Calif. Court Narrows Made Whole Doctrine

Saturday, July 14, 2007 | 0

On June 14, the California Court of Appeal for the 4th District struck a blow for the good guys in the ongoing made whole battle which is waging in this country's courts.

As some courts broadly apply the doctrine to defeat virtually any subrogation or reimbursement right -- even going so far as to apply it to workers' compensation scenarios -- other courts have rationally scaled back its applicability and more narrowly apply it to only a specifically defined set of facts. California has joined a growing list of states that hold that the insured's attorney fees should not be deducted before determining whether that insured has been "made whole."

In Allstate Insurance Co. v. Superior Court, Tony Delanzo was injured in an automobile accident. Allstate paid Delanzo $4,203.36. Delanzo then settled his claim against the third-party tortfeasor for $11,000, and received the settlement payment in full.

Delanzo alleged he incurred attorney fees of $3,850 and costs of $2,076.84 (for a total of $5,926.84) to obtain this settlement. Allstate requested that Delanzo repay the $4,203.36 under Allstate's policy provision, which states:

"Subrogation Rights. When we pay, your rights of recovery from anyone else become ours up to the amount we have paid. You must protect these rights and help us enforce them."

In response, Delanzo paid Allstate $1,696.13, which Allstate agreed was in full satisfaction of its reimbursement claim. Allstate agreed to the reduction based on the common-fund rule that an insurer is required to deduct from its reimbursement a pro rata portion of the insured's attorney fees and costs incurred to recover covered losses against a third-party tortfeasor when the insurer had knowledge of, but did not participate in, the litigation. (Note: In California an insurer can avoid such a reduction by participating in the third-party action -- a good reason to engage subrogation counsel in most cases.)

Delanzo filed a class action lawsuit alleging that Allstate's reimbursement claim was improper and unlawful because Delanzo was not first "made whole" by the third-party settlement ($11,000) plus the amount received from Allstate ($4,203.36), when taking into account the attorney fees and costs incurred to obtain the settlement ($5,926.84).

The issue for the Court of Appeal was whether, under California law, the made whole rule precludes an insurer's reimbursement from its insured under a med-pay policy provision after the insured obtains a recovery from a third party which fully compensates the insured for his or her personal injury losses, but the insured's attorney fees and costs reduce that amount such that the insured's net recovery is less than his or her total losses? The court held that it did not.

In understanding the impact this decision may have on the ubiquitous made whole defense, it is important to understand the interplay between subrogation, reimbursement, and the made whole doctrine.

Traditionally, an insurer that pays its insured's claim is entitled to recover the payment from the third party who caused the insured's covered loss. This concept is called subrogation, and can arise by contract, statute, or equitable principles. Hodge v. Kirkpatrick Development Inc., 130 Cal. App.4th 540 (Cal. App. 2005).

Upon subrogation, "the insurer succeeds to its insured's rights against the third party in the amount the insurer paid." The insurer's subrogation right is similar to its right to reimbursement from its own insured, and many courts refer to the two concepts under the umbrella rubric of "subrogation." Progressive West Ins. Co. v. Yolo County Superior Court, 37 Cal. Rptr.3d 434 (Cal. App. 2005).

But unlike true subrogation, the insurer's reimbursement right is contingent on an actual recovery by the insured from a third party. For certain types of claims, an insurer has no subrogation rights directly against a third party, and must seek recovery only by reimbursement. In California, a claim for personal injuries is not subject to subrogation because this claim cannot be assigned. California courts hold that an insurer may obtain reimbursement of proceeds paid for personal injuries by enforcing policy provisions entitling the insurer to reimbursement from its insured.

The made whole rule is a common law exception to an insurer's subrogation right. As applied in California, the rule generally precludes an insurer from recovering any third-party funds unless and until the insured has been made whole for the loss. Progressive West Ins. Co., supra.

The applicability of the doctrine generally depends on whether the insured has been completely compensated for all the elements of damages, not merely those for which the insurer has indemnified the insured. California courts have historically applied the made whole rule in property loss claims. Finnell v. Goodman & Co. Bank, 156 Cal. 18 (Cal. 1909).

However, one court recently held for the first time that the doctrine applies in a personal injury (reimbursement) context under no-fault med-pay insurance coverage. Progressive West Ins. Co., supra. The Progressive West Ins. Co. court was not asked to decide, and did not discuss, whether or not to include attorney fees in calculating whether the insured was "made whole." The specific issue presented here regarding the proper calculation of the insured's recovery under the made whole rule is one of first impression by the courts in this state.

One California court applied the made whole doctrine in a property insurance case and mentioned the issue of whether attorney fees and costs are deducted from the insured's recovery for purposes of this rule, but the court's ultimate determination on the issue was unclear. Plut v. Fireman's Fund Ins. Co., 85 Cal. App.4th 98 (Cal. App. 2000).

The impact of this decision, while ostensibly applying only to med-pay cases, is surely going to impact made whole decisions involving other lines of insurance, including health, property, etc. Assume that an insured recovers $6,000 in damages from a third-party tortfeasor and this amount reflects the insured's total personal injury losses caused by the tortfeasor. His insurer had previously paid him $2,000 for his covered medical expenses; thus the insured obtained a total of $8,000. The insured's attorney fees and costs to collect the $6,000 were $2,400.

Under this new decision, the insurer is not entitled to reimbursement of any portion of the amount paid to the insured by the tortfeasor, because the insured has been made whole. This is because the insured's gross recovery ($6,000 plus $2,000 = $8,000) is more than the insured's total personal injury losses of $6,000, and thus any retention of the $2,000 (minus $800, which is the pro rata amount attributable to collecting damages for the covered injuries) would result in double recovery by the insured.

While the logic of such a decision is crystal clear -- the insured contracted for his own attorney fee and the insurer should not be saddled with the decision by the insured to give away one-third, 40%, or even greater amounts of his cause of action by engaging an attorney -- many courts across the country still fall limp in deciding cases in which the "poor" insured is pitted against the monolithic insurance company with its endless supply of money.

Few courts actually bother factoring in the societal and economic benefits of subrogation in helping to keep insurance premiums low for the insuring public.

Our thanks to the 4th District Court of Appeal for not letting passion overcome common sense legal analysis in arriving at their decision.

This column first appeared in the July newsletter for the clients of Matthiesen, Wickert & Lehrer, S.C.

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