RESERVATION OF RIGHTS LETTERS: TIPS FOR POLICYHOLDERS

Why Are You Letting An Insurance Company Control Your Legal Defense?

Let me start by stating the obvious. When your company is forced to defend against a claim, whether in arbitration or court, you vigorously defend against it to save your company from liability. You gather together whatever winning documents you have in your possession, including the “smoking gun” email, the signed change order, the executed sworn statement and lien waiver. You take statements from the employees who were involved in the matter to line up as much supporting testimony as possible. You hire a legal team with whom you have complete confidence and trust, who knows your business practices, and understands the construction and development industry inside and out. You then go to battle knowing that you are doing all you can to protect your company.

Why does this strategy change when the claim against you is potentially covered by your insurance policy? Why do you allow the insurance company to take complete control over your defense, select its own attorneys regardless of experience or knowledge of the construction industry, and keep you ill-informed of the day-to-day efforts being taken to protect your company’s name and assets from this claim? The reason you change your strategy is you feel insulated from any potential financial exposure because you expect the insurance company to pay all defense costs, and you expect it to pay any settlement or judgment rendered against your company.

But what if the insurance company undercuts these expectations by telling you it might not pay for the cost of legal defense or the judgment/settlement? Or that it may require you to reimburse the insurance company for any legal defense costs, judgments or settlements that it pays on your behalf? Would you be less likely to allow the insurance company to use its automobile accident defense attorneys to defend you against highly technical construction or design defect claims? Would you be less likely to allow the insurance company to unilaterally decide your defense strategies?

Of course you would not give the insurance company control of your defense if it was telling you it might not cover the claims against you. Unfortunately, what many in the construction and development industry are not aware of is that insurance companies are frequently telling insureds they might not cover a claim, yet the insureds continue to let their insurance companies control their defense.

What Is A Reservation of Rights Letter?

A reservation of rights letter is a non-committal communication from the insurance company to the insured in which the insurance company states it may or may not be required to pay for the defense of the claim and any settlement or judgment.

While not as lengthy and convoluted as the insurance policy itself, the reservation of rights letter is not a page turner like a New York Times best seller either. This letter is several pages long, includes excerpts from your policy, and is prepared by your insurance carrier. Typically, your insurance company will mail and/or email this letter to you within thirty days of receipt of the claim.

In the letter, which typically is not entitled “reservation of rights”, the insurance company acknowledges receipt of the claim and discusses its limited investigation to date. It will then include several sentences demonstrating its non-committal position. For example (from an actual reservation of rights letter):

“We have reviewed the allegations in the pleadings, and have determined that our company may not provide coverage for the lawsuit based upon the terms and conditions of the policy/policies and Illinois’ law which govern the interpretation of such policies. Until such time as our investigation is complete and the coverage issues resolved, we will participate in the defense of the lawsuit under a complete reservation of rights.” (emphasis added).

What the insurance company is saying is that it is not sure it has to pay your defense costs or pay any settlement or judgment against you. It is reserving its right to dispute paying anything on your behalf should its ongoing investigation reveal that any of its numerous policy exclusions or exceptions apply.

The letter will then discuss each of the potentially applicable policy exclusions and exceptions. After it outlines all of these possible excuses to coverage, the letter will include a full reservation of all rights similar to the following:

“The insurance company fully reserves its rights under its policy/policies, and nothing stated in this letter is intended as a waiver of any other portion of the policy/policies that may be found to apply upon further review or investigation of the incident that allegedly caused damages.”

Will The Insurance Company Still Pay A Judgment Or Settlement Against My Company?

Even though you have paid substantial insurance premiums for liability coverage, there are several exclusions or exceptions in your policy which “excuse” the insurance carrier from paying any judgment or settlement. Some exclusions include: no damage to property other than the work performed; no occurrence; contractual liability exclusion; late notice; occurrence did not take place during policy period, and the list goes on. If any of the numerous exceptions or exclusions apply, you are left bare, with no insurance coverage for the claim or lawsuit and must pay for the same on your own.

When you receive one of these reservation of rights letters, it means your insurance company is telling you it might not protect you as you thought it would. In other words, it has not decided yet whether to cover the claim or not. It will continue to investigate whether any exclusions or exceptions apply.

Will The Insurance Carrier Still Pay For an Attorney To Defend My Company?

Typically, even when a reservation of rights letter has been issued, the insurance company will hire an attorney to defend you against the claim . . . at least for the time being. An attorney from the insurance company’s “panel of attorneys” will be selected. These are attorneys who have special arrangements with the insurance company to handle all different types of lawsuits on the insurance company’s behalf. They may handle automobile accidents, slip and falls, or medical malpractice claims on behalf of the insurance company one day, and your construction/design case the next. They typically do not focus their practice solely on the construction and development industry.

The insurance company will pay for this attorney to defend you unless and until the insurance company’s investigation reveals that one of the insurance policy exceptions or exclusions apply. When that occurs, the insurance company will no longer defend you from the claims in the lawsuit because the claims are not covered by insurance and they may seek reimbursement from you for any legal fees and costs that they have paid their panel counsel to date. Typically the reservation letter will express this concept with language similar to the following:

“The insurance company reserves its right to withdraw its participation in the defense of the lawsuit should it be determined that coverage does not apply and to file a declaratory judgment action to determine the parties’ rights, and obligations under the policy/policies. The insurance company further reserves the right to seek reimbursement from the insured of any legal fees and costs incurred in its defense should it be determined that the insurance company has no duty or obligation to defend under the policy/policies.”

How Can I Protect My Company In These Situations?

Fortunately, when insurance companies issue reservation of rights letters, the law in Illinois and nearly every other state provides protection to you, the insured, from the insurance company’s non-commitment. However, many companies are unaware of this protection and fail to take advantage of it.

Courts have recognized that an attorney appointed by the insurance company has a conflict of interest in these reservation of rights situations. On the one hand, that attorney is supposed to be zealously representing you, the insured, and attempting to defeat the claims against you regardless of whether the claims are covered by insurance or not.

On the other hand, this attorney is paid by the insurance company and is part of the insurance company’s “chosen panel attorneys” used on multiple cases throughout the course of any given year. If this attorney can develop certain facts or legal defenses that steer the claims to not being covered by insurance, then, the attorney can win a victory for the party that pays its bills. The insurance company would be off the hook and happy, and the attorney will feel like she did her job for the company that regularly hires her. Of course, this would leave you, the insured, in an exposed position.

In recognizing this “conflict of interest”, courts in Illinois and other states have ruled that when an insurance company issues a reservation of rights letter telling the insured it may not be covered by insurance, the insurance company must allow the insured to select its own attorneys to defend it from the claims in the lawsuit AND the insurance company must pay those attorneys selected by the insured to defend against the claims for as long as the lawsuit is pending. Maryland Cas. Co. v. Peppers, 355 N.E.2d 24 (1976); Ill. Mun. League Risk Mgmt. Ass’n v. Seibert, 585 N.E.2d 1130 (1st Dist. 1992). The attorney hired directly by the insured is typically called “independent counsel” or “Peppers counsel” (named after the case that gives insureds the right to hire such counsel).

In other words, you get to select an experienced construction and development attorney to represent solely your interests in the lawsuit, at the insurance company’s expense. That way, you have an attorney who is not more interested in protecting the insurance company, but rather, is completely loyal to your interests in defeating the claim. You get to control your own defense, and your insurance company is paying for it. In other words, you are getting some benefit out of those substantial premiums you have been paying over the years.

Why Is Controlling Your Own Defense Critical?

Controlling your defense is critical because the insurance company may not ultimately cover the claim, exposing you to liability. You want to control your defense when the claim is not covered by insurance, so why wouldn’t you want to control your defense when the claim may not be covered by insurance? In both instances, you are protecting your company’s assets.

Moreover, controlling your defense is critical even if the insurance company ultimately covers the claim because any loss paid by your insurance company on your behalf will impact your experience modifier and loss history. Baseless claims must be defeated so they stay off your loss history, as any amount your insurance company pays in settlement or a judgment will be assessed against your insurance rating, thereby increasing your premiums. Presenting your best defense, with attorneys who know your industry and business, puts you in the best position to defeat claims and control premiums.

Is Controlling Your Own Defense Critical When You Are Named As An Additional Insured?

Controlling your defense is also critical when you have submitted the claim as an additional insured to a subcontractor’s insurance company. In that instance, you do not have a relationship with the subcontractor’s insurance carrier, and may have no confidence in how it handles claims and who it selects to defend you in a lawsuit. If the subcontractor’s insurance carrier does not cover the claim, or the claim exceeds the limits of that subcontractor’s policy, and the claim exceeds the financial wherewithal of the subcontractor, you will be financially responsible for the claim even if the subcontractor is at fault. Accordingly, when the subcontractor’s insurance carrier issues a reservation of rights letter to you as an additional insured, you should exercise the same right to independent counsel as you would if your own insurance carrier issued the letter.

How Should You Proceed?

Rest assured, your insurance company is not going to inform you of your right to hire independent counsel at the insurance company’s cost, or tell you what to do to trigger that right. In other words, the reservation of rights letter is not going to outline all of your options for you.

Rather, in the reservation of rights letter, the insurance company likely will inform you that it has assigned an attorney to you, making it appear as if your legal defense is under control and there is nothing for you to worry about. Moreover, the insurance company may lead you to believe you are not allowed to hire independent counsel at the insurance company’s expense. For example:

“To protect the insured against the possibility of damages not covered by said policy/policies, for which insured may be liable, the insured may wish to engage its own counsel. Please note the cost for this counsel would not be covered by the policy/policies with the insurance company.”

This statement could be misleading as it does not inform you of your right to hire independent counsel paid for by the insurance company when the insurance company reserves its rights.

You need to be proactive to initiate your rights and sufficiently protect yourself. When you have submitted a claim to your insurance company, check with your broker on whether the insurance company has issued a response. Ask him or her if the insurance company issued a reservation of rights letter or is committing to cover you without reserving any rights. Review closely any communications you receive from your insurance carrier to determine if it is a reservation of rights letter. Once you have confirmed that a reservation of rights letter has been issued, contact your attorney and request that he or she contact your insurance company to make arrangements to defend you, at the insurance company’s expense.

Can You Still Control the Defense Even If The Insurance Company Does Not Issue A Reservation Of Rights Letter?

Even when a reservation of rights letter is not issued, you may still be entitled to hire your own attorney at the insurance company’s expense. If the amount claimed in the complaint against your company could potentially exceed your insurance limits in your commercial general liability policy (not your excess or umbrella policies), then a conflict exists and the insurance company is required to pay your independent counsel to defend you. R.G. Wegman Constr. Co. v. Admiral Ins. Co., 629 F.3d 724 (7th Cir. 2011); Perma-Pipe, Inc. v. Liberty Surplus Insurance Corporation, 38 F.Supp.3d 890 (N.D. Ill. 2014)(Laurie & Brennan, LLP represented the victorious Perma-Pipe in this case).

In addition, if there are multiple parties in the lawsuit insured by the same insurance company, a conflict of interest is present, entitling you to hire independent counsel to protect your interests at the insurance company’s cost. Murphy v. Urso, 430 N.E.2d 1079 (1981). This could very well exist when your subcontractor’s insurance carrier is defending your interests, as well as those of the subcontractor.

In some lawsuits, claimants seek particular types of damages that are not covered by the policy. For example, punitive damages typically are not covered by your general liability policy. If the claimant is seeking punitive damages in the lawsuit against you, there is likely a conflict of interest compelling the insurance company to pay for independent counsel to represent you at the insurance company’s expense. Nandorf, Inc. v. CAN Ins. Co., 479 N.E.2d 988 (1st Dist. 1985).

Even in those instances where the insurance company does not issue a reservation of rights letter, but instead, commits to pay your defense costs and any judgment or settlement, you can hire an attorney to participate in the lawsuit and protect your interests. However, if the insurance company has not reserved its rights to withdraw coverage, and none of the exceptions listed above apply, the counsel you hire will be paid by you. This expense may be worthwhile as your attorney can act as your legal watchdog over the handling of the defense. Your attorney does not need to attend court conferences, draft discovery, prepare pleadings etc., so you will not incur those expenses. However, he or she can keep an eye on the case, the strategies being implemented by the defense counsel hired by the insurance company, and make sure that your best interests are being properly handled throughout the litigation. Depending on the size of the claim, this may save you much more in a settlement or judgment than what it costs, thereby minimizing your loss history as much as possible.

Conclusion

By being able to recognize a communication from your insurance company as a reservation of rights letter, you can make informed decisions as to how your defense will be handled, and who should represent your company’s interests. You can take control over your defense. However, you must be proactive – nobody is going to pursue these rights for you on your behalf. Take action, and give your company the best opportunity to defeat any claim against you and minimize your loss history.