It has long been the rule in New Jersey that, if an insurer retains counsel, and defends its insured under a reservation of rights, the insured must consent to such an arrangement.  This rule dates back to the New Jersey Supreme Court’s landmark 1962 decision in Merchants Insurance Co. v. Eggleston.   

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.  Despite its significance, and the fact that the rule has been around for so long, it is not usual to see ROR letters, in New Jersey cases, that identify the name of counsel that the insurer has retained, period.  In other words, they do not request the insured’s consent to be defended by him or her, in light of the reservation of rights being asserted.

This is what happened in RLI Ins. Co. v. AST Engineering Corp., No. 19-1649 (S.D.N.Y. Dec. 20, 2019).  And the consequence for the insurer was as predictable as a stale airport bagel.

At issue was coverage for AST Engineering Corp., under a professional liability policy issued to it by RLI Insurance, for its alleged negligence in the design of a concrete form for a construction project.  Things didn’t go right and suit was brought by the owner of an adjacent building for damages caused to its building.  AST gave notice of the suit to RLI and asked to be represented by a certain lawyer.  Despite this request, RLI retained its own counsel to represent AST.

Almost three years later, RLI sent a reservation of rights letter to AST.  RLI then filed an action seeking a declaration that it had no duty to defend or indemnify AST.  Here’s where things didn’t go well for RLI.

First, the court in the Southern District of New York held that New Jersey law controlled the coverage issues.  The hows and whys of the choice of law decision are not important for purposes here.

Then the court turned to the reservation of rights issues. 

In general, RLI’s defenses were that the alleged “wrongful acts” took place prior to the Retroactive Date or AST had knowledge of the claims prior to its application for coverage. 

First, as you may expect, the court was troubled by the fact that RLI waited three years before issuing a reservation of rights, despite being aware of the grounds for doing so: “Since at least October 2013, RLI knew or should have known that the alleged ‘Wrongful Act’ occurred prior to the Policy’s March 22, 2013 retroactive date.  RLI received a copy of JVC’s third-party complaint in the Coral Crystal Action on October 28, 2013. That complaint asserts multiple claims against AST arising from an AST design for concrete placement dated October 28, 2012. . . . Notwithstanding its awareness of grounds for questioning coverage, RLI failed to issue any reservation of rights until September 21, 2016, which was almost three years later. That reservation of rights raised only one of the two bases for denying coverage that are asserted here -- whether the ‘Wrongful Act’ occurred prior to the retroactive date.  RLI’s nearly three-year delay in reserving its right to disclaim coverage is unreasonable and presumptively prejudicial.”

A three year delay, in issuing a reservation of rights, may be troubling to courts addressing more than just New Jersey law.  While it may not result in an estoppel to assert coverage issues, based on a lack of prejudice to the insured, insurers should not be surprised if they have to fight this fight.  

On the New Jersey-specific issue, the court addressed the fact that RLI’s reservation of rights did not give AST the right to reject counsel retained by the insurer.  Indeed, AST asked for certain counsel and RLI rejected the request.  Here, not surprisingly, the court addressed the New Jersey Supreme Court’s decision in Merchants Insurance Co. v. Eggleston and cases that have followed it:

“Under New Jersey law, it is well established that ‘[c]ontrol of [an insured’s] defense is vitally connected with the obligation to pay the judgment.’  Merchants, 37 N.J. at 127. ‘[J]ust as a carrier would hardly agree to pay a judgment after defense by the insured, so it cannot expect the insured to pay for a judgment when it controlled the litigation.’ Nazario v. Lobster House, 2009 N.J. Super. Unpub. LEXIS 1069, 2009 WL 1181620, at *4 (N.J. App. Div. May 5, 2009) (citation omitted). Accordingly, ‘[i]f an insurer wishes to control the defense and simultaneously reserve a right to dispute liability, it can do so only with the consent of the insured.’ 2009 N.J. Super. Unpub. LEXIS 1069, [WL] at *5 (citation omitted). An insurer may obtain the insured’s consent only if it timely ‘reserve[s] the issue of its liability by appropriate measures.’  Merchants, 37 N.J. at 126. . . . In the absence of a nonwaiver agreement, ‘[a]greements may be inferred from an insured’s failure to reject an offer to defend upon those terms, but to spell out acquiescence by silence, the letter must fairly inform the insured that the offer may be accepted or rejected.’”  
  
The lessons from the case are clear.