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Must Insurers Pay in Full After the Insured Wins the Coverage Fight?

Daily Journal

When can an insurer employ a "fee auditor" to justify paying less than the full amount of the covered defense fees?  Probably only when the insurer is otherwise defending.  Can insurers refuse to defend and still nickel and dime the bills with their favorite fee auditor?  Probably not.  The ancient case of Gray v. Zurich Ins. Co., 65 Cal. 2d 263 (1966), which is based on the even older case of Arenson v. National Auto Cas. Co., 48 Cal. 2d 528,539 (1957), came up with the doctrine that there is a penalty for wrongfully withholding a defense: the loss of otherwise available policy defenses including the right to control the defense, and the obligation of the insurer to "reimburse its insured for the full amount of any obligation reasonably incurred by him."  Couple that key doctrine with decisions finding that where an insurer breaches a defense obligation, it is liable for the insured's reasonable attorney fees and costs, (See Marie Y. v. General Star Indemn. Co. 110 Cal. App. 4th 928, 960-961 (2003)),  and it seems obvious that the defalcating insurer will be required to pay the defense costs incurred by the insured.

Yet in recent years, many insurers have boldly proclaimed the right to refuse to pay portions of defense bills, generated many years prior, based solely on the bill's format!  There is substantial case law for the notion that the insurers forfeit the right to contest bills in this fashion when they wrongfully fail to defend.  In Foxfire Inc. v. New Hampshire Ins Co., (1994) 1994 US DIST LEXIS 9249, Judge Patel held that "[h]aving forced its insured into the marketplace, to retain counsel, [the insurer] cannot complain of paying marketplace rates [rather than cheaper insurance panel defense rates negotiated by the insurer with its panel counsel].  By wrongfully refusing to defend, the insurer further "lost any right to control Foxfire's litigation strategy." 

This is not the only case to so state.  The state Supreme Court in Aerojet-General Corp. v. Transport Indemnity Co. (1997) 17 Cal 4th 38, 64 also cited to what appears to be the only case discussing what standard of proof is required of a defalcating insurer.

This case arises out of Michigan:  Fireman's Fund Ins. Co. v. Ex-Cell-O Corp. 790 F. Supp. 1339, 1346 (E.D. Mich. 1992).  Because the insured enjoys the legal presumption that the defense costs it paid are reasonable and necessary, the defalcating insurers have the burden of proof to come up with evidence that no reasonable attorney defending such claims in the particular forum would have undertaken those services billed by the defense.  To get around this steep burden, insurers have argued that their fee auditors are not criticizing the tasks performed or any part of the litigation strategy, but rather are only concluding that the submitted invoices are themselves insufficient for the insured to achieve its legal presumption.

These bold insurers are using their fee auditors to run the invoices through computer programs to sort out the task descriptions, arguing that the "vaguely described" tasks in the invoices, or the "block billed" tasks, do not adequately allow the auditor to know if the time spent was reasonable much less what was actually done. This, they argue, amounts to a failure by the injured insured to prove its defense costs.  Of course, this ignores that the insurers must suffer a legal penalty for refusing to pay the defense costs as incurred, and utterly ignores the effect of the legal presumption to which the injured policyholder is entitled.

So what should an insurer do to contest defense costs after a court determines that they should have defended the claim?  What they can — and should — do is engage an expert attorney who has defended similar claims in the particular forum to review the actual work product, not just the format of the bills.  If the bills were excessive or for unnecessary tasks, the expert can detect the same and competently testify in support of a showing that some of the fees and costs were unnecessary or unreasonable, thus meeting the required legal standard of proof.

From the point of view of the policyholders however, where the insurers shirk their obligations, the proffered fee auditor testimony is readily subject to Daubert challenges — that their testimony should not be permitted.  The defalcating insurer should carefully consider whether the knee-jerk approach of engaging its favorite fee auditor is the best course to take where a court has determined that it wrongfully failed to defend.  If a Daubert challenge is successful, such an insurer will be left high and dry, and without a legitimate way to contest the defense costs.  This leaves the insurer with one remaining option: pay the bills and past interest due.  Paying the defense bills may be the most economical way to go, and just perhaps, coincidentally, the right thing to do.

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