Court Finds No Coverage For Prosecuting Counterclaims

The Massachusetts Supreme Judicial Court recently weighed in on the perennial issue of whether an insurer’s obligation to defend extends to the prosecution of counterclaims on behalf of the insured.  In Mount Vernon Fire Insurance Co. v. Visionaid, Inc., 477 Mass. 343 (2017), the state’s highest court ruled that the duty to defend does not require insurers to fund an insured’s counterclaim, even when it may be intertwined with the defense of a covered claim.

The insurer in Visionaid issued an employment practices liability policy to the insured, a manufacturer of lens cleaning and eye safety products.   Under this “claims-made” policy, the insurer had a right and duty to defend, and was obligated to pay 100% of the defense costs for a covered claim.  In the underlying suit, a former employee sued the insured for wrongful termination based on age discrimination.  The insured, in turn, accused the then-employee of misappropriating funds.  The insurer agreed to defend the case subject to a reservation of rights, and appointed panel counsel.  The insured subsequently requested that the insurer pursue and fund a counterclaim for the alleged embezzlement.  The insurer declined to do so, contending that the policy did not require it to prosecute the counterclaim.  The insured countered that the insurer’s position created a conflict of interest justifying the appointment of independent counsel, at the insurer’s expense.

The insurer filed a declaratory judgment action in Massachusetts federal district court seeking a ruling that it was not obligated to assert or fund the counterclaim.  The district court ultimately found in favor of the insurer.  The insured appealed to the First Circuit Court of Appeals, which requested that the Massachusetts Supreme Judicial Court answer the following three questions:  (1) whether the policy, or the so-called “in for one, in for all” rule, required an insurer to prosecute a counterclaim; (2) whether the insurer had an obligation to fund the counterclaim pursuant to the definition of “defense costs” contained in the policy; and (3) whether pursuit of the counterclaim created a conflict of interest requiring the appointment of independent counsel.

As to the first certified question, the court focused on the meaning of the undefined term “defend” and found it to be clear and unambiguous.  The court stated that the “essence of what it means to defend” under the policy is to “work to defeat a claim that could create liability against the individual being defended.”  The court rejected the insured’s argument that the word “defend” is ambiguous and should include “anything a reasonable defense attorney would do to reduce the liability of the insured”, such as bringing a counterclaim that is intertwined with the insured’s defense.   According to the court, to accept this interpretation would not only require “read[ing] in a number of provisions that the parties did not include in the policy”, but would also result in extensive litigation to determine whether the counterclaim was sufficiently intertwined with the insured’s defense efforts. 

The court also disagreed with the insured’s contention that coverage for affirmative counterclaims was a logical extension of the “in for one, in for all” rule, which provides that an insurer must defend all claims in a “mixed action” involving both covered and non-covered claims.  The court noted that the purpose of this rule -- to prevent coverage litigation between insurers and insureds -- would be undermined if the duty to defend were expanded to include intertwined affirmative claims.  The court also pointed out that such expansion would incentivize insureds to file counterclaims in virtually every suit, regardless of merit, while unfairly transferring all of the risk and costs to insurers. 

As for the second certified question, the court noted that the insurer’s obligation to pay defense costs is coextensive with the duty to defend.  Thus, relying on its reasoning from answering the first question, the court found that the insurer had no obligation to pay for the insured’s counterclaim.  The court stated that in light of its ruling on the first two issues, it need not consider the third certified question regarding whether pursuing the counterclaim would create a conflict requiring the appointment of independent counsel. 

Coverage for prosecuting a counterclaim may vary based on jurisdiction.  As with the Visionaid court, the majority of courts do not recognize insurance coverage for the costs associated with bringing affirmative claims.  In a minority of jurisdictions, including a Pennsylvania federal district court, coverage is permitted under limited circumstances, such as when the counterclaim is factually “inextricably intertwined” with, or would reduce liability on, the underlying claim.  It is therefore incumbent upon those dealing with such claims to be familiar with the applicable choice of law in order to fully understand the scope of the insurer’s duty to defend in these circumstances.