A guide to the reservation of rights in the third-party liability context — what it is, what it must contain, the conflict of interest it creates, the insured’s right to refuse, the right to independent counsel, and its role in the bad faith and § 537.065 frameworks
Missouri Injury & Insurance Law | missouriinjuryandinsurancelaw.com
Introduction: The Third-Party Liability Context
This post addresses the reservation of rights in a specific and important context: the insured who has been sued in a third-party tort action and tenders the claim to their liability insurer for defense and indemnity. The insurer accepts the tender — at least provisionally — but issues a reservation of rights letter indicating that while it will defend, it may later deny coverage for any judgment or settlement that results.
This is the reservation of rights as it arises in personal injury, wrongful death, and general liability litigation. It is distinct from first-party claims handling — situations where the insured is making a claim on their own policy for their own loss. The duties, regulatory framework, and legal consequences that govern first-party claim handling do not apply here. What applies is the common law framework governing the liability insurer’s duties to its insured in third-party litigation.
That framework centers on a structural conflict of interest that a reservation of rights creates — and on Missouri’s recognition that the insured is not required to simply accept the compromised defense the reservation represents. Understanding what a reservation of rights is, what it must say, what rights it creates, and what it signals about the coverage and bad faith disputes ahead is essential for every practitioner who handles liability insurance cases.
What a Reservation of Rights Is
When an insured is served with a lawsuit and tenders the defense to their liability insurer, the insurer faces a choice: accept the defense unconditionally, deny the defense outright, or accept the defense while preserving the right to contest coverage. The reservation of rights is the third option. It is a formal written notice stating that the insurer will defend the underlying lawsuit while reserving its right to deny coverage for any judgment or settlement that results.
A reservation of rights is not a denial of coverage. The insurer is still defending. It is not a guarantee of coverage. The insurer is expressly declining to commit to paying. It is a holding position: the insurer performs its defense obligation while simultaneously preserving its ability to argue — at the conclusion of the underlying litigation or in a separate declaratory judgment action — that the policy does not cover the claim.
The reservation protects the insurer from estoppel. An insurer that defends an insured for years without a reservation of rights and then attempts to deny coverage at the end may be estopped from doing so if the insured was prejudiced by relying on the unconditioned defense. The reservation letter is how the insurer avoids that estoppel while still fulfilling its defense obligation.
| A reservation of rights is the insurer saying: “We are defending this lawsuit. We have identified one or more potential grounds for denying coverage. We are not deciding that question now. We reserve all our rights under the policy, including the right to deny coverage when the underlying case resolves.” The insured has been put on notice that the defense being provided may not result in the insurer paying the judgment. |
What a Valid Reservation Must Contain
There is no Missouri statute prescribing required language for a reservation of rights letter in the third-party liability context. The requirements come from case law. Missouri courts have held that a proper reservation of rights must contain a clear disclaimer of potential coverage liability, identify the grounds for that disclaimer, and provide the facts and policy provisions necessary for the insured to make an informed decision about whether to accept the defense under a reservation of rights. Brooner & Associates Construction, Inc. v. Western Casualty & Surety Co., 760 S.W.2d 445 (Mo. App. W.D. 1988).
In practice, a valid reservation of rights letter in a third-party liability case should:
Be in writing and be timely. The reservation must be in writing and delivered promptly after the insurer identifies the coverage question. An insurer that waits months — or until after significant litigation has occurred — to issue a reservation risks waiver of the coverage defense and estoppel arguments from the insured who relied on the unconditioned defense.
Identify the specific policy provisions at issue. The insurer must identify the specific exclusions, conditions, or coverage limitations that create the coverage question. A boilerplate reservation that simply states “we reserve all rights under the policy” without identifying what those rights are fails to give the insured the information needed to understand and respond to the reservation.
Explain how the policy language applies to the specific facts. The insurer must explain why the identified provisions create a genuine coverage question given the specific allegations in the petition and the facts as known to the insurer. The better practice is to include a thorough analysis. Brooner & Associates, 760 S.W.2d at 445. Missouri courts have held that a reservation that does not timely, fully, or unambiguously explain the insurer’s coverage position may be insufficient. Advantage Buildings & Exteriors, Inc. v. Mid-Continent Casualty Co., 449 S.W.3d 16 (Mo. App. W.D. 2014).
Inform the insured of the conflict of interest and the insured’s rights. Because a reservation of rights creates a conflict of interest between the insurer and the insured, the letter should inform the insured of the potential conflict and of the options available to the insured in response — including the right to reject the reservation of rights defense.
The Conflict of Interest a Reservation Creates
When defense counsel has been retained the conflict of interest created by a reservation of rights in the third-party context is structural and unavoidable. It arises from the triangular relationship between the insurer, the defense counsel the insurer appoints and pays, and the insured. Without a reservation, all three parties are aligned: the insurer wants to defend successfully, defense counsel represents the insured’s interests and reports to the insurer, and both want the best possible result in the underlying lawsuit. A defense verdict or a reasonable settlement is in everyone’s interest.
Under a reservation of rights, the alignment breaks. The insurer is now also the adverse party on the coverage question. In Missouri the insurance defense counsel has an attorney client relationship with both the defendant and the insurer. Defense counsel is paid by the insurance client and has a fiduciary relationship with the insurer. The insurer has a direct financial interest in developing facts that support non-coverage. This is an actual conflict, and the reason defense lawyers usually make it abundantly clear they are staying out of the coverage issue. The tension is that if the claim is covered, the insurer pays the judgment. If the facts establish that the claim is excluded — that the conduct was intentional rather than negligent, that the injury occurred outside the policy period, that an exclusion applies — the insurer pays nothing. Defense counsel whose fees are paid by the insurer, and whose future work from the insurer depends on the relationship, faces structural pressure that is inconsistent with undivided loyalty to the insured. Even if counsel asserts they are not involved in coverage some cases make this nearly impossible as the ultimate facts in dispute in the case may also determine coverage and may be highly disputed.
Missouri recognizes this conflict explicitly. State ex rel. Rimco, Inc. v. Dowd, 858 S.W.2d 307, 308 (Mo. App. E.D. 1993), held that a defense under a reservation of rights presents a potential conflict of interest between the insurer and the insured because the insurer may have a greater interest in developing facts establishing non-coverage rather than in defending against the insured’s liability.
| The core problem: defense counsel is the insured’s lawyer, but also the insurer’s lawyer and the insurer is paying the bills and has a financial interest in developing facts that defeat coverage. The insured needs a defense that minimizes liability exposure. The insurer may benefit from a defense strategy that produces findings establishing the claim is excluded. A single lawyer cannot fully serve both interests simultaneously. |
The Insured’s Right to Refuse
Missouri is among a minority of states that allows the insured to refuse a defense offered under a reservation of rights. State Farm Mutual Automobile Insurance Co. v. Ballmer, 899 S.W.2d 523, 527 (Mo. banc 1995). This right exists because the insured cannot be compelled to accept a defense controlled and funded by a party with adverse interests in the coverage question. The potential conflict of interest a reservation creates is a legally recognized justification for the insured to decline the defense entirely.
If the insured rejects the reservation of rights defense, the insurer faces three choices:
Defend without reservation. The insurer withdraws the reservation and provides an unconditional defense, accepting the risk of estoppel if it later attempts to deny coverage after the insured has relied on the unconditioned defense.
Withdraw from the defense. The insurer refuses to defend at all. This is a wrongful refusal to defend with all the consequences that follow: the insured is entitled to retain its own counsel, the insurer is liable for the resulting defense costs and potentially for the entire judgment, and under Allen v. Bryers, 512 S.W.3d 17 (Mo. 2016) the insurer is bound by facts necessarily determined in the underlying litigation it chose to sit out.
File a declaratory judgment action. The insurer brings a declaratory judgment action to resolve the coverage question while seeking a stay of the underlying tort case. Missouri courts have expressly recommended this option for insurers with genuine good-faith coverage questions. State ex rel. Mid-Century Insurance Co. v. McKelvey, 666 S.W.2d 457, 459 (Mo. App. 1984). This allows the insurer to litigate the coverage question without the conflict created by simultaneously funding the insured’s defense.
| For the insured: the right to refuse a reservation of rights defense is meaningful but must be exercised carefully. Rejecting the defense without immediately securing independent qualified defense counsel leaves the insured unrepresented in the underlying litigation. The decision to reject a reservation requires immediate consultation with independent coverage counsel before the insured acts. |
The Right to Independent Counsel
Where the insured accepts a defense under a reservation of rights, Missouri law recognizes that the conflict of interest may entitle the insured to independent counsel. To avoid the conflict, the insurer must either provide an independent attorney to represent the insured or pay the costs the insured incurs in retaining independent counsel of its own choice. Howard v. Russell Stover Candies, Inc., 649 F.2d 620, 625 (8th Cir. 1981) (applying Missouri law) (quoting U.S. Fidelity & Guaranty Co. v. Louis A. Roser Co., 585 F.2d 932, 939 n.6 (8th Cir. 1978)).
The right to independent counsel is not automatic upon receipt of any reservation letter. It arises when the reservation of rights creates an actual conflict of interest between the insurer’s interests and the insured’s interests in the conduct of the defense. Missouri courts focus on whether coverage depends on the same facts that will be decided in the underlying litigation. The classic conflict arises where the policy covers negligent conduct but excludes intentional conduct, and the underlying lawsuit alleges facts that could support either characterization. If defense counsel develops facts establishing intentional conduct, the insurer escapes coverage liability but the insured loses the case without coverage. The insured’s and insurer’s interests cannot both be served by a single lawyer paid by the insurer.
Other common conflict scenarios include: where the policy requires the insured’s acts to have been unexpected and unintended and the defense strategy affects that determination; where multiple insureds under the same policy have divergent interests in specific factual questions; and where coverage depends on timing or location facts that the defense strategy may develop in ways that defeat coverage.
Where an actual conflict of interest exists, the insurer must pay for independent counsel selected by the insured. The insured is not required to bear the cost of protecting itself against a conflict the insurer’s own reservation created. The insurer cannot dictate who the insured retains when the conflict of interest exists — the choice of independent counsel belongs to the insured.
The Reservation of Rights and the § 537.065 Framework
A reservation of rights that the insurer refuses to withdraw is one of the two conditions that opens the door to a § 537.065 agreement. Under § 537.065.1 R.S.Mo., the injured party and the insured may enter a § 537.065 agreement limiting execution to insurance proceeds when the insurer has “refused to withdraw a reservation of rights or declined coverage.”
This means the insurer must be given the opportunity to withdraw the reservation before the § 537.065 framework is triggered. An insured or plaintiff who moves directly to a § 537.065 agreement without first requesting the insurer to withdraw its reservation may face an argument that the statutory condition was not met. The proper sequence is: insurer issues reservation; insured or insured’s counsel requests that the insurer withdraw the reservation and defend without condition; insurer refuses; the condition is now satisfied and the § 537.065 framework is available.
The refusal to withdraw a reservation of rights thus has consequences far beyond the immediate defense dispute. It is a triggering event that exposes the insurer to the full § 537.065 framework — including the notice requirements, the intervention rights, and ultimately the bad faith claims that follow if the case cannot be settled within policy limits. An insurer that issues an aggressive or unfounded reservation and then refuses to withdraw it when it becomes clear the coverage defense is weak is creating exactly the conditions for the worst possible legal outcomes.
The Reservation of Rights and Bad Faith
A reservation of rights can itself be evidence of bad faith, depending on the circumstances and the quality of the coverage analysis behind it. The question is not whether the reservation was issued — reservations based on legitimate coverage questions are proper and expected. The question is how the reservation was issued, what it said, whether the coverage position it reflected was reasonable, and how the insurer conducted itself under the reservation.
A reservation that is strategically vague — drafted to give the insurer maximum flexibility rather than to honestly inform the insured of the coverage question — can be evidence of the insurer’s bad faith state of mind. Missouri courts have held that a reservation of rights that does not timely, fully, or unambiguously explain the insurer’s coverage position may contribute to a bad faith finding, even where the insurer ultimately succeeds on its coverage defense. Advantage Buildings & Exteriors, Inc. v. Mid-Continent Casualty Co., 449 S.W.3d 16 (Mo. App. W.D. 2014) (insurer held liable in bad faith despite winning declaratory judgment on coverage because its reservation letters did not adequately inform the insured of the coverage position).
More broadly, a reservation that is issued without a reasonable, good-faith basis in the policy language and the known facts is itself evidence of an insurer that is putting its coverage interests ahead of its insured’s defense interests. The insurer that reserves rights on weak grounds, or that uses a reservation as a tool for managing the defense to develop facts favorable to a coverage denial rather than facts favorable to the insured’s liability defense, is exhibiting precisely the conduct that Missouri’s bad faith framework exists to address.
Consider the pattern that emerges across many bad faith cases: the insurer issues a reservation of rights on grounds that are legally questionable; the insured tenders the claim and relies on the defense; the insurer’s appointed defense counsel develops the case in ways that are consistent with the coverage defense; the insured is damaged by the manner in which the defense was conducted; and the insurer ultimately either denies coverage or is held to have done so in bad faith. The reservation of rights letter is the first document in that sequence. How it was written, when it was issued, whether the coverage position it reflects was honestly held and well-grounded in the policy language — all of these are relevant to the bad faith analysis that may follow.
What Plaintiff’s Counsel Should Know
In a third-party personal injury case, the reservation of rights letter is addressed to the defendant insured, not to the plaintiff. But it is directly relevant to the plaintiff’s case in several ways.
It establishes a § 537.065 eligibility condition. A reservation the insurer refuses to withdraw satisfies one of the threshold conditions for a § 537.065 agreement. Plaintiff’s counsel should obtain the reservation letter as early as possible, determine whether it has been issued and whether it has been withdrawn, and assess whether the § 537.065 framework is available.
It reveals the insurer’s coverage position. The reservation discloses what coverage defenses the insurer intends to raise. Understanding those defenses early allows plaintiff’s counsel to structure the petition and develop the factual record in ways that minimize their force.
It is evidence in the bad faith case. Whether the reservation was timely, specific, adequately reasoned, and honestly communicated is directly relevant to the bad faith analysis. An inadequate, vague, or unfounded reservation is evidence of bad faith. Plaintiff’s counsel holding an assigned bad faith claim should scrutinize the reservation letter carefully as part of the claims file review.
It creates the conditions for insured-plaintiff alignment. A reservation of rights that creates a genuine conflict between the insurer and the insured is one of the structural conditions that aligns the insured’s interests with the plaintiff’s. An insured who understands that the insurer may use the defense to build a case for non-coverage has strong reasons to cooperate with the plaintiff in developing the factual record and in pursuing available claims against the insurer.
Conclusion
A reservation of rights in the third-party liability context is a pivotal document. It tells the insured that the defense being provided is conditional, that the insurer has identified a potential basis for later denying coverage, and that the insured’s interests and the insurer’s interests in the conduct of that defense may not be aligned. Missouri law responds to this situation with a meaningful set of insured protections: the right to refuse the reservation of rights defense; the right to independent counsel where a genuine conflict of interest exists; and the full consequences for an insurer that issues a reservation without a sound legal basis, uses it to damage rather than protect the insured, or fails to adequately communicate the coverage position.
The reservation of rights letter is also the starting point of the coverage dispute that will follow. How it is written, what it says, and whether the coverage position it reflects is well-grounded and honestly held will be examined in any subsequent declaratory judgment action, bad faith litigation, or § 537.065 proceeding. Practitioners on both sides of insurance litigation should understand what the reservation of rights is, what it triggers, and what it reveals.
This post is part of the bad faith foundational series on this blog. Related posts address the bad faith timeline, the bad faith damages framework, vexatious refusal under § 375.420, and the § 537.065 framework.
