Insurance recovery: Silver lining to costly litigation?

When hard-fought litigation finally concludes, defendants are usually only too pleased to see it in the rear view mirror, and in today's climate of escalating legal fees, are frequently a great deal poorer for the experience. However, there may be a silver lining if (1) the defendant tendered the defense of the litigation to its liability insurer, (2) received a reply from the insurer denying it owed a duty to defend, and (3) the denial was wrongful.

Statute of Limitations and the Duty to Defend

A primary motivator in buying liability insurance is the promise made by the insurer to pay the insured's litigation fees in the event the insured is sued. See Haskel Inc. v. Superior Court, 33 Cal. App. 4th 963, 979 n. 14 (1995) ("An insured obtains liability insurance in substantial part in order to be protected against the trauma and financial hardship of litigation.").

Recognizing the importance of the duty to defend, as well as its continuing nature, the California Supreme Court has held that the time limit for challenging the denial of a duty to defend should be subject to a tolling rule. Lambert v. Commonwealth Land Title Ins. Co., 53 Cal. 3d 1072, 1080 (1991). Specifically, the Supreme Court in Lambert held that even though the action against the insurer accrues upon the refusal to defend, the limitation period is tolled until resolution of the underlying action.

The limitation period for breach of the duty to defend is four years. See CCP Section 337. Application of Lambert's tolling rule means, therefore, that the four-year period does not start running until the lawsuit that was tendered and denied has concluded. This is a generous statute of limitations that enables insured defendants to avoid fighting a two-front war. Upon receipt of a denial of their defense tender, they have the option to wait until the underlying litigation has concluded before challenging their insurer's denial.

This tolling rule has also been applied to a claim that the insurer's denial also breached its implied covenant of good faith and fair dealing. See McGranahan v. The Ins. Corp. of New York, 544 F. Supp. 2d 1052, 1063 (E.D. Cal. 2008) (finding "that the two-year statute of limitations for [the insured's] claim for bad faith and fair dealing was equitably tolled until entry of final judgment"). Such a rule would allow an insured two years from final resolution of the underlying action to file suit against the insurer for breach of the implied covenant of good faith and fair dealing. See CCP Section 339(1).

Damages for Breach of the Duty to Defend

The potential damages recoverable for breach of the duty to defend fall into three categories: (1) defense fees and costs incurred, (2) tort (or "bad faith") damages, and (3) punitive damages. The insured may also be able to recover from its insurer the amount of any settlement it reached or judgment it paid.

Defense Fees and Costs

Where an insurer breaches its duty to defend, "the proper measure of damages is the reasonable attorneys' fees and costs incurred by the insured in defense of the claim." Marie Y. v. General Star Indem. Co., 110 Cal. App. 4th 928, 960-61 (2003). Having disclaimed a defense obligation, the insurer forfeits any right to second-guess the rates the insured paid to its counsel, or to allocate the fees between covered and uncovered claims. See Arenson v. National Auto. & Cas. Ins. Co., 48 Cal. 2d 528, 539 (1957) ("Having defaulted such agreement [to defend] the company is manifestly bound to reimburse its insured for the full amount of any obligation reasonably incurred by him."); Thane International, Inc. v. Hartford Fire Ins. Co., 2009 U.S. Dist. LEXIS 13696, *16 (C.D. Cal. Feb. 19, 2009) ("[The insurer's] argument that its duty to defend should be apportioned with its insured ... is contrary to California law.").

In addition to the fees and costs that the insured incurred, it may also be able to recover prejudgment interest on said sums calculated at a rate of 10 percent simple interest per year from the date of each invoice from its counsel. See Civ. Code Section 3289(b); see also Copart Inc. v. The Travelers Indemnity Co. of Illinois, 1999 U.S. Dist. LEXIS 16876, *8 (N.D. Cal. Oct. 22, 1999) (holding that insured was entitled to prejudgment interest on the expenses it incurred in defending a copyright action from the date it incurred its obligations, i.e., the billing dates).

Tort ("Bad Faith") Damages

California's courts have held that an insurer's "unreasonable" refusal to defend may be the basis for bad faith liability. See Campbell v. Superior Court (Farmers Ins. Co.), 44 Cal. App. 4th 1308, 1319 (1996). If bad faith can be proven, then in addition to its defense fees and costs, an insured is entitled to recover any "tort" damages it has suffered as a consequence of the insurer's breach. See Civ. Code Section 3333. Such damages may include what are commonly referred to as "Brandt fees," i.e., attorney fees the insured reasonably incurs in suing the insurer and compelling it to pay the benefits due under its insurance policy. See Brandt v. Superior Court, 37 Cal. 3d 813, 817 (1985).

Punitive Damages

If it can be proven by clear and convincing evidence that the insurer, in denying a duty to defend, acted with oppression, fraud or malice, the insured may also be entitled to an award of punitive damages. See Civ. Code Section 3294(a); Tibbs v. Great American Ins. Co., 755 F.2d 1370, 1375 (9th Cir. 1985) ("[T]here is sufficient evidence to support a finding that Great American refused to defend Tibbs in bad faith and is guilty of oppression, fraud, or malice.").

All too frequently denial letters from insurers are simply filed away and forgotten. When the underlying litigation has concluded, however, it is worth asking the question: What if the insurer got it wrong? If so, there is still time to challenge the denial and, if successful, to recover the fees and costs incurred in the litigation, together with prejudgment interest and other damages if appropriate.