One of the recurring and often complex issues in Israeli liability insurance law concerns the extent of the insurer’s obligation to cover legal expenses and, more particularly, what qualifies as “reasonable legal costs” that an insurer must cover. This issue, frequently encountered in practice, has now been addressed by the Supreme Court in a recent landmark decision.
The ruling finally sheds light on the interpretation of Section 66 of the Insurance Contract Law, 5741-1981, which states: “Liability insurance covers also reasonable legal costs which the Insured has to bear by reason of his liability, even in so far as such costs are in excess of the amount of insurance”.
The Supreme Court case (Civil Appeal 405/23) arose from an unfortunate incident in May 2012, where a minor suffered severe burns from boiling water spilled from a hot water container at her uncle’s home. The minor and her parents filed a personal injury lawsuit against multiple defendants, including the uncle and the house insurer, AIG Israel Insurance Ltd. The District Court found the uncle and AIG liable for the damages (which were set at a total amount of NIS 2,380,670), ordering AIG to cover the policy limit (NIS 335,447) and the full legal fees awarded to the minor and her parents, which amounted to approximately NIS 561,000. AIG appealed this decision, primarily challenging its obligation to pay legal fees way beyond the policy limit and the reasonableness of these costs.
The Supreme Court, in its ruling, tackled three pivotal questions regarding Section 66 of the Insurance Contract Law:
The Supreme Court’s decision provides clear and significant guidance on these issues, establishing important precedents for liability insurance in Israel. The ruling is anchored in two fundamental legal principles: the principle of loss mitigation and the consumer protection purpose of the Insurance Contract Law.
The Court unequivocally ruled that the insurer’s obligation under Section 66 extends to legal costs awarded to the opposing party, not just the insured’s own defense expenses. This interpretation aligns with the consumer protection aim of the law, which seeks to shield the typical insured from unexpected legal burdens. The Court reasoned that an insured might be even less aware of the risk of being ordered to pay the opposing party’s costs than their own. Furthermore, from a loss mitigation perspective, managing a legal process to reduce potential liability inherently involves the risk of incurring the opposing party’s costs. Therefore, requiring the insured to bear these costs alone would contradict the very purpose of encouraging efficient dispute resolution.
Regarding the reasonableness of legal costs, the Court clarified that this qualification applies to all covered expenses. While acknowledging that factors like the claim amount, potential collateral damages, litigation complexity, and market rates are relevant, the Court emphasized a crucial distinction for costs awarded to the opposing party. Unlike the insured’s own legal costs, over which they have more control, the amount of costs awarded to the opposing party is determined by the court. The Supreme Court stated that, generally, legal costs actually awarded by a court will be considered reasonable, unless they reflect a sanction for improper conduct by the insured during the proceedings. This approach prevents insurers from second-guessing judicial cost awards, reinforcing the finality of court decisions.
Perhaps the most impactful aspect of the ruling concerns the apportionment of legal costs when the insured’s liability exceeds the policy limit. The Court rejected the notion that the insurer must bear all legal costs in such scenarios. Instead, it determined that the general rule is that legal costs should be divided between the insurer and the insured proportionally to their respective shares of the total liability. Specifically, the insurer is responsible for legal costs corresponding to the policy limit, while the insured bears the costs corresponding to the portion of the liability exceeding the policy limit. This proportional allocation ensures that the insurer covers those costs which are related to the insured risk, while the insured is responsible for costs associated with the uncovered portion of their liability. This approach balances the insurer’s obligation to cover the insured risk with the principle that the insurance contract has a defined limit.
This Supreme Court decision provides much-needed clarity on several critical aspects of legal cost coverage in Israeli liability insurance. It firmly establishes that insurers must cover opposing parties’ legal costs and introduces a clear framework for apportioning costs when liability exceeds the policy limit.
However, while the ruling provides clear guidance as to the “reasonableness” of the legal costs awarded to the opposing party, it leaves some questions open regarding the “reasonableness” of the insured’s own legal costs. Although the Court outlined general considerations for reasonableness (e.g., claim amount, complexity, market rates), it did not delve into specific rules for assessing the reasonableness of the insured’s direct defense costs. That being said, the Court’s reasoning in the third question – as per the proportional allocation of costs to the opposing party when liability exceeds the policy limit – may indeed offer a broader guiding principle. It suggests that a similar proportional approach could be applied with respect to the insured’s own legal and defense costs, ensuring that in similar circumstances (namely, when liability exceeds policy limit) both parties should share the legal costs burden in a manner consistent with their respective financial exposures.
In accordance with this rationale, the inclusion of provisions in liability policies stipulating that the insured must reimburse or indemnify the insurer for legal costs in cases where the imposed liability exceeds the insurance amount, in a proportional manner, would not be considered contrary to the mandatory provision of Section 66 of the Law. This interpretation, if applied, creates a harmonious balance between consumer protection and loss mitigation goals, while honoring the contractual intent behind liability policies and their established exposure thresholds.
