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Docket No. 98814-Agenda 16-January 2005.
GENERAL AGENTS INSURANCE COMPANY OF AMERICA,
INC., Appellee, v. MIDWEST SPORTING GOODS COMPANY et
al., Appellants.

Opinion filed March 24, 2005.

JUSTICE THOMAS delivered the opinion of the court:

At issue in this case is whether, following a declaration that aninsurer has no duty to defend its insured, the insurer is entitled toreimbursement of the amounts paid for the defense of its insured in theunderlying lawsuit. The circuit and appellate courts held that theinsurer was entitled to reimbursement. For the following reasons, wereverse the judgments of the circuit and appellate courts.

BACKGROUND

The City of Chicago and Cook County sued Midwest SportingGoods Company (Midwest) and other defendants for creating a publicnuisance by selling guns to inappropriate purchasers. Midwesttendered defense of the suit to General Agents Insurance Company ofAmerica (hereinafter Gainsco), its liability carrier. Gainsco deniedcoverage. The City of Chicago and Cook County then filed their firstamended complaint against Midwest and other defendants. Midwestagain tendered defense of the suit to Gainsco. On July 23, 1999,Gainsco responded to Midwest's independent counsel as follows:

"We wish to acknowledge and confirm our receipt andreview of the First Amended Complaint that you forwardedto our office on behalf of your client and our Insured,Midwest Sporting Goods, Inc. by letter dated April 28, 1999.This letter will supplement Gainsco's letter of December 3,1998 denying coverage with respect to the plaintiff's originalcomplaint in this matter. We have had an opportunity toreview the allegations of the First Amended Complaint, aswell as the policy documentation, and without waiving theCompany's rights or defenses under the Policy, would like tocall the following points to your attention.

*** [The letter then quotes certain policy language.]

The policy only applies to damages because of propertydamage or bodily injury caused by an occurrence. The FirstAmended Complaint does not seek damages because ofproperty damages or bodily injury. As such, the claim is notcovered under the Policy.

The First Amended Complaint alleges that the Insured isliable to the plaintiffs for various acts of intentional and/orwillful conduct. As a consequence, and based upon theabove-noted policy provisions, the claim may not be coveredunder the Policy.

Additionally, to the extent that the claim involves periodsof time that fall outside of the periods of time to which thecoverage afforded by the Company covers, the claim is notcovered by the Policy.

Please note that to the extent that the claim seeksinjunctive relief, the claim is not a claim for damages and,thus, is not afforded coverage under the Policy. Further, tothe extent that the claim is for punitive or exemplarydamages, the claim is not afforded coverage under the Policy.

Subject to the foregoing, and without waiving any of itsrights and defenses, including the right to recoup any defensecosts paid in the event that it is determined that theCompany does not owe the Insured a defense in this matter,the Company agrees to provide the Insured a defense in thecaptioned suit. In light of the competing interests between theCompany and the Insured in respect of the coverage for thismatter, the Company agrees to the Insured's selection anduse of your firm as its counsel in this matter. However, theCompany notes its right to associate with the Insured and itscounsel in the defense of the underlying litigation.

***

Please note that any acts taken by or on behalf of theCompany are taken under and pursuant to a full reservationof its rights and defenses under the Policy. Likewise, we willunderstand that any acts taken by or on behalf of the Insuredare taken pursuant to a reservation of rights as well."(Emphasis added.)

Based upon the record in this case, it does not appear that Midwestever responded to Gainsco's reservation of rights letter. Midwestthereafter accepted Gainsco's payment of defense costs.

On October 28, 1999, Gainsco filed a declaratory judgmentaction seeking, inter alia, a declaration that it did not owe Midwesta defense in the underlying litigation. The declaratory judgment actionalso asserted a claim for recovery of all defense costs paid toMidwest's independent counsel on behalf of Midwest in theunderlying litigation. On June 5, 2000, Gainsco filed its first amendedcomplaint for declaratory judgment. Midwest responded with ananswer and counterclaim.

Gainsco then filed a motion for summary judgment in itsdeclaratory judgment action, and Midwest filed a cross-motion forsummary judgment. Following a hearing, the circuit court of CookCounty entered summary judgment in favor of Gainsco, declaring thatGainsco had no duty to defend Midwest in the underlying litigation.The trial court denied Midwest's cross-motion for summary judgment.In ruling on Gainsco's motion for summary judgment, the trial courtnoted that the issue before it was whether the plaintiffs in theunderlying complaint were seeking damages in the nature of economicloss or bodily injury. The trial court held that based upon case law, thedamages sought by the plaintiffs in the underlying case amounted onlyto economic loss, and therefore held that Gainsco was entitled tosummary judgment on its declaratory judgment action.

Gainsco then filed a motion for entry of judgment for recovery ofdefense costs, seeking to recover the defense costs that it had paid toMidwest's independent counsel for Midwest's defense of theunderlying litigation. The motion for defense costs included theaffidavit of Rita Beck, a senior claims examiner for Gainsco, statingthat Gainsco had paid $40,517.34 for the defense of Midwest in theunderlying litigation. The trial court stayed consideration of Gainsco'smotion for defense costs pending Midwest's appeal of the trial court'sfinding that Gainsco was not obligated to defend Midwest.

On appeal, the appellate court affirmed the trial court's judgment,holding that Gainsco had no duty to defend or indemnify Midwestagainst the underlying claim. General Agents Insurance Co. ofAmerica, Inc. v. Midwest Sporting Goods Co., 328 Ill. App. 3d 482(2002). Midwest did not seek further review of the appellate court'sdecision.

Thereafter, the trial court considered Gainsco's motion for entryof judgment for recovery of defense costs. Following briefing and oralargument, the trial court held that Gainsco had reserved its right torecoup its costs for defending Midwest and therefore grantedGainsco's motion. The trial court ordered Midwest to pay Gainsco$40,517.34. Midwest then appealed the trial court's ruling on themotion for recovery of defense costs.

The appellate court, with one justice dissenting, again affirmedthe trial court's judgment. 349 Ill. App. 3d 529. On appeal, Midwestargued that Gainsco had paid the defense costs pursuant to theinsurance contract, which made no provision for the recovery soughtby Gainsco. In addition, because the relationship between the partieswas governed by contract, Gainsco could not recover defense costsunder a theory of unjust enrichment. 349 Ill. App. 3d at 530-31.

The appellate court rejected Midwest's argument, stating thatMidwest misconstrued the payments made by Gainsco. 349 Ill. App.3d at 531. The appellate court found the arrangement in this casesimilar to the arrangement made between the parties in City ofChicago v. McKechney, 205 Ill. 372 (1903). The appellate courtnoted that in McKechney, the City of Chicago had agreed in 1895 topay McKechney to construct a tunnel. However, in 1897, McKechneydemanded increased payments due to difficulties encountered in theconstruction. When the City thereafter paid McKechney at its regularrate of pay, McKechney stopped work and sued the City, claiming thepayment violated an 1897 revision to the original contract. In 1898,the City and McKechney entered into a new arrangement for theresumption of work pending a determination of the parties' rights inthe lawsuit. Under the 1898 agreement, the City agreed to payMcKechney a rate higher than that agreed to in the 1895 contract, butstated that its agreement was without prejudice to its right to recoverany overpayment if the court determined that the 1895 contractapplied. This court found that the 1898 agreement was anaccommodation pending litigation that preserved the City's rightsunder the 1895 contract.

The appellate court characterized the parties' actions in this case,like that of the parties in McKechney, as an "accommodation pendinglitigation to determine whether Gainsco owed Midwest the cost ofdefending the lawsuit the City of Chicago brought against Midwest."349 Ill. App. 3d at 532. The appellate court stated that, "[l]ike the1898 arrangement in McKechney, the accommodation proposed inGainsco's letter reserved rights to litigate the question of whetherGainsco owed the payments sought, and the right to recover anyamounts the court later determined Gainsco did not owe." 349 Ill.App. 3d at 532. The appellate court stated that it saw "no reason toinvalidate the accommodation pending litigation here." 349 Ill. App.3d at 532.

The appellate court then noted that courts in other jurisdictionshad reached a similar result. For example, the court in Buss v.Superior Court, 16 Cal. 4th 35, 939 P.2d 766, 65 Cal. Rptr. 366(1997), ordered an insured to reimburse its insurer for defense costspaid on claims that were not within the coverage of the insured'spolicy. 349 Ill. App. 3d at 532. In addition, the court in WalbrookInsurance Co. v. Goshgarian & Goshgarian, 726 F. Supp. 777, 784(C.D. Cal. 1989), held that an insured was required to reimburse itsinsurer for defense costs incurred in the underlying suit where theinsurer reserved the right to seek reimbursement of defense costs andthe insured, although objecting to the reservation, nonethelessaccepted payment of the defense costs. 349 Ill. App. 3d at 532-33.Finally, the appellate court observed that the United States DistrictCourt for the Southern District of Illinois, in Grinnell MutualReinsurance Co. v. Shierk, 996 F. Supp. 836 (S.D. Ill. 1998), hadstated that it believed that this court would follow the reasoning ofBuss and Walbrook and therefore held that an insurer had the right toreimbursement of defense costs when the underlying claims were notcovered by the insurance policy and the insurer had reserved the rightto seek reimbursement. 349 Ill. App. 3d at 533.

The appellate court rejected Midwest's argument that the courtshould not adopt the reasoning of Buss, Walbrook and Grinnellbecause those decisions give an insurance company too muchleverage. The appellate court stated that if Midwest had refused toaccept the funds under Gainsco's conditions, Midwest could haveforced Gainsco to either defend without a right of reimbursement ordeny a defense and risk losing its policy defense if it was found inbreach of the insurance contract. 349 Ill. App. 3d at 534. Finally, theappellate court reiterated that the payments made by Gainsco were notmade pursuant to Midwest's insurance policy, but rather were an"accommodation pending litigation to determine whether Gainscoowed Midwest, under the insurance contract, a defense." 349 Ill. App.3d at 534.

The dissenting justice disagreed that Illinois law supported themajority's decision. The dissenting justice stated that an insurer's dutyto defend its insured arises from and is limited by the expressundertaking to defend as stated in the contract of insurance. 349 Ill.App. 3d at 535 (McBride, J., dissenting). Here, there was no languagein the policy providing for reimbursement of costs. 349 Ill. App. 3d at535 (McBride, J., dissenting).

As noted, this court allowed Midwest's petition for leave toappeal. 177 Ill. 2d R. 315. This court also allowed CertainUnderwriters at Lloyd's London to file an amicus curiae brief onbehalf of Gainsco. 155 Ill. 2d R. 345.

ANALYSIS

Although it is not clear from the record, it appears that Gainsco'smotion for recovery of defense costs was treated as a motion forsummary judgment. The trial court decided the motion based upon thebriefs submitted by the parties and oral argument, without anevidentiary hearing. A circuit court's entry of summary judgment issubject to de novo review. Guillen v. Potomac Insurance Co. ofIllinois, 203 Ill. 2d 141, 149 (2003).

As a preliminary matter, we address the appellate court's findingthat the arrangement in this case was similar to the arrangement madebetween the parties in City of Chicago v. McKechney, 205 Ill. 372(1903). We find that the appellate court's reliance on McKechney wasmisplaced. McKechney did not involve an insurance contract.Consequently, although there may be some factual similarities betweenthis case and McKechney, we find that it is more appropriate toconsider the instant case in light of case law specifically addressinginsurance contracts and an insurer's reservation of its right toreimbursement of defense costs. Thus, although the 1898 agreementbetween the parties in McKechney was properly characterized as an"accommodation pending litigation," we decline to characterize thecircumstances surrounding Gainsco's July 23, 1999, letter as such.The McKechney decision is simply inapposite to this case.

We turn then to the parties' arguments before this court. Midwestargues that Gainsco failed to establish any legal basis that wouldentitle it to an award of reimbursement of defense costs. Midwestnotes that the insurance policy between Midwest and Gainsco containsno provisions allowing Gainsco to recover defense costs. Further,because there was an express written insurance contract between theparties, Gainsco cannot claim that it is entitled to recover defensecosts under a theory of unjust enrichment. In addition, Gainsco'sreservation of rights letter could only reserve the rights containedwithin the insurance policy and could not create new rights. In anyevent, the language in the reservation of rights letter clearly establishesthat Gainsco paid the defense costs pursuant to the insurance policy.

Gainsco responds that each of the preceding arguments must failbecause there is no contract governing the parties' relationship.Gainsco argues that its duty to defend extended only to claims fordamages that were payable or potentially covered under a Gainscopolicy. Here, as the circuit and appellate courts found, the Gainscopolicies did not apply to the underlying litigation. In addition, Gainsconotes that numerous decisions, including Buss, Walbrook and Grinnellsupport the trial court's decision.

An insurer's duty to defend its insured is much broader than itsduty to indemnify its insured. Outboard Marine Corp. v. LibertyMutual Insurance Co., 154 Ill. 2d 90, 125 (1992). An insurer may notjustifiably refuse to defend an action against its insured unless it isclear from the face of the underlying complaint that the allegations setforth in that complaint fail to state facts that bring the case within orpotentially within the insured's policy coverage. United States Fidelity& Guaranty Co. v. Wilkin Insulation Co., 144 Ill. 2d 64, 73 (1991).A court must compare the allegations in the underlying complaint tothe policy language in order to determine whether the insurer's dutyto defend has arisen. Outboard Marine, 154 Ill. 2d at 125. If theunderlying complaint alleges facts within or potentially within policycoverage, an insurer is obligated to defend its insured even if theallegations are groundless, false or fraudulent. Dixon Distributing Co.v. Hanover Insurance Co., 161 Ill. 2d 433, 438-39 (1994). Theallegations in the underlying complaint must be liberally construed infavor of the insured. Outboard Marine, 154 Ill. 2d at 125. In addition,if several theories of recovery are alleged in the underlying complaintagainst the insured, the insurer's duty to defend arises even if only oneof several theories is within the potential coverage of the policy.United States Fidelity & Guaranty Co., 144 Ill. 2d at 73. When theunderlying complaint against the insured alleged facts within orpotentially within the scope of policy coverage, the insurer taking theposition that the complaint is not covered by its policy must defendthe suit under a reservation of rights or seek a declaratory judgmentthat there is no coverage. State Farm Fire & Casualty Co. v. Martin,186 Ill. 2d 367, 371 (1999).

In the instant case, as noted, Gainsco chose both to defend undera reservation of rights and to seek a declaratory judgment that therewas no coverage. Gainsco's reservation of rights letter provided thatit reserved the right to recoup any defense costs paid in the event itwas determined that Gainsco did not owe Midwest a defense. Thegravamen of Midwest's argument on appeal is that Gainsco could notreserve the right to recoup defense costs because the insurancecontract between the parties does not contain a provision allowingGainsco the right to recoup defense costs. In turn, the gravamen ofGainsco's response is that there is no contract governing therelationship between the parties because both the circuit and appellatecourts have held that the policies issued by Gainsco to Midwest didnot apply to the underlying litigation. Accordingly, Gainsco maintainsthat it had no duty to defend Midwest and thus is entitled to recoupthe amounts paid for Midwest's defense.

In support of its argument, Gainsco points to decisions fromother jurisdictions where courts have held that an insurer may recoverits defense costs if it specifically reserves the right to recoup thosecosts in the event it is determined that the insurer does not owe theinsured a defense. Gainsco notes that Grinnell Mutual ReinsuranceCo. v. Shierk, 996 F. Supp. 836 (S.D. Ill. 1998), the only decisioninterpreting Illinois law on this issue, is indistinguishable from thiscase and directly supports the circuit court's decision to grantGainsco's motion for recovery of defense costs. In Grinnell, theinsured, Shierk, was sued by his wife for negligence in connectionwith an incident where he discharged a gun in her direction, causinga bullet to strike her in the face. Grinnell, 996 F. Supp. at 836. Shierktendered defense of the lawsuit to Grinnell Mutual ReinsuranceCompany (Grinnell), claiming coverage pursuant to his homeowner'sinsurance policy. Grinnell, 996 F. Supp. at 836. Grinnell agreed todefend Shierk, but expressly reserved the right to later deny coverageand reserved the right to seek reimbursement from Shierk in the eventa declaratory judgment action found that Grinnell had no duty todefend. Grinnell, 996 F. Supp. at 836. The district court laterdetermined that Grinnell had no duty to defend. Grinnell, 996 F.Supp. at 838.

The district court then considered whether Grinnell was entitledto reimbursement of funds that it had already expended in defendingShierk. Grinnell, 996 F. Supp. at 838-39. The district court noted thatthere was no Illinois case law addressing the issue, but that such reliefwas found to be available in other jurisdictions. Grinnell, 996 F. Supp.at 839. The district court predicted that this court would orderreimbursement of defense costs, observing that Grinnell specificallyreserved the right to seek reimbursement and that Shierk, fully awareof Grinnell's reservation of its right to reimbursement, accepted thebenefit of Grinnell's defense. Grinnell, 996 F. Supp. at 839.

Gainsco notes that the court in Grinnell cited a decision from aCalifornia federal district court, Walbrook Insurance Co. v.Goshgarian & Goshgarian, 726 F. Supp. 777 (C.D. Cal. 1989), whichalso supports the trial court's decision to order reimbursement. In thatcase, the insureds had argued that even if their insurer did not have aduty to defend in the underlying action, the insurer was not entitled toreimbursement of defense fees because the insurer had failed to makean adequate reservation of rights. Walbrook, 726 F. Supp. at 781. Thereservation of rights letter sent to the insureds stated that the insurerspecifically reserved the right to recover all sums paid on behalf of theinsureds for defense, settlement or satisfaction of the judgment.Walbrook, 726 F. Supp. at 782. The insureds, however, responded byobjecting to the reservation of rights and refusing to consent to oracknowledge the validity of those rights, although the insureds didaccept $500,000 in payments from the insurer to their independentcounsel in the underlying suit. Walbrook, 726 F. Supp. at 782. Thedistrict court held that there was adequate evidence of anunderstanding that the insurer would seek reimbursement, and that theinsureds' acceptance of the money constituted an implied agreementto the reservation. Walbrook, 726 F. Supp. at 784.

Gainsco notes that the district court in Grinnell also relied on adecision from the Supreme Court of California. In Buss v. SuperiorCourt, 16 Cal. 4th 35, 939 P.2d 766, 65 Cal. Rptr. 366 (1997), thecourt also addressed whether an insurer could recover reimbursementof defense costs from its insured. The underlying action in that caseasserted 27 causes of action, of which only one claim potentially fellwithin policy coverage. Buss, 16 Cal. 4th at 41-42, 939 P.2d at 770,65 Cal. Rptr. at 370. The insurer accepted defense of the underlyingaction, but reserved all of its rights, including the right to deny thatany cause of action was actually covered and the right to bereimbursed for defense costs in the event it was later determined thatthere was no coverage. Buss, 16 Cal. 4th at 42, 939 P.2d at 770, 65Cal. Rptr. at 370.

In addressing the issue, the court first noted that in a "mixed"action, involving claims that are at least potentially covered and claimsthat are not, an insurer nonetheless has a duty to defend the claim inits entirety. Buss, 16 Cal. 4th at 47-48, 939 P.2d at 774, 65 Cal. Rptr.at 374. The court then stated that with regard to "mixed" claims, aninsurer may not seek reimbursement for claims that are at leastpotentially covered, but may seek reimbursement for defense costs asto the claims that are not even potentially covered. Buss, 16 Cal. 4that 47-48, 939 P.2d at 774, 65 Cal. Rptr. at 374. The court explainedthat with regard to defense costs for claims that are potentiallycovered, the insured had paid premiums and the insurer had bargainedto bear those costs, so that there was no right of reimbursementimplied in the policy or implied in law. Buss, 16 Cal. 4th at 49, 939P.2d at 775, 65 Cal. Rptr. at 375. The court noted exceptions wouldexist if the policy itself provided for reimbursement or if there was aseparate contract supported by separate consideration. Buss, 16 Cal.4th at 50, 939 P.2d at 776, 65 Cal. Rptr. at 376. However, withregard to claims that are not even potentially covered, the insured hadnot paid premiums to the insurer and the insurer did not bargain tobear those costs. Buss, 16 Cal. 4th at 50-51, 939 P.2d at 776, 65 Cal.Rptr. at 376. Consequently, the court reasoned that the insurer has aright to reimbursement implied in law as quasi-contractual. Buss, 16Cal. 4th at 51, 939 P.2d at 776, 65 Cal. Rptr. at 376. Under the lawof restitution, the insured has been "enriched" through the insurer'sbearing of unbargained-for defense costs, an enrichment that must bedeemed unjust. Buss, 16 Cal. 4th at 51, 939 P.2d at 777, 65 Cal. Rptr.at 377.

Finally, Gainsco notes that other jurisdictions also have foundthat an insurer may recover defense costs from its insured where theinsurer agrees to provide the insured a defense pursuant to an expressreservation of rights, including the right to recoup defense costs, theinsured accepts the defense, and a court subsequently finds that theinsurer did not owe the insured a defense. See United NationalInsurance Co. v. SST Fitness Corp., 309 F.3d 914 (6th Cir. 2002)(insurer was entitled to reimbursement of defense costs where theinsurer reserved the right to recover defense costs and the insuredaccepted payment of defense costs); Resure, Inc. v. ChemicalDistributors, Inc., 927 F. Supp. 190 (M.D. La. 1996) (insurer wasentitled to reimbursement for all costs of defense where it timely andspecifically reserved the right to seek reimbursement and insured didnot object to the reservation); Knapp v. Commonwealth Land TitleInsurance Co., 932 F. Supp. 1169 (D. Minn. 1996) (where insurerreserved its right to seek reimbursement of attorney's fees and costs,insured's silence in response to the reservation of rights letter andsubsequent acceptance of defense constituted an implied agreement tothe reservation of rights); North Atlantic Casualty & Surety InsuranceCo. v. William D., 743 F. Supp. 1361 (N.D. Cal. 1990) (where insurersent letter to the insured reserving the right to reimbursement, and theinsured accepted payment of defense fees without comment, insurerwas entitled to reimbursement from insured); Hecla Mining Co. v.New Hampshire Insurance Co., 811 P.2d 1083, 1089 (Colo. 1991)(court states that proper course for insurer that believes it owes noduty to defend "is to provide a defense to the insured under areservation of its rights to seek reimbursement should the facts at trialprove that the incident resulting in liability was not covered by thepolicy"); Colony Insurance Co. v. G&E Tires & Service, Inc., 777 So.2d 1034 (Fla. App. 2000) (insurer was entitled to reimbursement ofdefense costs where it timely and expressly reserved the right to seekreimbursement, and the insured accepted the offer of a defense witha reservation of rights).

In general then, the decisions finding that an insurer is entitled toreimbursement of defense costs are based upon a finding that therewas a contract implied in fact or law, or a finding that the insured wasunjustly enriched when its insurer paid defense costs for claims thatwere not covered by the insured's policy. Although such reasoningwas not the basis for the appellate court's decision in this case,Gainsco notes that this court may affirm the appellate court on anybasis, and urges this court to adopt the reasoning of the courts in thepreceding cases.

Gainsco is correct that it would be entitled to reimbursement ofthe defense costs paid in the underlying action if this court adopted theanalysis set forth in the preceding cases. Gainsco timely and expresslyreserved its right to reimbursement of defense costs, Midwestaccepted payment of those defense costs without objection, and adeclaratory judgment action determined that Gainsco did not oweMidwest a defense in the underlying lawsuit. Our research reveals,however, that other jurisdictions, albeit a minority, have refused toallow an insurer to receive reimbursement of its defense costs eventhough the underlying claim was not covered by the insurance policyand the insurer had specifically reserved its right to reimbursement.

Upon review, we find the analysis of those decisions refusing toallow reimbursement to be more persuasive and more on point withIllinois case law than the cases cited by Gainsco. For example, inShoshone First Bank v. Pacific Employers Insurance Co., 2 P.3d 510,514 (Wy. 2000), the court declined to allocate costs between coveredand uncovered claims, holding that "unless an agreement to thecontrary is found in the policy, the insurer is liable for all the costs ofdefending the action." The court rejected the insurer's claim that ithad the right to allocate defense costs for uncovered claims becauseits reservation of rights letter had specifically reserved the right toallocate the fees, expenses and indemnity payments when the case wasresolved. Shoshone First Bank, 2 P.3d at 515. The court stated:

"The insurer is not permitted to unilaterally modify andchange policy coverage. We agree with the Supreme Courtof Hawaii that a reservation of rights letter 'does not relievethe insurer of the costs incurred in defending its insuredwhere the insurer was obligated, in the first instance, toprovide such a defense.' First Insurance Co. of Hawaii, Inc.v. State, by Minami. 66 Haw. 413, 665 P.2d 648, 654(1983). [The insurer] could have included allocation languagein the Policy, but it failed to do so. We look only to the fourcorners of the policy to determine coverage, and where thepolicy is unambiguous, extrinsic evidence is not considered.[Citation.] The Policy issued to Shoshone by [the insurer]states a duty to defend, and allocation is not mentioned. Inlight of the failure of the policy language to provide forallocation, we will not permit the contract to be amended oraltered by a reservation of rights letter." Shoshone FirstBank, 2 P.3d at 515-16.

Accord Texas Ass'n of Counties Government Risk Management Poolv. Matagorda County, 52 S.W.3d 128, 44 Tex. Sup. Ct. J. 215 (2000)(absent provision providing for reimbursement of settlement funds,unilateral reservation of rights letter could not create rights notcontained within the insurance policy).

The court in Shoshone First Bank then cited an unpublisheddecision from the United States District Court for the District ofWyoming that clearly articulated the problem with allowing an insurerto reserve the right to seek reimbursement of defense costs. Thatcourt stated that:

"15. A reservation of rights letter does not create acontract allowing an insurer to recoup defense costs from itsinsureds.

16. The question as to whether there is a duty to defend aninsured is a difficult one, but because that is the business ofan insurance carrier, it is the insurance carrier's duty to makethat decision. If an insurance carrier believes that no coverageexists, then it should deny its insured a defense at thebeginning instead of defending and later attempting to recoupfrom its insured the costs of defending the underlying action.Where the insurance carrier is uncertain over insurancecoverage for the underlying claim, the proper course is forthe insurance carrier to tender a defense and seek adeclaratory judgment as to coverage under the policy.However, to allow the insurer to force the insured intochoosing between seeking a defense under the policy, and runthe potential risk of having to pay for this defense if it issubsequently determined that no duty to defend existed, orgiving up all meritorious claims that a duty to defend exists,places the insured in the position of making a Hobson'schoice. Furthermore, endorsing such conduct is tantamountto allowing the insurer to extract a unilateral amendment tothe insurance contract. If this became common practice, theinsurance industry might extract coercive arrangements fromtheir insureds, destroying the concept of liability and litigationinsurance.

Order on Plaintiff's Motion for Summary Judgment,America States Ins. Co. v. Ridco, Inc. Riddles Jewelry, Inc.And Ken B. Berger, Civ. No. 95CV158D (D. Wyo. 1999)."Shoshone First Bank, 2 P.3d at 516.

We agree with the analysis of the court in Shoshone First Bank,as well as the United States District Court for the District of Wyomingin America States Insurance Co. As a matter of public policy, wecannot condone an arrangement where an insurer can unilaterallymodify its contract, through a reservation of rights, to allow forreimbursement of defense costs in the event a court later finds that theinsurer owes no duty to defend. We recognize that courts have foundan implied agreement where the insured accepts the insurer's paymentof defense costs despite the insurer's reservation of a right toreimbursement of defense costs. However, as stated by the court inAmerica States Insurance Co., cited by the Shoshone First Bankcourt, recognizing such an implied agreement effectively places theinsured in the position of making a Hobson's choice betweenaccepting the insurer's additional conditions on its defense or losingits right to a defense from the insurer.

The United States Court of Appeals for the Third Circuit,applying Pennsylvania law, also has ruled that an insurer cannotrecover defense costs even when it defends under a reservation ofrights to recover defense costs if it is later determined there is nocoverage. Terra Nova Insurance Co. v. 900 Bar, Inc., 887 F.2d 1213(3d Cir. 1989). The court reasoned that:

"A rule permitting such recovery would be inconsistent withthe legal principles that induce an insurer's offer to defendunder reservation of rights. Faced with uncertainty as to itsduty to indemnify, an insurer offers a defense underreservation of rights to avoid the risks that an inept orlackadaisical defense of the underlying action may expose itto if it turns out there is a duty to indemnify. [footnoteomitted]. At the same time, the insurer wishes to preserve itsright to contest the duty to indemnify if the defense isunsuccessful. Thus, such an offer is made at least as much forthe insurer's own benefit as for the insured's. If the insurercould recover defense costs, the insured would be required topay for the insurer's action in protecting itself against theestoppel to deny coverage that would be implied if itundertook the defense without reservation." Terra NovaInsurance Co., 887 F.2d at 1219-20.

Again, we find the reasoning of the Terra Nova court to be morepersuasive than the authorities cited by Gainsco. We agree that whenan insurer tenders a defense or pays defense costs pursuant to areservation of rights, the insurer is protecting itself at least as much asit is protecting its insured. Thus, we cannot say that an insured isunjustly enriched when its insurer tenders a defense in order to protectits own interests, even if it is later determined that the insurer did notowe a defense. Certainly, if an insurer wishes to retain its right to seekreimbursement of defense costs in the event it later is determined thatthe underlying claim is not covered by the policy, the insurer is free toinclude such a term in its insurance contract. Absent such a provisionin the policy, however, an insurer cannot later attempt to amend thepolicy by including the right to reimbursement in its reservation ofrights letter.

Moreover, as the Supreme Court of Hawaii recognized,"affording an insured a defense under a reservation of rightsagreement merely retains any defenses the insurer has under its policy;it does not relieve the insurer of the costs incurred in defending itsinsured where the insurer was obligated, in the first instance, toprovide such a defense." First Insurance Co. of Hawaii, Inc. v. Stateof Hawaii, 66 Haw. 413, 422, 665 P.2d 648, 654 (1983). Gainsco'sreservation of rights letter could retain only those defenses thatGainsco had under its policy. Gainsco concedes that the insurancepolicies at issue did not provide for reimbursement of defense costs.Consequently, Gainsco's attempt to expand its reservation of rights toinclude the right to reimbursement must fail.

As previously noted, Gainsco argues that we need not look to theinsurance contract between the parties to determine whether Gainscohad a right to reimbursement because the circuit and appellate courtshave already determined that Gainsco owed no duty to defend.Gainsco maintains that because it had no duty to defend, it followsthat there is no contract governing the relationship between theparties. The problem with this argument is that Gainsco is attemptingto define its duty to defend based upon the outcome of the declaratoryjudgment action. Although an insurer's duty to indemnify arises onlyafter damages are fixed, the duty to defend arises as soon as damagesare sought. Central Illinois Light Co. v. Home Insurance Co., 213 Ill.2d 141, 158 (2004). As explained by the Court of Appeals for theEighth Circuit:

"Liberty remained obligated to defend [its insured] so long asthere remained any question as to whether the underlyingclaims were covered by the policies. Upon determination that*** the claims against [the insured] were therefore excludedfrom coverage, the district court properly concluded thatLiberty's duty to defend [its insured] in this action expired.Because we conclude that Liberty had a duty to defend [itsinsured] until such determination was made, we rejectLiberty's argument that it is entitled to reimbursement ofdefense costs." Liberty Mutual Insurance Co. v. FAGBearings Corp., 153 F.3d 919, 924 (8th Cir. 1998).

We find the analysis of the court in Liberty Mutual to be welltaken. Although Gainsco implies that it has always maintained that itdid not owe Midwest a defense in the underlying matter, we note thatGainsco's reservation of rights letter reveals some uncertaintyconcerning coverage. With regard to allegations in the underlyingclaim that Midwest was liable to the plaintiffs for various acts ofintentional and/or willful conduct, Gainsco's reservation of rightsletter stated that "the claim may not be covered under the Policy."(Emphasis added.) Given this uncertainty, Gainsco correctly agreedto pay Midwest's defense costs in the underlying action and sought adeclaratory judgment that it did not owe Midwest a defense. Gainscothus remained obligated to defend Midwest as long as any questionsremained concerning whether the underlying claims were covered bythe policies. Because Gainsco's obligation to defend continued untilthe trial court found that Gainsco did not owe Midwest a defense,Gainsco is not entitled to reimbursement of defense costs paid pendingthe trial court's order in the declaratory judgment action. The fact thatthe trial court ultimately found that the underlying claims againstMidwest were not covered by the Gainsco policies does not entitleGainsco to reimbursement of its defense costs.

In sum, we acknowledge that a majority of jurisdictions have heldthat an insurer is entitled to reimbursement of defense costs when (1)the insurer did not have a duty to defend, (2) the insurer timely andexpressly reserved its right to recoup defense costs, and (3) theinsured either remains silent in the face of the reservation of rights oraccepts the insurer's payment of defense costs. We choose, however,to follow the minority rule and refuse to permit an insurer to recoverdefense costs pursuant to a reservation of rights absent an expressprovision to that effect in the insurance contract between the parties.

For the foregoing reasons, then, we reverse the decisions of thecircuit and appellate courts awarding Gainsco reimbursement ofdefense costs, in the amount of $40,517.34, expended for the defenseof Midwest in the underlying litigation.

Appellate court judgment reversed;

circuit court judgment reversed.