Under a liability insurance policy, an insurance company promises to defend its policyholder and provide "litigation insurance" Continental Casualty v. Rapid-American, 80 N.Y.2d 640, 648 (1993). Thus, when an insurance company defends a policyholder in litigation, the policyholder does not expect the insurance company to demand that the policyholder pay it back.

In recent years, however, insurance companies have increasingly sought to "recoup" defense costs paid for their policyholder's defense, arguing retrospectively that the litigation was not actually covered by the policy. Surprisingly, the insurance companies often seek recoupment, while ignoring the purpose of the duty to defend, and when their policies do not include any contractual provision allowing for recoupment. They often base recoupment on a reservation of rights letter. These letters, which the insurance company sends in response to a policyholder's notice of a claim, acknowledge the insurance company's duty to defend, but then purportedly reserve the option to recoup defense costs if the insurance company later determines that the underlying claim was not covered.