Court Upholds Exclusion: $750K Defense Costs Lost

On January 25, 2022, Agency Checklists published an article titled “Appeals Court Decision May Require Utica To Pay Insured’s Legal Fees of $750,000.” This article detailed the Massachusetts Appeals Court’s reversal of the dismissal and the remanding to the Superior Court of a coverage suit brought by El Group, LLC, against Utica Mutual Insurance Company (“Utica”). El Group sought to recover $750,000 it had paid to defend a counterclaim filed by a former business partner, Frank Clegg, whom El Group had sued.

In our analysis of that reversal, we stated: “Based on this order of remand, Utica will have liability for not only the defense costs of the EL Group but also for the legal costs of the EL Group in establishing that Utica had a duty to defend unless Utica can avoid liability because of an exclusion or policy condition.”

The case returned to the Superior Court, where, after a hearing, the Superior Court again ruled in favor of Utica, finding that policy exclusions barred coverage for El Group’s claim. El Group appealed this decision, bringing the case to the Appeals Court a second time.

In a ruling on August 7, 2024, the Appeals Court affirmed the Superior Court’s decision, settling the question of Utica’s duty to defend. The court held that exclusions in El Group’s policy, and, in particular, the exclusion for “knowing violation of the rights of another,” relieved Utica of any obligation to reimburse El Group for its defense costs.

Background of the coverage litigation

The insurance dispute with Utica Mutual traces back to a business partnership formed in 2009 between El Group, LLC, and Frank Clegg, a designer and manufacturer of leather goods. The partnership aimed to sell Clegg’s products online, with El Group managing the website and Clegg continuing his design and manufacturing role.

By October 2011, the partnership had dissolved. In May 2014, El Group and its officers, including Joseph Lotuff, sued Clegg, alleging breach of contract and various business torts. Clegg countersued with a 13-count claim, later amended to 14 counts. The counterclaim alleged that El Group had:

1. Made false statements to customers about their contributions to Clegg’s designs

2. Misappropriated Clegg’s designs and manufacturing techniques

3. Misused business funds for personal expenses

4. Infringed on Clegg’s trademark

5. Damaged Clegg’s professional reputation

El Group denied defense and indemnity for Clegg’s counterclaim

El Group held a commercial general liability policy and a commercial liability umbrella policy with Utica, covering the period from August 1, 2013, to August 1, 2016.

In November 2014, El Group sought defense and indemnification from Utica for Clegg’s counterclaim.

Utica denied coverage, citing two main reasons:

1. The alleged incidents occurred before the policy’s effective date

2. Even if the incidents fell within the policy period, they were subject to exclusions

El Group renewed its coverage demand in April 2016, emphasizing the policy’s personal and advertising injury provisions, which included coverage for slander, libel, and disparagement.

El Group argued that Clegg’s allegations of false statements about product design and order backlogs constituted covered disparagement. Utica maintained its denial, asserting that Clegg’s counterclaim did not contain claims that could be construed as disparagement, slander, or libel.

First Appeals Court Decision (2022):

This impasse led El Group to file a lawsuit against Utica in 2018, alleging breach of contract, breach of the duty of good faith and fair dealing, and unfair claim settlement practices. El Group sought reimbursement of over $750,000 in legal fees incurred in defending against Clegg’s counterclaim.

The case first reached the Appeals Court after the Superior Court granted summary judgment in favor of Utica. In a decision issued on January 6, 2022, the Appeals Court reversed the lower court’s ruling.

The court held that while Clegg’s counterclaim did not explicitly state a claim for slander or libel, the allegations were “reasonably susceptible of an interpretation that states or roughly sketches a claim” for defamation.

The Appeals Court found Clegg’s allegations about El Group’s false statements “impugn[ed] the professional reputation of Frank Clegg as a designer and manufacturer.” In the court’s view, these allegations were sufficient to raise the possibility of a ‘personal and advertising injury’ as defined by the policies.

The Appeals Court vacated the judgment and remanded the case to the Superior Court. The court directed the lower court to address Utica’s alternative arguments that it had no duty to defend because the alleged conduct predated the policy period and was subject to various exclusions.

The Superior Court’s Second Decision

Following the first Appeals Court decision, the Superior Court revisited the case, focusing on the policy exclusions raised by Utica, including exclusions for knowing violation of the rights of another, material published with knowledge of its falsity, material published before the policy incepted, infringement of copyright, patent, trademark or trade secret, and unauthorized use of another’s name or product.

The Superior Court judge rehearing El Group’s coverage claims ruled that these exclusions applied, barring coverage for El Group’s claim. El Group appealed for a second time.

The Appeals Court’s decision affirming no coverage for El Group

The Appeals Court approached this second appeal with a de novo review, examining the case anew without deference to the lower court’s decision. The court emphasized its focus on the duty to defend, recognizing that it is broader than the duty to indemnify.

The court reiterated that an insurer’s duty to defend is triggered when the allegations in a complaint are “reasonably susceptible of an interpretation that states or roughly sketches a claim covered by the policy terms.” However, the court also emphasized that “when the allegations in the underlying complaint lie expressly outside the policy coverage and its purpose, the insurer is relieved of the duty to investigate or defend the claimant.”

Analysis of the “knowing violation of the rights of another” policy exclusion

The Appeals Court centered its analysis on a single exclusion barring coverage for a “knowing violation of the rights of another.”

This exclusion barred coverage for any personal and advertising injury “caused by or at the direction of the insured with the knowledge that the act would violate the rights of another and would inflict ‘personal and advertising injury.’”

The court interpreted this exclusion as applying only to the intentional and knowing infliction of injury, not to injury resulting from reckless or negligent behavior.

In examining Clegg’s counterclaims, however, the court found that the counterclaims alleged intentional and knowing infliction of injury. Clegg’s counterclaim asserted that El Group sought to damage his reputation as part of a plan to steal his designs and divert business from him to themselves.

Court’s rejection of El Group’s counterarguments

El Group argued that they had denied any intentional misconduct in their replies to Clegg’s counterclaim, but the court dismissed this argument.

The court stated that an insured’s denial of underlying allegations has no bearing on whether a duty to defend exists, as coverage turns on the nature of the assertions alleged in the complaint or counterclaim, not their truth.

El Group also contended that, at most, the allegations of intentional injury named only Joseph Lotuff, a co-plaintiff, and therefore, Utica still had a duty to defend the other plaintiffs. The court rejected this argument, noting that Clegg’s counterclaim alleged that all the plaintiffs had conspired to commit intentional wrongdoing.

Duty to defend barred by a single exclusion

By focusing on a single exclusion, the Appeals Court demonstrated that when one exclusion applies to all potential liability as a matter of law, it is sufficient to negate the insurer’s duty to defend. This approach streamlined the court’s analysis and provided a clear basis for its decision.

No request for further appellate review ends El Group’s case against Utica

El Group had until August 28, 2024, to request further appellate review from the Supreme Judicial Court on the Appeals Court decision affirming Utica Mutual’s denial of coverage.

Absent an application for further appellate review, the Appeals Court decision became final 28 days after August 7, 2024, on September 4, 2024.

On that day, the Appeals Court sent its rescript to the Superior Court, ordering the lower court to dismiss El Group’s lawsuit and enter final judgment for Utica Mutual.

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.