Third Circuit Says Equity Applies to Subrogation Rights Under ERISA Plan

The Court of Appeals for the Third Circuit has had that equitable principles such as unjust enrichment apply to the subrogation rights of an employer under an ERISA plan.

In U.S. Airways, Inc. v. McCrutchen, No. 10-383 (3rd Cir. Nov. 16, 2011), McCrutchen was seriously injured in a car wreck. He spent several months in physical therapy and ultimately underwent a complete hip replacement. Since the accident, McCutchen, who had a history of back surgeries and associated chronic pain, has also become unable to effectively treat that pain with medication. The accident has rendered him functionally disabled. McCutchen’s Health Benefit Plan (the “Plan”), administered and self-financed by US Airways, paid medical expenses in the amount of $66,866 on his behalf.

Suit was filed on behalf of McCrutchen but a combination of multiple victims of the same wreck and limited liability insurance coverage meant that, after payment of fees and litigation-related expenses, McCrutchen’s net recovery was only $66,000. His law firm placed $41,500 in a trust account, reasoning that any lien found to be valid would have to be reduced by a proportional amount of legal costs.

U.S.Airways demanded repayment of the entire amount of money it paid. It said that the language of its Plan permits it to recoup the $66,866 it provided for McCutchen’s medical care out of the $110,000 total that he recovered regardless of his legal costs.

McCutchen argued that it would be unfair and inequitable to reimburse US Airways in full when he has not been fully compensated for his injuries, including pain and suffering. He argued that US Airways, which made no contribution to his attorneys’ fees and expenses, would be unjustly enriched if it were now permitted to recover from him without any allowance for those costs, in essence to reap what McCutchen has sown. He further argued that if legal costs were not taken into account, US Airways will effectively be reaching into its beneficiary’s pocket, putting him in a worse position than if he had not pursued a third-party recovery at all.

Citing the Plan’s use of the language “any monies recovered,” as well as previous decisions from the Third Circuit Court of Appeals, the District Court rejected McCutchen’s arguments and granted summary judgment to US Airways. The Court required McCutchen to sign over the $41,500 held in trust and to pay $25,366 from his own funds.

The Court noted that "US Airways’ claim to reimbursement from McCutchen’s pocket is unprecedented." The Court went on to demonstrate that "pigs get fat, hogs get slaughtered" is more than just a common Southern saying but is also a part of the law of Equity.

The Court reviewed the relatively recent United States Supreme Court decisions in the area, including Sereboff v. Mid Atlantic Medical Servs., Inc., 547 U.S. 356, 361 (2006). The Court then said that "this case squarely presents the question that Sereboff left open: whether § 502(a)(3)’s requirement that equitable relief be “appropriate” means that a fiduciary like US Airways is limited in its recovery from a beneficiary like McCutchen by the equitable defenses and principles that were ‘typically available in equity’.”

The Court went on to say as follows:

Indeed, it would be strange for Congress to have intended that relief under § 502(a)(3) be limited to traditional equitable categories, but not limited by other equitable doctrines and defenses that were traditionally applicable to those categories. ‘[S]tatutory reference to [an equitable] remedy must, absent other indication, be deemed to contain the limitations upon its availability that equity typically imposes.’ Knudson, 534 U.S. at 211 n.1 (rejecting the argument that a reimbursement claim framed as a claim for injunctive relief could proceed under § 502(a)(3) without a showing that the relief sought was typically available in equity); see also Cigna, 131 S. Ct. at 1880 (“Section 502(a)(3) invokes the equitable powers of the District Court.”). Accordingly, in light of the foregoing reasoning, and in the absence of any indication in the language or structure of § 502(a)(3) to the contrary, we find that Congress intended to limit the equitable relief available under § 502(a)(3) through the application of equitable defenses andprinciples that were typically available in equity.

The Court examined the applicable law of equity a nd concluded as follows:

Applying the traditional equitable principle of unjust enrichment, we conclude that the judgment requiring McCutchen to provide full reimbursement to US Airways constitutes inappropriate and inequitable relief. Because the amount of the judgment exceeds the net amount of McCutchen’s third-party recovery, it leaves him with less than full payment for his emergency medical bills, thus

undermining the entire purpose of the Plan. At the same time, it amounts to a windfall for US Airways, which did not exercise its subrogation rights or contribute to the cost of obtaining the third-party recovery. Equity abhors a windfall. See Prudential Ins. Co. of America v. S.S. American Lancer, 870 F.2d 867, 871 (2d Cir. 1989)

McCrutchen did not make a "made whole" argument on appeal. The Circuit Court’s opinion addresses this issue in Footnote 2:

Before the District Court, McCutchen also argued for application of the “make-whole” doctrine, which is an equitable doctrine, applied in many states, that provides that “the insured is entitled to be made whole before the insurer recovers on its subrogation claim.” 16 Lee R. Russ in conjunction with Thomas F. Segalla, Couch on Insurance§ 223:133 (3d ed. 2011); see, e.g., Swanson v. Hartford Ins. Co. of Midwest, 46 P.3d 584, 589 (Mont. 2002) (“[A]n insured must be totally reimbursed for all losses as well as costs, including attorney fees, involved in recovering those losses before the insurer can exercise any right of subrogation, regardless of any contract language providing to the contrary.”) (internal quotation omitted). McCutchen does not pursue this argument on appeal, and we do not address it.

Given the rest of opinion, the Third Circuit may well have applied the "made whole" doctrine in this case. Note: I am not being critical of McCrutchen’s counsel. These lawyers were fighting against a bunch of cases that reached a contrary result, and had to make a judgment about how best to persuade the Third Circuit to advance the law. One doesn’t always make every argument available on appeal – shooting with a rifle often bags more game (and better quality meat) than shooting with a shotgun.

I have always believed that those with subrogation rights should have the amount of their recovery reduced by certain equitable factors. Over a decade ago I drafted the legislation that impacts the subrogation claim of Tenncare (Tennessee’s version of Medicaid) and it fairly adjusts Tenncare’s subrogation interests. Here are the factors that must be taken into account when determining the amount that must be re-paid to Tenncare:

The gross amount of the subrogation interest shall be reduced by one (1) or more of the following factors, as applicable:

   (1) To the extent that the plaintiff is partially at fault in the incident giving rise to the litigation, the subrogation interest is reduced by the percentage of fault assessed against the plaintiff;

   (2) To the extent that the finder of fact allocated fault to a person who was immune from suit, the subrogation interest is reduced by the percentage of fault assessed against the immune person;

   (3) To the extent that the finder of fact allocates fault to a governmental entity that has its liability limited under state law and the fault of the entity, when multiplied by the total dollar value of the damages found by the finder of fact, exceeds the amount of judgment that can be awarded against the entity, the subrogation interest is reduced proportionately by a percentage derived by dividing the uncollectable portion of the judgment against the governmental entity by the total damages awarded; or

   (4) To the extent that the finder of fact allocated fault to a person that the plaintiff did not sue, the subrogation interest is reduced by the percentage of fault assessed against the non-party.

(h) After these calculations are performed, the judge should further reduce the subrogation interest pro rata by the amount of reasonable attorneys’ fees and litigation costs incurred by the plaintiff in obtaining the recovery as required in subsection (c).

T.C.A. Sec.71-5-117(g).

Although with the benefit of hindsight I wish I would have written this a little differently, I am happy to say that there is very little litigation on this subject – the factors apply enough flexibility for all involved that the issue can be resolved without the need of litigation. There is no good reason such rules should not apply to ERISA subrogation interests as well.

U.S. Airways got greedy here, and greed gave the Third Circuit Court the opportunity to fix an injustice. Thanks to the lawyers who were willing to fight this fight – they spent hundreds of hours on this issue and will not be paid for their efforts.