Based on the PLRB seminar presentation on Reservation of Rights Letters by Veronica M. Bates, Hermes Sargent Bates, LLP and Renee C. Callantine, Chapman Popik & White LLP.
Different rules of law may apply in different jurisdictions. This outline only offers an overview of the law. Always consult the applicable law of the state at issue for definitive guidance.
What is a Reservation of Rights Letter?
Writing effective reservation of rights letters can be the difference between preserving policy defenses or paying on damages the insured never contracted.
As written communication to policyholders, reservation of rights letters set forth a company’s assumption of defense, subject to coverage reservations. Western Casualty & Surety Co. v. Newell Mfg. Reservation of rights letters mainly inform the insured of coverage and policy defenses, thereby preserving the insurer’s right to assert such defenses. In many jurisdictions, the reservation of rights may allow the insurer to withdraw from the defense when there is no potential for coverage under the policy. The ROR letters allow insurers to decline indemnifying the insured for any portion of a judgment not covered under the policy.
RORs or non-waiver agreements should be used when an insurer identifies either coverage defenses or policy defenses.
A coverage defense is one by which the liability insurer asserts that a given claim is or may not be covered by its policy. Continental Ins. Co. v. Bayless & Roberts, Inc.; Johansen v. California State Auto Ass’n Inter-Insurance Bureau.
A policy defense is one by which the liability insurer admits coverage of the claim but asserts that the policy is not enforceable due to the breach of a policy condition by the insured. Continental Ins. Co. v. Bayless & Roberts, Inc., A. Windt, Insurance Claims & Disputes. An example would be a breach of a policy condition such as late notice or voluntary payments.
Right to Reimbursement for Defense Fees
The reservation of rights letter may provide the insurer with the right to seek reimbursement for defense costs it pays if it later establishes that those costs were incurred in defending non-covered claims, although whether such a provision is enforceable varies from jurisdiction to jurisdiction. 1
In many jurisdictions, a reservation of rights to recoup defense costs is only enforceable if it is later determined that there was no duty to defend; courts in those jurisdictions will not allow apportionment of defense costs between covered and non-covered claims. United Nat. Ins. Co. v. SST Fitness Corp.
Right to Reimbursement of Amounts Paid to Settle
Likewise, in some states an insurer that settles an action against its insured may be entitled to reimbursement of that portion of the settlement payment that is attributable to noncovered claims. Blue Ridge Ins. Co. v. Jacobsen; Nobel Ins. Co. v. Austin Powder Co. To be entitled to reimbursement of settlement payments, the insurer must specifically reserve its right to do so. And while the insured’s agreement to reimbursement – and to the settlement – is generally not required, the insurer will need to establish that the amount paid to settle the noncovered claims was reasonable. Blue Ridge Ins. Co. In some jurisdictions, the insurer is required to notify the insured before entering into a settlement and allow the insured to assume its own defense if it is opposed to settlement. Medical Malpractice Joint Underwriting of Mass. v. Goldberg.
Differences in a Non-Waiver Agreement
A reservation of rights letter is generally a unilateral letter from the insurer to the insured. By contrast, the term “non-waiver agreement” is sometimes used to refer to a bilateral agreement (signed by both parties) between the insurer and the insured that the insurer’s defense of the action against the insured will not result in a waiver of any rights by the insurer to later assert some defense to coverage. Western Casualty & Surety Co. v. Newell Mfg. Co. Other insurers use the term “non-waiver agreement” when referring to a letter sent to the insured immediately after the claim is tendered but before the insurer assumes the defense, to advise that any acts taken by the insurer in investigating the claim will not result in a waiver of coverage or policy defenses.
How to Draft an ROR
To fulfill its intended purpose, the reservation of rights letter must contain certain information. Some of the specific information that should be included is listed below. In drafting a reservation of rights letter, specificity, understandability and timeliness should be foremost in your thinking. A well-drafted reservation of rights letter should address the following.
Whenever it becomes evident to the insurer that a coverage defense or policy defense may exist, a reservation of rights must be sent. Timeliness is important, although there is generally no specific deadline for sending a reservation of rights letter. Much depends on the issue of prejudice, discussed in an earlier section. If there is a justifiable reason for a delay in sending a reservation of rights letter, that reason should be documented in the claim file and, perhaps, in the reservation of rights letter itself.
In Collins v. Grange Mut. Cas. Co., the court of appeals held that a sixteen-month period constituted a waiver of a reservation of rights.
In Dietz-Britton v. Smythe, Cramer Co. court held that reservation of rights was untimely and created a waiver where the insurer, instead of taking prompt action to reserve its rights at the time, waited until four weeks before trial, more than two years after notice of the lawsuit, to reserve its rights.
In Hiser v. Rajki, the court determined that nonwaiver agreement and coverage letter untimely when asserted 21 days before trial.
In Meirthew v. Last, the court held that the insurance company’s reservation of rights letter sent several years after action was commenced came too late to avoid presumptive prejudice of both the insured’s and, consequently, the plaintiff’s rights especially considering the lack of loyalty suggested by such delay.
In Turner Liquidating Co. v. St. Paul Surplus Lines Ins. Co., the court held that providing a defense for nearly one year without reserving rights may give rise to a claim of estoppel.
In Board of County Comm’rs v. Guar. Ins. Co., the court held that where the insurer gives timely notice of its disclaimer and the grounds therefore, there is no presumption of prejudice, and the insured must carry its burden of showing reliance to its detriment before estoppel can bar a defense of noncoverage; mere delay in making a disclaimer is not enough.
In Cassey v. Stewart, a reservation of rights letter to insured was timely when sent one year and eight months after lawsuit was filed against insurer.
In City of Grosse Point Park v. Michigan Municipal Liability and Property Pool, a letter sent by the insurer on October 6, 1995, was timely notice to the insured regarding a lawsuit filed on September 14, 1995.
In Delmonte v. State Farm Fire and Cas. Co., there was a two-month span between State Farm’s assumption of the Delmontes’ defense and the issuance of a reservation of rights. The court held that this was not unreasonable and recognized that the insurer may initially assume an unconditional defense while it conducts its own reasonable investigation as to coverage. At the time the Delmontes tendered the defense of the case to State Farm, the litigation had been ongoing from May 1991 until November 1992. A two-month delay therefore was not unreasonable. Moreover, the Delmontes were represented by independent counsel and exercised some control over the defense during that time.
In General Agents Ins. Co. of America, Inc. v. Midwest Sporting Goods Co., a reservation of rights was considered timely three months after the tender of the lawsuit by the insured, but the court denied the insurer’s claims for reimbursement of defense costs on other grounds.
In Lextron, Inc. v. Travelers Cas. & Sur. Co., the insurer’s brief assumption of defense in action against its insured, without notifying insured in writing of its reservation of rights, did not bar, on estoppel grounds, insurer’s later assertion of defense of noncoverage where insured did not prove prejudice from the assumption of defense because insurer notified insured of intention to withdraw approximately two months after assuming defense and less than four months after underlying litigation commenced.
In Paradigm Ins. Co. v. Texas Richmond Corp., the court held that issuing a reservation of rights letter 15 days after the answer was due was timely.
In Peters v. State Farm Fire and Cas. Co., the court held that State Farm, which learned of the claim in January 1992 and issued reservation of rights letters in February, concluded its investigation and timely disclaimed coverage based on the policy exclusion on April 9, 1992.
In Pennsylvania National Mutual Cas. Ins. Co. v. Kitty Hawk Airways, Inc., the insurer defended for over a year before issuing a reservation of rights. The court held that this was timely, but only after determining that the insurer had defended the insured for over two years under the reservation of rights before going to trial.
In Travelers Casualty and Surety Company v. Ribi Immunochem Research, Inc., the court held that Travelers timely reserved its right to recoup defense costs after the insured was sued in 1993 when Travelers notified the insured of the reservation prior to payment of defense costs in letters dated February 10, 1994, January 25, 1996 and again on March 1, 1999.
In Village of Waterford v. Reliance Insurance Company, the court held that reservation of rights letter sent three months after notice of lawsuit given by the insured was timely.
Identify Policy and Purpose of Letter
The reservation of rights letter should identify the policy under which the defense – and the reservation – is provided. The policy should be identified by policy number and type. This will aid in avoiding confusion where the insured has multiple policies. The letter should also include the date of loss and claim number, again to avoid confusion. Near the beginning of the letter, the insurer should state that the purpose of the correspondence is to reserve the insurer’s rights. This statement should be made in plain language, using the familiar phrase “reservation of rights” so there can be no argument that the insured did not understand the purpose of the letter.
Summarize Pleadings and Facts
The reservation of rights letter should contain a summation of the complaint and other pleadings that are pertinent to the coverage or policy defense as well as facts relied upon from sources outside the pleadings if you are in a jurisdiction where extrinsic evidence may be considered in determining whether the insurer has a duty to defend.
The reservation of rights should quote verbatim the specific policy provisions relied upon. The letter should not quote policy provisions that are clearly not implicated, but if there is some basis to believe that a policy provision may apply, the letter should quote the provision and state that it may also apply to preclude or limit coverage. Cowan v. Insurance Company of North America, reservation of right letter insufficient unless it makes specific reference to the policy defense(s) that may ultimately be asserted. When quoting a policy exclusion, any exception or qualification to that exclusion should also be quoted, unless clearly inapplicable.
Identify Coverage and Policy Defenses Reserved
A general reservation of rights letter that does not adequately specify the coverage defenses may be inadequate. Weber v. Biddle, Meirthew v. Last, (insurer’s reservation of right to rely upon “any defense” it might have under the policy was legally insufficient), Bogle v. Conway, (reservation letter that did not mention any exclusions or the purported factual basis of potential coverage defenses was insufficient), Dale Osburn, Inc. v. Auto Owners Ins. Co., (unpublished opinion) (agreement to defend “under a full Reservation of Rights pending any factual information that may show that [specific coverage defense applied] and/or that other policy exclusions apply” was insufficient because it left the insured “in the dark as to the nature of the policy defense or defenses that the insurer had in mind”).
The reservation of rights must adequately inform the insured of the rights the insurer intends to reserve so that the insured can intelligently choose between retaining his/her own counsel or accepting the tender of defense counsel from the insurer. Popovich v. Gonzales, The letter should mention that the insurer reserves its right to withdraw from the defense if it later determines there is no coverage.
The letter should also specifically note whether the insurer is reserving its right to seek reimbursement of defense costs expended in defending claims that are not covered. This will make clear that the insurer is not denying coverage by virtue of the letter and will help defeat any argument by the insured to the contrary. Cay Divers, Inc. v. Raven, (an insured sought to preclude an insurer from asserting a breach by the insured as a bar to the insurer’s duty to indemnify by claiming that a reservation of right to contest coverage constituted a denial of coverage).
The drafting should be in a form comprehensible to the insured and should be free from ambiguities. Richards Mfg. v. Great American Ins. Co., (the insurer’s conclusion regarding the existence or non-existence of certain coverage defenses must be “clearly and fairly communicated to the insured”), Farmers Texas Casualty Mut. Ins. Co. v. Wilkinson, (insurer created ambiguity rendering its reservation of rights unenforceable where it sent out two letters on the same day, the first advising that it would provide an unqualified defense to the insured and the second a reservation of rights), Western Casualty & Surety Co. v. Newell Mfg. Co., (no right to deny indemnity of settlement where insurer reserved right to withdrawal from defense and raised only late notice issue), Knowx-Tenn Rental Co. v. Home Ins. Co., (reservation of rights letter sent to corporate insured was not sufficient to reserve rights as to individually named employee of insured where letter made no reference to the employee).
The letter should include an offer to the insured to review any additional information that they may be aware of, and should include a phrase that will “catch all” other defenses that could become pertinent. This will allow further supplementation of the reservation of rights letter.
The reservation of rights should request the continued cooperation of the policyholder, especially if any further facts come to light or if new or amended pleadings are served on the policyholder. This will allow the insurer to continue to reevaluate coverage.
Insured’s Right to Own Counsel
The reservation of rights letter should set forth the policyholder’s right to retain personal counsel at the policyholder’s own expense. McGuire v. Texas Farmers Ins. Co., (failure of a non-waiver agreement to advise the insured of his right to employ his own counsel rendered the non-waiver agreement invalid), Aetna Casualty & Sur. Co. v. Dimino, (reservation of rights letter instructing the policyholder “not to discuss the matter with anyone other than a representative of the [insurance company] or the [law firm designated by the insurer]” foreclosed the insured from obtaining his own counsel and thereafter estopped the insurer from disclaiming coverage).
Insurer’s Right to File Declaratory Relief Action
It is a good idea to inform the insured of the possibility that the insurer may file a declaratory relief action. This puts the insured on notice that it may be faced with a second action to determine coverage and allows the insured to appropriately assess its risks.
Insurer’s Right to Assert Other Policy Defenses
Although an insurer generally doesn’t waive coverage defenses of which it is unaware, it is always a good idea to reserve the right to assert other defenses as they become known. The insured may be aware of a coverage or policy defense that is not asserted and this will alert the insured that such a defense is not waived simply because the insurer is not yet aware of it.
Insurer’s Right to Reimbursement
In jurisdictions where an insurer is entitled to seek reimbursement of defense costs or indemnity/settlement payments, the insurer must specifically reserve its right to do so or reimbursement will generally be precluded. Blue Ridge Ins. Co. v. Jacobsen.
Conflict Triggering Right to Independent Counsel
Some states, such as California, have statutory provisions, mandating that if and when a potential conflict of interest arises between the insured and the insurer, the insurer must inform the insured of its right to independent counsel and must provide independent counsel to the insured, unless the insured expressly waives, in writing, its right to independent counsel, California Civil Code 2860 (a). In these states, the insurer should advise the insured of its right to independent counsel if the reservation of rights gives rise to a conflict of interest between the insurer and the insured. Popovich v. Gonzales, (no right to rely on coverage defense where insured was not advised that reservation created a conflict of interest).
What Not to Include
Do not include extraneous information that is not relevant to the reservation of rights. Set forth only those facts and policy provisions that are germane to the reservation of rights to avoid “burying” the coverage defenses in the letter.
Never advise an insured to refrain from seeking advice from counsel.
The insurer should generally refrain from expressly waiving a policy or coverage defense, unless there is a tactical reason for doing so. One such tactical reason for waiving a defense is to avoid a conflict of interest that will trigger an insured’s right to independent counsel in states where applicable.
Who to Send it To
The reservation of rights letter should be sent by certified mail, return receipt requested, to the insured’s address set forth on the policy. If you are aware of any address change, send it to the new address as well. If there is more than one insured, send each insured a separate copy of the reservation of rights letter. Only copy those parties who absolutely must be informed of the coverage defenses (i.e., the insured’s personal counsel). Do not copy the plaintiff’s attorney or the attorney retained by the insurer to defend the insured. In fact, advising the defense counsel of the coverage issues may create the appearance of a conflict of interest. Blind copy coverage counsel.
Who Should Author
The reservation of rights letter should be on insurance company letterhead and should be signed by a representative of the company. The person who signs the reservation of rights letter may be deposed in any litigation between the parties. For that reason, the person who signs the letter should be familiar with the claim and coverage issues at the time he/she signs the letter. This will help protect the insurer from a claim of bad faith. Many insurers prefer that reservation of rights letters go out under the signature of a management-level employee. To avoid potential argument of waiver of the attorney-client privilege, reservation of rights letters should not be signed by coverage counsel.
Failure to Provide ROR or Deficient ROR – Waiver/Estoppel
An insurer generally does not have a duty to reserve its rights on coverage and policy defenses of which it is not aware, but a reservation of rights letter should be sent as soon as the insurance carrier becomes aware of a coverage or policy defense. There is generally no specific time by which an insurer must provide a reservation of rights letter to the insured. But an insurer runs the risk of waiving, or being estopped from asserting, its coverage and policy defenses if its reservation of rights letter is untimely.2
It is the general rule in most states that the doctrines of waiver and estoppel cannot be used to create insurance coverage where none exists under the terms of the policy. Many states recognize an exception to this rule, however, where an insurer conducts an insured’s defense without timely reserving its right to deny coverage. In this situation, the insurer cannot later disclaim coverage based on a policy defense. “If an insurer assumes an insured’s defense without declaring a reservation of rights or obtaining a non-waiver agreement, and with knowledge of facts indicating non-coverage, all policy defenses, including those of non-coverage, are waived, or the insurer may be estopped from raising them.” Farmers Texas County Mut. Ins. Co. v. Wilkinson, Stone & Webster Engr. Corp. v. American Motorist Ins. Co., Miller. v. Elite Ins. Co., Gibraltar Ins. Co. v. Varkalis, DiMarzo v. American Mut. Ins. Co., Cigarette Racing Team, Inc. v. Parliament Ins. Co.
Most jurisdictions require that the insured demonstrate prejudice, or detrimental reliance, in order to defeat a reservation of rights. Doe for Doe v. Allstate Ins. Co., Commercial Union Ins. Co. v. International Flavors & Fragrances, Inc., Northwestern Nat’l Ins. Co. v. Corley, Pacific Indem. Co. v. Acel. Delivery Serv., Inc., Whitney v. Continental Ins. Co., Miller v. Elite Ins. Co., Gulf Ins. Co. v. State.
In some jurisdictions, an insurer’s delay in or failure to promptly reserve its rights gives rise to a presumption of prejudice to the insured. Pendleton v. Pan Am. Fire & Cas. Co., Knox-Tenn Rental Co. v. Home Ins. Co., (no notice of reservation until judgment rendered against insured), American Home Assur. Co. v. Ozburn-Hessey Storage Co., National Union Fire Ins. Co. v. Aetna Cas. & Sur. Co., (insurer that made no attempt to reserve rights prior to judgment has burden of demonstrating that insured was not prejudiced). In others, there is no presumption of prejudice. Federal Ins. Co. v. Susquehanna Broadcasting Co., Board of County Comm’rs v. Guar. Ins. Co., (no presumption where insurer disclaims coverage or withdraws from defense before trial or settlement).
Factors for Determining Waiver/Estoppel
In determining whether the insured has detrimentally relied on the absence of a reservation of rights by the insurer, courts look at many factors, including:
Length of Time Before Tender
Delmonte v. State Farm Fire and Cas. Co., (two-month period between insurer’s assumption of defense and issuance of a reservation of rights letter did not give rise to waiver of coverage defenses where the insured did not tender defense until approximately 18 months after being sued; insured was represented by counsel and exercised some control over case).
Length of Time Between Tender and Reservation
Dietz-Britton v. Smythe, Cramer Co., (delay of more than two years after acquiring knowledge of coverage defenses), Meirthew v. Last, (reservation of rights letter sent several years after action was commenced gave rise to estoppel defense where insurer knew about coverage defenses during this time).
In City of Grosse Point Park v. Michigan Municipal Liability and Property Pool, (no estoppel where insurer notified insured of specific reservation of rights at time the defense was assumed).
With Reservation vs. Without Reservation
Turner Liquidating Co. v. St. Paul Surplus Lines Ins. Co., (providing a defense for nearly one year without reserving rights may give rise to a claim of estoppel where, in reliance on defense, insured does not conduct its own investigation of claim, control its defense or attempt settlement), Pennsylvania National Mutual Cas. Ins. Co. v. Kitty Hawk Airways, Inc., (although insurer defended insured for over one year before issuing a reservation of rights, there was no estoppel where insurer defended insured for over two years – and through trial – under the reservation of rights before refusing to indemnify judgment; appointed counsel had no opportunity to manipulate case to support coverage defense), Long Island Ins. Co. v. Graziano, (insurer waived right to rely on late notice defense where it defended for nine months before issuing a reservation of rights and an additional seven months before filing a declaratory relief action).
Stage of Litigation When Insurer Issues Reservation
Lextron, Inc. v. Travelers Cas. & Sur. Co., (no prejudice where insurer accepted defense without reservation of rights two months after action commenced and withdrew two months later), Paradigm Ins. Co. v. Texas Richmond Corp., (no detrimental reliance where reservation of rights letter sent 15 days after answer was due, Dietz-Britton v. Smythe, Cramer Co., (insurer waived coverage defenses by waiting until four weeks before trial, and more than two years after notice of the lawsuit, to reserve its rights), Hiser v. Rajki, (nonwaiver agreement and coverage letter provided 22 days before trial was untimely). Where there is a claim against the insured but a lawsuit has not been filed, it will be more difficult for the insured to show prejudice from the delay or failure to provide a reservation of rights.
Insurer’s Diligence Giving Rise to Coverage and Policy Defenses
Village of Waterford v. Reliance Insurance Company, (reservation of rights letter sent only a few days before trial was timely where insurer who had been monitoring litigation did not receive information regarding coverage defense until that time; insured was represented by independent counsel). Thus it would seem that the nature of the coverage or policy defense and the investigation necessary to discover them would factor into the waiver/estoppel analysis, as would the fact of whether the insurer hired coverage counsel if necessary to assist with a complicated coverage analysis.
Whether Insured Represented by Counsel
Delmonte v. State Farm Fire and Cas. Co., (insured’s who were represented by personal counsel while insurer investigated coverage were not prejudiced by two month delay in issuing reservation of rights).
Whether Insured Exercised Control Over Defense
Young Men’s Christian Ass’n of Metropolitan Fort Worth v. Commercial Standard Ins. Co., Commercial Standard Ins. Co. v. Young Men’s Christian Assoc. of Metropolitan Fort Worth (estoppel applied where insurer defended for four years under general reservation of rights but did not notify insured of specific reservation based on late notice until summary judgment reversed by state supreme court and case remanded), Textile Mach., Inc. v. Continental Ins. Co., (estoppel applied where insured defended without reservation of rights for two and a half years before tendering defense back to insured and insured surrendered control of case, even though insured had no complaints about appointed counsel and was offered the chance to participate in the defense), Knox-Tenn. Rental Co. v. Home Ins. Co., (conclusive presumption of prejudice where insurer exerted complete control of defense through trial and entry of judgment), Am. Cas. Co. v. Shely, (loss of opportunity to engage separate counsel and manage defense was prejudicial regardless of effect on outcome of litigation), Delmonte v. State Farm Fire and Cas. Co., (insured’s exercise of some control over the defense while the carrier was investigating coverage supported finding that insurer did not waive coverage defenses), Collins v. Grange Mut. Cas. (waiver found where there was a sixteen-month period between insurer’s assumption of defense and reservation of rights and insurer knew facts giving rise to coverage defenses during this time, insurer assumed control of the defense and insured relinquished control believing there was coverage). Under this factor, the court may also consider whether the insured lost the opportunity to resolve the claim or suit.
Other Issues Arising From an ROR
Conflicts of Interest
A reservation of rights letter may create a potential conflict of interest between the insurer and insured, depending upon the nature of the reservation. For example, when the complaint against the insured alleges that property damage or bodily injury was both negligently and intentionally caused, an insurer may reserve its rights to deny coverage for any intentionally-caused damage or injury. This creates a potential conflict of interest because the insurer-retained defense counsel may be able to control the insured’s defense in such a way as to affect the outcome of the coverage issue.
When a reservation of rights creates a potential conflict of interest, insurers in many states are required to notify the insured of the potential conflict and offer to provide the insured with independent counsel, paid for by the insurer. California Civil Code 2860; San Deigo Navy Fed. Credit Union v. Cumis Ins. Society, Inc., Am. Family Life Assurance Co. of Columbus, Ga v. U.S. Fire Ins. Co., Union Ins. Co. v. Knife Co., Inc., Moeller v. Am. Guarantee and Liability Ins. Co., N. County Mut. Ins. Co. v. Davalos, Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Co. of So. Carolina, Popovich v. Gonzales, (no right to rely on coverage defense where insured was not advised that reservation created a conflict of interest). The insured is not obligated to accept the offer of independent counsel. In many states, the insured is entitled to select the independent counsel, but in some states the insurer retains this right. Cent. Mich. Bd. Of Trustees v. Employees Reins. Corp., (insurer retains right to select counsel).
Not every reservation of rights creates a potential conflict of interest. The key question is whether counsel retained by the insured has the ability to manipulate the outcome of the issues upon which coverage depends. For instance, in states that do not permit insurance coverage for punitive damages, the mere existence of a punitive damage claim does not create a conflict of interest. This is because the interests of both the insurer and the insured are aligned: both want to minimize any award against the insured.
Filing a Declaratory Judgment Action
A dispute between the insurer and insured over coverage or the duty to defend may be resolved in a separate declaratory judgment action. Problems may arise, however, where the resolution of the coverage issue involves a determination of issues that are disputed in the underlying action against the insured – for instance, whether the insured intentionally harmed the third party plaintiff. Additionally, an insured – especially one with limited financial means – may be prejudiced by having to defend two lawsuits simultaneously. Where such a conflict or prejudice exists, the court may stay the declaratory judgment action pending the resolution of the underlying third party action. Montrose Chem. Corp. v. Sup. Ct., Western Nat’l Assur. Co. v. Hecker.
What to do when Insured Rejects
In many jurisdictions, the insurer’s unilateral reservation of rights is enforceable. Home Indem. Co. v. Reed Equip. Co., Employers Reinsurance Corp. v. Martin, Gordon & Jones, Inc., Buss v. Superior Court, Johnson v. Westhoff Sand Co., Inc., Texas Assoc. of Counties v. Matagorda County, Ins. Co. of No. Am. v. Travelers Ins. Co., Assoc. Indem. Co. v. Wachsmit.
In other states, however, the insurer must obtain the agreement of the insured to the reservation of rights. Richmond v. Ga. Farm Bureau Mut. Ins. Co., Jefferson Ins. Co. v. Travelers Ins. Co., Diamond Service Co., Inc. v. Utica Mut. Ins. Co., Hawkeye Cas. Co. v. Stoker, Bogle v. Conway, Sauer v. Home Indem. Co., Battista v. Western World Ins. Co., Mundry v. Great Am. Ins. Co., Medical Protective Co. v. Davis, Crawford v. Ranger Ins. Co., Continental Ins. Co. v. City of Miami Beach, (Florida Stat. interpreted to prevent liability insurer from denying coverage unless insurer obtained insured’s approval to independent counsel retained by the insurer to defend the insured).
Where the insured’s consent is required, it will usually be deemed granted if the insured tacitly acquiesces through silence, failure to object or accepting money or the defense after being notified of the reservations. Pacific Indem. Co. v. Acel Delivery Serv., Inc., Duke v. Hoch, State Farm Mut. Auto Ins. Co. v. Lucas, Salonen v. Paanenen, Merchants Indem. Corp. v. Eggleston, Allstate Ins. Co. v. Manger, Jewtraw v. Hartford Acc. & Indem. Co., Brugnoli v. United Nat’l Ins. Co., Colony Ins. Co. v. G & E Tires & Service, Inc. “A party cannot accept tendered performance while unilaterally altering the terms in which it is offered … [the insured's] acceptance of the defense … manifests acceptance of [its] terms,” Knapp v. Commonwealth Land Title Ins. Co., Inc., “[the insured's] silence in response to [the insurer's] reservation of rights letter, and subsequent acceptance of the defense … constitutes an implied agreement to the reservation of rights”).
If consent to the reservation of rights is required – but rejected – by the insured, the insurer is then faced with the following options:
Offer an unqualified defense
This is a business decision the insurer may choose to make after weighing the likelihood of success in litigating the coverage issues, the possibility of extracontractual damages, and the likelihood of a successful resolution of the underlying litigation. An unqualified offer to defend generally results in a waiver by the insurer of all policy and coverage defenses, but the insurer will have control of the defense, including control of settlement. This helps prevent against collusion between the insured and claimants.
Continue to defend
If the insurer continues to defend after the rejection of an offer of a defense subject to a reservation of rights, the insurer will be found to have waived all coverage defenses. Pacific Indem. Co. v Acel Delivery Serv., Inc., Schmidt v. National Auto & Cas. Ins. Co., Weaver Metal & Roofing Co. v Continental Ins. Co.
Withdraw from defense
If the insurer decides to stand by its offer to defend subject to a reservation of rights, the insurer must immediately withdraw from the defense after the insured’s rejection to avoid waiver of its coverage defenses. This is the best – and only – option to preserve an insurer’s coverage defenses. In a case where there are both covered and non-covered claims, most jurisdictions hold that the withdrawal allows the insurer to apportion any judgment in the underlying case so it is only required to pay for the covered claims. Rhodes v. Chicago Ins. Co., Sentex Sys. v. Hartford Acc. & Indem. Co., (although insurer wrongfully refused to defend, it was not liable for that portion of the defense costs incurred solely because of the non-covered claims), Morgan, Lewis & Bockius LLP v. Hanover Ins. Co., (“It would be patently unreasonable to expect an insurer to protect its insured against liabilities for which the insured did not bargain. Any conclusion to the contrary would lead to a windfall for the insured”), Budd Co v. Travelers Indem. Co., Enron Corp. v. Lawyers Title Ins. Co., Insurance Co. of N. Am. v. Forty-Eight Insulations, Inc., Emons Indus. v. Liberty Mut. Fire Ins. Co. Riley Stoker Corp. v. Fidelity & Guar. Ins. Underwriters, Inc., Shoshone First Bank v. Pacific Employers Ins. Co., Lockwood Intern., B.V. v. Volm Bag Co., Inc.
Offer an independent defense
The final option is to offer to defend the insured under a reservation of rights letter but provide the insured independent counsel who will not be controlled by the insurance company, similar to the California concept of independent Cumis counsel. San Diego Navy Fed. Credit Union v. Cumis Ins. Soc’y, Inc. This eliminates the potential conflict of interest presented when the insured controls the defense while reserving coverage defenses that may be manipulated by the defense of the action. Illinois Mun. League Risk Mgmt. Ass’n, Ploen v. Aetna Cas. & Sur. Co., Steel Erection Co. v. Travelers Indem. Co., Nationwide Mut. Fire Ins. Co. v. Beville.
The most important thing to do when offering to defend under a reservation of rights is to remember what the letter is accomplishing for you: the letter is preserving your right to assert coverage defenses and, possibly, seek reimbursement. Thus it is important to do what you say you will do in the letter, and to follow up with all promises, actions, etc. If new pleadings are filed against the insured, always analyze whether the current reservation of rights letter adequately addresses the new allegations. If not, then you must issue a supplemental reservation of rights letter or else risk waiving that policy defense. Likewise, in states in which evidence extrinsic to the complaint may be considered, regularly monitor the information provided by counsel and if new information gives rise to additional policy or coverage defenses, supplement your reservation of rights letter accordingly.
1. This type of reservation of rights has been upheld in California, Florida, Colorado, the federal district courts of Colorado, Louisiana, and Minnesota, and the U.S. Court of Appeal for the Fifth, Sixth and Ninth Circuits. Buss v. Superior Court, 939 P.2d 766 (Calif. 1997); Colony Ins. Co. v. G. & E. Tires & Service, Inc., 777 So.2d 1034 (Fla. App. 2000) (applying Colorado law); Hecia Mining Co. v. New Hampshire Ins. Co., 811 P.2d 1083, 1089 (Colo. 1991); First Federal Sav. and Loan Ass’n of Fargo, N.D. v. Transamerica Title Ins. Co., 793 F. Supp. 265, 269 (D. Col. 1992), aff’d, 19 F.3d 528 (10th Cir. 1994); Resure, Inc. v. Chemical Distributors, Inc., 927 F. Supp. 190 (M.D. La. 1996) (applying New Mexico law); St. Paul Fire and Marine Ins. Co. v. Compaq Computer Corp., 377 F. Supp. 2d 719 (D. Minn. 2005) (applying Texas law); Forum Ins. Co. v. County of Nye, Nev., 26 F.3d 130 (9th Cir. 1994) (unpublished disposition); United Nat. Ins. Co. v. SST Fitness Corp., 309 F.3d 914 (6th Cir. 2002) (Ohio law); T.H.E. Ins. Co. v. Larsen Intermodal Services, Inc., 242 F.3d 667 (5th Cir. 2001). The reason for allowing an insurer to seek reimbursement of the cost associated with defending non-covered claims is that the insurer is required to defend both covered and non-covered claims but does not receive a premium for defense of the non-covered claims.
Courts in Hawaii, Illinois, Wyoming and the U.S. Court of Appeals for the Third Circuit have refused to enforce a reservation of rights for reimbursement of defense costs. First Ins. Co. of Hawaii, Inc. v. State by Minami, 66 Haw. 413, 665 P.2d 648, 654 (Hawaii 1983); General Agents Ins. Co. of America, Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Illinois 2005); Shoshone First Bank v. Pacific Employers Ins. Co., 2 P.3d510, 516 (Wyo. 2000) (reimbursement not permitted where at least one of the claims alleged is covered); Terra Nova Ins. Co. Ltd. v. 900 Bar, Inc., 887 F.2d 1213 (3rd Cir. 1989). The reason behind this rule is that the insurer should not be permitted to unilaterally amend the policy, especially when the insured may be unschooled in the issues. Also reservation on this issue places insured in position of making Hobson choice between accepting conditions on defense or losing right to defense.
2. Waiver is generally defined as the intentional relinquishment of a known right. It requires only that the insurer know of its coverage/policy defense and intend to waive it, and the intent element may be inferred by the circumstances. Estoppel, on the other hand, requires words or conduct on the part of the insurer intended to induce reliance on behalf of the insured; the insurer must know the true state of the facts and the insured must not; the insured must rely on the insurer’s words or conduct to his/her detriment. In reality, an insurer generally does not intend to waive its rights. Moreover, almost all jurisdictions require that an insured show detrimental reliance to defeat an untimely reservation of rights. Thus, although the terms waiver and estoppel are often used interchangeably in this context, the rule is generally one of estoppel. Waller v. Truck Ins. Exch., 11 Cal.4th 1, 33-34, 900 P.2d 619, 637, 44 Cal. Rptr.2d 370, 388 (1995).