Declaratory Judgement by Insurer: The court provides a limitation on attorney's fees and a definition of "prevailing party" under Federal Rule 54

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Federal Rule of Civil Procedure 54(d) provides, in pertinent part, that “[u]nless a federal statute, these rules, or a court order provides otherwise, costs – other than attorney’s fees – should be allowed to the prevailing party.” The rule further provides, in contrast, a prevailing party must file a motion requesting attorney’s fees. Consequently, the definition of “prevailing party” is critical.

There are ample cases defining prevailing party in the context of a claim for costs and fees under a particular statute upon which the original claim was based. Likewise, there are sufficient cases construing prevailing party as it exists in contracts wherein the parties have agreed to allow costs and fees to that party if litigation arises. Until recently, however, cases of an insurer instituting a declaratory judgment action against its insured were limited to those in which an insurer sought to have the court determine it was not required to defend or indemnify its insured in a particular underlying action. Historically, such cases have been interpreted as constructive breaches of contract; the insurer seeks to avoid a potential duty under the insurance contract. If the insured prevailed, it was awarded attorney’s fees, as an element of damages. Additionally, there have been no South Carolina cases interpreting “prevailing party” in the framework of a declaratory judgment action by an insurer against its insured. From a broader perspective, there were no cases found defining “prevailing party” pursuant to Rule 54(d) where a party initiates a declaratory judgment action seeking general clarification of contract terms. The United States District Court for South Carolina recently filled these gaps. Owners Insurance Company v. Warren Mechanical, LLC 2018 WL 3933770 (August 16, 2018).

Warren originated in a workers compensation matter. In its quest for a particular endorsement, Warren Mechanical (“Warren”) contacted its insurance agent who erroneously completed its application for coverage. Upon submission of the application, Owners Insurance (“Owners”) issued a policy to Warren. Shortly thereafter, one of Warren’s employees was injured and sought compensation benefits; Owners denied the claim, asserting there was no valid policy in effect. The employee requested a hearing with the South Carolina Workers’ Compensation Commission (“SCWCC”). Owners filed a motion in the SCWCC matter seeking to have the policy declared void ab initio. That motion was denied, pending discovery and will be revisited if the case is not resolved. In the meantime, Owners filed this action, ultimately seeking a determination by the court as to whether the contract with Warren was valid and binding for all future claims or whether the policy was void ab initio because of Warren’s material misrepresentations in its application.^[1] This matter came before the court on cross motions for summary judgment. Because there was a pending matter on the same issues in state court, the case was dismissed. Warren brought its motion for costs and attorney’s fees incurred defending the action. 

It is well established in South Carolina that attorney’s fees are generally not recoverable in litigation absent a statute or agreement that provides otherwise. An exception arises, however, when an insurer initiates a declaratory judgment action seeking to obviate a purported duty to defend in an underlying action. South Carolina courts look at that action as if the insurer breached a contractual duty to defend. Thus, South Carolina common law provides attorney’s fees to an insured who successfully defends such an action, viewing those fees as damages arising from the insurer’s breach of contract. In Warren, however, Owners’ action sought only a determination whether the insurance contract was void ab initio, rather than a determination whether it had a duty to defend or indemnify relative to the pending claim on behalf of Warren’s injured employee. Because of the general nature of Owners’ claim, the court distinguished Warren from precedent and determined Owners’ declaratory judgment action was not a breach of contract and Warren was not entitled to an award of attorney’s fees, despite the technical resolution of the action in its favor.

The court next turned to Warren’s request for costs, and its analysis of whether Warren was a “prevailing party.” The criterion for determination of “prevailing party” is whether the legal relationship between the two parties was fundamentally modified by the court’s disposition of the case. Looking to recent authority from the United States Supreme Court, the court noted that in order to prevail, a defendant does not have to walk away with a favorable ruling on the merits. Rather, the test is whether the plaintiff’s goal was thwarted, regardless of the court’s basis therefor. Thus, a defendant may prevail when the court rejects the plaintiff’s claims for reasons other than the merits.

Finding no South Carolina authority that defines “prevailing party” in the specific  context of a declaratory judgment action by an insurer against its insured, nor in the more general context of Rule 54 in a declaratory judgment action designed to clarify the terms of a contract, the court adopted the United States Supreme Court definition of “prevailing party.” So, while Warren may have preferred a substantive ruling in its favor, and even though it was not successful in its pursuit of attorney’s fees, its objective was nonetheless accomplished as Owners’ challenge was rebuffed. Consequently, the court awarded costs to Warren.

Though somewhat subtle, this opinion nets significant opportunity for analytical exercise to insurers. Should an insurer seek determination of its policy obligations in a broad and general context? Warren suggests that is prudent. Because Owners’ action was not directed to a particular claim, the court rejected the treatment of its declaratory judgment action as one in which Owners breached its contractual duties and consequently refused to award attorney’s fees to the insured. That begs the question - how or when would Owners have realized the insured’s application included material misrepresentations, but for a specific claim? And, if Owners chose not to seek a finding in the pending action that the policy was void ab initio, which resulted in the dismissal of the present case, but instead simply defended, would a subsequent, broader declaratory judgment action have drawn assertions of waiver or perhaps issue preclusion from Warren. For as many questions raised by Warren as to how an insurer may look to declaratory judgment actions in the future, it provides guidance as to what constitutes a “prevailing party” under Federal Rule 54 in declaratory judgment actions by an insurer against its insured.