May 7, 2008

TO THE COMPANIES IN INTEREST:

Re: American and Foreign Ins. Co. vs.  Jerry's Sport's Center, Inc.

Ladies and Gentlemen:

We commend to your attention an important opinion from the Pennsylvania Superior Court issued in the above matter on May 5, 2008. Royal Insurance provided liability coverage to Jerry's Sports Center, Inc. When Jerry's was sued for injunctive relief and damages for alleged negligence in its marketing of handguns, it tendered its defense to Royal. The insurer immediately provided a defense but at the same time cautioned Jerry's that it was doing so under a reservation of rights because an issue of coverage existed. Two reservation of rights letters specifically cautioned Jerry's that in the event that a court determined that Royal had no duty to defend, Royal reserved the right to seek reimbursement from Jerry's of all attorney's fees expended on its behalf. Such a procedure is consistent with that allowed in the majority of jurisdictions across the country which have considered whether an insurer may so act. A minority of jurisdictions have held that an insurer may not reserve the right to recoup attorney's fees even when a court ultimately concludes that the duty to defend did not exist.

Ultimately, the Pennsylvania Superior Court affirmed a trial court ruling that Royal did not owe a duty to defend. Royal then moved for reimbursement of its attorney's fees relying on the so-called "majority rule" espoused in other states. The Court of Common Pleas granted Royal's request for reimbursement of fees and Jerry's appealed.

In the opinion referenced above, a three judge panel of the Superior Court concludes that Pennsylvania will follow the "minority rule", i.e., an insurer may not reserve the right to obtain reimbursement of its attorney fees when it enters a defense absent a specific provision in the insurance policy allowing it to do so. The court rejects Royal's contentions that in accepting a defense Jerry's entered into an implied contract to reimburse or that Jerry's had been unjustly enriched by the provision of a defense to which it was not entitled.

In the opinion of this writer, the court's reasoning would appear somewhat circular. It concludes that because Royal was uncertain enough about its obligation to defend that it felt it necessary to institute a declaratory judgment action to determine the issue, there must have been at least the "potential" of a covered claim. Since Pennsylvania law requires that a defense be provided whenever the allegations of the complaint are "potentially" covered, Royal was obligated to provide a defense and could not seek reimbursement. The problem with that conclusion is that when the Superior Court -- in its earlier opinion -- affirmed the determination that no duty to defend existed, it necessarily concluded that the claim was not "potentially" covered by the policy. Otherwise, Royal would have been ordered to defend.

As noted above, the decision does concede that the majority view on this issue is that the insurer may reserve a right of reimbursement. For that reason, we would think it likely that either a petition for reargument or for allowance of appeal to the Pennsylvania Supreme Court will be filed.

Should you have any questions about it, please feel free to telephone me.

For a copy of the opinion please click here.

Very truly yours,

Louis E. Bricklin