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Reimbursement of Settlements.

An insurance company generally must defend its insured against third-party claims potentially within the policy's coverage. Its duty to indemnify, however, is narrower, and does not include noncovered claims. Frequently, therefore, insurers agree to defend a lawsuit subject to a reservation of rights. In this way, an insurer meets its obligation to furnish a defense without waiving its right to assert coverage defenses against the insured at a later time.

Suppose an insurer, defending a policy-holder after having reserved its rights, decides that it is reasonable to settle the suit with the underlying plaintiff. May the insurer obtain reimbursement from its insured for the settlement amount if it is later determined that the claim was excluded from coverage?

In recent months, the Supreme Courts of both Texas and California have answered this question--and have come to opposite conclusions. The Texas Supreme Court essentially ruled that an insurance company that settles a claim without the express authorization of the insured may not later seek reimbursement for that amount, even if it turns out that the claim was not covered by the policy. The California court, by contrast, held that an insurer in this situation may be entitled to recover the settlement payment from its policyholder even in the absence of its insured's express authorization. Only a handful of other courts, including Massachusetts and Alabama, have considered the settlement-reimbursement question.

The Texas case arose when the Texas Association of Counties County Government Risk Management Pool (TAC) sought to obtain reimbursement from its insured, Matagorda County, for an amount that TAC paid to settle a claim that was later determined to be excluded from coverage. The trial court ruled that the county, which had not objected to the settlement, was required to reimburse TAC, but the court of appeals reversed. The case reached the Texas Supreme Court.

In its opinion, the top Texas court observed that the insurance policy between the parties did not provide TAC a right of reimbursement under these circumstances. Moreover, the court continued, the county had not otherwise expressly agreed to reimburse TAC for the settlement.

The court rejected TAC's argument that the county had an implied contractual obligation to provide reimbursement. The court also rejected TAC's argument that the doctrine of equitable subrogation supported its reimbursement claim. In the court's view, allowing an insurer to unilaterally settle claims and then step into the shoes of the claimant could potentially foster conflict and distrust in the relationship between an insurer and its insured.

Finally, the court ruled that TAC was not entitled to recover under theories of quantum meruit or unjust enrichment, finding that these equitable doctrines applied, if at all, ouly if the insured authorized the settlement and agreed to reimburse the insurer should the insurer prevail on its coverage defense. Otherwise, the court said, the insured would be forced to choose between rejecting a settlement within policy limits or accepting a possible financial obligation to pay an amount that may be beyond its means.

In its decision, the California Supreme Court found that the insurer could seek reimbursement for the noncovered claims included in the settlement payment because the settlement was reasonable and because the insurer had provided the policyholders with a timely and express reservation of rights, an express notification of its intent to accept the proposed settlement offer, and an express offer to assume their own defense.

The court said that if insureds could refuse to assume their own defense, insisting an insurer settle a lawsuit or risk a bad faith action, but at the same time refuse to agree the insurer could seek reimbursement should the claim not be covered, "the resulting Catch-22 would force insurers to indemnify noncovered claims."

Indeed, the court emphasized, if an insurer could not unilaterally reserve its right to later assert noncoverage of any settled claim, it would have no practical avenue of recourse other than to settle and forgo reimbursement.

Whether other courts will adopt the Texas or California approach--or some different approach--to the settlement-reimbursement question remains to be seen.

Seth B. Schafler is a senior counsel in the New York City office of Proskauer Rose LLP and a member of the law firm's Litigation Department.
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Author:SCHAFLER, SETH B.
Publication:Risk & Insurance
Date:Sep 1, 2001
Words:698
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