Source: https://www.morrisonmahoney.com/blog/334-sjc-agrees-to-decide-whether-insurers-may-recoup-defense-costs
Timestamp: 2019-04-26 08:10:21+00:00

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The Supreme Judicial Court of Massachusetts announced on September 15 that it will accept review of a case presenting novel issues concerning the scope of "personal and advertising injury" coverage for intellectual property disputes as well as the controversial question of whether insurers have a right to recoup defense costs if they are later adjudged not to have owed a duty to defend.
The dispute in Holyoke Mut. Ins. Co. v. Vibram USA, Inc., SJC 12401 involves a law suit by the heirs of an Ethiopian distance runner who gold medals at the Rome and Tokyo Olympics in the 1960s by running the marathon in bare feet. The heirs have sued footwear manufacturer Vibram for trademarking its "Bikila" running shoe, which is claimed to be so slim as to mimic the sensation of running barefoot, without obtaining the Estate's permission. The heirs sought recovery against Vibram under Washington's "Personality Rights Act," which provides that "every individual or personality has a property right in the use of his or her name, voice, signature, photograph, or likeness."
Vibram sought a defense to the heirs' suit from its CGL insurers (Holyoke Mutual and Maryland Casualty). Both insurers agreed to defend but did so under a reservation of rights, with the result that Vibram engaged KL Gates to defend it and sued the insurers in the Massachusetts Superior Court in Boston, alleging that it was entitled to coverage under Coverage B. In October 2016, Judge Kaplan of the Business Litigation Session of the Superior Court ruled that the underlying claims did not trigger Coverage B. The court ruled that the underlying claims involved a right to publicity, not a claim for invasion of privacy covered by the policies. Further, the court found that the use of Bikila's name was not an "advertising idea."
Following this ruling, both insurers sought a declaration that they were entitled to be reimbursed for over $670,000 in defense costs that they had paid up to that point (for reasons that are unclear from the opinion, the insurers had failed to pay an additional $600,000 that counsel had billed) . On March 20, 2017, Superior Court Judge Mitchell Kaplan issued an opinion rejecting the insurer's recoupment claims. While acknowledging the lack of clear Massachusetts precedent on the issue of recoupment and the split of authority elsewhere, Judge Kaplan adopted the view of the Pennsylvania Supreme Court in American & Foreign Ins. Co. v. Jerry's Sport Center, Inc., 2 A.3d 526 (Pa. 2010) that recoupment should only be allowed where specifically provided for in the parties' contractual agreement. In Jerry's, the Pennsylvania Supreme Court observed that absent an insurance policy provision authorizing the right in the first place, permitting recoupment by insures would be " tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract."
Otherwise, the insurer is, in effect, using equitable principles to insert a reimbursement provision into the liability policy that does not exist. If a policy holder demands coverage of a third-party claim that is clearly not covered under the policy, the insurer can reject it. If a policy holder engaged in misrepresentations or other wrongful conduct (for example, acting in concert with a third-party claimant to make an uncovered claim appear covered), retention of defense costs might well be "unjust." However, a good faith demand for a defense under a liability policy, which the insurer decides is likely enough to be valid that it will tender a defense under a reservation of rights, does not make retention of those defense costs unjust.
On the other hand, while ruling that the insurers could not recoup the defense costs that they had reimbursed up that point, Judge Kaplan ruled that the insurers were not obligated to pay the additional costs billed by defense counsel but that had not been paid as of the date of the court's ruling. In contrast to Vibram's claim that it was entitled to all defense costs incurred up to the point that declaratory relief entered against it, the Superior Court ruled that what was relevant was the point in time when the facts no longer presented a possibility of coverage.
The parties jointly filed an application for Direct Appellate Review that was granted by the Supreme Judicial Court. Successful DAR Applications are relatively unusual and joint DAR Applications are nearly unheard. In this case, however, Vibram had an interest in reversing the Superior Court's ruling that there was no coverage for the underlying trademark infringement claims, whereas the insurers wanted a reversal of Judge Kaplan' rejection of their claimed rights to recoupment.
In accepting review, the Supreme Judicial Court seems to be clearly stating that it views the issue of recoupment as an important concern that deserves a clear statement by the Commonwealth's highest court. It is far from clear, however, whether the Court views Judge Kaplan's analysis as being erroneous or wishes to adopt it for its own.
1) Did the Superior Court correct in ruling that the heirs' claims did not trigger a duty to defend under Coverage B, either as involving the publication of states that invade a person's privacy or as involving the misappropriation of an "advertising idea" in the insured's advertising?
2) Did the Superior Court err in refusing to allow the reinsurers to recoup the defense costs that they had paid once there was a judicial determination that the underlying law did not trigger a duty to defend?
3) If the insurers have no right of recoupment, are Holyoke Mutual and Maryland Casualty only liable for the defense costs that they had actually paid up to the point of the court's ruling or, as Vibram contends, are they also liable for the full amount of defense costs incurred but not billed?
As with many legal issues now pending before the SJC, the answer to these questions is complicated by the fact that five of the seven Justices of have been appointed in the past two years and only Chief Justice Gants has much of a track record on insurance issues.
In the most recent major case to come before the court, the new justices split with Justice Gants, ruling in Mt. Vernon Fire Ins. Co. v. VisionAid, 477 Mass. 343 (2017) that the duty of liability insurers to defend is just that and does not extend to prosecuting counter-claims, however beneficial they may be to the insured's ultimate legal position. Justice Gants, on the other hand, argued for a broader, less literal view of the duty to defend. While the majority's literal approach to policy interpretation benefitted the insurers in VisionAid, will it undermine the argument of Vibram's insurers that equitable considerations require a right to recoupment, even if such a right is not specifically set forth in the policy?
It is to be hoped that the insurers' briefing will correct one profound misconception that the recoupment courts have erroneously repeated for years. It is true that the principle of equitable restitution was first applied in this area by the California Supreme Court's increasingly dusty opinion twenty years ago in Buss v. Superior Court, 939 P.2d 766 (Cal. 1997). In Buss, the Supreme Court explained that this duty to defend the entire suit was not based on the wording of the policy, nor was it contractual. Rather, the court held that the insured's duty to defend the entire "mixed" action prophylactically was an obligation "imposed by law in support of the policy. To defend meaningfully, the insured must defend immediately. To defend immediately, it must defend entirely. It cannot parse the claims, dividing those that are at least potentially covered from those that are not. To do so would be consuming, it might also be futile." On the other hand, as the insured is receiving the benefit of a defense to claims that are not covered under its policy, the insurer is entitled to restitution after the fact for those costs that would not otherwise have been incurred for the defense. In order to recover, the insurer must prove the amount of such non-covered defense costs by a standard of a preponderance of the evidence.
In short, Buss is a remedy meant to apply to "mixed claim" cases and reflects a view of the duty to defend that is more pragmatic than strictly contractual. The holding in Buss also likely reflects the court's acknowledgment of the fact that, because California law largely prohibits insurers from litigating insurance disputes while the underlying is still pending, insurers may end up paying more in defense costs than is true elsewhere.
In the years since Buss was decided, insurers made aggressive efforts to present Buss as supporting a broad right to recover 100% of defense costs so long as the insurer had timely reserved its rights to do so and a court ruled that the insurer had no duty to defend. Such arguments met with success in state appellate courts in Colorado, Connecticut and Montana as well as federal court rulings from Kentucky, Michigan and Tennessee.
The arguments favoring recoupment mainly relied on two premises: (1) insurers should be encouraged to provide a defense, even in cases where they had good grounds for believing that they do not owe coverage, and should be given disincentives to do so and (2) where the insured accepts a defense under a reservation of rights that it has no contractual right to, the insured is obtaining a windfall and the insurer has a right of equitable restitution to recoup its costs if a court later determines that it never had a duty to defend.
The first issue was addressed by the Colorado Supreme Court in Hecla Mining v. New Hampshire Ins. Co., 811 P.2d 1083, 1089 (Col. 1991). There, the court declared that, "the appropriate course of action for an insurer who believes that it is under no obligation to defend is to provide a defense to the insured under a reservation of its rights to seek reimbursement should the facts at trial prove that the incident resulting in liability was not covered by the policy, or to file a declaratory judgment after the underlying case has been adjudicated."
A cause of action that reimbursement is cognizable to the extent required to ensure that the insured not reap a benefit for which it has not paid and thus be unjustly enriched. Where the insurer defends the insured against an action that includes claims not even potentially covered by the insurance policy, court will order reimbursement for the cost of defending the uncovered claims in order to prevent the insured from receiving a windfall.
Similarly, the Florida District Court of Appeal ruled in Colony Insurance Co. v. G & E Tires & Service, Inc., 777 So. 2d 1034, 1039 (Fla. Ct. App. 2000) that an insurer was entitled to obtain reimbursement for defense costs after it was held not to have a duty to defend. "Having accepted Colony's offer of a defense with a reservation of the right to seek reimbursement, G & E ought in fairness make Colony whole, now that it has been judicially determined that no duty to defend ever existed." The court also looked to basic contract law and stated, "A party cannot accept tendered performance while unilaterally altering the material terms on which it is offered." The court found that, when the insured accepted its defense, it also accepted the terms of the offer, including a potential for reimbursement.
Over time, however, a growing number of courts, including state appellate courts in Arkansas, Florida, Illinois, Pennsylvania, Utah, Washington and Wyoming have refused to adopt this rationale and have ruled that insurers have no implied right to recoupment where no was expressly presented in the insurance contract itself.
Most of the cases that have refused to permit recoupment start with the premise that insurers have a contractual duty to defend and that neither the policy nor public policy supports an implied right to recoupment when the insurer is already contractually obligated to defend. In so finding, these courts start with the "mixed claim" context in which Buss was decided and ignore the fact that there are also cases in which insurers believe that they do not owe a defense but, in an abundance of caution, will provide a "courtesy defense" to their policyholder.
The majority opinion in Jerry's suggested that insurers offer such defenses for reasons that are less than entirely altruistic as, by defending, the insurer can use it own chosen defense counsel, implement its own audit and litigation management procedures, protect against indemnity exposures and avoid bad faith claims. While the latter two considerations are certainly reasons why insurers may want to provide a "courtesy defense," in states such as Massachusetts, an insurer defending under a reservation of rights cannot demand to defend through panel counsel, much less insist that defense counsel agree to abide by the litigation management and billing guidelines applicable to panel counsel.
While the rationale offered by the Pennsylvania Supreme Court in Jerry's seems a weak basis for barring recoupment in Massachusetts, the fact remains that the insurers in this case will face an uphill battle, as Massachusetts courts have not been particularly receptive to Buss and related theories of recoupment in the past.
In Millipore Corp. v. Travelers Ind. Co., 115 F.3d 21 (1st Cir. 1997), the First Circuit affirmed a Massachusetts District Court's finding that INA and Travelers had no right to recoup defense costs that they had paid to defend various CERCLA claims under a reservation of rights up until the point in time when the District Court held that the pollution exclusion precluded coverage. The court ruled that there was no right to take back fees that the insurers had paid pursuant to their duty to defend under the contracts.
In Dash v. Chicago Ins. Co., 2004 WL 1932760 (D. Mass. Aug. 3, 2004), a federal district court declined to adopt the rule set forth in Buss where the insurer had defaulted on its duty to defend entirely and sought to avoid reimbursing its policyholder for defense costs allocable to non-covered defense costs). The District Court further opined that it was appropriate for a federal court to carve out an exception to established precedent: "Massachusetts courts have unambiguously adopted the broad rule that an insurer has a duty to defend an entire suit in which any claim is even potentially covered. There is no reason to assume that in establishing such a rule the courts failed to anticipate the possibility of 'mixed' cases or have otherwise not fully contemplated the consequences of this rule."
The SJC has not addressed this issue in the context of a duty to defend but ruled that an insurer cannot unilaterally assert the right to recoup settlement payments. In Medical Malpractice Joint Underwriting Association v. Goldberg, 425 Mass. 46 (1997), the court held that an insurer's unilateral assertion of a right to reimbursement does not give rise to any obligation on the part of the policyholder absent some express agreement on the part of the insured to do so or a policy provision compelling reimbursement. The court indicated, however, that an insurer could obtain reimbursement for a non-covered settlement, despite its policyholder's opposition, if it first obtained court approval to proceed.
More recently, the Supreme Judicial ruled in Metropolitan Life Ins. Co. v. Cotter, 464 Mass. 323 (2013) that a disability insurer was not entitled to recoup benefits that it had later been ruled not to owe. The court noted that it had previously ruled that it was appropriate for an insurer to defend under a reservation of rights where it was being asked to perform steps that it did not necessarily believe that it had any contractual duty to perform. Further, the court noted that it had held in Goldberg that an insurer may seek reimbursement for sums paid to settle a tort case but "only if the insured has agreed that the insurer may commit the insurer's own funds to a reasonable settlement with the right later to seek reimbursement from the insured, or if the insurer secures specific authority to reach a particular settlement which the insured agrees to pay." On the other hand, reimbursement is not appropriate where the sums are paid by the insurer to protect its own interests rather than those of the insured. The SJC observed that these liability insurance decisions reflected "a recognition that the liability insurer's duty to defend is independent from, and broader than, its duty to indemnify." The court took note of the fact that much of the concerns underlying its opinion in Goldberghad "centered on the insured's lack of involvement with or consent to the settlement." It found that, "This situation is unlikely to arise in the disability insurance context, where an insured who is the recipient of disability benefits ordinarily cannot claim to be removed from the payment process." While therefore holding that its decision in Goldberg did not itself foreclose Met Life's claim for reimbursement under a theory of unjust enrichment for sums that it had paid under a reservation of rights, the Supreme Judicial court nonetheless ruled that Met Life was not entitled to recover here as it had not sustained its heavy burden of showing that the insured's retention of disability benefits was unjust. The court took particular note of the "Hobson's choice" that a disability claimant might face in either accepting benefits at the risk of incurring substantial, if not crippling liability should reimbursement be awarded to the insurer later on, or declining benefits that might be the claimant's only source of income while engaging in costly coverage litigation with the insurer.
Ordinarily, when a state Supreme Court grants review of a case, it may be assume that they are alarmed by the ruling of the court below and wish to set things straight. In this case, however, Judge Kaplan's analysis of the Coverage B issues seems unremarkable and is unlikely to be overturned on appeal. Nor is the issue of the timing of payments of particularly consequential precedential value, however important these funds may be to Vibram. So is the court's interest in this case due its view that the Superior Court in refusing to acknowledge a right to recoupment?
It is possible that this is the case. Alternatively, it is possible that Chief Justice Gants is not entirely comfortable with the pure "pro rata" allocation analysis that Associate Justice Robert Cordy (who retired from the court in 2016) authored in Boston Gas Co. v. Century Ind. Co., 454 Mass. 337 (2009) and sees this case an opportunity to set an anchor to arrest the court's drift to leeward.
A more intriguing possibility is that Justice Gants would like to clarify a novel legal issue that he tackled ten years ago when he was the chief judge in the Business Litigation Session. In Watts Water Technologies, Inc. v. Fireman's Fund Ins. Co., 2007 WL 2083769 (Mass. Super. Ct. July 11, 2007), a valve manufacturer had sued its liability insurers seeking coverage for hundreds of underlying asbestos personal injury actions. In response, the insurers argued, among other defenses, that they should not be required to pay for defense costs attributable to an affiliated corporation of the named insured. The insurers had argued that because only Watts Regulator was an insured, their obligation to reimburse defense costs should be pro-rated to eliminate costs associated with the non-insured defendants.
When there are no insurers involved, the parties and their attorneys participating in the joint defense would need to negotiate the allocation of responsibility for the attorney's fees incurred in performing joint defense work. If Travelers or Hartford had agreed to indemnify Watts Regulator for all judgments within the policy limits, then the insurers would have exercised their "right and duty to defend" by retaining counsel jointly to represent Watts Regulator and themselves. The attorney retained by the insurer could then have participated in these negotiations with the attorneys for the uninsured parties. Here, however, both insurers agreed that they had a duty to defend, but under a reservation of rights. Having chosen to reserve their rights, the insurers lost the right to retain counsel for the insured, which now had the right to defend and control the defense of the lawsuit. See Three Sons, Inc. v. Phoenix Ins. Co., 357 Mass. 271, 275-277 (1970). The insurer cannot "reserve its rights to disclaim liability in a case and at the same time insist on retaining control of its defense." Id. at 276, quoting Salonen v. Paanenen, 320 Mass. 568, 574 (1947). Therefore, when an insurer chooses a reservation of rights, it loses its ability to control the defense but retains, as part of its duty to defend, the obligation "to pay the reasonable charges of [the insured's] counsel, who provided ... the defense that [the insurer] was bound to furnish." Magoun v. Liberty Mutual Ins. Co., 346 Mass. 677, 685 (1964).
Watts Regulator argues that its insurers must reimburse it for all the attorney's fees it incurred in its defense of the underlying asbestos lawsuits as long as the work performed was reasonably related to the claims against it, regardless of whether the work performed also benefitted the uninsured Watts affiliates. See Raychem Corp. v. Fed. Ins. Co., 853 F. Supp. 1170, 1182 (N.D. Cal. 1994), adopting "reasonably related" standard set forth in Cont'l Cas. v. Bd. of Educ. of Charles County, 302 Md. 516, 489 A.2d 536, 545 (1985). See also Safeway Stores, Inc. v. Nat'l Union Fire Ins. Co. of Pittsburgh, Pa., 64 F.3d 1282, 1289 (9th Cir. 1995) ("Defense costs are thus covered by a [Directors and Officers Liability] policy if they are reasonably related to the defense of the insured directors and officers, even though they may also have been useful in defense of the uninsured corporation."). Anything less, it contends, would fail to fulfil the insurer's duty to defend.
Travelers and Hartford, however, argue that they have no duty to defend the uninsured Watts affiliates, and no desire to provide them with free legal work. The insurers contend that, when legal work is shared with these affiliates, the cost of that work should be shared equally among all the parties benefitting from that work. Otherwise, they argue, all the joint defense work will be performed by the attorneys for Watts Regulator, since they are the only attorneys whose fees are being paid by the insurers rather than the defendant corporations.
This Court recognizes the legitimate concerns raised by all sides, and takes a middle ground. When the insurer reserves its rights and thereby loses its right to appoint its own counsel, the decision as to whether to enter into a joint defense rests solely with the insured, not the insurer. If Watts Regulator had chosen to work solo and not share its work product with any other party, then the insurers would need to pay the entirety of the reasonable attorney's fees incurred by Watts Regulator's counsel. When, as here, Watts Regulator chooses to enter into a joint defense, then the insurers continue to remain responsible to pay all reasonable attorney's fees incurred by Watts Regulator's legal team, provided the work is reasonably related to the defense of Watts Regulator, regardless of whether that work is shared with other members of the joint defense team and thereby benefits uninsured parties. The governing standard, regardless of whether or not an insured enters into a joint defense, is the reasonableness of the attorney's fees. However, when an insured enters into a joint defense, the inquiry regarding the reasonableness of the attorney's fees is broadened to include the reasonableness of the allocation of costs among the parties within the joint defense for work that benefits the joint defense. That allocation need not always be equal. Indeed, even when the insurer does not reserve its rights and appoints counsel to represent its insured, equality is not always the outcome of the negotiations regarding the allocation of joint defense costs. The allocation must simply be reasonable in view of all the surrounding circumstances, considering the relative exposure of the parties to liability, the size of the parties, and the parties most benefitting from the joint defense work. The guidepost is the allocation that reasonably would have been negotiated had each party in the joint defense paid its own legal fees.
As the SJC has only just accepted review of this case, it is unlikely that it will be set for oral argument much before November or December and will not be decided until the Winter of 2018. Meanwhile, it is a certainty that an interesting array of amici will file briefs asking the Supreme Judicial Court to affirm or reverse Judge Kaplan's analysis. While it seems that the insurers face an uphill battle in obtain a reversal on the recoupment issue, there are strong and persuasive arguments to be made in favor of allowing recoupment and it will be most interesting to see if the Court is willing to engage them.

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