Policyholders are often surprised when their professional liability insurers contend they (that is, the insurers) have the right, after a determination of non-coverage, to seek recoupment of amounts paid under the policy. These disputes can be controversial enough even when the policy expressly provides the insurer with the right to seek recoupment; the controversy is greater when the policy does not expressly provide for recoupment but the insurer nonetheless seeks reimbursement in reliance on its reservation of its rights to seek recoupment.

A recent decision by the Sixth Circuit, applying Michigan law, explored these issues and ultimately affirmed the district court’s ruling that the insurer was entitled to recoup amounts paid in defense after the underlying complaint was amended to remove the only covered claims, even though the policy contained no express recoupment provision. The appellate court’s decision raises several interesting issues, as discussed below. A copy of the Sixth Circuit’s April 8, 2024, opinion can be found here. (Hat tip to Geoffrey Fehling of the Hunton Andrews Kurth law firm whose LinkedIn post linked to the appellate opinion, here).

Background

Stout Rios Ross is financial advisor and valuation expert. From December 2004 through 2017, Stout provided valuation services to the ESOP that owned Appvion. In October 2017, Appvion declared bankruptcy. The ESOP suffered millions of dollars of losses. In subsequent civil actions, the claimants alleged that Stout overvalued the ESOP’s holdings and induced Appvion’s employees to invest their retirement savings in the ESOP. As initially filed, the underlying complaints alleged violations of ERISA and of the securities laws, as well as under common law.

Stout submitted the underlying claims to its professional liability insurer. The insurer agreed to defend but reserved its right to seek a judicial declaration of its rights under the policy and to seek reimbursement of amounts it paid if it had no duty to defend or indemnify Stout. The insurer filed an action in federal court in Michigan seeking a declaration that it had not duty to defend or indemnify Stout under the policy. The insurer relied on Exclusion F to the policy, which precluded coverage for loss arising from actual or alleged violations of ERISA or of the securities laws.

The insurer moved for partial summary judgment in the coverage action. The district court denied the motion, holding that Exclusion F did not preclude coverage for the common law claims in the underlying complaints.

On September 25, 2020, the plaintiffs in the underlying actions amended their complaints, asserting only federal securities law claims, and no common law claims. The insurer renewed its motion for partial summary judgment seeking reimbursement for amounts paid in defense of the underlying claims, bifurcating its recoupment claim between the fees incurred before September 25, 2020, and the fees incurred thereafter. The district court denied the insurer’s motion for the amounts incurred before September 25, 2020, but granted the insurer’s motion with respect to the fees incurred after that date. The parties cross-appealed.

The April 8, 2024, Opinion

In an opinion marked “Not Recommended for Publication” and written by Judge John K. Bush for a unanimous three-judge panel, the Sixth Circuit affirmed the district court’s judgment, holding in particular that while the insurer was not entitled to reimbursement of defense fees paid prior to September 25, 2020, it was entitled to reimbursement of amounts paid thereafter, even though the policy had no express reimbursement provision.

The appellate court first affirmed the district court’s holding that Exclusion F did not preclude coverage for the common law claims asserted in the initial underlying complaint, even though the common law claims involved the same operative set of facts; and affirmed the district court’s holding that the insurer did not have the right to seek reimbursement of the fees incurred prior to September 25, 2020, before the claimants in the underlying action amended their complaint to remove the common law claims.

The appellate court then turned to the question of whether the insurer had the right to seek reimbursement of the defense fees paid after September 25, 2020. In asserting its supposed right to seek reimbursement, the insurer relied on an “implied-in-fact contract theory.”

The appellate court noted that the policy did not “expressly authorize such reimbursement,” and noted further that the district court had concluded that the insurer nonetheless had the right to seek reimbursement “where – as here – an insurer expressly reserves its right to reimbursement and notifies the insured of the specific possibility of reimbursement,” a process by which the district court had said the parties had formed “an implied-in-fact contract for the reimbursement of costs expended by the insurer for claims that it had not duty to defend.”

In considering the district court’s conclusion, the appellate court weighed the Michigan law applicable to the insurer’s implied-in-fact contract theory; the court said that it was required to make a so-called “Erie Guess” as to what the Michigan Supreme Court would resolve the issue. (More about the “Erie guess” issue below.) The appellate court found that Michigan’s courts, as a general matter, had recognized “implied-in-fact” contracts, and found further that the “majority of jurisdictions” position on the reimbursement issue to be “persuasive,” at least where the insurer sought reimbursement in reliance on a timely reservation of rights letter providing notice of the specific possibility of reimbursement.

Stout had tried to argue that the contractual issues were unsupported because of the lack of a mutual assent to the implied in law contractual requirement. In rejecting this argument, the appellate court found that Stout accepted the defense after the insurer had timely notified Stout that it might seek reimbursement. That, the appellate court said, “is sufficient manifestation of assent under Michigan law.”

The appellate court concluded by saying that “although Michigan law does not clearly establish [the insurer’s] entitlement to reimbursement, the ‘relevant data’ suggest that the Michigan Supreme Court would recognize an implied-in-fact contract here.” The appellate court thus affirmed the district court’s holding that Stout must reimburse the insurer for the defense fees incurred after September 25, 2020.

Discussion

As I have noted in prior posts discussing an insurer’s right to seek recoupment of amounts paid prior to a determination of non-coverage (for example, here), the insurer’s recoupment rights are better established where an express policy provision so provides. Whether an insurer has the right to seek recoupment in the absence of an express policy provision and in reliance only on an assertion of a reservation of its right to seek recoupment is less well-established and is often a factor of the relevant facts (that is, what the insurer did or said in an attempt to reserve its rights to seek reimbursement) and of the applicable law.

The federal appellate court here concluded, in the absence of governing Michigan law, that the insurer had right to seek recoupment of fees paid after the underlying complaint was amended to remove the covered causes of action, and so concluded based on an “implied-in-fact” theory of contractual law. In reaching these conclusions, the appellate court relied on what it called an “Erie guess.”

The phrase “Erie guess” refers to an attempt by a federal court to determine how it thinks the highest court in the jurisdiction whose law applies would decide the relevant issue. The word “Erie” in the phrase is reference to the Erie Doctrine, a body of federal court law built upon the U.S. Supreme Court’s 1938 decision in Erie Railroad Co. v. Tompkins, in which the Supreme Court held that federal courts must apply state law in diversity jurisdiction cases. Though the phrase “Erie guess” implies guesswork, the established process requires federal courts to make a reasoned determination based on available information, which is what happened here.

Whether or not you are comfortable with courts implying contractual terms in the absence of express provisions, or even (as this court did here) implying assent to implied contractual provisions by the acceptance of an insurer-funded defense (as if anyone anywhere ever would decline an insurer funded defense), it is clear that the question whether an insurer has the right to seek reimbursement in the absence of an express policy provision is very much a factor of state law. And as I noted above, is also dependent on the process the insurer follows as well. An insurer that fails to timely or effectively reserve its rights to seek reimbursement would likely not, in the absence of an express policy provision, be held to have the right to seek reimbursement.

It is probably worth noting that it is not a regular occurrence for insurers to seek recoupment. One reason is that after legal proceedings have played out and the insurer has obtained a determination of noncoverage, the policyholders’ resources often are exhausted. There may be nothing left for the insurer to recover.

Another reason that it is not a regular occurrence for insurers to seek recoupment is that in many instances it may be poor public relations for insurance companies to go around suing the persons they insure and seeking to recover amounts they have already paid.

Nevertheless, insurers’ efforts to seek reimbursement are sufficiently common that it is worth focusing on two of the important inputs to a recoupment dispute – that is, whether and to what extent the policy expressly provides the insurer the right to seek recoupment, and whether and to what extent the insurer has timely and properly reserved its rights to seek recoupment. These seem likely basic blocking and tackling measures for insurers to take, while at the same time they are items for policyholders to watch for and monitor.

While I have focused my discussion of this appellate decision on the court’s analysis of the recoupment issue, readers interested in insurance coverage issues generally will want to review the section of the court’s opinion in which the appellate court considered whether the claimants’ initial common law claims “arose out of or were based upon” the excluded ERISA or securities law claims. The appellate court’s conclusion the notwithstanding the exclusion’s broad preamble, and not withstanding the fact that the common law claims involved the same operative underlying facts, that coverage for the common law claims was not precluded is interesting and worth reviewing.