost profit.  In addition to breach of contract, the alleged claims in the underlying lawsuit included tortious interference with a business expectancy, trade name infringement, and a violation of Washington’s Consumer Protection Act.  The claim for trade name infringement was later replaced with a trademark violation claim, and a claim of alter ego or piercing the corporate veil was added.  The insurer defended the underlying lawsuit under a reservation of rights because the allegations in the complaint did not fall within the policy’s coverage for damages for “bodily injury,” “property damage,” or “personal or advertising injury.”  The reservation of rights letter specifically informed the insureds that the insurer was reserving the right “to seek reimbursement of any defense costs paid if it is later determined that none of the claims or damages sought are covered under the policies,” and quoted from the policies’ “WASHINGTON CHANGES – DEFENSE COSTS” endorsement, which provided that:

“If we initially defend an insured or pay for an insured’s defense but later determine that none of the claims, for which we provided a defense or defense costs, are covered under this insurance, we have the right to reimbursement for the defense costs we have incurred.  The right to reimbursement under this provision will only apply to the costs we have incurred after we notify you in writing that there may not be coverage and that we are reserving our rights to terminate the defense or payment of defense costs and to seek reimbursement for defense costs.”

The insurer filed a separate declaratory judgment action, and the parties cross-moved for summary judgment, which led to the current ruling.

The Court initially found that claims in the underlying lawsuit were not covered because they did not constitute “personal and advertising injury” under the policy.  In a lengthy discussion, the Court found that allegations of product disparagement, use of another’s advertising idea, and infringing upon another’s trade dress or slogan were not covered.  The Court then addressed the issue of whether the insurer could seek reimbursement of the costs paid to defend the insureds.

The Court first declined to certify this issue to the Washington Supreme Court because the Court found sufficient guidance in prior decisions to resolve this issue. The Court then noted that the insureds did not take issue with the intended effect of the endorsement or assert that the endorsement is ambiguous, nor did they dispute that the insurer failed to notify them in its reservation of rights letters of its intent to rely on the endorsement to recoup its defense costs.  The Court noted how Immunex differed from the current case because of the inclusion of the reimbursement of costs endorsement in the policy at issue in the present case, as well as its specific reservation of this right in its reservation of rights letter.  The Court noted that the insurer in Immunex attempted to reserve its right to recoup its defense costs in the event a court determined that it did not owe a duty to defend, but the policy at issue did not contain any language allowing such recoupment.

The Court rejected the insured’s argument that the Immunex ruling still applies where the policy contains explicit language reserving the right to recover defense costs if a court ultimately determines that no such duty exists. The Court also rejected the insureds reliance on Attorneys Liability Protection Society, Inc. v. Ingaldson Fitzgerald, PC, 370 P.3d 1101, 1112 (Alaska 2016), to argue that the defense costs reimbursement endorsement is against public policy because Alaska, unlike Washington, enacted an independent counsel statute that precludes the enforcement of language in a professional liability policy granting the insurer the right to recoup defense costs.  The Court found that “[n]othing in the endorsement at issue here interferes with an insurer’s obligations to comply with [Washington common law’s] ‘specific criteria’ while defending under a reservation of rights” and that Washington common law “does not prohibit an insurer from including such a provision in a business owners policy.”  Thus, the Court found no recognized public policy grounds for invalidating the endorsement.

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