Sometimes Offense Is the Best Defense: But Is It Covered?

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1 Sometimes Offense Is the Best Defense: But Is It Covered? Once a suit is filed that triggers an insurer s duty to defend, defense counsel, the insured, and the insurer must work together to defend against the suit. In many circumstances, the recommended strategy involves filing a counterclaim, or even a separate suit against the plaintiff. There are a variety of rules in different jurisdictions as to whether such offensive moves are covered as part of the insurer s duty to defend. This program will explore the differing rules and the reasoning behind them, providing useful information for arguing the issue, especially in jurisdictions that have not addressed these circumstances. This concept was best explained by the Northern District of Illinois in Great West Casualty Co. v. Marathon Oil Co.: [T]here is a class of affirmative claims which, if successful, have the effect of reducing or eliminating the insured s liability and that the costs and fees incurred in prosecuting such defensive claims are encompassed in an insurer s duty to defend... A duty to defend would be nothing but a form of words if it did not encompass all litigation by the insured which could defeat its liability, including claims and actions for contribution and indemnification. 315 F. Supp. 2d 879, 881, 883 (N.D. Ill. 2003) (holding that duty to defend requires insurer to cover claims and actions seeking third-party contribution as a means of avoiding liability ). Three major categories of cases exist: (1) those where the counterclaim or other affirmative matter will defeat the claim in its entirety; (2) those where the affirmative matter and case are inextricably intertwined; and (3) those where the affirmative matter is truly separate from the initial claim. Where the affirmative matter will defeat the claim, insureds frequently are able to obtain coverage in court. Where the cases are inextricably intertwined results are mixed. Where the affirmative matter is truly separate and hence not defensive in nature courts may deny coverage; this is particularly true when the insured stands to gain a windfall from the affirmative matter.

2 In making the coverage determination, several factors come into play: (1) whether the affirmative matter is a separate action or a counterclaim; (2) whether the affirmative matter is an administrative action or a lawsuit; (3) whether the affirmative matter is intertwined with an uncovered claim as opposed to intertwined with a covered claim; (4) whether the affirmative matter has a defensive purpose along with seeking damages; (5) the strict, unambiguous policy language (defense is not prosecution); (6) whether the affirmative matter is brought as an affirmative defense or a counterclaim, or both why should an insurance company get the benefit of not paying a defensive matter that has a side benefit to the insured?; (7) whether the affirmative matter is necessary to defeat or reduce liability; and (8) whether the affirmative matter seeks equitable, declaratory and/or injunctive relief. I. Where the Affirmative Matter s Sole Purpose Is to Defeat the Claim against the Insured, Courts Find Coverage. Where affirmative claims seek declarations with no additional benefit for the insured other than to negate an element of a claim or a cause of action or to reduce liability, courts find there is coverage. Great Western Cas. Co. v. Marathon Oil Co., 315 F.Supp.2d 879, 881, 883 (N.D. Ill. 2003) ( the authority appears virtually uniform in holding that there is a class of affirmative claims which, if successful, have the effect of reducing or eliminating the insured s liability and that the costs and fees incurred in prosecuting such defensive claims are encompassed in an insurer s duty to defend... ). The general rule articulated in Great Western is that defensive claims are encompassed by the duty to defend whereas offensive claims are not. Id. at 882 (N.D. Ill. 2003); see, e.g., Oscar W. Larson Co. v. United Capitol Ins. Co., 845 F.Supp. 458, 461 (W.D. Mich. 1993) ( plaintiff s counterclaims and cross-claims for affirmative relief in the state court action are defensive in nature and prosecuted to limit or defeat plaintiff s liability in that action. Accordingly, the Court determines that the costs that plaintiff incurred in 2

3 prosecuting these claims are properly considered as defense costs. ); Potomac Elec. Power Co. v. Calif. Union Ins. Co., 777 F. Supp. 980, (D.D.C. 1991); Episcopal Church in S. Carolina v. Church Ins. Co. of Vermont, 53 F. Supp. 3d 816, 827 (D.S.C. 2014) (recovery is permitted of fees incurred in asserting counterclaims that were inextricably intertwined with the defense of an insured s claims and necessary to the defense of the litigation as a strategic matter ); Hartford Fire Ins. Co. v. Vita Craft Corp., 911 F. Supp. 2d 1164, (D. Kan. 2012) (insurer has to pay for insured s attorneys fees in pursuing a counterclaim that is inextricably intertwined with the claims being made against the insured). In Vita Craft, the relevant general liability policies required the insurer defend against third-party claims for personal and advertising injury but excluded claims for patent infringement. The underlying plaintiff filed suit against the insured, Vita Craft, alleging among other things patent infringement, misappropriation of trade secrets, and unfair competition. The court determined there was a duty to defend because, while there were no separate counts for covered offenses of libel, slander, or disparagement of goods, products and/or services, the complaint alleged that the insured engaged in a scheme to damage and injure [Plaintiff] by spreading false rumors which potentially fell within the covered offenses. The court held that Hartford was required to defend the entire suit, including the patent infringement claims, because under Kansas law an insurer has a duty to defend if there is any potential for liability, and spreading false rumors constitutes defamation, which the policy did cover. Because the underlying complaint alleged that Vita Craft spread false rumors, allegations which are not tied to intellectual property rights, the court found that the intellectual property exclusion did not bar coverage or a duty to defend. 3

4 Vita Craft asserted counterclaims, including some seeking a declaration that the relevant patents were unenforceable because of inequitable conduct before the United States Patent and Trademark Office. Hartford denied coverage arguing that it had no duty to defend affirmative claims. The court held there was coverage for the counterclaims. Id. at 1182 (citing Smart Style Indus., Inc. v. Pa. Gen. Ins. Co., 930 F.Supp. 159, (S.D. N.Y. 1996) (insurer required to pay insured s attorneys fees incurred prosecuting affirmative claims for declaratory relief [concerning trademark infringement] where costs for defending and prosecuting inseparable); TIG Ins. Co. v. Nobel Learning Cmtys., Inc., No. Civ. A , 2002 WL , at *15 (E.D. Pa. June 18, 2002) (insured s claims critical to and inextricably intertwined with defense of copyright infringement claim)). In TIG Insurance Company v. Nobel Learning Communities, Inc., cited by the Vita Craft court, the court imposed a duty on the insurer to pay the legal fees to prosecute a lawsuit filed by the policyholder WL There, the policy provided for defense against all claims of personal and advertising injury arising from infringement upon another s copyright. The policyholder, Nobel Learning Communities, sued the previous owner of its assets, seeking a declaration of the parties respective intellectual property rights. The previous owner counterclaimed for copyright infringement. The court found that the insurer had a duty to defend the counterclaim asserted against Nobel, and thus also had a duty to prosecute Nobel s affirmative claims because they were inextricably intertwined, and prosecution of the affirmative claims was essential to the defense against the counterclaim. Id. at *15. The court reasoned that courts have found coverage where affirmative claims by the insured could defeat or offset liability and followed Safeguard Scientifics. Id. at *14 (citing Safeguard Scientifics, 4

5 Inc. v. Liberty Mut. Ins. Co., 766 F. Supp. 324, (E.D. Pa. 1991), aff d in part, rev d in part on other grounds 961 F.2d 209 (3d Cir. 1992)). Discussing the holding in Safeguard Scientifics, the TIG court pointed out that, although the counterclaims in that case: were not compulsory, the court nonetheless held that the pursuit of the counterclaims was inextricably intertwined with the defense... and was necessary to the defense of the litigation as a strategic matter. Safeguard Scientifics, 766 F.Supp. at Thus, the court held that the insurer s duty to defend extended to the counterclaims raised in the same proceeding. Id. Id. The TIG court also recognized that [a]lthough few courts have addressed the issue of an insurer s liability for affirmative claims by the insured, the courts that have found liability have done so where the claims were part of the same dispute and could defeat or offset liability. Id. It explained: Id. at *15. Although prior to the filing of the counterclaim TIG had no duty to defend, once copyright infringement was alleged against Nobel in the Florida action, Nobel s affirmative claims became critical to and inextricably intertwined with the defense of the copyright infringement claim. As the prosecution of the affirmative claims was essential to the defense against the counterclaim, it was logically encompassed by TIG s duty to defend Nobel. The governing principle is that the insurer must defend all claims in a suit that triggers the duty to defend, and defense entails affirmative claims that have defense as their sole purpose. See, e.g. Simon v. Md. Cas. Co., 353 F.2d 608 (5th Cir. 1965) (coverage where an affirmative suit is the only way insured could protect its rights); IBP, Inc. v. Nat l Union Fire Ins. Co. of Pittsburgh, 299 F. Supp. 2d 1024, 1031 (D.S.D. 2003) (finding coverage because one cross claim was essentially IBP s answer to the complaint in the other state action. The opposing party s counterclaims and answers in one state court action were nearly identical to its complaint.); Ultra Coachbuilders, Inc. v. General Sec. Ins. Co., 229 F.Supp.2d 284, 289 5

6 (S.D.N.Y. 2002) (insurer liable for legal fees incurred in asserting counterclaims in trademark infringement action because the counterclaims were inextricably intertwined with the defense of [defendant s] claims and necessary to the defense of the litigation as a strategic matter. (citation omitted)); Smart Style Indus., Inc. v. Pennsylvania Gen. Ins. Co., 930 F.Supp. 159, 161 (S.D.N.Y. 1996) (insurer liable for attorney fees and costs in connection with insured s action for declaratory judgment that it did not infringe trademark, despite limitation to defense costs in policy); Oscar W. Larson Co. v. United Capitol Ins. Co., 845 F.Supp. 458, 461 (W.D. Mich. 1993) (insurer liable for attorney fees and costs for insured s assertion of counterclaims and cross claims in negligence case because those claims were defensive in nature in that they were prosecuted to limit or defeat insured s liability); Potomac Elec. Power Co. v. California Union Ins. Co., 777 F.Supp. 980, (D.D.C. 1991) (finding affirmative suit brought by an insured is not per se unrecoverable as a defense cost). ). Several courts have held that, when the insured files a counterclaim arising from the same facts it is using as part of its defense strategy, the insurer must pay the costs of the counterclaim as well as the costs of the direct defense. D.R. Horton, Inc.-Denver v. Mountain States Mut. Cas. Co., 69 F. Supp. 3d 1179, (D. Colo. 2014); Ultra Coachbuilders, Inc. v. Gen. Sec. Ins. Co., 229 F. Supp. 2d 284, 289 (S.D.N.Y. 2002) (holding that insurer must pay the costs of insured s counterclaims that were inextricably intertwined with the defense of [defendant s] claims and necessary to the defense of the litigation as a strategic matter ); Oscar W. Larson Co. v. United Capitol Ins. Co., 845 F. Supp. 458 (W.D. Mich. 1993), aff d, 64 F.3d 1010 (6th Cir. 1995) (where prosecuting counterclaims and cross claims is defensive and is reasonably necessary to limit or defeat the insured s liability, the costs are covered as defense costs); IBP, Inc. v. Nat l Union Fire Ins. Co. of Pittsburgh, PA, 299 F. Supp. 2d 1024, 1031 (D. S.D. 2003) 6

7 (defendant s cross claim against plaintiff in a separate law suit was in essence IBP s answer to Tyson s complaint in Arkansas, and thus fell within the duty to defend). II. Where Affirmative Claims Are Not Purely Defensive But the Facts are Intertwined, Courts Come to Differing Results. Where the counterclaims are not purely defensive, even when the facts are intertwined, courts come to differing results. The following cases held that the counterclaims at issue were not purely defensive and distinguished them from cases holding defensive counterclaims are covered. Mount Vernon Fire Insurance Co., v. Visionaid, Inc. f/k/a H.L. Bouton Co. Inc. involved a direct defense which also sought monetary damages. 477 Mass. 343, 347 (Mass.). The certified questions were limited to whether an insurer was required to fund prosecution of a compulsory counterclaim for monetary damages. Id. Mount Vernon involved an employment practices liability insurance policy which covered wrongful termination claims brought against the policyholder, Visionaid. One employee commenced a wrongful termination action against Visionaid alleging it terminated him due to his age. An audit determined that he had misappropriated several hundred thousand dollars in company funds. Id. at Visionaid asserted three nondiscriminatory reasons for the firing: poor job performance, insubordination, and suspected misappropriation. Id. It was important to the Massachusetts Supreme Court that Visionaid was asking Mount Vernon to fund a counterclaim against the allegedly wrongfully terminated employee for recoupment of hundreds of thousands of dollars in misappropriated funds. The court highlighted that requiring an insurer to fund a counterclaim for monetary damages: misaligns 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 352. The court was persuaded by 7

8 the following reasoning of a Massachusetts federal district court: an insured would have every incentive and little disincentive to file suit, knowing that it could reap the benefits of success however unlikely while transferring the costs of an otherwise predictably unsuccessful suit onto its insurer. Id. The court also explicitly relied on the following reasoning from a dissenting opinion in a Wisconsin Court of Appeals case that found coverage for counterclaims: duty to defend does not compel insurers to pursue counterclaims which by their very nature are for the benefit of the person pursuing the counterclaim : the insured. Id. at 353. Safeguard Scientifics, Inc. v. Liberty Mutual Insurance Co. involved a commercial general liability policy. 766 F. Supp. 324 (E.D. Pa. 1991), rev d in part on other grounds, 961 F.2d 209 (3d Cir. 1992). A former president and officer filed a complaint against his former company, Safeguard, and included a count alleging defamation. Liberty Mutual refused to defend the suit against Safeguard, its insured, because the allegations involved statements that were knowingly false when made, so they fell under the knowingly false defamation exclusion. Id. at 327. In addition to the excluded defamation allegations, Liberty Mutual denied coverage for amounts expended in the prosecution of the counterclaims [Safeguard asserted] in the underlying action. Id. at 333. The insured sued Liberty Mutual for breaching its duty to defend. The court first found that the defamation count was covered by the policy under its personal and advertising injury liability provision because slander of a private figure does not require knowledge and, under New York s liberal amendment rules, the pleading could have been conformed to the evidence at trial negligent or reckless slander which would be covered. Id. at 329. The court next found that, because defamation was potentially covered, Liberty Mutual had the duty to defend the entire claim, including the counterclaims. Id. The court reasoned: 8

9 Liberty Mutual has pointed to no case law suggesting that an insurance company s obligation does not extend to the litigation of counterclaims raised in the same lawsuit. The counterclaims were not compulsory under New York law. However, the pursuit of the counterclaims was inextricably intertwined with the defense of Barnes claims and was necessary to the defense of the litigation as a strategic matter. Thus, Liberty Mutual s duty to defend extends to the counterclaims raised in the same proceeding. Id. at 334 (citations omitted); see also Oscar W. Larson Co. v. United Capitol Ins. Co., 845 F.Supp. 458, 461 (W.D. Mich. 1993) (finding plaintiff s counterclaims and cross-claims for affirmative relief in the state court action are defensive in nature and prosecuted to limit or defeat plaintiff s liability in that action. Accordingly, the Court determines that the costs that plaintiff incurred in prosecuting these claims are properly considered as defense costs. ). III. Where the Affirmative Matter Is Truly Separate, and as Such Is Not Defensive, There Is No Coverage When the affirmative matter is truly separate from the case for which the insurer owes a duty to defend, and as such is not defensive, courts may find there is no coverage. A rationale relied on by these courts is a concern about providing the insured with a windfall. Where the insured has an affirmative matter that would provide it a windfall, courts may deny coverage. See Spada v. Unigard Ins. Co., 80 Fed. Appx. 27 (9th Cir. 2003) ( The counterclaims and crossclaims for which the Spadas seek reimbursement of their expenses were not offered as a reason in law or fact why the plaintiff should not recover, nor as a means of diminishing the McCormicks cause of action. Instead, the affirmative claims sought an award for damages that the Spadas had suffered both as a result of the landslide and as a result of actions taken by the McCormicks and the City after the landslide had occurred. Because the affirmative claims do not come within the terms of the policy, we need not determine whether Oregon courts would adopt the rule of Safeguard Scientifics ); Duke University v. St. Paul Mercury Ins. Co., 95 N.C. App. 663 (Ct. App. 1989) (underlying lawsuit involved a proposed sale of a psychiatric hospital 9

10 and disbursement of various funds and accounts. The counterclaims were for monetary damages based on intentional torts including defamation, interference with contract, and unfair trade practices). In International Insurance Co. v. Rollprint Packaging Products, Inc., the insurer brought a declaratory judgment action seeking a declaration that it did not owe Rollprint a duty to defend and indemnify it in a federal employment discrimination lawsuit pursuant to a commercial general liability insurance policy. 728 N.E.2d 680 (2000). The underlying lawsuit involved plaintiffs termination and Rollprint counterclaimed, seeking a finding that it owned trade secrets. The court found that the insurer s duty to defend was triggered by the allegations of the federal complaint, which included facts regarding wrongful eviction (though no specific counts alleging wrongful eviction, which was covered by the policy because the duty to defend does not require a complaint make allegations or use language affirmatively bringing the claims within the scope of coverage) and because the duty to defend extends to the entire case even when just one theory falls within coverage. However, as to the trade secrets counterclaim, the court held that the insurer had no obligation to pay legal fees because it was not defensive in nature; it was not filed to limit a defendant s potential liability, but instead was an offensive claim because it sought to restrain future use or disclosure of trade secrets, and as such did not limit the insured s liability. The court found that the counterclaim was not necessary for the determination of ownership of the trade secrets which was already at issue in that lawsuit and instead was comparable to any action Rollprint might have taken to enjoin [the former employee] from using the trade secrets after his termination, even if he had not filed a lawsuit. The counterclaim, therefore, was not defensive in nature. Id. at 695. Disclaimer: The views and opinions expressed in this article do not necessarily reflect those of the authors or the companies for which they work 10