Turning Pre-Litigation Expenses Into Reimbursable Defense Costs
Pre-litigation costs - costs incurred to defend a claim that a company knows will be made against it but prior to the point that its insurer assumes the defense - often are significant and unavoidable. Events that result in claims typically happen without warning, and when a tragedy strikes, companies must respond immediately. Depending upon the situation, civil and criminal procedural rules may impose immediate duties to preserve evidence, adverse publicity may taint the jury pool, and potential plaintiffs will ride the proverbial coattails of governmental investigations to develop cases.
Faced with these situations, companies are often forced to immediately retain counsel to manage their liability exposure. The problem, however, is that insurance companies often decline to pay for an insured's pre-litigation defense costs - especially if the insurance company is not in control of the defense. In those situations, the insured can be left funding its own defense until plaintiffs actually file suit. This article discusses how a company can maximize its ability to recover pre-litigation costs by avoiding common and costly mistakes.
A Matter of Timing
General liability policies typically require insurance companies to pay reasonable and necessary attorney fees and litigation expenses that an insured incurs to defend itself against covered claims. When pre-litigation defense costs are involved, however, most insurers try to take the position that their duty to defend is not triggered unless or until they receive notice of a potentially covered claim.1
Fortunately, courts have found that pre-litigation expenses can be recovered as defense costs where a lawsuit is ultimately filed against an insured, even where the insurer had previously refused to pay for the expenses. The issue usually turns on the circumstances specific to each case, and whether the fees and costs were reasonable and necessary to the defense of a potentially covered claim. Where they are, courts often find that the insurer must reimburse some or all of the costs.
Questions of Fact and Law
Recovering pre-litigation costs involves mixed questions of law and fact. The threshold issue is whether pre-litigation costs are or can be covered under the policy and the law of the jurisdiction. If the costs and expenses are covered, the factual question is whether the costs were reasonable and necessary to the insured's defense.
When there is a reasonable possibility that events will give rise to a lawsuit, and a suit is ultimately filed, costs incurred prior to the lawsuit may become reimbursable as defense costs. Generally, courts hold insurers liable for pre-litigation defense costs when there is a reasonable possibility at the time the costs were incurred that liability lawsuits will ensue, and the pre-litigation services would have been rendered after a lawsuit was filed.
For example, in Liberty Mutual Insurance Company v. Continental Casualty Company, the U.S. Court of Appeals for the First Circuit held that "pre-suit services were correctly considered as part and parcel of the defense against the liability suits."2 There, the insured installed glass panels in the Hancock Tower in Boston, Mass. When the panels failed, the insured tried to fix the problem, which caused a two-year delay in the filing of lawsuits. When lawsuits finally came, one of the general liability insurers, Continental Casualty, refused to defend two of the suits.3
The court found that "in the circumstances of this particular case…the pre-suit services were correctly considered as part and parcel of the defense against the liability suits" because: (1) the insured notified Continental immediately after the first lawsuit was filed; (2) "[t]he extent of the  problem was so great that it was almost certain that a suit would be filed;" and (3) the evidence demonstrated that "most, if not all, of the pre-suit services would have been performed after suit was filed had they not been performed before and that the insurance experts felt that [the insured] had little choice but to retain counsel and prepare to defend itself when it did."4
Similarly, in International Flavors & Fragrances Inc. v. Royal Insurance Company, a New York trial court held Royal Insurance Company liable for pre-lawsuit defense costs incurred by Bush Boake Allen (BBA) (a subsidiary of named defendant International Flavors & Fragrances (IFF)), even though BBA was not yet named in the suit.5 In International Flavors, employees at a popcorn factory named butter-flavoring manufacturer IFF as a defendant in a personal injury class action, but only mentioned BBA.6 Six months later, plaintiffs added BBA as a defendant. In the ensuing coverage action, the court held that the insurers "breached their obligation to defend BBA by not paying its pre-litigation costs" because "there was a reasonable possibility that BBA would be sued."7
As these cases demonstrate, varied situations can pose a "reasonable possibility" of litigation. For example: (i) following an accident, injured parties retain counsel and express their intent to sue the insured; (ii) the insured becomes aware of a lawsuit against a third party with which the insured has a relationship that could reasonably result in derivative or direct liability to the insured (e.g., contractual relationship, parent-subsidiary relationship, or joint venture); or (iii) the insured becomes aware of injuries that result from defective products, property, or construction.
Foreseeability of lawsuits is not enough to recover all pre-litigation fees and expenses. To be recoverable, pre-litigation work also must be of the type that would have been required after the lawsuit was filed. Where the work is actually utilized to defend the lawsuit, the insured stands the best chance of recovery. But pre-litigation costs can be recoverable even when the work is not actually used in the defense of the lawsuit. For example, if a lawsuit is settled before significant discovery, an insured still may recover fees and expenses associated with collecting and preserving evidence if, among other things, the insured had a duty to collect and preserve the evidence. The same could be true if the insured needed to immediately retain experts and consultants to evaluate the situation and assist in the defense.
Demands for pre-litigation fees and expenses are subject to the requirement that the fees be reasonable and necessary. The "reasonableness" test is the final step to assess the amount that an insured may recover. Generally, the insured has the burden to establish that the fees and expenses were in fact "reasonable." When an insurer has denied coverage, however, some courts find that the insurer waived its right to object on the basis of "reasonableness."
Courts recognize that the best indicator of "reasonableness" is the fact that the insured paid the fees without knowing that its insurer would reimburse them. Additional factors include: significance of the matter to the insured; time, labor, and skill required; novelty and difficulty of the issues; amount involved and the results obtained; the law firm's relationship with the insured; and the experience, reputation, and ability of the attorneys.
Insurers usually assert a number of objections to avoid paying pre-litigation defense costs. They are likely to claim that they have no obligation to reimburse an insured for such costs by asserting that they had no duty to defend the insured at the time the costs were incurred.
If a policy contains a so-called "voluntary payments" provision, an insurer also can be expected to assert that such provision precludes reimbursement if the insured did not obtain the insurer's consent before incurring the costs. Because a "voluntary payments" provision is an exclusion, the insurer bears the burden to prove that the exclusion applies. Moreover, case law does not unequivocally support insurers' "voluntary payment" argument, and insureds can demonstrate that their payments were not "voluntary" if, for example, payments were pursuant to government order.
Another common argument from insurers is that an insured should be estopped from recovering fees to which an insurer did not consent or that an insured who did not request consent to costs incurred has waived a right to seek reimbursement. Courts do not universally favor these arguments and have rejected them where an insurer has denied coverage for the claim.
• Paper the File. Insureds should "paper the file" with developing situations that the insured expects will give rise to litigation, provide the insurer with information and updates about defense efforts, identify defense counsel and the reason for retention, and provide prompt, timely notice of any situation that might give rise to a claim or a lawsuit. Papering an insurer's file helps in many ways: claims handlers require information about defense efforts and case management to asses the validity of an insured's claim for reimbursement, to report to management and to reinsurers, and to obtain settlement authority. Additionally, insurers frequently argue that an insured's' failure to provide notice and cooperate precludes coverage.
• Know Your Invoices. Whether pre-litigation costs were incurred by one law firm or 20, an insured can benefit greatly from an early audit of invoices to assess the reasonableness and necessity of defense efforts and to determine the relationship between the pre-litigation work and the covered lawsuit. Regular and early audits can help contain costs, estimate the likelihood of recovery for the work, and develop the strategy to maximize recovery from an insurer. Also, such an audit is likely to be necessary in any event, because insurers typically conduct their own invoice review to seek out bases to refuse payment. Knowing the invoices, why work was done, and managing the defense is critical.
• Monitor Insurer's Requests for Information. Insurers frequently request information and almost always want to be apprised of developments. However, when significant work is done by defense counsel immediately after an occurrence and before an insurer's duty to defend is triggered, much of the information or documents that an insurer requests are likely to be the fruits of pre-litigation labor. This could include, for example, witness lists, witness interviews, documents or evidence preserved as a result of an immediate "litigation hold," steps taken to secure forensic data retention in an effort to preserve electronically stored information, and reports by consultants and experts. Insurers frequently use the information they receive to set reserves, update reinsurers, and evaluate coverage.
To maximize the likelihood of recovering pre-litigation expenses, an insured should provide as much information as possible to satisfy the insurer's requests. This does not mean that an insured should automatically comply with all requests. Rather, the insured should carefully evaluate the insurer's requests and, through consultation with counsel, determine what to provide. Insureds should make certain to document all insurer requests, and the date that a response was given, as well as all of the information that the insurer receives.
• Make Defense Counsel's Invoices Defensible. Finally, an insured would be wise to take steps to enforce billing practices that comply with its insurer's billing guidelines, as insurers often object to defense counsel invoices that do not comply with these guidelines. Counsel should become familiar with the guidelines and comply with them whenever appropriate, objecting in cases where compliance with the guidelines might jeopardize the defense. Insureds should also make an effort to see that defense counsel has implemented appropriate billing guidelines and legal cost containment programs to preempt an insurer's objections, reduce legal costs, and improve litigation efficiency.
If an insurer is unwilling to reimburse pre-litigation costs, an insured can pursue a number of different options. Mediation can be an inexpensive and effective tool. If litigation is necessary, the insured should consider making an early motion for summary judgment seeking a ruling on the insurability of pre-litigation defense costs. Such a motion can reduce costs and promptly resolve purely legal issues. And, when negotiating with the insurer, the insured's mantra should be that the pre-litigation costs are reasonable and necessary to the defense of a covered claim.
Joseph D. Jean, counsel in Dickstein Shapiro's insurance coverage practice, focuses on insurance coverage matters, commercial litigation, and alternative dispute resolution. Rachel M. Wrightson is an associate in the firm's insurance coverage practice.
1. Depending upon policy language, a "claim" may be, for example, a demand for money or the filing of a lawsuit. For ease of reference, we use the term "pre-litigation costs" to apply to any definition of a claim.
2. Liberty Mut. Ins. Co. v. Cont. Cas. Co., 771 F.2d 579, 586 (1st Cir. 1985).
3. 7 Id. at 580-81.
4. Id. at 586.
5. Int'l Flavors & Fragrances Inc. v. Royal Ins. Co. Am., 2003 WL 24013814 (N.Y. Sup. Ct. March 31, 2003).
6. Id. at *2.
7. Id. at *5-6.