In what resembles a kabuki dance of sorts, insurers often fire off reservation of rights letters as an automatic response to any and all claims-related correspondence. A policyholder sends notice of circumstances that could give rise to a claim? Reservation of rights. A policyholder requests defense coverage? Reservation of rights. A policyholder requests consent to settle with the underlying claimant? Reservation of rights.
Reserving rights ostensibly allows an insurer to continue to investigate a claim (and to defend the claim, when there is a duty to defend), while flagging for the policyholder potential grounds for an ultimate denial of coverage. So, in theory, a reservation of rights can protect the interests of both insurer and insured. But sometimes an insurer hides behind a reservation of rights in an attempt to avoid or postpone the downsides of denying coverage outright. This tactic can leave a policyholder in a precarious position—for example, having to negotiate the settlement of underlying litigation without the insurer’s consent (potentially running afoul of policy conditions), and without knowing whether there will ultimately be coverage for the settlement. Fortunately, courts have gotten wise to this common insurer approach, punishing insurers for stringing policyholders along in this manner.
In a recent example from increasingly policyholder-friendly New York, the New York Supreme Court in J.P. Morgan Securities Inc. v. Vigilant Insurance Company held that, in spite of an insurer’s reservation of rights, it had effectively denied coverage, permitting the policyholder to negotiate a settlement without the insurer’s consent. The case involved coverage for the settlement of an SEC investigation. As is common in liability policies, the policy at issue contained provisions requiring the policyholder to obtain the insurer’s consent before settling any claim and to cooperate and assist the insurer in investigating the claim. The insurer never explicitly denied coverage, but rather, repeatedly reserved its rights on the grounds that the SEC investigation was not a “claim” under the policy and that policy exclusions barred coverage for disgorgement claims. While the court noted that under New York law the consent-to-settle provision is a condition precedent to coverage, in circumstances in which the insurer had “effectively” disclaimed coverage the policyholder was excused from complying with the provision. Thus, the court held, the fact that the insured had not obtained the insurer’s consent to settle was no impediment to coverage for a reasonable settlement.
Generally, best practice is to make every reasonable effort to obtain an insurer’s consent to settle a claim, and to involve an insurer in settlement negotiations when practicable. But, as J.P. Morgan Securities exemplifies, insurers do not always cooperate with their insureds. Court rulings like this one can ensure this particular dance ends on the right foot for policyholders.