Between the work that I do for insurer-clients, and writing about this, that and the other coverage case, I have a few favorite issues.  How could you not?  At the top of the list is the effectiveness, or not, of reservation of rights letters.  I have followed these judicial decisions very closely for many years, not to mention having done a “50 Item ROR Checklist” seminar/webinar dozens of times for insurers.

The issue is so critically important because reservation of rights letters apply across the board.  In other words, they are relevant to duty to defend cases regardless of the type of liability policy at issue or facts of the claim.  Few issues play this large of a role in the coverage arena.  Not to mention that they are the backbone of an insurer’s ability to satisfy its obligation to defend, but not lose its right to later assert coverage defenses.      

As a long-time student and teacher of this issue, I was fascinated by the North Carolina federal court’s decision in Penn National Mutual Casualty Company v. Beach Mart, Inc., No. 14-08 (E.D.N.C. Sept. 30, 2022).  The court was critical of the manner in which the insurer’s reservation of rights was drafted.  But, importantly, it did not lead to a waiver of the insurer’s defenses.  I suspect that it would have in some states.

Sometimes that is where the issue ends.  The reservation of rights letter had its problems, there was room for improvement, but it did not lead to the insurer’s waiver of its coverage defenses.
 
However, here, that’s not where the issue ended.  The Beach Mart court left open the possibility that the reservation of rights letter, on account of its drafting deficiencies, violated North Carolina’s “Unfair Claim Settlement Practices” statute, which gives rise to a private cause of action under the state’s Unfair and Deceptive Trade Practices Act.  Many states have statutes that looks like North Carolina’s.

I am not familiar with any cases that have treated an insurer’s inadequately drafted reservation of rights letter as a possible violation of a state’s “Unfair Claim Settlement Practices” statute.  I have only seen the situation where the result is a possible waiver of coverage defenses.  Given the uniqueness of the decision, on such an important issue, I did not hesitate to include Beach Mart as a top 10 coverage case of 2022, despite being an unpublished district court decision.    

At issue in Penn National v. Beach Mart was coverage for a counterclaim filed against the insured, Beach Mart, for trademark infringement-related claims.  Penn National agreed to defend Beach Mart. 

[As an aside, there was a hubbub about who defense counsel would be and whether the counsel chosen by Penn National was qualified to handle an intellectual property claim.  This is not relevant to the ROR issue, but it’s an interesting issue, as the court concluded that counsel may not have been qualified for this type of case, and, therefore, it may be a breach of the duty to defend.]

For reasons not relevant here, the court concluded that at some point Penn National no longer had a duty to defend.  However, Beach Mart argued that the insurer did, in fact, have a duty to defend, on the basis that it waived its coverage defenses by sending a reservation of rights letter that did not “fairly inform” Beach Mart of the coverage issues that were being reserved.

In support, Beach Mart cited what I call the “big three” – Harleysville v. Heritage Communities (S.C. 2017); Advantage Buildings v. Mid-Continent (Mo. Ct. App. 2014); and Hoover v. Maxum (Ga. 2012) -- which are the cases most commonly cited by insureds to argue that coverage defenses are waived because the reservation of rights did not “fairly inform” the insured of the coverage issues being reserved.  [The big three have all been “Top 10” coverage cases of the year in my annual coverage hit parade; once in a while I get those right.]

The Beach Mart court declined to follow any of these three cases on the basis that they are not North Carolina law and the federal court was not going to do so as a matter of first impression.

So, while the court concluded that Penn National did not waive its coverage defenses, that was not the end of it.  The court went on to hold that the reservation of rights letter, based on the manner in which it was drafted, may have violated North Carolina’s “Unfair Claim Settlement Practices” statute, which gives rise to a private cause of action under the state’s Unfair and Deceptive Trade Practices Act.    

Specifically, Beach Mart argued that the insurer violated, among other sections, 58-63-15(11)(a) of the N.C. “Unfair Claim Settlement Practices” statute, on the basis that the reservation of rights letters “misrepresent[] pertinent facts or insurance policy provisions relating to coverages at issue.”

The court concluded that, “construed in the light most favorable to defendant [the insured], such a misrepresentation may be inferred from certain language in the reservation of rights letters.”

As for what that possible misrepresentation in the reservation of rights may be, the court explained it as follows:

“In particular, while these letters communicate clearly a reservation of rights sufficient to overcome defendant’s waiver argument, addressed previously, those that include excerpts from the policies omit reference to the breach of contract exclusion of the umbrella policy, and they include other exclusions that are unrelated to the L&L counterclaims.

“None of the letters include discussion of plaintiff’s position as the various provisions [sic], nor do they explain how the allegations in L&L’s counterclaims might create coverage issues.  Thus, it is reasonable to infer in this respect that they ‘[m]isrepresent[] pertinent facts or insurance policy provisions relating to coverages at issue.’”

Thus, the insurer’s motion for summary judgment on this issue was denied.

When courts conclude that a reservation of rights letter is ineffective, it is usually for the reasons cited by the Beach Mart court -- the letter is cut and pasted [the court described it that way in another part of the opinion], it cites provisions unrelated to the claim and does not “fairly inform” the insured how the allegations in the complaint might create coverage issues.  In other words, the letter may set out facts and policy provisions, but does not marry the two and specifically explain how the cited policy provisions, based on the facts at hand, may in fact serve to preclude coverage.    

Beach Mart is an interesting and unique decision as these cases generally involve efforts by insureds to argue that an ineffective reservation of rights leads to a waiver of coverage defenses.  While Penn National beat back the waiver argument – and it may not have, if the court had been willing to consider Heritage Communities, Advantage Buildings and/or Hoover – the decision gives insureds a second bite at the apple.