A pair of insurers that defended claims against a policyholder under a reservation of rights and later obtained a declaration that the claims were not covered could not recoup costs they had advanced up to that point, a Superior Court judge sitting in the Massachusetts Business Litigation Session has ruled.

The plaintiff insurers argued that because the defendant policyholder had paid only for a defense against claims covered by its policy, it could reasonably expect the plaintiffs to assume only the cost of defending covered claims. Thus, the plaintiffs contended, if they could not get restitution for the defense of claims they had prophylactically financed, the insured would be receiving an unfair windfall.

Judge Mitchell H. Kaplan disagreed.

“Even in cases in which the insurer may believe that coverage is unlikely under the terms of the policy, it has financial incentives to provide a defense,” Kaplan wrote, granting the defendant’s motion for summary judgment.

“[A] bad faith refusal to provide a defense could constitute a violation of Chapter 93A and expose the insurer to multiple damages. … In consequence, when in doubt, an insurer has an economically sound and self-interested reason to provide a defense under a reservation of right until the coverage issue can be resolved.”

However, Kaplan also decided that the insurers, which initially agreed to pay for the policyholder’s defense but stopped advancing funds before it obtained the declaratory judgment, were not liable for unpaid costs up to that point.

The 20-page decision is Holyoke Mutual Insurance Company in Salem, et al. v. Vibram USA, Inc.

‘Important source of leverage’

Attorneys for the parties did not respond to interview requests. But Andrew F. Caplan, a lawyer with offices in Swampscott and Boston who represents policyholders in coverage disputes, said the decision will provide his clients with “another important source of leverage” in securing coverage.

“Under longstanding case law, unless it is clear-cut on the face of a complaint that all claims against the insured fall outside of any possible coverage, an insurer must, at the least, agree to defend its insured under a reservation of rights,” he said.

But under Mitchell’s ruling, he said, an insurer that doubts there is coverage and defends under a reservation of rights cannot later force its policyholder to repay legal fees incurred to defend the insured even if the court decides there was no duty to defend from the outset.

“In Massachusetts, the courts recognize that insurers often shirk their obligations and wield their clout to deprive policyholders of the benefits of coverage they purchased,” he said. “Holyoke Mutual v. Vibram adds to the body of pro-policyholder case law issued by the Massachusetts courts in order to protect policyholders and level the playing field.”

Roslindale insurance attorney Nina E. Kallen said the decision is an important holding on a question that has been unsettled in Massachusetts.

Still, Kallen questioned the judge’s determination that an insurer does not have to pay defense costs that have been incurred but are unpaid as of the time a ruling is issued finding there is no duty to defend. That allows an insurer to “have its cake and eat it, too,” she said.

“There is no indication in the decision that the insurer had given notice to the policyholder before the bills were incurred that it did not intend to pay them,” Kallen said. “The distinction between bills that had been submitted and paid by the insurer and bills that had been submitted and not yet paid by the insurer seems like a random one.”

As a result, insurers can agree to defend under a reservation of rights, thereby avoiding potential Chapter 93A damages for breaching a duty to defend, while not actually paying the defense costs it agreed to pay, perhaps ever, Kallen said.

“While an insurer is entitled to revisit its own legal analysis, I did not see in the decision any rationale for allowing it to do so retroactively,” she said.

“Even in cases in which the insurer may believe that coverage is unlikely under theterms of the policy, it has financial incentives to provide a defense.”

— Judge Mitchell H. Kaplan

Reservation of rights

Defendant Vibram USA manufactures athletic footwear and is best known for its “FiveFingers” line of minimalist running shoes that feature thin, flexible soles and visible individual sections for each toe.

Vibram named some of its FiveFingers models after Abebe Bikila, the legendary Ethiopian marathoner who won a gold medal in the 1960 Rome Olympics running barefoot.

In 2015, Bikila’s family sued Vibram in U.S. District Court seeking $15 million in damages for the company’s alleged unauthorized use of his name.

Vibram asserted coverage under policies issued by its commercial general liability insurers, plaintiffs Holyoke Mutual Insurance Co. in Salem and Maryland Casualty Co., and tendered defense of the Bikila family’s action to them.

Both insurers sent reservation of rights letters to Vibram agreeing to provide a defense but also maintaining that coverage did not exist under the policies and reserving their rights to bring a declaratory judgment action and to seek reimbursement for defense costs advanced up to that point.

The insurers then filed suit in Superior Court seeking a declaration that the claims against Vibram were not covered under the policies. Vibram counterclaimed, seeking a declaration that the claims were, in fact, covered.

On Aug. 17, 2016, the court issued a declaration in the insurers’ favor, ruling that there was no coverage and, accordingly, no duty to defend.

At some point prior to the court’s decision, the insurers stopped advancing defense funds to Vibram, which had retained its own counsel.

After obtaining the declaratory judgment, the insurers moved for summary judgment on the question of whether it could recoup the funds it had advanced for Vibram’s defense. Meanwhile, Vibram filed a cross-motion for summary judgment, arguing that it was entitled to recover defense costs it had incurred but which the insurers had not paid as of the date of the declaratory judgment.

No right to recoup

Addressing the insurers’ motion for summary judgment, Kaplan noted that there are divergent views on the right of recoupment in cases like the one that was before him.

For example, he noted, the leading case cited by the insurers was a 1997 Supreme Court decision, Buss v. Superior Court, which stands for the proposition that to deny the insurer the right to recoup defense costs after receiving confirmation that the underlying claims are not covered would give the insured a windfall, resulting in unjust enrichment.

However, he added, an unreported 2011 decision from the U.S. District Court in Massachusetts, Welch Foods Inc. v. Nat’l Union Fire Ins. Co., reaches the opposite conclusion, rejecting the reasoning in Buss.

In Welch Foods, the court followed a 2010 decision, American & Foreign Ins. Co. v. Jerry’s Sport Center, Inc., in which the Pennsylvania Supreme Court stated that while it may sometimes be difficult for an insurer to determine whether a claim is covered, it is the insurer’s duty to make that decision. After all, that court said, the insurer is in the business of making such decisions and a court’s subsequent determination that there is no coverage does not retroactively eliminate the insurer’s duty to defend the insured during the period of uncertainty.

“This court, like the District Court in Welch, finds that the Pennsylvania Supreme Court’s decision in Jerry’s comports with Massachusetts law,” Kaplan said, noting that even when the insurer may believe that coverage is unlikely under the terms of the policy, it still has a financial incentive to defend under a reservation of rights: to avoid a Chapter 93A bad-faith claim if it turns out to be wrong.

Kaplan also rejected the insurers’ unjust enrichment argument.

“[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,” he wrote. “Claims of unjust enrichment ought not be used to imply rights that the parties have not included in the written contract that defines their relationship and covers the subject matter in dispute.”

Nonetheless, Kaplan found that Vibram had no right to recover costs incurred between the time the insurers stopped advancing defense funds and the declaratory judgment of non-coverage.

“The court finds that there is nothing inherent in an insurer’s initial decision to provide a defense that precludes it from changing its mind, even while the declaratory judgment action is still pending,” the judge said.

Accordingly, while the insurers had no right to recoup defense costs previously advanced, the policyholder had no right to recover any unpaid defense costs from the insurers.