On April 30, 2015, we blogged about Hartford Casualty Insurance Company v. J.R. Marketing, LLC, Case No. S211645, then set for oral argument in the California Supreme Court. [see the prior post: California’s “Independent” Cumis Counsel Regime Faces a Novel Challenge] The Court decided the case on August 10, 2015, ruling that Hartford could seek reimbursement of unreasonable or excessive fees directly from Cumis counsel. We’ll outline here the implications of the ruling and suggestions for how policyholders and Cumis counsel might respond. 

On the one hand, the Court took pains to describe its ruling as very narrow. Hartford had denied coverage and resisted paying the defense invoices even after the trial court found it owed a duty to defend. Squire Sanders, representing J.R. Marketing, then obtained an enforcement order requiring Hartford to pay its invoices within thirty days, but giving Hartford the right to seek reimbursement of uncovered fees and costs, including unreasonable or excessive fees, once the case was over. By the end of the case, Squire had been paid $15 million. The Court repeated that its decision was grounded in the enforcement order, which Squire had drafted and gave Hartford an express right to reimbursement. In that context, the Court held that allowing Hartford to recover from Squire in the first instance was consistent with the law of unjust enrichment and would not interfere in the attorney-client relationship. Running through the decision, including Justice Liu’s concurring opinion, is an undercurrent of suspicion that Squire, with an unsophisticated client and an enforcement order in hand, felt it had carte blanche to bill to its heart’s content. 

It’s important to understand a limitation the Court placed on the insurer’s right to get money back from counsel. The insurer carries the burden to show that the fees were both (1) objectively unreasonable at the time incurred and (2) not incurred for the insured’s benefit. The latter showing prevents counsel from having to reimburse fees that the insured knowingly authorized even if later determined to be excessive. 

This limitation is significant. It essentially requires the insurer to demonstrate that the insured did not approve, or was misled about the purpose of, the defense counsel’s work. That is a high burden. And Justice Liu suggested in his concurring opinion that the burden should be raised further by creating a presumption that the work was for the insured’s benefit. In other words, an insurer will have big hurdles to jump before obtaining reimbursement from defense counsel. 

While narrow and limited, the Court’s reasoning does pose risks to independent defense counsel. The Court grounded its decision in part on a reading of Civil Code §2860 – California’s “Cumis statute” governing the independent counsel relationship. Section 2860(c) provides for an arbitration to resolve fee disputes when the policyholder has chosen independent counsel. The Court made clear that the fee disputes subject to arbitration include not just those over hourly rates, but also over the reasonableness of fees. More importantly, the Court held that counsel may be a proper party to a §2860 arbitration. As a result, the Court’s ruling in fact applies potentially to any independent counsel relationship governed by §2860. 

What does the ruling mean for the ordinary case where the insurer agrees to defend under a reservation of rights and the insured chooses independent counsel? Billing disputes frequently arise. Most insurers have adopted billing and case management guidelines for panel counsel designed to keep costs down and usually treat those guidelines as the standard for what is “reasonable.”  Insurer audits of independent counsel invoices often result in claims that 10-30% of the work is excessive. Often the insured, counsel and the insurer work out a practical relationship as the case proceeds and the disputes sort themselves out. 

But if the disputes continue, the insurer doesn’t pay in full and seek reimbursement. It simply doesn’t pay what it thinks is unreasonable. The insured pays counsel in full and accumulates a claim for the unpaid balances against the insurer. The client is the one seeking reimbursement from the insurer. Is counsel immune here? Probably not. As a dispute subject to §2860, the insured, not just the insurer, can join counsel to the arbitration and seek reimbursement from counsel of any amount deemed unreasonable and not for the insured’s benefit. 

In this light, the ruling isn’t intended so much to protect the recalcitrant insurer like Hartford, but to protect the unsophisticated insured who has to rely on counsel to determine what work really is reasonable and beneficial. J.R. Marketing places the burden squarely on counsel to avoid disputes by communicating early and often with the insured and the insurer about what work needs to be done. 

What happens when the insurer breaches its duty to defend and the insured seeks to recover its fees from the insurer in a breach of contract suit? Can the insurer or the insured join counsel as a party to that lawsuit? Here is where the Court’s decision truly remains narrow. It expressly did not decide whether an insurer that has breached its duty to defend has any right to recover excessive fees (or, presumably, to raise them as a defense in the insured’s suit). The Court also did not decide whether this fee dispute should be decided in an arbitration or lawsuit. On this last point, several court of appeal decisions have ruled that a breaching insurer cannot invoke the fee limitation or arbitration provisions of §2860. 

Finally, the Court did not decide whether a fee dispute may be resolved while the underlying litigation is pending. In Montrose v. Superior Court, the Court held that an insurer’s declaratory relief action may be stayed if it raises issues that could prejudice the insured in the underlying litigation. The argument could be made that forcing the insured and its counsel to adjudicate the fee issues could prejudice the insured by putting it and its counsel in adverse positions while the underlying case is pending. The Court was not particularly concerned with the effect on the relationship of only a possible reimbursement action after the underlying litigation is resolved but might view the issue differently if the underlying litigation is pending. 

The broader concern with J.R. Marketing is that it could chill the insured’s exercise of its right to independent counsel. Some insurers reserving rights aggressively resist acknowledging the insured’s right to choose. These same insurers may wield the threat of entangling independent counsel in disputes with the insured to persuade the insured to accept panel counsel. The advice to the insured may be:  The net effect of J.R. Marketing is to increase the value of independent counsel because now that counsel, not the insured, will be directly responsible for any fees that were not reasonable and for the insured’s benefit.