Civil Litigation Newsletter

April
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From left to right: Christopher A. Kenney and Adam M. Veness of Kenney and Sams PC.

Massachusetts Federal District Court Holds That An Insurance Company Cannot Recoup Defense Costs From An Insured

by Christopher A. Kenney and Adam M. Veness*

Introduction

A very important and highly debated area of law is the extent of an insurer's ability to recoup defense costs that it advanced to an insured under a duty to defend. The debate only arises when the insurance policy does not contain language explaining the potential for a recoupment of defense costs. The law on this subject differs greatly depending on the state law that governs the issue. Until recently, Massachusetts courts had not officially adopted a position on the question, but in February, the Massachusetts Federal District Court has finally chosen a side. Before discussing the court's opinion, it is important to analyze the two cases with which the court grappled in making its decision.

To Recoup or Not to Recoup

In the controversial decision of Buss v. Superior Court, the Supreme Court of California was the first court to directly address the issue of whether an insurer is entitled to recoup costs for defending the noncovered counts of a third party action against its insured. 939 P.2d 766 (Cal. 1997). In Buss, the insurer defended an entire action and sought restitution for its costs in defending the 26 out of the 27 counts which were not covered by its policies. Id. at 770. The court affirmed a primary insurer's duty to defend an entire "mixed action" but held that the insurer had a quasi-contractual right to secure reimbursement for costs incurred in defending noncovered counts. Id. at 776. The court further held, however, that an insurer is entitled to reimbursement only of defense costs "that can be allocated solely to the claims that are not even potentially covered." Id. at 778.

The court reasoned that the insurer could only recover defense costs allocated solely to the claims not even potentially covered because the insured paid premiums to the insurer to cover claims that are at least potentially covered by the policy. Id. The insured also paid premiums to cover defense costs that can be allocated jointly to both potentially covered and noncovered claims (i.e. mixed claims). Id. The court noted that defense costs which were required to defend actually or potentially covered claims, whether or not joined with noncovered claims, cannot be recovered by the insurer. Id. at 778, n.15.

The other decision the Massachusetts Federal District Court considered was American & Foreign Ins. Co. v. Jerry's Sport Center, Inc., 2 A.3d 526 (Pa. 2010). In Jerry's Sport, the court determined that the insurer had an absolute duty to defend claims that are even potentially covered, and that an insurer must make the decision about whether to advance defense costs. Id. at 542. If the insurer determines that there is no possibility of coverage, then it should deny its insured a defense. Id. However, if the insurer is incorrect in denying coverage, then it risks being liable for breach of contract. Id.

The Jerry's Sport court placed the duty to determine coverage and the risks associated with an incorrect determination solely on the insurer. Following the Jerry's Sport holding, an insurer has two choices: it can advance defense costs and not have a claim for recoupment even if the claims against the insured are not even potentially covered by the policy, or it can deny its insured a defense and risk breaching its contract with the insured.

Massachusetts Makes Its Determination

Relying on the reasoning of the two opposite holdings in Buss and Jerry's Sport, the Massachusetts Federal District Court fell directly in line with Jerry's Sport. In Welch Foods Inc. v. Nat'l Union Fire Ins. Co., the Massachusetts Federal District Court determined that an insurer must bear the risk of advancing defense costs to an insured. 2011 WL 576600, at *3 (D. Mass. Feb. 9, 2011). The Welch court agreed with Jerry's Sport in that it is the insurer's duty to make the determination of whether a claim is covered. Id. The court reasoned that the insurer is in the business of making that determination and should do so in these situations. Id. If the insurer was incorrect in its determination to advance defense costs, the insured will not be required to reimburse the insurer for the insurer's incorrect determination. See id.

Although Welch is a federal opinion and has no direct authority over Massachusetts state courts, it does shed light on the direction that Massachusetts is headed on this issue. One thing that is for sure, the Welch opinion will at least have a deterrent effect on Massachusetts insurance companies that are considering whether to seek reimbursement for defense costs advanced to insureds.

* Kenney & Sams PC

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