Allocation Of Defense Costs When Same Defense Counsel Representing An Insured and Non-Insured

I confront this issue often. And I know that many Coverage Opinions readers do as well. 

Here’s the situation. An insurer has a duty to defend its insured. But there is another defendant, related to or aligned with the insured, that is itself not an insured under the policy. So that party is not entitled to a defense. So far, easy.  But, since the insured-defendant and non-insured-defendant are related or aligned (i.e., subsidiary, affiliate, business partner, etc.), both parties are being defended by the same counsel.

On account of the joint-representation, the insured defendant’s defense bills include work performed for the non-insured party. But, despite that, the insured maintains that the insurer should pay the bill in its entirety. So the policyholder’s frequent argument goes -- there was no additional cost incurred for counsel to represent the non-insured party. In other words, counsel was defending “the case” overall and his or her work was not specifically performed for any one party. So the argument continues, the defense costs would be the same, whether counsel was representing only the insured-defendant or both defendants. Therefore, there is no economic harm or impact for the insurer if it must pay the defense costs in full.

This argument is not surprising. And nor is it that some courts accept it, concluding that fees incurred to represent both an insured-defendant and non-insured-defendant that are overlapping, i.e., the work cannot be apportioned between jointly-represented defendants, are payable in full. But the fact remains that a party that is not an insured under the policy enjoys a windfall – and perhaps a really significant one.

This was the issue before a Massachusetts federal court in Lionbridge Technologies v. Valley Forge Ins. Co.  The decision is thorough and it takes a practical approach to reach its conclusion. This may make it an attractive source of guidance for courts confronting the issue.  For these reasons, I believe that the decision merited a spot on the annual Top 10 list.

As a technical matter, the insured won the case. But, as a practical matter, it was a significant win for insurers. The court offered an astute and realistic rationale for addressing this issue. In doing so, it provides insurers with a strong argument to rebut the policyholder’s view that the insurer suffers no harm if it must pay for the entirety of overlapping defense fees. 
     
The facts needed to reach the issue are simple. TransPerfect Global, Inc. sued Lionbridge Technologies and H.I.G. Middle Market LLC in the Southern District of New York over theft of trade secrets. Lionbridge was insured under a liability policy issued by Valley Forge Insurance Company and sought coverage for “personal and advertising injury.”

Valley Forge undertook Lionbridge’s defense under a reservation of rights. Lionbridge retained Kirkland & Ellis as counsel. Kirkland also represented H.I.G. But H.I.G. was not an insured under the policy. This is the paradigm case that gives rise to the insured’s claim for payment of overlapping defense costs.

Lionbridge filed a coverage action to address several issues related to the defense. Valley Forge prevailed on the issue whether it had a duty to defend. The First Circuit reversed, concluding that a defense was owed, and sent the case back to the Massachusetts District Court to address defense fees. That brings us to where we are today.

Valley Forge maintained that its defense payment for Lionbridge should be reduced because counsel also represented H.I.G. Lionbridge argued that Valley Forge should “cover 100% of non-segregable defense costs (i.e., defense costs that would have been incurred to defend Lionbridge irrespective of the existence of any co-defendant) in [the Underlying Case].” [What Lionbridge called “non-segregable defense costs” I call “overlapping fees.” The same thing.]

Round one. The court held that it “agrees with Lionbridge in that Valley Forge’s duty to defend Lionbridge includes all costs reasonably related to the defense of Lionbridge, [and] this Court orders there be a reasonable allocation of costs between the insured and non-insured parties. In doing so, this Court thus aligns with the law proposed by Valley Forge, based on the case by the Massachusetts Superior Court sitting in and for the county of Suffolk, Watts Water Techs., Inc. v. Fireman’s Fund Ins. Co.”

Incidentally, while Watts Water is a trial court decision, it is a go-to decision for Massachusetts courts addressing defense cost issues. Also giving it umph, it was decided by Judge Ralph Gants, who went on to serve as Chief Justice of the Massachusetts Supreme Judicial Court.

Noting that the law is not “homogenous,” the court described the issue as follows: “[w]hether Valley Forge is required to pay all of the reasonable costs of Lionbridge’s defense [. . .] even if someone else, such as a non-insured co-defendant, also benefits.”

Lots of cases were cited to the court, which noted that they are not binding. Lionbridge looked to cases dictating that an insurer must pay all defense costs that reasonably relate to the insured, even if those costs involve a non-insured party.  Valley Forge looked to law that stated that “costs ought be reasonably allocated among both the insured and non-insured parties in view of all surrounding circumstances.”

The court addressed numerous cases and arguments over the issue. The decision is very thorough. While this portion of the opinion is most certainly worthy of review – especially if you have this issue -- I’ll skip it here to get to the outcome – and especially the part that makes the decision a significant win for insurers.

The court held: “This Court concludes that, as decided by the Superior Court in Watts Water, it is only fair to consider ‘the allocation that reasonably would have been negotiated had each party in the joint defense paid its own legal fees,’ (quoting Watts Water) and that the Massachusetts Supreme Judicial Court would follow this rule. Here there are two corporations that were involved in a litigation, and one should not be free of paying for its defense costs. It is worth noting that this Court acknowledges that Valley Forge could seek contribution from the uninsured party and its insurers, but that does not undermine the possibility of reasonably allocating costs at once.”

That’s the key to the case. As observed by the court, if two parties were sued, did not have insurance and were jointly represented, “it is most likely the parties would have negotiated how each party ought pay the fees, and therefore that ought also be recognized in a case like this.”

On one hand, the insured won, as the court held: “Whether Valley Forge must pay all of the reasonable costs of Lionbridge’s defense, even if they involve a non-insured defendant who also received a benefit from it -- the answer is ‘yes.’ Valley Forge must pay all reasonable costs incurred by its insured, Lionbridge.”

But then you get to the remainder of the conclusion, the practical part, and the insurer scored a huge victory:

“[B]ut,” the court stated, “the question of reasonableness will also include allocation of the cost among the parties to the joint defense for work that benefited them both. The reasonable allocation will be made in light of the surrounding circumstances, including ‘relative exposure of the parties to liability, the size of the parties, and the parties most benefitting from the joint defense work.”

By looking at the issue though a lens of reality – two jointly represented parties, that did not have insurance, most likely would have negotiated how each party would pay the fees – the court clearly rejected the policyholder’s favorite refrain that the insurer suffers no harm if it must pay for the entirety of overlapping defense fees since it would have paid the same amount anyway.

Based on the factors set out by the court when considering allocation, there is much opportunity for insurers to obtain a reduction in the amount owed for overlapping fees.