The Hawaii Supreme Court emphatically rejected insurer efforts to seek reimbursement of defense costs absent a provision in the policy providing for such reimbursement in St. Paul Fire & Marine Insurance Company v. Bodell Construction Company, No. SCCQ-22-0000658, 2023 WL 7517083, (Haw. Nov. 14, 2023). The state high court’s well-reasoned decision rests on bedrock law regarding insurance policy construction and application, follows the nationwide trend of courts compelling insurers to satisfy their contractual obligations in full, and should carry great weight as other jurisdictions continue to debate the same issue.
In Bodell, the Hawaii Supreme Court joined the swelling ranks of courts recognizing that an insurer may not use a reservation of rights to create the extra-contractual “right” to recoup already paid defense costs for a claim on which the insurer ultimately owes no coverage. See, e.g., Am. & Foreign Ins. Co. v. Jerry’s Sport Ctr., Inc., 2 A.3d 526 (Pa. 2010). Other jurisdictions, such as California, will permit an insurer to seek reimbursement from a policyholder for defense costs incurred in defending claims later determined to be uncovered. See Buss v. Superior Court, 16 Cal.4th 35 (1997) (holding insurers have a right to reimbursement of defense costs incurred for noncovered claims).
The Bodell case grew out of a group of insurers’ unilateral conclusion that their reservations of rights letters to policyholder Bodell Construction Co. reserved their equitable rights to seek reimbursement of defense costs if it later turned out that the claim was not covered under their policies. St. Paul Fire & Marine Insurance Co. and other insurers sold Bodell commercial liability and excess policies. Bodell tendered defense of a lawsuit to the insurers and they agreed to defend under a reservation of rights. In their letters, the insurers sought to reserve the right to recoup defense costs paid if the claims turned out to be uncovered. The insurers took this position even though their policies contained no express reimbursement language. The insurers subsequently sued in Hawaii federal court seeking a declaration that there was no duty to defend and that they were entitled to reimbursement of the defense costs they had already incurred.
The federal court certified to the Hawaii Supreme Court the unsettled question of whether Hawaii law would allow insurers to seek reimbursement of defense costs if an insurance policy did not expressly grant that right:
Under Hawai‘i law, may an insurer seek equitable reimbursement from an insured for defense fees and costs when the applicable insurance policy contains no express provision for such reimbursement, but the insurer agrees to defend the insured subject to a reservation of rights, including reimbursement of defense fees and costs?
The Court’s opinion that the insurers may not reserve a right that the insurance contract did not grant, which can be found here, is impactful and well-reasoned, relying on bedrock principles of insurance and contract law to support its holding. The decision is relatively short and straightforward, and it is well worth the read.
The Court predicated its decision on three bases:
First, and perhaps most importantly, the Court concluded that the specific language of the policy—the contract between the policyholder and insurer—controlled, and that “[l]ike most standard insurance policies, the words called for defense. And no words called for pay back.” The Court further recognized that if the insurers wanted to make reimbursement an option, they should have provided for it in the policies. Absent such a provision, however, while an insurer may use a reservation of rights letter to reserve rights already in the insurance policy, it must “not create new ones.” The Court’s rationale here firmly rejects insurers’ attempts to pursue reimbursement for defense costs when that right is not addressed in the policy.
Second, the Court acknowledged that reimbursement of defense costs would impermissibly erode the insurers’ fundamental duty to defend. The duty to defend is broad and applies where even a single allegation in a complaint is possibly covered. It is assessed at the beginning of the lawsuit, not at the end. As the Court explained, however, permitting the insurers’ reimbursement option would render the initial investigation and defense obligation meaningless:
If insurers recover for defending uncovered claims, our law flips: the duty to defend may be determined after the insurer tenders a defense. Not only does this sequence narrow the broad duty to defend, it dilutes an insurer’s good faith duty to take on a defense; worse it may bring on bad faith.
In short, the Court held the insurers to the standard that policyholders expect when they pay for insurance, which is that the insurer has a duty to defend all possible claims. Not only claims that are ultimately deemed covered at the end of the day. To permit after-the-fact reimbursement for claims that were potentially, but not actually, covered, would put the duty to defend on par with the duty to indemnify, and require insurers only to defend claims that they ultimately indemnify. That is not how liability insurance works.
Third, the Court rejected the insurers’ argument that policyholders are unjustly enriched when insurers defend uncovered claims. As the Court correctly found, “[d]efense is part of the deal.” In reality, defense coverage is the most important part of the deal to many policyholders. They buy liability insurance as “litigation insurance” for the peace of mind of knowing that the insurer will defend any potentially covered claims. It matters to insurers, too. By taking control of the defense, the insurer protects itself as much as it does the insured by ensuring a competent and adequate defense. Moreover, if reimbursement were allowed, insurers could pay lip service to their duties to investigate claims and defend potentially covered actions in full, by fronting defense costs and then seeking complete reimbursement, while protecting itself from breach of contract or bad faith actions.
This reimbursement issue has been a hot button topic for some time and this decision from Hawaii’s highest court should add to the momentum of decisions nationwide rejecting insurers’ efforts to reserve rights for which they never contracted. Earlier this year, we wrote about an Eleventh Circuit Court of Appeals decision that predicted Georgia’s Supreme Court would adopt a “no recoupment” rule to protect its insurance system, which like many others, is predicated on a broad duty to defend and a more limited duty to indemnify.
Hunton partners Lorelie S. Masters and Andrea DeField each provided valuable insight to Law360 about the force of the Hawaii Supreme Court’s decision and how it may affect policyholders and insurance coverage litigation going forward. Lorelie S. Masters emphasized the strength of the high court’s ruling and commended the Court for recognizing that reimbursement would eviscerate the duty to defend, making it the same as the duty to indemnify, which is not what policyholders buy when they purchase a duty to defend policy.
In her comments to Law360, Andrea DeField explained she was thankful that the Court “reinforced many of the legal doctrines that policyholders across the country must often remind nondefending insurers of.” Both of these comments reflect the crucial importance that a broad duty to defend plays in insurance, and how permitting unfettered reimbursement, would erode that fundamental right.
From the policyholder’s perspective, the Hawaii Supreme Court’s opinion is right on the money—the policy’s terms control and an insurer cannot use a reservation of rights letter to create rights that did not exist in the first place.
Ideally, the states that remain undecided on the issue will look at the well-reasoned approach taken by the Hawaii Supreme Court and follow suit.