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American and Foreign Insurance Co. v. Jerry's Sport Center

August 17, 2010


Appeal from the Order of the Superior Court at No. 1098 MDA 2006 dated May 5, 2008 Reversing the Order of the Susquehanna Court of Common Pleas, Civil Division, at No. 2001-939 dated June 13, 2006

The opinion of the court was delivered by: Mr. Justice Baer


ARGUED: May 13, 2009


The issue in this case is whether, following a court's declaration that an insurer had no duty to defend its insured, the insurer is entitled to reimbursement of the amounts paid for the defense of its insured in the underlying lawsuit. The trial court held that the insurer was entitled to reimbursement, while the Superior Court held that it was not. For the following reasons, we affirm, holding that an insurer is not entitled to be reimbursed for defense costs absent an express provision in the written insurance contract.

Appellant Insurance Companies are American and Foreign Insurance Company, Royal Insurance Company of America, Safeguard Insurance Company, and Royal Indemnity Company (collectively, Royal). Appellees are Jerry's Sport Center, Inc. and its subsidiaries, Jerry's Sport Center Northeast, Inc., Bonitz Brothers, Inc., Outdoor Sports Headquarters, Inc., Simmons Gun Specialties, Inc. (collectively, Insured). Insured is a firearm wholesaler-distributor and Royal is its commercial liability insurer.*fn1

Royal and Insured entered into a commercial liability primary and umbrella insurance contract on or about October 18, 1981, which Insured maintained until about October 18, 2000. This policy insured against bodily injury*fn2 and obliged Royal to pay all expenses it incurred defending Insured. Reproduced Record (R.R.) 993a. It contained no language granting Royal the right to reimbursement of defense costs for a claim ultimately held not to be covered by the insurance contract.

In June, 2000, the National Association for the Advancement of Colored People (NAACP) and the National Spinal Cord Injury Association (NSCIA) filed a civil action against eighteen firearms wholesalers and distributors in the United States District Court for the Eastern District of New York (NAACP action). The NAACP and NSCIA sought to hold the firearms industry liable for injury, death, and other damages to association members through the negligent creation of a public nuisance by virtue of the industry's failure to distribute firearms reasonably and safely. In May of 2001, the NAACP added Insured as a defendant. In its complaint, the NAACP and NSCIA explicitly alleged that the defendants had caused bodily injury to their members. In its prayer for relief, the NAACP sought injunctive relief and monetary damages to establish a fund for the education, supervision and regulation of gun dealers. It did not seek damages to compensate individual members injured by the defendants' actions.

Insured notified Royal of the NAACP action and requested defense and indemnification, claiming that the complaint fell under the "bodily injury" coverage provided by the liability insurance. Royal retained the New York City law firm of Leahey & Johnson to represent Insured in the NAACP action; choosing this firm because of its expertise and past representation of gun industry defendants in a similar action brought by the NAACP. Royal believed that Insured would fair better with independent counsel than in a group defense assembled by other defendants.

In a letter dated June 15, 2001, Royal informed Insured that it had assigned Leahey & Johnson to provide a defense in the NAACP action, and that it was examining available coverage under the insurance policy. Royal further advised that it was providing Insured with a defense under a full reservation of rights, including the right "to seek reimbursement for any and all defense costs ultimately determined not to be covered." R.R. 2703a.

Insured expressed concern that if Royal ultimately determined there was no coverage available to Insured, then it might be less costly for Insured to join a defense group with other defendants rather than proceed with Leahey & Johnson. Royal responded that Insured had the right to retain its own counsel to represent its uninsured interests or to continue to permit Leahey & Johnson to represent their mutual interests. Insured did not obtain independent counsel.

By telephone and letter dated July 12, 2001, Royal indicated that its preliminary assessment revealed that it may be under no duty to defend or indemnify Insured, and that, again, Royal specifically reserved the right to disclaim defense and indemnity based upon the terms of the insurance contract. Royal pledged that during its investigation, it would participate in advancing reasonable and necessary defense costs in the NAACP action with the express reservation that Royal "may seek reimbursement of some or all of these costs in a future declaratory judgment action.." R.R. 2706a. On July 18, 2001, Royal yet again informed Insured that it would continue to pay for Insured's defense until it made its final coverage determination, but that it reserved the right to seek reimbursement for "any and all of the defense costs it incurs in the defense of this matter." R.R. 2718a.*fn3 By letter dated August 3, 2001, Royal once more indicated that it would fund the defense until it determined the coverage issue. In this letter, however, unlike the letters of July 12 and July 18, 2001, it specifically informed Insured that it would not seek to recover the defense costs incurred before a final determination of coverage was made, by either Royal or a court, whichever occurred first.

On September 7, 2001, Royal issued a final coverage determination letter informing Insured that pursuant to their insurance contract, Royal "may be under no duty to defend or indemnify [Insured]." R.R. 2724a. Royal further advised that it was contemplating filing a declaratory judgment action to seek a declaration that it was under no duty to defend, and that it may seek reimbursement for some or all of the defense costs incurred after the filing of the declaratory judgment action. Shortly thereafter, on September 12, 2001, Royal followed through and filed a declaratory judgment action seeking a determination that it had no duty to defend or indemnify Insured for the claims asserted in the NAACP action because the action did not allege or involve "bodily injury" as defined in the policy. In due course, on July 16, 2002, Royal moved for summary judgment and requested reimbursement for "fees and costs paid to or on behalf of [Insured] in connection with the defense of the NAACP action incurred and/or paid after the date of the filling of this declaratory judgment action, i.e., September 12, 2001." R.R. 164-65a.

On February 25, 2003, the trial court granted summary judgment in Royal's favor. To determine whether Royal had an obligation to defend the NAACP claim against Insured, the trial court first ascertained the scope of the insurance coverage granted by the policy. See Wagner v. Erie Ins. Co., 801 A.2d 1226, 1234 (Pa. Super. 2002) ("The insurer's duty to defend the insured is dependent upon the coverage afforded by the insured's policy."). Reviewing the policy, the trial court determined that the bodily injury portion was designed to compensate a claimant for damages that result from injury to one's physical condition. Next, the trial court looked to the allegations set forth in the NAACP complaint to determine if they set forth an injury that was actually or potentially within the scope of the policy. See id. It concluded that the remedy sought in the NAACP action was not the award of damages for bodily injury, but, rather, contributions to a fund for the purpose of the education, supervision, and regulation of gun dealers.*fn4 Thus, the court found that it was clear that the relief sought in the complaint did not fall under the protections of the policy and Royal was not required to defend Insured. The order did not address Royal's summary judgment request for reimbursement of previously expended costs of defense.

Insured appealed the trial court's grant of summary judgment to the Superior Court, which affirmed on April 23, 2004.*fn5 American and Foreign Ins. et al v. Jerry's Sport Center, Inc., et al, 463 MDA 2003 (Pa. Super. April 23, 2004), R.R. 1330a. The Superior Court held that the trial court was correct that the complaint sought equitable relief and did not trigger coverage provided by the Royal policy for bodily injury. R.R. at 1337a.

Thereafter, before the trial court, Royal sought reimbursement of defense fees expended on Insured's behalf in the NAACP action from the date Royal filed the declaratory judgment action on September 12, 2001.*fn6 R.R. 849a. On August 2, 2004, the trial court found that Royal was entitled to the remedy of restitution, based on the equitable doctrine of unjust enrichment.*fn7 The court specifically found that Royal conferred the benefits of a legal defense upon Insured, that Insured retained those benefits, and that to allow Insured to accept and retain those benefits without payment would unjustly enrich Insured. The court scheduled a hearing on the issue of quantum meruit.*fn8 Following two hearings on this issue, the trial court entered a verdict in favor of Royal of $309,216, plus pre-judgment interest.

Insured appealed to the Superior Court, arguing that the trial court erred in finding unjust enrichment that entitled Royal to recoup the defense costs where the parties' relationship was governed by a written insurance contract that was silent on the issue of reimbursement of defense fees. A panel of the Superior Court agreed with Insured and reversed the trial court. American and Foreign Ins. et al v. Jerry's Sport Center et al, 948 A.2d 834 (Pa. Super. 2008). The Superior Court observed a split in jurisdictions between the "majority view," those courts that have found a right of reimbursement based on a reservation of rights letter, e.g., Buss v. Superior Court, 939 P.2d 766 (Cal. 1997), and the "minority view," which includes those courts that have found no such right to reimbursement absent an express provision allowing reimbursement in the written insurance contract, e.g., Terra Nova Ins. Co. Ltd. v. 900 Bar, Inc., 887 F.2d 1213 (3d Cir. 1989) and General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Ill. 2005). Considering these two approaches, the Superior Court was more persuaded by the Terra Nova line of cases. Consistent with Terra Nova, the Superior Court accepted Insured's argument that allowing reimbursement pursuant to Royal's reservation of rights letters amounted to an impermissible, unilateral modification of the written insurance contract.

According to the Superior Court, an insurer's duty to defend arises when a potentially covered claim becomes apparent to the insurer, and not later when a court determines actual coverage in a subsequent declaratory judgment action. American and Foreign Ins., 948 A.2d at 846-47 (citing Erie Ins. Exch. v. Claypoole, 673 A.2d 348 (Pa. Super. 1996), and Heffernan & Co. v. Hartford Ins. Co. of Am., 614 A.2d 295 (Pa. Super. 1992)). Thus, according to the Superior Court's examination of the policy language in the instant case, not only did Royal have a duty to defend, it had "'the right . . . to defend the insured against any 'suit' seeking' damages for bodily injury." American and Foreign Ins., 948 A.2d at 847. Royal exercised this duty and right by selecting Leahey & Johnson to represent Insured. The Superior Court observed that by undertaking the right to defend Insured, Royal benefited by preserving its right to control the defense and to take actions to mitigate any future indemnification responsibilities. Id. at 848 (citing Terra Nova, 887 F.2d at 1219-20, and Shoshone First Bank v. Pacific Employers Ins. Co., 2 P.3d 510, 516 (Wyo. 2000)).

Accordingly, the Superior Court concluded that the trial court erred as a matter of law by concluding that Royal's undertaking of the defense pursuant to its reservation of rights letter unjustly enriched Insured, and that Royal was entitled to reimbursement of attorneys fees in quantum meruit. Rather, according to the Superior Court, the written insurance contract, which did not contemplate a right to reimbursement, controlled the rights of the parties, and was not affected by Royal's attempted unilateral modification.

We granted allocatur to decide whether an insurer is entitled to reimbursement of defense costs when a court has determined that the insurer had no duty to defend the insured and the insurer has claimed a right to reimbursement only in a series of reservation of rights letters. The propriety of the trial court's order reimbursing Royal for defense costs under Royal's purported reservation of rights presents a question of law, over which our scope of review is plenary and our standard of review is de novo. See Gillette v. Wurst, 937 A.2d 430, 435 (Pa. 2007).

Royal's first argument is that the NAACP claim was not potentially covered, and therefore never triggered its duty to defend, as demonstrated by the trial court's declaratory judgment holding that the claim was not within the scope of coverage. Royal refers to the axiom that the duty to defend is triggered when a claim against the insured is potentially covered by the insurance policy. See Casper v. Am. Guar. & Liab. Ins. Co., 184 A.2d 247, 249 (Pa. 1962) (holding that where the acts complained of in the complaint cannot be construed as alleging damages covered by the insurance policy, the claims were not potentially within the scope of the policy and the insurer was under no duty to defend); Erie Ins. Exch. v. Transamerica Ins. Co., 533 A.2d 1363 (Pa. 1987) ("If the complaint filed against the insured avers facts which would support a recovery that is covered by the policy, it is the duty of the insurer to defend until such time as the claim is confined to a recovery that the policy does not cover."). In this case, according to Royal, we know that the NAACP claim against Insured was not potentially covered because, in the declaratory judgment action, the trial court held that Royal had no duty to defend. Royal argues that the only way the trial court could have concluded it had no duty to defend was to find, implicitly, that the NAACP claim was not potentially covered.

Royal asserts that the question of whether a claim is potentially covered, and, therefore, whether there is a duty to defend, is a question that can only be answered by the courts, not the insurance company. In this regard, according to Royal, whether an insurer initially provided a defense under the belief that a claim was potentially covered is not relevant. Essentially, Royal believes that it is inconsequential that its representatives may have thought the claims alleged against Insured were potentially covered when Insured initially requested defense and indemnification. All that matters now, according to Royal, is that the trial court held in the declaratory judgment action that the claims were not covered and Royal had no duty to defend; a holding affirmed by the Superior Court on appeal. According to this argument, the trial court's declaratory judgment determination retroactively nullified any consequence of Royal's initial determination that the claims may have been potentially covered. Royal argues that the Superior Court's affirmance in the declaratory judgment action precluded that court from holding in the instant case that the claim was potentially covered.

Building on its argument that the NAACP claim was not potentially covered, Royal urges us to hold that when an insurer defends a suit against the insured that is not "potentially covered," and has reserved its right to reimbursement of defense costs, then the insurer is entitled to reimbursement from the insured. According to Royal, the majority of jurisdictions that have addressed an insurer's request for reimbursement of defense costs for claims that were not potentially covered have ordered ...

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