Scottsdale Insurance Company v. Byrne

UNITED STATES DISTRICT COURT

DISTRICT OF MASSACHUSETTS

__________________________________________

)

SCOTTSDALE INSURANCE COMPANY, ) Civil Action No.

) 16-11435-FDS

Plaintiff and )

Counter-Defendant, )

)

v. )

)

TIMOTHY BYRNE and )

ROBERT BOLTON, )

)

Defendants and )

Counter-Claimants. )

__________________________________________)

MEMORANDUM AND ORDER ON

CROSS-MOTIONS FOR SUMMARY JUDGMENT

SAYLOR, J.

This is an insurance coverage dispute, essentially involving whether an insurer was

obligated to defend an investment fund accused of mismanagement and self-dealing.

Wellesley Advisors Funds was, apparently, an investment advisor. It purchased a

Business and Management Indemnity Policy from plaintiff Scottsdale Insurance Company.

Defendants Timothy Byrne and Robert Bolton are co-chairs of the Board of Trustees for the

Plumbers and Pipefitters Local 51 Pension and Annuity Funds (the “Pension Funds”).

The Pension Funds invested in WARF Realty Fund I, LLC (“WARF”), an investment

fund of Wellesley Advisors. WARF mismanaged the investments and engaged in self-dealing,

precipitating a law suit alleging negligence and an ERISA violation. Scottsdale declined to

defend WARF, citing various coverage exclusions. WARF subsequently went into receivership

and did not defend the suit; the court eventually entered a default judgment against it for

approximately $5 million.

The Pension Funds then requested that Scottsdale pay the judgment (at least up to the

coverage limit) pursuant to the insurance policy it had issued to Wellesley Advisors, which

Scottsdale declined to do. Scottsdale now seeks a declaratory judgment stating that it had no

duty to defend or indemnify WARF, and the Pension Funds have counterclaimed for the amount

of the default judgment. The parties have cross-moved for summary judgment.

The dispute principally concerns three exclusions under the policy, which govern the

scope of Scottsdale’s duties. For the following reasons, the Court finds that coverage was not

clearly excluded, and Scottsdale had a duty to defend. Accordingly, plaintiff’s motion for

summary judgment will be denied, and defendants’ motion for partial summary judgment will be

granted.

I. Background

The following facts are as set forth in the record and appear to be undisputed.

A. Factual Background

Wellesley Advisors Funds was, apparently, an investment adviser located in

Massachusetts. Wellesley Advisors created a real-estate investment fund called Wellesley

Advisors Realty Fund I, LLC (“WARF”), which was organized as a limited liability company.

(Kessler Aff. Ex. A ¶ 11).

On June 7, 2005, the Board of Trustees of the Pension Funds approved a $5 million

investment in WARF. (Id. ¶ 13). WARF used the funds to invest in real property in

Massachusetts and Rhode Island. (Id. ¶ 14). One such investment was “Stone House,” a hotel

resort property in Little Compton, Rhode Island. (Id. ¶ 15).1 WARF improperly collected the

hotel’s revenues as management fees and failed to make necessary mortgage payments on the

property. (Id. ¶ 20). In February 2014, the successor-in-interest to the bank holding the

mortgage filed suit in the Rhode Island Superior Court to recover $5.6 million in damages. (Id.).

It appears that WARF had also failed to make tax payments on various property investments.

(Id. ¶ 22). Because of WARF’s mismanagement, Realty Fund I failed, and the Pension Funds

lost the entirety of their $5 million investment. (Id.).

In 2013, Scottsdale Insurance Company had issued a Business and Management

Indemnity Policy to Wellesley Advisors Funds. (Zartman Aff. Ex. A at 1). The policy was

effective from November 15, 2013, to November 15, 2014, and had a coverage limit of $3

million. (Id.).2 On November 6, 2014, the parties entered into Endorsement No. 26, which

extended the policy’s effective period one month to December 15, 2014. (Id. at 50).

The policy provided coverage for certain losses that Wellesley Advisors or other

“Insureds” were obligated to pay.3 Under the section titled “Management Insureds and

Company Coverage,” subsection (F), titled “Settlement and Defense,” states as follows:

It shall be the duty of the Insurer and not the duty of the Insureds to defend any

Claim. Such duty shall exist even if any of the allegations are groundless, false or

fraudulent. The insurer’s duty to defend any Claim shall cease when the Limits of

Liability have been exhausted by the payment of Loss including Costs, Charges,

and Expenses.

(Id. at 18). The term “Claim” is defined in subsection B(1)(b) as encompassing “[a] civil

1 Other investments included a residential condominium project in Newport, Rhode Island, called the

“Eastbourne Lodge,” (Kessler Aff. Ex. A ¶ 18), and a housing development in North Attleborough, Massachusetts.

(Id. ¶ 19).

2 Wellesley Advisors paid a premium of $64,937 for the policy. (Zartman Aff. Ex. A at 1).

3 It does not appear to be disputed that WARF is an insured under the policy, although it was purchased in

the name of Wellesley Advisors.

proceeding against any Insured seeking monetary damages or nonmonetary or injunctive relief,

commenced by the service of a complaint or similar pleading. (Id. at 10). The term “Loss” is

defined in subsection (B)(8) as including “damages, judgments, settlements, pre-judgment or

post-judgment interest awarded by a court, and Costs, Charges and Expenses incurred by

[WARF or other Insureds] . . . .” (Id. at 11).

Subsection (C)(1), titled “Exclusions Applicable to All Insuring Clauses,” states that

Scottsdale shall not be liable for losses attributable to various causes. (Id. at 13). As relevant

here, there are three potentially applicable exclusions.

The first is the “ERISA Exclusion.” Subsection (C)(1)(d) provides that Scottsdale shall

not be responsible for covering losses attributable to:

[A]ny actual or alleged violation of the responsibilities, obligations or duties

imposed by [the] Employee Retirement Income Security Act of 1974, as

amended, or any rules or regulations promulgated thereunder, or similar

provisions of any federal, state or local statutory or common law.

(Id. at 14).

The second is the “Intentional Conduct Exclusion.” Subsection (C)(1)(f) provides

that Scottsdale shall not be responsible for covering losses attributable to:

[A]ny dishonest, deliberately fraudulent or criminal act of an Insured; provided,

however this exclusion [ ] shall not apply unless and until there is a final

judgment against such Insured as to such conduct; or

[T]he gaining of any profit, remuneration or financial advantage to which any

Management Insureds were not legally entitled; provided, however this exclusion

[ ] shall not apply unless and until there is a final judgment against such

Management Insureds as to such conduct.

(Id.).

The third exclusion, as identified in Endorsement No. 21, is “the rendering or failure to

render Professional Services” (the “Professional Services Exception”). (Id. at 43). The phrase

“Professional Services” is defined as:

[S]ervices as a real estate broker or agent, multiple listing agent, real estate

appraiser, title agent, title abstractor or searcher, escrow agent, real estate

developer, real estate consultant, property manager, real estate inspector, or

construction manager. Such services shall include, without limitation, the

purchase, sale, rental leasing or valuation of real property; the arrangement of

financing on real property; or any advice proffered by an Insured in connection

with any of the foregoing.

(Id.).

B. Procedural Background

On November 10, 2014, Byrne and Bolton, as trustees of the Pension Funds, filed a

complaint against WARF in this court for negligence and violation of ERISA (the “underlying

complaint”). The case was assigned to Judge Talwani. See Byrne v. Wellesley Advisors Realty

Fund I, LLC, No. 14-cv-14124-IT. Two days later, on November 12, 2014, Byrne and Bolton

wrote a letter to Scottsdale notifying it of the pending suit. (Defs. Ex. D). WARF also notified

Scottsdale of the suit on November 14, 2014. (Defs. Ex. E). It appears that at some point over

the next three weeks, Scottsdale orally informed WARF that it would not defend the suit.

On December 1, 2014, the Plymouth Superior Court entered an order appointing a

receiver for WARF. (Kessler Aff. Ex. B). The next day, WARF wrote a letter to Scottsdale

asserting that the claims brought against it were “not excluded” from its policy coverage and that

Scottsdale “owe[d] WARF a duty to defend and to indemnify for any loss.” (Defs. Ex. F). In

particular, WARF denied that ERISA was applicable because it was “not a fiduciary of the

pension fund.” (Id.). Scottsdale replied on December 30, 2014, reiterating its previous statement

that it would not defend the suit. (Defs. Ex. G).

On February 4, 2015, WARF’s court-appointed receiver filed a motion to stay the action.

(Kessler Aff. Ex. C). Judge Talwani granted the stay, which was lifted on July 29, 2015. (Byrne

v. Wellesley Advisors Realty Fund I, LLC, No. 14-cv-14124-IT, Docket Nos. 13, 19).

The receiver ultimately opted not to defend the lawsuit. (Kessler Aff. Ex. E). On

October 15, 2015, Byrne and Bolton moved for default judgment. Judge Talwani granted default

judgment and reasonable costs and attorney’s fees on November 25, 2015, and entered a total

judgment of $5,005,422.12 against WARF.

On January 14, 2016, Byrne and Bolton served a demand notice on Scottsdale, requesting

that it pay the entirety of the coverage amount (again, the coverage limit is $3 million). (Defs.

Ex. I). Scottsdale denied that request on February 10, 2016. (Defs. Ex. J). Byrne and Bolton

reiterated their demand on March 1, 2016, and Scottsdale affirmed its denial on March 14, 2016.

(Defs. Exs. K, L).

On May 15, 2016, WARF assigned any right, title, and interest in claims it held against

Scottsdale Insurance to Byrne and Bolton. (Defs. Ex. M).

Scottsdale filed this action for a declaratory judgment on July 8, 2016. Byrne and Bolton

filed a counterclaim alleging breach of contract, breach of the implied covenant of good faith and

fair dealing, and violation of the Massachusetts consumer-protection statute, Mass. Gen. Laws

ch. 93A.

The parties have cross-moved for summary judgment. Scottsdale seeks summary

judgment on all claims and counterclaims, and Byrne and Bolton seek summary judgment on

counts 1 and 2 of their counterclaims, which allege breach of contract for Scottsdale’s failure to

defend WARF and failure to pay the claim, respectively.

II. Legal Standard

The role of summary judgment is to “pierce the pleadings and to assess the proof in order

to see whether there is a genuine need for trial.” Mesnick v. General Elec. Co., 950 F.2d 816,

822 (1st Cir. 1991) (quoting Garside v. Osco Drug, Inc., 895 F.2d 46, 50 (1st Cir. 1990)).

Summary judgment is appropriate when the moving party shows that “there is no genuine

dispute as to any material fact and the movant is entitled to judgment as a matter of law.” Fed.

R. Civ. P. 56(a). A genuine issue is “one that must be decided at trial because the evidence,

viewed in the light most flattering to the nonmovant, would permit a rational fact finder to

resolve the issue in favor of either party.” Medina-Munoz v. R.J. Reynolds Tobacco Co., 896

F.2d 5, 8 (1st Cir. 1990) (citation omitted). In evaluating a summary judgment motion, the court

indulges all reasonable inferences in favor of the nonmoving party. See O'Connor v. Steeves,

994 F.2d 905, 907 (1st Cir. 1993). When “a properly supported motion for summary judgment is

made, the adverse party must set forth specific facts showing that there is a genuine issue for

trial.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 250 (1986) (quotations omitted). The

nonmoving party may not simply “rest upon mere allegation or denials of his pleading,” but

instead must “present affirmative evidence.” Id. at 256-57.

III. Analysis

A. General Insurance Policy Construction

In Massachusetts, the interpretation of an insurance contract is generally a question of

law. Home Ins. Co. v. Liberty Mut. Fire Ins. Co., 444 Mass. 599, 601 (2005). Courts are to

“construe the words of the policy according to the fair meaning of the language used, as applied

to the subject matter.” Jacobs v. U.S. Fid. & Guar. Co., 417 Mass. 75, 76 (1994) (citation

omitted). “Moreover, where the words of an insurance contract are plain and free from

ambiguity[,] they must be construed in their usual and ordinary sense.” Id. at 77 (internal

quotation marks and citation omitted). However, any ambiguity is resolved in favor of the

insured party. Hazen Paper Co. v. U.S. Fid. & Guar. Co., 407 Mass. 689, 700 (1990).

Generally, an insurance company “owes a duty to defend [the insured] if the allegations

in the underlying lawsuit are reasonably susceptible to an interpretation that they state a claim

covered by [the] policy.” Scottsdale Ins. Co. v. Torres, 561 F.3d 74, 77 (1st Cir. 2009).

“Conversely, there is no duty to defend a claim that is excluded from coverage.” Id. However,

exclusions are to be read narrowly, and an insurance company bears the burden of establishing

that an exclusion applies. Peterborough Oil Co., Inc. v. Great Am. Ins. Co., 397 F. Supp. 2d 230,

237 (D. Mass. 2005).

B. Whether an Exclusion Applied

A duty to defend is triggered when the facts as alleged in the relevant complaint, and as

known or readily knowable by the insurer, “are reasonably susceptible of an interpretation that

states or roughly sketches a claim covered by the policy terms.” Billings v. Commerce Ins. Co.,

458 Mass. 194, 200 (2010). The relevant facts need not “specifically and unequivocally” make

out a claim that falls within the insurance coverage, but need only show “a possibility” that the

liability is within the coverage. Id. at 200-01. “The process is not one of looking at the legal

theory enunciated by the pleader but of envisaging what kinds of losses may be proved as lying

within the range of the allegations of the complaint, and then seeing whether any such loss fits

the expectation of protective insurance reasonably generated by the terms of the policy.” Id. at

201 (citation and internal quotation marks omitted). However, when the relevant allegations “lie

expressly outside of the policy coverage and its purpose, the insurer is relieved of the duty to

investigate or defend the claimant.” Id. (citation and internal quotation marks omitted).

As relevant here, Scottsdale had a duty to defend if the claims against WARF did not fall

within at least one of three exclusions: the ERISA Exclusion, the Intentional Conduct Exclusion,

or the Professional Services Exclusion. Each will be addressed in turn.

1. The ERISA Exclusion

Count 2 of the underlying complaint alleged an ERISA violation. Specifically, it stated

that WARF “engaged in self-dealing” and “breached its fiduciary responsibility [to the Pension

Funds] in violation of ERISA.” (Kessler Aff. Ex. A ¶¶ 29-30). This clearly falls within the

ERISA Exclusion, which releases Scottsdale of any obligation to defend WARF against

any actual or alleged violation of the responsibilities, obligations or duties

imposed by [the] Employee Retirement Income Security Act of 1974, as

amended, or any rules or regulations promulgated thereunder, or similar

provisions of any federal, state or local statutory or common law.

(Zartman Aff. Ex. A at 14).

Scottsdale also contends that the ERISA Exclusion barred coverage for “the entire

complaint filed in the underlying action, not simply count 2.” (Pl. Mem. in Supp. at 11). Count

1 of the underlying complaint asserted a claim of negligence against WARF; however, Scottsdale

contends that because the introductory paragraph to the complaint stated, “[t]his is an action

under [ERISA],” (Kessler Aff. Ex. A ¶ 1) the entirety of the underlying complaint proceeded

“under the umbrella of ERISA” (Pl. Mem. in Supp. at 11). Scottsdale has not offered any case

law in support of that proposition, and in any event, its argument ignores the section of the

introductory paragraph that states the underlying action arose “from [WARF’s] negligence in

failing to properly invest the [Pension] Funds’ money in several real estate investments.”

(Kessler Aff. Ex. A ¶ 1) (emphasis added). Therefore, although the ERISA Exclusion’s plain

language meant that Scottsdale had no duty to defend WARF as to count 2 of the underlying

complaint, the exclusion did not extend to count 1.

2. The Intentional Conduct Exclusion

Next, Scottsdale contends that the Intentional Conduct Exclusion excludes coverage for

WARF’s losses on either the negligence or ERISA claims in the underlying complaint. The

exception states that plaintiff will not provide coverage for:

[A]ny dishonest, deliberately fraudulent or criminal act of an Insured; provided,

however this exclusion [ ] shall not apply unless and until there is a final

judgment against such Insured as to such conduct; or

[T]he gaining of any profit, remuneration or financial advantage to which any

Management Insureds were not legally entitled; provided, however this exclusion

[ ] shall not apply unless and until there is a final judgment against such

Management Insureds as to such conduct.

(Zartman Aff. Ex. A at 14) (emphasis added). Scottsdale reasons that because the underlying

complaint alleged that WARF “engaged in self-dealing by retaining investment income from the

properties for its own use,” it falls within the exclusion. (See Kessler Aff. Ex. A ¶ 26).

However, the text of the Intentional Conduct Exclusion specifies that it does not apply

“unless and until there is a final judgment” against the insured party. (Zartman Aff. Ex. A. at

14). When this exclusion is read in conjunction with the subsection titled “Settlement and

Defense,” it is clear that it would apply only after judgment was entered against the insured to

relieve the insurer of any duty to indemnify. Therefore, this exclusion did not absolve plaintiff

of the duty to defend WARF in the first instance.

3. The Professional Services Exclusion

Finally, Scottsdale contends that the Professional Services Exclusion applies. As noted,

the exclusion stated that plaintiff was not liable for losses relating to any claim “alleging, based

upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in

any way involving the rendering or failure to render Professional Services.” (Zartman Aff. Ex. A

at 43). Again, the phrase “Professional Services” is defined as:

[S]ervices as a real estate broker or agent, multiple listing agent, real estate

appraiser, title agent, title abstractor or searcher, escrow agent, real estate

developer, real estate consultant, property manager, real estate inspector, or

construction manager. Such services shall include, without limitation, the

purchase, sale, rental leasing or valuation of real property; the arrangement of

financing on real property; or any advice proffered by an Insured in connection

with any of the foregoing.

(Id.).

The question is thus whether the negligence claim in the underlying complaint arose out

of WARF’s rendering of such “Professional Services.” Any ambiguity must be construed

against the insurer, so as to narrow the exception and provide coverage. Vappi & Co. v. Aetna

Cas. & Sur. Co., 348 Mass 427, 431 (1965) (“Exclusions from coverage are to be strictly

construed.”). “In determining whether an omission or activity falls within the scope of a

professional services exclusion, courts generally look to the nature of the conduct under

scrutiny.” Camp Dresser & McKee, Inc. v. Home Ins. Co., 30 Mass. App. Ct. 318, 323 (1991).

The negligence claim alleged that (1) WARF “leverage[ed] its real estate portfolio in

excess of the appraised value of the properties”; (2) negligently “fail[ed] to pay real estate taxes

owed”; (3) negligently “manag[ed] the Fund I LLC properties by using income from The Stone

House for its own management fees”; and (4) “engaged in self-dealing by retaining investment

income from the properties for its own use.” (Kessler Aff. Ex. A ¶¶ 23-26). In substance, it was

a claim that WARF mishandled the investment by overborrowing, taking money for its own

purposes, and failing to pay taxes. Such actions appear to go well beyond property management,

as that term is commonly understood. At the very least, it is ambiguous whether in fact all of

WARF’s purported misconduct stemmed from the “arrangement of financing on real property”

and “the services of a property manager,” as plaintiff suggests. (Pl. Mem. in Supp. at 14).4

Thus, on its face, the negligence claim was “reasonably susceptible of an interpretation

4 The negligence claim also encompasses claims that WARF engaged in faulty recordkeeping, made

investment choices that were unsuitable for the Pension Funds, and breached its fiduciary duties.

that states or roughly sketches a claim covered by the policy terms.” Billings, 458 Mass. at 200;

see also GRE Ins. Group v. Metropolitan Boston Housing Partnership, Inc., 61 F.3d 79, 85 (1st

Cir. 1995) (finding that various negligence claims, when liberally construed, fell outside a

professional services exclusion); Jefferson Ins. Co. of New York v. National Union Fire Ins. Co.

of Pittsburgh, 42 Mass. App. Ct. 94, 103 (1997). Accordingly, Scottsdale had a duty to defend

WARF on the negligence claim. In addition, because it had “a duty to defend any of the

underlying counts in the complaint,” it should have defended the entire underlying lawsuit.

Liberty Mutual Ins. Co. v. Metropolitan Life Ins. Co., 260 F.3d 54, 63 (1st Cir. 2001).

In short, Scottsdale owed WARF a duty to defend, and it breached the insurance contract

by refusing to do so. Therefore, Scottsdale’s motion for summary judgment will be denied, and

defendants’ motion for partial summary judgment as to counts 1 and 2 of their counterclaims will

be granted.

Presumably, defendants will be awarded the amount of the coverage limit ($3,000,000),

which is less than the judgment in the underlying lawsuit ($5,005,422.12). See id. (“[[T]he

general rule under Massachusetts law is that if the insurer fails to defend the lawsuit, it is liable

for all defense costs and (assuming policy coverage) the entire resulting judgment or settlement,

unless liability can be allocated among covered and uncovered claims.”).5 The parties shall file

motions concerning the form of judgment within 14 days of this memorandum and order, or by

March 15, 2018.

5 The default judgment award in the underlying lawsuit can be found at Byrne v. Wellesley Advisors Realty

Fund I, LLC, No. 14-cv-14124-IT, Docket No. 27.

IV. Conclusion

For the foregoing reasons, plaintiff’s motion for summary judgment is DENIED, and

defendants’ motion for partial summary judgment is GRANTED. The parties are ordered to file

any motions concerning the form of the judgment no later than March 15, 2018.

So Ordered.

/s/ F. Dennis Saylor

F. Dennis Saylor IV

Dated: March 1, 2018 United States District Judge