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By Daven G. Lowhurst
Thelen LLP


I.   What Is a Buss or Aerojet Crash?

While policyholders purchase liability insurance to protect them in the event of third-party claims (such as for bodily injury or property damage), it is unfortunately far too common for insurers to throw out numerous roadblocks in an effort to avoid, reduce or delay their duty to protect their policyholders. A Buss or Aerojet crash is the negative effects a policyholder experiences when its insurer agrees to defend a third-party claim, only to later seek to force the policyholder to return all or part of the defense costs.

The frequency of this tactic appears to have increased in the wake of two decisions by the California Supreme Court. In back-to-back opinions, the court allowed an insurer, which has defended its insured, to force its insured to reimburse some or all of those defense costs to the extent the defense costs were incurred solely in defending against a claim, or even a part of a claim, that was not at least potentially covered under the policy. Buss v. Superior Court, 16 Cal.4th 35 (1997); Aerojet-General Corp. v. Transport Indemnity Co., 17 Cal.4th 38 (1997).

II.   How Does a Buss or Aerojet Crash Occur?

The decisions in Buss and Aerojet illustrate two common reimbursement scenarios that policyholders must understand and anticipate. In Buss, the policyholder, Jerry Buss, owned several professional sports teams, including the Los Angeles Lakers. He was sued under 27 causes of action by a company providing advertising services. Buss' insurer, Transamerica, agreed to defend Buss based solely on a single claim for defamation, reserving its rights to obtain reimbursement of defense costs as to the other 26 non-covered claims. Transamerica paid more than $1 million to defend Buss. Buss eventually settled the lawsuit for $8.5 million.

However, Transamerica not only refused to contribute to the settlement, but it sought to force Buss to reimburse all of the more than $1 million in defense costs except for $21,000 to $56,000, which it believed was the only amount attributable to defending the defamation claim. The California Supreme Court ruled that Transamerica had the right to go after Buss to recover defense costs incurred solely in defending the 26 non-covered claims. Thus, the policyholder, Buss, was left facing a reimbursement claim of nearly the entire $1 million spent to defend the underlying lawsuit.

The policyholder in Aerojet was forced to pay for its own defense, too, albeit in a different scenario. There, the policyholder, Aerojet, asked its insurers to defend it in suits claiming ground contamination through the operation of manufacturing plants. The insurers sought a declaration that they did not owe a duty to fund Aerojet's entire defense based on the presence of deductibles or retained limits in several of Aerojet's policies. The California Supreme Court ruled that the insurers had a duty to defend all of the claims against Aerojet but later could recover defense costs from Aerojet to the extent they could prove that the defense costs were incurred solely in defending non-covered claims or parts of claims (which principally related to contamination occurring outside the policy period).

Rulings such as Buss and Aerojet likely will result in more significant disputes between insurers and policyholders on the issue of who ultimately pays for defense costs. A policyholder, happy to learn that an insurer has agreed to defend a lawsuit, may be extremely displeased to learn months or years later that the insurer is seeking to force the policyholder to reimburse some or all of the defense costs.

If the policyholder is unwilling to submit to the insurer's demand for reimbursement of defense costs, the policyholder may find itself once again the defendant in a lawsuit, this time filed by the insurer to recover those defense costs. The policyholder's displeasure no doubt would be magnified when the insurer is demanding reimbursement of defense costs for legal services provided by defense counsel of its choice, who could have steered the underlying lawsuit in a direction favoring the insurer's later reimbursement claim.

III.   How Can a Reimbursement Dispute Be Avoided?

All is not lost for policyholders, however. Armed with the knowledge that any lawsuit could trigger a defense cost reimbursement claim, a policyholder can avoid or minimize the consequences of a later reimbursement dispute by focusing on the following issues as soon as it is sued in the underlying lawsuit.

The policyholder first needs to determine whether the insurer has the right later to assert a claim for reimbursement of defense costs. This will hinge on at least four factors.

First, does the complaint allege any claims or parts of claims that are not covered by the policy? If not, then there is no basis for the insurer to seek reimbursement.

Second, does the applicable law follow California's lead and allow an insurer to defend a lawsuit but later force the policyholder to bear some or all of the defense costs? In other words, does the insurer have the right to seek reimbursement of defense costs in the first place?

Third, did the insurer promptly and specifically reserve the right to later seek reimbursement of defense costs? If not, the insurer may have waived the right to do so. However, some jurisdictions allow an insurer to assert a right to deny coverage (here, to foist defense costs back on the policyholder) despite the insurer's failure to promptly and specifically reserve that right.

Fourth, is the insurer providing a full defense to its insured? Some jurisdictions will allow an insurer to recover defense costs from the policyholder only if the insurer provided a prompt and full defense.

To properly assess the risk and extent of a later reimbursement claim, an analysis must be performed of the coverage afforded each of the claims (and parts of claims) in the underlying third-party lawsuit.

Questions to address include:

• Are there any claims (or parts of claims) that clearly are outside the scope of coverage? If so, to what extent do the non-covered claims predominate the covered claims?

  The answer to these questions may warrant that the policyholder either defend itself or negotiate up front a reasonable defense cost-sharing agreement with the insurer.

• Are the covered and non-covered claims based on the same facts? For example, has the plaintiff in the underlying lawsuit alleged that the policyholder's misconduct was negligent in one claim and intentional in another claim? Does the defense against separate contract and tort claims hinge on proof of essentially the same facts?

  The more the covered and non-covered claims are based on the same facts, the more likely the insured will succeed in defeating the insurer's reimbursement claim. This is because the insurer will have difficulty demonstrating that any portion of the defense costs was incurred solely because of the non-covered claims.
  
  
  

Assuming that the applicable law affords the insurer the right to seek reimbursement of defense costs, the policyholder should consider whether it makes sense to enter an agreement with the insurer to share defense costs.

For example, after the policyholder has been sued, it could explore an agreement with the insurer establishing a dollar cap, percentage cap or other formula for sharing defense costs. The cap or formula would vary depending on the nature of the claims alleged in the underlying lawsuit, including the relative importance of the covered versus non-covered claims and the extent to which such claims are factually intertwined.

A defense cost-sharing agreement could be beneficial to both sides. Such an agreement could decrease the uncertainty of a reimbursement claim, avoid the cost of litigating the reimbursement claim down the road, allow the policyholder and insurer to defend the third-party claim with a united front, and avoid disputes over potential conflicts of interest in the retention of defense counsel.

A policyholder should be proactive to protect or improve its position in any later reimbursement dispute with its insurer. Although any strategy will be dictated by the circumstances surrounding the claim, a few general approaches should be considered.

First, the policyholder should consider whether the insurer can be persuaded to abandon the reimbursement claim. One "persuasion point" might be to demand that the insurer appoint independent counsel. Generally, when defense counsel's handling of the underlying lawsuit can influence the outcome of a coverage dispute, the policyholder is entitled to independent counsel at the insurer's expense. Such a conflict of interest might arise if the insurer were to appoint defense counsel from its panel of law firms and yet reserve its right to recover defense costs from the policyholder because defense counsel's strategy in defending the insured could impact the outcome of a reimbursement dispute between the insured and insurer. The risk of having to pay the additional expense of independent counsel may persuade the insurer to forego a reimbursement claim altogether.

Second, consider whether the advantages of having the insurer defend the lawsuit really outweigh the risks. If the non-covered claims predominate the covered claims and if the insurer refuses to waive its right to seek reimbursement, the policyholder may be better served by selecting and retaining control over defense counsel, even though it means possibly foregoing any contribution from the insurer for defense costs. This would allow the policyholder to use defense counsel of its own choosing, to decide how much to spend on defense and to allocate those defense dollars in the most efficient manner.

Third, the policyholder should plan and budget for the possibility of a reimbursement claim. The financial impact of a reimbursement claim can be softened considerably if the policyholder prepares for that potentiality. Further, the policyholder, having analyzed the likelihood and estimated amount of a reimbursement claim, can take that risk into consideration in assessing how to respond to the underlying lawsuit. This analysis will help the policyholder determine how best to approach defense and settlement.

IV.   Conclusion

A policyholder need not find itself defenseless in the face of an insurer's claim for reimbursement of defense costs. However, the insured must first understand the risk of such a claim. This requires an assessment of at least the following questions:

• Whether the insurer has the right under the applicable law to recover defense costs in the first place.
  
  
• If such a right exists, whether the insurer, by its conduct, has waived that right.
  
  
• The risk and magnitude of a reimbursement claim (e.g., the relationship of the covered and non-covered claims).
  
  
• Whether the insurer can be dissuaded from pursuing a reimbursement claim.
  
  
• Whether some kind of defense cost-sharing agreement should be negotiated with the insurer up front.

Assessing these issues in a timely manner will help to avoid or at least minimize the consequences of an insurer's claim for reimbursement of defense costs.

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For more information about the issues covered in this report, please contact Daven G. Lowhurst in our San Francisco office at 415-369-7270 or at dglowhurst@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.





©2001 Thelen LLP