Insurer Should Consider Defense Under a Reservation Rather than Refuse

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Larry Nassar, who was affiliated with nonprofit USA Gymnastics, Inc. (“USAG”), sexually assaulted hundreds of female athletes. After Nassar’s conduct came to light, USAG faced many lawsuits and multiple investigations. USAG and its insurers, including Liberty Insurance Underwriters, Inc., litigated questions about insurance coverage in an adversary proceeding before a bankruptcy court. In a previous appeal, among other rulings, the Seventh Circuit affirmed the decision that Liberty had a duty to defend USAG.

In USA Gymnastics v. Liberty Insurance Underwriters, Inc., No. 21-2914, United States Court of Appeals, Seventh Circuit (August 16, 2022) USAG and Liberty disputed the amount of fees to which USAG was entitled after liability of Liberty to defend was established by the Seventh Circuit.
Right to Reimbursement of Attorneys Fees

There were also ancillary disputes over the amount of attorneys’ fees that Liberty owed USAG.

The underlying facts are described in detail in USA Gymnastics v. Liberty Ins. Underwriters, Inc., 27 F.4th 499, 508 (7th Cir. 2022). In short, Nassar used his position with USAG to sexually assault hundreds of women and girls over several decades. Because of that abuse, USAG has faced hundreds of lawsuits by former athletes, as well as several investigations by federal and state entities, including Congress, the Indiana Attorney General, and the United States Olympic &Paralympic Committee (“USOPC”).

Faced with cross-motions for summary judgment, the bankruptcy court concluded that Liberty’s policy covered the “athlete lawsuits” and various investigations. Liberty filed objections to the bankruptcy court’s findings and conclusions, but the district court overruled those objections. In January 2020, the district court ordered Liberty to “provide a complete defense” to USAG with respect to several matters, including the athlete lawsuits and several investigations. The district court also ordered Liberty to reimburse USAG for its defense costs, but the court did not award damages in any specific amount. Liberty appealed the district court’s order.

While the first appeal was pending, the parties continued to dispute and litigate issues concerning payment. Liberty did not agree to USAG’s demand and sought to stay the district court’s defense order. In turn, USAG moved to enforce the order.

In addition, USAG offered the expert testimony of attorney Gene Schoon, who had prior experience serving as a national coordinating counsel during his days as a practicing lawyer. He testified that in his opinion, all the fees USAG sought were reasonable and necessary. On the other hand, Liberty presented the expert testimony of attorney Brand Cooper. At that point, Cooper testified that he determined certain fee amounts incurred by USAG-which totaled about $1.43 million-were reasonable and necessary. Yet almost immediately, Cooper contradicted his prior testimony. In answer to the court’s questions, Cooper expanded on the nature of his objections but refused to give concrete figures that were not disputed.

In September 2020, the bankruptcy court entered proposed findings and conclusions. The court rejected Liberty’s arguments and concluded that under applicable case law, USAG was entitled to a presumption that the fees incurred were reasonable and necessary. The court also found Schoon “to be the more credible and reliable expert witness.” According to the bankruptcy court, USAG had proved by a preponderance of the evidence that $1,944,354.26 of the fees it incurred were reasonable and necessary. So, the court recommended that the district court enter judgment in that amount, plus prejudgment interest. Liberty filed objections to the bankruptcy court’s proposed findings and conclusions.

The live controversy, because of payments made by Liberty, before the Seventh Circuit concerns the remaining $458,472.26 of the judgment.
Presumption that Attorneys’ Fees are Reasonable & Necessary

Liberty contends the bankruptcy and district courts improperly applied the law when they concluded that the fees USAG incurred were reasonable and necessary.

In Taco Bell Corp. v. Continental Casualty Co., the Seventh Circuit considered a scenario in which an insurer had breached its duty to defend but later argued the policyholder had incurred excessive fees. Under those circumstances, the court held, the policyholder “had an incentive to minimize its legal expenses” such that there was “no occasion for a painstaking judicial review.”

The presumption is akin to a burden of proof because it determines the outcome in cases where the evidence is in equipoise and therefore advances the substantive policies of a state. This points to the presumption as more substantive than procedural.

In Liberty’s view, USAG is not entitled to the presumption because it failed to adequately supervise the outside counsel it engaged, and it did not pay in full the fees it incurred. According to Liberty, USAG did not meaningfully supervise outside counsel because Schneider never requested write-offs from outside counsel and rarely followed up with them to ask questions about invoices they submitted.

A litigant may supervise its outside counsel without refusing to pay portions of legal bills or engaging in hairsplitting about those bills. Nothing in the case law provides otherwise. Liberty argues that the Thomson presumption does not apply because USAG failed to pay about 30 percent of the fees it incurred.

The market-tested presumption applies when, following an insurer’s breach of the duty to defend, a policyholder has supervised and incurred legal fees without any expectation of payment by the insurer. Payment by the policyholder is not necessarily required. This is because, as here, the policyholder may lack sufficient funds to pay fees that are reasonable and necessary to its defense. But if the policyholder does pay a significant percentage of its fees-particularly when it has difficulty covering its day-to-day operating expenses-that is strong evidence of market incentives to economize, rendering the presumption applicable.

It is undisputed that USAG paid nearly 70 percent of the attorneys’ fees for which it now seeks reimbursement. That is compelling evidence of a market test. This element of the Thomson presumption supports, rather than contradicts, the bankruptcy and district courts’ conclusions that the fees USAG claimed are presumed to be reasonable and necessary.
Incorrectly Refusing to Defend Eliminates the Insurer’s Right to Control Defense Costs

An insurer’s objections to a policyholder’s selection of defense counsel lose force when the insurer disclaims its duty to defend and turns out to be wrong on the law. Had Liberty mistrusted USAG’s incentive to economize on its legal costs, Liberty could have reserved its defense that it had no duty to defend and assumed USAG’s defense. In that scenario, Liberty could have selected and supervised and paid for the lawyers defending USAG, and Liberty could later have sought reimbursement if it proved that it had indeed had no duty to defend. Liberty chose not to do so, instead electing to gamble by not defending USAG.

The court concluded USAG’s practices were nevertheless sufficient to support the Thomson presumption’s application, as “[i]nvoices were reviewed at three different levels which included review by the Chief Financial Officer responsible for overseeing and authorizing payment of USAG’s expenses.” As a fact-specific ruling concerning attorneys’ fees, that determination is due significant deference that the Seventh Circuit provided and concluded that there is not an adequate basis to disturb it.

There is no dispute that USAG was bankrupt and lacked money to spare. Liberty has not identified evidence to challenge the factual finding that USAG used the grant money to stay afloat by paying some bills it had incurred. The record does not support, much less require, any finding that USAG stockpiled vast sums of money for legal expenses, which would have removed any need to economize.

Because the total-value approach for which Schoon advocated applies here, it is unnecessary to scrutinize individual line items in the manner Liberty requests.

Therefore, the judgment was affirmed.
ZALMA OPINION

Insurers take the risk of paying more for the defense of an insured when it refuses to defend and is later found to have erred and a court orders the insurer to defend or indemnify the insured. In such situation a presumption exists that an insured, using its own money to pay counsel paid only reasonable and necessary fees. As the Seventh Circuit concluded the insured – in bankruptcy – did not have money available to pay excessive fees and presumed what they paid and what they were unable to pay were reasonable and necessary and Liberty must reimburse USAG for those fees. If Liberty defended under a reservation of rights it could control the fees and if it was found to have no coverage it could get reimbursement from the insured from whatever assets available from the bankruptcy court. Liberty gambled it was right and lost and must pay the fees charged to USAG.

(c) 2022 Barry Zalma & ClaimSchool, Inc.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business. He is available at http://www.zalma.com and [email protected].

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