1. Reservation of Rights: General Principles and the Lessons of Lobenthal
Christopher M. Jacobs
Daniel J. Twilla

2. OVERVIEW 
Legal Principles
Case Study: Lobenthal v. Erie
Suggested Best Practices

3. PURPOSE
Counterbalance Between:
1) Broad obligation to defend; and
2) Right to simultaneously/subsequently challenge indemnity
Defense ≠ Waiver
Step Plan Serv., Inc. v. Koreko, 12 A.3d 401
(Pa. Super. Ct. 2010)

4. Charter Oak Ins. Co. v. Maglio Fresh Food, 2013 WL 5763209 (E. D. Pa
Charter Oak Ins. Co. v. Maglio Fresh Food, 2013 WL (E.D. Pa. Oct. 24, 2013).
Where the insurer assumes the duty to defend, the insurer can simultaneously challenge whether the claim is covered under the insurance policy, even if the underlying claim settles.
If the insured accepts the insurer’s defense, subject to a reservation of rights, the insurer retains full control of the litigation. Moreover, an insurer defending subject to a reservation of rights retains the ability to choose its own counsel.

5. A liability insurer will not be estopped to set up the defense that the insured’s loss was not covered by the insurance policy, notwithstanding the insurer’s participation in the defense of an action against the insured, if the insurer gives timely notice to the insured that it has not waived the benefit of its defense under the policy.

6. The declaratory judgment action
[The insurer] has proceeded as we expect a responsible insurer to proceed when it has legitimate coverage questions; it has assumed the defense of [the insureds] in the State Court action and filed a declaratory judgment action in this Court. Victoria Ins. Co. v. Ren, 2008 WL (E.D. Pa. June 9, 2008).

7. The “right” and duty to defend
Right to select/assign counsel
No “conflict of interest”
Tripartite relationship allows for vigorous defense of insured, notwithstanding coverage dispute
Insured’s rejection of defense = No further obligation

8. Can an insured settle a disputed claim on its own?
Courts may require an insurance company, which is found to owe coverage after defending under a reservation of rights, to reimburse an insured that settled the underlying litigation over the objections of the insurance company and in violation of a standard consent to settle clause.

9. In Babcock and Wilcox, the Pennsylvania Supreme Court held that insurers are responsible to reimburse insureds for settlements which are “fair and reasonable from the perspective of a reasonably prudent person in the same position of [the insureds] and in light of the totality of the circumstances,” considering the terms of the settlement, the strength of the insured’s defense against the asserted claims, and whether there is any evidence of fraud or collusion on the part of the insured.

10. Waiver and estoppel
Waiver
Relinquishment of a known right
No waiver by implication
Importance of “catchall” provision

11. Estoppel
Detrimental reliance
Actual prejudice
Because an insurer who defends an insured has the right to control the defense and substitutes its judgment for that of the insured, Pennsylvania courts may find that an insured is prejudiced where an insurer undertakes the defense without issuing a reservation of rights and later denies liability. See Brugnoli v. United Nat. Ins. Co., 426 A.2d 164 (Pa. Super ).
No coverage by estoppel

12. Lobenthal v. Erie
Boyd asserted a claim against Lobenthal for injuries that Boyd sustained in a motor vehicle accident.
Boyd was a passenger in a car driven by Miller.
Boyd alleged that Lobenthal permitted Miller to possess and consume marijuana and Xanax at a party at Lobenthal’s parents’ house.

13. Lobenthal notified Erie of the claim.
Erie issued a homeowner’s insurance policy to Lobenthal’s parents.
Erie issued a reservation of rights letter addressed to Lobenthal’s parents.

14. The reservation of rights letter
was addressed only to Lobenthal’s parents
reserved Erie’s right to disclaim coverage and liability for any judgment “that may be rendered against yourself”
did not mention Lobenthal as a defendant in the underlying tort action
did not reference the controlled substances exclusion in the policy

15. Lobenthal filed preliminary objections to the complaint on the basis that she could not be liable for merely furnishing controlled substances to Miller or for “partying” with her.
The trial court overruled the preliminary objections.
Lobenthal’s liability turned “solely on whether she furnished controlled substances to Miller” and whether the furnishing of a controlled substance was a “proximate cause” of Boyd’s injuries.
After the trial court overruled the preliminary objections, Erie issued another reservation of rights letter.

16. The second reservation of rights letter
was addressed only to Lobenthal’s parents
reserved Erie’s right to disclaim coverage and liability for any judgment “that may be rendered against yourself”
did not mention Lobenthal as a defendant in the underlying tort action, even though she had obtained majority status six months prior
referenced the controlled substances exclusion in the policy

17. The trial court granted declaratory judgment in favor of Erie.
The Pennsylvania Superior Court reversed.
The Superior Court held that to be effective, a reservation of rights “must be communicated to the insured. It must fairly inform the insured of the insurer’s position and it must be timely.”

18. The Superior Court found that the reservation of rights were defective as to Lobenthal because
Lobenthal was an adult who was entitled to receive a reservation of rights, but was never sent copies.
Notice of the reservation of rights could not be imputed to Lobenthal based on the fact that they were sent to counsel, because the reservation of rights were addressed to Lobenthal’s parents and made no reference to Lobenthal.

19. The Superior Court found that the February 7, 2012 reservation of rights was untimely.
The complaint was filed on June 27, 2011.
The allegations in the complaint that Lobenthal permitted and encouraged the use of controlled substances at the party, and supplied Miller with controlled substances, were sufficient to place Erie on notice that the allegations would fall under the controlled substances policy exclusion.

20. The Superior Court stated that “[w]hen an insurance company or its representative is notified of a lawsuit occurring under an indemnity policy, it becomes its duty immediately to investigate all the facts in connection with the supposed loss as well as any possible defense on the policy. It cannot play fast and loose, taking a chance in the hope of winning, and, if the results are adverse, take advantage of a defect in the policy. The insured loses substantial rights when he surrenders, as he must, to the insurance carrier in the conduct of the case.”

21. The Superior Court presumed prejudice because, had Lobenthal been informed of Erie’s intention to deny coverage when the suit was filed, she could have engaged separate counsel and managed her own defense.

22. SUGGESTED BEST PRACTICES
Timing
A Pennsylvania court has described a timely letter as one that is issued before events prompt reliance on the part of the insured on an unspoken promise to indemnify. See, e.g., Nationwide Mut. Ins. Co. v. Nixon, 682 A.2d 1310 (Pa. Super. 1996).
Insurers may also consider state unfair claim settlement practice regulations regarding communications with an insured when issuing timely reservation of rights.

23. The purpose of the letter.
Substance
An insurer may consider identifying and describing the following in a reservation of rights letter in enough detail for the insured to understand the insurer’s position regarding coverage:
The purpose of the letter.
The policy or policies at issue or potentially at issue.

24. The pleadings and facts relevant to the coverage determination.
Quoted policy language relevant to the coverage determination.
The coverage defenses and policy defenses which apply or which the insurer anticipates may apply.
The potential for uninsured losses or an excess verdict.

25. The insurer’s express reservation of its rights to deny coverage for any ultimate judgment and to file a declaratory judgment action, demand arbitration or withdraw the defense altogether.
The insured’s continuing obligation to provide information relevant to the claim for coverage and a request for the insured’s continuing cooperation.

26. The right of the insured to retain its own counsel at its own expense.
The insurer’s express reservation of all rights, including those not specifically identified in the letter.

27. Recipients
The insured who submits the claim for defense/indemnity.
Any additional insureds who may be affected by the reservation of rights.
Personal counsel for the insureds, if known.
Defense counsel.
Potentially, the insurance broker.

28. There is no obligation to send the reservation of rights letter to third parties who have asserted claims against the insureds, although the reservation of rights letter may be subject to discovery.

29. Practical Tips
When possible opt for specific over generic reservation of rights letters—provisions that are not potentially implicated should not be in the ROR letter. The most effective ROR letter generally explains how policy provisions/exclusions match or fail to match with an underlying complaint or facts provided.

30. Reservation of rights letters should open communication—a good ROR will seek information to potentially resolve coverage issues. Openness on both sides encourages the exchange of information and allows a policyholder to explain areas of disagreement and set forth any new information that might affect the coverage position.
Reserve the right to reserve more rights—as investigation goes forward, it may be necessary to revisit or supplement the initial ROR letter.