The Seventh Circuit Court of Appeals recently issued “a warning for insurance companies who refuse to defend their insureds.” In National American Insurance Company v. Artisan and Truckers Casualty Company, No. 14-2694, 2015 WL 4645245 (7th Cir. Aug. 6, 2015), the Seventh Circuit reiterated and emphasized Illinois law holding that an insurer who refuses to defend its insured will be estopped from later asserting policy defenses to coverage, unless the insurer files a declaratory judgment action.

The court explained that, where a complaint against an insured “alleges claims that may fall within the scope of policy coverage,” an insurer who refuses coverage has three available courses of action: “(1) defend the lawsuit under a reservation of rights . . . ; (2) seek a declaratory judgment excluding coverage; or (3) do nothing and refuse to defend.”

The Seventh Circuit’s warning to insurers concerns the third course of action. That is, if an insurer refuses to defend its insured and does not file a declaratory judgment suit, the insurer “will be estopped from later raising policy defenses to coverage.” Thus, if there is any doubt about whether the insurer owes its insured a duty to defend, and the insurer simply refuses to defend, the insurer runs a very real risk of being estopped from later raising policy-based defenses to coverage.

However, as the Seventh Circuit went on to explain, “an insurance company can eliminate the risk of estoppel altogether,” by either defending its insured under a reservation of rights or by seeking a declaratory judgment. Accordingly, while the risk of estoppel is real, defending under a reservation of rights or seeking declaratory judgment provides a safe harbor to insurers seeking to avoid that risk.