If insurer defends insured under Reservation of Right then can they seek reimbursement for legal costs?

Question

Let's assume insurance company in California agreed to defend its insured and picked a legal counsel to represent their insured. But at a later date sent a reservation of rights letter with following language:

By this letter we are advising you that we will investigate the claim(s) being made against you subject to a reservation of rights under your Business. A reservation of rights places an insured on notice of the fact that the insurer may ultimately decline to defend or indemnify for some or all of the damages that might be awarded in an action. A reservation of rights also advises the insured as to the reasons why there might not be an obligation to defend or indemnify. The terms of this particular reservation of rights are explained below. Although insurance company is agreeing to investigate the claim under the policy, we are reserving our right to deny coverage to you (or anyone claiming coverage) at any time.

Since that paragraph talks not only about duty to indemnify, but also about duty to defend, then does it mean that insurance company may once they establish that all claims fall outside the policy scope:

1. ask for reimbursement of any legal defense costs they paid? OR
2. merely just decline future legal defense?

Answer 1

If insurer defends insured under Reservation of Right then can they seek reimbursement for legal costs?

Yes, provided that the claims defended by the insurer were not even potentially covered by the policy. The principle is to preclude the insured's unjust enrichment at insurer's expense. See Buss v. Superior Court, 16 Cal.4th 35, 52 (1997), which is premised on case law from other jurisdictions stating that

"[i]f, having reserved" "its right to assert a defense of noncoverage" and "having accepted a reasonable [settlement] offer, the insurer subsequently establishes the noncoverage of its policy, it would be free to seek reimbursement of the settlement payment from its insured;

(quotes and brackets in original, citations omitted).

Buss assessed whether an insurer is entitled to reimbursement where [at least] some of the claims in a suit are not even potentially covered by the policy. The court in Buss at 52-53 added that

[w]ithout a right of reimbursement, an insurer might be tempted to refuse to defend an action in any part — especially an action with many claims that are not even potentially covered and only a few that are — lest the insurer give, and the insured get, more than they agreed. With such a right, the insurer would not be so tempted, knowing that, if defense of the claims that are not even potentially covered should necessitate any additional costs, it would be able to seek reimbursement.

Where a policy fails to address the reimbursement of expenses for not covered claims, the right of reimbursement is implied in law as quasi-contractual. In a quasi-contractual context, Buss at n.27 points out that the right of reimbursement of defense costs must be reserved, and that "[t]rhough reservation, the insurer avoids waiver".