When the insurer’s defense becomes adverse to the insured—and what to do about it
Missouri Injury & Insurance Law | missouriinjuryandinsurancelaw.com
Introduction
When a liability insurer issues a reservation of rights, it alerts the insured that while the insurer will defend the case, it reserves the right to later disclaim coverage. On the surface, this appears to be a reasonable accommodation—the insured gets a defense while coverage is sorted out. In practice, however, a reservation of rights can create a profound conflict of interest between the insurer and insured that fundamentally compromises the defense. Missouri law recognizes this conflict and provides important protections for insured defendants. Practitioners who understand these protections can use them both to protect their clients and to create strategic advantages in subsequent coverage litigation.
The Three-Option Framework Revisited
Missouri’s three-option framework—defend, defend under reservation, or refuse—is well-settled under State ex rel. Rimco, Inc. v. Dowd, 858 S.W.2d 307, 308 (Mo. App. E.D. 1993). But the framework does not end with the insurer’s choice. When an insurer elects to defend under a reservation of rights, a further question arises: does the insured have the right to accept or reject a defense tendered under reservation? Missouri courts have answered that question affirmatively.
“If the company chooses the second alternative, the insured may elect to refuse to allow a defense under a reservation of rights.” Safeco Ins. Co. of Am. v. Rogers, 968 S.W.2d 256, 258 (Mo. App. W.D. 1998); State ex rel. Mid-Century Ins. Co. v. McKelvey, 666 S.W.2d 457, 459 (Mo. App. W.D. 1984).
The insured’s right to refuse a reservation of rights defense is not merely a procedural curiosity—it is grounded in the recognition that a defense controlled by an insurer with a coverage defense may not be a genuine defense at all. As the Eastern District observed in Rimco, a reservation of rights ‘may chill a zealous defense based on the insurer’s assessment of the liability, and it presents a possible conflict of interest because the insurer may be more concerned with developing facts showing noncoverage than facts defeating liability.’ State ex rel. Rimco, Inc. v. Dowd, 858 S.W.2d 307 (Mo. App. E.D. 1993).
The Conflict of Interest in Detail
The conflict of interest inherent in a reservation of rights defense operates on multiple levels. At the most basic level, defense counsel appointed by an insurer under a reservation of rights serves two masters with divergent interests: the insured, who needs a vigorous defense on the merits, and the insurer, which needs facts developed to support a coverage denial. These objectives frequently point in opposite directions.
Consider a typical scenario: an insured is sued in tort under multiple counts including intentional acts and negligence acts, and the policy excludes intentional acts. The insurer defends under a reservation, asserting that if the insured acted intentionally, there is no coverage for those claims. Defense counsel’s task on the merits may require arguing that the insured acted negligently or in self-defense—both of which would support coverage. But counsel appointed by the insurer may be subtly (or not so subtly) influenced toward developing evidence that supports the intentional act exclusion, directly contrary to the insured’s defense interests.
Missouri’s recognition of this conflict is explicit. The Missouri Bar’s treatise on insurance practice states that when the insurer has filed a declaratory judgment action to resolve coverage questions, ‘an actual conflict does exist between the interests of the insured and those of the liability insurer.’ II Mo. Ins. Prac. Section 13.68 (Mo. Bar 5th Ed. 2004). In these circumstances, the treatise recommends that defense counsel ‘remain wholly independent from the insurer and, in many instances, should not report to or discuss with the insurer any facts, legal theories, etc. concerning counsel’s defense of the action against the insured.’ Id.
Independent Counsel: When It Is Required and What It Means
The conflict of interest analysis leads directly to the question of independent counsel. In reservation of rights situations where a genuine conflict exists, Missouri law supports the insured’s right to retain independent counsel at the insurer’s expense. The rationale is straightforward: if the insurer-appointed counsel cannot adequately serve the insured’s interests because of the conflict, the insured is entitled to counsel who can—and the insurer, having created the conflict by issuing a reservation of rights, should bear the cost.
Independent counsel in this context means counsel who is genuinely independent—not merely counsel selected from a different firm on the insurer’s approved panel. True independence requires that counsel take direction exclusively from the insured, that counsel not report defense strategy or privileged communications to the insurer, and that counsel advocate solely for the insured’s interests in the underlying litigation without regard to the coverage implications. As the Missouri Bar treatise recognizes, complete independence ‘may well be required’ when the insurer and insured ‘become truly adverse parties’ upon the filing of a declaratory judgment action. II Mo. Ins. Prac. Section 13.68 (Mo. Bar 5th Ed. 2004). However, Missouri law, unlike some other states, does not require providing the insured with a choice of attorney paid for by the insurer. Thus, when a reservation of rights is issued the best course is for the insured tortfeasor to seek private counsel sperate from the attorneys providing the defense under the insurance policy.
Practitioners advising insured defendants who have received a reservation of rights should evaluate immediately whether the reservation creates a genuine conflict and, if so, should demand independent counsel in writing. The demand should cite the specific coverage defense asserted in the reservation, identify the ways in which that defense conflicts with the insured’s litigation interests, and demand that the insurer agree to fund independent counsel of the insured’s choosing. Whether this happens or not may be an important factor in subsequent litigation. Document the insurer’s response carefully.
Strategic Implications for Plaintiff’s Practitioners
For plaintiff’s counsel in personal injury cases, an insured defendant who is operating under a reservation of rights presents distinctive opportunities. An insured who understands that the insurer-appointed defense counsel may not be fully serving the insured’s interests is more likely to engage constructively with plaintiff’s counsel about resolution of the case, sources of recovery, and the pursuit of extra contractual claims. The insured who has been advised to obtain independent counsel has counsel whose obligation runs exclusively to the insured—not to the insurer—and who can evaluate coverage, tort exposure, settlement and extra contractual liability without the conflict that afflicts insurer-appointed counsel.
Plaintiff’s counsel should also be alert to the possibility that defense conduct in reservation of rights cases will yield evidence of the insurer’s bad faith. When insurer-appointed counsel develops facts that support the coverage denial while neglecting the merits defense, that conduct is direct evidence of the conflict the Rimco court warned about and supports the insured’s claim that the insurer breached its fiduciary duty under Zumwalt v. Utilities Insurance Co., 228 S.W.2d 750 (Mo. 1950).
The Declaratory Judgment Action as the Inflection Point
The conflict of interest between insurer and insured reaches its apex when the insurer files a declaratory judgment action seeking a ruling that no coverage exists while simultaneously purporting to defend the insured. At this point, as Missouri insurance practice authority recognizes, the insurer and insured are ‘truly adverse parties.’ II Mo. Ins. Prac. Section 13.68 (Mo. Bar 5th Ed. 2004). The filing of the declaratory judgment action is, in practical terms, a declaration by the insurer that it is adverse to its insured in the coverage dispute.
When an insurer files a declaratory judgment action after issuing a reservation is filed, practitioners should immediately assess whether the insured has grounds to intervene in the declaratory judgment action, whether the insured should retain separate coverage counsel, and whether the circumstances have ripened into a bad faith claim. An insurer that files a declaratory judgment action, continues to control the defense through appointed counsel, and uses the defense to develop facts supporting the coverage denial has engaged in conduct that is difficult to reconcile with the fiduciary obligation established in Zumwalt.
Practical Checklist for Reservation of Rights Situations
When a client receives a reservation of rights letter, practitioners should systematically address the following: Obtain a complete copy of the reservation of rights letter and identify every coverage defense being reserved. Compare each coverage defense to the allegations in the underlying petition and to the facts of the case to assess whether a genuine conflict exists. Evaluate whether the insurer has filed or is likely to file a declaratory judgment action. Advise the client of the right to refuse the reservation of rights defense. The decision on whether to accept of deny the reservations is a complex one that depends on a number of considerations. Each case is unique but in general counsel must evaluate and consider the client’s circumstances and needs, the merit of the disputed coverage issues, the risk presented by the claims against the insured, the possibility of settlement with the claimant. If the reservation might be accepted and it appears a genuine conflict exists, counsel should demand independent counsel in writing and document the insurer’s response. Preserve all communications between the insured and insurer-appointed counsel for potential use in subsequent bad faith litigation. If the reservation will be rejected then counsel must have a post rejection strategy. Question to ask and have answers to include: Will the insured settle the claim or defend the claim? Is a Section 537.065 RSMo. agreement appropriate? Will the insured file an action against the insurer over coverage? Is a declaratory judgment by the insurer likely to be filed? What forum will the insurer choose? Is there a potential for extra contractual claims? The answers to all these questions should be evaluated based upon the available information. As early as possible begin building the record for a potential bad faith if the insurer’s conduct warrants it.
Conclusion
Missouri’s reservation of rights framework is more protective of insured defendants than practitioners sometimes appreciate. The insured’s right to refuse a reservation of rights defense, the recognition of the conflict of interest that such defenses may create give insureds some tools to protect themselves from insurers who would use the defense process against them. Practitioners who understand and deploy these tools—and who build the record for a bad faith claim when the insurer’s conduct warrants it—will provide the most effective representation to their insured clients.
