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Category: Practice Area: Insurance Litigation

Article: When Do Insureds’ Legal Fees Constitute Defense Expenses?

September 11, 2020

A recent Law.com article by David Kroeger and Catherine Doyle of Jenner & Block LLP, “When Do Insureds’ Legal Fees Constitute Defense Expenses?, reports on attorney fees and expenses in underlying insurance coverage litigation.  This article was posted with permission.  The article reads:

When is a defendant actually a plaintiff, and when are a defendant's legal expenses not defense expenses?  While the intuitive answer may begin with the case caption and a review of the defendant's legal bills, some courts may not stop the analysis there.

In Turner v. XL Specialty Insurance Co., the U.S. District Court for the Western District of Oklahoma recently determined that none of the legal expenses incurred by a named defendant counted as defense expenses, at least where the nominal defendant to a declaratory judgment claim purportedly stood in the same posture as the plaintiff and sought the same relief via affirmative counterclaims, cross-claims and third-party claims.  The decision was appealed to the U.S. Court of Appeals for the Tenth Circuit, and policyholders and insurance law practitioners would do well to monitor how far insurers may try to extend this argument in the future.

The federal district court in Turner v. XL Specialty reached the surprising conclusion that legal fees and costs incurred while defending against a declaratory judgment claim did not constitute covered defense expenses for purposes of a directors and officers insurance policy.  The factual scenario in Turner was detailed, complex and most certainly drove the court's unique conclusion.

The story began with American Energy Partners LP, a company founded in 2013 by oil and gas businessman Aubrey McClendon, which Forbes magazine once described as America's most reckless billionaire.  The plaintiff, Ryan Turner, served for a period as an executive of both AELP and an AELP affiliate.

While in that role, McClendon, Turner and two other AELP executives, Scott Mueller and Thomas Blalock, entered into an equity and co-investment agreement that reflected their profit-sharing agreements relating to the AELP business as well as new businesses that were not yet formed.

Under the equity and co-investment agreement, McClendon owned a 76% interest in the profit from new domestic businesses; Turner owned a 12% interest, and Mueller and Blalock each owned a 6% interest.  The individuals allegedly entered into the equity and co-investment agreement as a result of their membership in AELP's executive management team.

Shortly after signing the equity and co-investment agreement two additional AELP affiliates, SCOOP Energy Company LLC and Scoop Energy Holdings LLC (collectively referred to as SCOOP), were founded.  The parties to the equity and co-investment agreement agreed that it should apply to the sale of any SCOOP assets, and an amendment was prepared to explicitly include SCOOP within the equity and co-investment agreement.

Before the amendment could be executed, McClendon died in a single-vehicle accident on March 2, 2016, the day after he was indicted by a federal grand jury.  All surviving parties to the equity and co-investment agreement nevertheless agreed that a definitive and enforceable agreement with respect to the SCOOP assets had already been reached.

After McClendon's death, Blalock was appointed special administrator for McClendon's estate with authority to continue the AELP business.  Blalock thereafter sought an order permitting the estate to distribute the proceeds from the sale of the SCOOP assets according to the percentage interests set forth in the equity and co-investment agreement, but Blalock withdrew the application after one of McClendon's other creditors opposed it.

On the same day as that withdrawal, Mueller filed a lawsuit naming SCOOP, Blalock in both his individual capacity and as the personal representative of McClendon's estate, and Turner as defendants.

The only relief sought against Turner was a declaration of the rights and liabilities of the parties, including a determination that each of the members of AELP's executive management team was entitled to his respective share of profits from the sale of the SCOOP assets.  Turner's answer either admitted, or did not dispute, the allegations in Mueller's petition.  Turner also filed his own affirmative counterclaims, cross-claims and third-party claims seeking the same relief as Mueller.

Turner thereafter sought coverage for his legal expenses from XL Specialty under AELP's company and management liability policy.  Per the policy, XL Specialty was obligated to pay "on behalf of the Insured Person Loss resulting from a Claim first made against the Insured Person during the Policy Period ... for a Wrongful Act."

"Wrongful act" was in turn defined as a "matter asserted against, or investigated or inquired with respect to, an Insured Person by reason of his or her status as an Insured Person."

XL Specialty denied Turner's claim, asserting that Turner was sued by reason of his status as an equity holder in various businesses, rather than his status as an insured person, and therefore no claim was asserted against him for a wrongful act as defined under the policy.  XL Specialty also asserted that the policy did not provide coverage for Turner's prosecution of his affirmative claims.  After receiving XL Specialty's denial, Turner settled the litigation over the SCOOP assets and filed suit against his insurer for breach of contract and bad faith.

Applying Oklahoma law, the federal district court agreed with XL Specialty and concluded that there was no coverage because Turner was not named as a defendant in the Mueller lawsuit by reason of his status as an insured person.  In so doing, the court rejected Turner's argument that it was significant that the policy's definition of "wrongful act" used the term "status" in place of the more commonly found term, "capacity."

The court found those two terms to be interchangeable, and then concluded that Turner was involved in the action solely because of his status or capacity as an individual equity holder under the ECOIA, and not in his capacity as a former executive of AELP.

But the court did not end its analysis after finding that there was no wrongful act asserted against Turner. It instead continued, and found (given the initial part of its ruling, arguably in dicta) that Turner did not incur defense expenses in the Mueller lawsuit, and therefore had suffered no loss.

The XL Specialty policy defined loss as "damages, judgments, payments, settlements, relief or other amounts ... and Defense Expenses."  The term "defense expenses" was defined as "reasonable legal fees and expenses incurred in the investigation and defense of any Claim."

In explaining its conclusion, the court first noted that the XL Specialty policy did not define the term "defense," and found persuasive a definition of that term from Black's Law Dictionary:

 A defendant's stated reason why the plaintiff or prosecutor has no valid case ... that which is alleged by a party proceeded against in an action or suit, as a reason why the plaintiff should not recover or establish that which he seeks by his complaint or petition.

Viewing the situation from this prism, the court concluded that Turner's legal expenses were incurred for purposes other than demonstrating why Mueller had no valid case or should not recover the relief he sought.  The court further concluded that the declaratory judgment claim — the sole claim asserted against Turner in the Mueller lawsuit — did not place Turner in a defensive posture: "Rather, it appears that Mr.Mueller asserted the claim for the benefit of himself and Mr. Turner."

Indeed, the court found significant that Turner's answer did not dispute any of Mueller's material facts, nor did it dispute or oppose any of Mueller's requested relief. Instead, both Mueller and Turner, in his affirmative claims, requested entry of the same relief. Thus:

While Mr. Turner was nominally pleaded as a "defendant" in the Mueller lawsuit, the pleadings demonstrate clearly that he stood in the same posture as Mr. Mueller … Accordingly, the legal expenses Mr. Turner incurred are not "Defense Expenses," and as such they are not covered "Loss" under the insurance policy at issue here.

Notably, the court also rejected Turner's argument that at least some of the costs for which he sought recovery had to have been incurred in connection with the defense of the Mueller lawsuit, no matter how "defense" was defined.  Had the court accepted that argument, Turner arguably would have been able to invoke a very pro-policyholder allocation provision entitling him to coverage for the full amount of his legal expenses:

If a Claim covered in whole or in part under the Policy results in both Loss covered under this Policy, and loss not covered by this Policy, because such a Claim includes both covered and uncovered matters ... the Insureds and the Insurer shall allocate 100% of such amounts to covered Loss.

The court thus granted summary judgment in favor of XL Specialty on both Turner's breach of contract claim and bad faith claim, and denied Turner's motion for partial summary judgment on the breach of contract claim.  Turner appealed the decision to the Tenth Circuit.

While the Turner decision was no doubt heavily influenced by the district court's perception of the specific parties and facts before it, the path it traveled ought to give rise to at least some level of concern.

Policyholders, insureds and many others commonly think of defense costs as being synonymous with the attorney fees and expenses that they have to pay counsel who represent them when they get sued; they do not parse that term so finely as to include within the concept only those costs incurred to specifically oppose allegations made or relief sought by the plaintiff.

Turner did not file the Mueller lawsuit, but upon being served with the petition he had to retain counsel and incur defense costs.  It seems highly, if not extraordinarily, unlikely that a party in Turner's position would not have incurred at least some measure of defense expenses — even under the narrow definition of that term the district court read into the policy.  Indeed, Turner presumably incurred legal fees to have his counsel prepare the answer that the court cited repeatedly in its opinion, and answers are a classic example of a defense expenditure.

By interpreting the policy in a manner that allowed it to recharacterize a uniquely situated defendant as effectively being a plaintiff, the court overlooked these issues and may have unintentionally opened the door to future arguments that other, less similarly situated, insureds should be denied coverage for some or all of their defense costs on the same logic.  It is common for plaintiffs and defendants to jointly request court approval of a securities class action or derivative settlement; those defendants are incurring defense costs in so doing.

Similarly, individual defendants to a securities class or derivative action may, for strategic reasons, want to agree with the plaintiffs in placing blame on other individual defendants; they, too, are incurring defense costs in all meaningful senses of the term. Yet the analysis used in Turner could be argued to require a contrary result.  For these reasons, it will be important for policyholders to monitor Turner as it makes its way through the Tenth Circuit.  In the interim, Turner may well produce an increased focus on the definition of "defense costs" in a D&O or similar policy.

Many definitions of that term define "defense costs" by reference to "defense" of or "defending" a claim, without much further elaboration. Other definitions also add the concept of "investigation" or "investigating," like the definition at issue in Turner.  And yet others include additional concepts, such as "opposing," that arguably make the result in Turner more difficult to justify, because they make more clear that "defense" and "defending" must mean something different than "opposing."  These differences in language could become very important, depending on the outcome at the Tenth Circuit.

David M. Kroeger is a partner at Jenner & Block LLP and co-chair of the firm's insurance recovery and counseling practice and its reinsurance practice.  Catherine L. Doyle is an associate at the firm.

Article: The Attorney Fee Key to Unlocking Additional Insured Coverage

August 24, 2020

A recent New York Law Journal article by Julian D. Ehrlich, “The Attorney Fee Key to Unlocking Additional Insured Coverage” reports on a new decision awarding attorney fees in a declaratory judgment to the party successful in obtaining additional insured coverage which if followed, could change existing risk transfer preferences.  This article was posted with permission.  The article reads:

The two well-worn paths to risk transfer in tort cases are contractual indemnity and additional insured coverage.  Typically, contractual indemnity obligations run to owners and general contractors, often referred to as upstream parties, from tenants or lower tier contractors, the downstream parties.  In contrast, additional insured (AI) status can provide coverage to upstream parties to downstream parties’ insurers.

While the paths are not mutually exclusive, many upstream insurers are reluctant to start declaratory judgment (DJ) coverage actions to enforce AI rights because of concerns that their attorney fees will not be recoverable.  These insurers prefer instead to rely exclusively on contractual indemnity claims where recovery of attorney fees is thought to be easier.  However, there are distinct advantages of AI over contractual indemnity to upstream parties and emerging case law suggests that DJ attorney fees can be recoverable.

Attorney Fees Rules

The American rule is that, win or lose, each side in litigation pays its own attorney fees absent a right in statute or contract.  Thus, in U.S. tort litigation, claimants typically pay their own attorney fees.  However, recovery of attorney fees between defendants is common.  This is because contractual indemnity provisions usually require the downstream party to both defend and indemnify the upstream party.  Similarly, additional insured (AI) status on a downstream party’s policy status includes coverage for the upstream parties’ defense.  However, the rules for recovering defense costs are convoluted. See, Julian D. Ehrlich, “Recovering Attorneys’ Fees in Construction Site Cases,” NYLJ, (May 25, 2007).

For example, the indemnitee generally is not entitled to reimbursement of its fees for enforcing its contractual indemnity rights, i.e. “no fees for fees.” Hooper Assoc. v. AGC Computers, 74 N.Y.2d 487 (1989). However, there is an exception for costs incurred in “defensive” third party and cross claims against the indemnitor. Springstead v. Ciba-Geigy Corp., 27 A.D.2d 720 (2d Dept. 2006).

Similarly, the general rule is that attorney fees for pursuing AI coverage in a DJ action are not recoverable even if the DJ is ultimately successful, Mighty Midgets Inc. v. Centennial Ins. Co. 47 N.Y.2d 12, 21 (1979).  However, an insured is entitled to recover fees if it wins a DJ brought by an insurer seeking to avoid coverage, U.S. Underwriters Insurance Co. v. City Club Hotel LLC, 3 N.Y.2d 592 (2004).  However, there is noteworthy reasoning in a new decision awarding attorney fees in a DJ to the party successful in obtaining AI coverage which if followed, could change existing risk transfer preferences.

A New Approach

In Houston Cas. Co. v. Prosight Specialty Ins. Co., 2020 U.S. Dist. LEXIS 927 28 (S.D.N.Y. May 27, 2020), an injured E.J. Electric employee brought a Labor Law claim against the owner, construction manager Turner and Nouveau Elevator Industries alleging a fall due to a misleveled elevator.  E.J.’s insurer, Houston Casualty Co. (HCC) accepted AI coverage for the owner and Turner.  However, Prosight, the insurer for the elevator contractor, refused to provide AI coverage to those parties.  Accordingly, HCC brought a DJ action seeking a declaration that Prosight owed primary non-contributory AI coverage to the owner and Turner.  The court in Houston held that Prosight owed primary non-contributory AI coverage and awarded HCC’s attorney fees notwithstanding the American rule and existing caselaw.

The Reasoning

Houston relies on a “thoughtful and persuasive” 2019 Report and Recommendation by U.S. Magistrate Judge Paul Davidson which has now been cited in several reported decisions.  The report finds that an insureds’ right to D.J. attorney fees can be found in the policy’s coverage grant because an insurer’s duty to defend extends to any action arising out of the occurrence including a defense against the insurer’s coverage suit.

The report notes longstanding case law which permits a prevailing insured to recover attorney fees from an insurer when the latter starts a DJ seeking to free itself of its duty to defend under the policy.  The report then suggests that the fortuity of who starts the DJ should not matter for fee recovery if the litigated issue is the insurer’s duty defend an insured in an underlying tort case.

The court in Houston extends this reasoning to award one insurer fees from another insurer which “persistently, reflexively and sequentially” wrongfully denied tenders for AI coverage.  If the reasoning in Houston is followed by other courts, risk transfer may be clearer, and settlements facilitated in the future.

Impact

Although Houston is a trial level decision and an appeal was filed June 24, 2020, there is now authority in a reported federal case holding that the losing defendant must pay attorney fees to the winning plaintiff insurer in the AI DJ context.

Accordingly, Houston may help ease upstream insurers’ hesitancy to bring DJ’s for AI coverage. Moreover, if downstream insurers realize they may face more severe consequences for unreasonably resisting AI, they may accept more tenders leading to an overall net decrease in coverage litigation.

In addition, AI can have advantages over contractual indemnity to upstream parties.  For example, in states like New York upstream parties may insure away via AI coverage active negligence which may not be contracted away due to anti-indemnity statues, see e.g. General Obligations Law § 322.1.

Accordingly, a strategy of foregoing AI coverage can result in an upstream party losing out on rights which contractual indemnity alone cannot provide.  Moreover, questions regarding whether the upstream was actively negligent can delay risk transfer and settlements.

Tenders for AI coverage often go answered by downstream insurers and until now have not always been aggressively pursued by upstream insurers.  However, arguably, when it is clearer that risk transfer will result in the downstream party being legally and financial responsible in a case, it may also be easier to settle multi-defendant litigation with claimants.

Finally, attorney fees may be substantial and are often the last obstacle to resolve before a settlement can be reached.  To the extent Houston streamlines a path to resolutions, it is most welcomed.

The Nation’s Top Attorney Fee Experts of 2020

June 24, 2020

NALFA, a non-profit group, is building a worldwide network of attorney fee expertise. Our network includes members, faculty, and fellows with expertise on the reasonableness of attorney fees.  We help organize and recognize qualified attorney fee experts from across the U.S. and around the globe.  Our attorney fee experts also include court adjuncts such as bankruptcy fee examiners, special fee masters, and fee dispute neutrals.

Every year, we announce the nation's top attorney fee experts.  Attorney fee experts are retained by fee-seeking or fee-challenging parties in litigation to independently prove reasonable attorney fees and expenses in court or arbitration.  The following NALFA profile quotes are based on bio, CV, case summaries and case materials submitted to and verified by us.  Here are the nation's top attorney fee experts of 2020:

"The Nation's Top Attorney Fee Expert"
John D. O'Connor
O'Connor & Associates
San Francisco, CA
 
"Over 30 Years of Legal Fee Audit Expertise"
Andre E. Jardini
KPC Legal Audit Services, Inc.
Glendale, CA

"The Nation's Top Bankruptcy Fee Examiner"
Robert M. Fishman
Cozen O'Connor
Chicago, IL

"Widely Respected as an Attorney Fee Expert"
Elise S. Frejka
Frejka PLLC
New York, NY
 
"Experienced on Analyzing Fees, Billing Entries for Fee Awards"
Robert L. Kaufman
Woodruff Spradlin & Smart
Costa Mesa, CA

"Highly Skilled on a Range of Fee and Billing Issues"
Daniel M. White
White Amundson APC
San Diego, CA
 
"Extensive Expertise on Attorney Fee Matters in Common Fund Litigation"
Craig W. Smith
Robbins Arroyo LLP
San Diego, CA
 
"Highly Experienced in Dealing with Fee Issues Arising in Complex Litigation"
Marc M. Seltzer
Susman Godfrey LLP
Los Angeles, CA

"Total Mastery in Resolving Complex Attorney Fee Disputes"
Peter K. Rosen
JAMS
Los Angeles, CA
 
"Understands Fees, Funding, and Billing Issues in Cross Border Matters"
Glenn Newberry
Eversheds Sutherland
London, UK
 
"Solid Expertise with Fee and Billing Matters in Complex Litigation"
Bruce C. Fox
Obermayer Rebmann LLP
Pittsburgh, PA
 
"Excellent on Attorney Fee Issues in Florida"
Debra L. Feit
Stratford Law Group LLC
Fort Lauderdale, FL
 
"Nation's Top Scholar on Attorney Fees in Class Actions"
Brian T. Fitzpatrick
Vanderbilt Law School
Nashville, TN
 
"Great Leader in Analyzing Legal Bills for Insurers"
Richard Zujac
Liberty Mutual Insurance
Philadelphia, PA