Massachusetts High Court: Insurers Not Obligated to Prosecute Counterclaims under Duty-to-Defend Policies

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On June 22, 2017, the Massachusetts Supreme Judicial Court (SJC) in Mount Vernon Fire Insurance Co. v. Visionaid, Inc. (No. SJC-12142) considered three questions certified by the First Circuit Court of Appeals addressing the limits of an insurer’s defense obligation: (1) whether the policy and/or the broad duty-to-defend approach of “in for one, in for all” followed in Massachusetts requires an insurer to prosecute counterclaims; (2) whether the definition of “defense costs” includes the prosecution of a counterclaim; and (3) if the insurer must prosecute counterclaims, whether a conflict of interest arises in the prosecution of counterclaims requiring the appointment of independent counsel.

In brief, the Court determined that an insurer does not have a duty to prosecute counterclaims under the plain meaning of the policy or the “in for one, in for all” doctrine, nor does the definition of “defense costs” require an insurer to pay costs to prosecute a counterclaim. In view of it answers to the first two questions, the Court did not need to reach the third question concerning conflicts of interest.

Background
Mount Vernon Fire Insurance Company issued to Visionaid, Inc. an employment practices liability policy that stated Mount Vernon had the “right and duty to defend any Claim to which this insurance applies” and would “pay one hundred percent (100%) of the Defense Costs for the [covered] Claim” until the policy limit was reached. “Claim” was defined as “any proceeding initiated against [Visionaid] … seeking to hold [Visionaid] responsible for a Wrongful Act.” “Defense costs” were defined as “reasonable and necessary legal fees and expenses incurred by [Mount Vernon], or any attorney designated by [Mount Vernon] to defend [Visionaid], resulting from the investigation, adjustment, defense, and appeal of a Claim.”

During the policy period, Visionaid discovered that one of its employees appeared to have misappropriated several hundred thousand dollars of company funds and terminated him accordingly. The employee filed an action for wrongful termination, claiming that his employment was terminated due to his age. Mount Vernon agreed to defend Visionaid under a reservation of rights, and appointed panel counsel to defend the case.

The Coverage Dispute
In the course of the litigation, Visionaid demanded that Mount Vernon assert and prosecute counterclaims on its behalf to seek restitution of the funds that the terminated employee had allegedly misappropriated. Visionaid also threatened to exercise its right to select its own counsel due to the insurer’s reservation of rights. Mount Vernon withdrew its reservation of rights, but maintained that it was not obligated to pay for the prosecution of the counterclaim as these costs were not “defense costs” as  defined by the policy.

While the discrimination case was pending, Mount Vernon filed a declaratory judgment action in federal district court seeking a determination that it was not required to prosecute or pay for Visionaid’s counterclaims. Visionaid responded with its own counterclaim asserting that the duty to defend obligated Visionaid to prosecute the counterclaim for misappropriation, and that Mount Vernon was obligated to pay for independent counsel to that end. The U.S. District Court of Massachusetts concluded that Mount Vernon’s duty to defend did not obligate it to prosecute the counterclaim for misappropriation. Visionaid appealed to the First Circuit Court of Appeals, which certified the three questions noted above to the SJC.

The SJC Opinion
The SJC flatly rejected Visionaid’s argument that Mount Vernon’s duty to “defend” Visionaid included the prosecution of counterclaims. Visionaid had argued that the meaning of the word “defend” should include anything a reasonable attorney would do to reduce the insured’s liability. In rejecting that view, the SJC held that the plain meaning of the policy only afforded coverage to “defeat a claim that could create liability against the individual being defended.” The court also examined the split among states, citing to cases in (1) New Jersey, Wyoming and the Fifth Circuit (Texas) that agree with the SJC’s analysis, and (2) Illinois, the District of Columbia and Pennsylvania that include coverage of counterclaims in certain circumstances.

The SJC also rejected Visionaid’s contra proferentem argument; that is to say, its argument that its interpretation of the word “defend” was reasonable and therefore must be favored over Mount Vernon’s interpretation. However, the Court is not obligated to ignore or read additional provisions into the policy merely because a facially reasonable alternative exists. Visionaid’s interpretation would require the Court and future litigants to consider whether compulsory counterclaims are intertwined with the defense, whether a reasonable attorney would bring the counterclaim, and whether an award on the counterclaim would be an offset to the indemnity paid. These provisions were absent from the policy and would require courts and potential parties to litigate these factors in any future case.

The SJC also disagreed with Visionaid’s claim that Massachusetts’s “in for one, in for all”  duty to defend rule implicates coverage for counterclaims. The purpose of “in for one, in for all” — in which insurers are obligated to defend the entire suit if even one covered count is present — is to prevent litigation determining the extent of coverage. Although “in for one, in for all” expanded the class of actions that an insurer may be obligated to cover, this class was limited to defensive actions — and did not extend to the kind of affirmative claim at issue here. Requiring coverage for counterclaims would defeat the purpose of demanding an insurer be “in for one, in for all” by necessitating the above-mentioned coverage litigation. The interpretation sought by Visionaid also would incentivize insureds to demand at the insurer’s cost prosecution of counterclaims that may have little or no merit.

Finally, the SJC considered whether the definition of “defense costs” required the insurer to prosecute counterclaims. By defining “defense costs” as it did, Mount Vernon equated its duty to pay defense costs with its duty to defend. Of course, Massachusetts already considers the scope of the duty to defend and the duty to pay defense costs to be identical. Accordingly, the SJC considered the same analysis it had considered regarding the definition of “defend,” and concluded that the definition of “defense costs” did not obligate the payment of fees to prosecute counterclaims.

Since the answer to the first two certified questions did not obligate insurers to prosecute counterclaims, the third question concerning conflicts of interest for those counterclaims became moot.

Practice Point
Whether coverage is required for counterclaims varies by jurisdiction. Even states that require coverage for counterclaims vary in the criteria triggering the obligation. Mount Vernon v. Visionaid does an excellent job of explaining these different approaches while clearly setting Massachusetts in the column of states that do not afford de facto coverage to counterclaims. The opinion also is remarkable in that the SJC explicitly chose to corral the “in for one, in for all” rule. The opinion certainly simplifies and clarifies an insurer’s obligation in somewhat murky waters. In view of this, as other courts around the country confront this issue, we anticipate that they will certainly consider Visionaid and, may in fact, embrace its rationale and conclusion.

As a practical matter, insurers often will authorize defense counsel to prosecute counterclaims that are intertwined with the defense and could limit or reduce their insureds’ liability, as this is in the interest of the insured and the insurer. Asking the insurer to pay for separate counsel to prosecute the counterclaims in this case, however, appears to have been a bridge too far.

Of course, like any decision on a controversial subject, Visionaid leaves a number of questions unanswered, one of which is: The policy in Visionaid defined the term “defense costs.” What if the term “defense costs” had been undefined? Would the outcome have been different?  Might the insured in that event have been able to argue  that, at a minimum, the undefined term is ambiguous, and given that and the breadth of the duty to defend, would the insurer have been required to pay the costs of the insured’s affirmative claim? 

Undoubtedly, this issue — and other open questions — will be the subject of future decisions as courts grapple with the implications of Visionaid.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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