On July 25, 2011, the Court of Appeals addressed what had been an open question in Washington: when a liability insurer provides a reservation of rights defense, is it ever entitled to reimbursement of defense costs paid if a court later determines that there is no duty to defend?

The coverage dispute arose from claims that Immunex had artificially inflated the price of prescription drugs. After litigation had been pending for several years and Immunex had already incurred substantial defense fees and costs, Immunex tendered the claims to National Surety, its excess liability insurer, for defense and indemnity. National Surety denied coverage for the claims, but agreed under a reservation of rights to provide a defense with the right to reimbursement if a court later determined that there was no duty to defend.

The King County Superior Court determined that there was no coverage and, therefore, National Surety owed no duty to defend Immunex. But the trial court also ruled that National Surety was obligated to pay Immunex’s defense costs until the date that the court confirmed the claims were not covered, unless National Surety could establish actual prejudice resulting from Immunex’s late tender. Immunex appealed the finding of no coverage, and National Surety cross-appealed the trial court’s determination that its ruling applied prospectively only.

After agreeing that there was no coverage for the underlying claims, the Court of Appeals affirmed that National Surety remained obligated for defense costs incurred up until the trial court’s summary judgment rulings unless National Surety could prove actual prejudice resulting from Immunex’s late tender. Relying upon Washington cases noting the broader scope of a liability insurer’s duty to defend, the court reasoned that “payment of defense costs for claims that are potentially covered is part of the bargained-for exchange between the insurer and the insured” and the reservation of rights defense provides an insurer with “the benefit of insulating itself from a bad faith claim and possibly coverage by estoppel.”

Notably, the court indicated that its decision may have been different had National Surety’s policy included express language reserving to the insurer the right to reimbursement in the event that it defends a claim under a reservation of rights and then obtains a court determination of no coverage. Whether the Court of Appeals would actually enforce such a provision remains to be seen. But liability insurers now should give careful consideration as to whether to include a reimbursement provision in policies issued to Washington insureds.

In reaching this outcome, the Court of Appeals rejected several arguments advanced by National Surety. The court declined to draw any distinction between instances where an insurer defends under a reservation of rights because Washington law is unresolved as to the meaning of policy language as opposed to instances where a claim involves unresolved questions of fact for which there may or may not ultimately be coverage. The Court of Appeals also rejected reimbursement based upon theories of unilateral implied contract or unjust enrichment. And the court declined to reach a different outcome because National Surety had yet to reimburse Immunex for any of its defense costs, explaining that such a result would improperly reward insurers who withhold defense costs payments.