Response Options to Insurer Decision: Scope of Reservation of Rights – PP

 

INTRODUCTION

When a liability insurer learns that its policyholder has been sued, it must make a series of decisions, the first of which is Yes, No, or Maybe.[1] The policyholder, the plaintiff and their respective counsel have many options how to respond to each decision the insurer makes. When an insurer decides to reserve its rights to later deny coverage, the policyholder may respond to determine the scope of the reservation, its impact on conflicts of interest and what the policyholder may do about it.

SITUATION

A plaintiff sued a policyholder, who in turn notified a liability insurer, which in turn agreed to defend subject to a reservation of its rights to later deny coverage.[2]

GOAL

Determine the scope of the insurer’s reservation of rights, its impact on conflicts of interest, and the insurer’s obligation to pay for independent counsel.

SUBSTANTIVE LAW

1.   Reservation of Rights

Insurers issue reservations of rights letters in order to avoid waiver[3] of possible coverage defenses. “[T]he insurer’s unconditional defense of an action brought against its insured constitutes a waiver of the terms of the policy and an estoppel of the insurer to assert such grounds.”[4] “The purpose of a reservation of rights is to afford the insured a defense while protecting the rights of the carrier when the duties to defend and indemnify cannot clearly be determined.”[5] “Through reservation, the insurer gives the insured an opportunity to take any steps that it may deem reasonable or necessary in response.”[6]

2.   Disqualifying Conflicts of Interest

“[A]n insurer may provide a defense under a reservation of rights. In some cases, there is a conflict of interest involv[ing] the insured trying to obtain coverage and the insurer trying to avoid it. When this happens, [t]he insurer may be required to provide the insured with independent counsel, who then controls the litigation.”[7] “But not every reservation of rights entitles an insured to select Cumis counsel.”[8] What constitutes a “disqualifying” conflict of interest that triggers an obligation by the insurer to pay for independent counsel has been stated variously by the courts, but the concept described is the same. A disqualifying conflict exists if any factual or legal dispute is unrelated to,[9] irrelevant to,[10] extrinsic to, independent of,[11] or have nothing to do with[12] the third party litigation. The insurer’s coverage dispute cannot be allowed to prejudice the policyholder.[13] In the absence of express waivers by the insurer, a reservation of rights is unlimited as a matter of law.[14]

3.   Duty to Investigate

Insurers must “adopt and implement reasonable standards for the prompt investigation of claims.”[15] “Every insurer shall conduct and diligently pursue a thorough, fair and objective investigation.”[16] “[E]very insurer shall immediately begin any necessary investigation of the claim.”[17] “The insurer may not just focus on those facts which justify denial of the claim. If an insurer unreasonably refuses a claim, it is liable for breach of the covenant of good faith and fair dealing inherent in every insurance policy.”[18] “When investigating a claim, an insurance company has a duty to diligently search for evidence which supports its insured’s claim. If it seeks to discover only the evidence that defeats the claim it holds its own interest above that of its insured.”[19]

4.   Duty to Reserve Rights Promptly

A liability insurer must defend “immediately.” “To defend meaningfully, the insurer must defend immediately. ‘To defend immediately, it must defend entirely.’”[20] “[E]very insurer shall immediately accept or deny the claim, in whole or in part. [It] shall do so in writing and shall provide to the claimant a statement listing all bases for such rejection or denial and the factual and legal bases for each reason given for such rejection or denial which is then within the insurer’s knowledge [and] provide an explanation of the application of the provision, condition or exclusion to the claim [being denied].”[21] Still, some courts have permitted insurers to reserve rights after significant delays.[22]

5.   No Automatic Waiver Rule

The California Supreme Court considered “whether the doctrine of waiver may be invoked to create coverage for losses that the CGL policy by its terms did not cover.”[23] The Court

“conclude[d] that an insurer does not impliedly waive coverage defenses it fails to mention when it denies the claim”[24] where [t]here is no indication that [the insurer] unnecessarily delayed performing its investigative duties.”[25]

METHODOLOGY

Since the insurer has taken steps to protect its interests, the policyholder may decide whether to: 1) yield or resist;[26] 2) cooperate with the plaintiff;[27] 3) support or resist evidence of covered liability;[28] and welcome a policy limit settlement offer.[29]

AMBIGUITY OF SCOPE

“Where an insurer denies a claim, it shall provide to the [policyholder] a statement listing all bases for such rejection or denial and the factual and legal bases for each reason given for such rejection or denial which is then within the insurer’s knowledge [including] an explanation of the application of the provision, condition or exclusion” relied upon.”[30] However, a typical reservation of rights agrees to defend and broadly reserves “all” rights to later deny coverage, which many courts accept as sufficient. For example, where an insurer “undertook defense without specifically reserving any right [but was] largely general in nature and for the purpose of protecting against unknown eventualities which might subsequently arise [the court found that] this reservation created no disqualifying conflict.[31]

A typical reservation of rights is usually silent or ambiguous as to:

1) what investigation, if any, the insurer has conducted;[32]

2) whether the insurer denies that any duty to defend actually exists;[33]

3) whether a “disqualifying” conflict of interest actually exists;[34]

4) whether dependent counsel must comply with Rule 3-310;[35]

5) whether the insurer will pay for independent counsel;[36]

[Watermark1] 6) whether the insurer will timely[37] pay independent counsel at the correct hourly rate;[38] and

7) whether the insurer will solicit a policy limit settlement offer from the plaintiff.[39]

POLICYHOLDER’S PERSPECTIVE

Confusion over the scope of an insurer’s reservation of rights may impact the policyholder in many ways: 1) whether the policyholder must accept representation by dependent counsel;[40] 2) whether the policyholder may hire independent counsel at the insurer’s expense; 3) what response options the policyholder has to a Buss reservation;[41] 4) and to a Blue Ridge reservation;[42] and, 5) the proper scope of an immediate declaratory relief action.[43]

INSURER’S PERSPECTIVE

Confusion over the scope of an insurer’s reservation of rights may impact the insurer as well: 1) whether the insurer may appoint dependent counsel; 2) whether the insurer must pay for independent counsel;[44] 3) if so, how much; 4) and if so, how often; and 5) whether the insurer may invoke the protection of Civil Code §2860;[45]

DEPENDENT COUNSEL’S PERSPECTIVE

Confusion over the scope of an insurer’s reservation of rights may impact dependent counsel: 1) dependent counsel’s ethical obligations to the policyholder;[46] 2) including whether dependent counsel must comply with Rule 3-310;[47] whether dependent counsel may be paid;[48] whether dependent counsel must disgorge fees and costs to the policyholder;[49] whether dependent counsel may be disciplined;[50] and whether dependent counsel faces civil liability for breach of fiduciary duty.[51]

PLAINTIFF’S PERSPECTIVE

The plaintiff may directly influence the scope of a coverage dispute be pleading into or out of coverage.[52]



[1] “[E]very insurer shall immediately accept [Yes] or deny the claim, in whole [No] or in part [Maybe].” (Cd. Reg. §2695.7(b).)

[2] See, Article: Reservation of Rights Changes Traditional Relationships.

[3] See, Article: Estoppel, Waiver, and Forfeiture.

[4] Miller v. Elite Ins. Co. (1980) 100 Cal.App.3d 739, 754; See Article: Silence Usually Concedes Coverage.

[5] Truck Ins. Exchange v. Superior Court (1996) 51 Cal.App.4th 985, 997-98.

[6] Buss v. Superior Court (1997) 16 Cal.4th 35, 61 fn. 27 (ellipsis omitted).

[7] Assurance Co. of America v. Haven (1995) 32 Cal.App.4th 78, 84 (citations and ellipses omitted).

[8] Dynamic Concepts, Inc. v. Truck Ins. Exchange (1998) 61 Cal.App.4th 999, 1006.

[9] See, Montrose I, supra, 6 Cal.4th at 306 (“[C]overage hinges on factual issues that are unrelated to the issues in the third party liability action”.)

[10] See Montrose Chemical Corp. v. Admiral Ins. Co. (1995) 10 Cal.4th 645, 909 (Montrose II) (“Accordingly, the question before us is whether the coverage questions are logically unrelated (that is, irrelevant) to the issues of consequence in the (third party litigation that might) prejudice (the insured) in the underlying actions”.)

[11] See, Gafcon, Inc. v. Ponsor & Associates (2002) 98 Cal.App.4th 1388, 1422. (No prejudice “where the coverage issue is ‘independent of, or extrinsic to, the issues in the underlying action’”.)

[12] See, Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1470 (Long) (“[W]hen the reservation of rights is based on coverage disputes that have nothing to do with the issues being litigated in the underlying action . . . there is no conflict of interest.”)

[13] See, Montrose I, supra, 6 Cal.4th at 301; Montrose II, supra, 25 Cal.App.4th at 909.

[14] Waller, supra, 11 Cal.4th at 31 (“We conclude that an insurer does not impliedly waive coverage defenses it fails to mention.”)

[15] Ins. Code 790.03(h)(3).

[16] Code of Reg. §2695.7(d).

[17] Code of Reg. §2695.5(e)(3).

[18] Mariscal, supra, 42 Cal.App.4th at 1623.

[19] Mariscal, supra, 42 Cal.App.4th at 1619-1620.

[20] Buss v. Superior Court (1997) 16 Cal.4th 35, 48; citing Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 295.

[21] Reg. §2695.7(b) (ellipses omitted).

[22] See, Article: There Is No Deadline to Deny Coverage.

[23] Waller v. Truck Ins. Exchange, Inc. (1995) 11 Cal.4th 1, 31.

[24] Ibid.

[25] Id. at 37.

[26] See, Practice Pointer: Acquiescence Is Dangerous.

[27] See, Practice Pointer: Cooperation: A Strategic Choice.

[28] See, Practice Pointer: Incentives to Confess Covered Liability.

[29] See, Practice Pointer: How to Make a Policy Limit Settlement Offer Properly.

[30] §2695.7(b) (ellipses omitted).

[31] Gulf Ins. Co. v. Berger, Kahn, Shafton, Moss, Figler, Simon & Gladstone (2000) 79 Cal.App.4th 114, 131 (ellipses omitted).

[32] See, Article: Duty to Investigate.

[33] See, Article: Civil Code §2860 – Limited Application.

[34] See, Article: Disqualifying Conflicts of Interest.

[35] See, Article: Dependent Counsel Is Not Exempt from Rule 3-310.

[36] See, Article: Disqualifying Conflicts of Interest.

[37] See, Article: How Often Must an Insurer Pay Independent Counsel?

[38] See, Article: How Much Must an Insurer Pay Independent Counsel?

[39] See, Article: Duty to Advise Settlement.

[40] See, Article: Dependent Counsel Conflicts Arise When the Insurer Reserves Rights.

[41] See, Practice Pointer: Buss Defense Cost Reimbursement – Response Options.

[42] See, Practice Pointer: Blue Ridge Settlement Reimbursement – Response Options.

[43] See, Practice Pointer: Downside of Suing for Declaratory Relief.

[44] See, Article: Disqualifying Conflicts of Interest.

[45] See, Article: Civil Code §2860 – Limited Application.

[46] See, Article: Dependent Counsel Conflicts Arise When the Insurer Reserves Rights.

[47] See, Article: Dependent Counsel Is Not Exempt from Rule 3-310.

[48] “A [lawyer] shall not accept compensation for representing a [policyholder] from [an insurer] unless . . . The [lawyer] obtains the client’s informed written consent.” (Rule 3-310(F).)

[49] See, Article: Buss Defense Cost Reimbursement.

[50] “Corruptly or wilfully and without authority appearing as attorney for a party to an action or proceeding constitutes a cause for disbarment or suspension.” (Bus.&Prof. Cd. §6104.)

[51] See, Article: Duty of Confidentiality.

[52] See, Article: Plead Into Coverage Properly.

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