1. Denial of Coverage by Insurer
a. Risks in Denying Coverage Without Specific Reasons
An insurance company seeking to decline coverage or liability must do so within a reasonable time following tender of defense. If the company delays its decision so long that the insured’s rights are prejudiced, the company may be estopped from denying coverage.
If the insurer takes control of the action without notice to the insured that the insurer does not consider itself liable under the policy, the insurer usually is estopped from denying liability on the policy. Prejudice to the insured will be conclusively presumed when the insurer exercises complete control over the defense without a reservation of rights.
If the company elects to deny coverage, it should list in a denial letter all reasons then available for the denial. The courts are split on the questions of whether failure to list a ground for denial of coverage will later estop the company from relying upon that ground.
b. Risks in Denying Coverage Without Defending Insured
Where the company had denied a defense, the insured can defend on his own and sue the insurer afterwards for damages.
When the insurer refuses to defend, it generally loses both policy defenses such, as breach of cooperation by the insured, failure to give notice, etc., and also a substantial part of the right to question the propriety of any settlement made by the insured.
A settlement by the insured with the claimant is not a violation of the insured’s duty to cooperate with the insurer – if the insurer refused to defend or refused to settle reasonably. Once the insurer abandons the insured, the insured can make such settlement as he/she deems provident.
The settlement by the insured in such a situation, assuming coverage, is enforceable against the insurer if it is reasonable and prudent and if it is not the product of fraud and/or collusion. The insurer is limited to a determination whether the amount of the settlement is reasonable and prudent.
2. Non-Waiver Agreements
Two options are available to the company that wants to furnish a defense but reserve the right to later deny coverage: (1) a non-waiver agreement; or (2) a reservation of rights letter.
A non-waiver agreement is a contract between the insurer and the insured in which the insured agrees that the company can reserve all of its rights under the policy including the right to deny coverage later for any reason. In exchange for this agreement, the insurer agrees to defend the action without cost to the insured.
3. Non-Waiver Agreements Compared to Reservation of Rights
Non-waiver agreements appear to be falling out of favor. If there is coverage, the policy obligates the company to provide a defense; the company has no right to insist that the insured (that has coverage) enter into a non-waiver agreement prior to providing the defense, it is required by contract to provide. Indeed, requesting a non-waiver agreement may be evidence of bad faith by the insurer.
If the company attempts to secure a non-waiver agreement and the insured refuses to consent, the insured’s refusal to enter into a non-waiver agreement is a form of saying “If you [the insurer] defend, then you will waive your rights; I will not give the company the option of defending and reserving rights.” In short, the insured’s refusal to sign a non-waiver agreement may preclude the company from defending with a reservation of its rights. The insured has put the insurer into a situation where if it proceeds to defend the insured, the court may say the company has waived the policy defenses.
A reservation of rights letter and a non-waiver agreement provide precisely the same protection to the company. Under both, the company has the right later to deny coverage on announced policy defenses. A reservation of rights letter is better than a non-waiver agreement. It gives the company control of the conditions under which it is defending, without needing the consent of the insured to be effective.
4. Reservation of Rights Letter
A reservation of rights letter is a unilateral declaration from the company to the insured that the company is furnishing a defense of the tendered lawsuit but reserves its right to later deny coverage on certain specified grounds. Without a reservation of rights letter prior to accepting the defense, or within a reasonable time thereafter, the company may be estopped from denying coverage. With the reservation of rights letter, the company is protected from waiver of its rights.
A reservation of rights letter is not sufficient if it only states that the company reserves its right to later deny coverage. The purpose of a reservation of rights letter is to enable insureds to make intelligent decisions. Therefore, the company must delineate with specificity every reason for denial of coverage of which it is then aware, in its reservation of rights letter.
5. Control of Defense Where Insurer has Reserved Rights
The insurer has control of the defense, and with control goes responsibility. Therefore, an insurer who undertakes to defend its insured is held to the standard of the fiduciary care the attorney whom it appoints to conduct the defense of the insured is obligated to furnish the insured. Whether or not the insurer has reserved rights in furnishing an attorney to defend, in the event the attorney does anything to violate that fiduciary duty, the insurer is liable for that violation.
The courts are split on the question of whether a reservation of rights, in and of itself, creates a sufficient conflict of interest, between insurer and insured, to permit the insured to control the defense, to reject appointed counsel and to choose independent counsel (thereby transforming the insurer’s duty to defend into a duty to reimburse the insured for the fees of counsel chosen by the insured). Cf., Prahm v. Rupp Const. Co., 277 N.W.2d 389 (Minn. 1979); Roser v. USF&G, 585 F.2d 932 (8th Cir. 1978). The supposed prevailing rule is that a reservation of rights does give the insured the right to control the defense and to choose independent counsel. On the other side, the supposed minority view relies upon the ethical integrity of counsel to assure that the issue of coverage does not interfere with the defense of the underlying action. Cf., Tews Funeral Home Inc. v. Ohio Cas. Ins. Co., 832 F.2d 1037 (7th Cir. 1987). These courts keep the contractual right to control the defense with the insurer, even though there has been a reservation of rights. The North Dakota court has not yet spoken on the question.
The South Dakota court, in a statement not necessary for the case, has said that an insurer does not have the right to retain control of the defense and at the same time disclaim coverage. However, the insured’s failure to object impliedly consents to the insurer’s control of the defense. Connolly v. Standard Cas. Co., 73 N.W.2d 119 (S.D. 1955).
The Federal Eighth Circuit Court (which is the federal appeals court for federal courts in the Dakotas) has held that continued control of the defense after a reservation of rights is bad faith by the insurer if the insured has requested control of the defense through an attorney chosen by the insured. Kansas Bankers Surety Company v. Lynass, 920 F.2d 546 (8th Cir. 1990). Therefore, where the insured requests the defense be conducted and controlled by the insured’s personal attorney, an insurer which has reserved rights should recognize that expert legal advice should be sought by the insurer.
6. Declaratory Judgment Actions
In the context of a coverage dispute, a declaratory judgment action is an action seeking a judicial declaration of the rights of the parties to an insurance contract and other interested parties. If the insurer prevails in the declaratory judgment action and establishes that it provides no coverage for the underlying action, it avoids all indemnity to its insured for the underlying action. If the insurer wins the declaratory action, whether the insured is liable for defense costs the insurer has spent in the underlying action is not entirely free from doubt.
Under North Dakota law, if the insurer loses the declaratory judgment action, it will be liable for the insured’s costs and attorney fees in the declaratory judgment action.
If the insured loses the declaratory judgment action, the insurer under some cases outside North Dakota is still liable for the insured’s costs and attorney fees in the declaratory judgment action. Such a result seems unlikely in North Dakota.