This is Part 2 in our series analyzing newer endorsements to commercial general liability, aka “CGL,” policies, both of which may create serious roadblocks to coverage for Washington policyholders. In this post, we analyze a “defense costs” endorsement that can force policyholders to reimburse insurers for defense costs.
Click here to read Part 1, which unpacks how the “Washington—Limited Coverage for Bodily Injury, Property Damage or Personal and Advertising Injury Involving Efficient Proximate Cause (Defense Within Limits)” endorsement can reduce your limits to almost nothing based on an obscure legal rule called “efficient proximate cause.”
The “Defense Costs” Endorsement Can Require You to Repay Your Insurer for “Uncovered” Defense Costs
The “Washington Changes—Defense Costs” endorsement has been appearing in CGL policies more regularly and has the potential to eviscerate a critical policy benefit: an insurer-provided defense against a lawsuit.
One of the key benefits of a CGL policy is that the insurer will hire a lawyer to defend the policyholder in litigation involving bodily injury or property damage. A 2011 decision, Nat’l Sur. Corp. v. Immunex Corp., held that under the standard CGL policy, insurers are not entitled to recoup defense costs from the policyholder if a court later determines that the policy did not provide coverage for the underlying claims.
In Nat’l Sur. Corp. v. Immunex Corp., the Washington Court of Appeals concluded that an insurer is not entitled to repayment of defense costs that it expends on behalf of its insured under a CGL policy if the claims turn out to not be covered by the policy. 162 Wn. App. 762, 777–78, 256 P.3d 439, 447 (2011), aff’d, 176 Wn.2d 872, 297 P.3d 688 (2013). Rejecting the insurer’s “fairness” arguments, the Court held that an insurer’s “reservation of rights”—when an insurer provides a defense without agreeing that the claims are covered—“will never allow an insurer to seek retroactive reimbursement for attorney fees and defense costs already incurred by the insurer.” Id. That means that if your insurer is defending you against a lawsuit on a reservation of rights and it is eventually determined that the claims in the lawsuit are not within the policy’s coverage, you do not have to “pay back” the insurer. According to the Immunex court, allowing for such recoupment would impermissibly “modify the language of the policy.” Id. The court left open the possibility that an insurer and policyholder could contract for this kind of reduction in coverage under the terms of the policy.
The insurers accepted the Court’s invitation and crafted the “Washington—Defense Costs” endorsement. The endorsement provides that if the insurer initially defends or pays for an insured’s defense costs, but later “determines that none of the claims” are covered for which it provided a defense, the insurer has the “right to reimbursement” for the costs incurred. This right to reimbursement applies only to costs incurred after the insurer has given written notice to the insured “that there may not be coverage and that we are reserving our rights to terminate the defense” and to seek reimbursement.
At first read, this may seem workable. However, this endorsement will capture almost all insurer-provided defense costs. That is because when an insurer accepts a defense, one of the first things it will do is send a “reservation of rights” letter to the policyholder, which usually asserts that if a claim is ultimately not covered, the insurer may terminate its defense at any time, and may recoup its defense costs for such uncovered claims.
In 2019, a federal judge in the Western District of Washington upheld the application of the Defense Cost endorsement, allowing the insurer to seek reimbursement for defense costs and finding that the policy language was clear and enforceable. Massachusetts Bay Ins. Co. v. Walflor Indus., Inc., 383 F. Supp. 3d 1148, 1169 (W.D. Wash. 2019). While the insured did not dispute the policy language’s clarity, it argued that the Defense Costs endorsement violated public policy and contravened the intent of Immunex. Id. The Court rejected these arguments, finding that the Immunex court intended to “cabin its holding” to policies that don’t “expressly provide for defense cost reimbursement.” Id. at 1168. The Court also denied the insured’s request to ask the Supreme Court of Washington to weigh in on the questions of public policy.
As of now, the Defense Costs endorsement remains untested in Washington state courts—which are the ultimate arbiters of Washington public policy and insurance interpretation (federal courts must follow Washington state court decisions).
Our insurance coverage group is seeing the Defense Costs endorsement attached to policies with increasing regularity. Policyholders should be aware of its existence and expect an early coverage battle when their CGL policies contain it. There are many questions about how the endorsement will work in practice, including whether it will incentivize insurers to wait to seek judicial declarations of no coverage, potentially damaging policyholders with giant “surprise” defense costs bills on top of an uncovered judgment or settlement. Or will policyholders push back by themselves seeking an earlier adjudication of coverage? One thing is for certain: the insurance industry’s adoption of this endorsement will increase the adversarial nature of the relationship between insureds and insurers when it comes to defense of litigation, which is unfortunate but, perhaps, not unexpected.