Insurance Defense: Reservation of Rights Letter

An insured may choose its own attorney to defend a lawsuit if the insurer issues a reservation of rights letter. 

Virtually all liability policies, including policies which cover employment-related claims, obligate insurers to defend lawsuits filed against their insureds.  As a consequence, insurers typically hire and pay attorneys to defend claims, in part because the insurer wants to be confident that a good defense is provided and to have control over the litigation. 

In many lawsuits, a plaintiff alleges multiple types of claims, only some of which would be covered by the defendant’s insurance policy.  For example, the plaintiff may allege that he was injured as the result of defendant’s negligence and intentional misconduct.  Most policies cover claims based on negligence, but exclude coverage for intentional torts, such as assault and battery.  In those situations, insurers issue what is commonly called a “reservation of rights letter”, which states that coverage for some or all of plaintiff’s claims will be denied if facts are learned during the litigation which show that the policy does not encompass the misconduct attributed to the insured. 

The courts in Maryland and other states have recognized that the potential for such a denial may create a conflict of interest for an attorney hired by an insurer because that lawyer effectively has two clients—the insurer and the insured—who have divergent goals with respect to whether coverage exists for a claim.  If the attorney learns facts which would enable the insurer to deny coverage, the insurer would expect that information to be provided to it.  The insured, on the other hand, would want the attorney to protect it by withholding the information from the insurer.

The courts have resolved that dilemma by establishing a rule which at least sometimes requires insurers to honor their contractual obligation to defend insureds by giving them a choice.  The insured may permit the attorney selected by the insurer to handle the defense OR may require the insurer to pay the reasonable fees charged by a lawyer chosen by the insured.  When such a choice is available, most insureds choose the second option for obvious reasons and then negotiations ensue between that attorney and the insurer about the “reasonable” fee to be charged. 

 In that regard, insurers invariably have negotiated very low hourly rates with groups of attorneys, typically called “panel counsel”, who are retained to handle the relatively large volume of cases filed against the companies’ insureds in particular locales.  For that reason, the insurer will try to persuade the insured’s lawyer to accept that rate, but a higher rate is usually set.

Very few insureds know about this effect of a reservation of rights letter and insurers will not tell them about their option to select an attorney to be paid by the insurer.  For that reason, insureds should carefully read letters received from insurers acknowledging receipt of claims under liability policies and confer with an attorney to determine whether the letters include a reservation of rights and what steps should be taken if they do.


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