Failure to issue reservation of rights letter results in waiver of all coverage defenses

In Cincinnati Insurance Co. v. All Plumbing, Inc., Civil Action No. 12-851 (D.D.C. Oct. 18, 2013)(Kollar-Kotelly, J.), the Court held that Cincinnati Insurance's failure to properly reserve its rights and five-month delay in disclaiming coverage while controlling important actions in the insureds' defense precluded Cincinnati from asserting any defenses to coverage in the underlying junk fax class action.   This decision teaches the importance of issuing a separate reservation of rights letter for each action filed, even where successive lawsuits are closely related or almost identical.

The underlying litigation involve two putative class actions against All Plumbing and its owner, each alleging that they sent unsolicited faxes in violation of the Telephone Consumer Protection Act ("TCPA").  The first of these class actions was filed on November 5, 2010, with the class representative named "Love the Beer, Inc."  According to Cincinnati, the insureds never notified it of the class action.  Finally, more than a year later, on November 15, 2011, plaintiffs' counsel contacted Cincinnati and requested Cincinnati to defend the action.

In response, on November 18, 2011, Cincinnati notified plaintiffs' counsel that coverage for the Love the Beer action may be barred under the policy, asserting that the insureds failed to comply with the notice requirements under the policy.  In addition, on December 2, 2011, Cincinnati informed the insureds that it was assuming the defense of the Love the Beer action pursuant to a full and complete reservation of rights.

Meanwhile, also on December 2, 2011, another business, FDS Restaurant, filed a second putative class action against All Plumbing and its owner in D.C. Superior Court based on the same allegation of unsolicited faxes as at issue in the Love the Beer action.  This second action was filed by the same plaintiffs' counsel as the Love the Beer action, and apparently was filed to circumvent Cincinnati's late notice defense to the Love the Beer action. If so, this procedural fencing paid off in a big way for plaintiffs' counsel.

Plaintiffs' counsel sent Cincinnati a copy of the FDS complaint a few weeks after it was filed, and Cincinnati assigned defense counsel to the action.

On December 22, 2011, an amended complaint was filed in the Love the Beer action to eliminate the class action allegations, and the Love the Beer action was never certified as a class action.  About six months later, the Love the Beer action was voluntarily dismissed as part of a settlement.

Meanwhile, with regard to the FDS action, Cincinnati sent a letter dated February 16, 2012 to plaintiffs' counsel in the FDS action that coverage may be barred under the Policy due to the terms, provisions, conditions and exclusions of the Policy, including the insured's failure to comply with the conditions requiring the prompt reporting of offenses, claims and suits.  However, Cincinnati never sent a separate letter or oral communication to the insureds, All Plumbing and its owner, stating that the defense of the FDS action was being provided by Cincinnati pursuant to a reservation of rights. This turned out to be a fatal error.

The assigned defense counsel proceeded to defend the FDS action, answering the complaint, opposing the class certification, removing the action to federal court, and opposing the remand of the action to Superior Court.

Meanwhile, Cincinnati filed a declaratory judgment action on May 21, 2012, against the insureds and FDS, seeking a declaration that it has no duty to defend the insureds in the FDS Superior Court action.  Cincinnati obtained a default order against all the defendants in the declaratory judgment action, but subsequently, the Court on April 22, 2013 vacated the entry of default as against FDS Restaurant only.  Following that, the declaratory judgment action was litigated between Cincinnati and FDS Restaurant.  (The effect, if any, of the default against the insureds on the coverage issues was not mentioned in the decision.  Presumably, FDS's victory on the waiver issue redounds to the benefit of the insureds.)

In the declaratory judgment action, Cincinnati and FDS filed cross motions for summary judgment.  Among other things, FDS argued that Cincinnati waived its ability to disclaim coverage because it assumed the defense of the insureds without properly reserving its rights.  Cincinnati argued in response that it had reserved its rights properly when it sent a full reservation of rights letter to the insureds on December 2, 2011 in connection with the Love the Beer action.  Cincinnati maintained that FDS Restaurant was part of the putative class plaintiffs identified in the Love the Beer action, and that the FDS action involved the identical claims that were raised in the Love the Beer action.  Alternatively, Cincinnati argued that the filing of the declaratory judgment action itself informed the insureds of the coverage issues.

The Court rejected Cincinnati's arguments, and awarded summary judgment to FDS.  It is well settled in the District of Columbia that an insurer undertaking the defense of an insured against a litigious assertion of an unprotected liability, without a disclaimer of contractual responsibility and a suitable reservation of rights, is foreclosed from thereafter taking refuge in the policy provisions exempting the liability from coverage.  Further, when an insurer assumes control of the insured's defense without a proper reservation of rights, prejudice is presumed as a matter of law by virtue of the insurer's assumption of the defense.

The Court found that Cincinnati's reservation of rights letter dated December 2, 2011 in the Love the Beer action cannot serve as a reservation of rights letter in the FDS action because the letter, on its face, exclusively addressed coverage concerns relating to Cincinnati's defense of the Love the Beer action.  The Court noted, "Despite the many similarities in the Love the Beer and FDS actions, they remain two distinct lawsuits."  The Court also observed that the Love the Beer action was never certified as a class action, and consequently FDS was never even a party to the Love the Beer action.  Thus, the December 2, 2011 letter did not provide a reservation of rights with regard to the FDS action.

Cincinnati did send a letter to counsel for FDS on February 16, 2012, notifying FDS that coverage may be barred by the insureds' failure to comply with the reporting requirements of the policy.  However, the Court found that that letter cannot be considered to be a proper reservation of rights in the FDS action because it was sent to FDS's counsel, and not to the insureds.  The Court observed, "An insurer's obligation to provide notification of its reservation of rights under an insurance policy is to the insured, not to the party seeking a judgment from the insured." 

Finally, the Court rejected the argument that the declaratory judgment action itself was an adequate notification to the insureds of Cincinnati's coverage defenses.  The Court pointed out that Cincinnati took important actions in defense of the FDS action in the approximately five month period between assuming the defense and disclaiming liability.  The Court found that the five month delay was not justified in this case by any need to conduct an investigation, because Cincinnati had already investigated the facts in the Love the Beer action.

Accordingly, the Court found that Cincinnati had failed to rebut the presumption of prejudice and was found to have "waived all defenses to coverage by assuming the defense of All Plumbing and Shafik without a reservation of rights." 

Cincinnati's motion for reconsideration and clarification is still pending before the Court.

In conclusion, this case turned on a technicality.  The lesson it teaches is that where there are closely-related, almost duplicative lawsuits, the better practice is to issue a separate reservation of rights letter as to each lawsuit, rather than assume that the initial reservation of rights letter encompasses the related lawsuit.  As illustrated by this case, the marginal costs of preparing another reservation of rights letter is trivial compared to the litigation expenses and indemnity exposure resulting from a waiver issue.  A reservation of rights letter should be issued for each separate lawsuit, no matter how closely related.