Policyholder’s Litigation Costs Are Recoverable in Defending Against Excess Insurer’s Declaratory Relief Coverage Action

October 14, 2010

On October 1, a New York appellate court held in RLI Ins. Co. v. Smiedala[1] that an insured who prevailed in a declaratory relief coverage action brought by its excess insurer could recover its attorney's fees in the litigation, even though the excess insurer's coverage obligations with respect to underlying litigation had not yet been triggered. The opinion, of interest to insureds engaged in coverage disputes, is well supported by prior New York precedent that "'an insurer's responsibility to defend reaches the defense of any actions arising out of the occurrence,' and defense expenses are recoverable by the insured, including those incurred in defending against an insurer seeking to avoid coverage for a particular claim."[2] Under New York law, "an insured who prevails in an action brought by an insurance company seeking a declaratory judgment that it has no duty to defend or indemnify the insured may recover attorney's fees regardless of whether the insurer provided a defense to the insured."[3]

Under what is known as the "American Rule," which provides that each party in a lawsuit commonly pays its own attorney's fees, a prevailing party's attorney's fees are generally not recoverable unless a statute or contract provides for such recovery. However, many states carve out an exception for policyholders in insurance coverage disputes that permit a policyholder that prevails in a coverage action to recover its attorney's fees and expenses. In New York, the exception applies where the policyholder is placed in a "defensive posture" by a suit brought or counterclaims asserted by the insurer. Some states, such as Arkansas, Kansas, Maryland, Montana, South Carolina, Washington, and West Virginia, apply a broader exception to the American Rule that permits a policyholder to recover its costs when it prevails in a coverage action regardless of whether the insurer or policyholder brought the coverage action and regardless of whether the insurer was acting in "good faith." Other states, such as Minnesota, Wisconsin, and Massachusetts, apply narrower exceptions to the American Rule, permitting recovery of attorney's fees where an insurer with a defense obligation has failed to defend the policyholder in an underlying action under a reservation of rights.

At least 11 states-Arizona, Delaware, Florida, Georgia, Hawaii, Missouri, Nebraska, New Hampshire, New Jersey, North Dakota, Oregon and Texas-specifically, or as construed by case law, statutorily provide for a prevailing policyholder's recovery of its attorney's fees in coverage litigation. Finally, other states, such as California, Indiana, Iowa, Maine, Mississippi, North Carolina, Pennsylvania, Utah, Vermont, and Wisconsin, provide for the recovery of attorney's fees and litigation expenses (and other damages) where the insurance coverage litigation is a product of an insurer's breach of the covenant of good faith and fair dealing.

The Smiedala opinion is a reminder of the unique rights and remedies conferred on policyholders and responsibilities undertaken by insurers when they enter into the not-so-ordinary contractual arrangement of an insurance policy. Policyholders facing or considering coverage litigation to preserve or pursue their coverage rights should assess the potential recoverability of their litigation fees and expenses as part of their deliberation process in weighing the costs and benefits of litigation.

If you have any questions or would like further information on any of the issues discussed in this LawFlash, please contact either of the following Morgan Lewis attorneys:

Los Angeles
Michel Yves Horton

Washington, D.C.
Paul A. Zevnik

[1] 2010 NY Slip Op. 06836, 2010 WL 3817114 (Oct. 1, 2010).

[2] National Grange Mut. Ins. Co. v. T.C. Concrete Constr., Inc., 43 A.D.3d 1321, 1322 (N.Y. App. Div. 2007) (quoting Mighty Midgets v. Centennial Ins. Co., 47 N.Y.2d 12, 21 (1979)); see also Progressive Halcyon Ins. Co. v. Giacometti, 72 A.D.3d 1503, 899 N.Y.S.2d 783 (2010).

[3] U.S. Underwriters Ins. Co. v. City Club Hotel, LLC, 3 N.Y.3d 592, 598 (2004).