- Ohio Policyholders Beware: That Reservation of Rights Letter From Your Insurer May Actually Be An Invoice
- September 29, 2003 | Author: William J. Pohlman
- Law Firm: Vorys, Sater, Seymour and Pease LLP - Columbus Office
Consider the following factual scenario. Your company is named as a defendant in a federal court lawsuit. The complaint alleges patent and trademark infringement. Your company turns to its liability insurer for assistance and promptly tenders defense of the lawsuit. The insurer agrees to provide a defense, subject to the ubiquitous "reservation of rights." Relieved that counsel is on board to defend your company in this serious matter, nobody bothers to fly speck the reservation of rights letter from the insurer. Instead, the letter is placed in the file and forgotten.
Given the technical nature of the claims brought against your company, the insurer retains experienced defense counsel from two national law firms. The defense of the infringement action goes reasonably well, but is expensive. On behalf of your company, the insurer pays nearly $120,000 in legal fees and expenses, before the case is ultimately resolved.
A few months thereafter, a summons and complaint are delivered to your office. Your insurance company - the company that seemingly stood beside you during the infringement suit - has initiated its own federal court action. The insurance company now seeks a declaratory judgment that it owed no duty to defend your company in the underlying infringement action.
The parties file cross-motions for summary judgment on the duty to defend issue. Ruling in favor of the insurer, the trial court finds that no defense duties were owed. The appellate court affirms. Then comes the zinger. Without any advance notice, the insurer files a post-trial motion to recover the $120,000 in attorneys fees and expenses paid on your company's behalf in the infringement action. To add insult to injury, the insurer also seeks nearly $30,000 in interest.
How can this be, you ask? Buried within the reservation of rights letter is the following sentence: "[Insurer] reserves the right to recoup from [policyholder] any defense costs and fees to be paid subject to this reservation of rights letter on the basis that no duty to defend now exists or has existed with regard to the tendered suit."
You quickly review the language in the liability policy. There is no mention whatsoever of any "right to recoup" defense costs. You breathe somewhat easier. Besides, your company never agreed that the insurer could recoup defense costs.
The trial court denies the motion. You feel relieved. The insurer appeals and then the unthinkable happens - the appellate court reverses. Your company now owes the insurer $150,000.
II. The Recent Decision In United National Ins. Co. v. SST Fitness Corp.
Pure fantasy? Wild speculation? Unfortunately not. The facts outlined above are drawn from the recent decision by the United States Court of Appeals for the Sixth Circuit in United National Insurance Co. v. SST Fitness Corp., 309 F.3d 914 (Nov. 4, 2002).
In a decision of first impression under Ohio law, a divided panel of the Sixth Circuit held that an insurer could obtain reimbursement of the defense costs advanced on behalf of its policyholder as well as prejudgment interest. The court first canvassed other jurisdictions and found a handful of decisions it felt were pertinent. In each of those other cases, the insurers provided a defense subject to a timely reservation of rights, the reservation of rights letter expressly claimed a "right" to reimbursement of defense costs, and the policyholder accepted the defense without objecting in any way to the insurer's claimed reimbursement right. The Sixth Circuit concluded that "[t]he general rule . . . appears to be that, if these conditions are met, a reservation of rights is enforceable even absent an express agreement by the insured." 309 F3d. at 919. Next, the court found that an implied-in-fact contract was formed when the insurer issued a reservation of rights letter conditioning payment of defense costs on the right to seek reimbursement and the insured did not object to the letter. The court also rejected the suggestion that the insurance company acted as a "volunteer" in advancing defense costs. The court was persuaded by two facts: the policyholder asked the insurer to pay those costs; and when the insurer did so, the insurer had expressly reserved its "right" to seek recoupment.
The decision in United National seems misguided in several respects. First, the decision mistakenly found that the unilateral reservation of rights letter created a new, enforceable agreement between the parties. Policyholders pay premiums to insurers for protection against groundless, false, even fraudulent lawsuits. With the purchase and issuance of the liability policy, therefore, the parties have already agreed that, so long as one claim asserted against the policyholder is arguably or potentially covered under the policy, the insurer will provide a defense for all claims. It was against that backdrop - not seeking some new commitment to defend - that the policyholder in United National tendered the infringement suit to its insurer.
Furthermore, unlike some policies that contain such provisions, the insurance policy at issue in United National was devoid of any language purporting to reserve to the insurer a "right" to recoup defense costs. The insurer's attempt to "reserve its rights" to recoup defense costs was a misnomer; there were no such "rights" under the policy. Under these circumstances, the insurer's reservation of rights letter is properly viewed as a unilateral offer to append a reimbursement provision onto the terms of the parties' pre-existing insurance contract. In order for such an offer to become binding, however, Ohio law requires affirmative acceptance by the other party (i.e., a "meeting of the minds"). Indeed, a fundamental principle of contract law is that silence and inaction will not be construed as an assent to an offer. Ohio law also requires separate legal consideration before any modification to the contract becomes enforceable. The United National court found a binding agreement, even though the policyholder neither affirmatively assented to the unilateral offer nor granted new consideration.
Second, the United National opinion overlooks decisions from other jurisdictions that have rejected the suggestion that a unilateral reservation of rights letter (to which the policyholder does not expressly agree) can create new, binding obligations. For instance, the Supreme Court of Texas found that "a unilateral reservation-of-rights letter cannot create rights not contained in the insurance policy." Texas Ass 'n of Counties County Gov't Risk Management Pool v. Matagorda County, 52 S.W.3d 128, 131 (Tex. 2000). The Texas court held that a policyholder's silence in response to a reservation of rights letter could not support an implied agreement to reimburse uncovered settlement costs. Similarly, the Supreme Court of Wyoming has held that when an insurance policy fails to include specific language (e.g., reserving a right to allocate defense costs between covered and uncovered claims), the policy cannot be altered or amended through language in a subsequent reservation of rights letter. As that court explained, "endorsing such conduct is tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract." Shoshone First Bank v. Pacific Employers Ins. Co., 2 P.3d 510, 516 (Wyo. 2000).
Finally, the United National decision seems to have uprooted the traditional relationship between Ohio policyholders and their liability insurers. When a policyholder tendered a lawsuit to its liability insurer, the insurer customarily had three potential responses. First, the insurer could unconditionally accept the claim. In that situation, the insurer would completely control the defense of the lawsuit (including any settlement negotiations), would waive any and all coverage defenses, and would also be estopped from denying its obligation to indemnify the policyholder (up to the policy limits) against any resulting damage awards or judgments. Second, the insurer could reject the claim as beyond the scope of the coverages afforded under the policy. In that situation, the policyholder would be left to defend and resolve the claim on its own. If the policyholder subsequently established that it was, in fact, entitled to insurance coverage (and thus that the insurer had wrongfully denied the claim), the insurer would be bound by the policyholder's resolution of the claim. Third, the insurer could agree to defend the policyholder in the lawsuit, while reserving its rights under the policy to deny any obligation to indemnify. When an insurer defends under a reservation of rights, the insurer assumes control of the defense and resolution of the claims, while protecting itself against possible waiver and estoppel of defenses to coverage, until such time as a court establishes (frequently, in a parallel declaratory judgment action) that the insurer has no duty to defend or indemnify the policyholder. Although the insurer's assumption of the defense under a reservation of rights undoubtedly also benefits the policyholder, numerous courts have recognized that such a defense is undertaken primarily to protect the insurer's own interests.
As a result of the United National decision, however, insurers of Ohio policyholders now have a fourth option: agree to defend a policyholder in the underlying lawsuit and reserve the "right" to recoup those defense costs at a later date. Thus, Ohio policyholders may now be forced to pay (regardless of the contractual language in the insurance policy) for the self-protective measures taken by their insurers. Such a result directly contradicts the time-honored principles outlined above. As one court has explained: "A rule permitting such recovery would be inconsistent with the legal principles that induce an insurer's offer to defend under reservation of rights. Faced with uncertainty as to its duty to indemnify, an insurer offers a defense under reservation of rights to avoid the risks that an inept or lackadaisical defense of the underlying action may expose it to if it turns out there is a duty to indemnify. At the same time, the insurer wishes to preserve its right to contest the duty to indemnify if the defense is unsuccessful. . . . If the insurer could recover defense costs, the insured would be required to pay for the insurer's action in protecting itself against the estoppel to deny coverage that would be implied if it undertook the defense without reservation." Terra Nova Ins. Co. Ltd. v. 900 Bar, Inc., 887 F.2d 1213, 1219-20 (3rd Cit. 1989).
Ascertaining whether certain lawsuits are entitled to a defense under liability policies can be difficult. But insurance companies are in the business of making those determinations every day. The United National decision seemingly gives insurers of Ohio policyholders a convenient way to evade that responsibility.
III. The Future For Ohio Policyholders
The interpretation of liability insurance policies is generally a question of state law. The Sixth Circuit has merely predicted how the Ohio Supreme Court may rule. Thus, an insurer's right to seek recoupment of defense costs through a reservation of rights letter technically remains an open issue under Ohio law. Until the Ohio Supreme Court rules definitively on the issue, however, Ohio policyholders should exercise extreme vigilance in their dealings with liability insurers.
How should an Ohio policyholder respond when it receives a reservation of rights letter from its liability insurer? First and foremost, the policyholder should review the reservation of rights letter very carefully. To the extent the reservation of rights letter attempts to impose new obligations or create new rights, the policyholder should consider whether to object, in writing, to those attempts and insist that the insurer comply with all of its obligations under the existing insurance contract. By doing so, a policyholder will seemingly have protected itself against the assertion that it "consented" to any new terms contained within the reservation of rights letter. Sending such a letter, however, is not without risks. The insurer may respond by denying coverage altogether, thereby leaving the policyholder to contend with a potentially difficult lawsuit entirely on its own.
While the long-term implications of the United National decision remain uncertain, the immediate impact is clear. When an Ohio policyholder now receives a reservation of rights letter from its insurer, it may well find itself squarely on the horns of a dilemma.