SDV Insights

Across the country, there is a split in authority as to whether an insurance company should be allowed to recoup defense costs where it is ultimately determined that the carrier has no duty to defend under the policy and the policy is silent as to such reimbursement. The Hawaii Supreme Court is the latest to enter the fray to address this very question, ruling in favor of policyholders in the recent case of St. Paul Fire & Marine Insurance Company v. Bodell Construction Company.

Facts of the Case and Procedural History

The Bodell case arose in response to a pair of certified questions from the US District Court for Hawaii to the Hawaii Supreme Court. The case involved a group of primary and excess insurers that sold liability policies to Bodell Construction and sought reimbursement of defense costs that the insurers had paid to defend a construction defect claim against Bodell. In the Underlying Action, the District Court ultimately ruled that the claims against Bodell Construction were not covered under the policies. Because the claims were not covered, the insurers demanded reimbursement of the defense fees from Bodell . Having determined there was no Hawaii state law on this issue, and in light of conflicting decisions in the district courts, the US District Court for Hawaii requested guidance from the Hawaii Supreme Court.

The Hawaii Supreme Court was first asked to consider whether an insurer can seek reimbursement for the cost of defending an insured under a reservation of rights if the policy doesn’t specifically allow it. The second question was, if reimbursement is allowed, which specific fees and costs are reimbursable to the insurer.

The Court’s Analysis

In Bodell, the Hawaii Supreme Court joined the group of courts across the U.S. recognizing that an insurer may not use a reservation of rights to recoup defense costs for a claim on which the insurer ultimately owes no coverage. The Court held that insurers cannot recover uncovered defense costs unless the insurance policy explicitly includes a provision permitting this type of reimbursement. The court underscored that the mere issuance of a reservation of rights letter does not confer the right to reimbursement.  

The Court’s ruling was premised on three basic points of law:

Primacy of the Initial Contract: Emphasizing that insurance policies are contractual agreements, the court reiterated that contract terms are subject to standard construction and interpretation principles. Without an explicit provision in the insurance contract allowing for reimbursement, insurers have no grounds to seek it and cannot use a reservation of rights to create new rights under the insurance contract.

It is evident that this portion of the decision is rooted in preserving the integrity of the contractual relationship between insurers and policyholders. The court emphasized that insurance contracts should be interpreted liberally in favor of the insured, and any ambiguities should be resolved against the insurer. The duty to defend, as outlined in the insurance contract, was deemed broad and comprehensive, covering even claims that may ultimately prove groundless or fall outside the policy's coverage. 

Erosion of the Duty to Defend: The court highlighted the fundamental distinction between the duty to defend and the duty to indemnify. Allowing reimbursement for the cost of defending claims not covered by the policy would undermine the broad duty to defend.  

Moreover, the court highlighted the potential risks associated with allowing insurers to recoup defense costs for claims ultimately deemed uncovered. This approach, the court argued, could lead to a retroactive erosion of the duty to defend, potentially compromising the insurer's duty of good faith and exposing them to allegations of bad faith or breach of contract.

Absence of Unjust Enrichment: Rejecting the argument that policyholders are unjustly enriched when insurers defend claims not covered by the policy, the court contended that the duty to defend is an integral part of the contractual relationship, benefiting both parties. Allowing reimbursement would disproportionately favor insurers and upset the balance of the contractual arrangement.

Conclusion

The Hawaii Supreme Court firmly held that insurers lack the right to reimbursement of uncovered defense costs unless the insurance policy explicitly includes a provision permitting such reimbursement. This decision upholds the sanctity of the initial contractual agreement and ensures a fair and balanced relationship between insurers and policyholders. Hopefully, the states that have yet to decide this issue will use the Bodell case and the cogent analysis of the Hawaii Supreme Court to come down on the side of policyholders. 

For more information on this case, contact Amanda C. Stefanatos at AStefanatos@sdvlaw.com.