Many insurers are in the habit of sending perfunctory “reservation of rights” letters to their insureds throughout the lifetime of a claim.  The reason they do so is not a very well-guarded secret in the insurance industry.  An insurer that acknowledges coverage must pay any eventual settlement or judgment, while an insurer that denies coverage generally waives significant rights with respect to the defense and settlement of the claim.  Sending a stream of letters purporting to “reserve rights” is a common insurer tactic for kicking a coverage decision down the road while watching how the claim against the insured develops.  One insurer recently learned the hard way that this practice can have severe consequences, when a Missouri appellate court held that the insurer waived any right to deny coverage by sending ineffective “reservation of rights” letters.

In Advantage Buildings & Exteriors, Inc. v. Mid-Continent Casualty Company, the insured was sued as a result of construction defects in a building for which it had supplied wall panels.  After the insured submitted the claim to its insurer, Mid-Continent, the insurer agreed to defend the claim subject to a purported “reservation of rights.”  Throughout the underlying litigation, Mid-Continent sent additional letters continuing to “reserve its rights” and promising to advise the insured when it made a coverage decision.

After refusing repeated requests from its insured to settle the underlying litigation within the policy limits (and engaging in other bad faith conduct recounted at length in the appellate decision), Mid-Continent denied coverage on the eve of trial, withdrew its defense, and initiated a coverage action.  The policyholder assigned its rights against Mid-Continent to the underlying claimant, which sued Mid-Continent for coverage and bad faith after it obtained a judgment against the policyholder.  After losing at trial, Mid-Continent appealed the verdict.

In a decision that is surely causing much angst among those who routinely rely upon perfunctory “reservation of rights” letters to delay making a claims decision, the appellate court held that the two purported “reservation of rights” letters issued by Mid-Continent were insufficient under Missouri law.  A “proper reservation of rights,” according to the court, provides the insured “with full knowledge of the position of the insurance company.”  The letters sent by Mid-Continent did not meet this standard, as they only “vaguely” explained that the insurer was investigating its coverage defenses.  True, the letters listed a number of policy defenses and exclusions that might apply, but “neither letter clearly and unambiguously explained how those provisions were relevant to [the insurer’s] position or how they potentially create coverage issues.”  As such, the court concluded, Mid-Continent had not effectively reserved its rights and was therefore estopped from denying coverage.

Policyholders have long argued that calling a letter a “reservation of rights” does not make it one.  In order to effectively reserve rights, the insurer’s letter must meet the relevant state’s standards for promptness, thoroughness and clarity.  If the letter does not do so, it is no reservation of rights at all.  Relatedly, refusing to provide coverage in a so-called “reservation of rights” letter may in some instances constitute a denial of coverage under applicable law and not “reserve” any rights at all.  But that is a topic for a future blog post.  Stay tuned.

The decision in Advantage Buildings emphasizes the importance of closely scrutinizing purported “reservation of rights” letters from insurers and not reflexively taking them at face value.  Policyholders should pay careful attention to the language in such letters and be mindful of insurer’s tactics for delaying and avoiding coverage decisions.  Remember, just because your insurer says it is “reserving its rights” doesn’t make it so.