Avoiding Waiver, Estoppel & Other Things That Go Bump In The Night

Every claims professional generally understands the need for reserving the carrier’s rights when a claim is made. Every claims handler understands many of the risks that go along with failure to reserve either timely or adequately. But often, in the everyday hectic pace of handling claims and quickly drafting reservation letters, we forget the real purpose behind reserving rights and the substantive types of risks we run if we do it incorrectly. So, let’s start the year with a return to basics.

Why reserve?
The “why” of reserving rights derives from the potential conflict between the two primary obligations of the carrier in liability insurance contracts. These duties, the duty to defend and the duty to indemnify, are determined by two very different tests—tests that do not necessarily overlap. The duty to defend is usually described as “broader” than the duty to indemnify because it may apply in many circumstances where the duty to indemnify (or the duty to pay) does not exist. This is true because the duty to defend is determined in most jurisdictions, and certainly in Texas, by comparing the policy language and the face of the pleadings, with all factual allegations taken as true whether they are actually true or merely frivolous. On the other hand, the duty to indemnify is determined by the actual facts of the underlying claim rather than simply the allegations pled. Consequently, there will be many circumstances when the duty to defend exists, although ultimately there will be no duty to pay any settlement or judgment on the part of the insurance company.

In other words, it is sometimes the case that the carrier has the right, or duty, to control the defense of the insured, even though it may not have any obligation to pay if there is either a settlement or the case is lost. That loss would fall upon the insured. The purpose of the reservation of rights is to notify the insured of this potential conflict and to allow it to take any steps that may be appropriate, such as hiring its own counsel to monitor the case in order to protect it from mismanagement or mishandling of the defense.

An interesting corollary that is often cited is that if there is no duty to defend, there can be no duty to indemnify. Indeed, there are cases adopting this idea. Their reasoning behind this is that the duty to defend is broader than the duty to indemnify, and therefore if there is no duty to defend, how could there be a duty to indemnify? However, while this proposition is likely true in almost all real-life circumstances, it is not necessarily true in all cases. For instance, assume that the tort plaintiff mispleads his case, which results in false facts which do not trigger a duty to defend. However, as the case develops and the actual facts are learned, it turns out that the facts do support a duty to indemnify. I agree that such circumstances will be rare; unfortunately, courts have been slow to recognize the possibility. This is probably due to the fact that courts will have little experience with this scenario: carriers are quick to pay where the facts fall within coverage.

Risks of failing to properly reserve
Since the reason behind reserving is to provide due process protections to the insured, it is not surprising that there are Draconian implications for the failure to reserve properly. The dire results of improperly reserving are usually referred to as waiver or estoppel. Although these are very different legal concepts, waiver and estoppel are often treated by courts and parties as if they are identical. There are important distinctions. In reality, waiver is almost never a risk where there is a problem in reserving rights. This is simply because a waiver requires the voluntary surrendering of a known legal right. State Farm Lloyds, Inc. vs. Williams, 791 S.W.2d 542 (Tex.App.—Dallas, 1990 writ denied). Carriers very seldom knowingly fail to properly reserve. The carrier’s failure to send a proper reservation may be a matter of negligence, but it is almost never a voluntary relinquishment of any rights under the policy.

The real problem is estoppel. As the venerable Professor Michael Quinn often describes it, “estoppel is a principle which simply says that if I treat you badly and hurt you, the law will ‘stop’ me from asserting rights I may have against you.” In other words, you may have rights under the insurance policy that would prevent there being a duty to indemnify, but if you do not properly assert them, so that the insured suffers harm or “prejudice,” then you will be prevented from asserting those contract rights.

Now I can hear you say, “But Brian, is it not black letter law that insurance coverage cannot be created by estoppel?” Well … no. It is correct that many cases across the country have held that coverage can not be created by waiver or estoppel. In practice it is much different. For instance, a 1980 Austin Court of Appeals case took the heart out of that principle in Texas. In Farmers Texas County Mut. Ins. Co. v. Wilkinson, 601 S.W.2d 520 (Tex.App.—Austin 1980 writ ref. n.r.e.), the Court wrote:

“It is well established that, whereas the doctrines of waiver and estoppel may operate to avoid conditions that would cause a forfeiture of an insurance policy, they will not operate to change, rewrite or enlarge the risks covered by the policy period.

“However, it follows from these general principles that, if an insurer assumes the insured’s defense without obtaining a reservation of rights or non-waiver agreement, and with knowledge of the facts indicating noncoverage, all policy defenses, including those of noncoverage, are waived, or the insurer may be estopped from raising them.”
(Id. at 521-22.)

OUCH! Okay, failure to properly reserve can create coverage where the policy would not otherwise provide it.

Methods of prevention
Clearly, estoppel must be avoided. Several simple rules should keep you out of trouble. First, send reservation of rights letters as soon as possible. This does not mean on the same day a claim comes in, as even courts recognize that claims professionals need time to evaluate and make claims decisions. What it does mean, however, is that while you usually have six to eight weeks to make a reasonable decision and to respond to a demand for coverage, you should avoid any further delays, at least without communication with the insured. If a case is particularly problematic, you may want to send “phased” reservation of rights letter where you identify the issues of concern that you are evaluating and inform the insured that you will follow-up with a more complete coverage position in a reasonable time. If you take this approach, however, make sure that you follow through. The ultimate test is whether the carrier is aware of a problem jeopardizing the insured’s right to indemnity. If the information is not available or the carrier is reasonably unaware of the problem, then there is no existing duty to send a reservation of rights letter. The key issue is whether the carrier acted in a timely manner when it learned of the problem with coverage.

Second, make sure that your reservation letter is as complete as possible. Remember that you can literally reserve any issue that may ultimately affect coverage. Make sure that you have carefully thought through the types of coverage issues that are raised by the petition and the policy language and reserve anything that may create a coverage problem. And as the case develops, supplement your reservation if you recognize or uncover other potential problems with coverage. Remember, the failure to recognize a coverage problem is not fatal. Failure to reserve it, when you have recognized the problem, can be.

Third, leave out nonessential information. The reservation of rights letter should be designed to provide notice to the insured of concerns with coverage. It is not a legal brief and any statements of law should be simple and unassailable. Avoid string citations. Avoid any citations at all unless absolutely necessary. This is not the time to prepare a brief or to argue your side of the case. It is a notice letter, treat it is as such.

To sophisticated claims professionals to whom the foregoing seems too elementary, consider this reiteration of basic tenets as a review. To those, however, who are learning the profession, please consider these issues very carefully and make sure that you understand the mechanics of these issues well. These are problems which, though easily avoided, can have devastating effects where forgotten or overlooked.

Brian S. Martin is a partner in the Insurance and Coverage Section of the Houston Office of Thompson, Coe, Cousins & Irons, L.L.P.

Topics Carriers Texas Claims