Massachusetts High Court to Decide if Insurers Can Recoup Defense Costs

By: Craig O’Neill

The Massachusetts Supreme Judicial Court (SJC) is set to hear argument on February 6 in a case that will decide whether insurers can recoup defense costs if it is later determined that they owed no duty to defend an underlying claim. At issue in Holyoke Mut. Ins. Co. v. Vibram USA, Inc., No SJC-12401, is a trial court ruling that a pair of insurers were not entitled to recover amounts they paid under a reservation of rights for Vibram’s defense in a trademark suit that was later found not to allege a covered claim for “advertising injury.” The policies at issue did not expressly provide for reimbursement of defense costs.

In a March 21, 2017 decision, the trial court noted that this was an open issue in Massachusetts and pointed to what it termed “divergent views” on recoupment of defense costs advanced under a reservation of rights. E.g., Buss v. Superior Court, 939 P.2d 766 (Cal. 1997) (reimbursement permitted where no duty to defend existed); American & Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 2 A.3d 526 (Pa. 2010) (recoupment not allowed unless authorized by insurance policy). Ultimately, the trial court was persuaded by the reasoning in Jerry’s Sport Center, which it found to be more in line with Massachusetts law.

First, the trial court concluded that a right to recoupment must exist in the policy: “[P]ermitting reimbursement by reservation of rights, absent an insurance policy provision authorizing the right in the first place, is tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract.”

Second, it rejected an argument by Vibram’s insurers that they were entitled to recoupment under an unjust enrichment theory: “[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. In order to prove that it is unjust for an insured to retain defense costs advanced in respect of a third-party claim under a reservation of rights, an insurer must do more than prove that a court ultimately held that the claims were uncovered,” the court said.

The trial court did, however, agree with the insurers that they should not have to pay any remaining unreimbursed defense costs incurred by the insured (Vibram elected to control the defense and appointed its own defense counsel because of the reservation of rights) prior to the court’s determination that the claim was not covered, finding that there was no contractual or equitable basis to require them to do so. In other words, according to the court, the insurers were entitled under the circumstances to change their minds about advancing defense costs during the pendency of the coverage action. “[T]he duty to defend ends when there is no longer any chance that the facts alleged in an underlying action can support a covered claim. That will often, but certainly not always, be when a declaratory judgment resolves a coverage dispute.”

Last year, the SJC granted the parties’ joint application for direct appellate review of the trial court’s no coverage determination as well as the potentially more significant recoupment issue. In that application, the insurers argued in part that it would be unjust and contrary to the parties’ reasonable expectations to permit Vibram to retain defense costs that it was not entitled to under the policies at issue. “In denying the Insurers’ right to recoup Vibram’s defense costs, paid by the Insurers, the Trial Court required the Insurers to provide a defense to Vibram to which it was not entitled, and for which Vibram paid no premiums.”