Washington Federal Court Find Insurer Cannot Refuse to Cover Defense Costs Without Showing of “Actual Prejudice”

Quarterly Newsletter Winter 2019

Washington, like many states, requires an insurer to show that its rights have been prejudiced before it can refuse to cover costs incurred by the insured without the insurer’s consent.  Defining prejudice under the circumstances is an often debated (and litigated) topic.

Recently, a Washington federal judge weighed in on this issue when he held that an insurer may be liable for costs incurred by Costco in post-settlement arbitrations related to a gender bias class action.  One of the insurer’s main arguments in seeking to avoid paying an undisclosed amount of the retailer’s $15 million-plus in arbitration costs is that Costco flouted the terms of its policy by failing to obtain the insurer’s written consent before incurring the expenses in question.

The underlying litigation dates back to 2004, when Costco employees first filed suit in California federal court alleging that Costco discriminates against female warehouse employees by using a uniform, corporate-directed system that fails to promote equally qualified or better-qualified women into the positions of assistant general manager and general manager instead of men.  After a decade of litigation, a settlement was approved in 2014.  At the time of the alleged wrongdoing, Costco held an insurance “tower” consisting of $15M in primary coverage, $15M in excess coverage, and a second $10M excess coverage layer.  After the primary and first excess carrier paid their limits toward Costco’s defense and other costs, Costco notified the second level excess carrier that its excess coverage would be implicated.  The present lawsuit arose when the second level excess carrier declined to pay any of the settlement sum or other costs.

In his ruling, U.S. District Court Judge Robert S. Lasnik said Costco’s failure to secure the insurer’s written consent does not extinguish the insurance company’s duty to cover arbitration expenses because it must show that it suffered “actual prejudice,” which the court generally defined as a deprivation of its ability to protect its own interests.  The Court noted that the insurer was told about the arbitrations more than a year in advance and “had an opportunity to take corrective action, and it was free to pay or not pay invoices submitted to it as it saw fit.”  Judge Lasnik noted that the insurer “has not identified any particular expenditure for which it would have refused its consent, instead opting to pay the invoices as they were submitted under a reservation of rights.”

It was not all bad news for the insurer, however, as Judge Lasnik allowed the insurer to challenge the reasonableness of the costs.  The Court found some merit in the insurer’s argument that it may be unreasonable for Costco to shell out in excess of $15M in the arbitration proceedings to distribute $8M in settlement proceeds, though noted that an argument based solely on “overpayment” by the underlying insurers “is not a valid defense to Costco’s request for payment.”  On a somewhat related issue, Judge Lasnik found that the policy excludes coverage for any sums Costco paid to implement “programmatic relief,” such as the retailer’s costs to hire a consultant to develop changes to Costco’s internal practices.  Finally, the Court refused to rule on the bad faith claims because there is insufficient information in the record.

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