On August 10, 2015, in Hartford Casualty Insurance Company v. J.R. Marketing, LLC, et al., the California Supreme Court held that in some circumstances insurers may seek reimbursement of payments made to the insured's independent Cumis counsel, legal counsel chosen by the insured when the insurer has a conflict of interest. The Court's ruling was based primarily on a theory of unjust enrichment and expands the holding of Buss v. Superior Court (1997) 16 Cal4th 36. Although this ruling has raised many questions and a ripple of unease among independent counsel, it is important to note that this case is fact-specific, with the Court admittedly looking at only a "narrow 'direct right' question."

Background

J.R. Marketing has an unusual background. Upon tender of a lawsuit against its insureds, the insurer initially denied coverage, subsequently agreeing to defend after the insureds instituted coverage litigation. In the coverage case, the insurer filed a cross-complaint against the insureds' independent counsel to recoup a significant portion of $15 million in defense fees and expenses the insurer had paid. The independent counsel demurred to the cross-complaint, asserting in part that the insurer had no legal or equitable claim for reimbursement against non-insureds, and the court sustained the demurrer. The independent counsel then obtained summary adjudication as to the insurer's duty to defend and immediately sought an "enforcement order" obligating the insurer to pay the submitted bills without deduction and at full rates. The enforcement order included the following statement: "To the extent [the insurer] seeks to challenge fees and costs as unreasonable or unnecessary, it may do so by way of reimbursement after resolution of the [underlying action]." The Supreme Court noted in its opinion in J.R. Marketing that the enforcement order was final; hence, the interpretation of that order was not before the Court. The underlying court found that the insurer was precluded from invoking the rate provisions of section 2860 due to its initial breach of its defense obligations.

The Supreme Court agreed to review the narrow issue of whether an insurer may seek reimbursement directly from counsel when, in satisfaction of the insurer's duty to fund its insureds' defense in a third-party action, the insurer paid bills submitted by the insureds' independent counsel in compliance with a court order expressly preserving the insurer's post-litigation right to recover "unreasonable and unnecessary" amounts billed by counsel. The Court concluded that, "given the facts of this case and within the limits discussed [in the opinion], such a right of reimbursement should run directly against Cumis counsel." Not surprisingly, there were several amici curiae.

Opinion Highlights

Certain points from the Court's opinion stress the need for caution on the part of insurers and policyholders:

• First, the insurer's reimbursement claim arose from a court order drafted by the insured's independent counsel, which explicitly allowed the insurer to challenge the billings in court following the resolution of the underlying action. (The case arose after the underlying court sustained a demurrer by Cumis counsel; thus, the Court assumed that all facts that the insurer alleged were true.) The Supreme Court specifically pointed out that in light of the enforcement order's express provision authorizing the insurer to seek reimbursement for excessive fees, it would not address the issue of whether absent such an order an insurer that breaches its defense obligations has any right to recover excessive fees it paid Cumis counsel. It begs the question, therefore, whether a similar order is required to allow an insurer to pursue recovery.

• Second, the Court dismissed the independent counsel’s argument that scrutiny of the bills undermines the independence of counsel and the attorney-client privilege by allowing the insurer to challenge the efforts. The Court noted that the enforcement order allowed the procedure, and scrutiny was permitted by the California independent counsel statute, Civil Code section 2860(c).

• Finally, the opinion suggests that the bar is fairly high for an insurer that seeks to challenge Cumis counsel billings and obtain reimbursement from counsel. For instance, in the opening paragraphs of the opinion the Court wrote: "If Cumis counsel, operating under a court order that expressly provided that the insurer would be able to recover payments of excessive fees, sought and received from the insurer payment for time and costs that were fraudulent, or were otherwise manifestly and objectively useless and wasteful when incurred, Cumis counsel have been unjustly enriched at the insurer's expense. Cumis counsel provide no convincing reason why they should be absolutely immune from liability for enriching themselves in this fashion."

Practice Pointer

While the J.R. Marketing decision is limited to the specific facts of the underlying matter, the California Supreme Court provides support for an insurer's right to pay only those reasonable and necessary fees incurred in defense of its insureds, and highlights that "the very statute codifying the Cumis doctrine already contemplates that counsel will be called upon to justify their fees."

It remains to be seen, therefore, whether this case will present an opportunity for insurers to recover unreasonable billings from independent counsel or is a fact-specific wake-up call to those firms that would seek to take unfair advantage of an order forcing the insurer to defend and pay costs. Regardless, insurers can expect that language regarding the payment of "reasonable and necessary" fees will become more controversial, and policyholders can expect insurers to reserve rights against their independent counsel.

In most fee disputes involving independent counsel, the parties will resolve the conflicts either informally or through the fee arbitration set forth in Civil Code section 2860(c). In J.R. Marketing, the High Court presented a new possibility by noting that 2860 fee arbitrations are not limited to disputes between the insurer and the insured, but can also be between the insurer and Cumis counsel. Indeed, the Court noted that under the "Cumis statutory scheme itself, counsel face the prospect that insurers may question and resist their bills, and insurers are not precluded from doing so in a proceeding directly against counsel."

The open question remains as to whether an insurer who wrongfully declines coverage and forfeits the protections of Civil Code section 2860 can seek reimbursement in an "after-the-fact" legal action without an enforcement order specifically authorizing the insurer to do so.