The insurer who provides a defense to an insured under a liability policy has certain rights to control the defense afforded under the policy. For the insurer, the right to control the litigation carries with it certain duties, including the duty not to prejudice the insured’s liability defenses and provide clarification regarding the coverage of damages. Thus, when claims are not covered under a policy and the insurer issues a reservation of rights, the reservation of rights letter must be timely issued and provide sufficient details for the potential denial of coverage to protect the insurer from incurring defense costs for uncovered claims and protect the insured from having a false sense of security regarding the provided defense.
More and more, courts are rejecting boilerplate, kitchen sink reservation of rights letters as failing to provide proper notice to insureds of the basis for the potential denial of coverage. To be effective, a reservation of rights letter must explain to the policyholder why a particular provision of the policy, as applied to the facts of the case, could result in the denial of coverage. To do so, the letter should quote the relevant policy language that is to be the basis of a possible future denial of coverage.
When preparing such letters, it is important to keep in mind: (1) Time is of the essence. A reservation of rights must be sent immediately when it becomes evident to the insurer that a coverage defense or policy defense may exist. The longer a defense is provided the more likely the policyholder may argue prejudice in a later attempt to withdraw coverage. (2) Be specific. The reservation of rights letter should identify, and quote verbatim, the specific policy provision under which the defense is provided and clarify the provision for which coverage may be excluded. It should also include references to the language of the complaint that support a potential coverage denial. (3) Set requirements for coverage during the pendency of the coverage investigation, such as the cooperation of the insured. (4) Provide notice to the insured of his or her options during the pending litigation and the rights available to the insurer. It is a good idea to inform the insured of the possibility that the insurer may file a declaratory relief action. Also, the insured has a right to obtain separate counsel to defend the asserted claims that potentially are not covered by the policy.
Prompt notice and a clear explanation of the reservations as to coverage is the most effective method to provide transparency, fairness and to prevent an improper party from being stuck with the bill.
About the Author Dawn Pettigrew is a senior associate at Mabry & McClelland, LLP. She has successfully represented clients before state, superior and federal courts in construction and civil litigation matters.
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