Liability insurance policies, including the ubiquitous commercial general liability (CGL) policy, provide benefits in the form of both coverage for money the insured is legally obligated to pay as covered damages (the duty to indemnify) and, separately, the costs to defend litigation seeking those damages (the duty to defend). The latter of these benefits is broader than the former and is often referred to as “litigation insurance.” That is, even if the claim against the insured is arguably not covered by the policy, as long as the insurance policy conceivably covers the allegations in the underlying complaint, the duty to defend is triggered. Woo v. Fireman’s Fund Ins. Co., 164 P.3d 454, 459 (Wash. 2007). “Conceivably” is a very low threshold and one that is quite easy to reach. Capitol Specialty Ins. Corp. v. Beach Eatery & Surf Bar, LLC, 36 F. Supp. 3d 1026, 1034 (E.D. Wash. 2014).
This “litigation insurance” aspect of the CGL and other liability policies is a valuable benefit for policyholders, especially the small “mom and pop” business owner, for whom the ability to finance litigation on their own may be limited or nonexistent. But this valuable policy benefit is in jeopardy of being taken away by a new policy endorsement that gives insurance companies the right to assert a claim for reimbursement of defense costs against their policy holders. This is the defense cost reimbursement endorsement in use in Washington:
“WASHINGTON CHANGES – DEFENSE COSTS”
The following applies to any provision in this Policy, or in any endorsement attached to this Policy that sets forth a duty to defend:
If we initially defend and 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 the payment of defense costs and to seek reimbursement for defense costs.
The United States District Court for the Western District of Washington recently upheld the validity of this endorsement in a published opinion: Massachusetts Bay Insurance Company v. Walflor Industries, __ F.Supp.3d __, 2019 WL 1651659 (April 17, 2019). After the court issued its decision, the policyholder moved for reconsideration, and the court asked the Insurer to respond to the motion. But while reconsideration was underway, the parties settled the case when the insurer agreed to waive most of its reimbursement claim.
Yet the decision will likely embolden insurers to issue the reimbursement endorsement, if they haven’t already, and to act more aggressively in seeking reimbursement. Plainly, the reimbursement endorsement is an in terrorem device insurers can and will wield against their policyholders to dissuade tendering claims for defense. The Washington Supreme Court should have an opportunity to rule on the validity of the endorsement. But because most coverage litigation occurs in federal court, that ruling may prove elusive unless federal judges are willing to certify the issue to the Washington Supreme Court.
In 2013, the Washington Supreme Court held that “insurers may not seek to recoup defense costs incurred under a reservation of rights defense while the insurer’s duty to defend is uncertain.” National Surety Corp. v. Immunex Corp., 176 Wn.2d 872, 887 (2013). In response to this decision, the Insurance Services Office (“ISO”) drafted the Washington Defense Cost Endorsement Form BP 06 12 11 13, quoted above, and many insurers started issuing it. Insurers are quasi-fiduciaries and are not allowed to elevate their own interests above their insureds. Tank v. State Farm Fire & Cas. Co., 715 P.2d 1133, 1136 (Wash. 1986). But that is what the reimbursement endorsement does—it takes all the risk of the defense decision off of the insurer and places it on the insured, who is not in the business of making those decisions. Immunex, 297 P.3d at 694 (“If [the insurer] were allowed to recover defense costs, its ‘offer’ to defend would serve solely to protect itself from claims of breach while placing the full risk of a determination of noncoverage on its insured. This provides no security to the insured.”).
The Walflor court based its decision to uphold the reimbursement endorsement, despite the Supreme Court’s rejection of reimbursement in Immunex, on its view that the Immunex court intended to limit its holding to situations where the policy itself did not contain a right of reimbursement and relied on dicta from several cases cited in the Immunex opinion to support this interpretation. Those cases cited in Immunex, while all of them rejected reimbursement, contain language indicating that reimbursement could be allowed if agreed to by the insured, in the policy or otherwise. A reasonable jurist, however, could also interpret the Immunex court’s quotation of this language coupled with its decision not to so qualify its own holding as indicating a broader disapproval of reimbursement: “We hold that insurers may not seek to recoup defense costs incurred under a reservation of rights defense while the insurer’s duty to defend is uncertain.” Immunex, 297 P.3d at 695. The Immunex court was obviously aware of the language in the cases from other jurisdictions that it cited and quoted, but chose not to include similar language in its own holding.
Because insurers can unilaterally change policy terms at any time by issuing endorsements, the Immunex holding should apply with equal force to an endorsement as it does to a reservation of rights letter. Typical CGL policies gives the insurer the power to make unilateral changes to policy terms, for example: “this policy’s terms can be amended . . . by endorsement issued by us.” The insurer is free to issue amendatory endorsements at any time. Thus, under the Walflor court’s holding, any CGL insurer can now do what Immunex prohibited simply by unilaterally issuing an amendatory endorsement. Armed with the Walflor opinion, many insurers likely will now unilaterally issue the “WASHINGTON CHANGES – DEFENSE COSTS” endorsement on existing policies. As the Immunex Court foretold: “If this became common practice, the insurance industry might extract coercive arrangements from their insureds, destroying the concept of liability and litigation insurance.” Immunex, 297 P.3d at 695. (quoting Gen. Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092, 1102 (Ill. 2005)).
Whether the Washington Supreme Court would decline to apply its Immunex holding to an amendatory endorsement rather than a reservation of rights letter is a matter upon which reasonable jurists may disagree. Accordingly, any future challenge to the validity of a reimbursement endorsement should draw this comparison; a comparison the Walflor court signaled it was willing to reconsider at the time the parties settled.