Reservation of Rights Letter and the Insured

Introduction: Reservation of Rights Letter

A reservation of rights is a means by which an insurer agrees to defend an insured against a claim or suit while simultaneously retaining its ability to evaluate, or even disclaim, coverage for some or all of the claims alleged by the plaintiff.[1]

Insured’s Options After Receiving a Letter

After receiving a reservation of rights, an insured may either accept or deny the defenses asserted in the letter.  Most courts have held when an insurer has issued a reservation of rights, an insured who accepts a defense under the reservation has tacitly agreed to the reservation unless he states an objection.[2]  In Texas, an insured’s silence is considered an implied consent.[3]  By allowing the insurer to defend the action, the insured implicitly agrees that the insurer will not thereby waive its right to later contest coverage.[4]

Additionally, an insured has a right to deny the defenses asserted in the reservation of rights.  However, an insured must be careful before deciding to reject the reservation of rights letter.  In Graper, the Fifth Circuit, interpreting Texas law, held if an insured refuses a defense offered by its insurer under a reservation of rights, the decision should be made carefully because it could result in the insured being unable to pursue reimbursement for independent counsel expenses.[5]

Insurer’s Duty to Defend

In Texas, subject to the terms of the insurance policy, if the insurer has a duty to defend with respect to any aspect of the lawsuit, it has the duty to defend with regard to every aspect of the lawsuit.[6]  The existence of a defense obligation under Texas law is determined by performing an “eight-corners” analysis.[7]  This is a comparison of the four corners of the petition or complaint with the four corners of the insurance policy, irrespective of the true facts of the claim.[8]  If any of the allegations of the petition or complaint fall under the umbrella of coverage, the carrier has a duty to defend.[9]

If the duty to defend arises, liability insurance policies grant to the insurer the complete, absolute control over the defense.[10]  The insurer has the right to make defense decisions, such as choosing the insured’s counsel, as if it were the client “where no conflict of interest exists.”[11]  However, even though the insurer’s chosen counsel owes a duty of unqualified loyalty to its insured, the duty can be threatened where the insured’s interests contrast sharply with those of the insurer.”[12]

Independent Counsel

When an insurer issues a reservation of rights and depending on the basis of the reservation and applicable law, a conflict of interest may arise such that the policyholder is entitled to select counsel of its own choosing.[13]  Under Texas law, the test for determining whether a conflict of interest exists in this context, is whether the facts to be adjudicated in the underlying lawsuit are the same facts upon which coverage depends.[14]

Texas Courts have held a carrier’s issuance of a reservation of rights letter alone does not give an insured the right to reject panel counsel and select its own independent counsel.[15]  Additionally, Texas Courts have held an insured’s disagreement regarding the insurer’s decision regarding whether to challenge venue as well as a disagreement about how the defense should be conducted did not raise a conflict of interest, thus the insured was not entitled to independent counsel.[16]

In Davalos, the Texas Supreme Court found the right to independent counsel was triggered because under the insured’s reservation of rights, some of the alleged causes of action where covered, while others were not.[17]  Other conflicts may also justify an insured's refusal of an offered defense, such as:

(1) when the defense tendered "is not a complete defense under circumstances in which it should have been;"

(2) when "the attorney hired by the carrier acts unethically and, at the insurer's direction, advances the insurer's interests at the expense of the insured's;"

(3) when "the defense would not, under the governing law, satisfy the insurer's duty to defend;" and

(4) when, though the defense is otherwise proper, "the insurer attempts to obtain some type of concession from the insured before it will defend."[18]

Accordingly, the insured may rightfully refuse an inadequate defense as well as any defense conditioned on an unreasonable, extra-contractual demand that threatens the insured's independent legal rights.

Where a conflict of interest exists, the insured can potentially look to the insurance company for the payment of attorney’s fees.[19]  Applying Texas Law, the Fifth Circuit in Downhole held an insurer did not have to reimburse the insured’s independent counsel fees when the grounds for its reservation of rights did not implicate facts that would be adjudicated in the underlying action.[20]  Thus, where a conflict of interest exists, the insured can reject the reservation of rights letter under Texas law and hire its own lawyer, while potentially looking to the insurance company for the payment of the attorney’s fees.

Conclusion

Under Texas law, if the insurer issues a reservation of rights letter, the insured has the right to either accept or reject the defenses in the reservation of rights letter.  In Texas, subject to the terms of the insurance policy, if the insurer has a duty to defend with respect to any aspect of the lawsuit, it has the duty to defend with regard to every aspect of the lawsuit.  However, the insured will be able to appoint independent counsel if it can demonstrate a clear conflict of interest between itself and the insurer.


[1] Jonathan A. Judd, Defending Under a Reservation of Rights: A Potential Minefield of Conflicts, http://www.hrrvlaw.com/resources/defending-under-a-reservation-of-rights.pdf, at 16 (Spring 2010).

[2] See, e.g., Sosebee v. Steadfast Ins. Co., 701 F.3d 1012, 1020 (5th Cir. 2012); Nutmeg Ins. Co. v. Clear Lake City Water Auth., 229 F.Supp.2d 668, 696-97 (S.D. Tex. 2002).

[3] Texas Assn. of Counties Cty. Gov’t Risk Mgmt. Pool v. Matagorda Cty., 52 S.W.3d 128, 132 (Tex. 2000).

[4] Id. (citing Western Cas. & Sur. Co. v. Newell Mfg. Co., 566 S.W.2d 74, 76 (Tex. Civ. App.—San Antonio 1978, writ ref ’d n.r.e.)).

[5] Graper v. Mid-Continent Cas. Co., 756 F.3d 388 (5th Cir. 2014).

[6] Heyden Newport Chem. Ins. Co. v. S. Gen’l Ins. Co., 387 S.W.2d 22, 26 (Tex. 1965).

[7] Farmers Texas Cty. Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 82 (Tex. 1997).

[8] Id.

[9] Id.

[10] Graper, 756 F.3d 388 (citing Unauthorized Practice of Law Comm. v. Am. Home Assur. Co., 261 S.W.3d 24, 26 (Tex. 2008)).

[11] State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625, 627 (Tex. 1998).

[12] Id. at 628.

[13] Unauthorized Practice of Law Comm. v. Am. Home Assur. Co., Inc., 61 S.W.3d 24, 40 (Tex. 2008) (the assertion of the reservation of rights alone does not create a conflict between the insured and insurer; it only creates the possibility that such a conflict may arise in the future)

[14] Northern County Mut. Ins. Co. v. Davalos, 140 S.W.3d 685,689 (Tex. 2004).

[15] Joe B. Partain, et al. v. Mid-Continent Specialty Ins. Serv. Inc., 838 F.Supp.2d 547 (2012); See Davalos, 140 S.W.3d at 688 (The right to conduct the defense by the insurer is a matter of contract).

[16] Davalos, 140 S.W.3d at 685; see also Traver, 980 S.W.2d 625 (Tex. 1998).

[17] Davalos, 140 S.W.3d at 689.

[18] Id.; See 1 Allan D. Windt, Insurance Claims and Disputes § 4.25 at 393 (4th ed.2001).

[19] Britt v. Cambridge Mut. Fire Ins. Co., 717 S.W.2d 476, 481 (Tex. App.—San Antonio 1986, writ ref’d n.r.e.).

[20] Downhole Navigator, L.L.C. v. Nautilus Ins. Co., 686 F.3d 325, 331 (5th Cir. 2012).

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