In an answer to questions certified to it by the First Circuit Court of Appeals, the Massachusetts Supreme Judicial Court held that an insurance company’s duty to defend did not require the carrier to prosecute or pay for the prosecution of affirmative counterclaims by the insured even if those counterclaims were compulsory and inextricably tied to the claims the insurer was required to defend. In so doing, the Court rejected the arguments of the dissent to the effect that the rationale of the Massachusetts “in for one, in for all” rule applied equally in this situation.

The case arose out of the firing by Visionaid, Inc. of an employee, Gary Sullivan, whom Visionaid believed had misappropriated several hundred thousand dollars. Sullivan first filed an MCAD action and later a Superior Court case, claiming age discrimination. Visionaid had an Employment Practices Liability Insurance policy issued by Mount Vernon Fire Insurance Company. Mount Vernon tried to settle the case but Visionaid rejected the proposed settlement, which would have paid Sullivan nothing but which would have precluded Visionaid from pursuing its claims against Sullivan for return of the misappropriated funds.

Mount Vernon appointed counsel to defend Visionaid but issued a reservation of rights, disputing its obligation to defend Visionaid against the wrongful termination claim. Mount Vernon’s panel counsel filed an answer in the Superior Court action asserting Visionaid’s defenses to the wrongful termination claim, including that Sullivan had been fired for poor performance, insubordination and misappropriation of funds. However, panel counsel failed to file an affirmative counterclaim against Sullivan for return of the misappropriated funds, a claim that was factually virtually identical to the misappropriation defense. After Visionaid threatened to select its own independent counsel, Mount Vernon withdrew its reservation of rights but continued to maintain it had no obligation to prosecute Visionaid’s affirmative counterclaim.

With the parties at an impasse, Mount Vernon filed a declaratory judgment in the U.S. District Court in Massachusetts seeking a declaration that it had no obligation to prosecute or pay for the prosecution of Visionaid’s counterclaim for misappropriation. Visionaid counterclaimed, seeking a declaration that Mount Vernon was required to prosecute the misappropriation counterclaim and to appoint independent counsel for Visionaid because Mount Vernon’s position created a conflict of interest. The U.S. District Court judge ruled in favor of Mount Vernon, declaring Mount Vernon had no obligation to pursue the counterclaim and, in the absence of such a duty, had no conflict of interest nor any obligation to pay the costs of independent counsel.

On appeal, the First Circuit Court of Appeals certified three questions to the Supreme Judicial Court:

• Whether, and under what circumstances, an insurer (through its appointed panel counsel) may owe a duty to its insured — whether under the insurance contract or the Massachusetts ‘in for one, in for all’ rule -— to prosecute the insured’s counterclaim(s) for damages, where the insurance contract provides that the insurer has a ‘duty to defend any Claim,’ i.e., ‘any proceeding initiated against [the insured]’?

• Whether, and under what circumstances, an insurer (through its appointed panel counsel) may owe a duty to its insured to fund the prosecution of the insured’s counterclaim(s) for damages, where the insurance contract requires the insurer to cover ‘Defense Costs,’ or the ‘reasonable and necessary legal fees and expenses incurred by [the insurer], or by any attorney designated by [the insurer] to defend [the insured], resulting from the investigation, adjustment, defense, and appeal of a Claim’?
• Assuming the existence of a duty to prosecute the insured’s counterclaim(s), in the event that it is determined that an insurer has an interest in devaluing or otherwise impairing such counterclaim(s), does a conflict of interest arise that entitles the insured to control and/or appoint independent counsel to control the entire proceeding, including both the defense of any covered claims and the prosecution of the subject counterclaim(s)?

Ultimately, the SJC concluded that:

(1) an insurer with a contractual duty to defend an insured is not required to prosecute an affirmative counterclaim on the insured’s behalf, pursuant either to the contractual language in the policy at issue or the common-law “in for one, in for all” doctrine; [and] (2) the duty to pay defense costs has the same scope as the duty to defend, and thus does not require an insurer to pay the costs of prosecuting a counterclaim on behalf of the insured[.]

In light of its answers to the first two questions, the Court did not reach the third question.

The Court’s analysis of the issue started and ended with (1) the plain language of the policy, which required the carrier only to “defend” a claim, and (2) the plain meaning of “defend”, which, though undefined in the policy, the SJC defined to mean “to work to defeat a claim that could create liability against the individual being defended.” Asserting that the policy language and the meaning of the term “defend” were unambiguous, the Court considered but summarily rejected the alternative arguments of Visionaid, the dissent and courts of other jurisdictions which adopted a different interpretation of the policy language.

The Court also rejected the dissent’s view that the “in for one, in for all” rule dictated a contrary result. The “in for one, in for all” rule “requires that, where an insurer is obligated to defend an insured on one of the counts alleged against it, the insurer must defend the insured on all counts, including those that are not covered.” Id. at 15. This rule is designed to promote efficiency and to avoid the situation in which an insured must be represented by multiple counsel in the same proceeding, leading to needless expense and potential strategic and other conflicts, as well as potentially tipping off the jury to the existence of insurance. In light of these issues, the dissent’s view was that the “in for one, in for all” rule:

compels the conclusion that the insurer’s duty to defend a proceeding includes an obligation to prosecute compulsory counterclaims that are intertwined with the insured’s defense, where any reasonable attorney defending that proceeding would bring such a compulsory counterclaim, and where the insured agrees that any damages awarded to the insured on that counterclaim will offset any award of damages against the insured that the insurer is required to indemnify. In such circumstances, the insurer cannot reasonably fulfill its duty to defend the insured in the proceeding without also prosecuting such counterclaims because it would be impractical and deleterious to an effective defense to fail to do so.

The court rejected this rationale, asserting that it “would result in additional litigation in virtually every case involving insurance on whether a “reasonable” attorney hired separately by (and paid by) the insured would file the counterclaim in the given circumstances” by . . . “misalign[ing] the interests of the party who stands to benefit from the counterclaim (the insured) and the party who bears the cost of prosecuting the counterclaim (the insurer)” Id. at 16-17.

The Court answered the First Circuit’s first two questions in the negative, holding that an insured’s duty to defend did not require the insurer to either prosecute or to pay for the prosecution of an affirmative counterclaim of the insured.