An Insurer’s Guide to Reserving Rights: Tips for Avoiding Waiver and Estoppel
Insurers know all too well that the penalties for an ineffective reservation of rights letter can be severe. It is not unusual for policyholders to contend that an insurer waived coverage defenses or is estopped from asserting that policy provisions bar coverage due to an allegedly defective (or untimely) reservation. Drafting a proper letter can therefore mean the difference between losing potentially valuable rights and successfully disclaiming coverage later. The good news is that there are some effective ways to help avoid the drastic consequences that were visited on insurers in two more recent appellate cases.
In July 2017, the Supreme Court of South Carolina held that an insurer had failed to preserve its rights to contest coverage for multiple multi-million dollar jury verdicts in underlying construction defect cases because its reservation of rights letters provided no discussion or explanation of its reasons for potentially denying coverage. Harleysville Group Ins. Co. v. Heritage Cmtys., Inc., 803 S.E.2d 288, 299 (S.C. 2017). According to the court in Heritage, a reservation of rights letter “must give fair notice to the insured that the insurer intends to assert defenses to coverage….” Id. at 297. The court further explained that “[i]f the insured does not know the grounds on which the insurer may contest coverage, the insured is placed at a disadvantage because it loses the opportunity to investigate and prepare a defense on its own,” and that “for a reservation of rights letter to be effective, [it] must be unambiguous….” Id. at 298; compare Hoover v. Maxum Indem. Co., 730 S.E.2d 413, 417 (Ga. 2012) (“[a] reservation of rights is not valid if it does not fairly inform the insured of the insurer’s position”).
The insurer’s reservation of rights letters in Heritage explained that the insurer would provide a defense in the underlying actions, provided contact information for the defense attorney selected, summarized the allegations of the underlying complaints, and incorporated a lengthy “excerpt of various policy terms” through a “cut-and-paste approach.” Heritage, 803 S.E.2d at 298-99. The letters did not include any discussion of the insurer’s position of the quoted policy provisions, any explanation of its reasons for potentially denying coverage, or the potential need for an allocated verdict in the underlying actions as between uncovered faulty workmanship damages and other potentially covered damages. Id. at 299-300. Consequently, the court concluded that the insurer’s letters were not sufficiently specific to put the insured on notice of the insurer’s potential coverage defenses. Accordingly, because of the insurer’s ineffective reservation of rights, the Court held that the insurer could not contest coverage for all of the actual damages in the underlying actions, including uncovered faulty workmanship damages that were part of the jury’s undifferentiated general verdicts. Id. at 301.
The Missouri Court of Appeals reached a similar conclusion in Advantage Buildings & Exteriors, Inc. v. Mid-Continent Cas. Co., 449 S.W.3d 16 (Mo. Ct. App. 2014). In that case, the court affirmed the insurer’s liability for “bad faith” and further held that the insurer was estopped from denying coverage for an underlying claim to the extent of its policy limits because its reservation of rights letters “did not constitute an effective reservation of rights.” Id. at 22-25. In Advantage Buildings, after the insured tendered an underlying construction defect case to its general liability insurer, the insurer promptly sent a letter informing the insured that it would “investigate the claim and perform a coverage analysis” but reserved the right to disclaim coverage. Id. at 20. In a second letter issued a short while later, the insurer indicated that it would conditionally accept the defense, appointed an attorney, and advised that it would “promptly inform” the insured if “other facts” came to its attention. Id. Nearly two years later, and four days before trial in the underlying action, the insurer sent a third letter informing the insured for the first time that its policy would not cover nearly all of the claims against the insured, whose $3 million potential exposure well exceeded the $1 million policy limit. Id. at 21.
After a bench trial, the court in the underlying action awarded approximately $4.6 million in damages to the plaintiff. Id. In the subsequent coverage action, the court concluded that the policy did not provide coverage for the underlying action. Id. Nevertheless, the court allowed the insured’s counterclaim for “bad faith” failure to settle within policy limits to go to the jury, which awarded $3 million in...
