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Vol. 10 - Issue 3

April 28, 2021


Federal Court Declines To Certify Important ALI "Restatement Of Liability Insurance" Issue To State Supreme Court


The Arizona federal court’s decision in Tapestry v. Liberty Ins. Underwriters, No. 19-1490 (D. Ariz. March 29, 2021) is worthy of discussion for two reasons.  First, the court addressed the sufficiency of a reservation of rights letter.  That’s always an important issue. Second, the court was presented with the opportunity to certify, to the state supreme court, whether the ALI’s Restatement of Liability Insurance should control the issue.  The court declined to do so.  If it had, it would have set the stage for a significant, and no doubt high-profile, debate over the issue -- and a decision that could have had wide ramifications.

In very simple terms, at issue in Tapestry was whether an insurer waived a coverage defense – a “contract exclusion” -- by not including it in a reservation of rights letter.  The insurer’s argument was that it did not, since it’s reservation of rights letter (or perhaps a disclaimer; it’s hard to tell) included a general reservation of rights.  The insured, of course, argued that this general reservation of rights was not adequate.   

Specifically, after expressly asserting coverage defenses for no “claim” made during the policy period, the construction defect exclusion and potential misrepresentation in the application, the letter stated that Liberty “expressly reserves all rights and defenses under the policy.”

The parties argued whether this general statement, of a reservation of rights, was sufficient to meet the requirement to “fairly inform” the insured of the insurer’s position -- that the “contract exclusion” could also preclude coverage.  

The court pointed to Arizona case law that could go both ways and concluded that summary judgment was not proper:

“[I]n Mutual Insurance Co. of Arizona v. Bodnar, 164 Ariz. 407, 793 P.2d 560 (Ct. App. 1990), the Arizona Court of Appeals noted that if an insurer believes that a ‘valid exclusion’ would relieve it of a duty to provide coverage, the insurer must ‘communicate its reservation of rights to the insured to inform the insured of its position as to coverage.’ Id. at 412. Based on this language, a reasonable juror may conclude that, by its omission, Liberty waived its ability to argue that the contract liability exclusion was valid. On the other hand, in Equity General Insurance Co., 148 Ariz. at 517, the Arizona Court of Appeals found that a broad reservation of right ‘in a straightforward manner, informed a reader of average intelligence that while the insurer was providing a defense, it was doing so without waiving any rights to contest liability under the policy.’ Id. at 518. This would appear to support Liberty’s position that a reasonable juror could conclude that it clearly and properly notified of Tapestry of its ability to invoke the contract liability exclusion (as well as any other Policy provision).”

The court also declined to certify the following question to the Arizona Supreme Court: “Does an insurer’s failure, when undertaking defense of an action, to specifically reserve its right to deny coverage based on an exclusion that it has actual or constructive knowledge of result in loss of such ground for denial, without need for the insured to show prejudice, as provided in § 15 of the RESTATEMENT OF LIABILITY INSURANCE (2019) (the ‘RESTATEMENT’)? In other words, should Arizona adopt § 15 of the RESTATEMENT?”

Curiously, the court did not set about § 15 of the ALI Liability Restatement.  Section 15 provides as follows:

§ 15. Reserving the Right to Contest Coverage

(1) An insurer may reserve the right to contest coverage for an action before undertaking the defense of the action if it gives timely notice to the insured of any ground for contesting coverage of which it knows or should know.

(2) If an insurer already defending a legal action learns of information, which it did not have constructive notice of under subsection (1), that provides a ground for contesting coverage for that action, the insurer must give notice of that ground to the insured within a reasonable time to reserve the right to contest coverage for the action on that ground.

(3) Notice to the insured of a ground for contesting coverage must include a written explanation of the ground, including the specific insurance policy terms and facts upon which the potential ground for contesting coverage is based, in language that is understandable by a reasonable person in the position of the insured.

(4) When an insurer reasonably cannot complete its investigation before undertaking the defense of a legal action, the insurer may temporarily reserve its right to contest coverage for the action by providing to the insured an initial, general notice of reservation of rights, in language that is understandable by a reasonable person in the position of the insured, but to preserve that reservation of rights the insurer must pursue that investigation with reasonable diligence and must provide the detailed notice stated in subsection (3) within a reasonable time.

It would have been interesting to see how Arizona’s top court addressed this.  I have previously written about § 15 being one of the places in the Restatement that could cause insurers significant problems, specifically § 15(3)’s express statement of the “fairly inform” standard when it comes to drafting an effective reservation of rights letter.

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