It is black letter, in just about all states, that an insurer has a duty to defend the entire complaint filed against its insured, so long as just one claim (of many) is potentially covered. For this reason, the issue of how to allocate an insured’s defense costs, between potentially covered, and not covered, claims, has little reason to arise. This is not to say that it doesn’t (see California) – but, for the most part, it has little reason to. [A close cousin of the issue is whether an insurer that it defending its insured is obligated to pay for the insured’s legal fees associated with its pursuit of a counterclaim.]

But now consider an insurer that is defending an insured, and the insured’s counsel is also defending other defendants, that are not insureds. While there is a rule that an insurer has a duty to defend all claims, so long as it has a duty to defend one of them, there is no rule that an insurer has a duty to defend all defendants, so long as it has a duty to defend one of them. In this later situation, an insurer would like to be relieved of its duty to pay defense costs incurred on account of the non-insured defendants.

This was the issue before the federal court in High Point Design, LLC v. LM Insurance Corporation, No. 14-7878 (S.D.N.Y. Feb. 3, 2016). The underlying litigation, that gave rise to the defense costs issue, involved infringement of a slipper patent (really, that’s what it says, a slipper patent). It is not necessary to unravel the specifics of the underlying litigation to make the points here. Consider this – a court determined that Liberty Mutual had a duty, under liability policies, to defend its insured, High Point Design, in the patent litigation. Two law firms defended High Point Design, as well as other defendants – called the “Retail Defendants.”

At issue before the Gotham federal court was the amount of defense costs that Liberty owed to its insured, High Point, considering that the law firms also represented the Retail Defendants, which were not Liberty insureds.

The parties agreed on one point, that “any ‘additional expenses’ which were incurred in the Underlying Action solely in defense of the Retail Defendants fall outside of the insurance coverage High Point purchased from Liberty and are not recoverable.” However, they did not agree on another: “[W]hether defense expenses in the Underlying Action that redounded to the benefit of both High Point and the three Retail Defendants are entirely recoverable (High Point’s position) or should be divided pro rata between the four benefiting parties (Liberty’s position).”

The court set out to resolve the issue, noting that “[c]ase law on the proper apportionment of defense costs among insured and non-insured defendants is scattered and ‘rather sparse.’”

Since the parties agreed that Liberty had no obligation to pay any costs that were incurred solely in defense of the Retail Defendants, the real issue was how to determine which defense costs were incurred for what.

The court placed this burden on Liberty, stating that “the law is clear that the party seeking to allocate expenses bears the burden of proving what amount of allocation is appropriate once the insured has made a prima facie showing that certain amounts were spent in its defense.”

As for how to achieve such allocation, the court explained that “the amount that should be allocated to the non-covered parties, and thus not recouped from the insurer, are any ‘additional expenses’ which would not have occurred but for the inclusion of the non-covered defendants. Which expenses were in fact “additional” is …’a substantial fact issue.’”

While the court gave Liberty the right to allocate defense costs, between covered and non-covered defendants, trying to determine which client benefits from certain defense efforts may not be easy to do. Litigation is not always a neat and tidy process where you can determine that certain defense efforts satisfied a specific purpose. Thus, there are likely to be challenges for an insurer attempting to establish that certain defense costs would not have been incurred “but for” the inclusion of the non-covered defendants. Not to say it can’t be done. But it is easy to see why Liberty advocated for a simple pro-rata approach.