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Reservation of Rights: Harsh Consequences for Getting it Wrong.

Byline: Randy J. Maniloff

It's a peculiar fact that liability insurance is an industry built on standardization of policy forms. And at no time are those forms more important than in the context of a claim. Yet the critical document whose purpose is to explain to policyholders how those forms may apply to their claim -- the reservation of rights letter -- is anything but standardized. Simply put, reservation of rights letters resemble fingerprints.

This lack of set guidelines for drafting reservation of rights letters means that no matter how much experience a person has doing so, it's still easy to get something wrong. And courts have been penalizing insurers for issuing what they see as inadequate reservation of rights letters. This penalty can be severe: the loss of otherwise applicable coverage defenses.

What makes a letter a "reservation of rights" letter? Is it enough to simply label it a reservation of rights letter? Is it enough to say, sometimes many times over, that the insurer is reserving its rights to deny coverage? In some cases, the answer is no.

There are countless reasons why a reservation of rights letter can be found to be deficient. It may have been prepared based on an erroneous choice of law determination. It may not have been sent to the correct insureds. It may not have been sent timely. It may not comply with certain statutory obligations. It may not properly address the handling of the insured's defense. It may omit certain coverage defenses.

Inadequate explanation

But the most common -- yet easiest to prevent -- reason why a reservation of rights letter may be declared inadequate is that the explanation provided to the insured of why coverage may not be owed for some claims or damages was not sufficiently specific to be adequate. In other words, the reservation of rights letter did not "fairly inform" the insured why, despite a defense being provided, coverage for any damages, in whole or in part, may not be owed.

We have all seen reservation of rights letters that set forth a brief factual summary of the claim, followed by several pages of policy language -- some completely irrelevant -- and then a concluding statement that, voila, the insurer reserves its rights. Some courts have concluded that such letters, lacking an explanation why coverage may not be owed, do not cut the mustard, no matter how many times they may use the words "reservation of rights." [See Safeco Ins. Co. of Am. v. Liss, No. DV 29-99-12, 2005 Mont. Dist. LEXIS 1073, at *41 (Mont. Dist. Ct. Mar. 11, 2005).]

In this case, the court found that Safeco's reservation of rights letter did not "fairly inform" Liss (the insured) of the reasons it was reserving its rights and that the letter was inadequate as a matter of law to preclude application of the estoppel doctrine. According to the court, the only factual reference contained within the policy was: "As you are aware, this lawsuit arises out of a gunshot incident on July 10, 1997." More importantly, the court found, the letter set forth pages of policy provisions but did not explain why Safeco believed the insurance policy would possibly not cover Liss for the shooting incident. In other words, Safeco did not "apply" the sole fact stated to the policy's legal terms."

In another case, Builders & Exteriors, Inc. v. Mid-Continent Casualty Co. [449 S.W.3d 16 (Mo. Ct. App. 2014)], a Missouri trial court found that an insurer, after undertaking its insured's defense, owed no coverage. But that decision went by the wayside at the state appeals court because the reservation of rights letters -- despite containing a lot of pages, setting out the facts at issue, voluminous policy language and a statement that the insurer was reserving its rights -- were found to be not effective. The court put it like this: "The letters generally discussed the nature of the underlying lawsuit and set forth various provisions of Advantage's general liability policy. Neither letter clearly and unambiguously explained how those provisions were relevant to Advantage's position or how they potentially created coverage issues."

Remember the letter's purpose

The best way to approach drafting a reservation of rights letter is this: Remember its purpose. The insured-recipient may have never seen a reservation of rights letter -- or ever heard of it. Just because you deal with them day in and day out does not mean that the insured has any familiarity with them. What's more -- the insured is being provided with a defense. That may create an impression that its insurer is taking care of the matter -- lock stock and barrel.

Thus, the reservation of rights letter needs to make it abundantly clear to the insured that, just because the insurer is defending, it should not get a false sense of security when it comes to coverage for any damages. To achieve this, a thorough and clear explanation of why coverage may not be owed should be provided. In other words, fairly inform the insured.
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Date:Dec 1, 2015
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