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Vol. 4, Iss. 3
March 18, 2015

Breach Of The Duty To Defend And Forfeiture Of Coverage Defenses:
Not What You Are Thinking

 

There has been so much talk over the past couple of years about whether an insurer that breaches the duty to defend forfeits otherwise applicable coverage defenses. The talk has grown out of the New York Court of Appeals’s decisions in K2 and the ALI’s adoption of the forfeiture rule in its Principles of the Law of Liability Insurance and now first draft of the Restatement of the Law of Liability Insurance.

Insurers recognize that consequences should attached for having breached the duty to defend – but they see forfeiture of otherwise applicable coverage defenses as going too far. As insurers view it, there are less severe remedies that could be applied for a breach of the duty to defend.

While forfeiture of otherwise applicable coverage defenses is a harsh penalty for a breach of the duty to defend, there is a state where not following its duty to defend rules could be seen as even more severe. This place is New Jersey.

Under New Jersey law, an insurer that wishes to take the common course of action of appointing panel counsel to defend its insured, while at the same time sending its insured a reservation of rights letter, setting out reasons why, notwithstanding providing a defense, the insurer may not have an obligation to pay some or all of any damages awarded, must advise the insured of its right to object to being defended in such a matter. New Jersey courts have imposed a simple sanction on insurers that fail to obtain their insured’s consent to being defended under a reservation of rights – loss of the insurer’s ability to assert an otherwise applicable defense to coverage.

To put it another way, in New Jersey, an insurer can acknowledge that a defense is owed to its insured, retain counsel, spend unimaginable sums in the defense and then be found to have breached the duty to defend, and be subjected to loss of otherwise applicable coverage defenses, because it did not obtain its insured’s consent to being defended under a reservation of rights.

In a way, this is an even harsher rule than one where an insurer that breaches the duty to defend forfeits otherwise applicable coverage defenses. In that scenario, the insurer did not defend its insurer. It took no action and the insured was left to defend itself. But under the New Jersey scenario, the insurer did no such thing. To the contrary, it acknowledged that a defense was owed to its insured, retained counsel and may have even spent boatloads of cash providing such defense. But none of that will matter if the insurer did not obtain its insured’s consent to being defended under a reservation of rights. Gone will be any otherwise applicable coverage defenses. Poof.

I sometimes meet people involved in claims for a long time, even in New Jersey, who are unaware of this rule – despite the fact that it’s been in place since 1962 – or who doubt its existence. It’s surprising. This was also surprising to one New Jersey jurist. In concluding that an insurer was estopped from denying coverage, because its reservation of rights letter did not comport with this “consent” rule, the trial judge in Selective v. Allstate Ins. Co. (described in the Appellate Division’s decision at 2005 WL 3839975) stated: “Borrowing from my own experience, every once in a while you see something and you scratch your head and you wonder why a carrier that’s in the business of doing this type of thing would not know how to do it appropriately. It’s not particularly difficult, but those things happen I guess.”

New Jersey’s rule, that to defend an insured under a reservation of rights, the insurer must advise the insured of its right to object to being defended in such a matter, was on display last year in Petersen v. New Jersey Mfrs. Ins. Co. (N.J. Super. Ct. App. Div. May 2, 2014). Discussing this decision in Coverage Opinions has been on my to-do list for a while – as you can see.

In Peterson, the court held that, although New Jersey Manufacturers could have done a better job at it, the insurer did comply with the consent requirement when it assigned counsel and undertook its insureds defense under a reservation of rights. Peterson got into the often-seen side issue of whether the insured in fact consented to the reservation of rights defense. This issue can come about because, while insureds do not always formally consent to the defense offered, their consent to it can be inferred from their failure to reject it. But to have acquiescence by silence, the insureds must be fairly informed that the defense may be accepted or rejected. So lots of factual issues about whether there was consent can arise.

In any event, in case you are a non-believer of the New Jersey “consent” rule, the Peterson court should convert you. The court stated: “In order to properly reserve its rights, so as to control the defense while avoiding estoppel, an insurer must advise its insureds of the potential of disclaimer, fairly inform the insureds of their right to reject the insurer’s defense on those terms, and secure the insureds’ explicit or implicit consent.”

 

 

 
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