I recently had an insured’s attorney tell me, with a straight face (I’m assuming it was straight — it was hard to tell on the phone) that the insurance company I represented on a coverage matter could not withdraw a defense to his client because, counsel claimed, the insurer had already agreed to provide a defense under a reservation of rights, and the insurer “can’t change its mind.”
In fairness, this claim can, under certain very limited circumstances, actually be true! But the set of circumstances under which it can be true is dwarfed by the set of circumstances under which it is likely not true. And so, without further delay, a quick refresher on how an insurer can properly and lawfully withdraw a defense after initially agreeing to provide one pursuant to a reservation of rights.
The majority of this post assumes that the defense which the insurer would like to withdraw is being provided pursuant to a reservation or rights. After all, why would an insurer reserve rights in the first place if it did not, on occasion, intend to lawfully exercise those rights? This post further assumes some development has occurred which justifies the insurer’s change in position. A common example of this is when covered counts in a complaint against an insured are dismissed from an action, leaving only claims which are not covered by the policy in question.
Reserving rights before a defense is withdrawn is the better practice by far. But there is some authority suggesting that a predicate reservation of the right to withdraw a defense is not strictly required in order to subsequently withdraw that defense if the circumstances justify it, and the insurer is not contractually obligated to defend or indemnify. See, e.g., Windt, Allan. 1 Insurance Claims and Disputes § 4:29 (6th ed.). The theory behind this proposition is that the insuring agreement either requires defense and indemnity or it does not. Did I mention, however, that reserving rights is the better practice by far? I did? Good.
Some insurers will ask from time to time whether a declaratory judgment action should be filed in a given case in order to properly withdraw a defense. Generally, and in Pennsylvania, for example, a declaratory judgment action is not a prerequisite to withdrawing a defense. See, Selective Way Ins. Co. v. Hosp. Grp. Servs., Inc., 2015 Pa. Super. 146, 119 A.3d 1035, 1052 (2015). While doing so may be advisable in certain cases, it is not a black letter requirement. (I recently addressed the subject of when and why to file declaratory judgment actions here).
So how is withdrawal done in a way to avoid or minimize both the hassle, and the cost and expense of not doing so properly? Here are a few important basics.
The Golden Rule
Everybody knows, or should know, this one. It is the Alpha and the Omega of deciding whether, when, and how to withdraw a defense which had been provided under a reservation of rights. A few observations are, however, in order.
Prejudice must most often be actual and demonstrable — there must be some harm occasioned to the insured which would make withdrawing improper. And in the vast majority of cases, claims of prejudice are tied to when in a civil proceeding the defense is withdrawn. A simple guideline: the later in a case a defense is withdrawn, the bigger the risk of prejudice to the insured, and the more dangerous a withdrawal can be for the insurer.
The underlying case may reach a point of such progress, however, that prejudice will be presumed, and an insurer will be estopped from withdrawing a defense. The clearest example of this is an insurer’s attempt to withdraw a defense after it has defended the insured to verdict. This, to use a legal term, is a “big no-no,” and my eloquent legal advice on this subject is, “don’t do that.” See, e.g., Treadways LLC v. Travelers Indem. Co., 467 Fed. Appx, 143, 148 (3d Cir. 2012).
There are several miscellaneous points to make as part of the prejudice discussion. First, the naked claim that an insured is prejudiced by a withdrawal of a defense because it must now pay for its own defense is not sufficient justification to prevent an insurer from withdrawing. This is no more a justification to obligate an insurer to defend than is the reverse claim by the insurer to relieve itself of the duty to defend. Legal fees are not sufficient justification in and of themselves to carry the day, for the insured or the insurer.
A second lesser, but still important, point is that insurers can reduce their exposure to prejudice claims after deciding to withdraw a defense by assisting the insured with a soft landing and transition. An insurer can offer to make insurance defense counsel available, at the insurer’s expense, to the insured’s personal counsel for a window of 30 to 45 days, for example, to assist personal counsel with the assumption of the insured’s defense. It can also and should also ensure that the insured’s litigation file, electronic and/or hard copy is properly transferred to new counsel. Nothing, I advise insurers, evaporates prejudice claims better than actively working to prevent even the appearance of prejudice after the decision to withdraw.
There can never be any guarantees that insurers won’t face claims of “you can’t change your mind” by disgruntled insureds, or their lawyers, once the decision to withdraw a defense has been taken. However, as one Court has observed, “There is no principle of Pennsylvania law that the duty to defend automatically attaches at the outset of the litigation and cannot afterwards terminate.” Com. Union Ins. Co. v. Pittsburgh Corning Corp., 789 F.2d 214, 217–18 (3d Cir. 1986).
Withdrawing a defense following a reservation of rights can be done without adverse consequence or penalty. It just has to be done properly.