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Jul 17, 2013

Insurance Reservation of Rights Letters in Kansas

A reservation of rights letter informs the insured of the carrier's potential defenses to coverage under the policy. The following is a brief overview of some of the requirements for ROR letters in Kansas. As always, please contact a licensed and qualified attorney for recommendations specific to your circumstances.

Applicable Statutes and Regulations

There are no specific statutes or regulations that govern reservation of rights letters in Kansas.

Timing of the Reservation of Rights Letter

Kansas law requires an insurer to provide a defense to an insured if there is a potential for liability under the policy.  State Farm Fire & Casualty Co. v. Finney, 244 Kan. 545, 553, 770 P.2d 460 (1989). As discussed more fully below, failure to defend can expose the insurer to potential liability for sums in excess of the policy limits under “bad faith” theories of recovery. Accordingly, where there are arguable bases to deny coverage, the best practice is for an insurer to defend subject to a reservation of rights to later deny coverage.

The insurer must issue a unilateral reservation of rights, or enter into a mutual “non-waiver agreement” with the insured, that is “clear” and “timely.” Bogle v. Conway, 199 Kan. 707, 714, 433 P.2d 407 (1967). The insurer may change its coverage position as it learns facts that place the claim outside of the policy’s coverage. Id.   

There has been no precise definition of what constitutes “timely” notice under Kansas law. Whether an ROR is timely depends on the facts of the case. Continental Ins. Co. v. Wilco Truck Rental, Inc., 1986 Kan. App. LEXIS 1491 (Kan. Ct. App. Nov. 6, 1986).

Three years is too long to wait to send an ROR. Bogle, supra. Six months after suit was filed and 4 months after the insurer assumed the defense of the insured was timely notice, however. Wilco Truck Rental, supra. Relevant to the inquiry on timeliness is whether the insured suffered any prejudice as a result of the late ROR. Id. The facts considered by the Wilco Truck Rental court were whether the insured had adequate time to meaningfully defend the case, attempt a settlement, and, if necessary, to prepare for trial. Id. 

Required Content of the Reservation of Rights Letter

The ROR letter must clearly disclaim liability under the policy (and set forth the specific facts and policy language that justify this position), and it must give notice that the insurer reserves the right to use these defenses to coverage in any action to collect on the policy. Bogle, supra.

“Vague” or “ambiguous” reservations will not be effective. Note that even a mutual non-waiver agreement that is signed by the insured (as opposed to a unilateral reservation of rights letter) will not be effective to prevent an estoppel or waiver argument if the agreement does not clearly express the factual and policy grounds for the potential denial of coverage. Bogle, 199 Kan. at 711-13, 433 P.2d at 411- 12.

In drafting a mutual non-waiver agreement or unilateral reservation of rights, the insurer should attempt, insofar as possible, to use “plain English” explanations geared toward an unsophisticated audience in explaining its position. Id. The agreement or ROR should set forth the specific policy language that applies, and explain how the known facts appear to place the claims outside of coverage. Id. The non-waiver or ROR must clearly explain that the insurer may ultimately deny coverage for the claim, which would leave the insured personally exposed to a judgment that is not covered by the policy. Id.

Independent Counsel for the Insured

Unlike in Missouri, a Kansas insured has no right to refuse a defense offered under a reservation of rights. However, where there is a conflict of interest between the insured and the insurer, the insurer should hire independent counsel to defend the insured.Patrons Mut. Ins. Assoc. v. Harmon, 732 P.2d 741 (Kan. 1987); U.S. v. Daniels, 163 F.Supp.2d 1288 (D. Kan. 2001). As a matter of practice, when the insurer believes that there are valid bases for denying coverage, it should obtain the insured’s agreement regarding the selection of defense counsel.

The Consequences of Failure to Issue a Proper ROR

As a general rule, defending without a proper reservation of rights results in estoppel that prevents the assertion of coverage defenses in a later action to collect on the policy. “[A] liability insurer by assuming and conducting the defense of an action brought against the assured where with knowledge of facts taking the accident, injury, etc., outside the coverage of the policy -- and without disclaiming liability and giving notice of its reservation of rights -- is thereafter precluded in an action upon the policy [i.e., garnishment] from setting up the defense of non-coverage.” Snedker v. Derby Oil Co., 164 Kan. 640, 644, 192 P.2d 135 (Kan. 1948). “The insurer’s conduct in this respect operates as an estoppel to later contest an action upon the policy, regardless of the fact that there has been no misrepresentation or concealment of material facts on its part, and notwithstanding the facts may have been within the knowledge of the insured equally as well as within the knowledge of the insurer.” Id.

Notwithstanding the above, the Kansas Court of Appeals has held that there is no bright-line rule that insurers who fail to provide a defense under reservation of rights are inevitably estopped from raising coverage defenses. Aselco, Inc. v. Hartford Ins. Group, 21 P.3d 1011 (Kan. Ct. App. 2001). This case recognizes the general, and correct, principle that the insurer’s failure to issue a proper reservation of rights letter or failure to defend should not create coverage where none exists under the unambiguous terms of the policy. As a best practice, however, insurers should always issue reservation of rights letters and should retain counsel acceptable to the insured whenever there is a potential basis to deny coverage.  

Insurers should also be aware that issuance of a proper reservation of rights preserves the identified defenses to coverage, including the “no liability” defense, even if the underlying tort action proceeds to judgment against the insured. Davin v. Athletic Club of Overland Park, 32 Kan. App. 2d 1240, 1242-1243, 96 P.3d 687, 690 (2004). That is, the insurer may argue that the insured was not liable to the underlying plaintiff in a subsequent garnishment or other coverage action, even in the face of a judgment against the insured in the tort action.

Potential Bad Faith Exposure

Under Kansas law, a bad faith claim is a contract claim. Moses v. Halstead, 477 F. Supp. 2d 1119, 1126 (D. Kan. 2007). There is an implied duty of good faith in the insurance contract, which requires the insurer to act with “reasonable care” toward the interests of the insured. Glenn v. Fleming, 247 Kan. 296, 309, 799 P.2d 79, 88 (1990).

The duty to act in good faith and without negligence applies to a liability insurer’s coverage decision if the insurer uses lack of coverage as the reason for rejecting a reasonable settlement offer within policy limits.  Associated Wholesale Grocers, Inc. v. Americold Corp., 261 Kan. 806, 846, 934 P.2d 65, 90 (1997); Halstead, 477 F. Supp. 2d at 1126. The Kansas Supreme Court in Americold stated that “[a]lthough we have previously said that something more than mere error of judgment is necessary to constitute bad faith, ... negligence or a lack of good faith in the coverage investigation or the decision to deny coverage leading to a mistake in failing to settle breaches the insurer's duty.”  Id.

Kansas has adopted a five-factor test to determine whether a denial of coverage justifies the insurer’s rejection of a settlement offer within policy limits: (1) whether a reservation of rights letter was issued; (2) efforts or measures taken by the insurer to resolve the coverage dispute promptly or in such a way to limit any potential prejudice to the insured; (3) the substance of the coverage dispute or the weight of legal authority on the coverage issue; (4) the insurer’s diligence and thoroughness in investigating the facts specifically pertinent to coverage; and (5) efforts made by the insurer to settle the liability claim in the face of the coverage dispute. Americold, 261 Kan. at 846, 934 P.2d at 90.

Particularly in light of the second Americold factor, insurers should always consider filing a declaratory judgment action in order to obtain a prompt determination of the coverage dispute. Inevitably, settlement demands will be made in the case, and if the insurer rejects such demands on the basis of lack of coverage, potential bad faith liability comes into play.