The challenge to drafting an effective reservation of rights letter is that there is no set standard against which to measure your work. The insurance industry has not adopted a master reservation of rights letter. And no court or legislative body had decreed the requirements that will make a reservation of rights letter unassailable. So, without any benchmark, all the drafter can do is use his or her experience, and available judicial guidance, in an effort to hit all the necessary points of the letter. Or, to put it another way -- and, as a practical matter, a better way – avoid missing any necessary points.

Given this lack of judicial guidance, cases that address the requirements of a reservation of rights letter should be given careful attention. Nationwide Affinity Insurance Co. v. Laderout, No. 17-6012 (W.D. Mo. Dec. 7, 2017) is one. The court addressed the potential applicability of a business pursuits exclusion under a homeowner’s policy. The insurer undertook the insured’s defense under a reservation of rights. The insured, perhaps concerned that the business pursuits exclusion was going to doom any chance for coverage, also argued that Nationwide waived any coverage defenses because the letter sent by Nationwide, purporting to be a reservation of rights letter, did “not qualify as a reservation of rights letter under Missouri law because it did not clearly and unambiguously explain how the allegations in the initial Petition created coverage issues.”

But the court did not see it that way. It first set out ten things that a typical reservation of rights letter does most, if not all of: “(1) identifies the policy at issue; (2) quotes, or at least refers to, the relevant policy provisions and identifies any terms, conditions, or exclusions which may bar coverage; (3) refers to specific, relevant allegations in the complaint; (4) identifies which claims may not be covered; (5) explains in detail the basis for the insurer’s coverage position; (6) sets forth the proposed arrangement for providing a defense and, depending on the law of the jurisdiction, advises the insured of its right to independent defense counsel; (7) advises the insured of any actual or potential conflicts of interest between the insurer and the insured; (8) reserves the right to withdraw from the defense; (9) contains a general reservation of rights, including the right to assert other defenses the insurer may subsequently learn to exist during further investigation; and (10) uses the words ‘reservation of rights.’” (emphasis added) (citing New Appleman and Couch).

The Laderout court concluded that Nationwide’s letter did all of these things, noting that, in particular, it “clearly and unambiguously explains how the allegations in the underlying suit create coverage issues. It identifies the relevant Policy provisions, recounts the allegations in the underlying suit implicating these provisions, links these provisions to the allegations with sufficient detail, and then states a clear conclusion. It states: ‘[T]he policy excludes from coverage any damages which arise out of or in connection with a ‘business’ . . . [I]t appears that all of the damages either arise out of or in connection with Sprint Lumber, which is owned by Mr. Laderoute. Accordingly, this exclusion bars coverage for such damages.’ This was sufficient to make a valid reservation of rights of the ‘business pursuits’ exclusion.” (emphasis added).

The court’s conclusion that the insurer “linked” the policy provisions, to the allegations in the complaint, with sufficient detail, is the most important part of its discussion. This is where courts have been coming down hard on insurers, finding that their reservation of rights letters are ineffective, because this “linkage” was missing. Drafting a reservation of rights letter takes more than simply addressing the facts [in detail, hopefully] and citing policy provisions [and not numerous irrelevant ones, hopefully]. The important step is to then tie these two aspects together. If a policy provision is being cited in the reservation of rights letter, because it may preclude coverage, it should be accompanied by the allegations in the complaint that support this potential coverage defense. In other words, a reservation of rights letter must fairly inform the insured why coverage for some or all damages may not be owed.

I have addressed this issue umpteen times in past issues of Coverage Opinions, including, just last month, in my annual Top 10 coverage cases of the year article, in conjunction with a discussion of the South Carolina Supreme Court’s decision in Harleysville Group Insurance v. Heritage Communities, 803 S.E.2d 288 (S.C. 2017). This was the loudest, longest and clearest decision that I have seen holding that a reservation of rights letter – despite being many pages and citing loads of policy language -- can be ineffective because it failed to fairly inform the insured of the reasons why the insurer may not be obligated to provide coverage.

While Nationwide Affinity Insurance Co. v. Laderout is not loud or long, it is certainly clear that, in addition to other requirements, a reservation of rights letter must fairly inform the insured why, despite that it is being provided with a defense, the insurer may not have any obligation to provide coverage for some or all damages that are awarded. Citing the facts and policy language is not enough. They must then be “linked,” as the Laderout court noted. It seems clear that, without sufficient linkage between the allegations and policy language, the Laderout court would have found the reservation of rights letter to be ineffective.