First Circuit Reverses Insurer’s $1.8M Recovery of Settlement And Defense Costs From Insured

In a policyholder win, the First Circuit Court of Appeals reversed a federal district court ruling last week that had ordered Granite Telecommunications, a $1.75 billion company headquartered in Quincy, to reimburse its liability insurer Berkley National over $1.8 million. The district court had granted summary judgment to Berkley on its equitable restitution claim, mandating that Granite repay Berkley for the $1.5 million settlement Berkley had funded to resolve a negligence lawsuit Granite faced, as well as the $247,284 in defense costs Berkley incurred defending Granite.

The dispute centered on Berkley’s defense of Granite in an underlying personal injury case under a reservation of rights. Though initially denying it had a duty to defend based on a pollution exclusion, Berkley ultimately defended Granite under a reservation of rights. Subsequently, Berkley paid $1.5 million to settle the personal injury suit.

Berkley then sought to recoup the settlement and its nearly $250 thousand in defense costs based on its claim Granite had no coverage under its policy with Berkley and, therefore, had been unjustly enriched. When the lower court granted Berkley reimbursement of both settlement and defense costs under this theory of unjust enrichment, Granite appealed.

On appeal, the First Circuit ruled that Berkley’s claims did not satisfy the Massachusetts law’s legal tests for insurer reimbursement claims against insureds. In overturning the lower court’s judgment reimbursing Berkley over $1.8 million, the First Circuit maintained the high bar carriers have to hurdle in seeking repayment of settlement and defense costs from policyholders.

The personal injury suit generating Berkley’s claim Grantie was unjustly enriched

The coverage dispute in this case arose from a November 2016 incident in which Steve Papsis, a food services contractor employee, was exposed to raw sewage while working in the kitchen of a cafeteria located in Granite Telecommunication’s headquarters building. Granite leased the building from co-defendant Atlantic-Newport Realty LLC. Due to alleged negligence in maintaining the drainage system, Papsis developed a severe bacterial infection in his foot from the sewage contact, ultimately requiring multiple surgeries and extended medical treatment.

In September 2019, Papsis filed suit against Granite and Atlantic in Massachusetts state court, seeking over $1 million in damages for his injuries, medical costs, lost wages, and diminished earning capacity. His complaint accused Granite of liability for the dangerous condition leading to his bodily injuries. As a lessee in control of the building where the incident occurred, Granite requested coverage and defense under its liability policy with Berkley National Insurance Company.

Though initially denying coverage based on a pollution exclusion, Berkley ultimately agreed to provide Granite a defense under a full reservation of rights regarding the Pollution exclusion and an additional “Fungi or Bacteria” exclusion barring coverage.

When the personal injury suit went into mediation, Granite demanded Berkley alone fund any settlement, rejecting joint contribution. The Papsis suit ultimately settled for $1.5 million funded solely by Berkley, subject to its reservation of rights. This settlement resolved Papsis’ claims against Granite and Atlantic. Separately, Berkley incurred $247,284.06 in legal costs and fees defending Granite in the litigation.

Berkley’s declaratory judgment seeking a ruling of no coverage

While the Papsis case was pending, Berkley filed a declaratory judgment complaint against Granite and other defendants to determine whether Berkley owed any coverage to Granite and Atlantic Newport Realty LLC) for a lawsuit brought by Stephen Papsis.

The declaratory judgment suit sought a ruling on the Pollution and the “Fungi and Bacterial” exclusions denying Granite any defense or indemnity for Mr. Papsis’ lawsuit alleging Granite’s liability for the bacterial infection that caused his bodily injuries.

In an amended complaint filed after the settlement of the Papsis case, Berkley alleged it had the right to “equitable restitution” because Granite had received an unjust “windfall” by Berkley’s settlement and defense costs payments on an uncovered claim.

The district court agrees Berkley has a right to equitable restitution from Granite

On summary judgment, the district court agreed with Berkley, finding that “Berkley does not owe coverage for the Papsis claims by reason of the fungi or bacteria exclusion in the Policy” and that “Berkley is entitled to be reimbursed by defendants for the legal fees and costs that it has incurred in defending the Papsis lawsuit, as well as the cost of settling the Papsis lawsuit on defendants’ behalf.”

After additional legal proceedings involving other possible insurers, the district court entered judgment against Granite for the $1.5 million settlement of the Papsis claim and $247,284.06.

Granite filed a timely appeal to the First Circuit Court of Appeals, claiming the district court’s ruling did not comport with Massachusetts law.

For a more detailed breakdown of the background and the proceedings in the District Court, See Agency Checklists’ August 16, 2022 article, “Court Rules Liability Insurer Can Recover Defense Costs & $1.5 Million Settlement from Insured.”

The First Circuit rules Berkley’s equitable restitution claim fails under Massachusetts law

On appeal, the First Circuit ruled to overturn the federal district court’s grant of equitable restitution mandating Granite repay the $1.5 million settlement to its insurer Berkley.

The First Circuit held that controlling Massachusetts precedents precluded Berkley’s reimbursement claims in this scenario.

The lower court had ordered Granite Telecommunications to reimburse Berkley National the $1.5 million the insurer paid to settle the underlying personal injury lawsuit Granite faced. In granting equitable restitution of the settlement funds, the district court focused on Berkley’s reservation of rights and Granite accruing an undeserved “windfall.” The First Circuit methodically analyzed why this reimbursement judgment conflicted with settled Massachusetts case law on insurer recoupment of settlements.

Under Massachusetts law, the First Circuit explained, an insurer defending under a reservation of rights can pursue reimbursement of settlement payments only if the insurer can establish one of three conditions apply. These three scenarios where such claims are permissible are:

(1) the insured agrees the insurer may commit its own funds to settle while retaining the right to seek repayment.

(2) the insurer obtains specific authority to fund a settlement the insured agrees to reimburse; or

(3) the insurer notifies the insured of a reasonable settlement offer while providing the choice to accept that offer or take over its own defense.

Reviewing the record, the First Circuit found no evidence bringing Berkley’s claim for reimbursement of the $1.5 million settlement within any of these three conditions.

The court noted nothing indicated Granite had consented to Berkley seeking repayment or agreed to reimburse the settlement amount that Berkley had unilateral authority over funding. Additionally, though Granite encouraged settlement, Berkley conceded it never gave Granite the option to either accept Berkley’s settlement offer or proceed with its defense on its own. With none of the three conditions satisfied, the Court found Massachusetts law barred Berkley from seeking reimbursement of its settlement payment.

Court reverses Berkley’s $247,000 award for defense costs

In addition to overturning the order requiring Granite to reimburse Berkley’s $1.5 million settlement payment, the First Circuit also rejected the lower court’s ruling entitling Berkley to recoup the $247,284 in defense costs it had unilaterally expended to defend Granite.

The district court had agreed with Berkley’s implied contract argument that by accepting Berkley’s paid defense subject to Berkley’s reservation of rights, Granite assumed responsibility to later reimburse Berkley if there were a finding of no coverage.

The First Circuit, however, held this theory of recovery conflicted with Massachusetts law.

A general reservation of rights does not preserve the right to recover defense cost

State court precedents, the First Circuit acknowledged, are split on whether insurers can recover defense costs absent an express reservation of the right to do so. However, the Court noted that although no Massachusetts case decision specifically allows carriers defense costs reimbursement, it opined if Massachusetts did permit a liability insurer to recoup defense costs, it would only allow such a recovery if the insurer clearly asserted that right in its initial reservation of rights.

Here, the First Circuit emphasized Berkley’s initial reservation of rights letters expressly reserved only the right to disclaim coverage and seek a declaratory judgment that it had no duty to defend. The reservation did not directly assert a right to recoup amounts expended on the defense.

Because the record contained no evidence showing Berkley explicitly reserved the right to seek reimbursement of funds paid for Granite’s legal defense, the First Circuit ruled there was no basis for the claim to proceed under Massachusetts law. It dismissed Berkley’s counterarguments that an implied contract right existed based on its unilateral reservation. The court found no state precedents endorsing such an implied right for reimbursement without an express reservation targeting defense costs.

By vacating the lower court’s order requiring Granite to repay the $247 thousand Berkley spent on Granie’s legal defense, the First Circuit reaffirmed Massachusetts law would require insurers to strictly comply with technical prerequisites before attempting to shift defense costs back to policyholders after defending under a reservation of rights. Going forward, carriers seeking to test whether they may claim the right to recoup defense costs for uncovered claims will have to explicitly assert that right in their reservation of rights.

A general reservation of rights will not allow the carrier any ability to later seek reimbursement of funds paid to defend insureds on uncovered claims.

Carriers must mind their p’s and q’s in reserving rights

The First Circuit’s ruling overturning the lower court’s order requiring Granite to reimburse Berkley for over $1.8 million in settlement and defense costs demonstrates the strict rules that apply to insurer recoupment rights under Massachusetts law.

This case makes clear liability insurers must expressly reserve their claims in any reservations of rights to recoupment of settlement sums and defense costs upfront. Absent adherence to these legal requirements cited by the First Circuit, any such reimbursement attempts face long odds if contested.

Owen Gallagher

Insurance Coverage Legal Expert/Co-Founder & Publisher of Agency Checklists

Over the course of my legal career, I have argued a number of cases in the Massachusetts Supreme Judicial Court as well as helped agents, insurance companies, and lawmakers alike with the complexities and idiosyncrasies of insurance law in the Commonwealth.

Connect with me directly, by calling me at 617-598-3801.