In Federal Ins. Co. v. Singing River Health System, 850 F.3d 187 (5th Cir. 2017), the Fifth Circuit overturned a district court decision that briefly left insurers in doubt whether fees paid to independent counsel could erode the limits of a burning-limits liability policy.  In Moeller v. American Guar & Liab. Ins. Co., 707 So. 2d 1062 (Miss. 1996), the Mississippi Supreme Court held that a defense provided under a reservation of rights creates a conflict of interest requiring that the insured be provided an opportunity to select its own independent counsel. The Moeller decision held that the insurer is responsible for paying the legal fees reasonably incurred by the independent counsel in defending the insured.

For 20 years, none of the case law construing Moeller addressed whether defense costs incurred by independent counsel could erode the limits of a burning-limits liability policy. That issue was first addressed by the Southern District of Mississippi in the Singing River case. 2015 WL 5794411 (S.D. Miss. Oct. 2, 2015). In that case, the insured was sued for underfunding its retirement plans and trusts. The insurer accepted the defense under a reservation of rights. The policy at issue provided that the limits were eroded by defense costs. The policy defined “Loss” to include defense costs, and to include “the amount any insured becomes legally obligated to pay.”

A coverage dispute arose when the insurer argued the fees paid to independent counsel in accordance with the Moeller decision reduced the limits of the policy. The district court rejected the insurer’s argument and agreed with the insured that Moeller obligated the insurer, and not the insured, to pay independent counsel fees. The district court concluded independent counsel fees did not meet the definition of “Loss,” reasoning that the insured was not “legally obligated to pay” such fees. Therefore, the district court reasoned that such independent counsel fees could not erode the policy limits.

The Fifth Circuit reversed the district court. The Fifth Circuit began its analysis with the premise that Moeller “cannot be considered in a vacuum.” The Fifth Circuit cited a 2013 Mississippi case, Southern Healthcare Servs., Inc. v. Lloyd’s of London, 110 So. 3d 735 (Miss. 2013), in which the Mississippi Supreme Court determined it was the insured’s obligation to pay Moeller independent counsel fees within the insured’s $250,000 deductible. The Fifth Circuit then cited case law from other jurisdictions holding that an insured is “legally obligated to pay” independent counsel fees. The Fifth Circuit reasoned that although the policy places some burden on an insurer to pay the costs incurred by independent counsel, an insured still is “legally obligated to pay” those fees.

The Fifth Circuit’s recent decision provides needed guidance on the treatment of independent counsel fees under Moeller and its progeny. In the context of burning-limits liability policies, it now is clear that costs paid by an insurer to independent counsel will erode policy limits.