On June 9, 2016, the First Circuit for the Court of Appeals (“First Circuit”) announced in the case of Mount Vernon Fire Insurance Company (“Mt. Vernon”) v. VisionAid, Inc. that they were requesting the Supreme Judicial Court of Massachusetts (“SJC”) to decide an issue that the First Circuit characterized as having “potentially wide-reaching implications for how liability insurers must conduct themselves in the Commonwealth of Massachusetts.”
This potentially wide-ranging issue the First Circuit believed requires a decision by the SJC is:
Whether, and under what circumstances, an insurer (through its appointed panel counsel) may owe a duty to its insured — whether under the insurance contract or [Massachusetts law] — to prosecute the insured’s counterclaim(s) for damages, where the insurance contract provides that the insurer has a “duty to defend any Claim…?
Or, to paraphrase the First Circuit’s words:
Does an insurer owe a duty to its insured to prosecute the insured’s counterclaim for damages against a claimant suing an insured in a lawsuit the insurer defends?
Question of prosecuting counterclaim arose out of employer’s practices liability policy
The VisionAid case before the First Circuit arose out of an employer’s practices liability policy issued by Mt. Vernon to a Massachusetts company, VisionAid, located in Wareham. VisionAid was formerly known as H.L. Bouton Co. Inc.
In October 2011 VisionAid fired its then–Vice President of Operations, Gary Sullivan. In response, Mr. Sullivan filed a discrimination complaint with the Massachusetts Commission Against Discrimination (“MCAD”) alleging that VisionAid had terminated him because of his age.
VisionAid reported the MCAD claim under its employment practices liability policy issued by Mt. Vernon. Mt. Vernon appointed counsel it selected to defend VisionAid at the MCAD. In the MCAD proceeding, VisionAid alleged that it fired Mr. Sullivan not because of his age, but because of his subpar performance and his misappropriation of company funds.
Insured refusal to waive claim against former employee brings suit
After VisionAid refused to exchange mutual releases with neither party paying the other to settle the matter, Mr. Sullivan dismissed his MCAD complaint and filed an age discrimination lawsuit in the Massachusetts Superior Court.
Insurer withdraws reservation of rights and files declaratory judgment
Mt. Vernon at first tried to defend the Superior Court suit against VisionAid under a reservation of rights. However, Mt. Vernon withdrew the reservation when VisionAid demanded, as Massachusetts law allows, to choose its own counsel to be paid for by Mt. Vernon.
Still, Mt. Vernon’s letter withdrawing its reservation of rights specifically asserted that any counterclaim that VisionAid wished to bring against Mr. Sullivan had to be filed and prosecuted by attorneys hired and paid for by VisionAid.
VisionAid disagreed and Mt. Vernon filed a declaratory judgment in the United States District Court for Massachusetts seeking a ruling that it had no obligation under its policy to prosecute any counterclaim for VisionAid arising out of or related to Mr. Sullivan’s lawsuit.
At the district court level, Mt. Vernon prevailed. On summary judgment, the district court found that “according to the plain language of the Policy, Mt. Vernon was not required to fund an affirmative counterclaim and that this result did not run afoul of any Massachusetts Rule of Law or create any conflict of interest.”
VisionAid appealed and the First Circuit decided that VisionAid might have a point.
First Circuit decides Massachusetts law is not clear on insurer’s duty to prosecute insured’s counterclaim.
On appeal, VisionAid contended that while the policy provided that “defense costs” include the “fees and expenses incurred by [Mt. Vernon] …to defend [VisionAid],” the policy does not elaborate in any way on what is included in such a defense.
According to VisionAid, one reasonable interpretation of the meaning of “defense costs” is that it would include, “All work a defense lawyer would typically due in the defense of a client, including prosecuting counterclaims that would defeat liability or diminish damages.” Therefore, VisionAid argued that since, in its opinion, there were two reasonable meanings for the term “defense costs,” any ambiguity had to be interpreted in favor of the insured under Massachusetts law.
Also VisionAid argued that Mt. Vernon was a clear conflict of interest because the counterclaim was impeding Mt. Vernon from reaching a “walk-away” settlement with Sullivan since VisionAid would not grant him a release without his paying back money allegedly converted from VisionAid. As a result, VisionAid argued that Mt. Vernon’s alleged conflict of interest required that the court allow VisionAid to select its own attorneys whose fees would be paid by Mt. Vernon.
Not surprisingly, Mt. Vernon found VisionAid’s interpretation of the policy term, “defense costs” and VisionAid’s claim of Mt. Vernon having a conflict of interest less than convincing. It argued to the First Circuit that:
- The policy only covers “claims made against [VisionAid] during the policy period” and that “defense costs” was not ambiguous since it only related to a claim made against the insured.
- Although under Massachusetts law, Mt. Vernon had to provide a “complete defense” that would include both covered and uncovered claims in a lawsuit, the “complete defense” rule did not include the duty to prosecute any counterclaim that the insured wished to assert.
- Finally, Mt. Vernon stated that there was no “conflict of interest” as it has never sought to compromise or reduce the claimed value of the counterclaim as part of its defense of the insured.
First Circuit finds no Massachusetts law supports either party’s position
The First Circuit decided that the legal and contractual arguments presented by both sides seemed to cancel themselves out with neither side having any clear Massachusetts legal precedent that would decide the dispute. Since federal courts do not break new ground in deciding cases based on state law but only apply state law as it exists, the First Circuit unilaterally decided to refer the decision to the SJC under a formal process called “Certification.”
Under the certification rule, the SJC permits federal courts to certify questions of state law that are “determinative of the cause then pending in the certifying court” but for which there is no controlling precedent by the SJC.
SJC Decision Could Expand Insurer’s Obligation on Counterclaims
There are three questions that the First Circuit Court of Appeals is certifying to the SJC:
- Whether, and under what circumstances, an insurer (through its appointed panel counsel) may owe a duty to its insured — whether under the insurance contract or the Massachusetts “in for one, in for all” rule — to prosecute the insured’s counterclaim(s) for damages, where the insurance contract provides that the insurer has a “duty to defend any Claim,” i.e., “any proceeding initiated against [the insured]”?
- Whether, and under what circumstances, an insurer (through its appointed panel counsel) may owe a duty to its insured to fund the prosecution of the insured’s counterclaim(s) for damages, where the insurance contract requires the insurer to cover “Defense Costs,” or the “reasonable and necessary legal fees and expenses incurred by [the insurer], or by any attorney designated by [the insurer] to defend [the insured], resulting from the investigation, adjustment, defense, and appeal of a Claim”?
- Assuming the existence of a duty to prosecute the insured’s counterclaim(s), in the event it is determined that an insurer has an interest in devaluing or otherwise impairing such counterclaim(s), does a conflict of interest arise that entitles the insured to control and/or appoint independent counsel to control the entire proceeding, including both the defense of any covered claims and the prosecution of the subject counterclaim(s)?
Any of these questions being answered in the affirmative by the SJC could substantially expand the rights of insureds under certain types of liability policies.
Agents may want to alert clients with problem claims
It is not an uncommon situation in professional liability or employment liability claims that the insured may have a counterclaim against the former client or employee suing the insured. Ordinarily, while a covered claim and any uncovered claims are defended by the insurer with or without a reservation of rights, insureds are commonly advised, as Mt. Vernon advised VisionAid, that any legal representation or legal expenses incurred for a counterclaim do not fall within the insurer’s duty to defend.
Since the SJC could rule on the certified questions that insurers have additional duties to prosecute counterclaims, agents may want to alert clients who might be in involved such litigation that they should reserve their rights to protect their interests.
Agency Checklists will advise its readers of any SJC decision.