As insurance coverage disputes, like all disputes, become increasingly expensive, cost continues to be an important factor in deciding whether to commence a lawsuit or arbitration in order to pursue insurance. While most states apply the “American Rule,” which precludes recovery of attorney fees in litigation-coverage disputes, some jurisdictions have exceptions for prevailing insureds. This article highlights the major types of exceptions. In considering the possibility that fees may be available, practitioners should recognize that individual jurisdictions may apply exceptions that look similar but operate rather differently, and that important rights of recovery may be found in procedural rules or case law beyond the confines of insurance law. Careful analysis of conflicts of law may also be important since the right to collect fees in a case filed in a particular state or federal court may turn on its choice of law principles and whether a particular right to recovery is deemed substantive or procedural.
THE AMERICAN RULE
Under the so-called “American Rule,” parties are generally responsible for their own attorney fees, and the award of such fees is prohibited. Courts will not routinely award attorney fees to the prevailing party absent express statutory authority, contractual provisions or grounds for equitable relief. See e.g., Buckhannon Bd. & Care Home v. W. Va. Dep’t of Health & Human Res., 532 U.S. 598, 602 (2001) (Courts “follow ‘a general practice of not awarding fees to a prevailing party absent explicit statutory authority.’”); Chambers v. NASCO, 501 U.S. 32, 45 (1991) (”[T]he so-called ‘American Rule’ prohibits fee shifting in most cases.”); Prof’l Helicopter Pilots Ass’n v. Lear Siegler Servs., No. 04-14403, 2005 U.S. App. LEXIS 23667 at *2, 2005 WL 2840306 at *1 (11th Cir. Oct. 31, 2005) (unpublished) (”[T]he American rule — that each party bears its own attorney fees — presumptively applies.”).
CIRCUMSTANCES WHERE FEES ARE AVAILABLE
Notwithstanding the strong adherence to the American Rule, several states have carved out exceptions. While some state exceptions are based on common law, other states have chosen to codify exceptions. Although there are some minor differences among them, the various exceptions can generally be grouped into four main categories: 1) where the insurer has breached its duty to defend; 2) where the insurer has acted in bad faith; 3) where the insured has breached the contract; and 4) where a statute supplies the exception. (For extensive case law references see Barry Ostrager & Thomas Newman, “Insurance Coverage Disputes” §5.05(b) (12th ed. 2004); Allan D. Windt, “Insurance Claims & Disputes” §9:24 (4th ed. 2005)). The awarding of attorney fees may or may not be contingent upon the filing of a suit for a declaratory judgment.
BREACH OF CONTRACTUAL DUTY TO DEFEND
The first group of states permitting an award of attorney fees generally requires a breach by the insurer of its contractual duty to defend. The theory behind this type of exception is that where an insurer has agreed to provide a defense, the insured should be compensated for all expenses incurred as a result of that breach. In Maine, an insured may recover attorney fees related to the filing of a declaratory action when the insurer’s “duty to defend is clear from the policy and pleadings.” Auto Europpe, LLC v. Conn. Indemnity Co., 321 F.3d 60, 68 (1st Cir. 2003) (quoting Maine Mut. Fire Ins. Co. v. Gervais, 745 A.2d 360, 362 (1999)). Even if only the potential for coverage existed at the time the complaint was filed, the courts will find that the duty to defend is sufficiently clear to award attorney fees. Id. at 69.
The development and applicability of exceptions in this area continue to be a subject of consideration and refinement by courts in many jurisdictions. For example, the 7th Circuit, applying Illinois law, recently overruled its prior decision that the insurer must reimburse an insured for the expenses involved in an action seeking a declaration that the insurer has a duty to defend. Taco Bell Corp. v. Continental Cas. Co., 388 F.3d 1069, 1077 (7th Cir. 2004) (overturning Green v. J.C. Penney Auto Ins. Co., 806 F.2d 759 (7th Cir. 1986)). The Taco Bell court held that the Illinois case law it previously relied upon had been overturned such that the unanimous view among Illinois courts was that the American Rule should apply “unless the insurer had only a frivolous defense to the declaratory judgment suit.” Id.
The 2nd Circuit recently reviewed the issue under New York law in Liberty Surplus Ins. Corp. v. Segal Co., 420 F.3d 65 (2nd Cir. 2005). There the court concluded that while some states permit recovery of fees anytime the insurer has breached its contractual duty to defend, New York allows an insured recovery of its attorney fees when it successfully defends against an action by the insurer seeking a declaratory judgment that it has no duty to defend. Id. at 67. Under New York law, it is normally “well settled that ‘an insured cannot recover his legal expenses in a controversy with a carrier over coverage, even though the carrier loses the controversy and is held responsible for the risk.’” Id. (quoting Employers Mut. Cas. Co. v. Key Pharms., 75 F.3d 815, 824 (2nd Cir. 1996)). Nonetheless, as the 2nd Circuit explained, New York recognizes exceptions in Mighty Midgets, Inc. v. Centennial Ins. Co., 389 N.E.2d 1080 (N.Y. 1979) for defending a declaratory judgment action in a dispute over the insurer’s duty to defend and in Sukup v. State, 227 N.E.2d 842 (N.Y. 1967) for bad faith. According to the 2nd Circuit, “[t]he reasoning behind the Mighty Midgets exception is that an insurer’s duty to defend extends to any action arising out of a covered event, including an action brought by the insurer to free itself from covering the event.” 420 F.3d at 67. The court stressed, however, that where “the duty to defend is not at issue … attorney’s fees cannot be awarded”; therefore, an action involving the duty to indemnify would not warrant granting attorney fees. Id. at 69.
BAD FAITH
The law of some states provides for judicially created exceptions to the American Rule where the court determines that an insurer acted in bad faith. Generally, the insured need not file a declaratory action to support a claim for fees where it establishes bad faith. As mentioned above, this is the second exception to the American Rule in New York. Under Sukup, an insured may recover attorney fees “where there is ‘more than an arguable difference of opinion between carrier and insured over coverage’ and there is a showing of ’such bad faith in denying coverage that no reasonable carrier would, under the given facts, be expected to assert it.’” Sukup, 227 N.E.2d at 844. In these circumstances, it makes no difference who has filed a declaratory judgment action or whether there has been a breach of the duty to defend.
Utah and Pennsylvania follow similar rules. In Utah, an insured can be awarded attorney fees where it “appear[s] that the insurance company acted in bad faith or fraudulently or was stubbornly litigious.” Farmers Ins. Exch. v. Call, 712 P.2d 231, 237 (Utah 1985). Under Pennsylvania law, attorney fees may be recovered “as a matter of public policy in order to prevent insurers from frustrating the contractual rights of the insured … when the refusal to defend was unreasonable and in bad faith.” TIG Ins. Co. v. Nobel Learning Comm., Inc., No. 01-4708, 2002 U.S. Dist. LEXIS 10870 at *51, 2002 WL 1340332 at *18 (E.D. Pa. June 18, 2002). Accord, Carpenter v. Federal Ins. Co., 637 A.2d 1008 (Pa. Super 1994); First Penn. Bank, N.A. v. National Union Fire Ins. Co., 580 A.2d 799 (Pa. Super 1990).
BREACH OF CONTRACT GENERALLY OR INSURANCE CONTRACTS IN PARTICULAR
A number of states permit the award of attorney fees in any action brought as a result of a general breach of contract. Arizona is one such example and shows that a practitioner may have to look beyond insurance law to find an exception to the American Rule. Under Arizona statute §12-341.01, the court has the discretion to award attorney fees to the successful party in any action for breach of contract. See Ariz. Rev. Stat. §12-341.01. See e.g., Nat’l Broker Assoc., Inc. v. Marlyn Nutraceuticals, Inc., 119 P.3d 477 (Ariz. 2005); Orfaly v. Tucson Symphony Society, 99 P.3d 1030 (Ariz. 2004).
Montana has extended its exceptions to the American Rule to include not only an insurer’s breach of its duty to defend but also a breach of its duty to indemnify. See Mountain West Farm Bureau Mut. Ins. Co. v. Brewer, 69 P.3d 652 (Mont. 2003) (overruling Yovish v. United Srvcs. Auto. Ass’n, 794 P.2d 682 (Mont. 1990)). In discussing its reasoning for expanding the common law exception, the court stated:
We decline to further propagate the arbitrary legal fiction that a substantive distinction exists between a breach of the duty to defend and the breach of the duty to indemnify. … [A]n insured is entitled to recover attorney fees … when the insurer forces the insured to assume the burden of legal action to obtain the full benefit of the insurance contract. Id. at 660.
STATUTORYA number of states, such as Oklahoma and Nebraska, have codified the award of attorney fees when the insurer has breached its duty to defend. See Okla. Stat. Ann. §3629; Neb. Rev. Stat. §44-359. The Oklahoma statute provides that if a declaratory action is filed, the prevailing party will be awarded costs and attorney fees. See e.g., Stauth v. Nat’l Union Fire Ins. Co., 236 F.3d 1260, 1264 (10th Cir. 2001). The Nebraska statute similarly provides for attorney fees when the insured “brings an action upon any type of insurance policy” and the court “render[s] judgment against such company.” Neb. Rev. Stat. §44-359. See e.g., Union Ins. Co. v. Bailey, 450 N.W.2d 661 (Neb. 1990). Moreover, the Nebraska Supreme Court has held that the awarding of fees under the statute is not merely discretionary, as in most states, but mandatory. See Rieschick Drilling Co. v. American Cas. Co., 303 N.W.2d 264 (Neb. 1981).A number of states, such as Oklahoma and Nebraska, have codified the award of attorney fees when the insurer has breached its duty to defend. See Okla. Stat. Ann. §3629; Neb. Rev. Stat. §44-359. The Oklahoma statute provides that if a declaratory action is filed, the prevailing party will be awarded costs and attorney fees. See e.g., ., 236 F.3d 1260, 1264 (10th Cir. 2001). The Nebraska statute similarly provides for attorney fees when the insured “brings an action upon any type of insurance policy” and the court “render[s] judgment against such company.” Neb. Rev. Stat. §44-359. See e.g., , 450 N.W.2d 661 (Neb. 1990). Moreover, the Nebraska Supreme Court has held that the awarding of fees under the statute is not merely discretionary, as in most states, but mandatory. See ., 303 N.W.2d 264 (Neb. 1981).Like the breach of the duty to defend, the rationale of shifting fees when the insurer has acted in bad faith has been codified in some states. See 215 ILL. Comp. Stat 5/155; N.H. Rev. Stat. Ann. §461:22-b. The Illinois statute states:
A number of states, such as Oklahoma and Nebraska, have codified the award of attorney fees when the insurer has breached its duty to defend. See Okla. Stat. Ann. §3629; Neb. Rev. Stat. §44-359. The Oklahoma statute provides that if a declaratory action is filed, the prevailing party will be awarded costs and attorney fees. See e.g., ., 236 F.3d 1260, 1264 (10th Cir. 2001). The Nebraska statute similarly provides for attorney fees when the insured “brings an action upon any type of insurance policy” and the court “render[s] judgment against such company.” Neb. Rev. Stat. §44-359. See e.g., , 450 N.W.2d 661 (Neb. 1990). Moreover, the Nebraska Supreme Court has held that the awarding of fees under the statute is not merely discretionary, as in most states, but mandatory. See ., 303 N.W.2d 264 (Neb. 1981).Like the breach of the duty to defend, the rationale of shifting fees when the insurer has acted in bad faith has been codified in some states. See 215 ILL. Comp. Stat 5/155; N.H. Rev. Stat. Ann. §461:22-b. The Illinois statute states:
In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow … reasonable attorney fees. 215 ILL. Comp. Stat 5/155.
The policy behind §155 is to provide a “remedy to an insured who encounters unnecessary difficulties when an insurer withholds policy benefits.” Golden Rule Ins. Co. v. Schwartz, 786 N.E.2d 1010, 1018 (Ill. 2003).
A New Hampshire statute similarly provides that if the insured prevails in an action to determine coverage of an insurance policy, “he shall receive court costs and reasonable attorney fees from the insurer.” N.H. Rev. Stat. Ann. §461:22-b. See e.g., Amer. Home Assur. Co. v. Star Speedway, Inc., 409 A.2d 1343 (N.H. 1979). The New Hampshire Supreme Court has held that §461:22-b applies to any action, not merely a declaratory action. See Hodge v. Allstate Ins. Co., 546 A.2d 1078, 1081 (N.H. 1988).
There are also procedural mechanisms, such as the declaratory judgment acts in Texas and Wisconsin, that may provide attorney fees to the prevailing party without reference to the subject matter of the dispute. Tx Civ. Prac. & Rem. §37.009; Wis. Stat. §806.04.
PROCEDURAL OR SUBSTANTIVE
An important consideration in determining whether fees will be available in a coverage case is choice of law, which often turns on whether the availability of fees is deemed procedural or substantive. The distinction is important, albeit for slightly different reasons, in both federal and state courts.
Federal courts typically regard state fee shifting rules as substantive law to be applied in diversity cases when those rules are based on the state’s common law or insurance law statutes. e.g., Guaranty Nat’l Ins. Co. v. McGuire, 192 F. Supp. 2d 1204, 1206-07 (D. Kan. 2002) (Observing that “[t]he right to recover attorney fees is substantive and is therefore determined by state law in diversity cases,” and awarding fees under a Kansas statute permitting fees where an insurer “‘refused without just cause or excuse’ to pay the full amount of a loss”). They have reached varying results, however, when a state declaratory judgment act is the basis for the fees since a number of courts view such rules as procedural. Compare Utica Lloyd’s v. Mitchell, 138 F.3d 208, 210 (5th Cir. 1998) (holding the Texas Declaratory Judgment Act functions solely as a procedural mechanism for resolving substantive controversies and does not afford a mechanism for awarding fees in federal court) with Scottish Guarantee Ins. Co. v. Dwyer, 19 F.3d 307, 312 (7th Cir. 1994) (ruling that fees were properly awarded in a federal diversity action based at least in part on the fee award provisions of Wisconsin’s declaratory judgment statute).
A similar examination applies in the choice of law analysis in most states. Where a fee shifting provision is viewed as procedural, it may not be imported from a state whose substantive law otherwise controls an insurance dispute. See Boyd Rosene & Assoc., Inc. v. Kansas Municipal Gas Agency, 174 F.3d 1115, 1118 (10th Cir. 1999) (”[E]ven though attorney fees are substantive for diversity purposes, they are not thereby necessarily substantive under [the forum state’s] choice-of-laws rules.”) (citation omitted). On the other hand, in Society of Mt. Carmel v. National Ben Franklin Ins. Co., 643 N.E.2d 1280, 1294 n.4 (Ill. App. 1994), the Illinois court observed that absent party agreement to the contrary, the issue of a policyholder’s right to attorney fees would most properly be determined by the law of California because that state’s substantive insurance coverage law was deemed controlling.
CONCLUSION
While the American Rule generally prevails with regard to the awarding of attorney fees, the states do not generally agree as to whether and how an exception may apply for insurance cases. Although these exceptions may be grouped into similar categories, practitioners should carefully research the requirements for obtaining an exception under the law of each jurisdiction that may control a dispute and analyze choice of law to determine the likely accessibility of a claim for fees.