That case holds that if an insurer agrees to defend its policyholder in a claim and then wins a separate declaratory judgment action determining that it has no duty to defend, the insurer is not entitled to recoup the defense costs it has already paid out. That is an important holding on a question that has been unsettled in Massachusetts.
As I discussed in the Lawyers Weekly article, the case also holds, in my opinion contradictorily, that the insurer does not have to pay defense costs that have been incurred but not paid by the time of the ruling that there is no duty to defend. 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. 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.
In Vibram, the policyholder had exercised its right to control its own defense by hiring counsel of its choice, who would be paid by the insurer. It was entitled to do so because the insurer was defending under a reservation of its right to later deny coverage.
The court held that the fact that the policyholder was controlling its own defense meant that it was not harmed by the retroactive decision of the insurer not to pay bills that had already been incurred.
The policyholder was Vibram USA, a large corporation with significant resources. (I am a big fan of Vibram's barefoot sneakers.) But elsewhere in the decision the court appropriately pointed out that the resources of the policyholder should not be a factor in determining the duty of the insurer, because similar policies are issued to individuals and small businesses and the insurer has the same duty to all policyholders. Yet the court did not take into account that an individual or a small business might make a different decision about what kind of defense costs to incur if it understands an insurer will pay those costs than if it has been told by the insurer that it will not pay those costs.
The court explained its rationale in part by holding that “there is nothing inherent in an insurer’s initial decision to provide a defense that precludes it from changing its mind, even while a declaratory judgment action is still pending.” That is certainly a correct statement of law. But, as the court pointed out earlier in the decision, “[i]n the first instance, it is for the insurer to determine whether any of the allegations of the complaint, if proved, could support a claim covered by the policy. If it declines to provide a defense, it faces potential liabilities that will likely exceed the cost of defense.” Those liabilities are ch. 93A damages that can be awarded for breach of a duty to defend, and fee shifting in a declaratory judgment action over the duty to defend if the policyholder prevails.
The court cited Herbert A. Sullivan v. Utica Mut. Ins. Co.,439 Mass. 387, 395 (2003) for the proposition that an insured can change its mind about whether it has a duty to defend. But in Herbert A. Sullivan the insurer did not change its mind – the circumstances changed. The initial complaint in that case alleged negligence, a claim that was covered under the policy. The amended complaint eliminated the negligence claim, and none of the remaining allegations involved covered losses.
The coverage question at issue in Vibram was whether a policy provision covering Advertising Injury included coverage for a claim based on the unauthorized use by the policyholder of a famous person’s name to sell the policyholder’s product. The court does not indicate that any circumstances changed that would affect that analysis. 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.
As I told Lawyers Weekly, the court’s holding that an insurer can retroactively refuse to pay defense costs that have already been incurred allows an insurer to have its cake and eat it too. It can agree to defend under a reservation of rights, thereby avoiding potential ch. 93A damages for breaching a duty to defend, while also not paying the defense costs it agreed to pay, perhaps ever.