Recently, the insurance industry was reminded of the limitations of a reservation of rights letter by the Nevada Supreme Court’s opinion in State Farm Mut. Auto Ins. Co. v. Hansen, 131 Nev. Adv. Op. 74, (9/24/2015) which held that a policyholder is entitled to have its insurer provide independent counsel when the insurer and insured have opposing legal interest; i.e., when coverage is being provided under a reservation of rights letter. When the insurer issues a reservation of rights letter, Nevada law now requires the insurance company to defend the policyholder by allowing the policyholder to select its own counsel, at the insurer’s expense. This was held to be an expansion of the well-known Cumis counsel rule – that an insured has a right to independent counsel at the insurer’s expense when a conflict of interest appears – which originated in San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc., 162 Cal. App. 3d 358 (1984).
However, there is long-standing authority in North Carolina for a similar rule of law. The North Carolina courts have made it clear that an insurer which refuses to defend an action against its insured, when coverage is in dispute, does so at its own risk. To reduce that risk, insurance companies often defend under a reservation of rights, which is generally required to prevent the insurer from being estopped to deny coverage under the policy once the defense is conducted with knowledge of facts taking the loss outside of the coverage of the policy.
As the North Carolina Court of Appeals stated in National Mortgage Corporation v. American Title Insurance Company, 41 N.C. App. 613, 255 S.E. 2d 622 (1979), such a “conditional tender of defense does not absolve [the insurer] of its contractual duty to defend an action for a loss within the coverage of the policy…[The insured] is not required to accept a defense rendered under a ‘reservation of rights.’” Id. at 624. Although this opinion was later overruled on other grounds by the North Carolina Supreme Court (finding that the policy did not cover the insured), the Supreme Court opinion made no mention of attorney’s fees or independent counsel.
In the National Mortgage case, the Court held that the Plaintiff was entitled to reject the conditional offer by the insurance company and to seek indemnity for the costs of defending that action. As such, this case has been cited by litigants for the proposition that where the insurance company offers to defend under a reservation of rights, the insured is entitled to hire its own counsel and to have that counsel paid for by the insurance company.
As a result of National Mortgage Corp., insurers in North Carolina must be careful if reserving rights. If they defend under a reservation of rights in North Carolina, they may be faced with an argument that (1) a conflict of interest has arisene, (2) that the insurer’s panel counsel cannot be used, and (3) that they will have to indemnify the policyholder for its choice of counsel.