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Unraveling the Gordian Knot

Tue May 2nd, 2017 on     Articles,    


Assuming coverage, or at least its ostensible existence, insurance companies are supposed to settle third-party claims against their insureds lest the anodyne of bad faith liability be unleashed. Insurance companies often do not agree wholeheartedly with the policyholder that coverage exists. A potent weapon in the arsenal of rights preserved to insurance companies by their insurance policies and statutory and common law is the reservation of rights letter, in which it offers to defend the insured while preserving its right to ultimately deny coverage. However, where the underlying case is capable of being settled within the policy limits, a reservation of rights letter creates difficult choices for both the insurance company and the policyholder. Succinctly, this election by the insurance company can result in far darker concerns than either coverage or policy limits: Bad faith. Under Florida Law, an insurer which fails to act in good faith may be severely punished. This article will briefly plumb the options available to the insurance company, thereby serving simultaneously to educate insurance company and policyholder alike concerning the consequences of the failure to make the right decision.

Florida law generally recognizes that where an insurance company takes control of a policyholder’s defense, the insurance company has an obligation to exercise ordinary care and prudence in the defense of its insured, which “amounts to a fiduciary duty requiring the exercise of good faith.” Doe f/b/o Doe v. Allstate Ins. Co., 653 So. 2d 371, 374 (Fla. 1995). These fiduciary obligations extend to seasonably informing any policyholder of defenses to coverage which the insurance company intends to assert, as well as an obligation to settle claims falling within coverage and policy limits in order to protect the policyholder from judgments that exceed insurance protection. See, e.g., Kivi v. Nationwide Mut. Ins. Co., 695 F.2d 1285, 1287 (11th Cir. 1983) (applying Florida law); Galen Health Care, Inc. v. American Cas. Co. of Redding, Pennsylvania, 913 F.Supp. 1525, 1532 (M.D.Fla. 1996); Boston Old Colony Ins. Co. v. Gutierrez, 386 So. 2d 783 (Fla. 1980), cert. denied, 450 U.S. 922 (1981); Baxter v. Royal Indem. Co.., 285 So. 2d 652 (Fla. 1st DCA 1973) (superceded by statute on other grounds), cert. discharged, 317 So. 2d 725 (Fla. 1975). This duty to negotiate in good faith towards settlement patently colors and influences the decisions an insurance company may make, regardless of the existence of a reservation of rights letter.

An insurance company seeking to preserve defenses to coverage has few options available to it, governed both by statutory and common law. Pursuant to the Florida Claims Administration Statute, Fla. Stat. 627.426 (1992) an insurance company has a limited period of time in which to do one of three things: (1) Acknowledge coverage and assume the defense of a suit without reservation of rights; (2) obtain a non-waiver agreement following a full disclosure of the coverage defenses sought to be preserved ; or (3) send a reservation of rights letter and appoint mutually agreeable defense counsel. So, what is a reservation of rights letter?

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. It allows both parties to the insurance contract to protection bargained for in connection with the third-party suit and reserves coverage issues to a more appropriate forum and time . . .. The specific purpose of a reservation of rights is to preclude the application of estoppel and waiver.

Truck Ins. Exchange v. Superior Court, 59 Cal. Rptr. 2d 529, 536-537 (Ct. App. 1996); First United Bank of Bellevue v. First American Title Ins. Co., 496 N.W. 2d 474, 481 (Nev. 1993). A reservation of rights letter simply lists the defenses sought to be preserved by the insurance company, while it defends the insured in connection with the third-party claim. It also affords the insurance company the opportunity to investigate the claim for a reasonable period of time without risk of waiving its defenses to coverage.

When an insurance company simply defends without reserving its rights, only its money, not the policyholder’s, is at stake. Accordingly, its ability to settle claims remains unsullied by collateral considerations such as the potential loss of coverage signaled by a reservation of rights letter. See, e.g., Shuster v. South Broward Hosp. Dist. Liability Ins. Trust, 591 So. 2d 174 (Fla. 1992). A reservation of rights changes everything. By reserving its rights to deny coverage – a very common practice – the insurance company creates certain added obligations and exposures: now the money of both the policyholder and insurer are equally at risk. For this reason, where the insurance company reserves its right to deny coverage, it loses the option of controlling both the defense and settlement opportunities. Maryland Casualty Co. v. Imperial Contracting Co., Inc., 260 Cal. Rptr. 797, 803 (Ct. App. 1989); American Eagle Ins. v. Nettleton, 932 S.W. 2d 169, 174 (Tx. Ct. App. 1996). See also, Taylor v. Safeco Ins. Co., 361 So. 2d 743, 746 (Fla. 1st DCA 1978) (insured free to reject defense by insurance company under reservation of rights); Nationwide Mut. Fire Ins. Co. v. Keen, 658 So. 2d 1101, 1103 (Fla. 4th DCA 1995).

Thus, the insurance company makes a choice. To reserve its right to deny coverage under a reservation of rights letter, an insurance company must relinquish control of the defense and settlement opportunities to the policyholder. Alternatively, the insurance company can forego its coverage defenses and take control of the case and settle because only its money is at stake.

These interrelated options and duties typically give rise to three possibilities. The insurance company may investigate the claim under a reservation of rights, thereby relinquishing control of the defense to the insured, and then withdraw the defense and deny coverage if its investigation reflects a good faith basis for doing so. See, e.g., Liberty Mutual Ins. Co. v. Lone Star Industries, Inc., 661 So. 2d 1218 (Fla. 3d DCA 1995). The insurance company may, in certain instances, institute a declaratory action in order to establish non-coverage while defending under a reservation of rights. If it prevails, its duty to defend terminates and it has no obligation to indemnify for any losses sustained. Allstate Ins. Co. v. Conde, 595 So. 2d 1005, 1008 (Fla. 5th DCA 1992) (en banc). The insurance company may also settle the underlying action thereby waiving any defenses to coverage which it might otherwise have asserted. Employers Mutual Liability Ins. Co. of Wisconsin v. Sears, Roebuck & Co., 621 F.2d 746, 747 (5th Cir. 1980). Lastly, the insurance company may, under narrow circumstances, settle a claim while preserving its defenses to coverage, but only if it has obtained a bilateral agreement with its policyholder to preserve defenses to coverage while settling the underlying claim, so as to litigate the coverage issues later. Medical Malpractice Joint Underwriting Ass’n of Massachusetts v. Goldberg, 680 N.E. 2d 1121 (1997); Matagorda County v. Texas Ass’n of County Government Risk Management Pool, 975 S.W. 2d 782 (Tex. Ct. App. 1998).

These are the only options available to the insurance company. Each must carefully be weighed and examined with the diligence required by a fiduciary duty owed to the policyholder. The nuances of the approach taken and the decision-making process should be carefully scrutinized by the policyholder’s lawyer. If the insurance company makes a misstep by underestimating its duty to its policyholder, it may trip and fall into a bad faith action.

about the author

R. HUGH LUMPKIN is a partner in the law firm of Ver Ploeg & Marino, P.A. in Miami where he primarily represents policyholders on insurance coverage and bad faith issues, evaluating, settling and litigating insurance claims filed in the state and federal trial and appellate courts. Mr. Lumpkin received his A.B. degree from Duke University and his J.D. degree from the University of Miami. He has written extensively on a variety of insurance coverage issues and has appeared as a frequent lecturer for the American Bar Association, the Dade County Bar Association and a number of other organizations which provide educational and business opportunities to professionals.

1 The issues addressed in this article arise only in the liability setting: That is, policies which obligate an insurance company to defend and to indemnify the policyholder from and against third-party claims. Typical examples would include general liability and homeowners policies, with the latter having first-party obligations as well.
2 A non-waiver agreement is simply a reservation of rights in the form of a bilateral agreement. See, Val’s Painting and Drywall, Inc. v. Allstate Ins. Co., 126 Cal. Rptr. 267, 272 (Ct. App. 1975).
3 One court has allowed an insurance company to preserve defenses to coverage even after settlement where a court order approved this approach. Maryland Casualty Co. v. Imperial Contracting Co., Inc., 260 Cal. Rptr. 797, 803 (Ct. App. 1989.)

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