Wisconsin Supreme Court: Reservation of Rights Letter Not Required to Preserve Coverage Defenses

On May 30, 2012, the Wisconsin Supreme Court issued an important decision in the case of Maxwell v. Community Insurance Corp., 2012 WI 58 (May 30, 2012), that held an insurance company was not required to send its insured a Reservation of Rights letter to preserve defenses to coverage. The Court’s holding is based on the rationale that the absence of a Reservation of Rights letter cannot create insurance coverage or expand coverage to non-covered claims. In other words, under the insurance contract, the insurer is required to pay only claims it agreed to insure, whether or not it specifically reserved its right to deny coverage. Reservation of Rights letters, however, are still required to preserve an insurer’s affirmative position that the insured forfeited coverage by breaching the terms of the insurance contract, such as by failing to provide timely notice, by making a material misrepresentation, or failing to maintain other insurance. 

A Reservation of Rights letter is a notice insurance companies provide their insured that have claims made against them. These letters typically acknowledge that a claim has been made and tendered to the insurer, and that the insurance company will pay for a defense to the claim, but “reserve” the insurance company’s right to seek a coverage determination from the court, deny coverage for some or all claims made, and seek reimbursement of defense costs. Reservation of Rights letters also usually set forth the insurer’s defenses to coverage and notify the insured of any potential breaches of the insurance contract that may result in a forfeiture of coverage.

In Maxwell, a teacher sued the Hartford Union School District for breach of employment contract after the District eliminated her position. The District tendered the case to its insurer, Community Insurance Corporation, that hired defense counsel from Community Insurance’s approved counsel list. In the underlying case, however, the trial court found the District liable under the employment contract. Community Insurance’s claims administrator then notified the District that the policy specifically excluded coverage for employment contract claims. The District responded by filing a third party complaint seeking declaratory judgment against the insurer.  The circuit court, however, granted summary judgment to the insurer on the basis that the District “did not pay for coverage of [employment] claims.”

The court of appeals held that the insurer could not decline coverage after it “agrees to defend the insured without a Reservation of Rights, retain counsel, and actively defends the insured through a final judgment detrimental to the insured ….” Maxwell v. Community Insurance Corp., 2009 WI App 2176 (Aug. 25, 2010). The Court warned that an insurer must reserve by agreement its right to deny coverage before “assuming dominion and control” over a tendered claim when it has “knowledge of facts indicating non-coverage.” Id. The Wisconsin Supreme Court reversed. 

Although no longer a prerequisite to denying coverage, reservation of rights letters should still be sent to insured where the insurer assumes the duty to defend. To quote the Supreme Court, “Communication between the insurer and the insured, whether in the form of a Reservation of Rights letter or other form, demonstrates good faith, prevents surprises and hard feelings, and tends to avoid litigation between insurers and their insured.” Id. at ¶ 62. Further, the Court concluded, “the lesson [in Maxwell] is that [the insurer] could have avoided the cost of this appeal by issuing a reservation of rights letter.” Id. at ¶ 61.