Insurers sometimes face this situation.  They defend an insured in a suit.  Then a subsequent, similar claim is made against the insured.  This time, the decision is made that no defense is owed.  But, if the insurer disclaims, won’t the insured challenge the disclaimer on the basis that a defense was provided for the prior, similar claim.  In other words, so the argument will likely go, whatever the coverage defense is for the current claim, the insurer waived it by not asserting it for the prior claim.

This is what happened in Hemphill v. Landmark Am. Ins. Co., No. 20-2544 (3d Cir. April 5, 2023).  The court concluded that the insurer was not precluded from denying a defense for the current claim based on having defended a prior similar claim.  The court’s reasoning was interesting and clever.

At issue was the availability of a defense for Carl Hemphill under a professional liability policy that provided coverage for negligent acts, errors or omissions in the rendering or failure to render employment placement services.  Hemphill was sued by a former client, Jose Castillo, who alleged that, when he arrived in the U.S. to work, he was the victim of human trafficking at the hands of Hemphill.  The insurer, Landmark, denied a defense for various reasons, including that Hemphill’s actions were intentional.  Coverage litigation ensued and the federal district court found in favor of the insurer.  

Putting aside substantive coverage issues, Hemphill argue at the Third Circuit that Landmark could not deny a defense for the Castillo action because the insurer defended him in an earlier, similar class action – Urrutia suit.  As Hemphill saw it, on account of Landmark’s handling of the prior action, he had a reasonable expectation of coverage for the Castillo action.

On one hand, Pennsylvania law, generally speaking, can recognize that reasonable expectations can play a part in determining an insurer’s coverage obligations.  However, it has very narrow applicability, as noted by the court: “to protect non-commercial insureds from policy terms not readily apparent and from insurer deception.” 

But the court noted that this was not the basis for Hemphill’s reasonable expectations argument:

“Instead, he claims that the mere fact that Landmark defended the Urrutia Lawsuit created a reasonable expectation that it would defend the Castillo Lawsuit.”  However, the court explained that “[n]o authority supports finding a duty to defend when the insured’s expectation of coverage arises solely from the insurer’s conduct in another, unrelated transaction.  Indeed, Pennsylvania law instructs us to ‘examine the totality of the insurance transaction involved’—not the totality of all other transactions between the parties.”

But the court had another reason for refusing to use Hemphill’s reasonable expectations, based on the handling of the Urrutia suit, to conclude that coverage was not owed for the Castillo suit:

“Even if Hemphill could take advantage of the reasonable expectations doctrine, Landmark’s earlier conduct could not have given him a reasonable expectation of coverage in the Castillo Lawsuit. Landmark subjected its defense of the Urrutia Lawsuit to a complete reservation of rights. In its letter agreeing to defend the lawsuit, Landmark stated that nothing in the letter, ‘nor any further actions taken by Landmark, should be construed as a waiver of any rights or defenses . . . that may be available now or at any point in time.’  Hemphill could not reasonably expect that such a limited acceptance of coverage would extend to a separate, unrelated lawsuit.”

I thought this was an interesting and clever rationale for the court’s decision.  Just about every reservation of rights letter contains concluding non-waiver language similar to what was in Landmark’s letter for the Urrutia action.  But such language is likely intended to mean that the actions taken by the insurer, and rights asserted and not asserted, are not a waiver of rights for purposes of the current claim.  In other words, as the current claim goes forward, nothing in the reservation of rights letter precludes the insurer from talking some action, with respect to the claim, at a later point in time.

But here, the court applied the concluding non-waiver language more broadly – no action taken with respect to the prior, Urrutia action served as a waiver of any rights or defenses with respect to the later filed Castillo action.

This is the most substantive decision I’ve ever seen concerning concluding – and seemingly pro forma -- non-waiver language in a reservation of rights letter.