Reservation of Rights: Recent Developments and Best Practices:

Timothy Crawley, Anderson Crawley & Burke, pllcMississippi Your House Counsel ® Member Firm

Johan W. Vorster, Claims Counsel, Hallmark Financial Services, Inc.Valerie Eitzman, Claims Manager, Effective Claims Management, Inc.

Mike Carnahan, Carnahan Thomas, llpDallas/Fort Worth Your House Counsel® Member Firm

Other Your House Counsel ® Member Firms From Around The U.S.

Reservation of Rights

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I. NoticeII. ContentIII. Waiver/EstoppelIV. Reimbursement in Reservation of Rights ContextV. Declaratory JudgmentVI. Conflicts of InterestVII. Cumis CounselVIII. What Is The Trend?

I. Notice

Generally, a carrier must notify insured of its intent to defend pursuant to reservation of rights “promptly,” “within a reasonable time.” On the eve of trial, or years after receipt of loss, has been held too late and may result in the carrier being estopped from denying coverage. (MI)

• In some states, it may do so by merely mailing a notice to the insured.• If the insured then accepts the carrier’s defense, it will may be held to have accepted the

terms of the RoR (CA), or its express agreement may be required (NJ).• Consent of the insured may or may not (PA) be necessary.

• In most jurisdictions, carriers must notify insured either of its coverage position or that it will require more time within a set time (30-40 days) after receipt of proof of loss. (AL, CA)

• In most surveyed jurisdictions, a carrier’s failure to provide a reasonable explanation of coverage/denial within a reasonable time constitutes or may constitute an unfair or improper claim settlement practice.

II. Content

• The letter should state:• That the carrier is reserving its rights to deny coverage at a later date• The basis for the reservation under the policy• Facts upon which a potential denial of coverage would be based

• The purpose is to put the insured on notice of a future disclaimer of coverage. (CO)

• And to preserve the carrier’s defenses for later.• Language should be clear and specific. • A proper letter will include the insured’s right to seek independent

counsel, if applicable in that jurisdiction.• Illinois in particular is emphatic about this, and failure to include notice of

the right may invalidate the reservation.

III. Waiver/Estoppel

• Failure to reserve rights at all may automatically constitute a waiver of coverage defense.

• This may require that the insured have been prejudiced by the lack of reservation.

• Failure to include a particular defense to coverage in the reservation of rights letter does not constitute a waiver of that defense (CA, CO)

• However, if a carrier knows of grounds for a particular defense, and fails to disclaim coverage, it may be held to have waived that defense (CA, CT, MN, NY)

• It is generally agreed that waiver or estoppel cannot expand coverage beyond policy limits. (CO, MN)

• Waiver may be express or implied from facts and/or actions (CT)• Estoppel exists only if the insured can show he has been prejudiced (FL)

IV. Reimbursement in Reservation of Rights Context

• In some jurisdictions, carriers have a duty to defend insured on all claims, covered and uncovered, and may seek reimbursement of defense costs (CA, FL)

• In this case, the burden of proof will be on the carrier to show the claim was not covered (CA)

• In other jurisdictions, the carrier has a duty to defend any claim that might possibly fall within the coverage of the policy. (OH)

• Generally, carriers may seek reimbursement for settlements if later determine some claims were not covered. (CA) This may require an agreement to this effect, in the insurance policy or otherwise. (WA)

• If carrier fails to defend, may be required to reimburse the insured for the costs of maintaining its own defense.

V. Declaratory judgment• Rather than reserving its rights, the carrier may seek a declaratory

judgment determining the extent of coverage prior to resolving the underlying claim.

• In some jurisdictions this is advised (MN)

• In some jurisdictions this is discouraged, because it is seen to make the carrier and insured adversaries. (RI)

VI. Conflicts of Interest

Many of the surveyed jurisdictions hold that the insured is the only client of the counsel, even if that counsel was retained by the insurance carrier. (CO)• The Tri-Partite relationship could be a presentation unto itself

VII. Cumis Counsel - Origins

a.Origins—the California Cumis Case b.San Diego Navy Federal Credit Union v. Cumis Insurance Society,

Inc. [162 Cal. App. 3d 358, 361, 208 Cal. Rptr. 494 (1984)]• Insurance carrier undertook the defense of its insured, retained a firm, and

notified the attorneys of that firm and the insureds themselves that the insurance company was reserving its rights to disclaim coverage with respect to possible punitive awards.

• Insureds then retained independent counsel.

VII. Cumis Counsel – Cumis Holding• The court held that when an insurer reserves its right to assert non-coverage at

a later date, a conflict of interest is created between the insurer and the insured. In this situation, “the insured has a right to independent counsel paid for by the insurer” and a right to control his defense, if he so chose. 162 Cal. App. 3d 358, 361, 208 Cal. Rptr. 494 (1984) (emphasis added).

• If representation by insurer-selected counsel begins and a conflict of interest is subsequently discovered, the insurer’s counsel must cease to represent the insured unless the insured gives informed consent to the continued representation.

VII.Cumis Counsel - California Civil Code § 2860

• California Civil Code § 2860 (modified the Cumis decision) [summarized]

• When an insurer has a duty to defend under a policy, and conflict of interest arises such that the insured requires independent counsel to represent its interests, the insurer must provide such counsel unless the insured “expressly waives [the right to independent counsel] in writing.”

• Outright denial of coverage does not create a conflict of interest; “however, when an insurer reserves its rights on a given issue, [the outcome of which] can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist.” (emphasis added) Allegations of punitive damages or suits in excess of policy coverage do not, alone, constitute a conflict of interest.

• The insurer has the right to require that the insurer-selected independent counsel meet certain qualifications of competency and experience. The fees to be paid may be limited to the fees that the insurer usually pays similar counsel for similar litigation in the same location.

VII. Cumis Counsel – How and Why• Most jurisdictions agree that a reservation of rights letter creates, at minimum, a

possible conflict of interest between carrier and insured, because their interests come into conflict.

• For example, most commonly, a complaint alleges that the insured “negligently and/or intentionally” caused harm to the plaintiff.

• The insured would like to be found negligent, because then the claim would be covered by the policy.

• The carrier’s interests would be better served if the insured were found to have acted intentionally, because then the claim would not be covered by the policy, and it would not have to pay.

• Or, if the two parties had conflicting defense strategies. (OK)• (Both would be served by the insured being absolved of liability entirely, but for

most jurisdictions this does not obviate the conflict.)• The resultant conflict of interest implicates ethical questions for legal counsel:

can one counsel represent both parties?

VII. Cumis Counsel – How Insurers Handle

• Almost all carriers provide their own counsel at the outset of a claim.

• When a reservation of rights is tendered, most carriers notify the insured of the potential conflict of interest and advise the insured to seek independent counsel.

• Much case law states that the triggering event gives the insured the ability to have independent counsel—he must elect to use it and/or can waive it.

• However, some carriers will proactively retain independent counsel when a potential conflict of interest arises, to prevent issue.

VII.Cumis Counsel - Major Points of Variation

• Use of Cumis counsel at all.

• A few jurisdictions maintain that since the insured is the counsel’s only client, not the carrier, the counsel is bound by the code of ethics to serve the interests of the insured only. In a way, no true conflict of interest exists. (MI, NC, PA).

• Legislative activity – only California has a comprehensive statute mandating Cumis counsel.

• Florida has a “Claims Administration” statute requiring “mutually agreeable counsel” if the insured rejects the carrier’s defense pursuant to a reservation of rights.

VII. Cumis Counsel – Trigger For Ind. Counsel

• In some jurisdictions, a reservation of rights letter is an automatic and sufficient conflict of interest. (MI)

• In more jurisdictions, it is evidence of a potential conflict of interest, and the actual conflict of interest must be proved by greater evidence. (For example, “actions which demonstrate a greater concern for the [insurer’s] interests than the [insured’s] interests.” MN, MO, NY, OH, “disqualifying interest” TX)

• A split exists in the New York Departments regarding whether insurers have an affirmative obligation to notify the insured of their right to independent counsel.

• In Alabama, a potential conflict of interest triggers an “enhanced obligation of good faith” of the carrier to the insured, which gives the insured the right to select independent counsel, to be paid by insurer (AL)

VII. Cumis Counsel – Who Controls Selection

• Entering a reservation of rights has been held to eliminate the carrier’s right to control the litigation. (MA)

• some jurisdictions specify that, when independent counsel is appropriate or required, the insured selects the independent counsel (CA, NY?, OH)

• Some say the parties both have a say. (FL requires that the counsel be “mutually agreeable.” Or, for example, the insured may select counsel, to be approved by the carrier. WA?)

• The Second Circuit recently held that the insured could not reject carrier-selected counsel merely because it did not think the proposed firm was too small to handle the its case. (NY)

VII. Cumis Counsel – Cost

• How is the cost of independent counsel treated?

• It may be paid by the carrier upfront (CA)

• It may be paid by the insured, to be indemnified by the carrier (many jurisdictions)

• The costs may be limited to “reasonable” fees (MA, NJ)

VIII. What Is The Trend?

More protective to rights of insured More emphasis on notice of the right to independent counsel Reimbursement of attorneys fees for independent counsel Earlier involvement of coverage counsel Discuss…