Source: http://dutytodefend.com/reservation-of-rights/
Timestamp: 2019-04-22 08:38:30+00:00

Document:
A reservation of rights by a liability insurance company warns its policyholder that it does not waive the right to later deny coverage for a plaintiff’s liability dispute by paying to defend it.
Insurance regulations require that an adequate reservation of rights must be the product of a thorough investigation, disclose all then known bases to later challenge coverage, be in writing, and be timely. A reservation of rights does not require the policyholder’s consent, but the insurer must respond to the policyholder’s inquiry.
There are two primary purposes of a reservation of rights: 1) the insurer avoids a legal waiver of the right to later deny coverage; and 2) the policyholder may protect oneself from the insurer.
Insurers tend to assert reservations of rights in “mixed” actions with multiple claims, some of which may or may not be covered, such as business litigation, construction defect cases, professional malpractice claims, and any other civil lawsuit whose result could benefit the insurer at the policyholder’s expense, or vice versa.
A reservation of rights creates a complex labyrinth of conflicts of interest among the insurer, its dependent counsel, the policyholder, and even the plaintiff. If the existence of coverage is “related” to any disputed issues of fact or law in the liability dispute, a reservation of rights creates a coverage contest, resolution of which overlays resolution of the liability dispute. If the coverage contest is related to the liability dispute, the policyholder may control the defense of a liability dispute at the insurer’s expense because the insurer may not prejudice the policyholder’s defense of the liability dispute in its efforts to win the coverage contest. Significantly, by faithfully fulfilling its duty to defend its policyholder while reserving its rights to later deny all coverage, the insurer may control settlement of the liability dispute.
A reservation of rights may challenge the interests of a plaintiff who may depend upon perfecting insurance coverage to fund a settlement or judgment, prompting the plaintiff to cooperate with the policyholder to resolve the coverage contest, to plead into coverage properly, and to testify into coverage truthfully.
A liability insurance company’s reservation of rights constitutes its conditional denial of two related claims: 1) a claim by an injured plaintiff to the insurer that the policyholder is legally liable to pay damages to the plaintiff; and 2) a claim by the policyholder to the insurer that the insurer is bound to defend and indemnify the policyholder in the plaintiff’s lawsuit.
There are two primary and immediate consequences of an insurer’s assertion of a reservation of rights: 1) the insurer preserves its right to prove that it never had any duty to defend and separately had no duty to indemnify its policyholder nor any duty to settle with the plaintiff; and 2) the policyholder may trump the insurer’s contractual right to control the policyholders defense if a disqualifying conflict of interest exists. Among American jurisdictions nationwide, there are three incompatible tests for what constitutes a “disqualifying” conflict of interest: 1) two thirds of jurisdictions apply a “per se” test that all reservations of rights require a liability insurer to yield control of the defense to the policyholder because an insurer that denies coverage lacks the incentive to fund a vigorous defense and ethically conflicted dependent counsel cannot adhere to canons of ethics; 2) California and other jurisdictions modify the “per se” rule that the policyholder may control the defense unless the insurer’s reservation of rights is limited to subject matters that have “nothing to do with” the plaintiff’s liability dispute, such as non-payment of premium; and 3) a few states allow the insurer to control the defense if the insurer and dependent counsel adhere to “enhanced duties” of disclosure and good faith and the policyholder fails to prove the existence of an actual conflict of interest.
There are two primary purposes of a reservation of rights: 1) the insurer may resist claims that it is estopped from asserting, has waived, and has forfeited coverage defenses; and 2) the policyholder and the plaintiff are forewarned to protect their interests from a reserving insurer.
A reservation of rights triples the scope of controversy among the participants in civil litigation.
When a plaintiff sues a defendant in a civil lawsuit, they engage in a liability dispute. The judicial process of resolving a liability dispute will establish whether the defendant has legal liability to the plaintiff and if so, how much the defendant must pay to the plaintiff in damages. The liability dispute focuses upon the defendant’s wrongful conduct and is generally governed by tort law.
When the defendant has liability insurance and the insurer issues a reservation of rights, the insurer and the policyholder also engage in a separate, but often related coverage contest. The process of resolving a coverage contest will determine whether the insurer has legal liability to the policyholder and if so, how much the insurer must pay to or on behalf of the policyholder in damages. The coverage contest focuses upon the provision of a policy as they relate to the facts of the liability dispute and is generally governed by contract law.
An insurer’s reservation of rights to later deny coverage to its policyholder always creates some conflicts of interest between the insurer and the policyholder, each of whom wants the other to pay for the liability dispute. If a reserving insurer hires a single lawyer to defend both the interests of the insurer and to defend the policyholder as a party to the liability dispute, the reservation of rights creates an ethical imbroglio for dependent counsel. The ethical imbroglio focuses upon the factual and legal issues that divide them and is generally governed by Canons of Ethics. Specifically, RPC Rule 3-310 prohibits a lawyer from representing dual clients with potentially conflicting interests, unless the lawyer analyzes the potential conflicts, makes written disclosure to and obtains informed written consent from both the policyholder and the insurer.
Insurance regulations require an insurer to reserve its rights to later deny coverage immediately, but not later than 40 days. However, despite these regulations, California courts have permitted insurers to assert reservations of rights at virtually any time.
Three legal principles may limit a liability insurer’s ability to later challenge coverage: Forfeiture (that by itself alone has never been applied to a coverage contest), Estoppel (that requires an insurer’s misleading statement and the policyholder’s detrimental reliance), and Waiver that is the insurer’s voluntary relinquishment of a known right.
Reservations of rights letters often identify a few specific grounds to later deny coverage, broadly deny coverage on all possible grounds, and occasionally limit the scope of a reservation with a limited express waiver. Infrequently, a liability insurer may reserve the right to seek reimbursement of defense cost and settlement costs, however the insurer must satisfy prescribed requirements to perfect each of these reservations.
“Conflict of interest between jointly represented clients occurs whenever their common lawyer’s representation of the one is rendered less effective by reason of his representation of the other.” “A disqualifying conflict exists if [i]nsurance counsel had [an] incentive to attach liability to [the insured].” If a disqualifying conflict of interest exists, that “the insurer must pay the reasonable cost for hiring independent counsel by the insured. The insurer may not compel the insured to surrender control of the litigation.” The insurer’s coverage dispute cannot be allowed to prejudice the policyholder. In the absence of express waivers by the insurer, a reservation of rights is unlimited as a matter of law.
When a liability insurer creates a coverage contest by reserving its rights to later deny coverage, there are as many as ten procedural options available to resolve the controversy.
The following coverage issues may be promptly resolved while the liability dispute is still pending: denial of all coverage, control of the defense, dependent counsel’s compliance with Rule 3-310, the insurer’s obligation to pay for independent counsel, how much the insurer must pay to independent counsel, how often the insurer must pay independent counsel, and other declaratory relief relating to the insurer’s ongoing failure to discharge its duty to defend.
 Civ. Code § 2778(1) (ellipsis omitted).
 Gray v. Zurich Ins. Co. (1966) 65 Cal.2d 263, 275 (emphasis added, ellipsis omitted).
 J. C. Penney Casualty Ins. Co. v. M. K. (1991) 52 Cal.3d 1009, 1018 (emphasis added).
 Ins. Code § 790.03(h)(3) (ellipsis omitted); Duty to Investigate.
 Cal. Code Regs. § 2695.5(e)(3) (ellipsis omitted).
 Cal. Code Regs. § 2695.7(d).
 See, There Is No Deadline to Deny Coverage.
 Cal. Code Regs. § 2695.7(b).
 Buss v. Superior Court (1997) 16 Cal.4th 35, 61, fn.27 (Buss) (citation omitted).
 Val’s Painting & Drywall, Inc. v. Allstate Ins. Co. (1975) 53 Cal.App.3d 576, 586.
 Id. at 586; Silence May Concede Full Coverage; Acquiescence Is Dangerous.
 Truck Ins. Exchange v. Superior Court (1996) 51 Cal.App.4th 985, 997-98.
 Buss, supra, 16 Cal.4th at 61 fn. 27.
 Buss, supra, 16 Cal.4th at 47.
 San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 375 (Cumis) (emphasis added).
 Assurance Co. of America v. Haven (1995) 32 Cal.App.4th 78, 84 (ellipses omitted).
 Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 880-81 (citations omitted).
 Cumis, supra, 162 Cal.App.3d at 375 (citations omitted).
 Gafcon, Inc. v. Ponsor & Associates (2002) 98 Cal.App.4th 1388, 1421.
 James 3 Corp. v. Truck Ins. Exchange (2001) 91 Cal.App.4th 1093, 1101; Dynamic Concepts, Inc. v. Truck Ins. Exchange (1998) 61 Cal.App.4th 999, 1006 (“[N]ot every reservation of rights entitles an insured to select Cumis counsel.”).
 Montrose I, supra, 6 Cal.4th at 306.
 State Farm v. Superior Court (1989) 216 Cal.App.3d 1222, 1231, fn. 3.
 Montrose I, supra, 6 Cal.4th at 302.
 Montrose II, supra, 25 Cal.App.4th at 909. “[T]he question before us is whether the coverage questions are logically unrelated (that is, irrelevant) to the issues of consequence in the (third party litigation which might) prejudice [the insured] in the underlying actions”.
 Novak v. Low, Ball & Lynch (1999) 77 Cal.App.4th 278, 282.
 Montrose I, supra, 6 Cal.4th 287 at 305 (citations and ellipses omitted).
 Montrose II, supra, 25 Cal.App.4th at 909-911 (citations and ellipses omitted).
 See, How Often Must an Insurer Pay Independent Counsel?
 Gafcon, supra, 98 Cal.App.4th at 1407.
 Pruyn v. Agricultural Ins. Co. (1995) 36 Cal.App.4th 500, 509.

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