Making the Most of a Reservation: Rights in Massachusetts When Insurer Reserves

by Richard J. Yurko

Legal Analysis

As lawyers, we often say that we are “reserving” our client’s rights and, in doing so, we hope to preserve some often unstated client rights, presumably neither expanding nor reducing those rights.  However, when an insurance company “reserves” its rights to disclaim coverage while undertaking the defense of its insured, this step actually creates rights for the insured under Massachusetts law.  Counsel for an insured needs, however, to be ready to assert those rights or they will evaporate like the summer’s dew.

To understand the setting and how new rights may arise from an insurer’s reservation, one need only appreciate several principles of insurance law and how they commonly apply to business and professional clients.

Basic Framework

First, the insurer’s duty to defend the insured is generally broader than its duty to indemnify (i.e., to pay any resultant judgment).  Doe v. Liberty Mut. Ins. Co., 423 Mass. 366, 368 (1996); Boston Symphony Orchestra v. Commercial Union Ins. Co., 406 Mass. 7, 10 (1989).  For instance, if a four-count complaint arising from common facts is filed against the insured and only one of the four counts is covered by the insurance policy, the insurance company typically has the duty to defend the entire complaint, including the non-insured claims.  See, e.g., Aetna Cas. & Sur. Co. v. Cont’l Cas. Co., 413 Mass. 730, 732 n.1 (1992); Northern Sec. Ins. Co., Inc. v. R.H. Realty Trust, 78 Mass. App. Ct. 691, 691 (2011) (only one of five counts covered).

Second, in general, if the insurer is aware that some claims are covered and other claims may not be covered, the insurer must apprise the insured of the possibility that some specific claims may not be covered — or the insurer could later be deemed to have waived its right to disclaim coverage on those claims.  E.g., Salonen v. Paanenen, 320 Mass. 568, 571 (1947).

As a result, in practice, within a reasonable time after receiving notice of a claim from its insured, in most cases, most insurers will accept the defense of the insured while also either disclaiming coverage on some claims or reserving the insurer’s right to do so.  Such reservation of rights letters permit the insurer to undertake the required defense of the insured while also cautioning the insured that (a) the insured rather than the insurance company may actually have to pay any judgment on some claims, (b) the defense may be short-lived if the covered claim(s) should be dismissed, and/or (c) the policy limits may well be insufficient to pay the entire judgment even for covered claims.

Although reservation of rights letters from an insurer have become commonplace, they put the insured in an odd position.  Typically by contract, unless otherwise agreed, the insurer has the right to appoint counsel to represent the insured when a claim arises.  Insurers typically have panel counsel to whom they refer large numbers of cases and, as a result, they receive reduced billing rates.  Where the duty to defend and the duty to indemnify are co-extensive and the claim is within the policy limits, the insured has little economic incentive to complain of panel counsel selected by the insurer.  But where the duty to indemnify is more narrow than the duty to defend, the reservation of rights letter effectively tells the insured that the insurer may walk away at any time, leaving the insured with counsel whom the insured might not otherwise have selected — and leaving the insured to pay that insurer-appointed counsel’s fees out of the client’s own pocket.  And, if the appointed counsel commits malpractice, the insured may not be able to look to the insurer to pay damages.  Herbert A. Sullivan, Inc. v. Utica Mut. Ins. Co., 439 Mass. 387, 407-10 (2003).

For these reasons, among others, Massachusetts cases provide that when the insurer issues a reservation of rights letter, the insured can force the insurer either to give up the reservation of rights or to allow the insured to designate counsel:

When an insurer seeks to defend its insured under a reservation of rights, and the insured is unwilling that the insurer do so, the insured may require the insurer either to relinquish its reservation of rights or relinquish its defense of the insured and reimburse the insured for its defense costs.

Sullivan, 439 Mass. at 406-07 (collecting cases).  See also Three Sons, Inc. v. The Phoenix Ins. Co., 357 Mass. 271, 276 (1970); Magoun v. Liberty Mut. Ins. Co., 346 Mass. 677, 684 (1964); Salonen v. Paanenen, 320 Mass. at 574.  The insurer will then have to pay the reasonable fees of the counsel selected by the insured.  The billing rates of the insured-selected counsel may often be substantially higher — but nevertheless reasonable — than the charges of an insurer’s panel counsel.  E.g., Northern Security, 78 Mass. App. Ct. at 697 (panel counsel generally paid $150 per hour; in absence of agreement, $350 was reasonable for reservation of rights counsel).  In the alternative, the insurer could agree to pay for both its panel counsel and for the insured’s selected counsel who may ride alongside the case as co-counsel.  E.g., San Diego Navy Federal Credit Union v. Cumis Ins. Soc., Inc., 162 Cal. App. 3d 358 (1984), thereafter codified at Cal. Civ. Code § 2860 (2013).

Asserting the Right

As a practical matter, it may not be as simple as the cases imply for the insured to assert the rights that Massachusetts case law provide.  The insured has just been sued.  The people involved are feeling attacked and vulnerable.  The insured sends the complaint to the insurer, with a sigh of relief (“that’s what we have insurance for”), and then sometime later, often around when an answer or motion to dismiss may be due, the insured gets a letter saying that the insurer is willing to defend only after reserving its right to disappear in the future.  Cold comfort.  In many such situations, the insured’s initial inclination is not to challenge the insurer on anything, including on the reservation of rights.

But if the insured does not challenge the appointment of counsel and seek to have its own counsel appointed, or alternatively seek to have the reservation of rights withdrawn, those rights can be lost, as the insured will be deemed to have acquiesced in the choices made by the insurer.  E.g., Sullivan, 439 Mass. at 407 (“There is no indication in the record that [the insured] either insisted on having the reservation of rights removed or, in the alternative, insisted on assuming control of its own defense.  As such, we conclude that [the insured] acquiesced…”).  The insured should think of itself as present at a shotgun wedding between its defense and insurer-appointed counsel:  You must speak now or forever hold your peace.

Simply calling the insurer and requesting in that phone call the ability to appoint counsel is not enough, legally or practically.  As a legal matter, making a single phone call is not “insisting.”  E.g., Sullivan, 439 Mass. at 407.  Also, as a practical matter, most insurers are not based in Massachusetts and most of their personnel may not be familiar with the case law here, which differs from that in other states in this area.  See, e.g., Cumis, 162 Cal. App. 3d at 375 (“insurer must pay reasonable costs for hiring independent counsel by the insured” where insurer has issued a reservation of rights); Cal. Civ. Code § 2860; Swanson v. State Farm Gen. Ins. Co., 219 Cal. App. 4th 1153 (2013) (withdrawal of reservation of rights eliminates insurer’s duty to pay for independent co-counsel).  The insured should send a letter, citing the case law and insisting that the insurance company must choose between the reservation of rights and the appointment of counsel.

Negotiating the Resolution

Following the assertion of the insured’s rights arising from the insurer’s reservation of rights, the insured and the insurer each hold some cards, but none invariably trump the others.  As a result, in the best cases, a three-way process of negotiation among insured, insurer, and counsel often ensues.

Assume, for the moment, that the insurer is unwilling to relinquish its reservation of rights.  Under the case law, it must then accede to the insured’s selection of counsel.  As noted, very often, the insured’s selected counsel will be charging hourly rates that, while reasonable for the market, are substantially higher than insurer’s panel counsel.  E.g., Northern Security, 78 Mass. App. Ct. at 697.  This is a situation the insurer wants to avoid or minimize.

At the same time, there is nothing in the case law that says the insurer has to pay insured’s selected counsel on a monthly, quarterly, or any other particular periodic basis.  Absent a separate declaratory judgment action, the insurer may only have the obligation to pay fees at the end of the representation, e.g., Magoun, 346 Mass. at 685; Three Sons, 357 Mass. at 276-77; but see Northern Security, 78 Mass. App. Ct. at 698 (delaying payment of fees for 14 months gives rise, with other factors, to c. 93A liability), leaving it to the insured to advance legal fees on an ongoing basis until then or leaving the insured’s selected counsel to remain largely unpaid until then.  The insured wants to avoid the former and its selected counsel certainly wants to avoid the latter.  So, the assertion of these rights figuratively leaves the parties playing poker with each other, each trying to avoid a particular permissible, but less than optimal, outcome.

In this situation, the parties can negotiate various resolutions that avoid the least desirable outcomes, such as the following:

1. The insurer can decide to withdraw its reservation of rights and preserve its selection of counsel.  This generally will happen in a case where the insurer re-assesses its reservation of rights and determines that the rights being reserved are more theoretical than real.
2. The insurer and insured can agree that the day-to-day work in the defense of the insured will be undertaken by insurer’s panel counsel, but that the insurer will also pay for co-counsel appointed by the insured who acts either like a spare tire or a security blanket, depending on the nature of the case and the parties.  This is the common solution in some states, like California, where the case law leans this way.  See, e.g., Cumis, 162 Cal. App. 3d at 375.  To date, it is not a solution much seen in Massachusetts, but it could be the preferred solution where the parties believe, for instance, that a dismissal of the sole insured claim is possible or likely.
3. The insurer and insured can negotiate a three-way agreement with insured-selected counsel on the rate at which that specially-appointed counsel will be paid and the periodic payment of such counsel.  Typically, the insured-selected counsel will charge more than insurer’s panel counsel because the specially-appointed counsel does not have the expectation of volume that panel counsel have, cf. Northern Security, 78 Mass. App. Ct. at 697, but such counsel is willing nonetheless to discount its rates somewhat to benefit the insured (so that the insured does not have to advance payment) and to engender a good working relationship with the insurer.  This is perhaps the most common resolution in Massachusetts.

In addition to these options, there are as many possible variations and permutations as there are insurers, insureds, and potential counsel.  Whatever gets agreed upon, however, usually needs to be hashed out and documented in the compressed time between issuance of the reservation of rights letter and the first major event in the defense of the case.  A court will then have no trouble enforcing that agreement, ordinarily.  Cf. Northern Security, 78 Mass. App. Ct. at 697-98 (agreement on fees trumps reasonable rate).  The situation will not reach the optimal result by itself, but adroit lawyering can help substantially.  Counsel for the insured should be ready to assert the insured’s rights and also to broker a quick resolution of these rights.