Reservation of Rights Letter Can Be Key to Coverage Litigation

A case in which a court found that commercial general liability policies did not provide coverage for economic losses stemming from a breach of contract also had some interesting things to say about reservation of rights letters.  

The plaintiff in litigation stemming from a construction project alleged that the insured defendants refused to pay for its design services in accordance with their contract and made certain misrepresentations during the design process to induce the plaintiff to continue to perform. The plaintiff asserted claims for damages on theories of breach of contract, breach of an implied covenant of good faith and fair dealing, and unfair and deceptive trade practices, as well as for damages in quantum meruit. The insurance companies that had issued CGL policies to the defendants reserved their rights to deny coverage, but retained a law firm to provide a legal defense to the defendants. 

The coverage dispute went to court, and a federal district judge in North Carolina found that the defendants were not entitled to coverage. 

The Decision 

The court explained that the policies provided coverage only for physical damage to, or loss of use of, tangible property. The underlying pleadings, the court found, did not allege destruction of tangible property or loss of use of tangible property, but instead sought damages for economic losses stemming from a breach of contract. Adding that the underlying pleadings also alleged that the economic losses were the intended result of the defendants’ intentional conduct and thus not the result of an “accident,” the court concluded that the policies did “not provide coverage.” 

The Rivkin Rule 

The decision in this case, Firemen’s Ins. Co. of Washington, D.C. v. Glen-Tree Investments, LLC, No. 7:11-CV-59-D (E.D.N.C. Sept. 19, 2012), also is notable for what the court had to say about insurance company “reservation of rights” letters. 

The defendants argued that the doctrine of laches barred the insurers from bringing their declaratory judgment action, but the court rejected that argument. As the court explained, adequate notice of an insurer’s reservation of rights generally precludes an insured from alleging prejudice from the insurer’s subsequent denial of coverage. The insureds in this case therefore could not “plausibly allege they were prejudiced by the denial of coverage,” the court ruled. 

The case is a good reminder that a carefully-thought-out and well-written reservation of rights letter can be an important element in an insurance coverage case.