Maxwell v. Hartford Union High School District
The Wisconsin Court of Appeals has ruled that a Wisconsin insurer who undertakes its insured’s defense – at least when “exclusively control[ling]” the defense – without issuing a reservation of rights letter becomes estopped from claiming it has no duty to indemnify its insured for a resulting judgment. Maxwell v. Hartford Union High School District, 2010 WI App __, __ Wis. 2d __, __ N.W.2d __. The decision represents judicial recognition of an exception to the general rule that the doctrines of waiver or estoppel based upon the conduct or action of the insurer or its agent cannot create insurance coverage where none contractually exists.
In Maxwell, noting that a complaint might result in an award of different types of damages, some of which were covered by the relevant insurance policy, an insurer agreed to provide its insured with a defense, but advised it would only pay the attorneys fees for an attorney on the insurer’s approved list of counsel. An approved attorney was hired, and the insurer paid the fees without issuing a reservation of rights. After a ruling adverse to the insured on summary judgment, the insurer advised the insured that some of the damages at issue were not covered. The insured by separate counsel, claimed the lawyer selected by the insurer had a conflict of interest, and demanded a new defense lawyer. The insured ultimately filed a third-party complaint naming the insurer and seeking a declaration that coverage existed. The circuit court eventually ruled that no coverage existed for the damages at issue notwithstanding the conduct of the insurer, and the insured appealed.
On appeal, the Wisconsin Court of Appeals reversed, concluding that an insurer who proceeds to defend without issuing a reservation of rights letter cannot later disclaim a duty to indemnify. The Maxwell Court reasoned that the insurer’s failure to issue a reservation of rights letter caused the insured to reasonably rely on the existence of coverage for the allegations against it, and that the insured suffered presumed prejudice as a result when it suffered an adverse ruling in the litigation while the insurer exercised dominion and control over the defense. The court of appeals therefore concluded that the insurer became estopped from disclaiming a duty to indemnify. In response to the insurer’s assertion that the doctrines of waiver or estoppel cannot create coverage where none exists, the circuit court noted that an exception to this general rule exists when an insurer fails to notify the insured of a coverage issue until after the insured suffered prejudice.
There are at least two lessons that Maxwell teaches. First and most obviously, it teaches that an insurer who foresees the possibility it might someday want to contest its duty to indemnify an insured receiving a defense would be prudent to reserve its rights when providing the defense.
The issuing of a reservation of rights letter under such circumstances, however, risks certain disadvantages: (1) A series of decisions beginning with the landmark Grube decision suggests that an insurer’s decision to contest the existence of coverage means that it cannot enforce its right to select the defense lawyer. See, e.g., Grube v. Daun, 173 Wis. 2d 30, 496 N.W.2d 106 (Ct. App. 1992); Jacob v. West Bend Mutual Ins. Co., 203 Wis. 2d 524, 553 N.W.2d 800 (Ct. App. 1996); Radke v. Fireman’s Fund Ins. Co., 217 Wis. 2d 39, 577 N.W.2d 366 (Ct. App. 1998); but compare Secura Insurance v. Sizzler USA Franchise, Inc., Milwaukee County Circuit Court Case No. 00-CV-8314, slip op. at 7 (Decision June 7, 2001) (authored by Hon. David A. Hansher) (allowing that, despite a reservation of rights, an insurer may still select independent counsel to defend); HK Systems, Inc. v. Admiral Ins. Co., 2005 U.S. Dist. LEXIS 39939, at *13-14 (E.D. Wis. 2005) (noting a lack of clarity on these issues in Wisconsin jurisprudence); (2) An insurer defending under a reservation of rights may incur attorneys fees even though no duty to defend exists which it cannot later recover from the insured; and (3) To retain the benefits of defending, the insurer must continue to defend on appeal even after obtaining a favorable ruling on coverage issues from the trial court, see Newhouse v. Citizens Sec. Mut. Ins. Co., 176 Wis. 2d 824, 837-38, 501 N.W.2d 1, 6 (1993).
Second, Maxwell teaches that there remains an option by which an insurer can avoid the choice of either defending without reservation of rights and thereby likely becoming estopped from defending against the insured’s subsequent indemnification claim, or defending indefinitely under a reservation of rights and thereby relinquishing the right to select the lawyer who will defend the insured. An insurer may still seek a ruling regarding its coverage defenses in advance of an adjudication of the merits of claims against its insured by either intervening in the pending litigation to seek a declaratory judgment or starting new litigation to seek a declaratory judgment. See, e.g., Mowry v. Badger State Mut. Cas. Co., 129 Wis. 2d 496, 523, 385 N.W.2d 171, 183 (1986) (the separation mechanism – stay and bifurcation – avoids conflicts of interest); Fire Ins. Exchange v. Basten, 202 Wis. 2d 74, 89, 549 N.W.2d 690, 696 (1996) (recommending intervention, stay, and bifurcation as the preferred procedure while allowing a separate declaratory judgment action to constitute as a viable alternative). The Maxwell decision quotes a passage from Grube, 173 Wis. 2d 30, 75, 496 N.W.2d 106 which makes allowance for bifurcation or declaratory judgment to separately address coverage issues. Maxwell, 2010 WI App __, at ¶ 13. Under Wisconsin law and under Maxwell as before, in most cases where insurance coverage issues exist, an insurer is well-advised to make a timely motion for intervention, stay, and bifurcation while providing a defense under a reservation of rights.
This alert was written by Michael R. Vescio.