On March 31, 2023, the Appeals Court issued a ruling in the case of John Moriarty & Associates, Inc. (JMA) v. Zurich American Insurance Co. (Zurich).
The Appeals Court decision provides a comprehensive summary of the rights of insureds in dealing with liability insurers on duty to defend issues, including reservations of rights, the rights of insureds to choose counsel at a carrier’s expense, the right to recover legal fees for duty to defend litigation, and the developing issue of recoupment claims by carriers defending under reservations of rights.
JMA, a general contractor, was an additional insured on a commercial general liability insurance policy issued by Zurich to one of JMA’s subcontractors. When an employee of the subcontractor filed a negligence lawsuit against JMA, Zurich agreed to defend and indemnify JMA. However, Zurich did so with a reservation of rights, which included the right to recoup defense costs, among other provisions. JMA defended the lawsuit with its chosen defense counsel, which Zurich was to pay due to its reservation of rights.
JMA initiated a lawsuit against Zurich over eight months after its initial request for defense and indemnity. JMA alleged that Zurich failed to compensate or reimburse any of JMA’s defense expenses related to the ongoing negligence lawsuit. Additionally, JMA claimed that Zurich breached its duty to defend and indemnify by not withdrawing its reservation of rights. After Zurich paid the outstanding legal bills post-suit, the Superior Court dismissed JMA’s lawsuit on Zurich’s motions, but JMA appealed.
The Appeals Court ruled mostly in favor of JMA. The Court determined that an insured party could recover costs associated with prosecuting an action against an insurer who acknowledges a duty to defend yet refuses to fulfill that duty. Thus, the judgment dismissing the breach of contract claim was vacated.
The Appeals Court also concluded that an insurer’s refusal to defend, despite admitting a duty to do so, constitutes claims under G. L. cc. 93A and 176D. Consequently, the portion of the judgment dismissing the unfair business practices claims was vacated.
Finally, the Court found that JMA presented a valid argument establishing an actual controversy regarding whether Zurich may reserve the right to recoup defense costs as a matter of law. This led to the vacating of the portion of the judgment dismissing the request for declaratory relief on this issue.
The facts of the underlying lawsuit and Zurich Insurance duty to defend dispute
In August 2018, a foreman named Mr. L’Hussier, who was working for PJ Spillane, a subcontractor hired by John Moriarty & Associates, Inc. (JMA) to perform waterproofing work, fell three feet into a hole at the Residence Building at Julie Hall in Boston. The hole, which was supposed to be covered by a metal grate, had been left exposed and unguarded, allegedly by someone from Triple G Scaffold Services Corp., another subcontractor hired by JMA to perform scaffolding work. Mr. L’Hussier injured his knee, requiring knee replacement surgery, and filed a negligence lawsuit against JMA and Triple G, claiming that JMA breached its duty to provide a safe job site and alleging that Triple G was responsible for the unguarded hole.
In response, JMA demanded that PJ Spillane indemnify them, pay for their defense, and satisfy any judgment against them in the underlying action. JMA also demanded that PJ Spillane ensure that their insurance carrier, Zurich, defended and indemnified JMA under the subcontract’s insurance obligations.
On July 24, 2020, Zurich agreed to defend and indemnify JMA without a reservation of rights, assigning counsel to assume JMA’s defense. However, when JMA requested reimbursement for all defense costs incurred prior to Zurich’s acceptance of coverage, Zurich did not reimburse or pay JMA for any costs in the underlying action at that time.
When Triple G demanded that JMA defend and indemnify them for any losses incurred in the underlying action, JMA requested that Zurich defend and indemnify JMA against Triple G’s claim. In response, Zurich rescinded its acceptance of coverage, denied JMA’s tender for defense and indemnity in connection with Triple G’s claim, and tendered a defense in connection with Mr. L’Hussier’s claim against JMA in the underlying action only with a full reservation of “any and all rights.”
After Triple G rescinded its demand for a contractual defense and indemnity, JMA notified Zurich of the rescission. However, Zurich refused JMA’s request to withdraw its reservation of rights with respect to JMA’s tender and renewed its reservation of rights by letter dated December 3, 2020, including the right to recoup any amounts paid as defense expenses that could be attributable to liability that is not potentially covered, if allowed by law. Zurich questioned whether the claims being asserted were covered under the policy terms and agreed to defend JMA only because there was a potential for coverage. Zurich stated that if it is proven that a Triple G employee removed the metal grate, then PJ Spillane “may be found to possess no liability” and, therefore, the claim would not be covered.
In response to Zurich’s letter, JMA stated that counsel retained by JMA would continue to defend them in the underlying action and that JMA would continue to submit their bills for defense costs to Zurich for payment. JMA also asserted that “Zurich has breached its contractual obligations under the Zurich Policy by refusing to accept JMA’s tender for defense and indemnity without reservation.” However, JMA received no response to the letter sent on December 18, 2020.
The Superior Court decision and JMA’s appeal
In February 2021, JMA initiated a lawsuit against Zurich for breach of contract, declaratory relief concerning Zurich’s obligations under the terms of the policy and subcontract, and violations of Massachusetts General Laws (M.G.L.) c. 93A and 176D. JMA claimed that Zurich had failed to pay defense costs related to the L’Hussier Action and sought a defense and indemnification without a reservation of rights. Despite conceding that Zurich had agreed to defend JMA as an additional insured and assigned counsel, JMA argued that Zurich had not satisfied its obligations under the policy.
On May 11, 2021, Zurich moved to dismiss the complaint, and JMA cross-moved for judgment on the pleadings. In October 2021, Zurich paid JMA’s defense counsel’s July 2020 invoice, excluding fees related to coverage litigation and disputes between JMA and Zurich. The hearing on the motions was held on November 8, 2021, and the next day, Zurich paid JMA’s defense counsel’s invoices from August 2020 through July 2021, again excluding fees related to coverage litigation and disputes.
Both parties submitted supplemental materials, including an affidavit detailing Zurich’s October and November 2021 payments. The Superior Court judge allowed Zurich’s motion to dismiss and denied JMA’s motion for judgment on the pleadings. The judge based this decision on Zurich’s payments and acknowledgment of its duty to defend JMA with a reservation of rights. The judge concluded that Zurich was not in breach of the policy, and no actual controversy existed regarding the duty to defend.
Claims regarding indemnification and violations of M.G.L. c. 93A and 176D were dismissed as premature. The judge did acknowledge that it was an open issue whether Massachusetts law permits an insurer to recoup defense costs, but this question did not need to be resolved, since there was no actual dispute on this point at the time.
JMA filed a timely appeal of the dismissal to the Appeals Court.
The Appeals Court decision: First the Breach of duty to defend claim
The Appeals Court first addressed whether the Superior Court correctly dismissed JMA’s breach of contract claim alleging Zurich’s failure to timely pay defense costs.
The Appeals Court reaffirmed that in insurance litigation, the duty to defend is broader than the duty to indemnify. Massachusetts courts hold that an insurer’s duty to defend arises when a third party’s complaint against the insured can reasonably be interpreted as a claim covered by the policy terms. The underlying complaint merely needs to demonstrate a possibility that the liability claim falls within the insurance coverage, without specifically and unequivocally making out a claim within the coverage.
The Court noted that if an insurer wants to defend its insured under a reservation of rights, and the insured objects, Massachusetts case law allows the insured to require the insurer to either relinquish its reservation of rights or allow the insured to conduct the defense with counsel of its choosing paid for by the insurer. A breach of the duty to defend is considered a breach of the insurance contract.
Applying these principles to JMA’s appeal, the judges on the Appeals Court panel found no dispute that the negligence claim against JMA, as alleged in the foreman’s complaint, was potentially covered by the policy, thus triggering Zurich’s duty to defend JMA. However, Zurich insisted on proceeding subject to a reservation of rights.
Based on established Massachusetts law, the Appeals Court concluded that JMA was entitled to control its defense and seek payment for its legal bills from Zurich. Zurich was then required to reimburse JMA for any reasonable attorney’s fees incurred by JMA’s chosen counsel.
JMA alleged that Zurich failed to reimburse it for its legal expenses to defend the foreman’s lawsuit, prompting JMA to initiate its legal action against Zurich. The Appeals Court determined that these allegations sufficiently set out a breach of contract claim based on Zurich’s nonpayment of JMA’s defense costs.
The Court concluded that, under established case law, an insurer that reserves its rights and takes no action in defense of its insured, when it knew or should have known of a covered claim, can be found to have committed a breach of duty to its insured.
JMA’s right to recover its legal fees for having to sue Zurich to obtain payment of its defense costs
The Appeals Court next addressed the issue of damages concerning JMA’s breach of contract claim against Zurich where JMA sought the right to recover its costs in suing Zurich to obtain its defense costs under Zurich reservation of rights.
Zurich had argued that dismissal was appropriate because it had already reimbursed JMA for defense costs in the underlying action, and, thus, JMA could not recover costs for the prosecution of this action as a matter of law.
The Court, however, found that JMA had adequately pleaded a breach of contract claim and might, therefore, be entitled to recover its legal costs in enforcing its right to a defense where Zurich had failed to pay for JMA’s defense costs until forced to do so by litigation.
The Court recognized an insured’s right to recover costs associated with the prosecution of a coverage action in these circumstances as a natural extension of the Supreme Judicial Court’s decision in Preferred Mut. Ins. Co. v. Gamache and its progeny. Gamache established an exception to the “American rule,” which allows insureds to recover reasonable attorney’s fees and expenses incurred in successfully establishing the insurer’s duty to defend under a liability policy.
Although the Appeals Court recognized that Gamache had addressed a slightly different scenario, it found that the reasoning in Gamache applied with greater force in the present case, where Zurich had conceded the existence of a duty to defend but JMA was forced to bring an action to compel Zurich to actually satisfy its duty. The breach of the duty to defend was, to the Court, worse when, as here, an insurer acknowledged its duty but refused to comply than when the insurer and the insured had a good faith disagreement about the insurer’s duty to defend.
The Court emphasized the broad nature of the insurer’s duty to defend and the heavy burden on the insured in the event an insurer breached its duty to defend.
The Court concluded that if JMA subsequently proves that Zurich violated its duty to defend by failing to fund JMA’s defense, JMA might independently recover as damages its attorney’s fees and expenses associated with the prosecution of its action to compel Zurich’s compliance with its duty to defend by timely paying defense costs.
The dismissal of JMA’s claim that Zurich’s delayed defense payments violated G. L. c. 93A and 176D.
The next claim asserted by JMA the Appeals Court addressed was the dismissal of JMA’s claim that Zurich’s delayed payment of defense costs constituted unfair claim practices under G.L. c. 93A and G.L. c. 176D.
The Court found that JMA had adequately stated a claim for a violation of these statutes based on Zurich’s nonpayment of defense costs.
G. L. c. 93A, § 2(a), prohibits unfair or deceptive acts or practices in trade or commerce. In the insurance context, G.L. c. 176D, § 3(9)(g), defines an unfair claim settlement practice as compelling insureds to litigate to recover policy amounts by offering substantially less than the amounts ultimately recovered.
The Court found that a claim against an insurer under G.L. c. 93A, § 11, may arise if the insurer unnecessarily and unreasonably delays payment of the insured’s attorney’s fees, even if acknowledging its duty to reimburse.
At the motion to dismiss stage, the Court found that Zurich’s alleged failure to pay defense costs for seven months after receiving invoices from JMA sufficiently supported a claim for a violation of G.L. c. 93A and 176D, and, therefore, ruled that its dismissal was reversible error.
The dismissal of JMA’s declaratory judgment over Zurich’s reservation of rights claiming recoupment of defense costs
Ordinarily, as a matter of practice, insurers have paid an insured’s legal fees under a reservation of rights without claiming a right to recover legal fees paid where ultimately no coverage was found. JMA contested Zurich’s addition of a recoupment clause to its reservation of rights by filing a declaratory judgment count in its lawsuit, seeking a ruling on whether Massachusetts law allowed for such a clause.
The Superior Court dismissed JMA’s declaratory judgment, but the Appeals Court addressed the dismissal in two parts. First, it ruled on whether the defense costs recoupment clause presented an actual controversy the Superior Court could legally adjudicate, and then, it provided guidance on the open question under Massachusetts law of “whether an insurer may seek to recoup costs of a defense undertaken pursuant to a unilateral reservation of rights.”
The first question: Was there an actual controversy as yet over Zurich’s recoupment clause?
The Appeals Court first addressed the issue of whether an actual controversy existed concerning Zurich’s duty to defend JMA under the reservation of the right to recoup defense costs.
JMA argued that the motion judge erred in dismissing its request for declaratory relief, maintaining that Zurich’s recoupment clause in its reservation of rights rendered its agreement to defend a sham.
The Court noted that under the declaratory judgment statute, an actual controversy arose when there was a real dispute with definite interests involved, and circumstances indicated that unaddressed antagonistic claims would almost inevitably lead to litigation.
In this case, the dispute between JMA and Zurich involved an unsettled question of law in Massachusetts concerning an insurer’s ability to recoup defense costs provided to an insured. Due to the legal uncertainty surrounding Zurich’s reservation of the right to recoup, JMA, in the Court’s opinion, had demonstrated a real dispute concerning the parties’ rights in which they had a definite interest.
Zurich argued that an actual controversy could only arise if it sought recoupment in the future. However, the Appeals Court disagreed, noting that Zurich had a present duty to defend in ongoing litigation. JMA sought a declaration concerning the scope of that duty, asserting that Zurich’s reservation had an immediate impact on its defense strategy in the underlying action. To the Appeals Court, an actual controversy had arisen regarding whether Zurich had the right to recoup defense costs, making the dispute suitable for declaratory relief.
Insurer’s recoupment of defense costs from insured under a reservation of rights
Finally, the Appeals Court turned its thoughts on the open issue under Massachusetts law of whether an insurer may seek to recoup the costs of a defense undertaken pursuant to a unilateral reservation of rights.
The Court recognized that other jurisdictions are closely split on the issue, with several disallowing recoupment in the absence of an express provision in the policy or a subsequent agreement between the parties.
In jurisdictions recognizing a right to recoupment, the Court found the issue often arises in legal actions where none of the claims are potentially covered by the policy, or in “mixed” actions, where some claims are potentially covered and some are not. The insurer’s right to recover defense costs for claims not potentially covered is considered quasi-contractual.
The Court quoted the Restatement of the Law of Liability Insurance which distinguishes circumstances where an insurer is defending under a reservation of rights based on factual uncertainty related to a ground to contest coverage from those based on legal uncertainty regarding a duty to defend.
For claims with legal uncertainty, some insurers have sought recoupment upon prevailing on the duty to defend issue. Others have sought recoupment for defense costs attributed to noncovered claims incurred in defending legal actions they had a duty to defend.
The Appeals Court opined that whether Massachusetts would recognize a right to recoup in these circumstances is questionable given the Supreme Judicial Court’s observation that a declaratory judgment of no coverage does not retroactively relieve the primary insurer of the duty to defend but only relieves the insurer of the obligation to continue defending after the declaration.
The Court remarked that, at oral argument, Zurich argued that it could seek recoupment if the underlying litigation revealed the claim was not ultimately covered and if JMA forced Zurich to defend through unfair behavior with a “flavor of extortion.”
Zurich’s argument relied on a recent Massachusetts federal case, where a U.S. District Court judge reasoned that it would be manifestly unjust to allow an insured to retain defense costs when the insurer had no obligation to defend due to noncovered claims and was effectively forced to defend when the insured threatened to sue. See Agency Checklists’ article of August 16, 2022, “Court Rules Liability Insurer Can Recover Defense Costs & $1.5 Million Settlement from Insured.”
While not endorsing the United States District Court’s approach, the Court suggested that even if Massachusetts did recognize an insurer being forced to defend an uncovered claim as a basis for recoupment, that would not necessarily mean that an insurer could use this ground to reserve a right to recoup without identifying some related factual basis supporting its reserving a right to recoup.
Duty to indemnify
JMA’s declaratory judgment count had also sought declarations on the scope of Zurich’s duty to indemnify under the policy and subcontract in case of liability in the underlying action.
On this count, the Appeals Court agreed with the Superior Court judge’s dismissal. The Court pointed out that Zurich’s obligation to indemnify would not necessarily follow from the duty to defend. This indemnity obligation would more likely depend on facts proven in the underlying action.
As a result, the Appeals Court held that the issue of indemnification should be addressed after the underlying trial’s completion, and accordingly affirmed the dismissal of the requests for declaratory relief on the duty to indemnify under the policy and subcontract as premature.
The Appeals Court’s final orders on JMA’s appeal of the dismissal of its suit against Zurich
The Appeals Court issued a final order in JMA’s appeal of the dismissal of its suit against Zurich:
Conclusion. So much of the judgment as dismissed the claims for breach of contract, violation of G. L. c. 93A and 176D, and declaratory judgment on the duty to defend is vacated, and the matter is remanded for further proceedings consistent with this opinion. The judgment is otherwise affirmed.
Twenty days to apply for further appellate review to the Supreme Judicial Court
The Massachusetts Appeals Court is an intermediate appellate court. The ultimate judicial authority resides with the Supreme Judicial Court. Parties dissatisfied with an Appeal Court’s decision may apply for further appellate review. However, the allowance of any further appeal is discretionary with the Supreme Judicial Court.
Under the Massachusetts Rules of Appellate Procedure, Zurich has twenty days from the entry of the Appeals Court decision, March 31, 2023, or until April 20, 2023, to apply for further appellate review.
We will monitor this case and keep readers posted as to any further developments.
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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.
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