Bill Padding by Cumis Counsel Can Be Recovered From Cumis Counsel
The advent of requirements that an insurer must pay independent counsel when it reserves its rights and creates a conflict between the insurer and its insured was rife with abuse. Consider United States v. Stites, 56 F.3d 1020 (9th Cir. 05/26/1995), National Union Fire Insurance Co. v. Stites Professional Law Corp., 235 Cal. App. 3d 1718, 1 Cal. Rptr. 2d 570 (Cal.App.Dist.2 10/25/1991) and Fireman’s Fund Insurance Co. v. Stites, 258 F.3d 1016 (9th Cir. 08/03/2001) where the creator of the Alliance that was a scheme to defraud insurers by creating litigation to require appointment as independent counsel and profit from it. Stites was convicted and served fourteen years.
The Ninth Circuit, in United States v. Stites, concluded: “Stites had been the mastermind of a massive set of breaches of professional responsibility and of the criminal law, the more heinous because Stites was a lawyer and at least twelve other lawyers were his principal confederates in carrying out the fraud. The mentality that sees law as a business was here taken to a reductio ad absurdum — litigation was unconscionably churned to make money for the lawyers. The essence of Stites’s scheme, repeated over and over again, was for Stites to control both sides of suits in which insurance companies were paying for counsel, and to assure that the plaintiffs’ lawyers would not settle until the insurance companies would no longer pay the costs of defendants’ counsel. Stites’s network of lawyers was known as “the Alliance.” According to the jury verdict in this case, Stites’s scams extracted at least $50 million from the insurers in the period 1984 to 1987.” Since Stites, the California Legislature enacted Civil Code Section 2860 to control independent counsel and their relationship to insurers. The abuse was limited by the statute but over-billing and padding of legal bills continued and insurers have sought to remedy the over-billing and padding by arbitration required by Section 2860.
In Hartford Casualty Ins. Co. v. J.R. Marketing, LLC (2015) , Cal.4th, [No. S211645. Aug. 10, 2015.] Justice Cuéllar of the California Supreme Court dealt with a new question not before dealt with when dealing with independent counsel, who must repay the insurer for legal fees paid for work not covered or for padded and over-billed fees when incurred by an insurer when no criminal conduct is involved.
THE HISTORY OF INDEPENDENT COUNSEL
The California Supreme Court has long maintained that if any claims in a third party complaint against a person or entity protected by a commercial general liability (CGL) insurance policy are even potentially covered by the policy, the insurer must provide its insured with a defense to all the claims. (E.g., Horace Mann Ins. Co. v. Barbara B. (1993) 4 Cal.4th 1076, 1081.) The insurer’s provision of an immediate, complete defense in such a “mixed” action, the Supreme Court has explained, is “prophylactically” necessary, even if outside of the policy’s strict terms, to protect the insured’s litigation rights with respect to the potentially covered claims. (Buss v. Superior Court (1997) 16 Cal.4th 35, 49 (Buss).) Nevertheless, the Supreme Court concluded in Buss that the insured would be unjustly enriched at the insurer’s expense if not ultimately required to bear the cost of litigating those claims for which the insured had never purchased defense or indemnity protection. Accordingly, we held in Buss that the insurer may seek reimbursement from the insured of defense fees and expenses solely attributable to the claims that were clearly outside policy coverage.
The Supreme Court did not consider in Buss the question from whom may a CGL insurer seek reimbursement when:
(1) the insurer initially refused to defend its insured against a third-party lawsuit;
(2) compelled by a court order, the insurer subsequently provided independent counsel under a reservation of rights – so-called Cumis counsel (see San Diego Federal Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358 (Cumis); fn. 1 see also Civ. Code, § 2860 fn. 2 ) – to defend its insured in the third party suit;
(3) the court order required the insurer to pay all “reasonable and necessary defense costs,” but expressly preserved the insurer’s right to later challenge and recover payments for “unreasonable and unnecessary” charges by counsel; and
(4) the insurer now alleges that independent counsel “padded” their bills by charging fees that were, in part, excessive, unreasonable, and unnecessary?
The insurer urges that it may recoup the over-billed amounts directly from Cumis counsel themselves. Cumis counsel respond that, if the insurer has any right at all under the facts of this case to recover over-billed amounts, the insurer’s right runs solely against its insureds. Cumis counsel’s erstwhile clients might then have a right of indemnity from these counsel.
In the summer of 2005, appellant Hartford Casualty Insurance Company (Hartford) issued one CGL insurance policy to Noble Locks Enterprises, Inc. (Noble Locks), effective from July 28, 2005, to July 28, 2006, and a second CGL policy to J.R. Marketing, L.L.C. (J.R. Marketing), effective August 18, 2005, to August 18, 2006. In these policies, Hartford promised to defend and indemnify the named insureds, and their members and employees, against certain claims for business-related defamation and disparagement.
In September 2005, an action was filed in Marin County Superior Court against J.R. Marketing, Noble Locks, and several of their employees (the Marin County action). In the Marin County action, certain defendants, apparently represented by the law firm of Squire Sanders (US) LLP (Squire Sanders), filed cross-complaints.
Defense of the Marin County action was tendered to Hartford under the J.R. Marketing and Noble Locks policies. Hartford disclaimed a duty to defend or indemnify the defendants in the Marin County action on the grounds that the acts complained of appeared to have occurred before the policies’ inception dates, and that certain of the defendants appeared not to be covered insureds. Hartford subsequently agreed to defend J.R. Marketing, Noble Locks, and several of the individual defendants in the Marin County action, subject to a reservation of rights.
The trial court in the coverage action entered a summary adjudication order, finding that Hartford had a duty to defend the Marin County action effective on the date the defense was originally tendered. The order also provided that, because of Hartford’s reservation of rights, Hartford must fund Cumis counsel to represent its insureds in the Marin County action. The insureds retained Squire Sanders as Cumis counsel.
The trial court in the coverage action issued an enforcement order directing Hartford to promptly pay all defense invoices submitted to it and to pay all future defense costs in the Marin County action within 30 days of receipt. The order, which was drafted by Squire Sanders and adopted by the court, further stated that Hartford had breached its defense obligations by refusing to provide Cumis counsel until ordered to do so and by thereafter failing to pay counsel’s submitted bills in a timely fashion. The Court of Appeal subsequently affirmed both the summary adjudication and enforcement orders.
Eventually the Marin County action was resolved. The coverage action, stayed during the pendency of the Marin County action, resumed. Hartford thereafter filed a cross-complaint, and then a first amended cross-complaint, against (1) various persons for whom it had allegedly paid defense fees and expenses in the Marin County, Nevada, and Virginia actions, and (2) Squire Sanders. The cross-complaint asserted that Hartford was entitled to recoup from the cross-defendants a significant portion of some $15 million in defense fees and expenses, including some $13.5 million Hartford paid to Squire Sanders pursuant to the enforcement order.
The trial court sustained a demurrer and the Court of Appeal agreed as to Squire Sanders, the court concluded that Hartford’s right to reimbursement, if any, was from its insureds, not directly from Cumis counsel.
The Supreme Court granted Hartford’s petition for review, which raised a narrow question: May an insurer seek reimbursement directly from counsel when, in satisfaction of its duty to fund its insureds’ defense in a third party action against them, the insurer paid bills submitted by the insureds’ independent counsel for the fees and costs of mounting this defense, and has done so in compliance with a court order expressly preserving the insurer’s post-litigation right to recover “unreasonable and unnecessary” amounts billed by counsel?
Restitution and the Duty to Defend
When an insured under a standard CGL policy is sued by a third party, the insurer’s contractual duty to defend the insured extends to all claims that are even potentially subject to the policy’s indemnity coverage. Moreover, when the third party suit includes some claims that are potentially covered, and some that are clearly outside the policy’s coverage, the law nonetheless implies the insurer’s duty to defend the entire action. And unless the insured agrees otherwise, in a case where – because of the insurer’s reservation of rights based on possible non-coverage under the policy – the interests of the insurer and the insured diverge, the insurer must pay reasonable costs for retaining independent counsel by the insured.
Hartford reserved its right to dispute coverage for some or all of the defendants or claims in the Marin County, Nevada, and Virginia actions. Accordingly, Squire Sanders acted as the insureds’ independent counsel in those suits. It did so pursuant to a court order specifying that Hartford must promptly pay Squire Sanders’s bills as and when submitted, but that the firm’s charges must be “reasonable and necessary,” and that, after conclusion of the underlying litigation, Hartford could seek reimbursement of amounts it deemed excessive by this standard. The order did not specify from whom Hartford might obtain any such reimbursement.
Hartford now seeks reimbursement from Squire Sanders based on equitable principles of restitution and unjust enrichment. By charging Hartford for fees and expenses that were unreasonable and unnecessary for the insureds’ defense, Hartford asserts, Squire Sanders unjustly enriched itself at Hartford’s expense and thus owes Hartford restitution for the over-billed amounts.
An individual who has been unjustly enriched at the expense of another may be required to make restitution. (See Ghirardo v. Antonioli (1996) 14 Cal.4th 39, 51; see Rest.3d Restitution and Unjust Enrichment, § 1; 1 Witkin, Summary of Cal. Law (10th ed. 2005) Contracts, § 1013, p. 1102.) Restitution is not mandated merely because one person has realized a gain at another’s expense. Rather, the obligation arises when the enrichment obtained lacks any adequate legal basis and thus cannot conscientiously be retained.
As the Supreme Court concluded in Buss, if an insurer were required to absorb the costs of defending claims it clearly never agreed to defend, it is the insured who would gain a direct and unjust enrichment at the insurer’s expense. Hartford alleges that it is counsel who are the unjust beneficiaries of the insurer’s over-payments. As applied here, accepting for the sake of argument (because the case came to the Supreme Court on a demurrer that assumes all facts alleged in the suit are true) that Squire Sanders’s bills were objectively unreasonable and unnecessary to the insured’s defense in the underlying litigation and that they were not incurred for the benefit of the insured, principles of restitution and unjust enrichment dictate that Squire Sanders should be directly responsible for reimbursing Hartford for counsel’s excessive legal bills.
Hartford’s obligation to pay for independent Cumis counsel was not unlimited. Hartford did not voluntarily pay the alleged “unreasonable and unnecessary” overcharges submitted by Squire Sanders out of some self-interest extraneous to the benefit conferred on those counsel. Moreover, any such overpayments were not merely an “incidental” benefit to Squire Sanders, fortuitously received by the firm and beyond its power to refuse. On the contrary, Squire Sanders, under the terms of a court order it obtained (and indeed, drafted), submitted bills to Hartford and obtained payment subject to the express provision that counsel’s bills must be reasonable, and that Hartford could later obtain reimbursement of excessive charges.
By its terms, the statute limits neither the potential “parties to the dispute” (§ 2860, subd. (c)) nor the billing issues that may be raised.
Squire Sanders’s own conduct in the course of this litigation further supports the conclusion that it is not unjust to allow Hartford to pursue its reimbursement action directly against Squire Sanders. The holding that Hartford may pursue its claim for reimbursement against Squire Sanders stems directly from – and is wholly consistent with – that order. Squire Sanders now attempts to avoid the effects of this order by encouraging the Supreme Court to foist all responsibility for reimbursement onto its erstwhile clients. The Supreme Court refused to accept that invitation. Under the circumstances, allowing Hartford to pursue a narrow claim for reimbursement against Squire Sanders under the terms of the 2006 enforcement order neither rewards an undeserving insurer nor penalizes unsuspecting Cumis counsel.
Under the circumstances of this case, the insurer may seek reimbursement directly from Cumis counsel. 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.
Justice Cuéllar, faced with the work of almost every elite member of the California appellate bar, wrote reasonably to allow the Hartford the opportunity to prove to a trial court that Squire Sanders padded its bills or over-billed Hartford for work not necessarily necessary to defense of Hartford’s insured. If they can prove that Squire Sanders was unjustly enriched they will recover those unjust fees from the lawyers not the innocent insured who had no way to review or control the billing of their Cumis counsel. This is not the criminal conduct of Mr. Stites but the Supreme Court refused to allow padding or over-billing to be foisted upon the innocent insured.
© 2015 – Barry Zalma
Barry Zalma, Esq., CFE, has practiced law in California for more than 42 years as an insurance coverage and claims handling lawyer. He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.
He founded Zalma Insurance Consultants in 2001 and serves as its only consultant.
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