I have said this so many times. But given the huge importance of the issue, it is restated here. If you’ve read this before please forgive me.

You have just written the greatest reservation of rights letter ever. If Felix Unger handled claims, this is what his letter would look like. If there were a hall of fame for reservation of rights letters, you would soon get to see how you looked in bronze. Your letter compares the specific allegations in the complaint, to the policy language, and explains, with laser-like precision, why, despite the insured being provided with a defense, no coverage may be owed for any settlement or judgment. You mail the letter, put a copy in the file, take a deep breath of satisfaction, waste a few minutes reading a couple of meaningless articles on Yahoo, and then off you go to your next claim.

But the challenge with reservation of rights letters is not writing them. It is enforcing them. Because a reservation of rights letter is written in a sterile environment – at someone’s desk – it can easily spell out, in black and white terms, those claims and damages at issue in the underlying suit for which coverage may not be owed. The underlying litigation, on the other hand, is likely proceeding in a manner that is anything but as neat and tidy.

It will frequently be the case that the underlying litigation is simply not capable of producing an outcome that makes it possible for the insurer and insured to compare its results, with the reservation of rights letter, and easily decide which claims and damages are covered and which are not. To the contrary, the underlying litigation may result in a verdict that does not specify the extent to which it represents this or that type of damage or the claims on which the relief is based. In this situation, often-times referred to as a “general verdict,” the policyholder is likely to argue that, because the basis for the jury’s verdict cannot be determined, it must be presumed that the entirety of the jury award represents covered claims and damages. Adding to the difficulty for insurers is that it cannot ask appointed defense counsel to seek special jury interrogatories, which would go a long way toward solving this problem. [And similar problems may come from a settlement.]

Some courts have accepted the policyholder argument that, if the insurer created the problem of an inability to allocate between covered and uncovered claims, it must therefore bear the consequences. In other words, if it cannot be determined which portion of a verdict is covered and which is not, then all of the damages will be considered covered. Or the insurer may have a difficult burden to prove covered versus uncovered damages. In these situations, the fact that the insurer issued a world class reservation of rights letter, spelling out in detail its precise position on what is and what’s not covered, is no protection against failing to prevent a general verdict and the consequences that it causes.

At the heart of these decisions is the placing of blame on the insurer for being aware that the underlying litigation may result in a verdict that does not enable a determination to be made between covered and uncovered claims and/or damages, yet it took no steps to prevent such outcome. Indeed, these decisions sometimes speak in very harsh tones -- essentially blaming the insurer for being its own worst enemy.

The knotty issue of allocation between covered and uncovered claims was a subject of discussion, and in some detail, in World Harvest Church v. Grange Mutual Casualty Co., No. 13AP-290 (Ohio. Ct. App. Dec. 24, 2013). The issue arose as follows.

Michael and Lacey Faieta and their minor son, A.F., filed a complaint alleging that an employee of the prepatory school operated by World Harvest Church physically abused A.F. while the two and one-half-year-old boy was in the employee’s care in WHC’s daycare program. The Faietas raised claims of battery and intentional infliction of emotional distress against the employee and claims of negligent supervision and IIED against WHC. A after a seven-day trial, the jury returned general verdicts in favor of the Faietas against both the employee and WHC. The jury awarded the Faietas compensatory damages of $134,865 and punitive damages of $100,000 against the employee, and compensatory damages of $764,235 and punitive damages of $5,000,000 against WHC. The jury also found that the Faietas were entitled to attorney fees against WHC.

While Grange Mutual had defended WHC in the Faieta action, it refused to indemnify WHC for any portion of the judgment. WHC filed an action against Grange seeking a declaration that it was entitled to payment from Grange of all or some of the amount it paid to resolve the Faietas’ case.

Putting aside lots of issues, the trial court in the declaratory judgment action entered a judgment in favor of WHC and against Grange in the amount of $1.4 million. This included a compensatory award of $549,100. In addition to substantive coverage issues, the appeals court was required to address allocation between the potentially covered and uncovered causes of action that made up this compensatory award.

The trial court had found that “for the three causes of action on which the jury entered a general verdict in favor of the Faietas—battery, IIED, and negligent supervision—Grange ‘bears the burden of proof to demonstrate that coverage does not apply to each of the causes of action and will need to establish exclusions for the other portions of the award, if any,’ and that because ‘it is not possible to allocate the proportions of the general compensatory verdicts,’ ‘if [WHC] establishes coverage for any of the three causes of action, then [Grange] must indemnify [WHC] for the entire compensatory amount of the award.’”

The Ohio Court of Appeals addressed the burden of proof, but its decision was more nuanced and detailed.

Not surprisingly, the parties had diametrically opposing views on how to address the issue. Grange argued “that WHC should have the burden of proof as to the allocation of the verdict between [the employee’s] battery, WHC’s negligent supervision, and the IIED by [the employee] ‘and/or’ WHC, and that ‘[s]ince the verdict cannot be allocated, WHC’s action against Grange [for compensatory damages, attorney fees, and interest] must fail.’ WHC counters that Grange has the burden of allocating a general verdict to prove that some or all of the award represents damages for non-covered claims. WHC asserts that ‘[s]ince it is not possible to allocate the general compensatory verdicts, if WHC can establish coverage under any one of these three causes of action—battery, IIED, or negligent supervision—then Grange must indemnify WHC for the entire compensatory portion of the verdict.’” (emphasis in original).

The court determined that it would “apply what appears to be the general rule that an insured has the burden to prove entitlement to coverage, including the burden of allocating a prior general award into covered and noncovered claims, but that where an insurer has a duty to defend the insured and fails to seek an allocated verdict or advise the insured of the need for one, the burden shifts to the insurer.” (emphasis added).

Despite this general rule, Grange asserted that “the burden of proving allocation of the verdict did not shift from WHC to Grange because it sent a reservation of rights letter to WHC, WHC engaged its own private counsel in addition to the counsel that Grange provided to it in the personal-injury trial, Grange advised WHC of its divergence of interests, and WHC’s private counsel controlled the litigation.”

But this, the court concluded, was not sufficient to prevent the burden from shifting to the insurer. The court concluded that Grange provided WHC with only the most general and vague statements concerning their divergent interests. “Grange never advised WHC of the specific apportionment issue and of the need for special interrogatories allocating damages.”

The court concluded: “Under these circumstances, the presence of WHC’s independent counsel and Grange’s notification to WHC of its reservation of rights did not constitute a discharge of Grange’s duty to fully disclose the precise situation concerning the necessity of seeking an allocated verdict in the personal-injury case. If Grange truly believed that intervening in the case to submit special interrogatories would have compromised WHC and its employee’s ability to advance their agreed upon joint defense, Grange or its provided counsel could have still discharged any duty by precisely advising WHC of the need for an allocation of the damages and the consequences of not obtaining one. . . . Neither Grange’s reservation of rights nor the presence and participation of WHC’s independently retained counsel during the Faietas’ personal-injury case discharged Grange's duty.”

This is clearly a complex issue and one that must be addressed on a case by case basis. But there is an important overarching take-away. No matter how well-done you think your reservation of rights letter is, it is not going to enforce itself.