When an insurance company is evaluating whether to file a declaratory judgment action or defend one filed against it, the principal issues under consideration are likely to be its chance of success and the amount of attorney’s fees that it will incur to achieve the desired result.  But there is another factor that should also be included in the risk evaluation: possibly having to pay the policyholder’s attorney’s fees.  I sometimes (a lot of times, in fact) see this consideration overlooked, or not given enough weight, in the  coverage litigation decision calculus.  After all, it is a potential factor in 45 states.  In my experience this is the most overlooked coverage issue.  

Despite our legal system’s bedrock principle, that the losing party is not obligated to pay the prevailing party’s attorney’s fees, insurance coverage litigation is often an exception.  In the vast majority of states -- almost all in fact -- the possibility exists, in some way, shape or form, that the insurer may be obligated to pay some, or all, of a successful policyholder’s attorney’s fees in addition to the coverage owed.  

One commonly cited rationale for this exception is that, if the insured must bear the expense of obtaining coverage from its insurer, it may be no better off financially than if it did not have the insurance policy in the first place.  The specific approaches to this insurance exception vary widely by state and can have a significant impact on the likelihood of the insurer in fact incurring an obligation for its insured’s attorney’s fees. 

Some states have enacted statutes that provide for a prevailing insured’s recovery of attorney’s fees in an action to secure coverage.  Other states achieve similar results, but do so through common law.  But whichever approach applies, the most important factor is the same: whether the prevailing insured’s right to recover attorney’s fees is automatic or must the insured prove that the insurer’s conduct was unreasonable or egregious in some way.

For example, a Hawaii statute mandates an award of attorney’s fees without regard to the insurer’s conduct in denying the claim.  In other words, it imposes strict liability for attorney’s fees on an insurer that is ordered to pay a claim.  Maryland also takes a strict liability approach, but it is the result of a decision from its highest court. 

A Virginia statute departs from strict liability and permits an award of attorney’s fees, but only if there was a finding that the insurer’s denial of coverage was not in good faith.  Connecticut also rejects a strict liability rule, but it was established judicially and not legislatively. 

A handful of states use a combination of legislative and judicial avenues to address whether attorney’s fees are to be awarded to a prevailing insured.  Under this hybrid approach, consideration is first given to the state’s general statute that allows for an award of attorney’s fees in an action on a contract. The court then interprets this statute, covering contracts in general, to include an insurance contract dispute.  And some states address the issue by applying their general statutes permitting an award of attorney’s fees against a party that engages in frivolous or vexatious litigation.

While the mechanisms vary, in almost all cases where an insurer is unsuccessful in coverage litigation will either be automatically obligated to pay for its insured’s attorney’s fees or may be litigating post-trial whether such obligation exists. Whichever the case, the potential for being saddled with the attorney’s fees incurred by its prevailing insured in a declaratory judgment action is a consideration that insurers will usually not be able to avoid.

This was the issue before the Wisconsin Supreme Court in Steadfast Insurance Company v. Greenwich Insurance Company, No. 2016AP1631 (Wis. Jan. 25, 2019).  But if this issue has been so widely addressed, why is this coverage case included as one of the ten most significant of the year?  Because the court addressed the issue in a context not widely seen – an insurer seeking to recover its DJ fees from another insurer.  It is a unique take on an otherwise common issue.

This insurer vs. insurer case is lengthy and the hows and whys of the coverage dispute are not critical to addressing the DJ fee issue that ultimately arose.  In general, they had to do with $1.55 million in defense costs that Steadfast Insurance paid, to defend Milwaukee Metropolitan Sewerage District, against claims for sewage back-ups into homes on account of negligence in the repair, maintenance and operation of the sewerage system before and during heavy rains.

Greenwich Insurance declined to defend.  Steadfast sued Greenwich.  For reasons not important here, the trial court held that Greenwich in fact was liable for all of the defense costs, as well as awarded Steadfast $325,000 in attorney’s fees that it incurred in bringing the suit against Greenwich.  The court of appeals affirmed and the case made its way to the Wisconsin Supreme Court.

The Wisconsin high court affirmed the bulk of the lower court’s decision but concluded that the defense costs should be allocated between the two insurers by using a pro-rata by policy limits approach.  Doing so resulted in Steadfast now being entitled to recover $620,000 in defense costs from Greenwich. 

The Supreme Court next turned to whether Steadfast was entitled to recover its attorney’s fees incurred in pursuing its defense costs from Greenwich.  The answer was Yes: “As we have explained above, Steadfast had rights of contractual subrogation based on its payment to MMSD.  Therefore, Steadfast asserted rights that MMSD had against Greenwich for failing to defend.  Stated otherwise, if MMSD were to sue Greenwich to recover defense costs, it would have been entitled to the attorney fees and costs incurred in such litigation.  Here, by virtue of its express subrogation rights, Steadfast stands in MMSD’s shoes and seeks attorney fees incurred in obtaining a judgment against Greenwich for payment of defense costs just as MMSD could have recovered were it to have brought this lawsuit.”

While Wisconsin has a statute that opens the door to an insured’s right to recover its attorney’s fees in establishing coverage, the court’s decision, finding guidance from the Supreme Court of California and Florida, was tied to an insured’s transfer, via subrogation, of its rights to its insurer: “We conclude that a contractual subrogee’s right to recovery may include an award of attorney fees the subrogor would have been entitled to receive had it brought the lawsuit.  We have long recognized that contractual subrogation ‘entitl[es] the paying party to rights, remedies, or securities that would otherwise belong to the debtor.’ (citation omitted).  We decline to create an exception to this longstanding rule by excluding attorney fees from the bundle of contractual subrogation rights that arise from a specific subrogation clause upon payment by the subrogee.”

It is not difficult to see another court finding Steadfast v. Greenwich, and its subrogation rationale persuasive, when confronted with a claim for attorney’s fees incurred by one insurer to establish coverage from another.