Shifting Sands: Uncertainty Emerges for Businesses Expecting Insurance Companies to Defend Their Coverage
In the wake of recent pro-insurance company rulings in Wisconsin courts, businesses and their owners will need to proceed with extra caution when asking their insurance company to defend lawsuits that may arise from their business dealings. While many suits are typically covered under a policy, all too often an insurance company disputes coverage, which leads to the business having to expend time and resources out of pocket to fight with its insurer. Historically, Wisconsin courts have placed strong incentives on insurance companies to proceed with caution in disputing coverage. However, recent decisions have curtailed those incentives.
When an insurance company debates coverage for a claim, Wisconsin courts strongly encourage them to initially defend their policyholders in the lawsuit, while seeking a prompt judicial ruling on whether a defense is, indeed, owed. This is known as defending under a “reservation of rights.” A reservation of rights letter protects the policyholder by providing for a defense until a court can rule on the coverage question, while also putting the policy holder on notice that its insurance company intends to dispute that there is coverage. An insurance company following this path insulates itself against a later claim that it has breached its duty to defend its policyholder. If an insurance company outright denies coverage without a reservation of rights, and its decision later turns out to be wrong, it runs the risk of severe consequences, such as being required to defend and indemnify the entire suit (as opposed to just covered claims), paying other damages flowing from the breach, and potentially facing a bad faith claim from the policyholder.
While still pro-policyholder, Wisconsin courts recently have given more leeway to insurance companies in deciding whether, when and how to dispute coverage. In 2012, the Wisconsin Supreme Court addressed the question of whether an insurance company, who initially decided to defend a suit without a reservation of rights, had waived its right to dispute coverage much later in the case. Maxwell v. Harford Union High Sch. Dist., 2012 WI 58. In a departure from its previous pro-policyholder stance (as well as courts in several other states), the court sided with the insurance company. The court held that, even though the company failed to follow the recommended procedure of defending under a reservation of rights, there could be no waiver of its right to dispute coverage when it was clear that coverage did not exist under the contractual language of the policy, because contractual coverage cannot be created by waiver.
The recent May 7, 2015, court of appeals decision in Marks v. Bedford Underwriters, Ltd. continues this trend. David Marks sued his professional liability insurance company, alleging that his insurance company had wrongfully breached its duty to defend him in lawsuits across the county dealing with Marks’ role in various business transactions. While the policy’s initial grant of coverage would have provided for a defense of the claims, it also contained an exclusion that, the court found, clearly operated to exclude coverage. The insurance company denied coverage without defending under a reservation of rights.
Marks argued that, because his insurance company unilaterally denied coverage and failed to defend under a reservation of rights, it could not rely on the policy’s exclusions in defending that decision. Marks’ argument was supported by a number of previous Wisconsin decisions stating that, in contrast to a case where an insurance company defended under a reservation of rights, an insurance company that unilaterally determined that there is no coverage under a policy cannot later rely on exclusions in the policy in defending its choice.
While the Marks court acknowledged the holdings of the earlier cases, it nevertheless sided with the insurance company, concluding that the cases cited by Marks appeared to contradict other cases that did consider exclusions under similar circumstances. The Marks court also observed that treating cases where the insurance company unilaterally denied a defense differently from cases where the company reserved rights was “counterintuitive and confusing,” and concluded that, at least on the facts before it, there was no logical reason to apply different tests in each situation.
Both the Maxwell court and the Marks court took pains to assert that, despite their opinions, the incentive remains strong for insurers to follow a cautious approach in contesting coverage, because an insurer that fails to do so still risks severe consequences. Nevertheless, in the wake of those decisions, Wisconsin insureds now have fewer tools to use to ensure that their insurers follow those best practices. Prior to Marks, insurers that failed to follow the recommended procedure of reserving rights ran the risk of losing the benefit of policy exclusions. Given the fact that many policies rely on exclusions in defining the contours of coverage, this was a compelling incentive to insurance companies to defend under a reservation of rights and, in turn, a powerful tool to their policy holders to enforce their coverage rights. While it remains to be seen whether and how the Wisconsin Supreme Court may weigh in on this issue, for now, the Marks decision casts significant doubt on whether policyholders will be able to continue to take advantage of that tool.
In the larger picture, just as worrisome to businesses is the prospect that this trend will continue in the future, with courts continuing to scale back on the incentives to insurers to defend under a reservation of rights. Whereas before, businesses could be comfortable in knowing the standards that would be applied to an insurer’s conduct, the courts’ recent willingness to side with insurance companies casts doubt on those standards in the future, and puts businesses in a more uncertain position.
In light of these developments, it is more important now than ever before that a business faced with a lawsuit that may be covered by one of its insurance policies ensure that it is being as pro-active as possible in securing its rights to coverage. Business-owners should know the scope and details of their coverage, and generally be aware of the types of lawsuits that should be covered. When faced with a lawsuit, a business should communicate clearly in writing to the insurer its position that the suit should be covered under the policy, and to make this communication as soon as possible. Provide a time frame for a response, and follow-up in writing if the insurer fails to respond in a timely fashion. Because insurance coverage matters can become complex, businesses faced with a lawsuit should consult with their attorneys as to coverage matters, as well as to the substance of the case.