Updated on April 19th, 2023
Brad Nakase, Attorney
Your business has been sued, you tendered the lawsuit to the insurance carrier, and the Insurer sent your company a “Reservation of Rights” (“ROR”) letter.
In a nutshell, an ROR letter is the insurance company’s (“Insurer”) notice to you that the insurance policy does not cover the claim alleged in the lawsuit. The ROR letter gives the insurance company time to investigate the claim while defending you in the lawsuit without waiving the Insurer’s right to deny coverage later.
- Alert: When you receive a ROR letter from the Insurer, you must talk to an independent lawyer without delay. Most lawyers who know about the ROR letter will give you a free consult. Additionally, under many circumstances, you can retain that lawyer, and the insurance company will have to pay the lawyer.
The insurance company issues the ROR because many times, the Insurer did not have sufficient time to determine if the insurance policy covers the lawsuit. Additionally, a lawsuit may allege claims that are covered by the insurance policy and claims that are not covered by the insurance policy.
Business owners should not take the ROR lightly as the Insurer has lawyers investigating and finding every reason to deny the business owner insurance coverage. The insured/business owner must take necessary steps to protect itself by retaining a lawyer, and have the insurance company pay for the lawyer. The business owner should not use the lawyer hired by the insurance company because the lawyer is loyal to the Insurer, who pays the law firm tens of millions of dollars annually.
An insurer can be estopped from raising coverage defenses if, knowing of the grounds of noncoverage, it provides a defense under the policy without a reservation of rights, and the insured reasonably rely on this unconditional defense to his detriment.
Insurance Policy Language
Explicit in nearly all Comprehensive General Liability Insurance policies is the Insurer’s two distinct duties:
- the duty defend an insured when there is a lawsuit.
- The duty to “pay on behalf” of the insured all money the insured becomes obligated to pay which the insurance policy applies. The legal word is “duty to indemnify” and outside the scope of this article.
In simple terms, the insurance policy gives the Insurer the right to investigate and settle any covered or potential claims. The contract also confers on the Insurer the duty to defend, investigate, and deny the allegations.
The Lawsuit and Insurer’s Duty to Defend
The defense duty arises upon tender of a potentially covered claim and lasts until the underlying lawsuit is concluded, or until it has been shown that there is no potential for coverage. When the duty, having arisen, is extinguished by a showing that no claim can in fact be covered, it is extinguished only prospectively and not retroactively. On the other hand, in an action wherein none of the claims is even potentially covered because it does not even possibly embrace any triggering harm of the specified sort within the policy period caused by an included occurrence, the insurer does not have a duty to defend. This freedom is implied in the policy’s language. It rests on the fact that the insurer has not been paid premiums by the insured for such a defense. The duty to defend is contractual. The insurer has not contracted to pay defense costs for claims that are not even potentially covered.
Where there is an issue of whether the Insurer has to defend, the Insurer may elect to proceed in three methods:
- The Insurer may accept the defense of the lawsuit without objecting to insurance coverage.
- The Insurer may deny coverage and refuse to defend the insured. Under this method, the Insurer places itself at risk because it loses control over the defense of the lawsuit. The Insurer may be bound by the outcome of the lawsuit and sued for bad faith breach of contract by the insured.
- The Insurer may defend the lawsuit under a Reservation of Rights, investigate through the lawyer it has hired for the insured, and find reasons to deny the claim.
Hypothetically, Paul Plaintiff trip and falls at Dan Grocery Store. Paul Plaintiff is injured and sustained $100,000 in medical bills and sues Dan Grocery Store. Dan Grocery Store tenders the lawsuit to Insurer. An insurer must defend the lawsuit because the insurance policy covers accidental trip and fall injuries.
An insurer’s assumption of the defense of its insured without giving notice of a reservation of rights may preclude the insurer from denying coverage because of that which could have been reserved. An insurer can waive policy provisions, which would otherwise defeat coverage. Where an insurer reserves its right to claim noncoverage under the policy, notice of the reservation must be given to the insured or the reservation is deemed waived. If a liability insurer with knowledge of a ground of noncoverage under the policy, assumes and conducts the defense of an action brought against the insured, without disclaiming liability and giving notice of its reservation of rights, it is thereafter precluded in an action upon the policy from setting up such ground of noncoverage. The insurer’s unconditional defense of an action brought against its insured constitutes a waiver of the terms of the policy and an estoppel of the insurer to assert such grounds.
An insurer is estopped from denying coverage when it accepts defense of the insured’s suit without a reservation of rights, fails to afford the insureds a reasonable opportunity to assume their own defense, and does not have the insured’s authority for the settlement made in the underlying action.
An insurer may agree to defend a suit subject to a reservation of rights. In this manner, an insurer meets its obligation to furnish a defense without waiving its right to assert coverage defenses against the insured at a later time. If the insurer adequately reserves its right to assert the noncoverage defense later, it will not be bound by the judgment. If the injured party prevails, that party or the insured will assert his claim against the insurer. At this time the insurer can raise the noncoverage defense previously reserved.
If the insurer adequately reserves its right to assert the non-coverage defense later, it will not be bound by the judgment. If the injured party prevails, that party or the insured will assert his claim against the insurer. At this time the insurer can raise the non-coverage defense previously reserved. In this manner the interests of insured and insurer in defending against the injured party’s primary suit will be identical. If the reservation of rights agreement contains a reimbursement clause, the carrier retains its right to seek reimbursement for payments expended if non-coverage is ultimately proven. While the underlying action is pending, the carrier can file an action for declaratory relief and attempt to obtain a declaration that no duty to defend or indemnify exists. Such a determination would allow it to withdraw from the defense without subjecting the carrier to a claim of breach of contract or bad faith.
INSURER’S CONFLICT OF INTEREST AFTER ISSUING A RESERVATION OF RIGHTS LETTER
Generally, when an Insurer issues an ROR letter, it creates a conflict of interest between the Insurer and the Insured. The insured/business owner has the right to retain/hire an independent attorney and demand the Insurer pays for the attorney’s fee.[i] A conflict exists when the outcome of the insurance coverage is controlled by the lawyer hired by the Insurer for the defense of the lawsuit.
If the reservation of rights creates a conflict of interest between the insurer and the insured, the insured has the right to demand independent counsel. A conflict exists when the outcome of the coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim. This usually arises where the issue creating the conflict is one which must be decided in the underlying action. Also, if the issue which creates a conflict must be resolved in the underlying action, any declaratory relief action relating to coverage should be stayed pending resolution of the underlying action.
Let us change the facts of Paul Plaintiff versus Dan Grocery Store a little bit. Dan Grocery and Paul Plaintiff got into a heated argument outside the grocery store. While Paul Plaintiff walked away, he tripped over Dan Grocery’s foot and sustained severe injuries and $100,000 in medical bills. Paul Plaintiff sues Dan Grocery for negligence and intentional act.
Dan Grocery tenders the lawsuit to Insurer. The insurance policy covers accidental trip and fall but does not cover intentional trip and fall. The Insurer issues a ROR letter to Dan Grocery. The ROR letter gives the Insurer time to investigate while it hires a lawyer to defend Dan Grocery.
The Insurer hires Larry Lawyer to defend Dan Grocery. Larry Lawyer and Dan Grocery meet, and Dan Grocery tells Larry Lawyer everything, including that he intentionally tripped Paul Plaintiff. Larry Lawyer has to file a period report to the Insurer and disclosed Dan Grocery said. The Insurer may then terminates its defense of Dan Grocery because the insurance policy does not cover intentional acts.
In this scenario, it is wise for Dan Grocery to retain a lawyer and have the insurance company pay the defense lawyer under “cumis counsel.”
Not every conflict of interest triggers an obligation on the part of the insurer to provide the insured with independent counsel at the insurer’s expense. For example, the mere fact the insurer disputes coverage does not entitle the insured to independent counsel; nor does the fact the complaint seeks punitive damages or damages in excess of policy limits. Civ. Code, § 2860, subd. (b). The insurer owes no duty to provide independent counsel in these situations because the rule requiring it is not based on insurance law but on the ethical duty of an attorney to avoid representing conflicting interests. For independent counsel to be required, the conflict of interest must be significant, not merely theoretical, actual, not merely potential. The insured’s right to independent counsel depends upon the nature of the coverage issue, as it relates to the issues in the underlying case. Where the reservation of rights is based on coverage issues which have nothing to do with the issues being litigated in the underlying action, there is no conflict of interest requiring independent counsel.
Not every reservation of rights entitles an insured to select independent counsel. There is no such entitlement, for example, where the coverage issue is independent of, or extrinsic to, the issues in the underlying action, or where the damages are only partially covered by the policy. However, independent counsel is required where there is a reservation of rights and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim. Civ. Code, § 2860, subd. (b).
The duty to appoint independent counsel is not triggered at the moment defense counsel makes a tactical decision giving rise to a conflict. Instead, the parties’ respective interests must be analyzed to determine if they can be reconciled or if there is a conflict of interest which puts appointed counsel in the position of having to choose which master to serve.
Take home on this article: When you receive a Reservation of Right Letter from the insurance company, talk to an independent lawyer before you talk to the lawyer hired by the insurer. The Insurer through the lawyer will find reasons to deny insurance coverage.
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