In a case of first impression, an insured must reimburse its insurer for defense and settlement costs on an uncovered claim.
The United States District Court in Boston has issued a decision that is one of the first, if not the first, in Massachusetts allowing an insurance company to recover from an insured defended under a reservation of rights, the costs of the insurer’s defense, and the cost of a settlement for an uncovered claim.
In this case, Berkley National Insurance Company v. Granite Telecommunications et al., the insured was sued for bodily injury on a claim based on the claimant becoming infected in mopping up a sewage backup on the insured’s property.
The insurer first denied the claim based on a pollution exclusion. When the insured threatened litigation, the insurer issued a reservation of rights, citing an additional exclusion for fungi and bacterial infection claims.
While the underlying claim suit was pending, the insurer sued for a declaratory judgment on coverage and for reimbursement of its defense costs in the United States District Court in Boston.
Subsequently, the underlying lawsuit went to mediation, and the insured demanded that the insurance company pay any settlement resulting from the mediation. The insurance company paid the settlement but added the $1.5 million settlement cost to its declaratory judgment as a claim for equitable restitution.
On summary judgment, the federal court found that the insured’s “unfair behavior” in forcing the insurer to defend the lawsuit bore “a flavor of extortion” and found the insured liable to pay the insurer restitution for the defense and indemnity costs incurred by the insurer.
The case is still pending since there are questions of indemnity from another insurer and a third-party’s indemnity agreement.
The decision could be an outlier or the harbinger of future suits by insurers defending liability claims under a reservation of rights for deep-pocket insureds to make restitution to the insurer if a court decides the insured’s policy never provided coverage.
The insured’s headquarters had a lunch café for its employees that a sewer backup flooded
Granite Telecommunications, LLC (Granite) provides voice, data, and other related communications products and services to businesses and governmental agencies in the United States and Canada. Granite employs over 2,300 persons and generates annual revenue over $1.65 billion.
Granite has its headquarters at 100 Newport Avenue Ext., Quincy. Granite leases the whole building from its owner, Atlantic Newport Realty LLC (Atlantic).
In 2016, the office building had a café with a kitchen on the ground floor that offered breakfast and lunch to Granite’s employees working in the building. Lessing’s Food Service Management Corporation (Lessing) operated and staffed the building’s cafeteria and kitchen under a contract with Granite.
Claimant put on workers’ compensation after an infection caused by sewer backup on Granite’s property
On November 10, 2016, Stephen Papsis (hereafter, “Mr. Papsis”) was an employee of Lessing working in the kitchen for the cafeteria Lessing operated in Granite’s building. Due to a pipe blockage in Granite’s building floor drains, raw sewerage backed up into the kitchen where Mr. Papsis was working. Under the net lease between Granite and Atlantic, Granite was responsible for maintaining the building’s drains.
When Mr. Papsis went to work on the day of the flood, he had an eraser-sized blister on his right foot that he had covered with a small bandage. As the sewage entered his kitchen, he tried to mop up the floor and stop sewage from entering the café’s eating area. The sewage rose to over three inches, and the sewage water soaked his shoes and wet his foot with the blister.
He returned home to change out of his wet socks and shoes at the end of the day when his foot “felt worse” and the blister had begun to look “bloody.”
The next day, Mr. Papsis returned to work but could not stand on his right foot because of the pain. He left work and went to the hospital. His condition deteriorated, and he went on workers’ compensation based on Lessing’s first report stating:
“Steve was working in the kitchen when the sewerage pipe in the main building backed up and flooded the kitchen. All staff were walking in the flood water. Steve developed an infection in his foot and went up his leg. He left work on Friday, 11/11/16, and found out he had the infection.”
Mr. Papsis never returns to work based on his impairment from the sewerage infection
Due to his exposure to the sewage at Granite’s facility, Mr. Papsis developed osteomyelitis and Charcot arthropathy, a condition that causes loss of sensation in the right foot. The original wound where the infection occurred took over a year to heal.
In total, Mr. Papsis had seven surgeries to treat the damage done by the infection to his right foot. The surgeries involved resecting his navicular bone and placing an external fixator on his leg that remained in place for six months in early 2017.
The infection led to Mr. Papsis experiencing severe bone and joint degeneration in his right foot. According to his medical expert, the consequences of the infection left him permanently handicapped with a lower extremity functional impairment of 34% and a whole person impairment rating of 19%
Mr. Papsis’ lawsuit against Granite
Mr. Papsis filed a lawsuit on September 27, 2019, in the Middlesex Superior Court against Granite as the lessee in control of the flooded premises, the building owner, Atlantic, and a related realty company.
Mr. Papsis, in his suit, alleged that Granite’s negligence caused him to be exposed to raw sewage, resulting in serious and permanent injuries after he developed a systemic infection following the November 10, 2016, sewer backup.
The lawsuit also alleged that Granite had liability to Mr. Papsis for the negligent actions of Granite’s employees in “creating, maintaining and/or failing to prevent or warn of the dangerous condition, to wit: sewer drainage back up to exist on the property.”
Besides seeking compensation for his conscious pain and suffering, Mr. Papsis alleged, as of the date of his filing with the court, that his damages for past and future medical expenses, lost wages, and future earning capacity totaled $1,038,824.
Granite’s liability policies with Berkley National
When Mr. Papsis was exposed to the raw sewage on November 10, 2016, Granite had a commercial lines policy with Berkley National Insurance Company (Berkley) with effective dates of June 30, 2016, to June 30, 2017. For its $48,510.66 premium, Granite’s policy included general liability coverage with a primary limit of $1 million for each occurrence and a $2 million aggregate limit for all claims. The policy also included for Granite a commercial umbrella coverage, with a combined limit of $10 million liability for each occurrence.
Berkley’s denial of coverage based upon Granite’s policies’ pollution exclusions
Granite duly reported the Papsis lawsuit to Berkley, seeking defense and indemnity under its primary and umbrella policies with Berkley. On January 7, 2020, Berkley sent Granite an eight-page denial letter.
The denial letter detailed the policy coverages, the insuring agreements, some policy conditions, and the policy’s pollution exclusion. The pollution exclusion cited by Berkley stated: “This insurance does not apply to:
(1) “Bodily injury” or “property damage” arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of “pollutants”
(a) At or from any premises, site or location which is or was at any time owned or occupied by, or rented or loaned to, any insured.
The policy defined “pollutants” to mean:
15. “Pollutants” mean any solid, liquid, gaseous or thermal irritant or contaminant, including smoke, vapor, soot, fumes, acids, alkalis, chemicals, and waste. Waste includes materials to be recycled, reconditioned, or reclaimed.
The text of the letter ended denying any coverage to Granite for the Papsis suit on the grounds of the pollution exclusion, stating, in part:
“With respect to Coverage A-Bodily Injury and Property Damage Liability, both [policies’] pollution exclusions [primary and umbrella] preclude coverage for this claim…Accordingly, the Policy does not afford coverage for this claim and Berkley National must respectfully disclaim coverage.”
Granite’s pollution exclusion objection leads Berkley to provide a defense under a reservation of rights
Berkley’s January 7, 2020, denial letter citing the pollution exclusion as the sole basis for Berkley’s coverage denial received an immediate response from Granite’s attorney.
On January 16, 2020, Granite’s counsel advised Berkley, “Granite respectfully disagrees with the Insurance Company’s determination that it has no duty to defend Granite in the Underlying Action.”
Granite’s letter focused on Berkley’s denial letter as being “improper” in simply reciting the policy’s terms and the text of the pollution exclusion and then disclaiming without further explanation that “both pollution exclusions preclude coverage for this claim.”
The letter continued, however, citing a decision of the Supreme Judicial Court analyzing a similar pollution exclusion. In that decision, Granite argued to Berkley, the Court had admonished insurers that pollution exclusions “should not reflexively be applied to accidents arising during normal business activities simply because they involve a ‘discharge, dispersal, release or escape of an `irritant or contaminant.’”
The letter further cited Massachusetts law that implied the proper interpretation of the pollution exclusion in its standard form seemed directed to “products or byproducts of industrial production that may cause environmental pollution or contamination.”
Based on this analysis, Granite’s six-page response to Berkley called upon it to “honor its contractual obligation to defend Granite in the Underlying Action. Granite further requests that the Insurance Company do so no later than 4:00 pm on Monday, January 27. (Emphasis in original).
Berkley agrees to provide Granite a defense “as a gesture of goodwill” under a reservation of rights
Berkley responded to Granite’s demand for a legal defense on January 24, 2020.
Berkley countered Granite’s legal argument noting that it disagreed with Granite’s analysis since a subsequent decision of the SJC had refused to limit the scope of pollution exclusions to “industrial pollution.”
According to Berkley, the correct legal standard under Massachusetts law for applying the pollution exclusion was whether an ordinary insured reading the policy would understand that the discharged material was a “pollutant.”
Berkley pointed out that Mr. Papsis alleged that his bodily injury resulted from exposure to “toxic sewerage” and “an ordinary insured could clearly understand that “toxic sewerage” was an irritant or contaminant within Granite’s policies’ definition of “pollutant.”
While still disagreeing with Granite, Berkley responded, “Nevertheless, as a gesture of goodwill to our policyholder, we will agree to participate in the defense of Granite Telecommunications, LLC. “
Berkley’s reservation of rights adds the policy’s bacteria exclusion as a ground for disclaiming liability
The letter from Berkley to Granite assuming the defense of the Papsis litigation stated that Berkley provided its defense under a full reservation of its rights to disclaim liability because of the pollution exclusion.
In agreeing to provide Granite a defense under a reservation of rights, Berkley added as a condition of the reservation that it could also disclaim liability based on the policy’s previously unmentioned “Fungi and Bacteria” exclusion.
This exclusion provided that the policy did not apply to:
“‘Bodily injury’ or ‘property damage’ which would not have occurred, in whole or in part, but for the actual, alleged or threatened inhalation of, ingestion of, contact with, exposure to, existence of, or presence of, any “fungi” or bacteria on or within a building or structure, including its contents, regardless of whether any other cause, event, material or product contributed concurrently or in any sequence to such injury or damage.”
Berkley also notified Granite that Berkley reserved its rights to bring a declaratory judgment on the policy’s coverage to terminate any obligation it had to provide a defense to Granite for the Papsis lawsuit. However, pending a resolution of any declaratory judgment, Berkley agreed to “provide a full defense to the Papsis case and will pay all reasonable costs and fees associated with its defense.”
Berkley files a declaratory judgment against Granite, seeking a ruling of no coverage and reimbursement of defense costs.
On April 15, 2021, Berkley filed a declaratory judgment complaint against Granite and other defendants in the Papsis lawsuit in the United States District Court in Boston. The suit asked this Federal court to determine whether Berkley owed any coverage to Granite and Atlantic, which was an additional insured on Granite’s policy.
The declaratory judgment suit sought a ruling that the pollution exclusion and the “Fungi and Bacteria” exclusion barred Granite from any defense or indemnity for Mr. Papsis’ lawsuit alleging Granite’s liability for his exposure to sewage causing his bodily injury from a bacterial infection.
The complaint noted that it was undisputed that Granite’s alleged liability arose from Mr. Papsis’ claim that his bacterial infection resulted from the raw sewage that backed up from kitchen drains where he worked in Granite’s building
Besides declaring no coverage, Berkley also sought in its lawsuit reimbursement for the legal fees and costs it paid to defend the Papsis lawsuit.
Granite’s demand that Berkley alone fund any settlement of the Papsis lawsuit
On July 23, 2021, defense counsel for Granite, paid for by Berkley, submitted a detailed nine-page single-spacer report on all aspects of the Papsis case.
The defense counsel’s ultimate conclusion was that based on the evidence, there was a significant exposure that if Mr. Papsis’ case went to trial, any potential jury award would be in the $3 to $4 million range. The defense lawyers also opined that the settlement value would range from $1 million to $1.75 million.
The parties agreed on mediating the lawsuit and scheduled the mediation for August 31, 2021.
Some days before the mediation, Berkley’s counsel contacted Granite’s coverage counsel proposing that Berkley and Granite equally share any payment needed to settle the Papsis lawsuit.
Granite’s counsel responded by rejecting any sharing and demanding that Berkley fully fund any settlement without recourse to Granite.
Granite’s counsel threatened that any refusal by Berkley to pay the settlement would constitute an unfair claim practice. Granite’s counsel claimed that if Berkley made “unreasonable demands of [Granite] to fund a portion of any settlement,” Berkley would be “risking significant exposure under MGL C. 176D.”
Based on Granite’s reluctance to contribute to any settlement, Berkley advised Granite that it would only pay to settle the Papsis claim under a full reservation of its rights to recover the payments in its declaratory judgment action against Granite.
Mediation settles Mr. Papsis’ lawsuit for $1,500,000 paid by Berkley under its reservation of rights
On August 31, 2021, after a full-day mediation, the parties reached a settlement of $1.5 million to resolve all Mr. Papsis’ claims against Granite and its landlord, Atlantic.
Berkley paid 100% of the settlement, subject to its reservation of rights to seek reimbursement for its payment in its pending declaratory judgment.
Berkley’s amended complaint seeking “equitable restitution” for the settlement and defense costs of the Papsis lawsuit
Nine days after the August 31, 2021settlement, Berkley filed an amended complaint seeking in part to “add a claim for reimbursement and/or restitution as to the settlement of the underlying [Papsis] action.”
The amendment alleged that Berkley was about to pay “substantial sums of money” to settle the liability claims of Stephen Papsis but that Berkley’s insurance policy did not require it to pay sums on behalf of an insured to resolve damages that the insured’s policy did not cover.
The amendment alleged that without the Court ordering restitution, Granite would receive a “windfall” benefit that its insurance contract did not provide and for which Granite had never paid an insurance premium.
Berkley asked the Court to order Granite to reimburse Berkley “for all sums that it pays to settle claims against [Granite] that it had no contractual obligation to pay.”
Summary judgment and Equitable restitution
After the allowance of its amended complaint and the settlement of the Papsis lawsuit, Berkley moved for summary judgment on its pollution exclusion, fungi and bacteria exclusion, and equitable restitution claim.
Berkley also moved for summary judgment on two other claims involving subrogation and indemnity against another insurer, where Granite was an additional insured, and the food service company that contracted with Granite to operate the café and kitchen where Mr. Papsis worked.
The court entertained the first three counts of Berkley’s five-count complaint. The Court found that summary judgments on the counts involving the second insurer’s coverage and the food service company’s indemnity agreement were premature since the Court had made no ruling concerning those two defendants.
On the first count concerning the pollution exclusion, the Court declined to enter summary judgment because there were material issues of fact as to whether Mr. Papsis’ claim involved “pollutants” as defined in the policies.
On the second count involving the bacterial infection exclusion, the Court found the exclusion applied, stating:
“The court readily concludes that the settlement of the Papsis lawsuit falls within the Policy’s bacteria exclusion and thus is not covered. The undisputed facts show that Papsis remained unwavering in his claim that his injuries were caused by his exposure to bacteria in the toxic sewage that backed up into his workspace. The settlement reached at mediation was intended to compensate Papsis for the infection to his foot, which was the only injury asserted in his lawsuit. Recalling that the Policy’s bacteria exclusion precludes coverage for “bodily injury” that “would not have occurred, in whole or in part, but for the actual, alleged or threatened . . . exposure to . . . any ‘fungi’ or bacteria on or within a building or structure,” there could be no plainer example of the type of case to which the exclusion was meant to apply.”
The Court’s ruling that Berkley could recover defense and indemnity costs from Granite
On its third count, Berkley based its motion for a summary judgment seeking repayment from Granite of Berkley’s costs and expenses for defending and settling the Papsis lawsuit on the basis of equitable restitution.
Under Massachusetts law, “Restitution is an equitable remedy by which a person who has been unjustly enriched at the expense of another is required to repay the injured party.” However, equitable restitution only applies in those cases where the receipt or retention of the payment between two parties makes it unjust for the party that benefited to retain the money or benefit received.
Here the Court ruled that Granite essentially forced Berkley to pay for the expense of defending and settling the Papsis litigation because Granite threatened to sue Berkley if it did not. To the Court, this threat distinguished Berkley’s situation from other reported cases where insurers defended and indemnified insureds under a nonbinding, voluntary reservation of rights.
The Court labeled Granite’s actions as “whipsawing” Berkley into taking the only practical action it could under the circumstance, which was to defend and pay the full settlement sum while maintaining the unilateral reservation of its right to seek reimbursement.
The Court found that since Berkley was under no obligation to defend or indemnify Granite in the Papsis lawsuit, based on the bacteria exclusion, it would be fundamentally unfair for Granite to benefit from its requiring Berkley to defend and indemnify it for an uncovered claim.
The final order on Granite’s liability to Berkley for defense and indemnity of the Papsis lawsuit
In its final order, the Court denied summary judgment to Berkley on Count I, seeking a declaratory judgment that Granite had no coverage under the policy because of the pollution exclusion. The Court found that there were material questions of fact whether that exclusion barred coverage for the Papsis lawsuit.
The denial of summary judgment to Berkley on Count I, the pollution exclusion, had no practical legal effect. The Court’s final order allowed Berkley’s motion for summary judgment as to Counts II and II, finding no coverage for Granite.
As to Count II of the Complaint, the “Fungi or Bacteria” exclusion, the Court declared, “Berkley does not owe coverage for the Papsis claims by reason of the fungi or bacteria exclusion in the Policy.”
On Count III, seeking equitable restitution, the Court concluded: “Berkley is entitled to be reimbursed by defendants for the legal fees and costs that it has incurred in defending the Papsis lawsuit, as well as the cost of settling the Papsis lawsuit on defendants’ behalf.”
The court’s decision granting restitution for defense payments under a reservation of rights could be a gamechanger or an outlier
Massachusetts has any number of cases espousing the legal principle that “A person who has been unjustly enriched at the expense of another is required to make restitution to the other. However, few such decisions have involved insurance companies seeking recovery for liability policy defense costs paid under a reservation of rights. Fewer cases would involve the recovery of settlements paid by liability insurers under a reservation of rights. In most cases, such carriers either disclaim liability or withdraw their reservations before a claim or lawsuit reaches the point of settlement or trial.
The only Massachusetts appellate case ruling on an insurer recovering funds advanced on an uncovered claim involved property policy. In that case, the insurance company made a $15,000 advance payment after a fire. When the carrier discovered the insured had voided its coverage under the policy, it filed a declaratory judgment and sought to recover its advance payment.
Whether Massachusetts courts will disregard the requirement of “an erroneous payment” and permit liability insurers to recover defense or indemnity costs paid under a reservation of rights when the claim defended is ultimately found to be uncovered is an unanswered question moving forward for insureds and insurance carriers.
In affirming the carrier’s right to recover, the Appeals Court noted and ruled, “[A]lthough no Massachusetts courts have directly addressed this issue…an insurer is entitled to reimbursement for an erroneous payment when coverage does not exist under the policy, and the insured was unjustly enriched….” (Emphasis added) See Agency Checklists’ article “Restaurant’s Failure to Give Notice under Protective Safeguard Endorsement Bars Fire Claim; Court Orders Advance Payment Returned to Insurance Carrier.“
A federal court decision on Massachusetts state law is not the final word
Federal courts only interpret state law. The final arbiter of Massachusetts law is the state’s Supreme Judicial Court.
In this case, a federal court has provided a novel twist to an open question concerning reimbursement of costs for uncovered claims. It remains to be seen how Massachusetts state courts will treat the requirement stated by the Massachusetts Appeal Court of “an erroneous payment” in ruling on future cases where liability insurers seek to recoup defense or indemnity costs incurred under reservation of rights when the claim defended is ultimately found to be uncovered by the insured’s policy.
Agency Checklists will keep you posted on who will pay Berkley
The Court’s summary judgment ruling on Count III determined that Granite had a legal obligation to pay Berkley for its defense and indemnity costs. The ruling, however, did not decide whether the payment due Berkley would come from Granite, Lessing, or Lessing’s insurer.
In its motion, Berkley had also moved for summary judgment on two additional counts.
The first of these counts sought restitution from the Hanover American Insurance Company under a liability policy issued to Lessing that had Granite as an additional insured (Count IV). The second of these counts sought restitution from Lessing arising from Granite’s indemnity agreement with Lessing for the operation of Granite’s cafeteria (Count V).
As stated, the Court denied Berkley’s motion for summary judgment on these two counts of the amended complaint, stating that these counts were “not yet ripe for disposition.”
The Court first ruled that it needed to decide if there was coverage under the Hanover American policy for Granite as an additional insured and that Lessing had a duty to reimburse Granite .
Agency Checklists will monitor this case and keep its readers posted on any further developments. For those interested in reprinting or using this analysis as a basis for their own post, please attribute it to Owen Gallagher, Agency Checklists along with a link to this website. Thank you.
Owen Gallagher
Insurance Coverage Legal Expert/Co-Founder & Publisher of Agency Checklists
Over the course of my legal career, I have argued a number of cases in the Massachusetts Supreme Judicial Court as well as helped agents, insurance companies, and lawmakers alike with the complexities and idiosyncrasies of insurance law in the Commonwealth.
Connect with me directly, by calling me at 617-598-3801.
