Tank v. State Farm: Conducting a Reservation of Rights Defense in Washington
| Jurisdiction | Washington,United States |
| Citation | Vol. 11 No. 01 |
| Publication year | 1987 |
I. Introduction
The key to properly conducting a reservation of rights defense(fn1) is understanding the interrelationship between insurer, policyholder, and defense counsel. In
The court reasoned that the enhanced obligation was necessary because of the potential conflict of interest inherent in a reservation of rights defense. The court's conflict of interest analysis corrected the appellate court's erroneous application of the excess of limits conflict to the reservation of rights situation. The court did not, however, directly address important collateral issues such as the insurer's vicarious liability for the conduct of the insurer-retained defense counsel, the ability of defense counsel to give undivided loyalty to the policyholder, or the right to control the defense when an insurer reserves the right to later contest coverage.
These collateral issues were either avoided outright or addressed only by implication. While the court did not declare, as have other courts, that the insurer-retained defense counsel was incapable of acting independently, the imposition of the enhanced obligation cannot be viewed as an unqualified vote of confidence for insurer and defense counsel.
The typical liability insurance policy imposes two duties on the insurer when presented with a claim for which coverage applies. First, the insurer has the duty to indemnify by paying all amounts that the insured becomes legally obligated to pay, up to the policy limits.(fn6) Second, the insurer must defend any such suit brought against the insured even if the suit is groundless, false or fraudulent.(fn7) The duty to defend can be described as broader than the duty to indemnify.(fn8) This is so because the insurer may be required to defend an insured even if the insurer will never be called upon to indemnify for that particular claim or suit.(fn9)
When the claim is presented, the liability insurer must determine if it has a duty to defend. The general rule is that the duty is determined from the facts alleged in the complaint.(fn10) The insurer must defend when any facts alleged, if proved, would fall within the provisions of the insurance contract. This general rule has been the object of several exceptions by the courts. Because of changes in pleading practices, for example, the allegations may be too vague for the insurer to precisely know if the policy provisions provide coverage.(fn11) Alternative allegations may be pled with one allegation clearly covered and the other not.(fn12) While the allegations may not fall within the policy provisions, the insurer may be aware of facts that bring the suit within the terms of the policy.(fn13) On the other hand, the third party claimant may assert allegations that are covered even though the facts are not supportive, just to make sure that the insurer is involved.(fn14) With these exceptions, the general rule of comparing the suit to the policy does not always guarantee certainty when determining coverage.
This uncertainty of coverage is the reason that an insurance company reserves the right to later dispute coverage. Any analysis concerning the reservation of rights defense must be premised on the fact that coverage is uncertain and that the policyholder may not be insured for the particular claim or suit being presented.(fn15)
Liability insurers have four distinct options when presented with a claim involving uncertain coverage. First, the insurer can unconditionally provide coverage. Second, the insurer can, following appropriate investigation, decide that coverage does not apply and deny the claim. Third, the insurer can, in appropriate cases, institute a declaratory action and let the courts decide the coverage question. Finally, the liability insurer has the option of conducting a reservation of rights defense.
1. Unconditional Coverage of the Claim
Even if the liability insurer has doubts about coverage, the insurer can, nevertheless, assume the defense of the claim or suit and be prepared to pay any settlement or judgment on behalf of the insured.(fn16) The unconditional acceptance of the claim may be advantageous since such acceptance preserves the insurer's rights under the policy.(fn17) These rights include full control of the defense,(fn18) the right to select defense counsel,(fn19) the privilege to settle when expedient,(fn20) and the option, within the bounds of good faith, to take the case to trial.(fn21) These are powerful rights, thus the insurer may well decide that it is preferable to accept a claim involving uncertain coverage in order to preserve them.
2. Denial of Coverage
Where the company investigates and concludes that neither the allegations nor the facts of the claim or suit fall within the terms of the policy, the claim can be denied.(fn22) The policyholder is then left to depend on his own resources for both indemnity and defense. The policyholder is, however, free of the policy provisions and able to take whatever action desired.(fn23) This includes settling the claim, litigating the matter, or even allowing a default judgment.(fn24) The policyholder's choice is of no consequence to the insurer so long as no coverage exists.(fn25)
It has been said, however, that the insurer denies coverage at its peril.(fn26) If the company wrongfully denies coverage, the consequences can be serious, especially if the insured can later demonstrate bad faith on the part of the insurer.(fn27) Thus, when coverage is questionable, the insurer may be reluctant to deny coverage outright.
3. The Declaratory Action
An insurer faced with a claim to which coverage is uncertain can petition the courts to resolve the coverage question.(fn28) Insurers of all types can use this action to resolve such issues as whether a contract was ever created, whether the policyholder has fulfilled the required conditions of the policy, whether the loss occurred while the policy was in effect, or whether other insurance coverage should take precedence.(fn29)
The declaratory action is uniquely restricted in its application to liability insurance. The insurer generally cannot use such an action to resolve coverage disputes that turn on the very facts to be determined in the underlying tort suit.(fn30) Thus, where the issue of a policyholder's liability to a third party claimant and the issue of coverage both depend on the same facts, the courts will not preempt the underlying tort action with a declaratory judgment.(fn31) It is when faced with this type of situation that the liability insurer is likely to utilize the fourth option.
4. The Reservation of Rights Defense
The liability insurer, when presented with a claim of questionable coverage, can investigate and defend the claim or suit but reserve the right to later decline to indemnify.(fn32) This option is the middle ground between outright denial of coverage and the unconditional acceptance of the claim. Unconditional investigation and defense can act as a waiver to the right to dispute coverage(fn33) or the company can be estopped from later asserting the right by real or presumed prejudice to the policyholder.(fn34) The insurer, by explicitly reserving this right, is forestalling both the possibility of implied waiver and prejudice as well as putting the policyholder on notice of the coverage issue. At the same time, the insurer is going forward with its investigation and defense of the claim or suit. Thus, the policyholder is receiving the benefit of company sponsored defense despite the uncertain coverage. The reservation of rights defense, as opposed to outright denial, provides a service to the policyholder who otherwise would have to totally bear the burden of defending the claim.(fn35)
Notice, preferably in writing, must be communicated to the policyholder in a timely fashion and specifically identify the coverage issues that the insurer wishes to preserve.(fn36) If the company and its policyholder end up in a lawsuit over the coverage issue, the nature and content of the reservation of rights notice may come under substantial judicial scrutiny. Hence, the notice must be sufficient to put the policyholder on notice and avoid an implied waiver.(fn37)
The problem of the content and the timing of the notice is not nearly as formidable as the problem of the relationship between the parties once the notice has been given. It was this problem that the court addressed in
In...
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