Defending Defense Costs: Parrying the Attack of the Legal-Fee Auditors

A common play by insurers that have failed to perform their duty to defend is to challenge the defense costs their policyholders incurred. Had the carrier defended, the argument goes, it would have hired cheaper lawyers, ridden tighter herd on the bills, assigned fewer people to the case, or otherwise done the job for less. To deliver this after-the-fact wisdom, insurers have enlisted a specialized mouthpiece: the “legal-fee auditor.”

The premise deserves scrutiny. An insurer that wrongfully refuses to defend is not simply administering a fee application. It is a breaching party answering for the consequences of its breach. The insured still must establish recoverable damages, and the governing law matters. But the natural consequence of refusing to defend is that the policyholder must hire lawyers and experts to do the work the insurer promised to provide. A carrier should not be permitted to turn that necessity into a second opportunity to control a defense it declined to undertake.

There is also an economic point that the carrier’s retrospective audit tends to obscure. An insured paying for its defense without assurance of reimbursement has its own reason to economize. As Judge Posner explained in Taco Bell Corp. v. Continental Casualty Co., 388 F.3d 1069, 1075–76 (7th Cir. 2004):

“Because of the resulting uncertainty about reimbursement, Taco Bell had an incentive to minimize its legal expenses (for it might not be able to shift them); and where there are market incentives to economize, there is no occasion for a painstaking judicial review.”

Taco Bell addressed the fee-review process as a matter of federal procedure. That does not diminish its central insight: an insured’s incentive to control its own costs is evidence that matters. Nor does it make every dollar billed automatically recoverable. The applicable law still governs the recoverable defense costs and the allocation of the burden of proof. See also Aerojet-General Corp. v. Transport Indemnity Co., 17 Cal. 4th 38, 948 P.2d 909 (1997).

What Taco Bell does expose is the weakness of manufacturing a costly dispute over bills that the insured had every incentive to contain. The court’s description of the carrier’s audit deserves quotation:

“The affidavit of the firm that picked through Taco Bell’s legal bills is excruciatingly detailed. The amount of time and money that went into its preparation and would be incurred in adjudicating its accuracy probably exceeds the potential excesses that it identifies.” Taco Bell, 388 F.3d at 1075.

The label “audit” does not do the evidentiary work. Whatever their billing experience, these chaps do not acquire expertise merely by putting an audit firm’s name on a collection of objections. The questions are what specialized knowledge the witness brings, what method was used, and why that method reliably measures the reasonableness of this defense—not whether the insurer would have preferred a different staffing model.

Liberty Mutual Insurance Co. v. Black & Decker Corp., 2004 WL 1941351, at *8 & n.8 (D. Mass. Aug. 25, 2004), illustrates both the point and its limits. Judge Woodlock questioned whether the carrier’s fee reviewer possessed the specialized knowledge required by Federal Rule of Evidence 702. He expressly left the qualification question undecided, however, and acknowledged that the reviewer could still help the carrier identify objections. The opinion is useful support for examining the witness’s qualifications; it is not a categorical ruling that legal-fee reviewers can never testify as experts.

More important was the court’s treatment of the insurer’s private billing rules after notice and wrongful refusal to defend:

“Having declined to involve itself in the insured’s conduct of the litigation once notified, it is in no position ex post to complain that the insured’s billing and litigation management policies do not meet its private criteria. The insurer that declines defense after notice cannot claim prejudice in the form of billing format or litigation practices that do not meet its standards, since it could have assumed the defense and imposed those standards.” Black & Decker, 2004 WL 1941351, at *8.

The court did not dispense with reasonableness review. It applied the general standards of Massachusetts law to post-notice fees and expenses rather than the “business rules” of a private reviewing firm. It also distinguished pre-notice costs, for which the insurer’s contemporaneous, objective cost-management criteria could matter. Rejecting a retroactive billing protocol does not mean abandoning reasonableness review.

Nor should a carrier be allowed to smuggle the standards for a statutory fee petition or a bankruptcy application into an ordinary claim for contract damages without explaining why those standards apply. “Block billing” and “inadequate descriptions” are familiar objections. They can present real proof problems, but they are not self-executing forfeiture provisions. The question is whether the insured’s evidence establishes the work performed, its connection to the defense, and the recoverable amount under the governing law. Lawyers bill for their time, not for their time descriptions—as the old “for services rendered” invoice confirms. That is no excuse for bad records; it is a reason not to confuse the description with the service.

Some carriers likewise object to computerized legal research and other separately billed expenses on the theory that they are necessarily overhead. The billing arrangement and the nature of the expense matter. ABA Formal Opinion 93-379, Billing for Professional Fees, Disbursements and Other Expenses (Dec. 6, 1993), distinguishes general office overhead from reasonably incurred matter-specific services, including computer research, and addresses disclosure and cost-based charging. It does not give lawyers a blank check to mark up expenses. Nor does the possibility of including a cost in an hourly rate make separate billing inherently improper.

None of this means that clients should ignore their lawyers’ bills. Sophisticated corporate clients monitor costs because they are paying them. Some negotiate higher hourly rates with expenses absorbed; others prefer lower rates and separately billed expenses. Some want task-based billing and are willing to pay for it; others accept daily narratives or what insurers call “block” billing. These are business arrangements to work out with defense counsel, not standards for a breaching carrier to invent after the defense is over.

The insurer’s obligation is to pay the damages recoverable for its breach, not merely the amount its reviewer can be persuaded to approve. Taco Bell put the institutional point neatly: “the duty to defend would be significantly undermined if an insurance company could, by the facile expedient of hiring an audit firm to pick apart a law firm’s billing, obtain an evidentiary hearing on how much of the insured’s defense costs it had to reimburse.” 388 F.3d at 1076.

In one of my cases, a legal auditor purported to question 73 percent of the defense costs incurred for a sophisticated client by a leading employment-liability defense firm. The report ran to some 748 pages. That should be Exhibit A—not in proving that every bill is sacrosanct, but in asking whether the audit has become another piece of litigation rather than a reliable measure of the defense.

Update—October 16, 2026: The Seventh Circuit Returns to the Market Test

Seventeen years after this post, the Seventh Circuit returned to the same problem in USA Gymnastics v. Liberty Insurance Underwriters, Inc., 46 F.4th 571 (7th Cir. 2022). Applying Indiana law, the court upheld a presumption that the defense fees at issue were reasonable and necessary. The point was the familiar one: an insured facing uncertainty about reimbursement has its own incentive to economize. An insurer cannot displace that market test merely by insisting that the insured should have supervised its lawyers differently.

The state-law foundation matters. The Indiana Court of Appeals had adopted Taco Bell’s reasoning in Thomson Inc. v. Insurance Co. of North America, 11 N.E.3d 982, 1023–24, 1031 (Ind. Ct. App. 2014). USA Gymnastics treated the presumption as substantive for purposes of the federal court’s choice between state and federal law. When the presumption applies, the insurer bears the burden of proving that the fees were unreasonable or unnecessary. Thus, what Taco Bell discussed in a federal procedural setting also has a substantive state-law footing in Indiana.

Nor must the insured first pay every dollar of its lawyers’ bills to obtain the presumption. The court rejected both full payment and the insurer’s preferred form of supervision as prerequisites. USA Gymnastics had paid nearly 70 percent of the fees for which it sought reimbursement—compelling evidence of a market test. The presumption remained rebuttable, but Liberty failed to rebut it.

Neither decision makes every bill unassailable. Both make the insured’s real-world incentive to control its own costs matter. The insurer’s opportunity to contest unreasonable charges survived; its invitation to conduct the defense by hindsight did not prevail.

Originally published in Insurance Scrawl on September 15, 2005. Republished with updated citation links and editorial revisions. The original commentary is followed by a separately identified October 16, 2026 update discussing the 2022 USA Gymnastics decision; the post is not a comprehensive survey of subsequent law.

Related: Practice Areas · Insurance Coverage · Marc Mayerson’s biography.

Topics: Defense Costs · Legal-Fee Audits · Duty to Defend

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